UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
------- Exchange Act of 1934 for the quarterly period ended March 31, 2004
or
------- Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from
________ to _________.
Commission File No. 0-21527
MEMBERWORKS INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 06-1276882
------------------------ ----------------
(State of Incorporation) (IRS Employer
Identification No.)
680 Washington Boulevard
Stamford, Connecticut 06901
--------------------------------------- ----------------
(Address of principal executive offices) (Zip Code)
(203) 324-7635
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
[X] Yes [ ] No
The aggregate market value of the voting stock held by non-affiliates of the
Registrant at April 29, 2004 was $250,575,939. The aggregate market value was
computed by reference to the closing price of the Registrant's Common Stock as
of that date. For purposes of calculating this amount only, all directors,
executive officers and shareholders reporting beneficial ownership of more than
10% of the Registrant's Common Stock are considered to be affiliates.
Indicate the number of shares outstanding of each of the registrant's class of
common stock as of the latest practicable date: 10,529,199 shares of Common
Stock, $0.01 par value as of April 29, 2004.
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, 2004
and June 30, 2003 2
Condensed Consolidated Statements of Operations for the three
and nine months ended March 31, 2004 and 2003 3
Condensed Consolidated Statements of Cash Flows for the nine
months ended March 31, 2004 and 2003 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
Forward Looking Statements 26
Item 3. Quantitative and Qualitative Disclosures about Market Risk 27
Item 4 Controls and Procedures 28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 29
Item 2 Changes in Securities and Use of Proceeds and Issuer
Purchases of Equity Securities 30
Item 6. Exhibits and Reports on Form 8-K 30
Signatures 31
1
MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
March 31, June 30,
2004 2003
---------------- -------------
Assets (Unaudited)
Current assets:
Cash and cash equivalents $ 118,957 $ 72,260
Restricted cash 2,682 2,732
Accounts receivable (net of allowance for doubtful accounts of $1,744 and
$1,743, at March 31, 2004 and June 30, 2003, respectively) 11,853 8,713
Prepaid membership materials 2,709 2,196
Prepaid expenses and other current assets 8,681 7,571
Membership solicitation and other deferred costs 58,804 77,883
---------------- -------------
Total current assets 203,686 171,355
Fixed assets, net 22,920 24,969
Goodwill (Note 4) 42,039 42,039
Intangible assets, net (Note 4) 6,019 6,656
Other assets 6,352 3,486
---------------- -------------
Total assets $ 281,016 $ 248,505
================ =============
Liabilities and Shareholders' Deficit
Current liabilities:
Current maturities of long-term obligations $ 329 $ 244
Accounts payable 25,677 32,644
Accrued liabilities 56,216 59,105
Deferred membership fees 147,685 167,643
Deferred income taxes 5,373 879
---------------- -------------
Total current liabilities 235,280 260,515
Deferred income taxes 6,778 5,145
Other long-term liabilities 3,842 3,128
Convertible debt (Note 8) 90,000 -
---------------- -------------
-------------
Total liabilities 335,900 268,788
---------------- -------------
Commitments and contingencies (Note 9) - -
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;
19,042 shares issued (17,847 shares at June 30, 2003) 190 178
Capital in excess of par value 152,804 122,425
Accumulated equity (deficit) 2,110 (17,829)
Accumulated other comprehensive loss (458) (469)
Treasury stock, 8,788 shares at cost (6,126 shares at June 30, 2003) (209,530) (124,588)
---------------- -------------
Total shareholders' deficit (54,884) (20,283)
---------------- -------------
Total liabilities and shareholders' deficit $ 281,016 $ 248,505
================ =============
The accompanying notes are an integral part of
these consolidated financial statements.
2
MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
Three months ended March 31, Nine months ended March 31,
--------------------------- ---------------------------
2004 2003 2004 2003
------------- ------------ ------------ ------------
Revenues $ 118,519 $ 118,647 $ 355,507 $ 337,696
Expenses:
Marketing 60,941 73,012 194,342 208,460
Operating 22,324 20,653 66,829 57,905
General and administrative 20,438 19,130 58,400 56,757
Amortization of intangible assets 258 336 847 1,075
------------- ------------ ------------ ------------
Operating income 14,558 5,516 35,089 13,499
Settlement of investment related litigation - - - 19,148
Loss on sale of subsidiary - - - (959)
Net loss on investment - - - (206)
Interest (expense) income, net (1,265) 149 (2,317) 553
Other income (expense), net 672 (112) 459 (176)
------------- ------------ ------------ ------------
Income before income taxes 13,965 5,553 33,231 31,859
Provision for income taxes 5,586 2,221 13,292 12,744
------------- ------------ ------------ ------------
Net income $ 8,379 $ 3,332 $ 19,939 $ 19,115
============= ============ ============ ============
Basic earnings per share $ 0.81 $ 0.27 $ 1.83 $ 1.49
============= ============ ============ ============
Diluted earnings per share $ 0.68 $ 0.25 $ 1.62 $ 1.43
============= ============ ============ ============
Weighted average common shares used in earnings per share calculations:
Basic 10,301 12,515 10,895 12,805
============= ============ ============ ============
Diluted 13,380 13,104 13,211 13,387
============= ============ ============ ============
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,
----------------------------
2004 2003
------------ -------------
Operating activities
Net income $ 19,939 $ 19,115
Adjustments to reconcile net income to net cash provided
by operating activities:
Change in deferred membership fees (20,074) (19,376)
Change in membership solicitation and other deferred costs 19,156 30,317
Depreciation and amortization 7,649 9,150
Deferred income taxes 6,127 11,728
Tax benefit from employee stock plans 6,497 641
Gain on settlement of investment related litigation - (19,148)
Loss on sale of subsidiary - 959
Net loss on investment - 206
Other 928 1,609
Change in assets and liabilities:
Restricted cash 50 4,348
Accounts receivable (3,140) (7,495)
Prepaid membership materials (963) (232)
Prepaid expenses and other current assets (629) (794)
Other assets (267) (349)
Accounts payable (6,967) (2,334)
Accrued liabilities (3,038) 4,788
------------ -------------
Net cash provided by operating activities 25,268 33,133
------------ -------------
Investing activities
Acquisition of fixed assets (4,876) (4,099)
Settlement of investment related litigation - 19,148
Purchase price adjustments from sale of subsidiary - (750)
Other investments - (500)
------------ -------------
Net cash (used in) provided by investing activities (4,876) 13,799
------------ -------------
Financing activities
Net proceeds from issuance of stock 23,632 3,177
Treasury stock purchases (84,942) (25,323)
Net proceeds from issuance of long-term obligations 87,948 -
Payments of long-term obligations (368) (1,001)
------------ -------------
Net cash provided by (used in) financing activities 26,270 (23,147)
------------ -------------
Effect of exchange rate changes on cash and cash equivalents 35 57
------------ -------------
Net increase in cash and cash equivalents 46,697 23,842
Cash and cash equivalents at beginning of period 72,260 45,502
------------ -------------
Cash and cash equivalents at end of period $ 118,957 $ 69,344
============ =============
The accompanying notes are an integral part of
these consolidated financial statements.
4
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information. Accordingly, such
statements do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
The preparation of these consolidated financial statements in conformity with
generally accepted accounting principles requires management of MemberWorks
Incorporated ("the Company" or "MemberWorks") to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates. Operating results for
the three and nine months ended March 31, 2004 are not necessarily indicative of
the results that may be expected for the fiscal year ending June 30, 2004. For
further information, refer to the financial statements and footnotes thereto
included in the Company's Annual Report on Form 10-K with respect to the fiscal
year ended June 30, 2003.
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and
include the accounts of the Company and its subsidiaries. All significant
intercompany accounts and transactions have been eliminated.
NOTE 2 - RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year
presentation.
NOTE 3 - STOCK-BASED COMPENSATION
In accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"), the Company applies the intrinsic value
method in accounting for employee stock options. Accordingly, the Company
generally does not recognize compensation expense with respect to stock-based
awards to employees. If compensation cost for the Company's stock-based
compensation plans had been determined based on the fair value (estimated using
the Black-Scholes option-pricing model) at the grant dates for awards under
those plans consistent with the method of Financial Accounting Standards Board
Statement ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), and SFAS No. 148, "Accounting for Stock-Based Compensation Transition and
Disclosure" ("SFAS 148"), the Company's pro forma net income and earnings per
share would have been as follows:
Three months ended Nine months ended
March 31, March 31,
-------------------------- -------------------------
2004 2003 2004 2003
-------------------------- ------------ ------------
Net income reported $ 8,379 $ 3,332 $ 19,939 $ 19,115
Add: Stock-based employee compensation expense determined under
the intrinsic value based method for all awards, net of
related tax effects - - - -
Deduct: Stock-based employee compensation expense determined
under the fair value based method for all awards, net of
related tax effects 1,145 1,456 3,672 4,527
----------- ---------- ---------- ----------
Pro forma net income $ 7,234 $ 1,876 $ 16,267 $ 14,588
=========== ========== ========== ==========
Earnings per share:
As reported:
Basic $ 0.81 $ 0.27 $ 1.83 $ 1.49
Diluted $ 0.68 $ 0.25 $ 1.62 $ 1.43
Pro forma:
Basic $ 0.70 $ 0.15 $ 1.49 $ 1.14
Diluted $ 0.60 $ 0.14 $ 1.34 $ 1.09
5
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 4 - GOODWILL AND OTHER INTANGIBLE ASSETS
The gross carrying value and accumulated amortization of goodwill and other
intangibles are as follows (in thousands):
As of March 31, 2004 As of June 30, 2003
------------------------------------ -----------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
------------------ ----------------- ----------------- ---------------
Amortized intangible assets:
Membership and Client Relationships $ 13,405 $ (7,511) $ 13,195 $ (6,730)
Other 950 (825) 950 (759)
------------------ ----------------- ----------------- ---------------
Total amortized intangible assets $ 14,355 $ (8,336) $ 14,145 $ (7,489)
------------------ ----------------- ----------------- ---------------
Intangible assets, net $ 6,019 $ 6,656
================== =================
Unamortized intangible assets:
Goodwill $ 42,039 $ 42,039
================= =================
Acquired intangibles, except member relationships, are recorded at cost and are
amortized on a straight-line basis over their estimated useful lives ranging
from 3 to 20 years. The value of member relationships is amortized using an
accelerated method based on estimated future cash flows. The future intangible
amortization expense for the next five years is estimated to be as follows (in
thousands):
Fiscal Year:
2004 1,090
2005 900
2006 755
2007 599
2008 485
As a result of increased integration of operations and management at three of
its five reporting units during fiscal 2003, the Company aggregated these three
reporting units into a single reporting unit for fiscal 2004 impairment testing
purposes, resulting in a total of three reporting units in the current year.
