UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
X Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended June 30, 2004 or
____ Transition report pursuant to Section 13 or15(d) of the Securities Exchange
Act of 1934 for the transition period from ________ to _________.
Commission File No. 0-21527
MEMBERWORKS INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 06-1276882
- ------------------------ --------------------
(State of Incorporation) (I.R.S. Employer
Identification No.)
680 Washington Boulevard
STAMFORD, CONNECTICUT 06901
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(203) 324-7635
(Registrant's telephone number, including area code)
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. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
[X] Yes [ ] No
The aggregate market value of the voting stock held by non-affiliates of the
Registrant at December 31, 2003 was $128,298,966. The aggregate market value of
the voting stock held by non-affiliates of the Registrant at June 30, 2004 was
$190,018,728. 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 August 13, 2004 was
10,263,269.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Proxy Statement for the 2004 Annual Meeting of Stockholders of
MemberWorks Incorporated are incorporated by reference in Parts II and III of
this report.
INDEX
PAGE
Part I Item 1. Business 1
Item 2. Properties 6
Item 3. Legal Proceedings 6
Item 4. Submission of Matters to a Vote of Security Holders 7
Executive Officers of the Registrant 7
Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 8
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 10
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 18
Item 8. Financial Statements and Supplementary Data 19
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 19
Item 9A. Controls and Procedures 19
Item 9B. Other Information 20
Part III Item 10. Directors and Executive Officers of the Registrant 20
Item 11. Executive Compensation 20
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters 20
Item 13. Certain Relationships and Related Transactions 20
Item 14. Principal Accountant Fees and Services 20
Part IV Item 15. Exhibits and Financial Statement Schedules 20
Signatures 22
Exhibit listing 23
PART I
ITEM 1. BUSINESS
OVERVIEW
MemberWorks Incorporated (the "Company"), a Delaware Corporation, began doing
business as Cardmember Publishing Corporation in 1986, was organized as
MemberWorks Incorporated in 1996 and has been doing business as MemberWorks
Incorporated since then.
The Company is a marketing services leader, bringing value to consumers by
designing innovative membership programs that offer members easy access to a
variety of discounted products and services provided by the Company's
participating vendors. In April 2004, the Company broadened the scope of its
business by acquiring Lavalife Inc. ("Lavalife"), a personals service. As a
result of this acquisition, the Company is now a leading global provider of
web-based and interactive voice response ("IVR") based personals services. The
acquisition of Lavalife benefits the Company by providing access to one of the
largest and fastest growing consumer categories on the internet while expanding
its target market. In addition, it is the Company's intention to cross-market
the products and services of the Company and Lavalife.
In the past, the Company operated in one business segment, membership. With the
acquisition of Lavalife, the Company analyzes its business in the following two
business segments: Membership and Personals. See Note 20 of the consolidated
financial statements contained in this 2004 Annual Report filed on Form 10-K for
additional financial information about the Company's business segments.
MEMBERSHIP
MEMBERSHIP PROGRAMS
The Company designs its membership programs to address the particular needs and
preferences of its members by combining various features and benefits to
customize its membership programs. The Company's membership programs provide
substantial benefits to the Company's members, clients and vendors. The
Company's members benefit by receiving an array of programs and services in the
categories of health, shopping and personal security.
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 the marketing solicitation. Membership materials,
which include a membership brochure and a membership card with a membership
identification number, are either mailed or emailed to the consumer during the
trial period. The brochure outlines in detail the benefits offered and contains
a toll-free number and a website address, which may be used to access membership
benefits and information. In the event that a consumer elects not to participate
in the membership program, he or she can call a toll-free number during the
trial period to cancel the service without incurring any additional charges.
Trial memberships are generally for a period of 7 to 30 days and there are no
conditions with respect to the ability of the consumer to terminate a trial
membership.
If the membership is not canceled during the trial period, the consumer is
charged the annual or monthly membership fee, depending upon the applicable
payment plan offered. For annual members, in the event that the members do not
cancel the membership after the initial one year membership term, they receive a
renewal notice in advance of each membership year and are 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 generally for a pro rata refund of the membership fee based on the
remaining portion of the membership period at the time of the cancellation.
Monthly members are billed each month after the trial period ends and continue
to be billed each month until the member cancels. The Company's membership
programs had approximately 5.6 million retail members as of June 30, 2004.
The Company has traditionally marketed its membership programs which have an
up-front annual membership fee. However, beginning in 2003 and continuing into
2004, the Company expanded its marketing of membership programs in which the
membership fee is payable monthly. During 2004, approximately 64% of the
Company's new member enrollments were in a monthly payment program and it is the
Company's intention to further increase the mix of monthly payment programs in
2005. Membership fees vary depending upon the particular services offered in the
membership program.
The Company's programs are designed to offer members a combination of everyday
savings, event-oriented discounts and peace of mind benefits, and are offered in
English, French and Spanish. The Company partners with leading, brand name
merchants and service companies to offer consumers valuable packages of
members-only benefits. Membership programs are packaged around popular spending
categories and typically offer potential savings well in excess of the program
fee. In addition, membership programs are increasingly customized for specific
clients. The Company's programs fall into the three categories described below.
1
HEALTHCARE
Health, wellness, and self-improvement programs offer significant savings on a
comprehensive array of healthcare products, including prescription drugs,
vitamins and supplements, eye glasses and contact lenses, hearing aides, durable
medical equipment, and select consumer products. The programs also offer
discounts on professional services, including medical, dental, chiropractic,
alternative medicine, elder care and other personal health services.
SECURITY
Security and insurance programs offer discounts on products and services that
enhance and improve the consumer's sense of security and well being. These
programs offer access to services that help manage privacy and protection
including identity theft insurance, card registration and credit reporting,
scoring, and monitoring. Insurance programs offer competitively priced insurance
products including life, supplemental health, accidental death, short-term and
long-term disability, warranty and identity theft insurance coverage. Other
program benefits include 24-hour protection services, roadside assistance and
financial, tax, and retirement planning.
DISCOUNTS
Discount programs offer exclusive access to members-only savings with leading
brand name merchants covering a wide range of consumer spending categories
including travel, transportation, entertainment, dining, shopping, home and
small business. Savings are available through discounted gift cards, coupons,
promotion codes and rebates.
