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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, 1998
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 18, 1998 was $146,790,122. 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 18, 1998 was
15,570,187.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Proxy Statement for the 1998 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, a Delaware Corporation organized in 1996, and doing
business as CardMember Publishing Corporation since 1989, 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. MemberWorks believes, based on
its senior management's extensive knowledge of the industry and its
relationships with leading consumer - driven organizations such as banks, credit
card issuers, retailers, mortgage companies and telecommunications providers,
that it is a leading designer and provider of innovative membership service
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 a 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. However, the Company
continues to expand its distribution channels and now markets its programs
through arrangements with mortgage companies and telecommunication providers as
well.
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 $680 billion in 1997. 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 client
organizations 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 twelve membership service programs, which combined had
approximately 3.5 million members as of June 30, 1998, 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, ranged from approximately $50 per year to
approximately $120 per year during fiscal 1998. The Company can create
customized service programs for clients based on elements of its standard
programs. Currently, the Company markets the following twelve 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.
- - SmartSource(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.
- - 24Protect(SM) is designed to protect the member and their families
with a variety of toll-free services including a nurse hotline,
emergency home repairs, and roadside assistance.
- - CardMember Protection Service(SM) offers credit card registration
including one call stop notices, emergency cash and airline tickets
and $500 fraud reimbursement.
- - Coverdell/Monumental General Life and Accident Insurance includes low
limit and high limit life insurance, accidental death, accidental
injury and hospital indemnity insurance.
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. Currently, during the course
of an initial annual membership term or renewal term, a
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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.
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, personal computer programs and personal protection
services. 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 AND MEMBERLINK 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 expanded how it delivers its membership service programs through
its wholesale and MemberLink(SM) programs. For wholesale programs, 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. Similarly, the Company's MemberLink(SM)
programs also serve as a more efficient and cost effective way to acquire
members. The Company has agreements with its clients to utilize the client's
inbound call center to market its products. Under these arrangements, inbound
callers to a client, meeting certain criteria, are offered the Company's
membership service programs by the client's service representative or by a
MemberWorks membership service representative through a call transfer. In 1998
approximately 6% of the Company's revenues came from wholesale and
MemberLink(SM) programs.
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 420 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.
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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 thereby allowing 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 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 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 discounted 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 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 its clients. 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 offered by the Company. MemberWorks
seeks to build upon its existing customer relationships by integrating and
cross-selling its different membership service programs.
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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 over 50 credit card issuer clients to whom
it is obligated to pay royalties, including 17 of the top 25 issuers of bank
credit cards, three of the top five issuers of oil company credit cards and
three of the top five issuers 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 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.
Through acquisition, the company has added consumer checking accounts
as a distribution channel. The Company's subsidiary, Coverdell & Company
("Coverdell"), markets insurance and investment products to checking account
customers through its relations with major financial institutions.
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 upon first obtaining client
approval.
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 21.9%, 13.9%, and 13.7% of the Company's revenues for the
year ended June 30, 1998 were attributable to members solicited from the
customer lists provided by Sears, Capital One, and First USA, 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. For example, 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. Additionally, 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 deemed by them to be "unfair or
deceptive acts or practices." Further, some states have enacted laws and others
are considering enacting laws targeted directly at regulating 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
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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
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's competitors, including
large retailers, travel agencies, insurance companies, financial service
institutions and Cendant Corporation, some of which have substantially larger
customer basis and greater financial and other resources than the Company,
offer membership programs which provide services similar to, or which directly
compete with, those provided by the Company. To date, the Company has
effectively competed with its competitors. However, there can be no assurance
that the Company's competitors will not increase their emphasis on programs
similar to those offered by the Company to more directly compete with the
Company, or 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 or that new
competitors will not enter the market, or that other businesses will not
themselves introduce competing programs. Such 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. Additionally, 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.
EMPLOYEES
As of June 30, 1998, the Company employed 661 persons on a full-time
basis and 125 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, Atlanta, Georgia,
Omaha, Nebraska and Houston, Texas. The Stamford office serves as the Company's
headquarters. The Atlanta office serves as the corporate offices for
Coverdell & Company, a wholly-owned subsidiary of the Company. 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 .... 72,130 2006
Atlanta, GA ..... 13,692 2002
Omaha, NE ....... 58,207 1998 through 2000
Houston, TX ..... 41,591 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. 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.
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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, 1998.
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 30,1998:
First Quarter 22 3/8 16
Second Quarter 22 1/8 16 5/8
Third Quarter 30 3/8 20
Fourth Quarter 32 1/2 25 7/16
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 18, 1998, there were 40,000,000 shares of Common Stock
authorized of which 15,570,187 shares of Common Stock were outstanding, held of
record by approximately 2,100 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 June 30, 1998, the net proceeds of the offering
were used as follows (in thousands):
Acquisitions of other businesses $5,524
Purchase and installation of machinery and equipment $6,916
Repayment of indebtedness $2,818
Working Capital $4,264
------
$19,522
=======
The remaining $16,878,000 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 person owning ten percent or more of any
class of equity securities of the issuer; and to affiliates of the issuer.