Goodwill was tested for impairment during the quarter ended September 30, 2003
as required by SFAS 142. The Company concluded that none of its goodwill was
impaired. Fair value was estimated using discounted cash flow methodologies. In
addition, the Company reassessed the estimated useful lives of its
definite-lived intangible assets and determined that the lives were appropriate.
The Company will test the goodwill of each of its reporting units annually or
more frequently if impairment indicators exist.
NOTE 5 - FOREIGN CURRENCY INSTRUMENTS
MemberWorks uses purchased option contracts and forward contracts designated as
cash flow hedges to protect against the foreign currency exchange risk inherent
in its acquisition of Lavalife Inc. ("Lavalife"), which is denominated in
Canadian dollars (see Note 15). During the quarter ended March 31, 2004,
MemberWorks hedged a portion of the cash outflows associated with the
acquisition. The risk of loss associated with purchased options is limited to
premium amounts paid for the option contracts. The risk of loss associated with
forward contracts is equal to the exchange rate differential from the time the
contract is entered into until the time it is settled. These contracts expire on
April 1, 2004 concurrent with the closing of the Lavalife acquisition.
The change in the fair value of a cash flow hedge is recognized currently in
earnings and is reported as a component of other income, net. Hedge
effectiveness is measured by comparing the hedging instrument's cumulative
change in fair value from inception to maturity to the forecasted transaction's
terminal value. As of March 31, 2004, MemberWorks held purchased option
contracts and forward contracts with a notional amount of approximately
$103,522,000, a net asset value of $867,000 and a net realized gain of $403,000,
net of taxes.
NOTE 6 - ALLOWANCE FOR MEMBERSHIP CANCELLATIONS
Accrued liabilities set forth in the accompanying condensed consolidated balance
sheets as of March 31, 2004 and June 30, 2003 include an allowance for
membership cancellations of $16,353,000 and $20,934,000, respectively. Recording
an allowance for membership cancellations has the effect of reducing the amount
of deferred membership fees recorded.
6
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 7 - RESTRUCTURING CHARGES
During fiscal 2002, the Company announced the implementation of several cost
saving initiatives due to a slowdown in consumer response rates and increased
economic uncertainty in both the U.S. and abroad. This restructuring program
included a workforce reduction, the closing of the Company's United Kingdom
operations and the downsizing of the operational infrastructure throughout the
Company. As a result of the restructuring program, the Company recorded
restructuring charges of $6,893,000 during the quarter ended December 31, 2001.
The following is a rollforward of the major components of the restructuring
reserve (in thousands) which is recorded in accrued liabilities and other
long-term liabilities:
Workforce Lease
Reduction Obligations Total
-------------- ------------- -------------
Restructuring reserve balance at June 30, 2002 $ 391 $ 2,546 $ 2,937
Additions to the reserve - - -
Charges to the reserve 300 836 1,136
-------------- ------------- -------------
Restructuring reserve balance at June 30, 2003 91 1,710 1,801
Additions to the reserve - - -
Charges to the reserve 91 71 162
-------------- ------------- -------------
Restructuring reserve balance at March 31, 2004 $ - $ 1,639 $ 1,639
============== ============= =============
NOTE 8 - CONVERTIBLE DEBT
On September 30, 2003, the Company issued $90,000,000 aggregate principal amount
of 5.5% convertible senior subordinated notes ("Convertible Notes") due
September 2010 in a private offering pursuant to rule 144A of the Securities Act
of 1933, as amended. The Convertible Notes bear interest at the rate of 5.5% per
year, which will be payable in cash semi-annually in arrears on April 1 and
October 1 of each year. The first payment was due on April 1, 2004. Holders of
the Convertible Notes may convert their notes into shares of MemberWorks common
stock at any time prior to maturity at an initial conversion price of
approximately $40.37 per share, which is equivalent to an initial conversion
rate of approximately 24.7739 shares per $1,000 principal amount of the
Convertible Notes. In accordance with Accounting Principles Board Opinion No.
14, "Accounting for Convertible Debt and Debt Issued with Stock Purchase
Warrants," these Convertible Notes have been classified as a liability.
On December 3, 2003, Memberworks filed on Form S-3 a shelf registration
statement with the Securities and Exchange Commission covering the resale of the
Convertible Notes and the common stock issuable upon their conversion, which was
declared effective on April 9, 2004.
Debt issuance costs associated with this issuance were $3,432,000 for the nine
months ended March 31, 2004. Debt issuance costs are capitalized and amortized
as interest expense over the term of the Convertible Notes using the effective
interest method.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
The Company operates in leased facilities. Management expects that leases
currently in effect will be renewed or replaced by other leases of a similar
nature and term.
On March 25, 2004, MemberWorks entered into an amended and restated senior
secured credit facility that allows borrowings of up to $45,000,000. Borrowings
under the senior secured credit facility accrue interest at either the
Eurodollar rate, or the higher of the Prime rate or the Federal Funds rate, plus
an applicable margin. As of March 31, 2004, the availability under the senior
secured credit facility was further reduced by an outstanding letter of credit
of $5,495,000. Subsequent to the completion of the issuance of $150,000,000
aggregate principal amount Senior Notes (see Note 15), the availability under
the senior secured credit facility will be further reduced by one years worth of
interest on the Senior Notes.
7
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Except as set forth below, in management's opinion, there are no significant
legal proceedings to which the Company or any of its subsidiaries is a party or
to which any of their properties are subject. The Company is involved in other
lawsuits and claims generally incidental to its business including, but not
limited to, various suits, including previously disclosed suits, brought against
the Company by individual consumers seeking monetary and/or injunctive relief
relating to the marketing of the Company's programs. In addition, from time to
time, and in the regular course of its business, the Company receives inquiries
from various federal and/or state regulatory authorities.
In March 2001, an action was instituted by plaintiff Teresa McClain against
Coverdell & Company ("Coverdell"), a wholly-owned subsidiary of the Company,
Monumental Life Insurance Company and other defendants in the United States
District Court for the Eastern District of Michigan, Southern Division. The
suit, which seeks unspecified monetary damages, alleges that Coverdell and the
other defendants violated the Michigan Consumer Protection Act and other
applicable Michigan laws in connection with the marketing of Monumental Life
Insurance Company insurance products. The complaint includes a claim that the
suit should be certified as a class action and the plaintiff has filed a motion
for class certification to which all of the defendants have filed opposing
papers regarding the same. The Court certified a class of Michigan residents.
The Court of Appeals denied the defendants' petition for leave to appeal the
certification order. The Company believes that the claims made against Coverdell
are unfounded and Coverdell and the Company will vigorously defend their
interests against this suit.
On January 24, 2003, the Company filed a motion with the Superior Court for the
Judicial District of Hartford, Connecticut to vacate and oppose the confirmation
of an arbitration award issued in December 2002. The arbitration, filed against
the Company by MedValUSA Health Programs, Inc. ("MedVal") in September 2000,
involved claims of breach of contract, breach of the duty of good faith and fair
dealing, and violation of the Connecticut Unfair Trade Practices Act ("CUTPA").
Even though the arbitrators found that MemberWorks was not liable to MedVal for
any compensatory damages, they awarded $5,495,000 in punitive damages and costs
against MemberWorks solely under CUTPA. MemberWorks believes that this
arbitration award is unjustified and not based on any existing legal precedent.
Specifically, the Company is challenging the award on a number of grounds,
including that it violates a well defined public policy against excessive
punitive damage awards, raises constitutional issues and disregards certain
legal requirements for a valid award under CUTPA. The hearing on the Company's
motion was held on February 10, 2003. On June 22, 2003, the Superior Court
denied the Company's motion to vacate the award, and the Company filed an appeal
of that decision. While the Company intends to take action to prevent the
enforcement of the award by, among other things, vigorously pursuing an appeal,
there can be no assurance that MemberWorks will be successful in its efforts.
The Company has made no provision in its financial statements for this
contingency because it believes that a loss is not probable. If the Company were
ultimately unsuccessful in this or other available appeals, and a final
non-appealable court order confirming the arbitration award is rendered, the
payment of the award could have a material adverse effect on the Company's
results of operations in the period in which the final order is entered.
On October 21, 2003, the Florida Attorney General's Office filed a civil
complaint against the Company based upon concerns that some of its past
marketing practices may have violated various consumer laws. The Company
believes that any legitimate concerns have previously been fully addressed,
including the implementation of industry-leading Best Marketing Practices and
voluntary agreements incorporating those practices, such as the nationwide
assurance agreement that the Company entered into with the State of Nebraska in
2001. The Company believes that the allegations of the complaint are unfounded
and the Company intends to vigorously defend its interests in this matter. The
Company further believes that the potential liability represented by the lawsuit
and the final resolution of this matter will not be material to the Company.
