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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, 1999
Commission File No. 0-21527
MEMBERWORKS INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 06-1276882
(State of Incorporation) (I.R.S. Employer
Identification No.)
9 West Broad Street;
Stamford, Connecticut 06902
(Address of principal executive offices) (Zip Code)
(203) 324-7635
(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 July 16, 1999 was $286,254,983. 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 July 16, 1999 was 15,736,639.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Proxy Statement for the 1999 Annual Meeting of Stockholders of
MemberWorks Incorporated are incorporated by reference in Part III of this
report.
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INDEX
Page
Part I Item 1. Business 1
Item 2. Properties 7
Item 3. Legal Proceedings 7
Item 4. Submission of Matters to a Vote of Security Holders 7
Executive Officers of the Registrant 8
Part II Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters 9
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 15
Item 8. Financial Statements and Supplementary Data 15
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 15
Part III Item 10. Directors and Executive Officers of the Registrant 15
Item 11. Executive Compensation 15
Item 12. Security Ownership of Certain Beneficial Owners and Management 15
Item 13. Certain Relationships and Related Transactions 15
Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 15
Signatures 17
Exhibit listing 18
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PART I
Item 1. Business
BACKGROUND
MemberWorks Incorporated ("MemberWorks" or the "Company"), 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, retailers, telecommunications companies, mortgage
companies, direct response television companies and catalog companies, 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 minimal incremental marketing
cost. The Company's programs are primarily marketed to customers through
arrangements with its client organizations including banks, retailers, major oil
companies, telecommunications companies, mortgage companies, direct response
television companies and catalog companies.
Businesses which sell services and products to consumers have substantially
increased the use of direct marketing techniques to reach their customers.
According to the Direct Marketing Association, the estimated total consumer
sales as a result of direct marketing in the United States were approximately
$760 billion in 1998. The Company believes that membership service programs are
one of the fastest growing areas of direct marketing. Membership service
programs, if designed, marketed and managed effectively, can be of substantial
value to the consumers who become members of such programs, to the businesses
which market to consumers and to the client organizations 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, catalog companies, e-commerce providers,
banks, insurance companies and direct response television companies 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 resources such as extensive vendor networks and experienced
management teams in order to market programs quickly and successfully.
DESCRIPTION OF BUSINESS
The Company's seventeen membership service programs, which combined had
approximately 5.3 million members as of June 30, 1999, 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 $200 per year during fiscal 1999. The Company can create
customized service programs for clients based on elements of its standard
programs. Currently, the Company markets the following seventeen programs:
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- - PremierHealth Trends(R) is a unique membership program that provides
health conscious individuals and their families convenient access to
information and substantial savings on quality health care services,
including pharmacy purchases (retail, mail order and online), vision
exams and eyewear, hearing exams and appliances and chiropractic
services.
- - PremierHealth(R) combines the benefits of the Countrywide Dental
Program(R), which offers members unlimited access to a network of
independent dentists in 47 states, and PremierHealth Trends(R) as
well as providing members up to 25% off elder/long-term care.
- - PremierHealth Plus(R) is a uniquely comprehensive health care discount
program that provides unlimited access to a nationwide network of
250,000 doctors and 2,800 hospitals, as well as the benefits of
PremierHealth(R). Members are eligible for significant savings on
medical care (physicians and hospitals), dental care, pharmacy
purchases (retail, mail order and online), vision exams and eyewear,
hearing exams and appliances, chiropractic care and elder/long-term
care services. PremierHealth Plus(R) is not an insurance plan, but can
be used with most insurance programs to reduce a member's insurance
co-payments. Members are instructed to check with their insurance
providers to evaluate how the program will coordinate with their
particular insurance coverage.
- - Travel Arrangements(SM) offers an exceptional variety of travel savings
and values. This innovative travel service includes merchandise and
travel discounts, money saving vacation packages and special services.
- - Connections(SM) includes member-only offers valid at leading national
retail stores, amusement parks, restaurants and movie theaters, as well
as access to a discount shopping service that provides the guaranteed
lowest prices on the highest quality brand name electronics, appliances
and furniture.
- - Leisure Advantage(SM) is designed for people with active lifestyles and
provides members with discounts on all types of leisure time
merchandise, apparel and services.
- - Essentials(SM) is a unique membership program that provides members
with opportunities to receive exclusive savings and services on
fashion, fitness and grooming.
- - ValueMax Shopping Service(SM) is designed to provide significant
savings to members on a broad range of brand name merchandise as well
as travel services, eyewear, prescriptions, cars and financial
services.
- - Rate Saver(SM) is a one-of-a-kind membership service designed to
provide members with significant savings and discounts on their
everyday household expenses including utilities, long distance and
home repair.
- - BusinessMax(SM) provides valuable resources to assist members in
operating their businesses more effectively.
- - 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 and savings for the
novice computer user who is also interested in saving money on the
latest technological products in consumer electronics and home
entertainment.
- - 24Protect(SM) is designed to protect the member and their family
through a variety of money saving around-the-clock professional
assistance and services.
- - CardMember Protection Service(R) offers credit card registration
including one-call urgent stop notices, fraud reimbursement and
emergency cash.
- - Privacy Plus(SM) is a comprehensive personal information monitoring
program which provides a member access to his/her own credit records,
drivers records, Social Security records and other important personal
data.
- - Coverdell Accidental Death Insurance
- - Coverdell Term Life Insurance
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In general, members subscribe for renewable one-year memberships in the
Company's programs. When consumers agree to enroll in a program, they generally
receive a trial membership. During this time, the member may use the program's
services without obligation, as outlined in a membership brochure received by
mail along with a membership card and membership identification number. The
brochure outlines in detail the benefits which the service offers and contains
toll free numbers which may be called to access service benefits and
information. In the event that a consumer elects not to participate in the
service, he or she can call a toll free number during the trial period to cancel
the service without charge. Trial memberships are generally for a period of 30
days and there are no conditions with respect to the ability of the consumer to
terminate a trial membership. The Company does not record any revenue with
respect to trial memberships.
If the membership is not canceled during the trial period, the consumer is
charged the annual membership fee. In the event that the member does not cancel
the membership after the initial membership term, he or she generally receives a
renewal kit in the mail in advance of each membership year and is charged for
the succeeding year's membership fee. During the course of an initial annual
membership term or renewal term, a member may cancel his or her membership in
the program, either for a complete refund of the membership fee for that period
or a prorata refund based on the remaining portion of the membership period.
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. MemberWorks only collects and maintains customer data that is required
to administer its business activities, such as a customer's name, address and
billing information. The Company pays the client an annual royalty for initial
and renewal membership fees received by the Company from consumers provided by
the client. The royalties paid to clients by the Company average approximately
20% of initial and renewal membership fees.
The Company also offers its service programs through clients who have inbound
call centers. This type of marketing method, which the Company refers to as
MemberLink(SM), essentially turns the client call center into a profit center.
