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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1997
Commission File No. 0-21527
MEMBERWORKS INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 06-1276882
-------- ----------
(State of Incorporation) (I.R.S. Employer
Identification No.)
680 Washington Blvd.; Suite 1100;
Stamford, Connecticut 06901
- --------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(203) 324-7635
--------------
(Registrant's telephone number,
including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock, $0.01 Par Value
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.[ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant at September 15, 1997 was $121,771,818. 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.) The
number of shares of Common Stock outstanding as of September 15, 1997 was
14,727,807.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Proxy Statement for the 1997 Annual Meeting of Stockholders of
MemberWorks Incorporated are incorporated by reference in Part III of this
report.
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PART I
Item 1. Business
BACKGROUND
MemberWorks believes, based on its senior management's extensive knowledge
of the industry and its relationships with major credit card issuers in banking,
oil and retail, that it is a leading designer and provider of innovative
membership service programs. MemberWorks designs and manages innovative
membership programs providing substantial benefits to member consumers, those
organizations offering the programs and vendors whose products and services are
offered through the programs. The Company addresses the needs of organizations
seeking to leverage the expertise of an outside provider in offering these
programs. In return for providing the Company with customer lists, the Company's
clients receive royalty payments. Clients also benefit because the programs are
designed and managed to strengthen the relationship between clients and their
customers. MemberWorks offers its programs to increasingly sophisticated
consumers seeking economy, efficiency and convenience in their purchase of
products and services. Members save time by telephonically purchasing goods and
services and obtaining useful information. Members also benefit because the
vendors agree to allow discounts on products and services not generally
available to non-members. For participating vendors, the programs provide the
opportunity to reach a large number of demographically attractive members at
minimal incremental marketing cost. The Company's programs are primarily
marketed to credit card holders through arrangements with its client
organizations including banks, retailers, major oil companies and other credit
card issuers.
Businesses which sell services and products to consumers have
substantially increased the use of direct marketing techniques to reach their
customers. The estimated total consumer sales as a result of direct marketing in
the United States were approximately $630 billion in 1996. The Company believes
that membership service programs are one of the fastest growing areas of direct
marketing. Membership service programs, if designed, marketed and managed
effectively, can be of substantial value to the consumers who become members of
such programs, to the businesses which market to consumers and to the client
organizations, such as credit card issuers, banks, insurance companies and
others, which offer the programs to their customers.
Historically, a substantial number of the businesses which utilize
membership service programs have been issuers of credit cards. More recently,
however, other businesses, including retailers, resort operators, banks,
insurance companies and non-profit organizations have also begun to offer
service programs. In many cases, these businesses lack the core competency to
successfully design, market and manage membership programs. As a result, these
businesses seek to outsource to companies which are able to apply advanced
database systems to capture, process and store consumer and market information,
are able to use their experience to provide effective programs, and are able to
realize economies of scale. In addition, businesses seeking to implement
membership service programs demand that the provider of those programs have the
expertise to continue to introduce innovative new programs and that the provider
have such resources as extensive vendor networks and experienced management
teams, in order to market programs quickly and successfully.
DESCRIPTION OF BUSINESS
The Company's nine membership service programs, which combined had
approximately 2.0 million members as of June 30, 1997, offer unique and valuable
services, information and savings opportunities. The service programs are
marketed under the name of the program on behalf of the client and are designed
and developed to capitalize on the client's existing relationship with its
customers or other constituents. In general, membership fees, which may be
payable monthly or annually depending on the program, ranged from approximately
$40 per year to approximately $107 per year during fiscal 1997. The Company can
create customized service programs for clients based on elements of its standard
programs. Currently, the Company markets the following nine programs.
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- HealthTrends(R) is a unique membership program for the health conscious
individual or family, providing convenient information and substantial
savings on quality health and personal care services and maintenance.
- The Countrywide Dental Program(R) ("CDP") consists of a network of
independent dentists in 47 states who have agreed to accept a reduced fee
schedule for subscribers in the program. CDP is not an insurance plan, but
can be used with any dental insurance program to reduce a member's insurance
co-payments.
- The Countrywide Dental and Health Program(SM) offers a combination of
benefits from the Company's Countrywide Dental Program(R) and
HealthTrends(R) services. This combined service provides members and
their families dental services at special discounted rates in addition to
substantial discounts on eyewear, pharmaceuticals, hearing aids and
chiropractic benefits.
- Travel Arrangements(SM) is a comprehensive discount travel program that
offers substantial savings and convenience on a broad range of business,
leisure, and vacation travel services.
- Connections(SM) is designed to provide savings to members on a broad range
of entertainment and leisure time activities and contains a shopping service
for substantial savings on a wide array of merchandise.
- Leisure Advantage(SM) provides discounts on many types of sports and
athletic merchandise, apparel, and services.
- MoneyMaster(SM) helps members plan for and manage their personal finances,
taxes, insurance, and retirement planning. This service complements and can
integrate some of the benefits currently offered by the Company's financial
institution clients.
- Home PC Link(SM) offers a wide range of assistance to the first time
computer purchaser as well as to existing users seeking information on
upgrading their systems and enhancements.
- Essentials(SM) offers fitness, fashion and beauty services for men and
women, through discounts on clothing, haircuts, health clubs and nutrition
counseling.
In general, members subscribe for renewable one-year memberships in the
Company's programs. When consumers agree to enroll in a program, they generally
receive a trial membership. During this time, the member may use the program's
services without obligation, as outlined in a membership brochure received by
mail along with a membership card and membership identification number. The
brochure outlines in detail the benefits which the service offers and contains
toll free numbers which may be called to access service benefits and
information. In the event that a consumer elects not to participate in the
service, he or she can call a toll free number during the trial period to cancel
the service without charge. Trial memberships are generally for a period of 30
days and there are no conditions with respect to the ability of the consumer to
terminate a trial membership. The Company does not record any revenue with
respect to trial memberships.
If the membership is not canceled during the trial period, the consumer is
charged the annual membership fee. In the event that the member does not cancel
the membership after the initial membership term, he or she generally receives a
renewal kit in the mail in advance of each membership year and is charged for
the succeeding year's membership fee. During the course of an initial annual
membership term or renewal term, a member is free to cancel a membership in the
program, generally for a complete refund of the membership fee for that period.
The Company offers its service programs to consumers through clients, such
as credit card issuers, who have an existing relationship with those consumers.
The client provides the Company with lists of consumers which the Company inputs
into its database management system to model, analyze and identify likely
members. The Company pays the client an annual royalty for initial and renewal
membership fees received by the Company from consumers provided to it by the
client. The royalties paid to clients by the Company average approximately 20%
of initial and renewal membership fees.
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The Company has developed a consultative product development process
coordinating the efforts of its sales and marketing group with those of its
client management group in order to anticipate client needs for new product
offerings. The Company's senior management works with both of these groups to
develop and refine new program concepts and then to introduce the new program.
An important factor in the Company's ability to develop innovative programs is
its emphasis on telemarketing, which allows it to obtain and analyze market
trend information quickly. The Company believes this method of product
development has allowed it to respond quickly and effectively to market demand
for new programs.
The Company believes that it was the first membership company to introduce
aggregated discount services in the areas of health, sports, fashion and beauty,
financial and personal computer programs. The Company also believes that all of
its programs are innovative with respect to the variety and quality of
particular services, discounts and other features which those programs offer. By
bundling and reconfiguring various features of its standard programs, the
Company can customize a program to the particular needs and demands of its
clients.
WHOLESALE PROGRAMS
In addition to marketing its programs directly to consumers through lists
provided by credit card issuers and other businesses and organizations, the
Company has begun to provide membership service programs on a wholesale basis.
Typically, the Company works with a wholesale client to incorporate elements
from one or more of its standard service programs in the design of a custom
program for the client. The client will then provide the membership in the
customized format to its customers as a value-added feature. The client pays the
Company the membership fees for the customers who receive the service program.
Wholesale programs substantially reduce the cost for the Company to acquire new
members, which results in higher profit margins for the Company. Accordingly,
the Company provides membership in the service program for fees which are less
than the Company's standard fees for the program. To date, substantially all of
the Company's revenues have been from individual memberships.
MEMBER SERVICE
The Company believes that providing high quality service to its members is
extremely important in order to encourage memberships and to strengthen the
affinity of those members for the client which offered the service program.
Currently, the Company maintains two call centers located in Omaha, Nebraska and
Houston, Texas, with a total of approximately 270 membership service
representatives. The Company's service centers are available to members, toll
free, 24 hours-a-day, seven days-a-week. All new membership service
representatives are required to complete a two-week classroom training course
before beginning to take calls and attend on-the-job training thereafter.
Through both its training programs, its systems and its software, the Company
seeks to provide members with friendly, rapid and effective answers to
questions. The Company also works closely with its clients' customer service
staffs to ensure that their representatives are knowledgeable in matters
relating to membership service programs offered by the Company.
TECHNOLOGY
The Company has invested substantially in advanced management information
systems to allow it to operate its business more efficiently and productively.
Accordingly, the Company has developed proprietary software that is designed to
accept its clients' customer databases for review, analysis and modeling in
order to identify likely members. The Company receives new member information
from telemarketers on a daily basis, and the system routes that data to other
Company facilities for member fulfillment and allows the Company to mail member
information kits to new members very rapidly. The system also receives
confirmation of billing data from the Company's merchant processors on a regular
basis, permitting the Company to update the status of each member, including
member profile information.
In providing quality service to its members, the Company's management
information system interacts with the Company's advanced call routing system to
prepare the Company's membership service representatives to better serve members
by displaying a member's profile prior to receiving the call. The Company's
telecommunications systems also monitor the performance quality of its
membership service representatives and other aspects of its business through
sophisticated reporting capabilities. In addition, the Company's marketing
experts use both the
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Company's proprietary systems and advanced systems from outside vendors to
review, analyze and model the demographics of lists of prospective members
supplied by clients, in order to determine which customers are most likely to
respond to an offer and retain their membership.