NOTE 10 - INCOME TAX EXPENSE
Income tax expense as a percentage of pre-tax income was 40% for the three and
nine months ended March 31, 2004 and 2003. The effective tax rate was higher
than the U.S. statutory rate for the three and nine months ended March 31, 2004
and 2003 primarily due to state taxes and other non-deductible items. Tax
benefits resulting from the exercise of nonqualified stock options and the
disqualifying dispositions of shares issued under the Company's stock based
compensation plans reduced taxes payable by $4,944,000 and $344,000 during the
quarters ended March 31, 2004 and 2003, respectively. Tax benefits resulting
from the exercise of nonqualified stock options and the disqualifying
dispositions of shares issued under the Company's stock based compensation plans
reduced taxes payable by $6,497,000 and $641,000 during the nine months ended
March 31, 2004 and 2003, respectively. Such benefits are credited to capital in
excess of par value.
8
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 11 - EARNINGS PER SHARE
Basic and diluted earnings per share amounts are determined in accordance with
the provisions of SFAS No. 128, "Earnings Per Share." The following table sets
forth the reconciliation of the numerators and denominators in the computation
of basic and diluted earnings per share (in thousands, except per share data):
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------------- ------------------------
2004 2003 2004 2003
------------- ------------ ----------- ------------
Numerator:
Income available to common shareholders used in basic earnings per
share $ 8,379 $ 3,332 $ 19,939 $ 19,115
Add back: Interest expense on convertible securities 742 - 1,493 -
------------- ------------ ----------- ------------
Income available to common shareholders after assumed conversion of
convertible debt for diluted earnings per share $ 9,121 $ 3,332 $ 21,432 $ 19,115
============= ============ =========== ============
Denominator:
Weighted average number of common shares outstanding - basic 10,301 12,515 10,895 12,805
Effect of dilutive securities:
Convertible securities 2,229 - 1,494 -
Options 850 589 822 582
------------- ------------ ----------- ------------
Weighted average number of common shares outstanding - diluted 13,380 13,104 13,211 13,387
============= ============ =========== ============
Basic earnings per share $ 0.81 $ 0.27 $ 1.83 $ 1.49
============= ============ =========== ============
Diluted earnings per share $ 0.68 $ 0.25 $ 1.62 $ 1.43
============= ============ =========== ============
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, 2004 and 2003, the Company had 0 and 2,812,000 shares, respectively,
of potentially dilutive stock options outstanding that are not included in the
calculation as they are antidilutive. For the nine months ended March 31, 2004
and 2003, the Company had 6,000 and 3,108,000 shares, respectively, of
potentially dilutive stock options that are not included in the calculations as
they are antidilutive.
NOTE 12 - COMPREHENSIVE INCOME
The components of comprehensive income are as follows (in thousands):
Three months ended Nine months ended
March 31, March 31,
-------------------------- --------------------------
2004 2003 2004 2003
------------ ------------- ------------- ------------
Net income $ 8,379 $ 3,332 $ 19,939 $ 19,115
Foreign currency translation gain (loss) (5) 72 11 (8)
------------ ------------- ------------- ------------
Comprehensive income $ 8,374 $ 3,404 $ 19,950 $ 19,107
============ ============= ============= ============
NOTE 13 - NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which was revised in December 2003. FIN
46 clarifies the application of Accounting Research Bulletin No. 51 and provides
guidance on the identification of and reporting for variable interest entities.
FIN 46 is effective immediately for variable interest entities formed after
January 31, 2003 and is effective for periods ending after March 15, 2004 for
any variable interest entity formed prior to February 1, 2003. The adoption of
FIN 46 did not have a material impact on the Company's financial statements.
In May 2003, the Financial Accounting Standards Board issued SFAS No.150,
"Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity " ("SFAS 150"). This statement requires that certain
financial instruments that were accounted for as equity under previous guidance
be classified as liabilities in statements of financial position. SFAS 150 is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. The adoption of SFAS 150 did not have a material
impact on the Company's financial statements.
9
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 14 - GUARANTOR AND NONGUARANTOR FINANCIAL STATEMENTS
On April 13, 2004, MemberWorks entered into an agreement to sell an aggregate of
$150.0 million of Senior Notes ("Senior Notes") in private placements pursuant
to Rule 144A (see Note 15). The Senior Notes will be unsecured obligations and
will rank pari passu in right of payment to all of the Company's existing and
future senior unsecured indebtedness and senior in right of payment to all of
the Company's existing and future subordinated indebtedness that expressly
provides for its subordination to the Notes. The Senior Notes will be fully and
unconditionally guaranteed by all of the Company's existing and future domestic
subsidiaries and certain of the Company's existing and future foreign
subsidiaries.
The following consolidating financial information presents the consolidating
balance sheets as of March 31, 2004 and June 30, 2003, the related statements of
operations for each of the three and nine month periods ended March 31, 2004 and
2003 and the related statements of cash flows for the nine month periods ended
March 31, 2004 and 2003. The information includes the elimination entries
necessary to consolidate MemberWorks ("Parent") with the guarantor and
nonguarantor entities.
Investments in subsidiaries are accounted for by the Parent using the equity
method of accounting. The guarantor and nonguarantor subsidiaries are presented
on a combined basis. The principal elimination entries eliminate investments in
subsidiaries and intercompany balances and transactions.
10
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
As of March 31, 2004
----------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------------------------- ---------------------------------------------
Assets (in thousands)
Current assets:
Cash and cash equivalents $ 105,417 $ 12,256 $ 1,284 $ - $118,957
Restricted cash - 2,682 - - 2,682
Accounts receivable 4,903 3,736 3,214 - 11,853
Intercompany receivable - 6,039 1,046 (7,085) -
Prepaid membership materials 1,977 163 569 - 2,709
Prepaid expenses and other current assets 6,260 1,921 500 - 8,681
Membership solicitation and other deferred costs 49,423 6,609 2,772 - 58,804
-------------------------- ---------------------------------------------
Total current assets 167,980 33,406 9,385 (7,085) 203,686
Fixed assets, net 20,277 588 2,055 - 22,920
Goodwill - 35,320 6,719 - 42,039
Intangible assets, net - 6,019 - - 6,019
Other assets 6,305 47 - - 6,352
Investment in subsidiaries 59,276 - - (59,276) -
-------------------------- ---------------------------------------------
Total assets $ 253,838 $ 75,380 $ 18,159 $ (66,361) $ 281,016
========================== =============================================
Liabilities and Shareholders' (Deficit) Equity
Current liabilities:
Current maturities of long-term obligations $ 309 $ 20 $ - $ - $ 329
Accounts payable 10,046 13,083 2,548 - 25,677
Accrued liabilities 50,332 3,826 2,058 - 56,216
Intercompany payable 6,073 1,012 - (7,085) -
Deferred membership fees 141,921 1,229 4,535 - 147,685
Deferred income taxes 3,426 (360) 2,307 - 5,373
-------------------------- ---------------------------------------------
Total current liabilities 212,107 18,810 11,448 (7,085) 235,280
Deferred income taxes 4,097 3,181 (500) - 6,778
Other long-term liabilities 2,518 - 1,324 - 3,842
Convertible debt 90,000 - - - 90,000
-------------------------- ---------------------------------------------
Total liabilities 308,722 21,991 12,272 (7,085) 335,900
-------------------------- ---------------------------------------------
Shareholders' (deficit) equity:
Preferred stock - - - - -
Common stock 190 6 3 (9) 190
Capital in excess of par value 152,804 52,296 9,564 (61,860) 152,804
Accumulated (deficit) equity 2,110 1,087 (3,222) 2,135 2,110
Accumulated other comprehensive loss (458) - (458) 458 (458)
Treasury stock (209,530) - - - (209,530)
-------------------------- ---------------------------------------------
Total shareholders' (deficit) equity (54,884) 53,389 5,887 (59,276) (54,884)
-------------------------- ---------------------------------------------
Total liabilities and shareholders' (deficit)
equity $ 253,838 $ 75,380 $ 18,159 $ (66,361) $ 281,016
========================== =============================================
11
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
As of June 30, 2003
----------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------------------------- --------------------------------------------
Assets (in thousands)
Current assets:
Cash and cash equivalents $ 51,895 $ 18,716 $ 1,649 $ - $ 72,260
Restricted cash - 2,732 - - 2,732
Accounts receivable 2,811 3,907 1,995 - 8,713
Intercompany receivable 686 298 - (984) -
Prepaid membership materials 1,762 170 264 - 2,196
Prepaid expenses and other current assets 6,032 1,031 508 - 7,571
Membership solicitation and other deferred costs 73,856 1,853 2,174 - 77,883
-------------------------- --------------------------------------------
Total current assets 137,042 28,707 6,590 (984) 171,355
Fixed assets, net 22,193 535 2,241 - 24,969
Goodwill - 35,320 6,719 - 42,039
Intangible assets, net - 6,656 - - 6,656
Other assets 3,426 60 - - 3,486
Investment in subsidiaries 56,419 - - (56,419) -
-------------------------- --------------------------------------------
Total assets $ 219,080 $ 71,278 $ 15,550 $ (57,403) $ 248,505
========================== ============================================
Liabilities and Shareholders' (Deficit) Equity
Current liabilities:
Current maturities of long-term obligations $ - $ 244 $ - $ - $ 244
Accounts payable 17,678 13,018 1,948 - 32,644
Accrued liabilities 53,692 3,333 2,080 - 59,105
Intercompany payable - 804 180 (984) -
Deferred membership fees 163,276 1,007 3,360 - 167,643
Deferred income taxes 662 (1,701) 1,918 - 879
-------------------------- --------------------------------------------
Total current liabilities 235,308 16,705 9,486 (984) 260,515
Deferred income taxes 2,456 3,260 (571) - 5,145
Other long-term liabilities 1,599 63 1,466 - 3,128
-------------------------- --------------------------------------------
Total liabilities 239,363 20,028 10,381 (984) 268,788
-------------------------- --------------------------------------------