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 1999, approximately 11% of the Company's revenues came from
MemberLink(SM) programs. The Company pays the client an annual royalty for
initial and renewal membership fees or a fee per marketing pitch or per net
sale. Generally MemberLink(SM) arrangements serve as a more efficient and cost
effective way to acquire members than the Company's traditional marketing model.
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.
In addition to marketing its programs directly to consumers either through lists
provided by credit card issuers and other businesses and organizations or
through clients' inbound call centers, the Company also delivers its membership
service programs through its wholesale 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 or resell the product. 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.
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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 three call centers located in Omaha, Nebraska;
Houston, Texas and Montreal, Canada with a total of approximately 600 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 its training programs, its systems and its software, the Company seeks
to provide members with friendly, rapid and effective answers to questions. The
Company also works closely with its clients' customer service staffs to ensure
that their representatives are knowledgeable in matters relating to membership
service programs offered by the Company.
TECHNOLOGY
The Company has invested substantially in advanced management information
systems to allow it to operate its business more efficiently and productively.
Accordingly, the Company has developed proprietary software that is designed to
accept its clients' customer databases for review, analysis and modeling in
order to identify likely members. The Company receives new member information
from telemarketers on a daily basis, and the system routes that data to other
Company facilities for member fulfillment 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
and inbound call marketing, which the Company refers to as MemberLink(SM). 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. In addition, some of the Company's
individual memberships are available on-line to interactive computer users
through the World Wide Web.
The Company also sells 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.
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The Company has begun to sell service programs internationally through the
opening of its first international office in London, England. In addition, the
Company pursued its strategy for international expansion through its acquisition
of Comp-U-Card Canada in May 1999. Currently Comp-U-Card Canada provides credit
card enhancement services to Canadian financial institutions through wholesale
arrangements.
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.
DISTRIBUTION
The Company arranges with its client organizations 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.
The Company obtains substantially all of the information necessary to the
Company's marketing efforts from customer lists supplied by its clients. 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.
The Company primarily distributes its programs through outbound telemarketing
efforts. All telemarketing is outsourced to third party contractors. More
recently, the Company has employed inbound telemarketing techniques, referred to
as MemberLink(SM) arrangements.
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. Direct mail marketing is also used to
distribute the Company's service programs.
In addition, the Company is continually testing and developing new distribution
channels. On July 27, 1999, MemberWorks completed its purchase of CIC
Interactive, an Internet direct marketing company and online provider of
value-added membership programs. The Company believes that the Internet will be
an important channel for the distribution of its service programs in the future.
The Company also distributes its products through wholesale arrangements where
the Company is not responsible for marketing to the customer.
Membership service programs sponsored by the Company's three largest clients
accounted for 15.7%, 11.1% and 10.7% of revenues from Citibank, First USA and
Sears, respectively, for the fiscal year ended June 30, 1999.
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
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a variety of enforcement or private actions for any failure to comply with such
regulations. The Company's provision of membership programs requires the Company
to comply with certain state regulations, changes in which could materially
increase the Company's operating costs associated with complying with such
regulations. The risk of noncompliance by the Company with any rules and
regulations enforced by a federal or state consumer protection authority may
subject the Company or its management to fines or various forms of civil or
criminal prosecution, any of which could materially adversely affect the
Company's business, financial condition and results of operations. Also, the
media often publicizes perceived noncompliance 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.
The Company currently maintains rigorous security and quality controls to ensure
that all of its marketing practices meet or exceed industry standards and all
state and federal regulations. The Company only collects and maintains customer
data that is required to administer its business activities, such as a
customer's name, address and billing information and only public information is
used for marketing and modeling purposes, such as demographic, neighborhood and
lifestyle data. The Company neither resells any confidential customer
information that is obtained or derived in its marketing efforts nor purchases
consumer information from financial institutions.
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 and financial service institutions, some of
which have substantially larger customer bases and greater financial and other
resources than the Company's, 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, 1999, the Company employed 1,039 persons on a full-time basis and
168 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.
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Item 2. Properties
The Company leases space in Stamford, Connecticut; Atlanta, Georgia; Omaha,
Nebraska; Houston, Texas; White Plains, New York; Montreal, Canada and London,
England. The Stamford office serves as the Company's headquarters.
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 72,626 2002 through 2006
Atlanta, GA 16,122 2002
Omaha, NE 93,320 1999 through 2009
White Plains, NY 4,100 2000
Houston, TX 41,591 2006
Montreal, Canada 12,357 2003
London, England 500 2000
Item 3. Legal Proceedings
The Company and its subsidiaries are parties in multiple defendant class action
lawsuits in Minnesota and California, and a civil action brought by the
Minnesota Attorney General's Office in connection with alleged violations of
Minnesota statutes with regard to its sales practices in Minnesota. These
proceedings are in preliminary stages and the Company cannot predict their final
outcome or estimate the amounts or potential range of loss, if any, with respect
to the resolution of these proceedings. The resolution of these proceedings is
uncertain and there is no assurance that additional lawsuits will not be brought
in other jurisdictions based on similar or related claims. Although the Company
believes that it has strong defenses to the claims made in these actions, the
possible outcome of these proceedings could potentially include judgements
against the Company or settlements and could potentially require substantial
payments by the Company.
In addition to the foregoing, from time to time the Company may be involved in
other litigation or proceedings regarding claims arising in the normal course of
business, the adverse outcome of which, could potentially require substantial
payments by the Company.
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, 1999.
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Executive Officers of the Registrant
The executive officers of the registrant of the Company and their respective
ages as of June 30, 1999 are as follows:
Name Age Position
- ---- --- --------
Gary A. Johnson 44 President and Chief Executive Officer, Director
Dennis P. Walker 54 Executive Vice President, Director
James B. Duffy 45 Senior Vice President and Chief Financial Officer
Wayne T. Gattinella 47 Senior Vice President, Marketing
Laura J. Pelco 39 Senior Vice President, Sales
David Schachne 38 Senior Vice President, New Business Development
GARY A. JOHNSON, a co-founder of the Company, has served as President and Chief
Executive Officer and a director of the Company since its inception. From 1987
to 1989, Mr. Johnson founded and served as President of American Target Group
Marketing, a marketer of membership services for magazine publishers. From 1983
to 1987, Mr. Johnson was Vice President of New Product Development and Marketing
for CUC, a membership program services marketing firm. From 1981 to 1983, Mr.
Johnson was a Marketing Director of the Marketing Consulting Division of General
Electric. Mr. Johnson received a B.S. from Tufts University and an M.B.A. from
Harvard Business School.
DENNIS P. WALKER, a co-founder of the Company, has served as Executive Vice
President and a director of the Company since its inception. Prior to founding
the Company, Mr. Walker founded and served as President of Walker Enterprises, a
direct marketing and credit card merchandising business from 1978 to 1988. Prior
to Walker Enterprises, he was employed by F.D.R. and IBM Corporation. Mr. Walker
received a B.A. from the University of Nebraska.