FULFILLMENT
In most cases the products and services offered to members through the
Company's programs are provided directly to the members by independent vendors.
The Company evaluates and engages only those vendors which can cost-effectively
deliver high quality products and services. Vendors generally benefit by gaining
significant volume demand with minimal associated marketing expense.
Accordingly, vendors gain access and marketing exposure to the Company's
membership base and, pursuant to contractual arrangements with the Company,
generally quote a discount price. The Company receives no material payments from
these vendors for rendering services to the Company's members and, in certain
cases, the Company pays its vendors a fee based on the volume of members in the
Company's program or based on other agreed upon factors.
The Company's contracts with its vendors are generally for a one year
term, with subsequent one year renewal terms at the option of the Company.
Vendors may cancel contracts with the Company but, in most cases, only for cause
and subject to notice provisions to provide the Company time to locate a
substitute vendor. Most vendor contracts are non-exclusive, but have
requirements that the vendors maintain the confidentiality of the terms of the
contract.
SALES AND MARKETING
The Company solicits members for its programs primarily by direct
marketing methods, including telemarketing, which it outsources to third party
contractors. To a lesser extent the Company uses direct mail, either as a solo
piece mailed at its own expense or at its client's expense. Some of the
Company's individual memberships are available on-line to interactive computer
users through the World Wide Web.
The Company primarily offers its programs to consumers listed in databases
provided to it by clients. The Company's proprietary software and systems permit
it to accept this information from a client in electronic form. Marketing
specialists at MemberWorks are then able to review, analyze and model the
information on the database in order to design and implement an effective
telemarketing program. In addition, the Company has recently begun to sell
service programs on a wholesale basis. Under those programs, the Company does
not pay for the marketing costs to solicit memberships. Instead, the client
offering the memberships is responsible for marketing, usually with the
assistance of the Company. In some cases, the client may provide wholesale
memberships to its customers free of charge and pay the periodic membership fee
to the Company for each customer membership. In other cases, the client may
charge a reduced fee to its customer.
The Company's sales strategy is to establish and maintain long-term
relationships with those clients who offer its programs. The Company employs a
consultative sales process to understand and define client needs and to
determine how those needs can be addressed by the membership service programs
which the Company offers. MemberWorks seeks to build upon its existing customer
relationships by integrating and cross-selling its different membership service
programs.
DISTRIBUTION
The Company arranges with client financial institutions, retailers, oil
companies and other credit card issuers to market membership programs to such
clients' individual account holders and customers. Clients generally receive
royalties on initial and renewal memberships. The Company's contracts with these
clients typically grant the Company the right to continue providing membership
services directly to such clients' individual account holders even if the client
terminates the contract, provided that the client continues to receive its
royalties. Currently, the Company has 43 credit card issuer clients to whom it
is obligated to pay royalties, including 16 of the top 25 issuers of bank credit
cards, three of the top five issuers of oil company credit cards and the leading
issuer of retail company credit cards.
The Company is also actively developing new distribution channels.
MemberLink(SM) is an arrangement where inbound callers to a client, meeting
certain criteria, are offered the Company's membership service programs
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by the client's service representative or by a MemberWorks membership service
representative through a call transfer. Access and information about several of
the Company's membership service programs are also available through client home
pages on the World Wide Web.
The Company obtains substantially all of the information necessary to the
Company's marketing efforts from customer lists supplied by its clients. Clients
provide the lists to the Company for use in marketing a single, specific program
which has been pre-approved by the client. As a result, the Company's ability to
market a new program to an existing customer base or an existing program to a
new customer base is dependent on first obtaining approval from a client.
Most client relationships are pursuant to contracts which may be
terminated by the client upon 30 to 90 days notice without cause and without
penalty. Upon such termination, the Company generally has the right to continue
its relationship with the client's customers that have become program members
for a specified period to substantially the same extent as prior to the
termination, but may not resolicit those members upon such member's cancellation
or non-renewal of the member's membership.
Approximately 30.7% and 13.8% of the Company's revenues for the year ended
June 30, 1997 were attributable to members solicited from the customer lists
provided by Sears and Capital One, respectively.
GOVERNMENT REGULATION
The primary means which the Company uses to market its programs is
telemarketing. The telemarketing industry has become subject to an increasing
amount of Federal and state regulation as well as general public scrutiny in the
past several years. The Federal Telephone Consumer Protection Act of 1991 limits
the hours during which telemarketers may call consumers and prohibits the use of
automated telephone dialing equipment to call certain telephone numbers. The
Federal Telemarketing and Consumer Fraud and Abuse Prevention Act of 1994 and
Federal Trade Commission ("FTC") regulations promulgated thereunder, prohibit
deceptive, unfair or abusive practices in telemarketing sales. Both the FTC and
state attorneys general have authority to prevent telemarketing activities that
constitute "unfair or deceptive acts or practices." Additionally, some states
have enacted laws and others are considering enacting laws targeted directly at
telemarketing practices, and there can be no assurance that any such laws, if
enacted, will not adversely affect or limit the Company's current or future
operations. Compliance with these regulations is generally the responsibility of
the Company, and the Company could be subject to a variety of enforcement or
private actions for any failure to comply with such regulations. The Company's
provision of membership programs requires the Company to comply with certain
state regulations, changes in which could materially increase the Company's
operating costs associated with complying with such regulations. The risk of
noncompliance by the Company with any rules and regulations enforced by a
Federal or state consumer protection authority may subject the Company or its
management to fines or various forms of civil or criminal prosecution, any of
which could materially adversely affect the Company's business, financial
condition and results of operations. Also, the media often publicizes perceived
non-compliance with consumer protection regulations and violations of notions of
fair dealing with consumers, and the membership programs industry is susceptible
to peremptory charges by the media of regulatory noncompliance and unfair
dealing.
COMPETITION
Competition in the membership services market for clients, such as credit
card issuers, is intense. Several of the Company's competitors offer membership
programs which provide services similar to, or which directly compete with,
those provided by the Company. Because contracts between clients and program
providers are often exclusive with respect to a particular service, potential
clients may be prohibited from contracting with the Company to promote a program
if the services provided by the Company's program are similar to, or merely
overlap with, the services provided by an existing program of a competitor. Most
of the Company's clients provide, either directly or through third parties,
programs offered by the Company's competitors, and the Company's agreement with
Sears, its principal client, permits Sears to offer its customers programs that
directly compete with those offered by the Company. Competition for new members
is also intense, particularly as the market becomes saturated with customers who
are already members of competing programs. The Company's principal competitor is
CUC International Inc. ("CUC"). The Company's other competitors include large
retailers, travel agencies,
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financial institutions and other organizations. There can be no assurance that
the Company's competitors will not increase their emphasis on programs similar
to those offered by the Company and more directly compete with the Company, that
new competitors will not enter the market, or that other businesses will not
themselves introduce competing programs.
Many of the Company's current and prospective competitors, including CUC,
have substantially larger customer bases and greater financial and other
resources than the Company. There can be no assurance that the Company's current
or potential competitors will not provide programs comparable or superior to
those provided by the Company at lower membership prices or adapt more quickly
than the Company to evolving industry trends or changing market requirements. In
addition, alliances among competitors may emerge and rapidly acquire significant
market share. Increased competition may result in price reductions, reduced
gross margins and loss of market share, any of which could materially adversely
affect the Company's business, financial condition and results of operations.
There can be no assurance that the Company will be able to compete effectively
against current and future competitors.
The Company believes that the principal competitive factors in the
membership services industry include the ability to identify, develop and offer
innovative service programs, the quality and breadth of service programs
offered, price and marketing expertise. The Company believes that its ability to
compete also depends in part on a number of competitive factors outside its
control, including the ability to hire and retain employees, the development by
others of service programs that are competitive with the Company's service
programs, the price at which others offer comparable service programs and the
extent of the Company's competitors' responsiveness to customer needs.
Providers of membership programs compete for client marketing budget
dollars with other marketing activities and, in particular, other forms of
direct marketing activities, such as direct mail. In recent years, there have
been significant advances in new forms of direct marketing, such as the
development of interactive shopping and data collection through television, the
Internet and other media. Many industry experts predict that electronic
interactive commerce, such as shopping and information exchange through the
World Wide Web, will proliferate significantly in the foreseeable future. To the
extent such proliferation occurs, it could have a material adverse effect on the
demand for membership programs. Furthermore, as the telemarketing industry
continues to grow, the effectiveness of telemarketing, which is the Company's
major means of marketing its programs, as a direct marketing tool may decrease
as a result of increased consumer resistance to telemarketing in general.
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EMPLOYEES
As of June 30, 1997, the Company employed 463 persons on a full-time basis
and 35 on a part-time basis. None of the Company's employees are represented by
a labor union. The Company believes that its employee relations are good.
Item 2. Properties
The Company leases space in Stamford, Connecticut, Omaha, Nebraska and
Houston, Texas. The Stamford office serves as the Company's headquarters. The
Omaha and Houston locations are primarily call centers for membership services
representatives, operations and telemarketing personnel. The Omaha location is
also the Company's main computer and telecommunications systems center and
contains member fulfillment and warehouse facilities.
A summary of key information with respect to the Company's leased
facilities is as follows:
Location Square Footage Year of Lease Expiration
-------- -------------- ------------------------
Stamford, CT..................... 27,550 2006
Omaha, NE........................ 54,143 1997 through 2000
Houston, TX...................... 40,631 2006
Item 3. Legal Proceedings
From time to time, the Company may be involved in litigation or in
settlement proceedings relating to claims arising out of its operations in the
normal course of business. Except as described below, the Company is not
currently a party to any legal proceedings, the adverse outcome of which,
individually or in the aggregate, could have a material adverse effect on the
Company's business, financial condition and results of operations.
On September 13, 1996, the Company and certain of its executive officers
entered into an agreement settling litigation involving a former officer of the
Company. The fulfillment of the settlement terms did not have a material impact
on the Company's business, financial condition and results of operations.