Shareholders' (deficit) equity
Preferred stock - - - - -
Common stock 178 6 3 (9) 178
Capital in excess of par value 122,425 52,296 9,564 (61,860) 122,425
Accumulated (deficit) equity (17,829) (1,052) (3,929) 4,981 (17,829)
Accumulated other comprehensive loss (469) - (469) 469 (469)
Treasury stock (124,588) - - - (124,588)
-------------------------- --------------------------------------------
Total shareholders' (deficit) equity (20,283) 51,250 5,169 (56,419) (20,283)
-------------------------- --------------------------------------------
Total liabilities and shareholders' (deficit)
equity $ 219,080 $ 71,278 $ 15,550 $ (57,403) $ 248,505
========================== ============================================
12
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
For the three months ended March 31, 2004
----------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------------------------- --------------------------------------------
(in thousands)
Revenues $ 98,329 $ 15,310 $ 5,216 $ (336) $ 118,519
Expenses:
Marketing 51,773 7,813 1,355 - 60,941
Operating 17,216 2,992 2,452 (336) 22,324
General and administrative 16,762 2,719 957 - 20,438
Amortization of intangible assets - 258 - - 258
-------------------------- --------------------------------------------
Operating income 12,578 1,528 452 - 14,558
Equity in income of subsidiaries 1,214 - - (1,214) -
Interest (expense) income, net (1,317) 26 26 - (1,265)
Other income, net 681 (1) (8) - 672
-------------------------- --------------------------------------------
Income before income taxes 13,156 1,553 470 (1,214) 13,965
Provision for income taxes 4,777 621 188 - 5,586
-------------------------- --------------------------------------------
Net income $ 8,379 $ 932 $ 282 $ (1,214) $ 8,379
========================== ============================================
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
For the three months ended March 31, 2003
----------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------------------------- --------------------------------------------
(in thousands)
Revenues $ 102,939 $ 12,821 $ 3,085 $ (198) $ 118,647
Expenses:
Marketing 65,870 6,173 969 - 73,012
Operating 16,891 3,134 826 (198) 20,653
General and administrative 15,808 2,588 734 - 19,130
Amortization of intangible assets - 336 - - 336
-------------------------- --------------------------------------------
Operating income 4,370 590 556 - 5,516
Equity in income of subsidiaries 703 - - (703) -
Interest (expense) income, net 110 35 4 - 149
Other income, net (98) - (14) - (112)
-------------------------- --------------------------------------------
Income before income taxes 5,085 625 546 (703) 5,553
Provision for income taxes 1,753 250 218 - 2,221
-------------------------- --------------------------------------------
Net income $ 3,332 $ 375 $ 328 $ (703) $ 3,332
========================== ============================================
13
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
For the nine months ended March 31, 2004
----------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------------------------- --------------------------------------------
(in thousands)
Revenues $ 299,505 $ 43,308 $ 13,814 $ (1,120) $ 355,507
Expenses:
Marketing 168,897 21,852 3,593 - 194,342
Operating 52,360 9,350 6,239 (1,120) 66,829
General and administrative 47,778 7,808 2,814 - 58,400
Amortization of intangible assets - 847 - - 847
-------------------------- --------------------------------------------
Operating income 30,470 3,451 1,168 - 35,089
Equity in income of subsidiaries 2,846 - - (2,846) -
Interest (expense) income, net (2,479) 82 80 - (2,317)
Other income, net 497 32 (70) - 459
-------------------------- --------------------------------------------
Income before income taxes 31,334 3,565 1,178 (2,846) 33,231
Provision for income taxes 11,395 1,426 471 - 13,292
-------------------------- --------------------------------------------
Net income $ 19,939 $ 2,139 $ 707 $ (2,846) $ 19,939
========================== ============================================
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
For the nine months ended March 31, 2003
----------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------------------------- --------------------------------------------
(in thousands)
Revenues $ 291,320 $ 37,588 $ 9,455 $ (667) $ 337,696
Expenses:
Marketing 187,899 17,355 3,206 - 208,460
Operating 47,241 8,997 2,334 (667) 57,905
General and administrative 46,607 7,854 2,296 - 56,757
Amortization of intangible assets - 1,075 - - 1,075
-------------------------- --------------------------------------------
Operating income 9,573 2,307 1,619 - 13,499
Settlement of investment related litigation 19,148 - - - 19,148
Loss on sale of subsidiary (959) - - - (959)
Net loss on investment (206) - - - (206)
Equity in income of subsidiaries 2,418 - - (2,418) -
Interest (expense) income, net 417 89 47 - 553
Other income, net (144) 2 (34) - (176)
-------------------------- --------------------------------------------
Income before income taxes 30,247 2,398 1,632 (2,418) 31,859
Provision for income taxes 11,132 959 653 - 12,744
-------------------------- --------------------------------------------
Net income $ 19,115 $ 1,439 $ 979 $ (2,418) $ 19,115
========================== ============================================
14
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the nine months ended March 31, 2004
--------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
--------------------------------------------------------------------------
(in thousands)
Operating activities
Net income $ 19,939 $ 2,139 $ 707 $ (2,846) $ 19,939
Adjustments to reconcile net income to net cash
provided by operating activities:
Change in deferred membership fees (21,355) 222 1,059 - (20,074)
Change in membership solicitation and other
deferred costs 24,433 (4,756) (521) - 19,156
Depreciation and amortization 6,037 1,073 539 - 7,649
Deferred income taxes 4,405 1,262 460 - 6,127
Tax benefit from employee stock plans 6,497 - - - 6,497
Other 811 117 - - 928
Change in assets and liabilities:
Restricted cash - 50 - - 50
Accounts receivable (2,092) 171 (1,219) - (3,140)
Intercompany receivable & payable 6,759 (5,533) (1,226) - -
Prepaid membership materials (665) 7 (305) - (963)
Prepaid expenses and other current assets 130 (767) 8 - (629)
Other assets 195 (462) - - (267)
Accounts payable (7,560) (7) 600 - (6,967)
Accrued liabilities (3,442) 561 (157) - (3,038)
--------------------------------------------------------------------------
Net cash provided by operating activities 34,092 (5,923) (55) (2,846) 25,268
-------------------------------------------------------------------------
Investing activities
Acquisition of fixed assets (4,252) (279) (345) - (4,876)
Investment in subsidiaries (2,846) - - 2,846 -
--------------------------------------------------------------------------
Net cash used in by investing activities (7,098) (279) (345) 2,846 (4,876)
--------------------------------------------------------------------------
Financing activities
Net proceeds from exercise of stock options 23,632 - - - 23,632
Treasury stock purchases (84,942) - - - (84,942)
Net proceeds from issuance of convertible debt 87,948 - - - 87,948
Payments of long-term obligations (110) (258) - - (368)
--------------------------------------------------------------------------
Net cash provided by (used in) financing activities 26,528 (258) - - 26,270
--------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash
equivalents - - 35 - 35
--------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 53,522 (6,460) (365) - 46,697
Cash and cash equivalents at beginning of period 51,895 18,716 1,649 - 72,260
--------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 105,417 $ 12,256 $ 1,284 $ - $ 118,957
==========================================================================
15
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
For the nine months ended March 31, 2003
-------------------------------------------------------------------------
Guarantor Nonguarantor Consolidated
Parent Subsidiaries Subsidiaries Eliminations Total
-------------------------------------------------------------------------
(in thousands)
Operating activities
Net income $ 19,115 $ 1,439 $ 979 $ (2,418) $ 19,115
Adjustments to reconcile net income to net cash
provided by operating activities:
Change in deferred membership fees (17,836) (682) (858) - (19,376)
Change in membership solicitation and other deferred
costs 29,373 280 664 - 30,317
Depreciation and amortization 7,057 1,356 737 - 9,150
Deferred income taxes 10,262 813 653 - 11,728
Tax benefit from employee stock plans 641 - - - 641
Gain on settlement of investment related litigation (19,148) - - - (19,148)
Loss on sale of subsidiary 959 - - - 959
Net loss on investment 206 - - - 206
Other 1,609 - - - 1,609
Change in assets and liabilities:
Restricted cash - 4,348 - - 4,348
Accounts receivable (7,555) 284 (224) - (7,495)
Intercompany receivable & payable 1,762 1,485 (3,247) - -
Prepaid membership materials (219) 6 (19) - (232)
Prepaid expenses and other current assets (648) (275) 129 - (794)
Other assets (397) 48 - - (349)
Accounts payable (3,119) 709 76 - (2,334)
Accrued liabilities 4,637 84 67 - 4,788
-------------------------------------------------------------------------
Net cash provided by (used in) operating activities 26,699 9,895 (1,043) (2,418) 33,133
-------------------------------------------------------------------------
Investing activities
Acquisition of fixed assets (3,962) (96) (41) - (4,099)
Settlement of investment related litigation 19,148 - - - 19,148
Purchase price adjustments from sale of subsidiary (750) ` - - - (750)
Investment in subsidiaries (2,418) - - 2,418 -
Other investments (500) - - - (500)
-------------------------------------------------------------------------
Net cash (used in) provided by investing activities 11,518 (96) (41) 2,418 13,799
-------------------------------------------------------------------------
Financing activities
Net proceeds from exercise of stock options 3,177 - - - 3,177
Treasury stock purchases (25,323) - - - (25,323)
Payments of long-term obligations - (1,001) - - (1,001)
-------------------------------------------------------------------------
Net cash used in financing activities (22,146) (1,001) - - (23,147)
-------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash
equivalents - - 57 - 57
-------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 16,071 8,798 (1,027) - 23,842
Cash and cash equivalents at beginning of period 34,476 8,463 2,563 - 45,502
-------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 50,547 $ 17,261 $ 1,536 $ - $ 69,344
=========================================================================
16
MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 15 -SUBSEQUENT EVENT
Acquisition of Lavalife Inc.