JAMES B. DUFFY joined the Company as Senior Vice President and Chief Financial
Officer in June 1996. Prior to joining the Company, Mr. Duffy served in various
senior financial management positions, most recently as Senior Vice President,
Business Planning, at Merck Medco Managed Care, Inc., a prescription benefit
management company, from 1986 to 1996.
WAYNE T. GATTINELLA joined the Company as Senior Vice President, Marketing in
February 1998. Prior to joining MemberWorks, Mr. Gattinella was Senior Vice
President of Sales and Marketing for Merck-Medco. Prior to joining Medco in
1992, Mr. Gattinella was Vice President of Consumer Marketing for MCI
Telecommunications, where for 10 years he lead the new product development,
sales and marketing of the Company's consumer long distance services nationally.
Mr. Gattinella holds an M.B.A. from St. Joseph's University and a B.S. from
Drexel University.
LAURA J. PELCO joined the Company in 1993 and currently serves as Senior Vice
President, Sales. Prior to joining the Company, Ms. Pelco founded and operated
several companies in the United States and abroad, most recently a data entry
and transcription business based in the Caribbean. Ms. Pelco holds a B.A. from
Westminster College.
DAVID SCHACHNE joined the Company as Vice President, Marketing in 1990 and
currently serves as Senior Vice President, New Business Development. He has held
various senior management positions in the Company. Prior to joining the
Company, Mr. Schachne served for 6 years as Vice President of Sleep
Technologies, Inc., a manufacturer and direct marketer of home furnishings. Mr.
Schachne received a B.A. from the State University of New York, Albany and an
M.B.A. from Harvard Business School.
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PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
The 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, 1999:
First Quarter 36 7/8 13 7/8
Second Quarter 31 1/8 12 1/2
Third Quarter 37 1/4 29 7/8
Fourth Quarter 49 1/2 25
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
As of July 16, 1999, there were 40,000,000 shares of Common Stock authorized of
which 15,736,639 shares of Common Stock were outstanding, held by approximately
2,251 stockholders of record. 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, 1999, the net proceeds of the offering were used as
follows (in thousands):
Acquisitions of other businesses $ 15,443
Loan to affiliate 930
Purchase and installation of machinery and equipment 12,946
Repayment of indebtedness 2,818
Working Capital 4,264
------------
$ 36,401
============
Of the $2,818,000 used to repay indebtedness, $1,855,000 represented direct or
indirect payments to directors, officers, general partners of the issuer or
their associates; to persons owning ten percent or more of any class of equity
securities of the issuer and to affiliates of the issuer.
9
12
Item 6. Selected Financial Data
The selected consolidated statements of operations data for each of the years
ended June 30, 1995, 1996, 1997 1998 and 1999 and the selected consolidated
balance sheet data as of June 30, 1995, 1996, 1997, 1998, and 1999 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,
-----------------------------------------------------------------------
1995 1996 1997 1998 1999
-------- --------- -------- --------- ---------
(In thousands, except per share data)
CONSOLIDATED STATEMENTS OF
OPERATIONS DATA:
Revenues $ 41,547 $ 57,012 $ 79,174 $ 120,834 $ 218,086
Total expenses 52,279 62,259 83,032 117,749 210,138
-------- --------- -------- --------- ---------
Net income (loss) before cumulative effect of
accounting change $(10,732) $ (5,247) $ (3,858) $ 3,085 $ 7,948
Cumulative effect of accounting change -- -- -- -- (3,367)
-------- --------- -------- --------- ---------
Net income (loss) $(10,732) $ (5,247) $ (3,858) $ 3,085 $ 4,581
======== ========= ======== ========= =========
Basic earnings (loss) per share:
Income (loss) before cumulative effect of
accounting change $ (1.14) $ (0.49) $ (0.35) $ 0.21 $ 0.52
Cumulative effect of accounting change -- -- -- -- (0.22)
-------- --------- -------- --------- ---------
Basic earnings (loss) per share $ (1.14) $ (0.49) $ (0.35) $ 0.21 $ 0.30
======== ========= ======== ========= =========
Diluted earnings (loss) per share:
Income (loss) before cumulative effect of
accounting change $ (1.14) $ (0.49) $ (0.35) $ 0.19 $ 0.46
Cumulative effect of accounting change -- -- -- -- (0.20)
-------- --------- -------- --------- ---------
Diluted earnings (loss) per share $ (1.14) $ (0.49) $ (0.35) $ 0.19 $ 0.27
======== ========= ======== ========= =========
Weighted average common shares outstanding 9,953 11,956 13,901 14,837 15,361
======== ========= ======== ========= =========
Weighted average common shares and common
equivalent shares outstanding 9,953 11,956 13,901 16,381 17,124
======== ========= ======== ========= =========
June 30,
----------------------------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
(In thousands, except per share data)
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents $ 5,323 $ 4,312 $ 40,758 $ 35,933 $ 50,939
Cash flow provided by (used in) operating
activities (3,476) 1 7,835 8,930 50,573
Total assets 29,726 41,927 84,423 133,929 212,377
Long-term obligations 8,065 1,089 438 69 6
Redeemable preferred stock 10,926 20,487 -- -- --
Shareholders' equity (deficit) (30,367) (36,332) 14,030 29,080 32,837
10
13
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 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, 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 that sell services had 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 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 July 1, 1998. The Company
has recorded the cumulative effect of this change in accounting principle in the
first quarter of fiscal 1999. See note 2 to the consolidated financial
statements 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 9, 1999, the Company acquired Quota-Phone, Inc. ("Quota-Phone") for
$7.75 million in cash and 41,666 shares of MemberWorks Common Stock with an
approximate fair market value of $1.5 million as of the closing date.
Quota-Phone is a wholesale provider of discount shopping services and
"no-expiration" coupons. The transaction was accounted for as a purchase and,
accordingly, the assets and liabilities at June 30, 1999 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 18, 1999, the Company acquired Comp-U-Card Canada Group ("CUC Canada")
for approximately $9.2 million in cash. CUC Canada is a leading provider of
credit card enhancement services in Canada. The transaction was accounted for as
a purchase and, accordingly, the assets and liabilities at June 30, 1999 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.
FISCAL 1999 COMPARED TO FISCAL 1998
REVENUES. Revenues increased 80% to $218.1 million in 1999 from $120.8 million
in 1998 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 5.3
million members at June 30, 1999 from 3.5 million members at June 30, 1998. If
revenues from Coverdell and Company, acquired on April 2, 1998, were included in
both periods on a pro forma basis, twelve month revenues would have increased
66%. The increase in the Company's membership base was due to increased demand
for the Company's existing programs, as well as new programs introduced in 1998
and 1999. The increase in the weighted average program fee was due to an
increase in program pricing and new programs with higher fees. Revenues from
11
14
renewals increased to $92.2 million in 1999 from $50.6 million in 1998. As a
percentage of individual membership revenues, these amounts represented 45% in
1999 and 44% in 1998.