In June 1996, the Company received notice from a third party that "Money
Master" was a registered servicemark of such party and that the Company's use of
its MoneyMaster servicemark infringes such party's rights. The Company believes
that its servicemark does not infringe such party's servicemark, but there can
be no assurance that the Company will prevail in its position on this matter.
The Company has notified the other party of its position, but has not received a
response to that notification.
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Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the quarter
ended June 30, 1997.
EXECUTIVE OFFICERS OF REGISTRANT
The executive officers of registrant of the Company, and their
respective ages as of June 30, 1997, are as follows:
Name Age Position
- ---- --- --------
Gary A. Johnson 42 President and Chief Executive Officer, Director
Dennis P. Walker 52 Executive Vice President, Director
James B. Duffy 43 Senior Vice President and Chief Financial Officer
Steven H. Levenherz 53 Senior Vice President - Administration/Law
David Schachne 36 Senior Vice President - Marketing
Gary A. Johnson, a co-founder of the Company, has served as President
and Chief Executive Officer and a Director of the Company since its
inception. From 1987 to 1989, Mr. Johnson founded and served as President of
American Target Group Marketing, a marketer of membership services for
magazine publishers. From 1983 to 1987, Mr. Johnson was Vice President of
New Product Development and Marketing for CUC, a membership program services
marketing firm. From 1981 to 1983, Mr. Johnson was a Marketing Director of
the Marketing Consulting Division of General Electric. Mr. Johnson received
a B.S. from Tufts University and an M.B.A. from Harvard Business School.
Dennis P. Walker, a co-founder of the Company, has served as Executive
Vice President and a Director of the Company since its inception. Prior to
founding MemberWorks, Mr. Walker founded and served as President of Walker
Enterprises, a direct marketing and credit card merchandising business from
1978 to 1988. Mr. Walker received a B.A. from the University of Nebraska.
James B. Duffy joined the Company as Senior Vice President and Chief
Financial Officer in June 1996. Prior to joining the Company, Mr. Duffy served
in various senior financial management positions, most recently as Senior Vice
President, Business Planning, at Merck Medco Managed Care, Inc., a prescription
benefit management company, from 1986 to 1996.
Steven H. Levenherz, Senior Vice President - Administration/ Law, joined
the Company in May 1993 and, through June 1996, served as Chief Financial
Officer. Prior to joining the Company, Mr. Levenherz was an independent
consultant in financial and mergers and acquisitions matters from 1992 through
1993 and, from 1990 to 1992 he served as Chief Financial Officer at Phoenix
Partners, a merchant banking firm. From 1987 to 1990 Mr. Levenherz served as
Senior Vice President of Financial Planning at Horsehead Industries, Inc., a
leveraged buy-out company. Mr. Levenherz received a B.B.A. from the Baruch
School of the City College of New York and a J.D. from the University of North
Carolina, Chapel Hill.
David Schachne joined the Company as Senior Vice President - Marketing
in 1990. Prior to joining the Company, Mr. Schachne was Vice President of
Sleep Technologies, Inc., a manufacturer and wholesaler of home furnishing
products. Mr. Schachne received a B.A. from the State University of New
York, Albany and his M.B.A. from Harvard Business School.
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PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters
The Company completed an initial public offering of its Common Stock, par
value $0.01 per share ("Common Stock") on October 23, 1996 at an initial price
to the public of $17.00. The Common Stock is listed on the NASDAQ National
Market (NASDAQ) under the symbol MBRS. The following table sets forth for the
periods indicated the high and low closing sale prices per share as reported on
the NASDAQ.
High Low
---- ---
Fiscal Year Ended June 30,1997:
First Quarter N/A N/A
Second Quarter(October 18,1996 17 10 1/2
through December 31,1996)
Third Quarter 18 1/4 13
Fourth Quarter 18 1/2 14 3/4
As of September 15, 1997, there were 40,000,000 shares of Common Stock
authorized of which 14,727,807 shares of Common Stock were outstanding, held of
record by approximately 1,700 stockholders. The Company has not declared or paid
any cash dividends to date and anticipates that all of its earnings in the
foreseeable future will be retained for use in its business. The Company's
future dividend policy will depend on the Company's earnings, capital
requirements, financial condition, requirements of the financing agreements to
which the Company is a party and other factors considered relevant by the Board
of Directors.
The effective date of the registration statement pursuant to which the
Company conducted the public offering of its Common Stock described above was
October 18, 1996 and the file number was 333-10541. The Company filed its
initial report on Form SR on January 27, 1997 for the period ended January 18,
1997.
From the effective date of the registration statement filed in connection
with the offering to July 31, 1997, the net proceeds of the offering were used
as follows (in thousands).
Purchase and installation of machinery and equipment.......... $2,473
Repayment of indebtedness..................................... $2,818
Working Capital............................................... $2,894
------
$8,185
======
The remaining $28,215,000 of the proceeds has been invested in
short-term, highly rated money market funds, government securities and
commercial paper. Of the $2,818,000 used to repay indebtedness, $1,855,000
represented direct or indirect payments to directors, officers, general
partners of the issuer or their associates; to persons owning ten percent or
more of any class of equity securities of the issuer; and to affiliates of the
issuer.
Item 6. Selected Financial Data
The selected consolidated statements of operations data for each of the
years ended June 30, 1993, 1994, 1995, 1996, and 1997 and the selected
consolidated balance sheet data as of June 30, 1993, 1994, 1995, 1996, and 1997
set forth below are derived from the consolidated financial statements of the
Company, which have been audited by Price Waterhouse LLP. The selected
consolidated financial information of the Company is qualified by reference to
and should be read in conjunction with Item 8- "Consolidated Financial
Statements and Supplementary Data," and Item 7- "Management's Discussion and
Analysis of Financial Condition and Results of Operations" appearing elsewhere
herein.
Year Ended June,
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1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(In thousands, except per share data)
CONSOLIDATED STATEMENTS OF
OPERATIONS DATA:
Revenues from membership fees.................... $17,269 $25,830 $ 41,547 $57,012 $79,174
Total expenses................................... 21,527 31,846 52,279 62,259 83,032
------ ------- ---------- ------- -------
Net loss......................................... $(4,258) $(6,016) $ (10,732) $(5,247) $(3,858)
======= ======= ========== ======= =======
Net loss per share (a)........................... $ (0.42) $ (0.35)
======= =======
Weighted average common and common
equivalent shares outstanding (a)................ 12,741 13,901
======= =======
(a) 1996 net loss per share and weighted average shares outstanding represent
pro-forma calculations and have been adjusted to reflect as outstanding all
Common Stock and common stock equivalents issued during the twelve-month period
preceding the October 18, 1996 initial public offering of the Company's Common
Stock, using the treasury stock method and including the number of shares issued
on October 23, 1996 necessary to redeem the Series E and F Preferred Stock.
10
11
June 30,
------------------------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
(In thousands)
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents................ $ 1,017 $ 2,566 $ 5,323 $ 4,312 $40,758
Working capital (deficit)................ (4,605) (11,065) (13,410) (18,977) 7,731
Total assets............................. 13,545 23,823 29,726 41,927 84,423
Long-term obligations.................... 4,338 3,731 8,065 1,089 438
Redeemable preferred stock............... 5,216 6,096 10,926 20,487 -
Shareholders' equity (deficit)........... (12,737) (18,627) (30,367) (36,332) 14,030
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Information required by this Item is attached as Appendix A.
Item 8. Financial Statements and Supplementary Data
Information required by this Item is attached as Appendix B.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information contained in the Company's Proxy Statement under the
sections titled "Election of Directors" is incorporated herein by reference in
response to this item. Information regarding the Executive Officers of the
Company is furnished in Part I of this Annual Report on From 10-K under the
heading "Executive Officers of the Registrant".
Item 11. Executive Compensation
The information contained in the Company's Proxy Statement under the
section titled "Executive Compensation" is incorporated herein by reference in
response to this item.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information contained in the Company's Proxy Statement under the
section titled "Security Ownership of Certain Beneficial Owners and Management"
is incorporated herein by reference in response to this item.
Item 13. Certain Relationships and Related Transactions
The information contained in the Company's Proxy Statement under the
section titled "Certain Relationships and Related Transactions" is incorporated
herein by reference in response to this item.
11
12
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements
The following consolidated financial statements of MemberWorks
Incorporated are included in Appendix B attached hereto.
Consolidated Balance Sheets as of June 30, 1997 and 1996 Consolidated
Statements of Operations for the years ended June 30,
1997, 1996 and 1995
Consolidated Statements of Shareholders' Equity for the years ended
June 30, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the years ended June 30,
1997, 1996 and 1995
Notes to Consolidated Financial Statements
Report of Independent Accountants
(a) (2) Financial Statement Schedule
Report of Independent Accountants on Financial Statement Schedule 17
Schedule II - Valuation and Qualifying Accounts - Years ended June 30,
1997, 1996 and 1995 17
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions, or are inapplicable, and
therefore have been omitted.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the last quarter of the period
covered by this report.
(c) Exhibits:
Exhibits filed as a part of this Annual Report on Form 10-K are listed in
the Index to Exhibits immediately preceeding the exhibits located at the
end of this Annual Report.
12
13
MEMBERWORKS INCORPORATED
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) 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)
By: /s/ Gary A. Johnson
----------------------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
Date: September 29, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
Signature Title Date
- --------- ----- ----
By: /s/ Gary A. Johnson President, Chief Executive Officer and Director September 29, 1997
-----------------------
Gary A. Johnson
By: /s/ Dennis P. Walker Executive Vice President and Director September 29, 1997
-----------------------
Dennis P. Walker
By: /s/ James B. Duffy Senior Vice President, Chief Financial Officer September 29, 1997
-----------------------
James B. Duffy
By: /s/Stephen J. Clearman Director September 29, 1997
-----------------------
Stephen J. Clearman
By: /s/Alec L. Ellison Director September 29, 1997
-----------------------
Alec L. Ellison
By: /s/ Michael R. O'Brien Director September 29, 1997
-----------------------
Michael R. O'Brien
By: /s/ Marc S. Tesler Director September 29, 1997
-----------------------
Marc S. Tesler
13
14
Exhibit
No. Description
--- -----------
*3.1 Restated Certificate of Incorporation of the Registrant, to be filed
upon closing of this offering. (filed as Exhibit 3.3 to the Company's
Registration Statement on Form S-1, Registration No. 333-10541, filed
on October 18, 1996)
*3.2 Restated By-laws of the Registrant. (filed as Exhibit 3.4 to the
Company's Registration Statement on Form S-1, Registration No.