VENDORS
In most cases, the products and services accessed through the Company's
membership programs are offered and provided directly to members by independent
benefit providers or vendors. The Company evaluates and engages only those
vendors who can cost-effectively deliver high quality products and services. The
Company's participating vendors generally benefit by obtaining access to a large
number of demographically attractive consumers with minimal incremental
marketing costs. Specifically, vendors gain access and marketing exposure to the
Company's membership base and, in almost all cases, pursuant to contractual
arrangements with the Company, provide a members-only discount on products or
services. The Company generally does not receive 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 number of members in the Company's program
or based on other agreed upon factors.
The Company's contracts with its vendors are generally for one year or more,
with subsequent one-year renewal terms at the Company's option. In most cases,
vendors may cancel contracts with the Company 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 require vendors to maintain the
confidentiality of the terms of the contract.
CLIENTS
The Company's programs are primarily marketed to customers through arrangements
with the Company's clients, which include banks and other financial
institutions, e-commerce companies, direct response television companies,
catalog companies, retailers and other organizations with large numbers of
individual customers. Clients receive royalty payments in exchange for the
clients providing new members or access to potential members. In some cases,
these businesses lack the core competency to successfully design, market and
manage membership programs. As a result, these businesses seek to outsource the
implementation of membership programs to providers, such at the Company, that
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 membership programs and are able to realize economies of scale. In
addition, businesses outsourcing their membership programs demand that the
program provider have the expertise to continue to introduce innovative new
programs and have resources, such as extensive vendor networks and an
experienced management team, to launch membership programs quickly and
successfully.
Membership programs sponsored by the Company's two largest clients, West
Corporation and Citibank, N.A. (and its affiliates), accounted for 18% and 12%
of revenues, respectively, for the year ended June 30, 2004. A loss of either of
these clients could have a material effect on the Company's results of
operations.
MARKETING AND DISTRIBUTION
The Company solicits members for its programs primarily by direct marketing
methods, including inbound call marketing, referred to as MemberLink, online
marketing, outbound telemarketing, which it outsources to third party
contractors, and direct mail, which is mailed either at the Company's own
expense or at its client's expense. The Company has been able to effectively
diversify its distribution channels since its initial public offering in 1996,
at which time the Company's primary method of solicitation was outbound
telemarketing. For the year ended June 30, 2004, outbound telemarketing was the
source for approximately 10% of the Company's new member enrollments.
2
MemberLink inbound call marketing occurs when clients' inbound callers who meet
certain criteria are offered the Company's membership service programs by the
client's service representative or by a membership service representative of the
Company through a call transfer. The Company pays the client either a royalty
for initial and renewal membership fees or a fee per marketing offer or per
sale. MemberLink arrangements generally have been a more efficient and cost
effective way to acquire members than the Company's traditional outbound
telemarketing marketing model.
Online marketing is conducted through arrangements with Internet service
providers ("ISP's"), online retailers and online marketers. The marketing
methods include banner ads and pop-up boxes. The Company buys advertising or
pays the client either a royalty for membership fees or a fee per impression or
per sale.
Substantially all of the information necessary for the Company's marketing
efforts is supplied by its clients in accordance with strict consumer privacy
safeguards. 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 may be
dependent upon first obtaining client approval.
The Company's contracts with its clients typically grant the Company the right
to continue to provide membership services directly to such clients' individual
account holders even if the client terminates its contract with the Company.
Many client relationships are pursuant to contracts that 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 indefinitely with the client's customers that have become program
members.
The Company also delivers its membership service programs through loyalty
arrangements with client partners. The Company works with its clients to
incorporate elements from one or more of the Company's standard service programs
and designs a custom program for the client. The client then either provides the
customized membership program to its customers as a value-added feature or
resells the customized membership program. In some cases, the client provides
loyalty memberships to its customers free of charge and pays the periodic
membership fee to the Company for each customer's membership. In other cases,
the client charges a reduced fee to its customer. The client pays the Company
the membership fees for the customers who receive the customized membership
program. Under the Company's loyalty 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.
MEMBERSHIP SERVICE
The Company believes that providing high quality service to its members is
extremely important in order to retain members and to strengthen the affinity of
the clients' customers that were offered the membership program. Currently, the
Company maintains four membership call centers located in Montreal, Canada,
Houston, Texas, Omaha, Nebraska and Chicago, Illinois, with a total of over 700
membership service representatives. All new membership service representatives
are required to attend on-the-job training. Through its training programs,
systems and software, the Company seeks to provide members with friendly, rapid
and effective answers to questions. Members can access their benefits 24 hours a
day via the program's web site or automated telephone response technology. The
Company also works closely with its clients' customer service staff to ensure
that their representatives are knowledgeable in matters relating to membership
service programs offered by the Company.
COMPETITION
The Company believes that the principal competitive factors in the membership
services industry include the ability to identify, develop and offer innovative
membership programs, the quality and breadth of membership programs offered,
competitive prices and in-house marketing expertise. The Company's competitors
offer membership programs which provide services similar to, or which directly
compete with, those provided by the Company. Some of these competitors have
substantially larger customer bases and greater financial and other resources
than those of the Company. To date, the Company has effectively competed with
such 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; provide
programs comparable or superior to those provided by the Company at lower
membership prices; 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
marketing margins or 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.
3
PERSONALS
On April 1, 2004, the Company completed the acquisition of all of the assets and
outstanding capital stock of Lavalife, a leading provider of online and
IVR-based interactive personals services. Lavalife now operates as a
wholly-owned subsidiary of the Company. The purchase price, excluding fees and
expenses, was Cdn$152.5 million, or $116.5 million, and is subject to certain
purchase price adjustments. The acquisition was funded with cash on hand and
borrowings under the Company's senior secured credit facility.
Lavalife's open-minded approach to dating allows members to choose how they want
to "click with other singles" by offering different levels of dating. Lavalife
offers both web-based, IVR-based, and most recently, cellular phone-based
personals services to its customers. These services allow customers to interact
with each other from anywhere in real time by phone, email, text chat or video.