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 75% to
$43.0 million in 1999 from $24.6 million in 1998. As a percentage of revenues,
operating expenses decreased to 19.7% in 1999 from 20.4% in 1998 primarily due
to the increase in leverage of certain costs which do not increase
proportionately with revenue.
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 77% to $126.8 million in
1999 from $71.6 million in 1998. The increase was due primarily to increased
telemarketing and royalty expenses associated with the larger membership base.
As a percentage of revenues, marketing expenses decreased to 58.1% in 1999 from
59.2% in 1998 due to the favorable effect of an increase in more efficient
marketing methods and improved retention rates. In addition to marketing
expenses, the Company also monitors the spending for membership solicitation and
other deferred costs. These costs increased 54.5% to $146.5 million in 1999 from
$94.8 million in 1998 due to increased marketing efforts incurred to grow the
membership base. The Company expects these costs will continue to increase in
future periods in order to continue the expansion of the Company's membership
base.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
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 83% to $42.5 million in
1999 from $23.2 million in 1998. This increase was attributable to the costs
incurred for additional personnel in all areas and related facilities costs as
well as amortization expense of intangibles related to business acquisitions. As
a percentage of revenues, general and administrative expenses increased to 19.5%
in 1999 from 19.2% in 1998. Excluding the amortization expense related to
businesses acquired, general and administrative expenses would have decreased to
18.4% in 1999 from 18.8% in 1998.
OTHER INCOME, NET. Other income, net is primarily composed of interest income
from cash and cash equivalents. Other income, net of $2.2 million was reported
in 1999 compared to $1.7 million reported in 1998 due to higher cash balances
available for investment. 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, 1999 and 1998 due to tax losses
realized. As of June 30, 1999, the Company had accumulated federal net operating
loss carry forwards of $66.7 million.
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
million and $0.8 million, respectively.
OPERATING EXPENSES. 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.
12
15
MARKETING EXPENSES. Marketing expenses increased 41% 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.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 43% 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, NET. Other income, net of $1.7 million was reported in 1998
compared to $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, 1996.
The Company invests in short-term, investment-grade, interest-bearing
securities and the amount of interest income fluctuates based upon the amount
of funds available for investment and prevailing interest rates.
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.
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 used
the remainder of the net proceeds of the initial public offering for working
capital and other general corporate purposes, including business acquisitions.
Net cash provided by operating activities was $50.6 million, $8.9 million and
$7.8 million for the years ended June 30, 1999, 1998 and 1997, respectively.
This improvement in operating cash flow in fiscal 1999 is primarily due to an
increase in accounts payable and accrued liabilities, more efficient marketing
methods utilized to acquire new members during the year and increased retention
of those members as well as an overall improvement in operating results.
Net cash used by investing activities increased to $32.4 million in 1999 up from
$10.0 million and $3.8 million in 1998 and 1997, respectively. In fiscal 1999,
the Company acquired Quota-Phone for $9.25 million, of which $7.75 was paid in
cash, and CUC Canada for $9.2 million in cash. In fiscal 1998, the Company
acquired Coverdell and Company for $3.9 million in cash plus common stock and
options worth $14.5 million. In addition, the Company's capital expenditures
were $12.1 million in 1999 compared to $4.6 million in 1998 and $3.8 million in
1997. The increased expenditures were due to a computer system upgrade and
expansion of the Company's fulfillment center and office facilities.
The Company's net cash used in financing activities was $3.2 million in 1999
compared to $3.7 million used in financing activities in 1998 and $32.4 million
provided by financing activities in 1997. On April 22, 1999, the Board of
Directors authorized the repurchase, as conditions warrant, of up to an
additional 150,000 shares of the Company's Common Stock. During fiscal 1999, the
Company completed the repurchase program authorized by the Board of Directors in
January 1998 which authorized the repurchase of 150,000 shares of the Company's
Common Stock. The Company bought back 111,000 shares for $3.8 million under
these plans during fiscal 1999 compared to the purchase of 156,000 shares for
$3.5 million during fiscal 1998 and 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.
13
16
As of June 30, 1999, the Company had cash and cash equivalents of $50.9 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. There were no borrowings under this line
of credit during the year ended June 30, 1999. 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,
together with its available bank credit facility, will be sufficient to meet its
funding requirements for at least the next twelve months.
On July 27, 1999, the Company purchased the remaining 81% of CIC Interactive for
a cash payment of $15.9 million. CIC is an Internet direct marketing company and
online provider of value-added membership programs. The acquisition will be
accounted for under the purchase method of accounting during the quarter ended
September 30, 1999.
YEAR 2000 ISSUES
The Year 2000 presents the risk that information systems will be unable to
recognize and process date-sensitive information properly from and after January
1, 2000. 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. Based on the reviews and
analysis performed by the Company and an outside consultant and since a majority
of its internal information technology systems have been developed or modified
within the last 5 years, the Company believes that the risk of significant
noncompliance of its internal information technology systems is minimal.
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.
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.
The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
operations, liquidity or financial conditions. However, due to the general
uncertainty inherent in the Year 2000 problem, resulting in part from the
uncertainty of the Year 2000 readiness of third-party suppliers and customers,
the Company is unable to determine at this time whether the consequences of Year
2000 failures will have a material impact on the Company's operations, liquidity
or financial conditions.
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,
uncertainty as to new and existing accounting rules and interpretations;
uncertainty as to the Company's future profitability; the Company's ability to
develop and implement operational and financial systems to manage rapidly
growing operations; competition in the Company's existing and potential future
lines of business; the Company's ability to integrate and operate successfully
acquired businesses and the risks associated with such businesses; the Company's
ability to obtain financing on acceptable terms to finance the Company's growth
strategy and for the Company to operate within the limitation imposed by
financial arrangements; uncertainty as to the future profitability of acquired
businesses; the ability of the Company and its vendors to complete the necessary
actions to achieve a Year 2000 conversion for its computer systems and
applications; and other 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.
14
17
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
In the normal course of business, the Company employs established policies,
procedures and internal processes to manage its exposure to market risks. The
Company does not hold or issue derivative or other financial instruments for
trading purposes.
Item 8. Financial Statements and Supplementary Data
The financial statements and related notes and report of independent accountants
for the Company are included following Part IV, 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 Form 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.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Index to Financial Statements and Financial Statement Schedules
Page
----
Report of PricewaterhouseCoopers LLP, Independent Accountants F-1
Consolidated Balance Sheets as of June 30, 1999 and 1998 F-2
Consolidated Statements of Operations for the years ended June 30,
1999, 1998 and 1997 F-3
Consolidated Statements of Shareholders' Equity for the years ended
June 30, 1999, 1998 and 1997 F-4
Consolidated Statements of Cash Flows for the years ended June 30,
1999, 1998 and 1997 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, 1999, 1998 and 1997 F-15
15
18
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
The Company filed on Form 8-K dated April 9, 1999, under Item 5 "Other
Events and Exhibits," an announcement of the consummation of the merger
of QP Acquisition Corp. into Quota-Phone, Inc.