333-10541, filed on October 18, 1996)
*4.1 Amended and Restated Registration Rights Agreement, dated as of
September 9, 1994 between the Registrant and Brown Brothers Harriman
& Co. (filed as Exhibit 4.3 to the Company's Registration Statement
on Form S-1, Registration No. 333-10541, filed on October 18, 1996)
*4.2 Registration Rights Agreement, dated September 20, 1995 among the
Registrant and the Stockholders set forth on Schedule I thereto.
(filed as Exhibit 4.4 to the Company's Registration Statement on Form
S-1, Registration No. 333-10541, filed on October 18, 1996)
*10.1 Amended Employee Incentive Stock Option Plan. (filed as Exhibit 10.1
to the Company's Registration Statement on Form S-1, Registration
No. 333-10541, filed on October 18, 1996)
*10.2 1995 Executive Officers' Stock Option Plan. (filed as Exhibit 10.2 to
the Company's Registration Statement on Form S-1, Registration No.
333-10541, filed on October 18, 1996)
*10.3 1995 Non-Employee Directors' Stock Option Plan. (filed as Exhibit
10.3 to the Company's Registration Statement on Form S-1,
Registration No. 333-10541, filed on October 18, 1996)
*10.4 1996 Stock Option Plan. (filed as Exhibit 10.4 to the Company's
Registration Statement on Form S-1, Registration No. 333-10541, filed
on October 18, 1996)
*10.5 1996 Employee Stock Purchase Plan. (filed as Exhibit 10.5 to the
Company's Registration Statement on Form S-1, Registration No.
333-10541, filed on October 18, 1996)
*10.6 401(k) Profit Sharing Plan of the Registrant, dated April 1, 1996.
(filed as Exhibit 10.6 to the Company's Registration Statement on
Form S-1, Registration No. 333-10541, filed on October 18, 1996)
14
15
*10.7 Term Lease Master Agreement between IBM Credit Corporation and the
Registrant, dated as of November 26, 1991. (filed as Exhibit 10.7 to the
Company's Registration Statement on Form S-1, Registration No.
333-10541, filed on October 18, 1996)
*10.8 Master Lease Agreement between Bankers Leasing Association, Inc. and
the Registrant, dated as of May 7, 1996. (filed as Exhibit 10.8 to
the Company's Registration Statement on Form S-1, Registration No.
333-10541, filed on October 18, 1996)
*10.9 Amended and Restated Credit Agreement, dated as of April 8, 1996 among
the Registrant, the lender parties thereto and Brown Brothers Harriman &
Co. (filed as Exhibit 10.11 to the Company's Registration Statement on
Form S-1, Registration No. 333-10541, filed on October 18, 1996)
*10.10 Warrant Agreement dated as of September 9, 1994, between the Registrant
and Brown Brothers Harriman & Co. (filed as Exhibit 10.12 to the
Company's Registration Statement on Form S-1, Registration No.
333-10541, filed on October 18, 1996)
*10.11 Form of Warrant for the Purchase of Class A Common Stock, dated March
30, 1994. (filed as Exhibit 10.13 to the Company's Registration
Statement on Form S-1, Registration No. 333-10541, filed on October
18, 1996)
*10.12 Form of Stock Subscription Warrant, dated as of July 31, 1995. (filed
as Exhibit 10.14 to the Company's Registration Statement on Form S-1,
Registration No. 333-10541, filed on October 18, 1996)
*10.13 Form of Stock Subscription Warrant with Voting Rights, dated August
3, 1995(filed as Exhibit 10.15 to the Company's Registration
Statement on Form S-1, Registration No. 333-10541, filed on October
18, 1996)
*10.14 Form of Stock Subscription Warrant, dated August 15, 1995. (filed as
Exhibit 10.16 to the Company's Registration Statement on Form S-1,
Registration No. 333-10541, filed on October 18, 1996)
*10.15 Consulting Agreement, dated as of January 1, 1996, by and between the
Registrant, Giga Information Group, Inc. and Neill Brownstein. (filed
as Exhibit 10.19 to the Company's Registration Statement on Form S-1,
Registration No. 333-10541, filed on October 18, 1996)
*10.16 Agreement dated as of October 7, 1994 by and between Sears,
Roebuck and Co. and the Registrant. (filed as Exhibit 10.20 to the
Company's Registration Statement on Form S-1, Registration No.
333-10541, filed on October 18, 1996)
15
16
*10.17 License Agreement, dated August 1, 1990, by and between the Registrant
and Sears Roebuck and Co. (filed as Exhibit 10.21 to the Company's
Registration Statement on Form S-1, Registration No. 333-10541, filed
on October 18, 1996)
*10.18 Lease Agreement between Stamford Towers Limited Partnership and the
Registrant, dated January 15, 1996. (filed as Exhibit 10.22 to the
Company's Registration Statement on Form S-1, Registration No.
333-10541, filed on October 18, 1996)
*10.19 Business Property Lease between V and R Joint Venture and the
Registrant, dated October 4, 1995. (filed as Exhibit 10.23 to the
Company's Registration Statement on Form S-1, Registration No.
333-10541, filed on October 18, 1996)
*10.20 Arena Tower II Lease Agreement by and between Arena Tower II
Corporation and the Registrant, dated February 12, 1996, as amended.
(filed as Exhibit 10.24 to the Company's Registration Statement on
Form S-1, Registration No. 333-10541, filed on October 18, 1996)
10.21 Amendment No. 1 to Amended and Restated Credit Agreement, dated May 8,
1997 among the Registrant, the lender parties thereto and Brown
Brothers Harriman & Co.
10.23 Lease Agreement between Stamford Towers Limited Partnership and the
Registrant, dated May 20, 1997.
10.24 Second Amendment to Lease Agreement between Arena Tower II Corporation
and Registrant dated January 24, 1997.
10.25 Third Amendment to Lease Agreement between Arena Tower II Corporation
and Registrant dated July 23, 1997.
10.26 Sublease Agreement between Brenmar Marketing Company, Inc. and
Registrant dated June 23, 1997.
11 Statement re computation of per share earnings.
21 Subsidiaries of the Registrant.
23 Consent of Price Waterhouse LLP.
27 Financial Data Schedule.
- ---------------------------------------------------
*Previously filed.
16
17
Report of Independent Accountants on
Financial Statement Schedule
To the Board of Directors and Shareholders of
MemberWorks Incorporated
Our audits of the consolidated financial statements referred to in our report
dated July 29, 1997 appearing in the 1997 Annual Report to the Shareholders of
MemberWorks Incorporated (which report and consolidated financial statements are
attached as Appendix B to this Annual Report on Form 10-K) also included the
audit of the Financial Statement Schedule listed in Item 14(a) of this Form
10-K. In our opinion, this Financial Statement Schedule presents fairly, in all
material respects, the information set fourth therein when read in conjunction
with the related consolidated financial statements.
Price Waterhouse LLP
New York, New York
July 29, 1997
MEMBERWORKS INCORPORATED
Schedule II - Valuation and Qualifying Accounts
Column A Column B Column C Column D Column E
- ----------------------------------- ----------------- ---------------------------------------- ------------------- ----------------
Additions
----------------------------------------
Balance at Charged to Charged to
Beginning Costs and Other Accounts Deductions Balance at
Description of Period Expenses --Describe --Describe End Of Period
- ----------------------------------- ----------------- ------------------- -------------------- ------------------- ----------------
YEAR ENDED JUNE 30, 1997
Allowance for cancellations ...... $ 10,117,000 $ 77,853,000(A) $ 76,569,000(B) $11,401,000
Valuation allowance for deferred
tax assets .................... 11,599,000 $ 1,378,000 12,977,000
YEAR ENDED JUNE 30, 1996
Allowance for cancellations ...... 6,765,000 61,264,000(A) 57,912,000(B) 10,117,000
Valuation allowance for deferred
tax assets .................... 9,700,000 1,899,000 11,599,000
YEAR ENDED JUNE 30, 1995
Allowance for cancellations ...... 5,101,000 46,667,000(A) 45,003,000(B) 6,765,000
Valuation allowance for deferred
tax assets .................... 6,003,000 3,697,000 9,700,000
- -------------------------------------------
(A) Charged to balance sheet account "Deferred membership fees"
(B) Charges for refunds upon membership cancellations.
17
18
APPENDIX A
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
MemberWorks addresses the needs of organizations seeking to leverage the
expertise of an outside provider in offering membership service programs.
Membership service programs offer selected products and services from a variety
of vendors intended to enhance the existing relationships between businesses and
consumers. The Company derives its revenues principally from annually renewable
membership fees. The Company receives full payment of annual fees at or near the
beginning of the membership period, but recognizes revenue ratably over the
membership period. Similarly, the costs associated with soliciting each new
member, as well as the cost of royalties, printing and mailing of membership
materials are amortized ratably over the same period. 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.
FISCAL 1997 COMPARED TO FISCAL 1996
Revenues
Revenues increased 39% to $79.2 million in 1997 from $57.0 million in 1996 due
to an increase in the Company's membership base and an increase in the weighted
average program fee. The Company's membership base increased to 2.0 million
members at June 30, 1997 from 1.5 million members at June 30, 1996. The increase
in the Company's membership base was due to an increase in the members enrolled
in existing programs and the roll-out of new programs introduced in 1996 and
1997. The increase in the weighted average program fee was due to an increase in
the percentage of members enrolled in programs with higher fees. Revenues from
renewals increased to $33.4 million in 1997 from $23.3 million in 1996. As a
percentage of individual membership revenues, these amounts represented 43% in
1997 and 41% in 1996.