To acquire new users and retain existing customers, Lavalife relies on its
innovative products, marketing relationships with major media groups,
advertising campaigns in large markets, a widely recognized brand name and an
advanced technology infrastructure. These interactive services allow customers
who want to enhance their social lives to search for a date, meet new people and
communicate with other customers in a real time, "Anywhere", "Anytime" and
"Anyhow" environment. As of June 30, 2004, Lavalife had approximately 600,000
active customers.
Lavalife employs a transactional business model, in which customers buy
non-refundable credits up front and spend those credits only when they want to
interact with other customers. Lavalife's competitors generally employ a
subscription business model, in which customers pay a fixed periodic fee. The
Company believes a transactional model is more attractive to new customers, who
will join due to a lower initial cost and the ability to easily control their
spending. The customer determines when to use the credits to communicate with
other customers. Furthermore, once a customer has an account balance, the
customer has a strong financial incentive to return to use their remaining
credits. To further encourage return visits, Lavalife continues to expand its
existing service offerings and introduce innovative interactive products
including video and real time online social networking.
Lavalife maintains a call center located in Toronto, Canada with a total of
almost 200 call center representatives.
The personals business is very competitive and highly fragmented. Primary
competitors of the various brands that comprise personals include numerous
online and offline dating and matchmaking services (both free and paid), some of
which operate nationwide and some of which operate locally, and the personals
sections of newspapers and magazines. In addition to broad-based personals
services, there are numerous niche websites and offline personals services that
cater to specific demographic groups.
TECHNOLOGY
The Company has invested substantially in new technology, including a
sophisticated customer service platform ("CRM"), data warehousing and mining
capabilities, and various Internet applications which work together to allow the
Company to effectively and efficiently service its members. The Company receives
new member information from its clients daily, and that information is
maintained on core infrastructure systems that drive information constantly to
CRM, fulfillment, billing and data warehousing systems. This allows for rapid
fulfillment of member information kits as well as other benefits. All membership
information is maintained on a state-of-the-art CRM system, which allows
extremely responsive targeted call center interactions. The Company 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 systems interact with the Company's advanced call routing system in
order to display member profile information prior to answering the call,
allowing the Company's membership service representatives to have the best
possible information prior to serving the members. 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 proprietary systems in combination with 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 enroll in a membership.
4
Lavalife recently upgraded its integrated network to support both its IVR and
web operations. The Lavalife infrastructure for both the IVR and the web is
built on state of the art, industry standard, high capacity technology designed
to support the significant level of member interaction and a quality experience.
The technology supports such high demand features as live chat, voice messaging,
quick response searches for "who's online now" and instant messaging. The
network operations centers, located in Toronto, Canada and Sydney, Australia,
allow the personals business to scale both its web and IVR operations, as well
as support text messaging operations, with full remote management capabilities
of all services.
GOVERNMENT REGULATION
The Company markets its membership programs and personals services through
various distribution channels including refundable royalty payments,
telemarketing, direct mail, non-refundable royalty payments, and advertising
costs. These channels are regulated at both the state and federal levels and the
Company believes that these marketing methods may increasingly be subject to
such regulation, particularly in the area of consumer privacy. Regulation may
limit the Company's ability to solicit new members or to offer one or more
products or services to existing members. The telemarketing industry has become
subject to an increasing amount of federal and state regulation. 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, including the Telemarketing Sales
Rule, as amended, promulgated thereunder, prohibit deceptive, unfair or abusive
practices in telemarketing sales. Both the FTC and state attorneys general have
authority to prevent marketing 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
and/or Internet marketing practices, and there can be no assurance that any such
laws, if enacted, will not adversely affect or limit the Company's current or
future operations. Compliance with these regulations is generally the
responsibility of the Company, and the Company could be subject to a variety of
enforcement and/or private actions for any failure to comply with such
regulations. The Company's provision of membership programs and personals
services 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. Noncompliance 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 have a material adverse affect on 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 making the membership
programs industry susceptible to peremptory charges of regulatory noncompliance
and unfair dealing by the media.
The Company currently maintains rigorous security and quality controls that are
intended to ensure that all of its marketing practices meet or exceed industry
standards and all applicable state and federal laws and regulations. The Company
only collects and maintains customer data that is necessary to administer its
business activities, such as a customer's name, address and encrypted 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 consumer information that is obtained or
derived in its marketing efforts nor purchases consumer information from
financial or other institutions.
FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS
See Note 20 of the consolidated financial statements contained in this 2004
Annual Report on Form 10-K for financial information about geographic areas.
EMPLOYEES
As of June 30, 2004, the Company employed 1,414 persons on a full-time basis and
202 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.
AVAILABLE INFORMATION
The Company's Internet address is http://www.memberworks.com. Information on the
Company's website is not a part of this Annual Report on Form 10-K.
The Company makes available, free of charge on or through its website, the
Company's annual reports on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, Section 16 filings and all amendments to those reports as
soon as reasonably practicable after such material is electronically filed with
or furnished to the Securities and Exchange Commission ("SEC"). You may read and
copy any document filed with the SEC at its public reference facility at 450
Fifth Street, N.W., Washington, D.C. 20459. Please call the SEC at
1-800-SEC-0330 for further information on the operation of the public reference
facility.
5
ITEM 2. PROPERTIES
A summary of key information with respect to the Company's leased facilities is
as follows:
LOCATION YEAR OF LEASE
MEMBERSHIP SQUARE FOOTAGE EXPIRATION
Omaha, NE 93,123 2009 through 2015
Stamford, CT 63,559 2006
Montreal, Canada 48,193 2011
Houston, TX 41,591 2006
Atlanta, GA 13,717 2005
Chicago, IL 11,676 2005
PERSONALS
Toronto, Canada 73,926 2009
The Stamford, Connecticut office serves as the Company's corporate headquarters.
All other locations serve as the operational offices for the Company. The
Company believes that its properties are generally in good condition, are well
maintained and are suitable and adequate to carry on its business.
ITEM 3. LEGAL PROCEEDINGS
Except as set forth below, in management's opinion, there are no significant
legal proceedings to which the Company or any of its subsidiaries is a party or
to which any of their properties are subject. The Company is involved in other
lawsuits and claims generally incidental to its business including, but not
limited to, various suits, including previously disclosed suits, brought against
the Company by individual consumers seeking monetary and/or injunctive relief
relating to the marketing of the Company's programs. In addition, from time to
time, and in the regular course of its business, the Company receives inquiries
from various federal and/or state regulatory authorities.