On April 1, 2004, MemberWorks completed its acquisition of all of the assets and
outstanding capital stock of Lavalife, a leading provider of online and
IVR-based interactive personals services. Lavalife will operate as a
wholly-owned subsidiary of MemberWorks. The purchase price, excluding fees and
expenses, was CAD$152,500,000, or $116,300,000, and is subject to certain
adjustments. The acquisition was funded with cash on hand and borrowings under
the Company's $45,000,000 senior secured credit facility. The acquisition will
be accounted for under the purchase method of accounting.
$150,000,000 9.25% Senior Notes due 2014
On April 13, 2004, MemberWorks issued $150,000,000 in aggregate principal amount
of 9.25% Senior Notes due 2014 ("Senior Notes"). These Senior Notes were sold at
98.418% of the principal amount which results in an effective rate of 9.5%.
Interest is payable in cash semi-annually in arrears on April 1 and October 1 of
each year, with the first payment due on October 1, 2004. A portion of the
proceeds from the offering of these Senior Notes was used to repay amounts
borrowed under the senior secured credit facility to fund a portion of the
Lavalife acquisition. The Company intends to use the remaining proceeds for
general corporate purposes, including working capital, future acquisitions and
purchases of MemberWorks common stock under the Company's stock buyback program
to the extent permitted under the indenture governing the Senior Notes and the
senior secured credit facility.
The offering of Senior Notes was made solely by means of a private placement to
qualified institutional buyers pursuant to Rule 144A under the Securities Act of
1933, as amended, and to certain persons in offshore transactions pursuant to
Regulation S under the Securities Act. The Senior Notes have not been registered
under the Securities Act and may not be offered or sold in the United States, or
to a U.S. person, absent registration or an applicable exemption from
registration requirements. MemberWorks intends to use its best efforts to
register these Senior Notes within 120 days after the issue date.
17
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
MemberWorks designs and manages innovative membership programs and provides
organizations with an opportunity to leverage the expertise of an outside
provider in offering these membership programs to their customers. Membership
programs offer selected products and services from a variety of vendors for
either an annual fee or a monthly fee. MemberWorks derives its revenues
principally from renewable membership fees, which are billed to the customer
either on an annual or monthly basis. In the case of annual programs, the
Company receives full payment at or near the beginning of the membership period,
but recognizes the revenue as the member's refund privilege expires. Membership
fees that are billed monthly are recognized when earned. MemberWorks has
traditionally marketed its membership programs with an up-front annual
membership fee. However, during fiscal 2003, the Company expanded its marketing
of membership programs in which the membership fee is payable in monthly
installments. It is the Company's intention to further increase the mix of
monthly payment programs during fiscal 2004. Profitability and cash flow
generated from renewal memberships exceed that of new memberships due to the
absence of solicitation costs associated with new member procurement.
In accordance with Financial Accounting Standards Board ("FASB") Statement 131,
"Disclosures about Segments of an Enterprise and Related Information,"
MemberWorks operates in one reportable operating segment.
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those policies that are important to the
Company's financial condition and results of operations and involve subjective
or complex judgments on the part of management, often as a result of the need to
make estimates. The following areas all require the use of judgments and
estimates: membership cancellation rates, deferred marketing costs, valuation of
goodwill and intangible assets, estimation of remaining useful lives of
intangible assets and valuation of deferred tax assets. Estimates in each of
these areas are based on historical experience and various assumptions that
MemberWorks believes are appropriate. Actual results may differ from these
estimates. MemberWorks believes the following represent the critical accounting
policies of the Company as contemplated by Financial Reporting Release No. 60,
"Cautionary Advice Regarding Disclosure about Critical Accounting Policies." For
a summary of all of the Company's significant accounting policies, see Note 2 of
the Notes to the consolidated financial statements located in the Company's 2003
Annual Report on Form 10-K.
Revenue recognition
Membership fees are billed through clients of the Company primarily through
credit cards. In the case of annually billed membership programs, members may
cancel their membership in the program generally for a prorata refund of the
membership fee based on the remaining portion of the membership period. In
accordance with Staff Accounting Bulletin 101, "Revenue Recognition in Financial
Statements" ("SAB 101"), deferred membership fees are recorded, net of estimated
cancellations, and are amortized as revenues from membership fees upon the
expiration of membership refund privileges. An allowance for membership
cancellations is established based on management's estimates and is updated
regularly. In determining the estimate of allowance for membership
cancellations, management analyzes historical cancellation experience, current
economic trends and changes in customer demand for the Company's products.
Actual membership cancellations are charged against the allowance for membership
cancellations on a current basis. If actual cancellations differ from the
estimate, the revenues would be impacted.
Membership solicitation and other deferred costs
The Company's marketing expenses are comprised of telemarketing, direct mail,
refundable royalty payments, non- refundable royalty payments and advertising
costs. Telemarketing and direct mail costs are direct response advertising costs
which are accounted for in accordance with American Institute of Certified
Public Accountants Statement of Position 93-7, "Reporting on Advertising Costs"
("SOP 93-7"). Under SOP 93-7, direct response advertising costs are deferred and
charged to operations over the membership period as revenues from membership
fees are recognized. Refundable royalty payments are also deferred and charged
to operations over the membership period in order to match the marketing costs
with the associated revenues from membership fees. Advertising costs and
non-refundable royalty payments, which include fee per pitch, fee per sale and
fee per impression marketing arrangements, are expensed when incurred.
18
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Total membership solicitation costs incurred to obtain a new member are
generally less than the estimated total membership fees. However, if total
membership solicitation costs were to exceed total estimated membership margins,
an adjustment would be made to the membership solicitation and other deferred
costs balance and marketing expenses to the extent of any impairment.
Valuation of goodwill and other intangibles
MemberWorks reviews the carrying value of its goodwill and other intangible
assets and assesses the remaining estimated useful lives of its intangible
assets in accordance with FASB Statement No. 142, "Goodwill and Other Intangible
Assets." The Company reviews the carrying value of its goodwill and other
intangible assets for impairment by comparing such amounts to their fair values.
MemberWorks is required to perform this comparison at least annually or more
frequently if circumstances indicate possible impairment. When determining fair
value, the Company utilizes various assumptions, including projections of future
cash flows. A change in these underlying assumptions would cause a change in the
results of the tests and, as such, could cause fair value to be less than the
carrying amounts. In such an event, MemberWorks would then be required to record
a corresponding charge, which would negatively impact earnings. Goodwill at July
1, 2003 and 2002 was tested for impairment during the quarters ended September
30, 2003 and 2002, respectively. The Company concluded that none of its goodwill
was impaired as of July 1, 2003 or 2002.
Income Taxes
The Company accounts for income taxes under the provisions of FASB Statement No.
109, "Accounting for Income Taxes." Deferred tax assets and liabilities are
recognized for future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. MemberWorks estimates current tax provisions or
benefits based on a projected effective tax rate for the fiscal year ended June
30, 2004 using the most currently available information and forecasts. The
projected effective tax rate is updated for actual results and estimates when
they become known. In addition, MemberWorks assesses the realization of deferred
tax assets considering various assumptions, including estimates of future
taxable income and ongoing tax strategies. A change in these underlying
assumptions would impact the results of operations.
THREE MONTHS ENDED MARCH 31, 2004 VS. THREE MONTHS ENDED MARCH 31, 2003
REVENUES. Revenues were $118.5 million for the quarter ended March 31, 2004
compared to $118.6 million for the quarter ended March 31, 2003. Revenues in the
March 31, 2003 quarter benefited from the Company's initiative to migrate its
members that participated in full money back refund policy programs to prorata
refund policy programs, which was completed during fiscal 2003. As a result of
this migration, revenues which would have been recognized at the end of a
membership year under a full money back refund policy program were recognized
during the membership year as the refund privileges expired in accordance with
SAB 101. Revenues in the March 31, 2004 quarter benefited from the formation of
new client partnerships and expanded product marketing with certain existing
clients. The Company has continued its strategic initiative to shift new
marketing towards members on a monthly payment program, and as a result, the
renewal revenues from annual payment programs as a percentage of total revenues
decreased to 42% in 2004 from 48% in 2003. Revenues from members who are charged
on a monthly payment program increased to $45.9 million for the quarter ended
March 31, 2004 from $20.1 million for the quarter ended March 31, 2003 primarily
due to an increase in members enrolled in a monthly payment plan and an increase
in the average monthly price point. The increase in members enrolled in monthly
payment programs was more than offset by a decrease in members enrolled in
annual payment programs. Net active members decreased 3% to 6.1 million at March
31, 2004 from 6.3 million at March 31 2003. Net active members decreased due to
decreased levels of marketing during the March 2004 quarter.
MARKETING EXPENSES. Marketing expenses consist of costs incurred to obtain new
members and royalties paid to clients. Marketing expenses decreased 17% to $60.9
million for the quarter ended March 31, 2004 from $73.0 million for the quarter
ended March 31, 2003 and, as a percentage of revenue, marketing expenses
decreased to 51.4% in 2004 from 61.5% in 2003. The improvement in the marketing
expense ratio is primarily due to the increase in the mix of marketing in the
Company's more profitable Online and MemberLink channels in combination with the
increase in the profitability of monthly revenues due to the maturing membership
base.