Operating Expenses
Operating expenses consist of costs incurred in servicing the Company's
membership base, including personnel, telephone and computer processing costs,
as well as expenses associated with the production and distribution of
membership information kits. Operating expenses increased 44% to $16.8 million
in 1997 from $11.6 million in 1996. As a percentage of revenues, operating
expenses increased to 21.2% in 1997 from 20.4% in 1996. These increases were
primarily due to the Company opening a new membership service facility in
Houston, Texas which commenced operations during the June 1996 quarter as well
as increased operating costs necessary to support the growing membership base.
Marketing Expenses
Marketing expenses consist of fees to telemarketers to solicit potential
members, royalties to clients, direct mail costs and other solicitation
expenses. Marketing expenses increased 33% to $50.9 million in 1997 from $38.4
million in 1996. The increase was due primarily to increased solicitation costs
and increased royalty expense associated with the larger membership base. As a
percentage of revenues, marketing expenses decreased to 64.3% in 1997 from 67.4%
in 1996. The decrease was due to the effect of increased retention and an
increase in the weighted average program fee. In addition to marketing expenses,
the Company also monitors the spending for membership solicitation and other
deferred costs, which is amortized ratably over the membership period. These
costs increased 31% to $62.9 million in 1997 from $48.2 million in 1996
primarily due to increased marketing efforts incurred to expand the membership
base. The Company expects these costs will continue to increase in future
periods in order to continue the expansion of the Company's membership base.
General and Administrative Expenses
General and administrative expenses consist of personnel and facilities expenses
associated with the Company's executive, sales, marketing, finance, product and
account management functions. General and administrative expenses increased 37%
to $16.3 million in 1997 from $11.9 million in 1996. The increase was
attributable to the costs incurred for additional personnel in all areas and
related facilities costs. The additional personnel were necessary to support the
Company's growth and expansion. As a percentage of revenues, general and
administrative expenses decreased to 20.6% in 1997 from 20.9% in 1996.
Other (Income) Expense, Net
Other (income) expense, net is primarily composed of interest income from cash
and cash equivalents, partially offset by financing charges relating to notes
payable, equipment leases and other debt. Other income, net of $930,000 was
reported in 1997 compared to other expense, net of $310,000 reported in 1996.
The increase in other income, net was primarily due to the interest earned on
cash and cash equivalents resulting from the proceeds of the initial public
offering completed on October 23, 1996. The Company invests in short-term,
investment-grade, interest bearing securities, and the amount of interest income
fluctuates based upon the amount of funds available for investment and
prevailing interest rates.
1
19
MEMBERWORKS INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Provision for Income Taxes
The Company was not required to record a provision for income taxes for the
years ended June 30, 1997 and 1996 due to its net operating losses. As of June
30, 1997, the Company had accumulated federal net operating loss carry forwards
of $32.0 million.
FISCAL 1996 COMPARED TO FISCAL 1995
Revenues
Revenues increased 37% to $57.0 million in 1996 from $41.5 million in 1995 due
to an increase in the Company's membership base and an increase in the weighted
average program fee. The Company's membership base increased to 1.5 million
members at June 30, 1996 from 1.1 million members at June 30, 1995. The increase
in the Company's membership base was due to an increase in the members enrolled
in existing programs and the introduction in 1996 of three new programs. The
increase in the weighted average program fee was due to an increase in the
percentage of members enrolled in programs with higher fees and an increase in
the initial and renewal fees for certain programs. Revenues from renewals
increased to $23.3 million in 1996 from $15.0 million in 1995. As a percentage
of individual membership revenues, these amounts represented 41% in 1996 and 37%
in 1995.
Operating Expenses
Operating expenses increased 20% to $11.6 million in 1996 from $9.7 million in
1995. The increase was due principally to additional costs incurred to support
the growth in the membership base, partially offset by the absence of costs
associated with the Company's discount coupon business, which was discontinued
in 1995. As a percentage of revenues, operating expenses decreased to 20.4% in
1996 from 23.4% in 1995. Excluding expenses associated with the discontinued
discount coupon business, operating expenses as a percentage of revenues in 1995
would have been 20.7%. The decrease as a percentage of revenues primarily
resulted from increased efficiencies in the Company's membership service
operations.
Marketing Expenses
Marketing expenses increased 17% to $38.4 million in 1996 from $32.8 million in
1995. The increase was due primarily to increased solicitation costs and
increased royalty expense associated with the larger membership base. As a
percentage of revenues, marketing expenses decreased to 67.4% in 1996 from 78.9%
in 1995. The decrease was due to lower per member telemarketing costs, as well
as the favorable effect of an increase in the weighted average program fee and
an increase in renewal revenues as a percentage of total revenues. Membership
solicitation and other deferred costs, which are amortized ratably over the
membership period, increased 20% to $48.2 million in 1996 from $40.2 million in
1995 primarily due to increased marketing efforts.
General and Administrative Expenses
General and administrative expenses increased 34% to $11.9 million in 1996 from
$8.9 million in 1995. The increase was the result of hiring additional personnel
at all levels and the related increase in facilities costs, partially offset by
the absence of costs associated with the Company's discount coupon business,
which was discontinued in 1995. As a percentage of revenues, general and
administrative expenses decreased to 20.9% in 1996 from 21.4% in 1995. Excluding
general and administrative expenses associated with the discontinued discount
coupon business, general and administrative expenses increased as a percentage
of revenues to 20.9% in 1996 from 18.7% in 1995. The increase as a percentage of
revenues was primarily a result of hiring additional personnel in the second
half of fiscal 1996 and a related increase in facilities costs.
Other (Income) Expense, Net
Other expense, net decreased to $310,000 in 1996 from $893,000 in 1995 as the
result of lower borrowings by the Company in 1996.
Provision for Income Taxes
The Company was not required to record a provision for income taxes for the
years ended June 30, 1996 and 1995 due to its net operating losses.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company funded operations primarily through private sales of
securities. More recently, the Company sold 2,400,000 shares of its Common Stock
in an initial public offering on October 18, 1996. Net proceeds of the offering,
after deducting underwriting discounts, commissions and offering expenses,
approximated $36.4 million. Approximately $2.5 million of the net proceeds were
utilized to redeem all outstanding shares of Series E and Series F Preferred
Stock on October 23, 1996. The Company expects to use the remainder of the net
proceeds of the initial public offering for working capital and other general
corporate purposes, including possible acquisitions.
Net cash provided by operating activities was $7.8 million and $1,000 for the
years ended June 30, 1997 and 1996, respectively, and net cash used by operating
activities was $3.5 million for the year ended June 30, 1995. This improvement
in operating cash flow is due to several factors including improved operating
results, improved membership solicitation cost ratios and improved control over
receivables and payables.
2
20
MemberWorks Incorporated
Management's Discussion and Analysis of Financial Condition and Results of
Operations
The Company's capital expenditures for 1997, 1996 and 1995 were $3.8 million,
$2.3 million and $519,000, respectively. The increased expenditures in 1997
compared to 1996 were primarily related to an upgrade of the Company's mainframe
computer system and the Company's new membership services facility opened in the
June 1996 quarter. The Company expects to have increased capital expenditures in
fiscal 1998 to increase capacity of its computer systems and increase capacity
of its services and office facilities.
The Company's net cash provided by financing activities was $32.4 million in
1997 primarily due to the initial public offering of the Company's Common Stock.
During the third quarter of fiscal 1997, the Company's Board of Directors
authorized a plan to repurchase up to 150,000 shares of the Company's Common
Stock. The Company bought back 47,000 shares for $715,000 under this plan during
the fourth quarter of 1997. The repurchased shares will be used to provide
Common Stock required for exercises of options granted by the Company under the
1996 Stock Option Plan.
Working capital at June 30, 1997 was $7.7 million compared to negative working
capital of $19.0 million at June 30, 1996. This improvement is primarily due to
the receipt of net proceeds from the initial public offering. As of June 30,
1997, the Company had cash and cash equivalents of $40.8 million. In addition,
the Company has a $7.0 million bank credit facility which bears interest at the
higher of the base commercial lending rate for the bank or the Federal Funds
Rate plus 0.5% per annum. Borrowings as of and during the year ended June 30,
1997 were not significant. Because of ongoing costs in connection with
soliciting new members, the Company expects to continue to utilize net cash
generated from operating activities, if any, to increase the Company's
membership base. The Company believes its existing cash balances, bank credit
facility and funds generated from operations will be sufficient to meet its
funding requirements for at least the next twelve months.
CERTAIN FACTORS AFFECTING FUTURE RESULTS
The preceding Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that involve risks and
uncertainties, including the statements in Liquidity and Capital Resources
regarding the adequacy of funds to meet future funding requirements. The
Company's actual results may differ significantly from the results discussed in
the forward-looking statements. A number of uncertainties exist that could
affect the Company's future operating results, including, without limitation,
the Company's history of losses, the Company's ability to retain existing
clients and attract new clients, the Company's dependence on membership
renewals, intense competition, the Company's continuing ability to develop new
programs which generate consumer interest, and general economic factors. The
Company has incurred significant operating losses since its inception. Although
the Company has experienced revenue growth in recent periods, such growth rates
may not be sustainable and are not indicative of future operating results. There
can be no assurance that the Company will achieve or maintain profitability in
the future.