In March 2001, an action was instituted by plaintiff Teresa McClain against
Coverdell & Company ("Coverdell"), a wholly-owned subsidiary of the Company,
Monumental Life Insurance Company and other defendants in the United States
District Court for the Eastern District of Michigan, Southern Division. The
suit, which seeks unspecified monetary damages, alleges that Coverdell and the
other defendants violated the Michigan Consumer Protection Act and other
applicable Michigan laws in connection with the marketing of Monumental Life
Insurance Company insurance products. The Court certified a class of Michigan
residents. The Court has now signed an Order granting preliminary approval of a
settlement agreement that has been signed by all parties. The Court will hold
the Fairness/Approval hearing on November 22, 2004. The settlement agreement
will have no financial or other material impact on Coverdell's business.
On January 24, 2003, the Company filed a motion with the Superior Court for the
Judicial District of Hartford, Connecticut to vacate and oppose the confirmation
of an arbitration award issued in December 2002. The arbitration, filed against
the Company by MedValUSA Health Programs, Inc. ("MedVal") in September 2000,
involved claims of breach of contract, breach of the duty of good faith and fair
dealing, and violation of the Connecticut Unfair Trade Practices Act ("CUTPA").
Even though the arbitrators found that the Company was not liable to MedVal for
any compensatory damages, they awarded $5.5 million in punitive damages and
costs against the Company solely under CUTPA. The Company believes that this
arbitration award is unjustified and not based on any existing legal precedent.
Specifically, the Company is challenging the award on a number of grounds,
including that it violates a well-defined public policy against excessive
punitive damage awards, raises constitutional issues and disregards certain
legal requirements for a valid award under CUTPA. The hearing on the Company's
motion was held on February 10, 2003. On June 22, 2003, the Superior Court
denied the Company's motion to vacate the award, and the Company filed an appeal
of that decision. While the Company intends to take action to prevent the
enforcement of the award by, among other things, vigorously pursuing an appeal,
there can be no assurance that the Company will be successful in its efforts.
The Company has made no provision in its financial statements for this
contingency because it believes that a loss is not probable. If the Company were
ultimately unsuccessful in this or other available appeals, and a final
non-appealable court order confirming the arbitration award is rendered, the
payment of the award could have a material adverse effect on the Company's
results of operations in the period in which the final order is entered.
On October 21, 2003, the Florida Attorney General's Office filed a civil
complaint against the Company based upon concerns that some of its past
marketing practices may have violated various consumer laws. On June 28, 2004,
the Company announced that it had reached a voluntary settlement with the
Florida Attorney General's office to alleviate concerns that some of its past
marketing practices may have confused some consumers. In connection with the
settlement, the Company agreed to formalize its existing national Best Marketing
Practices in the state of Florida and to pay the state of Florida costs of
investigation of $950,000. The Company expects that the agreement will have
little new effect on its business in Florida as the agreement serves to
formalize the Company's already existing national marketing best practices in
the state.
6
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, 2004.
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the registrant of the Company and their respective
ages as of July 31, 2004 are as follows:
NAME AGE POSITION
- -------------------- --- -------------------------------------------------------
Gary A. Johnson 49 President and Chief Executive Officer, Director
Vincent DiBenedetto 47 Executive Vice President, Health and Insurance Services
James B. Duffy 50 Executive Vice President and Chief Financial Officer
GARY A. JOHNSON, a co-founder of the Company, has served as President, Chief
Executive Officer and a director since its inception.
VINCENT DIBENEDETTO joined the Company in October 2000 and currently serves as
Executive Vice President, Health and Insurance Services. Prior to joining the
Company, Mr. DiBenedetto was President of Discount Development Services, L.L.C.,
a subsidiary of the Company which was acquired in October 2000.
JAMES B. DUFFY has served as Executive Vice President and Chief Financial
Officer since he joined the Company in 1996.
7
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's 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.
FISCAL YEAR ENDED JUNE 30, 2004: HIGH LOW
First Quarter $38.22 $19.75
Second Quarter 34.00 24.16
Third Quarter 36.77 26.96
Fourth Quarter 35.02 26.89
FISCAL YEAR ENDED JUNE 30, 2003: HIGH LOW
First Quarter $18.80 $12.48
Second Quarter 19.53 16.65
Third Quarter 20.71 14.00
Fourth Quarter 24.00 19.30
HOLDER AND DIVIDEND INFORMATION
As of August 13, 2004, there were 40,000,000 shares of the Company's Common
Stock authorized of which 10,263,269 shares were outstanding, held by
approximately 1,705 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 and to repurchase
its common stock under the stock repurchase program. 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.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SECURITIES FUTURE ISSUANCE UNDER
TO BE ISSUED UPON WEIGHTED-AVERAGE EQUITY COMPENSATION PLANS
EXERCISE OF EXERCISE PRICE OF (EXCLUDING
PLAN CATEGORY OUTSTANDING OPTIONS OUTSTANDING OPTIONS SECURITIES REFLECTED IN
(A))
----------------------- --------------------- ----------------------------
(a) (b) (c)
Equity compensation plans approved by
security holders 1,772,000 $ 22.35 837,000
Equity compensation plans not approved by
security holders (1) 1,533,000 $ 17.50 63,000
----------------------- --------------------- ----------------------------
Total 3,305,000 $ 20.10 900,000
======================= ===================== ============================
(1) These shares represent an increase in the share reserve during 2002
under the 1996 Stock Option Plan. These options have an exercise price per
share that is equal to or greater than the fair market value at the date of
grant and they generally become exercisable over a four to five year period
and expire at the earlier of termination of employment or ten years from the
date of grant.
RECENT SALES OF UNREGISTERED SECURITIES
In April 2004, the Company completed the sale of $150.0 million aggregate
principal amount of 9.25% Senior Notes due 2014 ("Senior Notes") to qualified
institutional buyers pursuant to Rule 144A of the Securities Act of 1933, as
amended. Net proceeds from this offering were $142.4 million. A portion of the
proceeds was used to repay amounts borrowed under the senior secured credit
facility to fund a portion of the Lavalife acquisition. The Company intends to
use the remaining proceeds for general corporate purposes, including working
capital, future acquisitions and purchases of the Company's common stock under
the Company's stock buyback program to the extent permitted under the indenture
governing the Senior Notes and under the senior secured credit facility.