19
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
OPERATING EXPENSES. Operating expenses consist of member service call center
costs, membership benefit costs and membership program fulfillment costs.
Operating expenses increased 8% to $22.3 million for the quarter ended March 31,
2004 from $20.7 million for the quarter ended March 31, 2003. As a percentage of
revenues, operating expenses increased to 18.8% for the quarter ended March 31,
2004 from 17.4% for the quarter ended March 31, 2003. These increases were due
to increased call center and other membership benefit costs incurred to service
the membership base.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
primarily include personnel-related costs, occupancy costs and other overhead
costs. General and administrative expenses increased 7% to $20.4 million for the
quarter ended March 31, 2004 versus $19.1 million for the quarter ended March
31, 2003. As a percentage of revenues, general and administrative expenses
increased to 17.2% in 2004 from 16.1% in 2003 primarily due to higher employee
related costs.
INTEREST EXPENSE, NET. Interest expense, net consists primarily of interest
expense, interest income and the amortization of debt issuance costs related to
the Company's line of credit and convertible senior subordinated notes. Interest
expense, net was $1.3 million for the quarter ended March 31, 2004 compared to
interest income, net of $0.1 million for the quarter ended March 31, 2003. The
increase in interest expense is due to the issuance of the convertible senior
subordinated notes in September 2003 ("Convertible Notes").
PROVISION FOR INCOME TAXES. During the quarter ended March 31, 2004, the Company
recorded a tax provision of $5.6 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, 2004 primarily due to state taxes
and other non-deductible items. 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%.
NINE MONTHS ENDED MARCH 31, 2004 VS. NINE MONTHS ENDED MARCH 31, 2003
REVENUES. Revenues increased 5% to $355.5 million for the nine months ended
March 31, 2004 from $337.7 million for the nine months ended March 31, 2003. The
increase in revenues is primarily due to an increase in the weighted average
program price point and the formation of new client partnerships and expanded
product marketing with certain existing clients. As a result of the Company's
strategic initiative to shift new marketing towards members on a monthly payment
program, renewal revenues from annual payment programs as a percent of total
revenues decreased to 41% in 2004 from 48% in 2003. Revenues from members who
are charged on a monthly payment program increased to $115.0 million for the
nine months ended March 31, 2004 from $53.9 million for the nine months ended
March 31, 2003 due to an increase in members enrolled in a monthly payment plan
and an increase in the average monthly price point. The increase in members
enrolled in monthly payment programs was more than offset by a decrease in
members enrolled in annual payment programs.
MARKETING EXPENSES. Marketing expenses decreased 7% to $194.3 million for the
nine months ended March 31, 2004 from $208.5 million for the nine months ended
March 31, 2003 and, as a percentage of revenue, marketing expenses decreased to
54.7% in 2004 from 61.7% in 2003. The improvement in the marketing expense ratio
is primarily due to the increase in the mix of marketing in the Company's more
profitable Online and MemberLink channels in combination with the increase in
the profitability of monthly revenues due to the maturing membership base.
OPERATING EXPENSES. Operating expenses increased 15% to $66.8 million for the
nine months ended March 31, 2004 from $57.9 million for the nine months ended
March 31, 2003. As a percentage of revenues, operating expenses increased to
18.8% for the nine months ended March 31, 2004 from 17.1% for the nine months
ended March 31, 2003. These increases were due to increased call center and
other membership benefit costs incurred to service the membership base.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 3% to $58.4 million for the nine months ended March 31, 2004 versus
$56.8 million for the nine months ended March 31, 2003 primarily due to higher
salary and employee related costs. As a percentage of revenues, general and
administrative expenses decreased to 16.4% in 2004 from 16.8% in 2003 primarily
due to leveraging the increase in our reported revenues.
20
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
INTEREST EXPENSE, NET. Interest expense, net increased to $2.3 million for the
nine months ended March 31, 2004 from interest income, net of $0.6 million for
the nine months ended March 31, 2003. The increase is due to the issuance of the
Convertible Notes in September 2003.
PROVISION FOR INCOME TAXES. During the nine months ended March 31, 2004, the
Company recorded a tax provision of $13.3 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, 2004 primarily due to state
taxes and other non-deductible items. 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%.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $25.3 million for the nine months
ended March 31, 2004 versus $33.1 million for the nine months ended March 31,
2003. The decrease in operating cash flow in the nine months ended March 31,
2004 versus the prior year was primarily due to the impact of changes in assets
and liabilities which reduced cash by $15.0 million in the nine months ended
March 31, 2004 and reduced cash by $2.1 million in the nine months ended March
31, 2003. The $12.9 million decrease in changes in assets and liabilities over
the prior year was primarily driven by the Company's transition to monthly
billing which resulted in a $4.6 million decrease in the allowance for
cancellations, timing of certain vendor payments and the release of cash held in
escrow in the first quarter of fiscal 2003. Operating cash flow also decreased
over the prior year period due to increased operating expenses, general and
administrative expenses and interest expense during the nine months ended March
31, 2004. These decreases were partially offset by an increase in marketing
margin before deferral (revenues before deferral less marketing costs before
deferral) which had a positive impact on cash flow from operations of $160.2
million in the nine months ended March 31, 2004 compared to $140.2 million in
the nine months ended March 31, 2003. The improvement in the marketing margin
before deferral is primarily due to the increase in the mix of marketing in the
Company's more profitable Online and MemberLink channels in combination with the
increase in the profitability of monthly revenues due to the maturing membership
base as well as lower marketing levels.
The Company's management believes that revenues before deferral and marketing
costs before deferral are important measures of liquidity. Revenues before
deferral are revenues before the application of SAB 101 and represent the actual
membership fees billed during the current reporting period less an allowance for
membership cancellations. Marketing costs before deferral are marketing costs
before the application of SAB 101 and SOP 93-7 and represent the Company's
obligation for marketing efforts that occurred during the current reporting
period.
Revenues before deferral for the nine months ended March 31, 2004 and 2003 are
calculated as follows:
March 31,
----------------------------
2004 2003
------------- -------------
Revenues reported in the Statements of Operations $ 355,507 $ 337,696
Change in deferred membership fees (20,074) (19,376)
------------- -------------
Revenues before deferral $ 335,433 $ 318,320
============= =============
21
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Revenues before deferral increased 5% to $335.4 million for the nine months
ended March 31, 2004 from $318.3 million for the nine months ended March 31,
2003. The increase in revenues before deferral is primarily due to an increase
in the weighted average program price point of both annual and monthly payment
programs. New annual weighted average price points increased to $107 for the
nine months ended March 31, 2004 from $102 for the nine months ended March 31,
2003. Monthly weighted average price points increased to $11.36 for the nine
months ended March 31, 2004 from $10.00 for the nine months ended March 31,
2003. Revenues before deferral from members who are charged on a monthly payment
program were $120.5 million during the nine months ended March 31, 2004 and
$53.9 million during the nine months ended March 31, 2003 due to the increases
in the average monthly members billed each period and the weighted average price
point. The increase in revenues from monthly payment programs was partially
offset by a decrease in revenues from annual payment programs. The following
table summarizes the average monthly members billed each quarter during the nine
months ended March 31:
Fiscal Year 2004 Fiscal Year 2003
----------------- --------------
First Quarter 955 576
Second Quarter 1,239 588
Third Quarter 1,343 664
The following table summarizes the components of revenues before deferral for
the nine months ended March 31:
2004 2003
----------------- --------------
New annual 19% 37%
Renewal annual 45% 46%
Monthly 36% 17%
As a percentage of total revenues before deferral, renewal revenues from annual
payment programs decreased to 45% in the nine months ended March 31, 2004 from
46% in the nine months ended March 31, 2003 due to the Company's strategic
initiative to shift new marketing towards members on a monthly payment program.
This shift to monthly payment programs has a near-term negative impact on
operating cash flow due to the timing of revenues collected relative to the
corresponding timing of marketing expenditures.
Marketing costs before deferral for the nine months ended March 31, 2004 and
2003 are calculated as follows:
March 31,
----------------------------
2004 2003
------------- -------------
Marketing expenses reported in the Statements of Operations $ 194,342 $ 208,460
Change in membership solicitation and other deferred costs (19,156) (30,317)
------------- -------------
Marketing costs before deferral $ 175,186 $ 178,143
============= =============
Marketing costs before deferral decreased 2% to $175.2 million for the nine
months ended March 31, 2004 from $178.1 million for the nine months ended March
31, 2003. As a percent of revenues before deferral, marketing expenses before
deferral were 52.2% for the nine months ended March 31, 2004 and 56.0% for the
nine months ended March 31, 2003. These decreases were primarily due to the
increase in the mix of marketing in the Company's more profitable Online and
MemberLink channels in combination with the increase in the profitability of
monthly revenues due to the maturing membership base and lower marketing levels
in the March 2004 quarter. The lower marketing levels are reflected in the 3%
decrease in the membership base which was 6.1 million as of March 31, 2004
compared to 6.3 million at March 31, 2003.
22
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Net cash used in investing activities was $4.9 million during the nine months
ended March 31, 2004 versus net cash provided by investing activities of $13.8
million during the nine months ended March 31, 2003. Net cash provided by
investing activities during the nine months ended March 31, 2003 included $19.1
million of proceeds related to the settlement of a lawsuit and $0.8 million of
funds paid in connection with a purchase price adjustment related to the sale of
iPlace, Inc. Capital expenditures were $4.9 million during the nine months ended
March 31, 2004 and $4.1 million during the nine months ended March 31, 2003.