3
21
APPENDIX B
FINANCIAL STATEMENTS
MemberWorks Incorporated
CONSOLIDATED BALANCE SHEETS
June 30,
(In thousands, except per share data) 1997 1996
- ------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 40,758 $ 4,312
Accounts receivable 3,193 6,439
Prepaid membership materials 1,678 1,065
Prepaid expenses 284 204
Membership solicitation and other deferred costs 31,773 25,686
- ------------------------------------------------------------------------------------------------------------------------
Total current assets 77,686 37,706
Fixed assets, net 6,377 3,261
Other assets 360 960
- ------------------------------------------------------------------------------------------------------------------------
$ 84,423 $ 41,927
- ------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term obligations $ 724 $ 991
Accounts payable 13,854 10,433
Accrued liabilities 13,904 14,631
Deferred membership fees 41,473 30,628
- ------------------------------------------------------------------------------------------------------------------------
Total current liabilities 69,955 56,683
Long-term obligations 438 1,089
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities 70,393 57,772
Redeemable preferred stock -- 20,487
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities and redeemable preferred stock 70,393 78,259
- ------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies (Note 4) -- --
Shareholders' equity:
Common stock, $0.01 par value --
40,000 shares authorized (27,630 shares at June 30, 1996);
14,942 shares issued (5,857 shares at June 30, 1996) 149 59
Capital in excess of par value 59,472 3,602
Deferred compensation (1,445) (1,400)
Accumulated deficit (43,158) (38,320)
Treasury stock, 221 shares at cost (174 shares at June 30,1996) (988) (273)
- ------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity (deficit) 14,030 (36,332)
- ------------------------------------------------------------------------------------------------------------------------
$ 84,423 $ 41,927
- ------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
1
22
MemberWorks Incorporated
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended June 30,
(In thousands, except per share data) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------------
Revenues from membership fees $ 79,174 $ 57,012 $ 41,547
Expenses:
Operating 16,762 11,623 9,702
Marketing 50,904 38,410 32,799
General and administrative 16,296 11,916 8,885
Other (income) expense, net principally interest (930) 310 893
- ------------------------------------------------------------------------------------------------------------------------
Total expenses 83,032 62,259 52,279
- ------------------------------------------------------------------------------------------------------------------------
Loss before income taxes (3,858) (5,247) (10,732)
Provision for income taxes -- -- --
- ------------------------------------------------------------------------------------------------------------------------
Net loss $ (3,858) $ (5,247) $(10,732)
- ------------------------------------------------------------------------------------------------------------------------
Net loss per share $ (0.35) $ (0.42)
- ------------------------------------------------------------------------------------------------------------------------
Weighted average common and common equivalent shares outstanding 13,901 12,741
- ------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
2
23
MemberWorks Incorporated
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Capital in
Common Stock excess of Deferred Accumulated Treasury
(In thousands) Shares Amount par value compensation deficit stock Total
- -------------------------------------------------------------------------------------------------------------------------
Balance-- June 30, 1994 5,781 $ 58 $ 1,538 $ -- $ (20,223) $ -- $ (18,627)
For the year ended June 30, 1995:
Issuance of common stock 76 1 64 65
Issuance of warrants -- --
Acquisition of treasury stock 84 (273) (189)
Preferred stock dividends and accretion (884) (884)
Net loss (10,732) (10,732)
- -------------------------------------------------------------------------------------------------------------------------
Balance-- June 30, 1995 5,857 59 1,686 -- (31,839) (273) (30,367)
For the year ended June 30, 1996:
Issuance of common stock -- -- 1 1
Issuance of warrants 515 515
Preferred stock dividends and accretion (1,234) (1,234)
Deferred compensation 1,400 (1,400) --
Net loss (5,247) (5,247)
- -------------------------------------------------------------------------------------------------------------------------
Balance-- June 30, 1996 5,857 59 3,602 (1,400) (38,320) (273) (36,332)
For the year ended June 30,1997:
Issuance of common stock 2,621 26 36,547 36,573
Acquisition of treasury stock (715) (715)
Preferred stock dividends and accretion (980) (980)
Conversion of preferred stock
into common stock 6,464 64 18,854 18,918
Deferred compensation 469 (45) 424
Net loss (3,858) (3,858)
- -------------------------------------------------------------------------------------------------------------------------
Balance-- June 30, 1997 14,942 $149 $59,472 $ (1,445) $ (43,158) $ (988) $ 14,030
- -------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
3
24
MemberWorks Incorporated
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended June 30,
(In thousands) 1997 1996 1995
- -------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net loss $ (3,858) $ (5,247) $ (10,732)
Adjustment to reconcile net loss to net cash
provided by (used in) operating activities:
Membership solicitation and other deferred costs (62,929) (48,201) (40,178)
Amortization of membership solicitation and other deferred costs 56,842 43,097 36,092
Deferred membership fees 10,845 7,036 6,569
Depreciation and amortization 1,295 746 536
Other 424 469 711
Change in assets and liabilities affecting operating cash flows:
Accounts receivable 3,246 (5,074) 659
Prepaid membership materials (613) (733) 30
Prepaid expenses (80) (114) 20
Other assets (31) (252) (40)
Accounts payable 3,421 2,729 476
Accrued liabilities (727) 5,545 2,381
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 7,835 1 (3,476)
- -------------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Acquisition of fixed assets (3,760) (2,264) (519)
Investment in and advances to joint venture -- (48) (98)
- -------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (3,760) (2,312) (617)
- -------------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Net proceeds from issuance of stock and warrants 36,573 12,887 4,012
Redemption of preferred stock (2,549) (4,000) --
Preferred stock dividends -- (402) --
Payments of long term obligations (918) (7,395) (3,749)
Purchase of treasury stock (715) (175) --
Debt issuance costs (20) (117) (273)
Proceeds from issuance of notes payable -- 502 6,860
- -------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 32,371 1,300 6,850
- -------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 36,446 (1,011) 2,757
Cash and cash equivalents at beginning of year 4,312 5,323 2,566
- -------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 40,758 $ 4,312 $ 5,323
- -------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
4
25
MemberWorks Incorporated
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1: NATURE OF BUSINESS
MemberWorks Incorporated (the "Company") is a leading provider of innovative
membership service programs. The Company addresses the needs of organizations
seeking to leverage the expertise of an outside provider in offering membership
service programs. Membership service programs offer selected products and
services from a variety of vendors intended to enhance the existing
relationships between businesses and consumers.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation-consolidation
The consolidated financial statements include the Company and its wholly owned
subsidiaries. All significant intercompany accounts and transactions have been
eliminated.
Use of estimates
The preparation of these consolidated financial statements in conformity with
generally accepted accounting principles requires management of the Company to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Fair value of financial instruments and concentration of credit risk
All current assets and liabilities are carried at cost, which approximates fair
value because of the short-term maturity of those instruments. The recorded
amounts of the Company's long-term obligations also approximate fair value.
Financial instruments which potentially subject the Company to concentration of
credit risk consist primarily of accounts receivable from financial and other
card holder based institutions (clients of the Company) whose card holders
constitute the Company's membership base. These entities include major banks,
financial institutions, large oil companies and retailers located in the United
States.
Fixed assets
Fixed assets and capital leases are carried at cost, less accumulated
depreciation and amortization. Depreciation and amortization are calculated
using the straight-line method over the lesser of the estimated productive lives
of the assets or the terms of the related leases, and range from three to ten
years. Maintenance and repair expenditures are charged to operations as
incurred.
Revenue recognition
Membership fees are billed through clients of the Company to credit card
holders. An allowance for cancellations is established based on the Company's
most recent actual cancellation experience, updated regularly. Deferred
membership fees are recorded, net of estimated cancellations, when the trial
period has elapsed, and are amortized as revenues from membership fees on a
straight-line basis, over the remainder of the membership period, generally
twelve months. Membership cancellations are charged to the allowance for
cancellations on a current basis. During an initial annual membership term or
renewal term, a member may cancel his or her membership in the program,
generally for a complete refund of the membership fee for that period. Accrued
liabilities set forth in the accompanying consolidated balance sheets as of June
30, 1997 and 1996 include an allowance for membership cancellations of
$11,401,000, and $10,117,000 respectively.
Accounts receivable includes $1,220,000 and $3,624,000 of unbilled receivables
as of June 30, 1997 and 1996, which were billed and collected subsequent to the
balance sheet date, and arise in certain instances when the Company elects to
bill subsequent to, rather than upon, acceptance of membership.
Membership service programs sponsored by two clients of the Company accounted
for 30.7% and 13.8%, respectively, of revenues from membership fees for the
fiscal year ended June 30, 1997, 35.2% and 10.5%, respectively, for the fiscal
year ended June 30, 1996 and 41.0% and 9.0%, respectively, for the fiscal year
ended June 30, 1995.
Membership solicitation and other deferred costs
Membership solicitation costs include telemarketing, printing, postage and
mailing costs related directly to membership solicitation (i.e. direct response
advertising costs). In accordance with Statement of Position 93-7, "Reporting on
Advertising Costs", direct response advertising costs are deferred and charged
to operations as revenues from membership fees are recognized. Other deferred
costs consist of royalties paid to clients, transaction processing fees, and
members' kit costs, which relate to the same revenue streams as the direct
marketing costs and are also charged to income over the membership period.
Membership solicitation costs incurred to obtain a new member generally are less
than the initial membership fee. However, if membership solicitation costs were
to exceed membership fees, an adjustment would be made to the extent of any
impairment.
5
26
Memberworks Incorporated
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Earnings per share
Earnings per share is determined by dividing the net loss, after preferred stock
dividends and accretion, by the weighted average number of common shares
outstanding during the period plus, when their effect is dilutive, common stock
equivalents.
The 1996 per share information represents pro forma earnings per share amounts.
Pro forma earnings per share is determined by dividing net loss, after adding
back preferred stock dividends paid when applicable, by the weighted average
number of common and common equivalent shares outstanding during the period.
Common stock equivalents include stock options, warrants and preferred stock
which was converted into Common Stock upon the closing of the initial public
offering of the Company's Common Stock (see Note 7). The pro forma weighted
average number of shares has been adjusted to reflect as outstanding all Common
Stock and common stock equivalents issued during the twelve month period
preceding the initial public offering of the Company's Common Stock using the
treasury stock method, as well as the number of shares which would be necessary
in order to redeem the Series E and F Preferred Stock.