8
PURCHASES OF EQUITY SECURITIES BY THE ISSUER
The following table summarizes the shares of the Company's equity securities
purchased by or on behalf of the Company:
(c) Total Number (d) Maximum
of Shares Number of Shares
Purchased as Part that May Yet be
(a) Total Number of Publicly Purchased Under
of Shares (b) Average Price Announced Plans the Plans or
Period Purchased Paid per Share or Programs (1) Programs
--------------------------------------- -------------------- -------------------- --------------------- -------------------
April 1, 2004 to April 30, 2004 - - - 1,316,607
May 1, 2004 to May 31, 2004 213,700 $28.63 213,700 1,102,907
June 1, 2004 to June 30, 2004 109,400 $28.77 109,400 993,507
-------------------- -------------------- --------------------- -------------------
Total 323,100 $28.68 323,100 993,507
==================== ==================== ===================== ===================
(1) During 2004, the Board of Directors authorized the following share amounts
to be purchased under the Company's stock buyback program originally
authorized during fiscal 1997:
July 2003 - authorized an additional 1,000,000 shares, no expiration, which
authorized shares have been repurchased by the Company.
September 2003 - authorized an additional 1,000,000 shares, no expiration,
which authorized shares have been repurchased by the Company.
January 2004 - authorized an additional 1,000,000 shares, no expiration.
9
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated statements of operations data for each of the years
ended June 30, 2004 through 2000 and the selected consolidated balance sheet
data as of June 30, 2004 through 2000 set forth below are derived from the
audited consolidated financial statements of the Company. The selected
consolidated financial information of the Company is qualified by reference to
and should be read in conjunction with Item 8, "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,
--------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2004 2003 2002 2001 2000
CONSOLIDATED OPERATING DATA:
Revenues $ 488,739 $ 456,881 $ 427,602 $ 475,726 $ 330,107
Operating income (loss) 52,870 22,286 11,889 (33,324) (1,440)
Net income (loss) before provision for income taxes 46,598 40,595 43,918 (26,757) 10,333
Provision for income taxes 18,638 16,239 - - -
Net income (loss) before cumulative effect of accounting 24,356
change 27,960 43,918 (26,757) 10,333
Net income (loss) 27,960 24,356 38,011 (52,487) 10,333
COMMON STOCK DATA:
Diluted earnings (loss) before cumulative effect of accounting
change per share $ 2.29 $ 1.84 $ 2.95 $ (1.75) $ 0.61
Diluted earnings (loss) per share $ 2.29 $ 1.84 $ 2.55 $ (3.44) $ 0.61
Diluted weighted average common shares outstanding 13,208 13,233 14,909 15,248 16,993
JUNE 30,
--------------------------------------------------------------
2004 2003 2002 2001 2000
CONSOLIDATED FINANCIAL POSITION DATA AND LIQUIDITY:
Cash and cash equivalents $ 159,496 $ 72,260 $ 45,502 $ 21,745 $ 30,169
Total assets 453,162(1) 248,505 280,817 348,461 316,772
Long-term liabilities 246,943 8,273 3,627 3,057 1,083
Shareholders' (deficit) equity (46,083) (20,283) (20,630) (25,965) 19,021
Cash flow provided by operating activities 47,948 48,533 17,014 12,022 44,910
(1) In 2004, the Company completed the acquisition of all of the assets and
capital stock of Lavalife Inc.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is a leader in bringing value to consumers by designing innovative
membership programs that offer members easy access to a variety of discounted
products and services provided by the Company's participating vendors. In April
2004, the Company broadened the scope of its business by acquiring Lavalife, a
personals service. As a result of this acquisition, the Company is a leading
global provider of web-based and IVR based personals services. The acquisition
of Lavalife benefits the Company by providing access to one of the largest and
fastest growing consumer categories on the internet while expanding its target
market.
In the past, the Company operated in one business segment, Membership. However,
with the acquisition of Lavalife, management analyzes the Company's business
based on the following two business segments: Membership and Personals. For
additional financial information about of these business segments, see Note 20
to the consolidated financial statements.
Membership service programs offer consumers a variety of products and services
from selected vendors for an annual or monthly fee. Revenues are derived
principally from recurring fees which are billed to the member either on an
annual or monthly basis. In the case of annually billed membership fees, the
Company receives full payment at or near the beginning of the membership period,
but recognizes the revenues as the member's refund privilege expires. Membership
fees that are billed monthly are recognized when earned. 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.
10
The personals service business segment employs a transactional business model,
in which users buy non-refundable credits up front and spend those credits only
when they want to interact with other users. Personals services revenues are
generally recognized when the services are used.
CRITICAL ACCOUNTING POLICIES
Critical accounting policies are those policies that are important to the
Company's financial condition and results of operations and involve subjective
or complex judgments on the part of management, often as a result of the need to
make estimates. The following areas require the use of judgments and estimates:
membership cancellation rates, deferred marketing costs, valuation of goodwill
and other intangible assets, estimation of remaining useful lives of intangible
assets and valuation of deferred tax assets. Estimates in each of these areas
are based on historical experience and various assumptions that the Company
believes are appropriate. Actual results may differ from these estimates. The
Company believes the following represent the critical accounting policies of the
Company as contemplated by Financial Reporting Release No. 60, "Cautionary
Advice Regarding Disclosure about Critical Accounting Policies." For a summary
of all of the Company's significant accounting policies, see Note 2 to the
consolidated financial statements located in this 2004 Annual Report on Form
10-K.
MEMBERSHIP REVENUE RECOGNITION
Revenues are billed primarily through credit and debit cards. Members who are
enrolled in a monthly payment plan may cancel their membership at any time, at
which time, the billings will be discontinued. Revenues from these membership
programs are recognized when earned. Members who are enrolled in an annual
payment plan may cancel their membership in the program at any time and will
receive a pro rata refund of the fee paid based on the remaining portion of the
membership period. In accordance with Staff Accounting Bulletin 104, "Revenue
Recognition" ("SAB 104"), deferred revenues are recorded, net of estimated
cancellations, and are amortized as revenues upon the expiration of membership
refund privileges. An allowance for membership cancellations is established
based on management's estimates and is updated regularly. In determining the
estimate of allowance for membership cancellations, management analyzes
historical cancellation experience, current economic trends and changes in
customer demand for the Company's products and services. Actual membership
refunds are charged against the allowance for membership cancellations on a
current basis. If actual cancellations differ from the estimate, the results of
operations would be impacted.