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Item 6. Selected Financial Data
The selected consolidated statements of operations data for each of the
years ended June 30, 1994, 1995, 1996, 1997, and 1998 and the selected
consolidated balance sheet data as of June 30, 1994, 1995, 1996, 1997, and 1998
set forth below are derived from the consolidated financial statements of the
Company, which have been audited by PricewaterhouseCoopers 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 30,
------------------------------------------------------------------------
1994 1995 1996 1997 1998
-------- -------- -------- -------- --------
(In thousands, except per share data)
CONSOLIDATED STATEMENTS OF
OPERATIONS DATA:
Revenues ................................. $ 25,830 $ 41,547 $ 57,012 $ 79,174 $120,834
Total expenses ........................... 31,846 52,279 62,259 83,032 117,749
-------- -------- -------- -------- --------
Net (loss)/income ........................ $ (6,016) $(10,732) $ (5,247) $ (3,858) $ 3,085
======== ======== ======== ======== ========
Basic (loss)/earnings per share .......... $ (0.64) $ (1.14) $ (0.49) $ (0.35) $ 0.21
======== ======== ======== ======== ========
Diluted (loss) earnings per share ........ $ (0.64) $ (1.14) $ (0.49) $ (0.35) $ 0.19
======== ======== ======== ======== ========
Weighted average common shares outstanding 9,768 9,953 11,956 13,901 14,837
======== ======== ======== ======== ========
Weighted average common shares and common
equivalent shares outstanding ............ 9,768 9,953 11,956 13,901 16,381
======== ======== ======== ======== ========
June 30,
----------------------------------------------------------------------------
1994 1995 1996 1997 1998
--------- --------- --------- --------- ---------
(In thousands)
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents ...... $ 2,566 $ 5,323 $ 4,312 $ 40,758 $ 35,933
Working capital (deficit) ...... (11,065) (13,410) (18,977) 7,731 (5,978)
Total assets ................... 23,823 29,726 41,927 84,423 133,929
Long-term obligations .......... 3,731 8,065 1,089 438 69
Redeemable preferred stock ..... 6,096 10,926 20,487 -- --
Shareholders' equity (deficit) . (18,627) (30,367) (36,332) 14,030 29,080
Item 7. 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 generally 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.
On September 1, 1998, the Company issued a press release that stated it
had contacted the Securities and Exchange Commission ("SEC") to determine
whether the SEC staff's view regarding the timing of revenue recognition for
companies such as MemberWorks Incorporated that sell services has changed in the
wake of Cendant Corporation's agreement (announced on August 27, 1998) with the
SEC to modify its revenue recognition practices. The Company had requested the
SEC staff to comment on and has provided the SEC staff with
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information demonstrating the continued appropriateness of its revenue
recognition practices. The Company has consistently followed these
practices in accordance with generally accepted accounting practices and with
the concurrence of PricewaterhouseCoopers LLP, its independent accountants. As a
result of this review and several discussions with the SEC staff, the staff
has not objected to the Company's decision to presently continue to follow its
revenue recognition practices, as described above. The SEC staff did request
the Company to change its method of accounting for printing and mailing of
membership materials, beginning as of July 1, 1998. The Company will record the
cumulative effect of this change in accounting principle in the first quarter
of fiscal 1999. See footnote 12 on page F-13 for a description of the change
and its financial impact.
On September 28, 1998, the SEC issued a press release and stated the
"SEC will formulate and augment new and existing accounting rules and
interpretations covering revenue recognition, restructuring reserves,
materiality, and disclosure;" for all publicly-traded companies. Until such time
as the SEC staff issues such interpretative guidelines, it is unclear what, if
any, impact such interpretative guidance will have on the Company's current
accounting practices. However, the potential changes in accounting practice
being considered by the SEC staff could have a material impact on the manner in
which the Company recognizes revenue. Any such changes would have no effect on
reported cash flow or the economic value of the Company's memberships.
On April 2, 1998, the Company acquired all of the outstanding common
stock of Coverdell & Company, Inc. ("Coverdell") for $18.4 million. Coverdell is
a marketer of insurance and investment products. The transaction was accounted
for as a purchase and accordingly the assets and liabilities at June 30, 1998
and results of operations from the date of acquisition associated with the
acquired business have been included in the Company's financial position and the
results of operations. On May 14, 1998, the Company purchased a minority
interest in ConsumerInfo.Com for $1.6 million in cash. ConsumerInfo.Com is a
privately held, on-line provider of credit monitoring membership programs. This
transaction has been accounted for as an investment under the cost method.
FISCAL 1998 COMPARED TO FISCAL 1997
REVENUES. Revenues increased 53% to $120.8 million in 1998 from $79.2
million in 1997 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 3.5 million members at June 30, 1998 from 2.0 million members at
June 30, 1997. Excluding the impact of the Coverdell acquisition, revenue
increased 47% to $116.0 million in 1998 and the Company's membership base
increased to 2.9 million in 1998. 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 1997 and 1998. 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 $50.6
million in 1998 from $33.4 million in 1997. As a percentage of individual
membership revenues, these amounts represented 44% in 1998 and 43% in 1997. In
the second half of fiscal 1998 the Company refined its estimate of its program
specific provision for cancellations to reflect more current experience. The
effect of this refinement was to increase revenues and net income by
approximately $1,000,000 and $750,000, respectively.