(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.
16
19
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: August 25, 1999
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 August 25, 1999
---------------------------------
Gary A. Johnson
By: /s/ Dennis P. Walker Executive Vice President and Director August 25, 1999
---------------------------------
Dennis P. Walker
By: /s/ James B. Duffy Senior Vice President, Chief Financial Officer August 25, 1999
------------------------------------
James B. Duffy
By: /s/ Stephen J. Clearman Director August 25, 1999
---------------------------------
Stephen J. Clearman
By: /s/ Alec L. Ellison Director August 25, 1999
-------------------------------------
Alec L. Ellison
By: /s/ Michael R. O'Brien Director August 25, 1999
--------------------------------
Michael R. O'Brien
By: /s/ Marc S. Tesler Director August 25, 1999
-------------------------------------
Marc S. Tesler
17
20
Exhibit
No. Description
*3.1 Restated Certificate of Incorporation of the Registrant. (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)
*10.9 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)
*10.13 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)
*10.18 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)
18
21
*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. (filed as Exhibit 10.21 to the Company's
Annual Report on Form 10-K, Registration No. 333-10541, filed on
September 29, 1997)
*10.23 Lease Agreement between Stamford Towers Limited Partnership and the
Registrant, dated May 20, 1997. (filed as Exhibit 10.23 to the
Company's Annual Report on Form 10-K, Registration No. 333-10541,
filed on September 29, 1997)
*10.24 Second Amendment to Lease Agreement between Arena Tower II Corporation
and Registrant dated January 24, 1997. (filed as Exhibit 10.24 to the
Company's Annual Report on Form 10-K, Registration No. 333-10541,
filed on September 29, 1997)
*10.25 Third Amendment to Lease Agreement between Arena Tower II Corporation
and Registrant dated July 23, 1997. (filed as Exhibit 10.25 to the
Company's Annual Report on Form 10-K, Registration No. 333-10541,
filed on September 29, 1997)
*10.26 Sublease Agreement between Brenmar Marketing Company, Inc. and
Registrant dated June 23, 1997. (filed as Exhibit 10.26 to the
Company's Annual Report on Form 10-K, Registration No. 333-10541,
filed on September 29, 1997)
*18 Letter re: Change in Accounting Principle. (filed as Exhibit 18 to the
Company's Annual Report on Form 10-K, Registration No. 333-10541,
filed on October 8, 1998)
21 Subsidiaries of the Registrant.
23 Consent of PricewaterhouseCoopers LLP.
27 Financial Data Schedule.
- ---------------------------------------------------
*Previously filed.
19
22
MEMBERWORKS INCORPORATED
Report of Independent Accountants
---------------------------------
To the Board of Directors and Shareholders
Of MemberWorks Incorporated
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of
MemberWorks Incorporated and its subsidiaries at June 30, 1999 and 1998, and the
results of their operations and their cash flows for each of the three years in
the period ended June 30, 1999 in conformity with generally accepted accounting
principles. In addition, in our opinion, the financial statement schedule listed
in the accompanying index presents fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and
financial statement schedule 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.
As discussed in Note 2 to the consolidated financial statements, the Company
changed its method of accounting for printing and mailing of membership
materials.
PricewaterhouseCoopers LLP
New York, New York
July 28, 1999
F-1
23
MEMBERWORKS INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands)
June 30,
-----------------------------------
1999 1998
------------ -------------
ASSETS
Current assets:
Cash and cash equivalents $ 50,939 $ 35,933
Accounts receivable 11,717 7,107
Prepaid membership materials 4,177 2,931
Prepaid expenses 2,313 1,060
Membership solicitation and other deferred costs 78,010 51,771
--------- ---------
Total current assets 147,156 98,802
Fixed assets, net 18,858 9,677
Intangible and other assets 46,363 25,450
--------- ---------
Total assets $ 212,377 $ 133,929
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term obligations $ 72 $ 380
Accounts payable 29,729 21,967
Accrued liabilities 40,702 20,680
Deferred membership fees 109,031 61,753
--------- ---------
Total current liabilities 179,534 104,780
Long-term obligations 6 69
--------- ---------
Total liabilities 179,540 104,849
--------- ---------
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; 15,909 shares issued
(15,653 shares at June 30, 1998) 159 156
Capital in excess of par value 76,999 74,478
Deferred compensation (511) (978)
Accumulated deficit (35,492) (40,073)
Accumulated other comprehensive loss (14) --
Treasury stock, 488 shares at cost (377 shares at June 30, 1998) (8,304) (4,503)
--------- ---------
Total shareholders' equity 32,837 29,080
--------- ---------
Total liabilities and shareholders' equity $ 212,377 $ 133,929
========= =========
The accompanying notes are an integral part of
these consolidated financial statements.
F-2
24
MEMBERWORKS INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
For the year ended June 30,
---------------------------------------------
1999 1998 1997
------------ ------------- ------------
Revenues $ 218,086 $ 120,834 $ 79,174
Expenses:
Operating 43,002 24,610 16,762
Marketing 126,814 71,594 50,904
General and administrative 42,476 23,245 16,296
Other income, net principally interest (2,154) (1,700) (930)
--------- --------- ---------
Total expenses 210,138 117,749 83,032
--------- --------- ---------
Income (loss) before income taxes 7,948 3,085 (3,858)
Provision for income taxes -- -- --
--------- --------- ---------
Net income (loss) before cumulative effect of accounting change 7,948 3,085 (3,858)
Cumulative effect of accounting change (3,367) -- --
--------- --------- ---------
Net income (loss) $ 4,581 $ 3,085 $ (3,858)
========= ========= =========
Basic earnings (loss) per share:
Income (loss) before cumulative effect of accounting change $ 0.52 $ 0.21 $ (0.35)
Cumulative effect of accounting change (0.22) -- --
--------- --------- ---------
Basic earnings (loss) per share $ 0.30 $ 0.21 $ (0.35)
========= ========= =========
Diluted earnings (loss) per share:
Income (loss) before cumulative effect of accounting change $ 0.46 $ 0.19 $ (0.35)
Cumulative effect of accounting change (0.20) -- --
--------- --------- ---------
Diluted earnings (loss) per share $ 0.27 $ 0.19 $ (0.35)
========= ========= =========
Pro forma amounts assuming new accounting principle is retroactively applied:
Net income (loss) 4,581 2,572 (4,329)
Earnings (loss) per share assuming no dilution 0.30 0.17 (0.31)
Earnings (loss) per share assuming full dilution 0.27 0.16 (0.31)
Weighted average common shares used in earnings per share calculations:
Basic 15,361 14,837 13,901
========= ========= =========
Diluted 17,124 16,381 13,901
========= ========= =========
The accompanying notes are an integral part of
these consolidated financial statements.