MEMBERSHIP SOLICITATION AND OTHER DEFERRED COSTS
The Company's marketing expenses are comprised of refundable royalty payments,
non-refundable royalty payments, advertising costs, telemarketing and direct
mail. Refundable royalty payments are deferred and charged to operations over
the membership period in order to match the marketing costs with the associated
revenues from membership fees. Advertising costs and non-refundable royalty
payments, which include fee per offer, fee per sale and fee per impression
marketing arrangements, are expensed when incurred. Telemarketing, which
includes the cost of third party vendors to solicit members on the Company's
behalf, and direct mail, which includes the cost of printing and mailing direct
mail pieces, are direct response advertising costs which are accounted for in
accordance with American Institute of Certified Public Accountants Statement of
Position 93-7, "Reporting on Advertising Costs" ("SOP 93-7"). Under SOP 93-7,
direct response advertising costs are deferred and charged to operations over
the membership period, which is the period of expected future benefit, as
revenues from membership fees are recognized.
Total membership solicitation costs incurred to enroll a new member are
generally less than the estimated total net membership revenues. However, if
total membership solicitation costs were to exceed total estimated net
membership revenues, an adjustment would be made to the membership solicitation
and other deferred costs balance to the extent of any impairment.
VALUATION OF GOODWILL AND OTHER INTANGIBLES
The Company reviews the carrying value of its goodwill and other intangible
assets and assesses the remaining estimated useful lives of its intangible
assets in accordance with Financial Accounting Standards Board ("FASB")
Statement No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). The
Company reviews the carrying value of its goodwill and other intangible assets
for impairment by comparing such amounts to their fair values. The Company is
required to perform this comparison at least annually or more frequently if
circumstances indicate possible impairment. When determining fair value, the
Company utilizes various assumptions, including projections of future cash
flows. A change in these underlying assumptions would cause a change in the
results of the tests and, as such, could cause fair value to be less than the
carrying amounts. In such an event, the Company would then be required to record
a corresponding charge which would negatively impact earnings. Goodwill at July
1, 2003, 2002 and 2001, was tested for impairment during the quarters ended
September 30, 2003, 2002 and 2001, respectively. The Company concluded that none
of its goodwill was impaired as of July 1, 2003 or 2002. As of July 1, 2001, the
Company determined that there was an impairment of goodwill of $5.9 million at
one of its reporting units due to the change in methodology of calculating
impairment under SFAS 142 concurrent with downward trends in the operations of
the reporting unit. This amount was recorded as a cumulative effect of
accounting change in the statement of operations in 2002.
11
INCOME TAXES
The Company accounts for income taxes under the provisions of FASB Statement No.
109, "Accounting for Income Taxes." Deferred tax assets and liabilities are
recognized for future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. The Company assesses the realization of deferred tax
assets considering various assumptions, including estimates of future taxable
income and ongoing tax strategies. A change in these underling assumptions could
impact the results of operations.
RESULTS OF OPERATIONS
PERCENT INCREASE
-------------------------
REVENUES: 2004 2003 2002 '04 VS. `03 '03 VS. `02
----------- ----------- ---------- ------------- -----------
Membership $ 471,049 $ 456,881 $ 427,602 3% 7%
Personals 17,690 - - NM NM
----------- ----------- ---------- -------------------------
Total $ 488,739 $ 456,881 $ 427,602 7% 7%
=========== =========== ========== =========================
NM = Not Meaningful
MEMBERSHIP
Revenues increased 3% in 2004 primarily due to an increase in the weighted
average program price point per retail member. The net active retail members
decreased 11% in 2004 to 5.6 million primarily due to a decrease in marketing
expenses in 2004. The decline in the net active retail members may impact future
revenues and profitability. Revenues in 2003 benefited from the completion of
the migration of members that participate in a full-money-back refund policy
program to a pro rata refund policy program, which did not have an impact on
2003.
Revenues increased 7% in 2003 primarily due to the effect of the migration of
members that participate in a full-money-back refund policy program to a pro
rata refund policy program as well as an increase in the weighted average
program price point per retail member. As a result of the Company's strategic
initiative to move its members to a pro rata refund policy program, revenues
which would have been recognized at the end of a membership year are now
recognized ratably during the membership year as the refund privileges expire in
accordance with SAB 104. In addition, 2002 revenues included $9.4 million of
revenues from iPlace, Inc., which was sold in the first quarter of 2002. As of
June 30, 2003, the Company had 6.3 million net active retail members compared to
6.6 million as of June 30, 2002.
Beginning in 2003 and continuing through 2004, the Company increased the mix of
programs marketed with a monthly payment plan and decreased the mix of programs
marketed with an annual payment plan. This change was initiated due to improved
consumer response rates to the Company's marketing efforts and improved
profitability of monthly payment plan programs. The mix of members enrolled in a
monthly payment plan program was 64% in 2004, 27% in 2003 and 17% in 2002. The
Company expects to continue to increase the mix of programs marketed with a
monthly payment plan in 2005.
Revenues from members enrolled in different payment programs are summarized
below:
PERCENT
INCREASE/(DECREASE)
------------------------
REVENUES: 2004 2003 2002 '04 VS. `03 '03 VS. `02
----------- ----------- ---------- ------------ -----------
Monthly payment plans $ 160,599 $ 76,859 $ 41,273 109% 86%
Annual payment plans:
Initial year 113,231 163,604 180,672 (31)% (9)%
Renewal year 197,219 216,418 205,657 (9)% 5%
----------- ----------- ---------- ------------------------
Total $ 471,049 $ 456,881 $ 427,602 3% 7%
=========== =========== ========== ========================
12
PERSONALS
Revenues were $17.7 million in 2004 and represent the revenues of Lavalife,
which was acquired by the Company on April 1, 2004. There were approximately
600,000 active customers as of June 30, 2004.