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
47% to $24.6 million in 1998 from $16.8 million in 1997. As a percentage of
revenues, operating expenses decreased to 20.4% in 1998 from 21.2% in 1997
primarily due to increased wholesale revenues.
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 40.6% to $71.6 million in
1998 from $50.9 million in 1997. 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
59.2% in 1998 from 64.3% in 1997. The decrease was primarily due to improved
member retention, an increase in the weighted average program fee, and increases
in MemberLink and wholesale revenues. In addition to marketing expenses, the
Company also monitors overall membership solicitation and other deferred costs,
which are amortized ratably over the membership period. These costs increased
51% to $94.8 million in 1998 from $62.9 million in 1997 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.
10
11
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses primarily 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 42.6% to
$23.2 million in 1998 from $16.3 million in 1997. The increase was attributable
to the cost 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 19.2% in 1998 from 20.6% in 1997. The
decrease in this percentage is due primarily to revenues increasing at a greater
rate than general and administrative expenses.
OTHER (INCOME) EXPENSE, NET. Other (income) expense, net is primarily
composed of interest income from cash and cash equivalents. Other income, net of
$1.7 million was reported in 1998 compared to other income, net of $0.9 million
reported in 1997. The increase in other income, net was due to the interest
earned on a full year of cash and cash equivalents resulting from the proceeds
of the initial public offering completed on October 23, 1997. 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.
PROVISION FOR INCOME TAXES. The Company was not required to record a
provision for income taxes for the years ended June 30, 1998 and 1997 due to tax
losses realized in those years. As of June 30, 1998, the Company had accumulated
federal net operating loss carry forwards of $56.4 million.
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 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 quarter ended June 1996 as
well as increased operating costs necessary to support the growing membership
base.
MARKETING 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 primarily due to increased
retention and an increase in the weighted average program fee. Membership
solicitation and other deferred costs, which are amortized ratably over the
membership period, 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.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses increased 37% to $16.3 million in 1997 from $11.9 million in 1996. The
increase was attributable to the cost 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, net of $0.9 million was
reported in 1997 compared to other expense, net of $0.3 million reported in
1996. The increase in other income, net was due to the interest earned on cash
and cash equivalents resulting from the proceeds of the initial public offering
completed on October 23, 1996.
11
12
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 tax
losses realized in those years.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of capital have been from the issuance of
equity securities and internally generated cash from operations. 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 $8.9 million, $7.8
million, and $1.0 thousand for the years ended June 30, 1998, 1997, and 1996,
respectively. This improvement in operating cash flow is due to several factors
including improved operating results and improved membership solicitation costs.
The Company believes that the Coverdell business will have a negative impact on
short-term operating cash flow because its member fees have been collected
monthly rather than annually, in advance.
Net cash used by investing activities increased to $10.0 million in
1998 up from $3.8 million and $2.3 million in 1997 and 1996, respectively. The
increase is primarily due to the Company's acquisition of Coverdell and its
investment in ConsumerInfo.Com, which were funded through available cash
balances. The Company purchased Coverdell on April 2, 1998 with a cash payment
of $3.9 million plus common stock and options worth $14.5 million. The Company
funded its investment in ConsumerInfo.com with a cash payment of $1.6 million.
The Company's capital expenditures were $4.6 million in 1998 compared to $3.8
million in 1997, and $2.3 million in 1996. The increased expenditures were
primarily related to computer system upgrades and software as well as office and
call center expansion. The Company expects to increase capital expenditures in
fiscal 1999 to further increase capacity of its computer systems and increase
capacity of its office facilities.
The Company's net cash used by financing activities was $3.7 million in
1998 primarily due to purchases of treasury stock compared to $32.4 million and
$1.3 million provided by financing activities in 1997 and 1996, respectively.
As discussed above, the Company completed an initial public offering in October
1996 which generated net proceeds of approximately $36.4 million. During 1998,
the Company completed the repurchase program authorized by the Board of
Directors in January 1997. On January 15, 1998, the Board of Directors
authorized the repurchase, as conditions warrant, of up to an additional 150,000
shares of the Company's Common Stock. The Company bought back 156,000 shares for
$3.5 million under these plans during fiscal 1998 compared to the purchase of
47,000 shares for $0.7 million in 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.
As of June 30, 1998, the Company had cash and cash equivalents of $35.9
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, 1998 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.
YEAR 2000 ISSUES
The Company has completed an analysis of its software and hardware to
determine if its systems are Year 2000 compliant. The Company's project to
evaluate, modify, and test its systems is substantially complete and involved
communication and testing with all of the Company's clients and vendors. This
testing has involved processing of customer files both by the Company and its
clients and vendors and the results have been positive.