F-3
25
MEMBERWORKS INCORPORATED
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in thousands)
Accumulated
Common Stock Capital in Other
-------------- Excess of Deferred Accumulated Comprehensive Treasury
Shares Amount Par Value Compensation Deficit Loss Stock Total
------- ------ --------- ------------ ----------- -------- --------- ---------
Balance - June 30, 1996 5,857 $ 59 $ 3,602 $(1,400) $(38,320) $ -- $ (273) $ (36,322)
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 (980)
accretion (980)
Conversion of preferred stock 18,918
into common stock 6,464 64 18,854 424
Deferred compensation 469 (45)
Comprehensive loss:
Net loss (3,858)
Total comprehensive loss (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
Comprehensive income:
Net income 3,085
Total comprehensive income 3,085
------ ------ ------- ----------- ----------- -------- -------- ---------
Balance - June 30, 1998 15,653 156 74,478 (978) (40,073) -- (4,503) 29,080
For the year ended June 30, 1999:
Issuance of common stock 256 3 2,521 2,524
Acquisition of treasury stock (3,801) (3,801)
Deferred compensation 467 467
Comprehensive income:
Net income 4,581
Currency translation adjustment (14)
Total comprehensive income 4,567
------ ------ -------- -------- ----------- -------- -------- ---------
Balance - June 30, 1999 15,909 $ 159 $ 76,999 $ (511) $(35,492) $ (14) $ (8,304) $ 32,837
====== ====== ======== ======== =========== ======== ======== =========
The accompanying notes are an integral part of
these consolidated financial statements.
F-4
26
MEMBERWORKS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the year ended June 30,
------------------------------------------
1999 1998 1997
------------ ------------- ------------
OPERATING ACTIVITIES
Net income (loss) $ 4,581 $ 3,085 $ (3,858)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Cumulative effect of accounting change 3,367 - -
Membership solicitation and other deferred costs (146,519) (94,835) (62,929)
Amortization of membership solicitation
and other deferred costs 116,913 74,837 56,842
Deferred membership fees 45,069 20,280 10,845
Depreciation and amortization 5,517 2,525 1,295
Other 730 514 424
Change in assets and liabilities:
Accounts receivable (1,549) (3,319) 3,246
Prepaid membership materials (1,026) (1,253) (613)
Prepaid expenses (1,161) (631) (80)
Other assets (1,212) (56) (31)
Accounts payable 5,941 3,556 3,421
Accrued liabilities 19,922 4,227 (727)
------------ ------------- ------------
Net cash provided by operating activities 50,573 8,930 7,835
------------ ------------- ------------
INVESTING ACTIVITIES
Acquisition of fixed assets (12,101) (4,586) (3,760)
Business combinations, net of cash acquired
and other investments (20,316) (5,446) --
------------ ------------ ------------
Net cash used in investing activities (32,417) (10,032) (3,760)
------------ ------------- ------------
FINANCING ACTIVITIES
Net proceeds from issuance of stock and warrants 1,022 505 36,573
Treasury stock purchases (3,801) (3,515) (715)
Payments of long-term obligations (371) (713) (918)
Preferred stock redemption - - (2,549)
Debt issuance costs - - (20)
------------ ------------- ------------
Net cash (used in) provided by financing activities (3,150) (3,723) 32,371
------------ ------------- ------------
Net increase (decrease) in cash and cash equivalents 15,006 (4,825) 36,446
Cash and cash equivalents at beginning of year 35,933 40,758 4,312
============ ============= ============
Cash and cash equivalents at end of year $ 50,939 $ 35,933 $ 40,758
============ ============= ============
The accompanying notes are an integral part of
these consolidated financial statements.
F-5
27
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 primarily in
the United States.
Fixed assets
Fixed assets, capitalized software costs 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 and is 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, either
for a complete refund of the membership fee for that period or a prorata refund
based on the remaining portion of the membership period. Accrued liabilities set
forth in the accompanying consolidated balance sheets as of June 30, 1999 and
1998 include an allowance for membership cancellations of $24,811,000 and
$16,362,000, respectively.
As of June 30, 1999, there were no unbilled receivables included in accounts
receivable. Accounts receivable includes $2,033,000 of unbilled receivables as
of June 30, 1998, 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 the Company's three largest clients
accounted for 15.7%, 11.1% and 10.7% of revenues, respectively, for the fiscal
year ended June 30, 1999. Membership service programs sponsored by the Company's
three largest clients 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 the Company's two largest clients accounted for 30.7% and
13.8% of revenues, respectively, for the fiscal year ended June 30, 1997.
F-6
28
Membership solicitation and other deferred costs
Membership solicitation costs include telemarketing and direct mail costs
related directly to membership solicitation (i.e. direct response advertising
costs). In accordance with Statement of Position 93-7, "Reporting on Advertising
Costs", direct response advertising costs are deferred and charged to operations
as revenues from membership fees are recognized. Other deferred costs consist of
royalties paid to clients and transaction processing fees, 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.
Effective July 1, 1998, the Company changed its method of accounting for
printing and mailing membership materials. Historically, the Company had
accounted for the costs of printing and mailing of membership materials by
amortizing these costs ratably over the membership period as revenue was
recognized. Effective July 1, 1998, the Company started expensing these costs
upon the mailing of membership materials. The cumulative effect of this change
in accounting principle as of July 1, 1998 of $3,400,000 was recorded in the
first fiscal quarter ended September 30, 1998 as a reduction of membership
solicitation and other deferred costs and net income.
Earnings per share
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, 1999 and
1998, the diluted weighted average common shares outstanding includes 1,763,000
and 1,544,000, respectively, of dilutive stock options and warrants. Preferred
stock dividends of $980,000 have been deducted from net loss for the year ended
June 30, 1997 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 member and customer relationships and
goodwill that arose in connection with business acquisitions. Goodwill
represents the excess of acquisition costs over the fair value of net assets
acquired and is amortized on a straight-line basis over the estimated useful
lives ranging from fifteen to 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 ranging from two to twenty years. The
value of member relationships is amortized over twenty years using an
accelerated method based on estimated future cash flows. Intangible and other
assets set forth in the accompanying consolidated balance sheets as of June 30,
1999 and 1998 include acquired member and customer relationships of $8,757,000
and $10,199,000, respectively, net of accumulated amortization of $1,467,000 and
$301,000, respectively, and goodwill of $31,057,000 and $12,771,000,
respectively, net of accumulated amortization of $1,049,000 and $162,000,
respectively. The consolidated balance sheets as of June 30, 1999 and 1998
include total accumulated amortization of intangible and other assets of
$3,057,000 and $818,000, respectively.
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". The Company reviews its
intangible and other long-lived assets for events or changes in circumstances
which indicate that their carrying value may not be recoverable. As of June 30,
1999, no impairment has been indicated.
F-7
29
Foreign currency translation
Assets and liabilities of foreign subsidiaries are translated at the exchange
rates in effect as of the balance sheet dates. Equity accounts are translated at
historical exchange rates and revenues, expenses and cash flows are translated
at the average exchange rates for the periods presented. Translation gains and
losses are included as a component of comprehensive income (loss) in the
consolidated statements of shareholders' equity.