PERCENT INCREASE
--------------------------
OPERATING INCOME: 2004 2003 2002 '04 VS. `03 '03 VS. `02
----------- ------------ --------- ------------ -------------
Membership $ 52,533 $ 22,286 $ 11,889 136% 87%
Personals 337 - - NM NM
------------ ----------- ---------- --------------------------
Total $ 52,870 $ 22,286 $ 11,889 137% 87%
============ =========== ========== ===========================
NM = Not Meaningful
MEMBERSHIP
Operating income increased 136% in 2004 primarily due to a decrease in marketing
expenses incurred of 11% while revenues increased 3%. Marketing expenses were
$248.9 million in 2004 versus $280.7 million in 2003 and, as a percentage of
revenues, marketing expenses were 53% in 2004 versus 61% in 2003. These
decreases were primarily due to the decrease in the level and mix of members
enrolled through the higher cost outbound telemarketing channel. The decrease in
members enrolled through the outbound telemarketing channel was not completely
offset by an increase in the level of members enrolled through the Company's
more profitable Online and MemberLink channels. Operating income was reduced by
an increase in operating expenses and general and administrative expenses.
Operating expenses increased 12% in 2004 and, as a percent of revenues were 19%
in 2004 and 17% in 2003, primarily due to increased member service call center
related costs incurred to improve the value and quality of services offered to
the retail membership base. General and administrative expenses increased 9% in
2004, and as a percent of revenues were 17% in 2004 and 16% in 2003, primarily
due to increased employee related expenses.
Operating income increased 87% in 2003 primarily due to decreased general and
administrative expenses in 2003 and a $6.9 million restructuring charge recorded
in 2002 (see Note 5 of the consolidated financial statements contained in this
Annual Report on Form 10-K). General and administrative expenses decreased 6% to
$74.1 million in 2003 from $79.2 million in 2002 and, as a percent of revenues
were 16% in 2003 and 19% in 2002. The decrease in general and administrative
expenses is primarily due to the sale of iPlace, Inc. and the closing of the
United Kingdom operations in 2002. The improvement in general and administrative
expenses was partially offset by an increase in marketing expenses. Marketing
expenses increased 13% in 2003, and as a percent of revenues were 61% in 2003
and 58% in 2002, primarily due to a higher level of non-refundable royalties and
advertising costs incurred in 2003 due to the Company's shift away from
telemarketing.
PERSONALS
Operating income was $0.3 million in 2004 and represented the results of
Lavalife, which was acquired on April 1, 2004. Operating income reported for
2004 reflects $1.3 million of expense for the amortization of intangible assets.
PERCENT
INCREASE/(DECREASE)
-----------------------
CORPORATE: 2004 2003 2002 '04 VS. `03 '03 VS. `02
------------ ----------- ----------- ---------- -----------
Interest (expense) income, net $ (6,621) $ 570 $ 333 NM 71%
Other income (expense), net 349 (244) (734) 243% 67%
Settlement of investment related litigation - 19,148 - NM NM
(Loss) gain on sale of subsidiary - (959) 65,608 NM NM
Net loss on investment - (206) (33,628) NM NM
Minority interest - - 450 0% NM
Provision for income taxes 18,638 16,239 - 15% NM
NM = Not Meaningful
Interest (expense) income, net. The increase in interest expense, net in 2004
was due to nine months of interest expense related to the 5.5% Convertible Notes
issued in September 2003 and three months of interest expense related to the
9.25% Senior Notes issued in April 2004.
Settlement of investment related litigation. In 2003, the Company, along with
certain of the other former shareholders of iPlace, Inc., settled their lawsuit
against Homestore.com, Inc. The total settlement amount in favor of the
plaintiffs was $23.0 million of which the Company received $19.1 million.
13
(Loss) gain on sale of subsidiary. In 2002, the Company sold its investment in
iPlace, Inc. for $50.1 million in cash and 1.6 million shares of Homestore.com,
Inc. common stock and reported a gain of $65.6 million. In 2003, the Company
settled with Homestore.com, Inc. all issues pending related to amounts held in
escrow in connection with the sale and recorded a net loss of $1.0 million
related to this settlement in 2003.
Net loss on investment. In 2002, the Company reported a loss of $33.6 million
reflecting the write-down of the Company's investment in Homestore.com, Inc.
common stock to its fair market value. In 2003, the Company sold all of its
Homestore.com, Inc. common stock and recognized a loss of $0.2 million.
Provision for income taxes. In 2004 and 2003, the Company recorded a provision
for income taxes of $18.6 million and $16.2 million, respectively, based on an
effective tax rate of 40%. The effective tax rate was higher than the U.S.
federal statutory rate due to state tax expense and other non-deductible items.
In 2002, the Company was not required to record a provision for income taxes due
to its ability to utilize net operating loss carryforwards against which the
Company had previously carried a full valuation allowance. As of June 30, 2004
and 2003, the Company had accumulated federal net operating loss carryforwards
of $6.5 million and $41.4 million, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Net cash flow provided by operating activities is an important measure used to
understand the Company's liquidity. Management believes it is useful to report
the components of net cash provided by operating activities as follows: Revenue
before deferral, marketing costs before deferral, operating expenses, general
and administrative expenses, and changes in assets and liabilities. For
definitions and reconciliations of revenue before deferral and marketing costs
before deferral see "Reconciliation of Non-GAAP Measures" located elsewhere in
this Annual Report on Form 10-K. Net cash provided by operating activities was
$47.9 million, $48.5 million and $17.0 million for the years ended June 30,
2004, 2003 and 2002, respectively.
Revenues before deferral increased 9% to $456.5 million in 2004 and increased 2%
to $417.9 million in 2003. These increases were primarily due to an increase in
the weighted average program price point per retail member. The new annual
weighted average program price points per retail member were $107, $104 and $88
during 2004, 2003 and 2002, respectively. Monthly weighted average program price
points per retail member were $11.37, $10.11 and $8.97 during 2004, 2003 and
2002, respectively. Revenues before deferral also included $17.1 million of
revenues from Lavalife, which was acquired on April 1, 2004.