The cost of the project has not been material to the Company and has
been funded through operating cash flows. The Company has expensed all costs
associated with this project as incurred.
12
13
Although management believes the Company's systems will be Year 2000
compliant, the Company has begun developing contingency plans to address any
possible system failures. Because the Company uses multiple vendors to process
its billing transactions, its external risk is mitigated as vendors may be used
interchangeably. However, there can be no assurance that these, or other
companies on which the Company relies will be timely converted or that any such
failure to convert would not have an adverse effect on the Company's systems and
operations.
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 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 and has reported net income 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
maintain profitability in the future.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
None.
Item 8. Financial Statements and Supplementary Data
The financial statements and related notes and report of independent
auditors for the Company are included following Part I, V, beginning on page
F-1, and identified in the index appearing at Item 14(a).
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.
13
14
PART IV
Item 14. Exhibits, Financial Statements, Financial Statement Schedules and
Reports on Form 8-K
(a) Index to Financial Statements and Financial Statement Schedules
Page
Report of PricewaterhouseCoopers LLP, Independent Auditors F-1
Consolidated Balance Sheets as of June 30, 1998 and 1997 F-2
Consolidated Statements of Operations for the years ended
June 30, 1998, 1997 and 1996 F-3
Consolidated Statements of Shareholders' Equity for the years ended
June 30, 1998, 1997 and 1996 F-4
Consolidated Statements of Cash Flows for the years ended
June 30, 1998, 1997 and 1996 F-5
Notes to Consolidated Financial Statements F-6
The following Financial Statement Schedule is included:
Schedule II - Valuation and Qualifying Accounts - Years ended
June 30, 1998, 1997 and 1996 F-14
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
(1) The Company filed Current Report on Form 8-K, dated April 17,
1998, reporting Item 2 ("Acquisition or disposition of
assets") event.
(2) The Company filed Current Report on Form 8-K/A, dated June 17,
1998, reporting Item 2 ("Acquisition or disposition of
assets") event, including the financial statements of
Coverdell & Company as of December 31, 1997.
(c) Exhibits:
Exhibits filed as a part of this Annual Report on Form 10-K are listed
in the Index to Exhibits immediately preceding the exhibits located at
the end of this Annual Report.
14
15
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: October 7, 1998
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 October 7, 1998
---------------------------------------------
Gary A. Johnson
By: /s/ DENNIS P. WALKER Executive Vice President and Director October 7, 1998
---------------------------------------------
Dennis P. Walker
By: /s/ JAMES B. DUFFY Senior Vice President, Chief Financial Officer October 7, 1998
---------------------------------------------
James B. Duffy
By: /s/ Stephen J. Clearman Director October 7, 1998
---------------------------------------------
Stephen J. Clearman
By: /s/ ALEC L. ELLISON Director October 7, 1998
---------------------------------------------
Alec L. Ellison
By: /s/ MICHAEL R. O'BRIEN Director October 7, 1998
---------------------------------------------
Michael R. O'Brien
By: /s/ MARC S. TESLER Director October 7, 1998
---------------------------------------------
Marc S. Tesler
15
16
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)
*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)
16
17
*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)
*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.
17
18
*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.
18 Letter re: Change in Accounting Principle.
23 Consent of PricewaterhouseCoopers LLP.
27 Financial Data Schedule.
- ---------------------------------------------------
*Previously filed.
18
19
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 28, 1998 appearing on page F-1 in this Annual Report on Form 10-K
also included the audit of Schedule II-Valuation and Qualifying Accounts. 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.
/s/ PricewaterhouseCoopers LLP
New York, New York
July 28, 1998
19
20
MEMBERWORKS INCORPORATED
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 stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
MemberWorks Incorporated and its subsidiaries at June 30, 1998 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended June 30, 1998, 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.
/s/ PricewaterhouseCoopers LLP
New York, New York
July 28, 1998
F-1
21
MEMBERWORKS INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
June 30,
---------------------------
1998 1997
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 35,933 $ 40,758
Accounts receivable 7,107 3,193
Prepaid membership materials 2,931 1,678
Prepaid expenses 1,060 284
Membership solicitation and other deferred costs 51,771 31,773
----------- -----------
Total current assets 98,802 77,686
Fixed assets, net 9,677 6,377
Intangible and other assets 25,450 360
----------- -----------
Total assets $ 133,929 $ 84,423
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term obligations $ 380 $ 724
Accounts payable 21,967 13,854
Accrued liabilities 20,680 13,904
Deferred membership fees 61,753 41,473
----------- -----------
Total current liabilities 104,780 69,955
Long-term obligations 69 438
----------- -----------
Total liabilities 104,849 70,393
----------- -----------
Commitments and contingencies (Note 5)
Shareholders' equity:
Preferred stock, $0.01 par value --
1,000 shares authorized; no shares issued -- --
Common stock, $0.01 par value --
40,000 shares authorized; 15,653 shares issued
(14,942 shares at June 30, 1997) 156 149
Capital in excess of par value 74,478 59,472
Deferred compensation (978) (1,445)
Accumulated deficit (40,073) (43,158)
Treasury stock, 377 shares at cost (221 shares at June 30, 1997) (4,503) (988)
----------- -----------
Total shareholders' equity 29,080 14,030
----------- -----------
Total liabilities and shareholders' equity $ 133,929 $ 84,423
=========== ===========
The accompanying notes are an integral part of
these consolidated financial statements.