Supplementary loss per share for the year ended June 30, 1997 is $0.32. The net
loss used in the calculation of supplementary loss per share is $4,395,000 for
the year ended June 30, 1997. The net loss excludes accretion related to the
Series A, B, C, D and H Preferred Stock and preferred stock dividends on Series
E and F Preferred Stock as the conversion and redemption of these securities is
assumed to have occurred at the beginning of the period. The weighted average
shares used in the calculation of supplementary earnings per share includes the
number of shares of common stock whose proceeds were to be used to retire the
Series E and F Preferred Stock as outstanding for the entire period.
Cash and cash equivalents
The Company considers highly liquid investment instruments with terms of three
months or less at the time of acquisition to be cash equivalents.
Income taxes
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109 "Accounting for Income Taxes" (FAS 109).
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.
Impairment of long-lived assets
The Company accounts for the impairment and disposition of long-lived assets in
accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of" (FAS 121). In accordance
with FAS 121, long-lived assets to be held are reviewed for events or changes in
circumstances which indicate that their carrying value may not be recoverable.
As of June 30, 1997, no impairment has been indicated.
Stock-based compensation
The Company accounts for stock option grants in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB
25). In fiscal 1997, the Company implemented the disclosure-only provisions of
SFAS No. 123, "Accounting for Stock-Based Compensation" (FAS 123). See Note 8
for the required disclosures.
Reclassification
Certain reclassifications have been made to prior period financial statements to
conform to the presentation for the financial statements for the year ended June
30, 1997.
NOTE 3: FIXED ASSETS
Fixed assets are comprised of the following (in thousands):
1997 1996
- --------------------------------------------------------------------------------
Computer and office equipment $ 7,385 $ 3,955
Furniture and fixtures 875 709
Leasehold improvements 816 113
- --------------------------------------------------------------------------------
9,076 4,777
Accumulated depreciation and amortization (2,699) (1,516)
- --------------------------------------------------------------------------------
$ 6,377 $ 3,261
================================================================================
6
27
Memberworks Incorporated
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 4: LONG-TERM OBLIGATIONS
Notes payable
Notes payable are summarized as follows (in thousands):
1997 1996
- --------------------------------------------------------------------------------
Bank Credit Agreement $ 10 $ 10
Stockholder notes payable -- 267
Equipment term loans 633 1,031
- --------------------------------------------------------------------------------
643 1,308
Less current maturities 446 675
- --------------------------------------------------------------------------------
Long-term notes payable $ 197 $ 633
- --------------------------------------------------------------------------------
The Company has a Bank Credit Agreement which allows for borrowings up to
$7,000,000. Borrowings under the facility accrue interest at the higher of the
base commercial lending rate for the bank or the Federal Funds Rate plus 0.5%
per annum. A commitment fee is charged based on the total facility at the rate
of 0.5% per annum. The credit agreement is secured by all of the Company's
assets, including the stock of its subsidiaries.
At June 30, 1996 the Company had 12.0% notes totaling $267,000 payable to two
common stockholders. The Company paid the outstanding balance of these notes
plus accrued interest with a portion of the proceeds from the initial public
offering.
The Company has several equipment term loans extending to September 2001,
secured by certain computer equipment. Interest is at rates of 7.5% to 11.6%,
and principal is repayable monthly. The aggregate amount of payments related to
the equipment term loans is $476,000 in 1998, $192,000 in 1999, $6,000 in 2000
and $2,000 in 2001.
Other (income) expense in 1997, 1996 and 1995, as shown in the statement of
operations, includes interest expense of $303,000, $615,000 and $1,018,000
respectively.
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. Rent expense under operating leases was $1,213,000, $733,000,
and $491,000 for the fiscal years ended June 30, 1997, 1996 and 1995,
respectively.
During 1996 and 1995, the Company entered into capital leases for certain
computer equipment totaling $406,000, and $68,000 respectively, of capitalized
cost. Lease amortization for the years ended June 30, 1997, 1996 and 1995 was
$63,000, $194,000 and $163,000, respectively, and is included in depreciation
and amortization expense.
The future minimum lease payments under capital leases (including present value
of net minimum lease payments) and operating leases as of June 30, 1997 are as
follows (in thousands):
Capital Operating
Fiscal Year leases leases
- -------------------------------------------------------------------------------
1998 $316 $ 1,349
1999 197 1,290
2000 56 1,274
2001 9 1,068
2002 -- 1,055
Thereafter -- 4,073
- -------------------------------------------------------------------------------
Total minimum lease payments 578 $10,109
- -------------------------------------------------------------------------------
Less-Amount representing interest 59
===============================================================================
Present value of net minimum lease payments
including current maturities of $278 with
interest rates ranging from 6.9% to 10.4% $519
================================================================================
In September 1996, the Company and certain of its executive officers entered
into an agreement settling litigation involving a former officer of the Company.
The fulfillment of the settlement terms did not have a material impact on the
Company's business, financial condition and results of operations.
NOTE 5: INCOME TAXES
There was no current or deferred provision for income taxes for the years ended
June 30, 1997, 1996 and 1995. No current provision was required because tax
losses were incurred in those years. Deferred tax assets and liabilities result
from differences in the basis of assets and liabilities for tax and financial
statement purposes. The tax effects of the basis differences and net operating
loss carry forwards, and the valuation allowance established in accordance with
FAS 109, are summarized below as of June 30, 1997 and 1996 (in thousands):
7
28
MEMBERWORKS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------
Benefit of net operating loss carry forward $ 12,632 $ 6,963
Deferred membership fees 8,542 10,602
Allowance for membership cancellations 3,687 3,361
Other deferred tax assets 428 562
Membership solicitation and other deferred costs (12,312) (9,889)
- --------------------------------------------------------------------------------
Total deferred tax assets 12,977 11,599
Less: Valuation allowance (12,977) (11,599)
- --------------------------------------------------------------------------------
Net deferred tax asset $ -- $ --
- --------------------------------------------------------------------------------
The valuation allowance for deferred tax assets as of July 1, 1995 was
$9,700,000. The net change in the valuation allowance for the years ended June
30, 1997 and 1996 were increases of $1,378,000, and $1,899,000 respectively. At
June 30, 1997, the Company had federal net operating loss carry forwards of
$32,006,000 expiring at various dates from June 30, 2005 to June 30, 2012. The
Company's ability to use these losses to offset future taxable income would be
subject to limitations under the Internal Revenue Code if certain changes in the
Company's ownership occur. The Company also has state net operating loss carry
forwards expiring at various dates through June 30, 2002 available to reduce
future state taxable income.
NOTE 6: REDEEMABLE PREFERRED STOCK
In connection with the Company's initial public offering of its Common Stock
(see Note 7), Series A, B, C, D, and H Preferred Stock were converted into
Common Stock. The difference between the recorded fair values of the Series A,
B, C, D, and H Preferred Stock and their redemption values was being accreted
using the interest method and resulted in a charge to retained earnings of
$364,000 during fiscal 1997. Approximately $2,549,000 of the proceeds from the
initial public offering were used to redeem all outstanding shares of Series E
and F Preferred Stock. The Series E and F Preferred Stock were recorded net of
discounts of $522,000 and $491,000, respectively, and were being accreted using
the interest method. The unamortized portion of the discounts were charged to
retained earnings upon redemption and amounted to $509,000. As a result of these
transactions there is no redeemable Preferred Stock outstanding as of June 30,
1997.
During fiscal 1996 the Company issued 317,150 shares of Series H Preferred Stock
for a total of $13,000,000. In addition, warrants to acquire 72,000 shares of
Common Stock at $0.0014 per share were issued in conjunction with the issuance
of Series H Preferred Stock. As a result, the recorded value of the Series H
Preferred Stock was $12,800,000, reflecting a $200,000 discount attributable to
the warrants, which was being accreted through the exercise date using the
interest method. Additionally, the Company paid $114,000 of issuance costs in
connection with this offering, which was recorded as a reduction in net
proceeds, and was being accreted to the redemption date.
On September 28, 1994, the Company issued 40,000 shares of Series G Preferred
Stock with attached warrants to acquire 288,000 shares of Common Stock for a
total of $4,000,000. On August 3, 1995, the Company redeemed 40,000 shares of
issued and outstanding Series G Preferred Stock and redeemed attached warrants
to acquire 288,000 shares of Common Stock of the Company for $4,000,000, and
also paid the investor a preferred dividend in the amount of $402,000.
Additionally, the Company substituted 113,227 warrants to acquire Common Stock,
exercisable at $0.0014 per share, in exchange for the 288,000 warrants
previously redeemed. As a result the substituted warrants issued were accounted
for at fair value of $315,000 and recorded as a charge to operations as a cost
of redeeming the Preferred Stock.
NOTE 7: SHAREHOLDERS' EQUITY
Initial Public Offering
Effective October 18, 1996, the Company sold 2,400,000 shares of its Common
Stock at $17.00 per share in an initial public offering. Net proceeds of the
offering, after deducting underwriting discounts, commissions and offering
expenses, aggregated $36,401,000. Approximately $2,549,000 of the proceeds of
the offering were used to redeem all outstanding shares of Series E and Series F
Preferred Stock. The remaining $33,852,000 in proceeds were retained for general
corporate purposes, including acquisition of new members, program development,
capital expenditures and working capital. Consummation of the initial public
offering resulted in the automatic conversion of Series A, B, C, D, and H
Preferred Stock into Common Stock.
Common Stock
In August 1996, the Company amended its certificate of incorporation to increase
the authorized number of shares of stock to 41,000,000. A total of 32,000,000
shares were designated as Common Stock, par value $0.01, 8,000,000 shares were
designated as Class A common stock, par value $0.01 and 1,000,000 shares were
designated as Preferred Stock, par value $0.01.
8
29
MEMBERWORKS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In August 1996, the Board of Directors authorized the automatic reclassification
and conversion of Class A common stock into Common Stock upon the closing of the
Company's initial public offering and the elimination of Class A common stock.
In addition, the Board of Directors authorized the automatic reclassification
and conversion of Class B common stock into Common Stock. The consolidated
financial statements have been restated to reflect the above transactions,
including the reclassification and conversion of 5,599,000 shares of Class A
common stock outstanding as of June 30, 1996 into Common Stock and the
reclassification of the 8,000,000 authorized shares designated as Class A common
stock as of June 30, 1996 into Common Stock, for all periods presented.