Net cash provided by financing activities was $26.3 million for the nine months
ended March 31, 2004 versus net cash used in financing activities of $23.1
million for the nine months ended March 31, 2003. The increase in cash provided
by financing activities was primarily due to the issuance of $90.0 million
aggregate principal amount convertible senior subordinated notes ("Convertible
Notes") due September 2010. The Convertible Notes bear interest at the rate of
5.5% per year, which will be payable in cash semi-annually in arrears on April 1
and October 1 of each year, with the first payment due on April 1, 2004. The net
proceeds were be used for general corporate purposes, including mergers and
acquisitions and additional repurchases of the Company's common stock under its
stock buyback program. Upon the occurrence of a change in control, holders of
the Convertible Notes may require the Company to repurchase all or part of the
Convertible Notes for cash. In addition, the Company received $23.6 million from
the exercise of stock options during the nine months ended March 31, 2004. These
increases in financing activities during the nine months ended March 31, 2004
were offset by increased spending under the Company's stock repurchase program.
The Company purchased 2,662,000 shares for $84.9 million, an average price of
$31.91, during the nine months ended March 31, 2004 compared to 1,432,000 shares
for $25.3 million, an average price of $17.69, during the nine months ended
March 31, 2003. The Company utilized cash from operations, stock option
exercises and the issuance of the Convertible Notes to repurchase shares.
During the nine months ended March 31, 2004, the Board of Directors authorized
3.0 million additional shares to be repurchased under the buyback program. As of
March 31, 2004, the Company had 1,317,000 shares available for repurchase under
its buyback program.
As of March 31, 2004, the Company had cash and cash equivalents of $119.0
million. In addition, on March 25, 2004, MemberWorks entered into an amended and
restated senior secured credit facility that allows borrowings of up to $45.0
million. Borrowings under the senior secured credit facility accrue interest at
either the Eurodollar rate, or the higher of the Prime rate or the Federal Funds
rate, plus an applicable margin. As of March 31, 2004, the availability under
the senior secured credit facility was reduced by an outstanding letter of
credit of $5.5 million and pursuant to the completion of the issuance of the
$150.0 million aggregate principal amount of Senior Notes ("Senior Notes")
issued on April 13, 2004 (discussed below), the availability under the senior
secured credit facility have been further reduced by one years worth of interest
on the Senior Notes. As of April 29, 2004, the availability under the senior
secured credit facility is approximately $25.6 million. As of March 31, 2004,
the effective interest rate for borrowings under the senior secured credit
facility was 4.0%. The senior secured credit facility has certain financial
covenants, including a maximum debt coverage ratio, potential restrictions on
additional borrowings and potential restrictions on additional stock
repurchases. As of March 31, 2004, the Company was in compliance with all such
debt covenants.
On April 1, 2004, MemberWorks completed its acquisition of all of the assets and
outstanding capital stock of Lavalife Inc. ("Lavalife"), a leading provider of
online and IVR-based interactive personals services. Lavalife will operate as a
wholly-owned subsidiary of MemberWorks. The purchase price, excluding fees and
expenses, was CAD$152.5 million, or $116.3 million, and is subject to certain
adjustments. The acquisition was funded with cash on hand and borrowings under
the Company's $45.0 million senior secured credit facility. The acquisition will
be accounted for under the purchase method of accounting.
23
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
On April 13, 2004, MemberWorks issued $150.0 million in aggregate principal
amount of 9.25% Senior Notes due 2014. These Senior Notes were sold at 98.418%
of the principal amount which results in an effective rate of 9.5%. Interest is
payable in cash semi-annually in arrears on April 1 and October 1 of each year,
with the first payment due on October 1, 2004. A portion of the proceeds from
the offering of these Senior Notes was used to repay amounts borrowed under the
senior secured credit facility to fund a portion of the Lavalife acquisition.
The Company intends to use the remaining proceeds for general corporate
purposes, including working capital, future acquisitions and purchases of
MemberWorks' common stock under the Company's stock buyback program to the
extent permitted under the indenture governing the Senior Notes and the senior
secured credit facility. The offering was made solely by means of a private
placement to qualified institutional buyers pursuant to Rule 144A under the
Securities Act of 1933, as amended, and to certain persons in offshore
transactions pursuant to Regulation S under the Securities Act. The Senior Notes
have not been registered under the Securities Act and may not be offered or sold
in the United States, or to a U.S. person, absent registration or an applicable
exemption from registration requirements.
Subsequent to the of acquisition of Lavalife and the issuance of the senior
notes discussed above, the Company believes that existing cash balances,
together with funds available under its senior secured credit facility, will be
sufficient to meet its funding requirements for the foreseeable future.
The Company did not have any material commitments for capital expenditures as of
March 31, 2004. The Company intends to utilize its existing cash balances, cash
generated from operations and cash generated from the issuance of the senior
notes to fulfill any capital expenditure requirements for the remainder of
fiscal 2004.
COMMITMENTS
The Company is not aware of any factors that are reasonably likely to adversely
affect liquidity trends, other than the risk factors presented in the Forward
Looking Statements in this Form 10-Q filing. The Company does not have
off-balance sheet arrangements, non-exchange traded contracts or material
related party transactions.
Future minimum payments of contractual obligations as of March 31, 2004 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 $ 22,190 $ 6,042 $ 8,481 $ 4,764 $ 2,903
Capital leases 1,269 309 710 250 -
Convertible notes payable 90,000 - - - 90,000
Other long-term obligations 20 20 - - -
-------------- ------------- -------------- -------------- ---------------
Total payments due $ 113,479 $ 6,371 $ 9,191 $ 5,014 $ 92,903
============== ============= ============== ============== ===============
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.
On March 4, 2004, MemberWorks announced it entered into an agreement to acquire
Lavalife. On April 1, 2004, MemberWorks completed its acquisition of all of the
assets and outstanding capital stock of Lavalife. The purchase price, excluding
fees and expenses, was CAD$152.5 million, or $116.3 million, and is subject to
certain adjustments. The acquisition was funded with cash on hand and borrowings
under the Company's $45.0 million senior secured credit facility. The
acquisition will be accounted for under the purchase method of accounting.
24
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which was revised in December 2003. FIN
46 clarifies the application of Accounting Research Bulletin No. 51 and provides
guidance on the identification of and reporting for variable interest entities.
FIN 46 is effective immediately for variable interest entities formed after
January 31, 2003 and is effective for periods ending after March 15, 2004 for
any variable interest entity formed prior to February 1, 2003. The adoption of
FIN 46 did not have a material impact on the Company's financial statements.
In May 2003, the FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity "
("SFAS 150"). This statement requires that certain financial instruments that
were accounted for as equity under previous guidance be classified as
liabilities in statements of financial position. SFAS 150 is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. The adoption of SFAS 150 did not have a material impact on the
Company's financial statements.
25
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements that are
based on current expectations, estimates, forecasts and projections about the
industry in which MemberWorks operates and the Company's management's beliefs
and assumptions. These forward-looking statements include statements that do not
relate solely to historical or current facts and can be identified by the use of
words such as "believe," "expect," "estimate," "project," "continue" or
"anticipate." These forward-looking statements are made pursuant to safe harbor
provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are not guarantees of future performance and are
based on a number of assumptions and estimates that are inherently subject to
significant risks and uncertainties, many of which are beyond our control,
cannot be foreseen and reflect future business decisions that are subject to
change. Therefore, actual outcomes and results may differ materially from what
is expressed or forecasted in such forward-looking statements. Among the many
factors that could cause actual results to differ materially from the
forward-looking statements are:
o higher than expected membership cancellations or lower than expected
membership renewal rates;
o changes in the marketing techniques of credit card issuers;
o increases in the level of commission rates and other compensation required
by marketing partners to actively market with MemberWorks;
o potential reserve requirements by business partners such as the Company's
credit card processors;
o unanticipated termination of marketing agreements;
o the Company's ability to integrate acquired businesses into the Company's
management and operations and operate successfully;
o the extent to which MemberWorks can continue to successfully develop and
market new products and services and introduce them on a timely basis;
o unanticipated changes in or termination of the Company's ability to process
membership fees through third parties, including credit card processors and
bank card associations;
o the Company's ability to develop and implement operational and financial
systems to manage growing operations;
o the Company's ability to recover from a complete or partial system failure
or impairment, other hardware or software related malfunctions or
programming errors;
o the degree to which the Company is leveraged;
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 further changes in the already competitive environment for the Company's
products or competitors' responses to the Company's strategies;
o changes in the growth rate of the overall U.S. economy, or the
international economy where MemberWorks does business, such that credit
availability, interest rates, consumer spending and related consumer debt
are impacted;
o additional government regulations and changes to existing government
regulations of the Company's industry, including the Federal Trade
Commission's 2003 Amendment to its Telemarketing Sales Rule which creates a
national do-not-call list;
o the Company's ability to compete with other companies that have financial
or other advantages;
o adverse movement in foreign exchange rates;
o the Company's ability to attract and retain active members and users;
o adverse results of litigation or regulatory matters; and
o new accounting pronouncements.
Many of these factors are beyond MemberWorks' control, and, therefore, its
business, financial condition, results of operations and cash flows may be
adversely affected by these factors.
MemberWorks cautions that such factors are not exclusive. All of the
forward-looking statements made in this Quarterly Report on Form 10-Q are
qualified by these cautionary statements and readers are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of the
date of this Quarterly Report on Form 10-Q. Except as required by law,
MemberWorks does not have any intention or obligation to publicly update any
forward-looking statements, whether as a result of new information, future
events or otherwise.