F-2
22
MEMBERWORKS INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
For the year ended June 30,
-----------------------------------------
1998 1997 1996
------------ ------------ ------------
Revenues $ 120,834 $ 79,174 $ 57,012
Expenses:
Operating 24,610 16,762 11,623
Marketing 71,594 50,904 38,410
General and administrative 23,245 16,296 11,916
Other (income) expense, net principally interest (1,700) (930) 310
----------- ----------- -----------
Total expenses 117,749 83,032 62,259
----------- ----------- -----------
Income (loss) before income taxes 3,085 (3,858) (5,247)
Provision for income taxes -- -- --
----------- ----------- -----------
Net income (loss) $ 3,085 $ (3,858) $ (5,247)
=========== =========== ===========
Earnings per share:
Basic $ 0.21 $ (0.35) $ (0.49)
=========== =========== ===========
Diluted $ 0.19 $ (0.35) $ (0.49)
=========== =========== ===========
Weighted average common shares used in earnings per share calculations:
Basic 14,837 13,901 11,956
=========== =========== ===========
Diluted 16,381 13,901 11,956
=========== =========== ===========
The accompanying notes are an integral part of
these consolidated financial statements.
F-3
23
MEMBERWORKS INCORPORATED
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
Capital in
Common Stock Excess of Deferred Accumulated Treasury
Shares Amount Par Value Compensation Deficit Stock Total
-------- -------- --------- ------------ ------------ ----------- ------------
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
For the year ended June 30, 1998:
Issuance of common stock 711 7 15,006 15,013
Acquisition of treasury stock (3,515) (3,515)
Deferred compensation 467 467
Net income 3,085 3,085
-------- -------- --------- ------------ ------------ ----------- ------------
Balance - June 30, 1998 15,653 $ 156 $ 74,478 $ (978) $ (40,073) $ (4,503) $ 29,080
======== ======== ========= ============ ============ =========== ============
The accompanying notes are an integral part of
these consolidated financial statements.
F-4
24
MEMBERWORKS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
For the year ended June 30,
------------------------------------------
1998 1997 1996
------------ ------------ ------------
OPERATING ACTIVITIES
Net income (loss) $ 3,085 $ (3,858) $ (5,247)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Membership solicitation and other deferred costs (94,835) (62,929) (48,201)
Amortization of membership solicitation 74,837 56,842 43,097
and other deferred costs
Deferred membership fees 20,280 10,845 7,036
Depreciation and amortization 2,525 1,295 746
Other 514 424 469
Change in assets and liabilities:
Accounts receivable (3,319) 3,246 (5,074)
Prepaid membership materials (1,253) (613) (733)
Prepaid expenses (631) (80) (114)
Other assets (56) (31) (252)
Accounts payable 3,556 3,421 2,729
Accrued liabilities 4,227 (727) 5,545
----------- ----------- -----------
Net cash provided by operating activities 8,930 7,835 1
----------- ----------- -----------
INVESTING ACTIVITIES
Acquisition of fixed assets (4,586) (3,760) (2,264)
Business combinations, net of cash acquired
and other investments (5,446) -- (48)
----------- ----------- -----------
Net cash used in investing activities (10,032) (3,760) (2,312)
----------- ----------- -----------
FINANCING ACTIVITIES
Net proceeds from issuance of stock and warrants 505 36,573 12,887
Treasury stock purchases (3,515) (715) (175)
Payments of long-term obligations (713) (918) (7,395)
Preferred stock redemption -- (2,549) (4,000)
Debt issuance costs -- (20) (117)
Proceeds from issuance of notes payable -- -- 502
Preferred stock dividends -- -- (402)
----------- ----------- -----------
Net cash (used in) provided by financing activities (3,723) 32,371 1,300
----------- ----------- -----------
Net (decrease) increase in cash and cash equivalents (4,825) 36,446 (1,011)
Cash and cash equivalents at beginning of year 40,758 4,312 5,323
----------- ----------- -----------
Cash and cash equivalents at end of year $ 35,933 $ 40,758 $ 4,312
=========== =========== ===========
The accompanying notes are an integral part of
these consolidated financial statements.
F-5
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 cardholders 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 primarily
through credit cards. 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, 1998 and 1997 include an allowance for membership cancellations of
$16,362,000, and $11,401,000 respectively. In the second half of fiscal 1998
the Company refined its estimate of its program specific provision for
cancellations to reflect more current experience. The effect of this refinement
was to increase revenues and net income by approximately $1,000,000 and
$750,000, respectively.