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.
Reclassification
Certain reclassifications have been made to prior period financial statements to
conform to the presentation of the financial statements for the year ended June
30, 1999.
New accounting pronouncements
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use" ("SOP 98-1"), which is effective for
financial statements for fiscal years beginning after December 15, 1998. SOP
98-1 provides guidance on accounting for the costs of computer software
developed or obtained for internal use. The adoption of SOP 98-1 is not expected
to materially impact the presentation and disclosure in the Company's financial
statements.
NOTE 3 - BUSINESS COMBINATIONS
Acquisitions
On May 18, 1999, the Company acquired Comp-U-Card Canada Group ("CUC Canada")
for $9,247,000. CUC Canada is a leading provider of credit card enhancement
services in Canada. 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 CUC Canada's operations are included in the consolidated financial
statements from the date of acquisition.
On April 9, 1999, the Company acquired Quota-Phone, Inc. ("Quota-Phone") for
$7,750,000 in cash and 41,666 shares of MemberWorks Common Stock with an
approximate fair market value of $1,500,000 as of the closing date. Quota-Phone
is a wholesale provider of discount shopping services and "no-expiration"
coupons. 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
Quota-Phone's operations are included in the consolidated financial statements
from the date of 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. 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.
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)
F-8
30
Other Investments
On May 14, 1998, the Company purchased a minority interest of less than twenty
percent in CIC Interactive ("CIC"), formerly 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.
Refer to Note 11 for further discussion.
NOTE 4--FIXED ASSETS
Fixed assets are comprised of the following at June 30, (in thousands):
1999 1998
---- ----
Computer software and equipment $ 16,411 $ 9,544
Furniture and fixtures 3,218 2,250
Telephone equipment 2,455 1,737
Leasehold improvements 2,376 1,196
Construction in progress 2,719 --
-------- --------
27,179 14,727
Accumulated depreciation and amortization (8,321) (5,050)
-------- --------
$ 18,858 $ 9,677
======== ========
Depreciation and amortization expense was $3,278,000, $1,770,000 and $1,183,000
for the years ended June 30, 1999, 1998 and 1997, respectively.
NOTE 5--LONG-TERM OBLIGATIONS
Notes payable
Notes payable are summarized as follows at June 30, (in thousands):
1999 1998
---- ----
Bank Credit Agreement $ 10 $ 10
Equipment term loans 7 197
---- ----
17 207
Less current maturities 16 200
---- ----
Long-term notes payable $ 1 $ 7
==== ====
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 equipment term loan expires in fiscal 2001 and is secured by certain
computer equipment. Interest is at a rate of 10.8%, and principal is repayable
monthly. The aggregate amount of payments related to the equipment term loan is
$5,000 in 2000 and $2,000 in 2001.
Other income in 1999, 1998 and 1997, as shown in the statement of operations,
includes interest expense of $55,000, $146,000 and $303,000, 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 $2,974,000, $1,640,000
and $1,213,000 for the fiscal years ended June 30, 1999, 1998 and 1997,
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, 1999, 1998 and 1997 was $77,000, $137,000 and $218,000,
respectively, and is included in depreciation and amortization expense.
F-9
31
The future minimum lease payments under capital leases (including present value
of net minimum lease payments) and operating leases as of June 30, 1999 are as
follows (in thousands):
CAPITAL OPERATING
FISCAL YEAR LEASES LEASES
- ----------- ------ ------
2000 $ 56 $ 4,077
2001 9 4,197
2002 - 3,941
2003 - 3,272
2004 - 2,632
Thereafter - 9,601
-------------- -------------
Total minimum lease payments 65 $ 27,720
=============
Less--Amount representing interest 4
--------------
Present value of net minimum lease payments including current maturities of $56
with interest rates ranging from 10.1% to 10.4% $ 61
==============
The Company and its subsidiaries are parties in multiple defendant class action
lawsuits in Minnesota and California, and a civil action brought by the
Minnesota Attorney General's Office in connection with alleged violations of
Minnesota statutes with regard to its sales practices in Minnesota. These
proceedings are in preliminary stages and the Company cannot predict their final
outcome or estimate the amounts or potential range of loss, if any, with respect
to the resolution of these proceedings. The resolution of these proceedings is
uncertain and there is no assurance that additional lawsuits will not be brought
in other jurisdictions based on similar or related claims. Although the Company
believes that it has strong defenses to the claims made in these actions, the
possible outcome of these proceedings could potentially include judgements
against the Company or settlements and could potentially require substantial
payments by the Company.
NOTE 6--INCOME TAXES
There was no current or deferred provision for income taxes for the years ended
June 30, 1999, 1998 and 1997. 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, 1999 and 1998 (in thousands):
1999 1998
---- ----
Benefit of net operating loss carry forward $ 30,236 $ 22,122
Deferred membership fees 5,893 6,565
Allowance for membership cancellations 8,186 5,492
Other deferred tax assets 1,165 419
Membership solicitation and other deferred costs (31,196) (20,859)
-------- --------
Total deferred tax assets 14,284 13,739
Less: Valuation allowance (14,284) (13,739)
-------- --------
Net deferred tax asset $ -- $ --
======== ========
The valuation allowance for deferred tax assets as of July 1, 1997 was
$12,977,000. At June 30, 1999, the Company had federal net operating loss carry
forwards of $66,666,000 expiring at various dates from June 30, 2004 to June 30,
2019. Approximately $4,776,000 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, 2004 available to reduce future state
taxable income.
F-10
32
NOTE 7--SHAREHOLDERS' EQUITY
Initial Public Offering
Effective October 18, 1996, the Company sold 2,400,000 shares of its Common
Stock at $17.00 per share in an initial public offering. Net proceeds of the
offering, after deducting underwriting discounts, commissions and offering
expenses, aggregated $36,401,000. Approximately $2,549,000 of the proceeds of
the offering 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. The preferred stock had been offered at a
discount which was being accreted to the redemption date.
Stock Repurchases
On April 22, 1999, the Board of Directors authorized the repurchase, as
conditions warrant, of up to an additional 150,000 shares of the Company's
Common Stock. During fiscal 1999, the Company completed the repurchase program
authorized by the Board of Directors in January 1998 which authorized the
repurchase of 150,000 shares of the Company's Common Stock. During fiscal 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. The Company bought back 111,000 shares for
$3,800,000 under these plans during fiscal 1999, 156,000 shares for $3,500,000
during fiscal 1998 and 47,000 shares for $700,000 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 8--STOCK OPTIONS AND WARRANTS
Stock Compensation Plans
At June 30, 1999, the Company has five stock-based compensation plans which are
described below. The Company applies APB 25 and related interpretations in
accounting for its plans. Compensation expense of $467,000, $467,000 and
$424,000 has been recognized during 1999, 1998 and 1997, respectively, related
to its stock option plans under APB 25. Had compensation cost for the Company's
stock based compensation plans been determined based on the fair value at the
grant dates for awards under those plans consistent with the method of SFAS No.