26
MEMBERWORKS INCORPORATED
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
As of March 31, 2004, the Company has a senior secured credit facility that
allows borrowings of up to $45.0 million. Borrowings under the senior secured
credit facility accrue interest at either the Eurodollar rate, or the higher of
the Prime rate or the Federal Funds rate, plus an applicable margin. There were
no borrowings outstanding under this senior secured credit facility as of March
31, 2004. As of March 31, 2004, the availability under the senior secured credit
facility was reduced by an outstanding letter of credit of $5.5 million and
pursuant to the completion of the issuance of the Senior Notes on April 13,
2004, the availability under the senior secured credit facility have been
further reduced by one years worth of interest on the Senior Notes. As of April
29, 2004, the availability under the senior secured credit facility is
approximately $25.6 million. In addition, the Company has $90.0 million
aggregate principal amount of 5.5% convertible senior subordinated notes due
September 2010. The Convertible Notes bear interest at the rate of 5.5% per year
payable in cash semi-annually in arrears on April 1 and October 1 of each year.
The first payment was due on April 1, 2004. Management believes that an increase
in the Prime 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 25,
2005, 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 Risk
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.
In connection with the acquisition of Lavalife, MemberWorks employed policies
and procedures to manage foreign currency risks associated with the purchase
price, which was denominated in Canadian dollars. MemberWorks' objective in
managing its exposure to foreign currency exchange rate fluctuations was to
reduce the impact of adverse fluctuations on cash flows associated with foreign
currency exchange rate changes. Accordingly, MemberWorks utilized foreign
currency option contracts and forward contracts to hedge its exposure related to
the Lavalife acquisition.
MemberWorks monitors its foreign currency exchange exposures to ensure the
overall effectiveness of its foreign currency hedge positions. However, there
can be no assurance that MemberWorks' foreign currency hedging activities will
substantially offset the impact of fluctuations in currency exchange rates on
its results of operations and financial position.
Market Risk
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, 2004. 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.
27
MEMBERWORKS INCORPORATED
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures.
The Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of the Company's disclosure controls and procedures (as defined
under Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this
report and have concluded that the Company's disclosure controls and procedures
were effective. The Company's disclosure controls and procedures are designed to
ensure that material information relating to MemberWorks and its consolidated
subsidiaries that is required to be disclosed in its reports under the Exchange
Act is accumulated and communicated to the chief executive officer and chief
financial officer.
Notwithstanding the foregoing, although there can be no assurance that the
Company's disclosure controls and procedures will detect or uncover all failures
of persons within the Company and its consolidated subsidiaries to disclose
material information otherwise required to be set forth in the Company's
periodic reports, the Chief Executive Officer's and Chief Financial Officer's
evaluation concluded that they are reasonably effective to do so.
Changes in internal control over financial reporting.
During the third quarter of fiscal 2004 there were no changes in the Company's
internal control over financial reporting that could have materially affected,
or are reasonably likely to materially affect our internal control over
financial reporting.
28
MEMBERWORKS INCORPORATED
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Except as set forth below, in management's opinion, there are no significant
legal proceedings to which the Company or any of its subsidiaries is a party or
to which any of their properties are subject. The Company is involved in other
lawsuits and claims generally incidental to its business including, but not
limited to, various suits, including previously disclosed suits, brought against
the Company by individual consumers seeking monetary and/or injunctive relief
relating to the marketing of the Company's programs. In addition, from time to
time, and in the regular course of its business, the Company receives inquiries
from various federal and/or state regulatory authorities.
In March 2001, an action was instituted by plaintiff Teresa McClain against
Coverdell & Company ("Coverdell"), a wholly-owned subsidiary of the Company,
Monumental Life Insurance Company and other defendants in the United States
District Court for the Eastern District of Michigan, Southern Division. The
suit, which seeks unspecified monetary damages, alleges that Coverdell and the
other defendants violated the Michigan Consumer Protection Act and other
applicable Michigan laws in connection with the marketing of Monumental Life
Insurance Company insurance products. The complaint includes a claim that the
suit should be certified as a class action and the plaintiff has filed a motion
for class certification to which all of the defendants have filed opposing
papers regarding the same. The Court certified a class of Michigan residents.
The Court of Appeals denied the defendants' petition for leave to appeal the
certification order. The Company believes that the claims made against Coverdell
are unfounded and Coverdell and the Company will vigorously defend their
interests against this suit.
On January 24, 2003, the Company filed a motion with the Superior Court for the
Judicial District of Hartford, Connecticut to vacate and oppose the confirmation
of an arbitration award issued in December 2002. The arbitration, filed against
the Company by MedValUSA Health Programs, Inc. ("MedVal") in September 2000,
involved claims of breach of contract, breach of the duty of good faith and fair
dealing, and violation of the Connecticut Unfair Trade Practices Act ("CUTPA").
Even though the arbitrators found that MemberWorks was not liable to MedVal for
any compensatory damages, they awarded $5.5 million in punitive damages and
costs against MemberWorks solely under CUTPA. MemberWorks believes that this
arbitration award is unjustified and not based on any existing legal precedent.
Specifically, the Company is challenging the award on a number of grounds,
including that it violates a well-defined public policy against excessive
punitive damage awards, raises constitutional issues and disregards certain
legal requirements for a valid award under CUTPA. The hearing on the Company's
motion was held on February 10, 2003. On June 22, 2003, the Superior Court
denied the Company's motion to vacate the award, and the Company filed an appeal
of that decision. While the Company intends to take action to prevent the
enforcement of the award by, among other things, vigorously pursuing an appeal,
there can be no assurance that MemberWorks will be successful in its efforts.
The Company has made no provision in its financial statements for this
contingency because it believes that a loss is not probable. If the Company were
ultimately unsuccessful in this or other available appeals, and a final
non-appealable court order confirming the arbitration award is rendered, the
payment of the award could have a material adverse effect on the Company's
results of operations in the period in which the final order is entered.
On October 21, 2003, the Florida Attorney General's Office filed a civil
complaint against the Company based upon concerns that some of its past
marketing practices may have violated various consumer laws. The Company
believes that any legitimate concerns have previously been fully addressed,
including the implementation of industry-leading Best Marketing Practices and
voluntary agreements incorporating those practices, such as the nationwide
assurance agreement that the Company entered into with the State of Nebraska in
2001. The Company believes that the allegations of the complaint are unfounded
and the Company intends to vigorously defend its interests in this matter. The
Company further believes that the potential liability represented by the lawsuit
and the final resolution of this matter will not be material to the Company.
29
MEMBERWORKS INCORPORATED
PART II. OTHER INFORMATION (CONTINUED)
Item 2. Changes in Securities and Use of Proceeds and Issuer Purchases of
Equity Securities
On September 30, 2003, the Company completed the sale of $90.0 million aggregate
principal amount of 5.5% convertible senior subordinated notes due September
2010 to qualified institutional buyers pursuant to Rule 144A of the Securities
Act of 1933, as amended.
On December 3, 2003, MemberWorks filed on Form S-3 a shelf registration
statement with the Securities and Exchange Commission covering the Convertible
Notes and the common stock issuable upon their conversion, which was declared
effective on April 9, 2004.
The following table summarizes the shares of MemberWorks' equity securities
purchased by or on behalf of MemberWorks:
(c) Total Number of (d) Maximum Number
Shares Purchased as of Shares that May
Part of Publicly Yet be Purchased
(a) Total Number (b) Average Price Announced Plans or Under the Plans or
Period of Shares Purchased Paid per Share Programs (1) Programs
------------------------------------------------------------ -------------------- --------------------- --------------------
January 1, 2004 to January 31, 2004 96,800 $29.36 96,800 1,403,607
February 1, 2004 to February 29, 2004 75,400 $34.88 75,400 1,328,207
March 1, 2004 to March 31, 2004 11,600 $33.68 11,600 1,316,607
-------------------- -------------------- --------------------- --------------------
Total 183,800 $31.90 183,800 1,316,607
==================== ==================== ===================== ====================
(1) The Board of Directors authorized during fiscal 2004 the following share
amounts to be purchased under the Company's stock buyback program:
July 2003 - authorized an additional 1,000,000 shares, no expiration
September 2003 - authorized an additional 1,000,000 shares, no
expiration January 2004 - authorized an additional 1,000,000 shares, no
expiration
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
14 Code of Conduct
31.1 Rule 13a-14(a) CEO Certification.
31.2 Rule 13a-14(a) CFO Certification.
32.1 CEO Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 CFO Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
a) Reports on Form 8-K
On January 27, 2004, the Company furnished on Form 8-K under Item 7 "Financial
Statements and Exhibits" and Item 12 "Results of Operations and Financial
Condition" a press release announcing fiscal year 2004 second quarter results.
On March 3, 2004, the Company filed on Form 8-K under Item 5 "Other Events" and
Item 7 "Financial Statements and Exhibits" a press release announcing an
agreement to acquire Lavalife Inc.
On March 26, 2004, the Company filed on form 8-K under Item 7 "Financial
Statements and Exhibits" and Item 9 "Regulation FD" financial and other
information pertaining to the offering of $150.0 million aggregate principal
amount of Senior Notes and the acquisition of Lavalife Inc.
On March 26, 2004, the Company filed on form 8-K under Item 5 "Other Events" and
Item 7 "Financial Statements and Exhibits" a press release announcing the
offering of $150.0 million of Senior Notes pursuant to Rule 144A of the
Securities Act of 1933.
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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, 2004 By: /s/ Gary A. Johnson
---------------------------------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
May 14, 2004 By: /s/ James B. Duffy
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James B. Duffy, Executive Vice President and
Chief Financial Officer (Principal Financial
and Accounting Officer)
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