Accounts receivable includes $2,033,000 and $1,220,000 of unbilled
receivables as of June 30, 1998 and 1997, 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 three clients of the Company
accounted for 21.9%, 13.9% and 13.7% of revenues, respectively for the fiscal
year ended June 30, 1998. Membership service programs sponsored by two clients
of the Company accounted for 30.7% and 13.8% of revenues, respectively, for the
fiscal year ended June 30, 1997 and 35.2% and 10.5% of revenues, respectively,
for the fiscal year ended June 30, 1996.
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
F-6
26
MEMBERWORKS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
Earnings per share
The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 128, "Earnings Per Share" ("FAS 128"). All earnings per share
amounts have been restated to conform to FAS No. 128. Basic earnings per share
is computed using the weighted average number of common shares outstanding
during the reporting period. Earnings per share assuming dilution is computed
using the weighted average number of common shares outstanding and the dilutive
effect of potential common shares outstanding, determined using the treasury
stock method. For the year ended June 30, 1998, the diluted weighted average
common shares outstanding includes 1,544,000 of dilutive stock options and
warrants. Preferred stock dividends of $980,000 and $586,000 have been deducted
from net loss for the years ended June 30, 1997 and 1996, respectively to arrive
at net loss available to common shareholders.
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 SFAS 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.
Intangible assets
Intangible assets principally include acquired member and customer
relationships and goodwill that arose in connection with the acquisition of
Coverdell & Company, Inc. Goodwill represents the excess of acquisition costs
over the fair value of net assets acquired and is amortized on a straight-line
basis over twenty years. Other acquired intangibles, except member
relationships, are recorded at cost and are amortized on a straight-line basis
over their estimated useful lives, primarily twenty years. The value of member
relationships is amortized over twenty years using an accelerated method based
on estimated future cash flows. The Company periodically reviews goodwill and
other intangibles to assess recoverability from future operations using
undiscounted cash flows. Intangible and other assets set forth in the
accompanying consolidated balance sheet as of June 30, 1998 include acquired
member and customer relationships of $10,199,000 and goodwill of $12,771,000,
net of accumulated amortization of $301,000 and $162,000, respectively, as of
June 30, 1998.
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, 1998, 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) and its related interpretations.
New accounting pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 130 "Reporting
Comprehensive Income" and No. 131 "Disclosures about Segments of an Enterprise
and Related Information". SFAS No. 130 requires the presentation of the
components of comprehensive income in a company's financial statements for
fiscal years beginning after December 15, 1997. Comprehensive income is defined
as the change in a company's equity during a financial reporting period from
transactions and other events and circumstances from nonowner sources (including
cumulative translation adjustments, minimum pension liabilities and unrealized
gains/losses on available for sale securities). SFAS No. 131 requires that
public companies report certain information about operating segments. It also
requires that public business enterprises report certain information about their
products and services, geographic areas in which they operate and major
customers. SFAS No. 131 is effective for fiscal years beginning after December
15, 1997. In the initial year of application, comparative information for
earlier years is to be restated. The adoption of these statements is not
expected to materially impact the presentation and disclosure in the Company's
financial statements.
F-7
27
MEMBERWORKS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3 - BUSINESS COMBINATIONS
Coverdell Acquisition
On April 2, 1998, the Company acquired all of the outstanding common
stock of Coverdell & Company, Inc. ("Coverdell"). The purchase price totaled
approximately $18,400,000, including $3,900,000 in cash, 448,000 shares of the
Company's common stock, with a fair value of $13,600,000, and options to acquire
93,000 shares of the Company's common stock with a fair value of $900,000. Cash
for the acquisition was funded entirely from internal cash reserves of the
Company. The acquisition was accounted for as a purchase, with the purchase
price allocated to the assets acquired and liabilities assumed based upon their
respective estimated fair values at the date of acquisition. The results of
Coverdell's operations are included in the consolidated financial statements
from the date of acquisition.
The fair values of assets and liabilities acquired, based on certain
estimates and appraisals obtained are summarized as follows (In thousands):
Current assets $ 818
Non-current assets 482
Identifiable intangible assets 10,500
Goodwill 12,933
Accounts payable and accrued liabilities (6,356)
----------
Total $ 18,377
==========
Pro Forma Results
The following unaudited pro forma results of operations for 1998 and
1997 have been prepared assuming the Coverdell acquisition had occurred as of
July 1, 1996. These pro forma results are not necessarily indicative of the
results of future operations or of results that would have occurred had the
acquisition been consummated as of that date (In thousands except per share
data).
1998 1997
---- ----
Revenues $ 131,200 $ 90,400
Net income (loss) 500 (5,200)
Basic and diluted earnings (loss) per share $0.03 ($0.43)
ConsumerInfo.Com Investment
On May 14, 1998 the Company purchased a minority interest of less than
twenty percent in ConsumerInfo.Com, a privately held, on-line provider of credit
monitoring membership programs for $1,600,000 in cash. This investment is
accounted for under the cost method of accounting.