123 "Accounting for Stock-Based Compensation", the Company's pro forma net
income (loss) and earnings (loss) per share would have been as follows:
Year ended June 30,
1999 1998 1997
------- ------- ---------
($ in thousands, except per share data)
Net income (loss):
As reported $ 4,581 $ 3,085 $ (3,858)
Pro forma 1,180 1,871 (4,464)
Earnings (loss) per share:
As reported
Basic $ 0.30 $ 0.21 $ (0.35)
Diluted 0.27 0.19 (0.35)
Pro forma
Basic $ 0.08 $ 0.13 $ (0.39)
Diluted 0.07 0.11 (0.39)
The pro forma effect on fiscal 1999, 1998 and 1997 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.
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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, 1999, 1998 and 1997:
1999 1998 1997
---- ---- ----
Dividend yield 0% 0% 0%
Expected volatility 50% 42% 42%
Risk free interest rate 4.8% 5.8% 6.4%
Expected lives 5 years 4.5 years 4.8 years
The weighted average fair value per share of options granted at market value
were $8.52, $9.04 and $4.34 for the years ended June 30, 1999, 1998 and 1997,
respectively. The weighted average fair value per share of options granted below
market value was $11.90 for the year ended June 30, 1997.
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. During fiscal 1999, the Board
of Directors and shareholders approved an increase in the number of shares of
Common Stock reserved for issuance under the 1996 Stock Option Plan from
1,800,000 to 3,600,000. 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 shareholders of the Company
approved the adoption of the 1995 Executive Officers' Stock Option Plan and the
1995 Non-Employee Directors' Stock Option Plan under which the Board is
authorized to grant 360,000 and 180,000 options, respectively, to acquire shares
of Common Stock at a price per share equal to or greater than fair market value
at the date of grant. Under the Executive Officers' Stock Option Plan, the Board
can determine the date on which options vest and become exercisable. Options
become exercisable over a four year period under the Non-Employee Directors'
Stock Option Plan.
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, $122,000 and $79,000 for the years ended June
30, 1999, 1998 and 1997, 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, 1999, 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.
During fiscal 1999, the Compensation Committee of the Company's Board of
Directors approved a stock option exchange program. Pursuant to this exchange
program, options granted on April 2, 1998 with an exercise price of $30.375 and
a vesting period of four years were cancelled in exchange for new options
granted on October 28, 1998
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with an exercise price of $15.00 and a vesting period of four years. A total of
100,000 shares were exchanged. No compensation expense has been recognized in
the financial statements as the exercise price was equal to the market value of
the stock at the date of grant, October 28, 1998.
Information with respect to options to purchase shares issued under these plans
is as follows:
1999 1998 1997
---- ---- ----
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
(Shares in thousands) SHARES PRICE SHARES PRICE SHARES PRICE
------ ----- ------ ----- ------ -----
Outstanding at beginning of year 1,754 $ 8.25 1,649 $ 4.78 1,278 $ 2.62
Granted at market value 1,343 17.96 257 21.84 486 9.88
Granted below market value - - - - 43 2.78
Replaced/Exchanged 100 15.00 93 20.81 - -
Exercised (182) 4.01 (202) 2.30 (93) 1.50
Cancelled (100) 30.38 - - - -
Forfeited (73) 13.78 (43) 11.45 (65) 3.83
------- ----- -----
Outstanding at end of year 2,842 $ 12.46 1,754 $ 8.25 1,649 $ 4.78
======= ===== =====
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------- --------------------------
SHARES AVERAGE AVERAGE SHARES AVERAGE
OUTSTANDING REMAINING EXERCISE OUTSTANDING EXERCISE
(Shares in thousands) AT 6/30/99 LIFE (YEARS) PRICE AT 6/30/99 PRICE
---------- ------------ ----- ---------- -----
$1.27 to $1.99 503 4.1 $2.32 417 $2.23
$2.00 to $3.99 333 7.0 4.17 243 4.17
$4.00 to $7.99 372 7.2 9.78 163 9.75
$8.00 to $15.99 810 9.1 15.00 10 14.95
$16.00 to $19.99 500 8.9 17.28 28 16.00
$20.00 and over 324 10.6 26.00 95 20.77
-------------- --------------
2,842 7.9 $12.46 956 $6.38
============== ==============
Options exercisable as of June 30, 1998 and 1997 were 781,000 and 630,000,
respectively.
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. During fiscal 1999, 16,087
shares were purchased under the plan. Purchases under the plan during fiscal
1998 were not significant.
Warrants
During fiscal 1999, warrants to acquire 16,344 shares of Common Stock were
exercised (9,324 at $0.0014 per share and 7,020 at $3.56 per share). In
addition, during fiscal 1999, warrants to acquire 19,757 shares of Common Stock
at $3.56 expired. 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, 1999, the Company had outstanding warrants to purchase an
aggregate of 165,553 shares of Common Stock with the following per share
exercise prices: 131,000 at $2.05 and 34,553 at $0.0014. These warrants expire
at various dates between December 1999 and August 2000.
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NOTE 9--EMPLOYEE BENEFIT PLAN
Under the Company's 401(k) profit sharing plan, employees of the Company over
the age of 18 are eligible to contribute to the plan on the first day of a
fiscal quarter following the completion of 60 days of service. 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, 1999, 1998 and 1997.
NOTE 10--STATEMENT OF CASH FLOWS
Supplemental disclosure of cash flow information (in thousands):
YEAR ENDED JUNE 30,
1999 1998 1997
---- ---- ----
Cash paid during the period for interest $ 55 $ 114 $ 205
Cash paid during the period for income taxes $ 76 $ - $ 30
Supplemental schedule of noncash investing and financing activities:
Dividends accumulated on Series E and F preferred stock - - 53
Accretion of discount on Series E, F and H preferred stock - - 563
Accretion to redemption value on Series A, B, C and D preferred
stock - - 364
NOTE 11 - SUBSEQUENT EVENT
On July 27, 1999, the Company purchased the remaining 81% of CIC Interactive for
a cash payment of $15,885,000. CIC is an Internet direct marketing company and
online provider of value-added membership programs. The acquisition will be
accounted for under the purchase method of accounting during the quarter ended
September 30, 1999.
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MEMBERWORKS INCORPORATED
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Balance at Charged to Charged to
Beginning of Costs and Other Accounts Deductions -- Balance at End
Description Period Expense -- Describe Describe of Period
- ----------- ------ ------- -------------- -------- ---------
YEAR ENDED JUNE 30, 1999
Allowance for cancellations $ 16,362,000 $ - $ 192,019,000 A $ 183,570,000 B $ 24,811,000
Valuation allowance for deferred tax assets 13,739,000 - 545,000 C - 14,284,000
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 C - 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 C - 12,977,000
(A) Charged to balance sheet account "Deferred membership fees."
(B) Charges for refunds upon membership cancellations.
(C) Increase in the valuation allowance for deferred tax assets is due to an
increase in deferred tax assets.
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