In September 1996, the Board of Directors approved a 7.2 for 1 stock split of
the Company's Common Stock which became effective on September 25, 1996.
Stock Repurchases
During fiscal 1997, the Board of Directors authorized the Company to purchase up
to 150,000 shares of its Common Stock, as conditions warrant, to be used in
connection with the Company's Common Stock requirements for its 1996 Stock
Option Plan. During fiscal 1997, the Company repurchased 47,000 shares of Common
Stock at a cost of $715,000.
NOTE 8: STOCK OPTIONS AND WARRANTS
Stock Compensation Plans
At June 30, 1997, the Company has five stock-based compensation plans, which are
described below. The Company applies APB Opinion 25 and related Interpretations
in accounting for its plans. Compensation expense of $424,000 and $3,000 has
been recognized during 1997 and 1996, respectively, related to its stock option
plans under APB 25. Had compensation cost for the Company's stock-based
compensation plans been determined based on the fair value at the grant dates
for awards under those plans consistent with the method of FAS No. 123, the
Company's pro forma net loss would have been $4,464,000 and $5,356,000 for 1997
and 1996, respectively, and pro forma net loss per share would have been $0.39
and $0.43 for 1997 and 1996, respectively. The pro forma effect on fiscal 1997
and 1996 net losses and per share amounts is not representative of the pro forma
effect on net income (loss) in future years because it does not take into
consideration pro forma compensation expense related to grants made prior to
July 1, 1995.
Under the stock option plans and the agreement with an executive officer
described below, the fair value of each option grant is estimated on the date of
grant using the Black-Scholes option-pricing model with the following weighted
average assumptions for the years ended June 30, 1997 and 1996: Dividend yield
of 0%, expected volatility of 42%, risk free interest rates of 6.4% for 1997 and
6.7% for 1996 and expected lives of 4.8 years for 1997 and 6.3 years for 1996.
The weighted-average fair value of options granted at market value were $4.34
and $1.32 for the years ended June 30, 1997 and 1996, respectively. The
weighted-average fair value of options granted below market value were $11.90
and $5.67 for the years ended June 30, 1997 and 1996, respectively.
The Company's 1990 Employee Incentive Stock Option Plan ("Amended 1990 Stock
Option Plan") provides for the grant of "incentive stock options" to employees
and officers of the Company and non-qualified stock options to employees,
consultants, directors and officers of the Company. On August 13, 1996 the Board
of Directors voted that no further options may be granted under the Amended 1990
Stock Option Plan effective upon the closing of the initial public offering.
During fiscal 1996, the Board of Directors and stockholders of the Company
approved the adoption of the 1995 Executive Officers' Stock Option Plan and the
1995 Non-Employee Directors' Stock Option Plan under which the Board is
authorized to grant 360,000 and 180,000 options, respectively, to acquire shares
of Common Stock at a price per share equal to or greater than fair market value
at the date of grant. Under the Executive Officers' Stock Option Plan, the Board
can determine the date on which options vest and become exercisable. Options
become exercisable over a four year period under the Non-Employee Directors'
Stock Option Plan.
During fiscal 1997, the Board of Directors approved the Company's 1996 Stock
Option Plan (the "1996 Stock Option Plan"), which became effective upon the
closing of the Company's initial public offering. The 1996 Stock Option Plan
authorizes the issuance of up to 1.8 million shares of Common Stock pursuant to
the grant to employees of incentive stock options and the grant of non-qualified
stock options to employees, consultants, officers or directors of the Company.
Under the 1996 Stock Option Plan the Board can determine the date on which
options can vest and become exercisable as well as the term of the options
granted.
9
30
MEMBERWORKS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Under the stock option plans described above, options generally become
exercisable over a four year period and expire at the earlier of termination of
employment or ten years from date of grant (eight years for grants prior to
December 31, 1995).
The Company had an agreement with an executive officer, whereby the Company was
required to grant options to purchase up to 144,000 shares of Common Stock to
the executive for achievement of certain performance goals. These options have a
stated exercise price of $2.78 per share and vest ratably over a four year
period from date of grant. The executive was granted 43,200 and 14,400 options
to purchase Common Stock in 1997 and 1996, respectively. The Company recognized
compensation expense of $79,000 and $3,000 for the years ended June 30, 1997 and
1996, respectively.
In connection with a grant of options in June 1996 to purchase 360,000 shares of
Common Stock, the Company recognized compensation expense of $345,000 during the
year ended June 30, 1997. Compensation expense is being recognized over the four
year vesting period and is measured based on the excess of the fair market value
of the Company's stock over the grant price of the options.
Information with respect to options to purchase shares issued under the plans is
as follows:
1997 1996 1995
--------------------- ------------------- ------------------
Average Average Average
Exercise Exercise Exercise
(Shares in thousands) Shares Price Shares Price Shares Price
- -------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 1,278 $2.62 652 $1.64 607 $1.43
Granted at market value 486 9.88 300 2.78 220 2.08
Granted below market value 43 2.78 374 4.12 -- --
Exercised (93) 1.50 -- 2.08 (76) 0.84
Forfeited (65) 3.83 (48) 1.95 (99) 1.89
----- ----- ---
Outstanding at end of year 1,649 $4.78 1,278 $2.62 652 $1.64
- -------------------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
------------------------------------- -------------------------
Number Average Average Number Average
Range of Outstanding Remaining Exercise Exercisable Exercise
Exercise Prices at 6/30/97 Life (Years) Price at 6/30/97 Price
- --------------------------------------------------------------------------------------------------------
$0.46 to $1.99 367 3.3 $ 1.51 347 $ 1.49
$2.00 to $3.99 451 6.2 2.59 118 2.47
$4.00 to $7.99 360 9.0 4.17 90 4.17
$8.00 and over 471 9.2 9.90 75 8.00
----- ---
1,649 7.0 $ 4.78 630 $ 2.83
- ---------------------------------------------------------------------------------------------------------
Options exercisable as of June 30, 1996 and 1995 were 378,000 and 248,000,
respectively.
10
31
MEMBERWORKS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Employee Stock Purchase Plan
During fiscal 1997, the Company adopted the 1996 Employee Stock Purchase Plan
which provides for the issuance of up to 360,000 shares of Common Stock. The
plan permits eligible employees to purchase Common Stock through payroll
deductions, which may not exceed 10% of an employee's compensation, at a price
equal to the lower of (a) 85% of the closing price of the Common Stock on the
day the purchase period commences, or (b) 85% of the closing price of the Common
Stock on the day the purchase period terminates. Because the first purchase
period under the Employee Stock Purchase Plan ends on October 1, 1997, no shares
were purchased under the Plan during fiscal 1997.
Warrants
During fiscal 1997, warrants to acquire 128,653 shares of Common Stock were
exercised (113,227 at $0.0014 per share and 15,426 at $2.05 per share). As of
June 30, 1997, the Company had outstanding warrants to purchase an aggregate of
255,634 shares of Common Stock with the following per share exercise prices:
56,167 at $3.56; 127,467 at $2.05; and 72,000 at $0.0014. These warrants expire
at various dates between March 1999 and August 2000.
NOTE 9: EMPLOYEE BENEFIT PLAN
Effective April 1, 1996 the Company adopted a 401(k) profit sharing plan.
Employees of the Company are eligible to contribute to the plan once they have
completed one year of service and attained age 18. Employees may contribute up
to 15% of their compensation subject to certain limitations. The Company may
elect to make matching contributions or profit sharing contributions to the
plan. There were no Company contributions made for the years ended June 30, 1997
and 1996.
NOTE 10: STATEMENT OF CASH FLOWS
Included in other adjustments to reconcile net loss to net cash used in
operating activities for fiscal 1995 is a charge to operations of $659,000
related to the Company discontinuing its domestic discount coupon business. The
total operating loss of this business in fiscal 1995, including the $659,000,
was $1,639,000.
Supplemental disclosure of cash flow information and noncash investing and
financing activities (in thousands):
Year ended June 30,
1997 1996 1995
- --------------------------------------------------------------------------------
Cash Flow Information:
Cash paid during the period for interest $205 $493 $896
Cash paid during the period for income taxes $ 30 $ 45 $ --
Noncash investing and financing activities:
Capital lease obligation related to
acquisition of fixed assets $ -- $406 $ 68
Dividends accumulated on Series E, F and G
preferred stock $ 53 $212 $424
Accretion of discount on Series E, F, G
and H preferred stock $563 $219 $163
Accretion to redemption value on Series A,
B, C, and D preferred stock $364 $648 $297
Issuance of warrants $ -- $200 $ --
- --------------------------------------------------------------------------------
11
32
REPORT OF INDEPENDENT ACCOUNTANTS
- --------------------------------------------------------------------------------
To the Board of Directors and Shareholders of
MemberWorks Incorporated
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of MemberWorks
Incorporated and its subsidiaries at June 30, 1997 and 1996, and the results of
their operations and their cash flows for each of the three years in the period
ended June 30, 1997, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP
Price Waterhouse LLP
New York, New York
July 29, 1997
12
33
EXHIBIT INDEX
-------------
Exhibit
No. Description
------- -----------
10.21 Amendment No. 1 to Amended and Restated Credit Agreement, dated May 8,
1997 among the Registrant, the lender parties thereto and Brown
Brothers Harriman & Co.
10.23 Lease Agreement between Stamford Towers Limited Partnership and the
Registrant, dated May 20, 1997.
10.24 Second Amendment to Lease Agreement between Arena Tower II Corporation
and Registrant dated January 24, 1997.
10.25 Third Amendment to Lease Agreement between Arena Tower II Corporation
and Registrant dated July 23, 1997.
10.26 Sublease Agreement between Brenmar Marketing Company, Inc. and
Registrant dated June 23, 1997.
11 Statement re computation of per share earnings.
21 Subsidiaries of the Registrant.
23 Consent of Price Waterhouse LLP.
27 Financial Data Schedule.