NOTE 4--FIXED ASSETS
Fixed assets are comprised of the following at June 30, (in thousands):
1998 1997
---- ----
Computer and office equipment $ 9,940 $ 5,955
Furniture and fixtures 1,854 875
Telephone equipment 1,737 1,430
Leasehold improvements 1,196 816
-------- --------
14,727 9,076
Accumulated depreciation and amortization (5,050) (2,699)
-------- --------
$ 9,677 $ 6,377
======== ========
Depreciation and amortization expense was $1,770,000, $1,183,000, and
$614,000 for the years ended June 30, 1998, 1997 and 1996, respectively.
F-8
28
MEMBERWORKS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--LONG-TERM OBLIGATIONS
Notes payable
Notes payable are summarized as follows at June 30, (in thousands):
1998 1997
---- ----
Bank Credit Agreement $ 10 $ 10
Equipment term loans 197 633
------ ------
207 643
Less current maturities 200 446
------ ------
Long-term notes payable $ 7 $ 197
====== ======
The Bank Credit Agreement allows 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.
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 $192,000 in 1999, $6,000 in 2000 and
$2,000 in 2001.
Other (income) expense in 1998, 1997, and 1996, as shown in the
statement of operations, includes interest expense of $146,000, $303,000, and
$615,000 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 $1,640,000,
$1,213,000, and $733,000 for the fiscal years ended June 30, 1998, 1997 and
1996, respectively.
During 1996, the Company entered into capital leases for certain
computer equipment totaling $406,000 of capitalized cost. Lease amortization for
the years ended June 30, 1998, 1997 and 1996 was $137,000 , $218,000 , and
$194,000, 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,
1998 are as follows (in thousands):
CAPITAL OPERATING
FISCAL YEAR LEASES LEASES
1999 $197 $ 2,335
2000 56 2,559
2001 9 2,354
2002 -- 2,340
2003 -- 1,706
Thereafter -- 3,494
---- --------
Total minimum lease payments 262 $14,788
=======
Less--Amount representing interest 20
----
Present value of net minimum lease payments
including current maturities of $180 with
interest rates ranging from 6.9% to 10.4% $242
====
F-9
29
MEMBERWORKS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--INCOME TAXES
There was no current or deferred provision for income taxes for the
years ended June 30, 1998, 1997 and 1996. 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, 1998 and 1997
(in thousands):
1998 1997
---- ----
Benefit of net operating loss carry forward $ 22,122 $ 12,632
Deferred membership fees 6,565 8,542
Allowance for membership cancellations 5,492 3,687
Other deferred tax assets 419 428
Membership solicitation and other deferred costs (20,859) (12,312)
------- --------
Total deferred tax assets 13,739 12,977
Less: Valuation allowance (13,739) (12,977)
--------- ---------
Net deferred tax asset $ -- $ --
========= =========
The valuation allowance for deferred tax assets as of July 1, 1996 was
$11,599,000. The net change in the valuation allowance for the years ended June
30, 1998 and 1997 were increases of $762,000, and $1,378,000 respectively. At
June 30, 1998, the Company had federal net operating loss carry forwards of
$56,422,000 expiring at various dates from June 30, 2005 to June 30, 2013.
Approximately $5,832,000 of the net operating loss carry forwards are limited in
their use to the future taxable income of Coverdell. 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, 2003 available to reduce future state taxable
income.
NOTE 7--REDEEMABLE PREFERRED STOCK
As a result of the Company's initial public offering of its Common
Stock (see Note 8), there is no redeemable preferred stock outstanding as of
June 30, 1998.
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 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.
F-10
30
MEMBERWORKS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 8--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 was 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.
Stock Repurchases
During 1998, the Company completed the repurchase program authorized
by the Board of Directors in January 1997 which authorized the repurchase of
150,000 shares of the Company's common stock. On January 15, 1998, the Board of
Directors authorized the repurchase, as conditions warrant, of up to an
additional 150,000 shares of the Company's Common Stock. The Company bought
back 156,000 shares for $3.5 million under these plans during fiscal 1998
compared to the purchase of 47,000 shares for $0.7 million in 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.
NOTE 9--STOCK OPTIONS AND WARRANTS
Stock Compensation Plans
At June 30, 1998, 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 $467,000,
$424,000, and $3,000 has been recognized during 1998, 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 SFAS No. 123 "Accounting for Stock - Based Compensation", the
Company's pro forma net income (loss) would have been $1,871,000, ($4,464,000),
and ($5,356,000), for 1998, 1997, and 1996, respectively, and pro forma basic
earnings (loss) per share would have been $0.13, ($0.39), and ($0.50), for 1998,
1997, and 1996, respectively. For the year ended June 30, 1998, pro forma
diluted earnings per share would have been $0.11. The pro forma effect on fiscal
1998, 1997, and 1996 results 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, 1998, 1997 and 1996:
Dividend yield of 0%, expected volatility of 42%, risk free interest rates of
5.8% for 1998, 6.4% for 1997 and 6.7% for 1996 and expected lives of 4.5 years
for 1998, 4.8 years for 1997, and 6.3 years for 1996. The weighted-average fair
value of options granted at market value were $9.04, $4.34 and $1.32 for the
years ended June 30, 1998, 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 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 1,800,000 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.
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
F-11
31
MEMBERWORKS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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.
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 $122,000, $79,000 and $3,000 for the years
ended June 30, 1998, 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 each of the years ended June 30, 1998 and 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.
In connection with the acquisition of Coverdell on April 2, 1998 (see
Note 3), the Company substituted 93,000 options to acquire Common Stock for
options to acquire Coverdell common stock with the same terms and conditions at
an exercise price of $20.81 per share. The fair value of these options,
approximately $900,000, has been accounted for as a part of the Coverdell
purchase price.
Information with respect to options to purchase shares issued under the
plans is as follows:
1998 1997 1996
---- ---- ----
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
(Shares in thousands) SHARES PRICE SHARES PRICE SHARES PRICE
------ ----- ------ ----- ------ -----
Outstanding at beginning of year 1,649 $ 4.78 1,278 $ 2.62 652 $ 1.64
Granted at market value 257 $ 21.84 486 $ 9.88 300 $ 2.78
Granted below market value -- $ -- 43 $ 2.78 374 $ 4.12
Replaced 93 $ 20.81 -- $ -- -- $ --
Exercised (202) $ 2.30 (93) $ 1.50 -- $ 2.08
Forfeited (43) $ 11.45 (65) $ 3.83 (48) $ 1.95
--------- --------- ---------
Outstanding at end of year 1,754 $ 8.25 1,649 $ 4.78 1,278 $ 2.62
========= ========= =========
OPTIONS EXERCISABLE
OPTIONS OUTSTANDING --------------------------
NUMBER AVERAGE AVERAGE NUMBER AVERAGE
OUTSTANDING REMAINING EXERCISE OUTSTANDING EXERCISE
AT 6/30/98 LIFE (YEARS) PRICE AT 6/30/98 PRICE
---------- ------------ ----- ---------- -----
$1.27 to $1.99 240 2.5 $ 1.58 240 $ 1.58
$2.00 to $3.99 394 6.0 $ 2.61 186 $ 2.55
$4.00 to $7.99 351 8.0 $ 4.17 171 $ 4.17
$8.00 to $15.99 433 8.2 $ 9.99 91 $10.05
$16.00 to $19.99 143 9.0 $16.03 -- $ --
$20.00 and over 193 11.7 $25.76 93 $20.81
--------- ---------
1,754 7.3 $ 8.25 781 $ 5.66
========= =========
Options exercisable as of June 30, 1997 and 1996 were 630,000 and 378,000,
respectively.
F-12
32
MEMBERWORKS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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. Purchases under the plan
during fiscal 1998 were not significant.
Warrants
During fiscal 1998, warrants to acquire 57,509 shares of Common Stock
were exercised (28,121 at $0.0014 per share and 29,388 at $3.56 per share). As
of June 30, 1998, the Company had outstanding warrants to purchase an aggregate
of 198,125 shares of Common Stock with the following per share exercise prices:
26,779 at $3.56; 127,467 at $2.05; and 43,879 at $0.0014. These warrants expire
at various dates between March 1999 and August 2000.
NOTE 10--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,
1998, 1997, and 1996.
NOTE 11--STATEMENT OF CASH FLOWS
Supplemental disclosure of cash flow information (in thousands):
YEAR ENDED JUNE 30,
1998 1997 1996
--------------------------------
Cash paid during the period for interest $ 114 $ 205 $ 493
Cash paid during the period for income taxes $ -- $ 30 $ 45
Supplemental schedule of noncash investing
and financing activities:
Capital lease obligation related to
acquisition of fixed assets $ -- $ -- $ 406
Dividends accumulated on Series E, F and G
preferred stock $ -- $ 53 $ 212
Accretion of discount on Series E, F, G
and H preferred stock $ -- $ 563 $ 219
Accretion to redemption value on Series A,
B, C, and D preferred stock $ -- $ 364 $ 648
Issuance of warrants $ -- $ -- $ 200
NOTE 12--SUBSEQUENT EVENTS
Effective July 1, 1998, the Company changed its method of accounting
for printing and mailing of membership materials. Historically, the Company has
accounted for the costs of printing and mailing of membership materials by
amortizing these costs ratably over the membership period as revenue is
recognized. Effective July 1, 1998, the Company will expense these costs upon
the mailing of membership materials. The cumulative effect of this change in
accounting principle as of July 1, 1998 of $3.4 million will be recorded in the
first fiscal quarter ended September 30, 1998 as a reduction of membership
solicitation and other deferred costs and net income. If this accounting
principle had been followed in previous years net income for fiscal 1998 would
have been reduced by $603,000 ($0.04 per share) and net losses for fiscal 1997
and 1996 would have been increased by $478,000 ($0.03 per share) and $576,000
($0.05 per share), respectively.
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33
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, 1998
Allowance for cancellations .............. $ 11,401,000 $101,381,000(A) $ 96,420,000(B) $ 16,362,000
Valuation allowance for deferred
tax assets ............................ 12,977,000 $ 762,000 13,739,000
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
- ------------------
(A) Charged to balance sheet account "Deferred membership fees"
(B) Charges for refunds upon membership cancellations.
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