As described above, the Company increased the mix of programs marketed with a
monthly payment plan beginning in 2003 and continuing through 2004. The table
below summarizes the components of revenues before deferral for the years ended
June 30:
2004 2003 2002
----------- ---------- ----------
Monthly payment plans $ 166,365 $ 76,859 $ 41,273
Annual payment plans:
Initial year 78,190 149,393 157,816
Renewal year 194,812 191,626 211,397
Personals 17,100 - -
----------- ---------- ----------
Total $ 456,467 $ 417,878 $ 410,486
=============== ========== ==========
Marketing costs before deferral were $230.4 million, $229.3 million and $233.9
million in 2004, 2003 and 2002, respectively. In 2004, marketing costs before
deferral increased 0.5% primarily due to marketing costs incurred by Lavalife
offset by the decrease in the level and mix of members enrolled through the
higher cost outbound telemarketing channel. The decrease in members enrolled
through the outbound telemarketing channel was not completely offset by the
increase in the level of members enrolled through the Company's more profitable
online and Memberlink channels. As a percent of revenue before deferral,
marketing costs before deferral were 50% in 2004 versus 55% in 2003 due to the
effect of higher weighted average program price points, as described above, the
effect of the maturing base of members enrolled in a monthly payment plan
program and the reduced level and mix of higher cost outbound telemarketing
costs. In 2003 marketing costs before deferral decreased 2% and, as a percent of
revenue before deferral, decreased to 55% in 2003 versus 57% in 2002, primarily
due to the effect of higher weighted average program price points per retail
member, as described above.
14
Net cash provided by operating activities in 2004 was impacted by increased
operating expenses, general and administrative expenses and net interest expense
as described above. Net cash provided by operating activities in 2003 benefited
from decreased general and administrative expenses in 2003. In addition, 2002
included a restructuring charge, which is described above. Net cash provided by
operating activities was also impacted by changes in assets and liabilities,
which used $4.1 million of cash in 2004, had no significant impact in 2003 and
used $9.8 million of cash in 2002. The primary driver of the increase in cash
used by changes in assets and liabilities in 2004 is the decrease in the
allowance for membership cancellations and reflects the decrease in the level of
marketing as well as the decrease in the programs marketed with an annual
payment program. The Company expects an increase in cash paid for taxes in 2005
as the remaining federal net operating loss carryforwards have been reduced to
$6.5 million as of June 30, 2004.
Net cash used in investing activities was $129.6 million in 2004, and net cash
provided by investing activities was $12.4 million in 2003 and $40.2 million in
2002. In 2004, the Company completed the acquisition of Lavalife for $114.9
million in cash. Also in 2004, the Company purchased $7.7 million of short-term
investments. Net cash provided by investing activities in 2003 included the
Company's $19.1 million settlement of a lawsuit against Homestore.com Inc. Net
cash provided by investing activities in 2002 reflected the receipt of $46.0
million in net proceeds from the sale of iPlace, Inc. Capital expenditures were
$7.1 million, $5.5 million and $5.8 million in 2004, 2003 and 2002,
respectively.
Net cash provided by financing activities was $168.8 million in 2004 and net
cash used in financing activities was $34.2 million in 2003 and $33.5 million in
2002. Net cash provided by financing activities in 2004 principally reflected
the issuance of $229.8 million in debt, net of issuance costs, the proceeds from
the exercise of employee stock options of $33.6 million and the proceeds from
the issuance of restricted stock of $9.1 million (See Note 8 of the consolidated
financial statements contained in this Annual Report on Form 10-K). These
sources of cash were partially offset by the use of $94.2 million in cash to
repurchase the Company's stock. Net cash used in financing activities in 2003
principally reflected the repurchase of the Company's stock for $37.2 million
partially offset by proceeds from the exercise of employee stock options of $4.1
million. Net cash used in financing activities in 2002 principally reflected the
purchase of Company stock for $34.3 million partially offset by proceeds from
the exercise of employee stock options of $1.5 million.
DEBT ISSUANCES
During 2004 the Company issued $90.0 million aggregate principal amount 5.5%
convertible senior subordinated notes ("Convertible Notes") due September 2010
and $150.0 million of Senior Notes. The Convertible Notes bear interest at the
rate of 5.5% per year, which will be payable in cash semi-annually in arrears on
April 1 and October 1 of each year, and the first payment was paid on April 1,
2004. The net proceeds were to be used for general corporate purposes, including
mergers and acquisitions and additional repurchases of the Company's common
stock under its stock buyback program. Upon the occurrence of a change in
control, holders of the Convertible Notes may require the Company to repurchase
all or part of the Convertible Notes for cash. The Senior Notes were sold at
98.418% of the principal amount which results in an effective yield of 9.5%.
Interest is payable in cash semi-annually in arrears on April 1 and October 1 of
each year, with the first payment due on October 1, 2004. A portion of the
proceeds from the offering of the Senior Notes was used to repay amounts
borrowed under the senior secured credit facility to fund a portion of the
Lavalife acquisition. The Company intends to use the remaining proceeds for
general corporate purposes, including working capital, future acquisitions and
repurchases of the Company's common stock under the Company's stock buyback
program to the extent permitted under the indenture governing the Senior Notes
and the senior secured credit facility. The Senior Notes offering was made
solely by means of a private placement to qualified institutional buyers
pursuant to Rule 144A under the Securities Act of 1933, as amended, and to
certain persons in offshore transactions pursuant to Regulation S under the
Securities Act. The Senior Notes have not been registered under the Securities
Act and may not be offered or sold in the United States, or to a U.S. person,
absent registration or an applicable exemption from registration requirements.
CREDIT FACILITY
The Company has an amended and restated senior secured credit facility that
allows borrowings of up to $45.0 million. Borrowings under the senior secured
credit facility accrue interest at either the Eurodollar rate, or the higher of
the Prime rate or the Federal Funds rate, plus an applicable margin. As of June
30, 2004, the availability under the senior secured credit facility was reduced
by an outstanding letter of credit of $5.5 million and one year's worth of
interest on the Senior Notes. As of June 30, 2004, the availability under the
senior secured credit facility is approximately $25.7 million. As of June 30,
2004, the effective interest rate for borrowings under the senior secured credit
facility was 4.0%. The senior secured credit facility has certain financial
covenants, including a maximum debt coverage ratio, potential restrictions on
additional borrowings and potential restrictions on additional stock
repurchases. As of June 30, 2004, the Company was in compliance with all such
debt covenants.
STOCK REPURCHASE PROGRAM
The Company purchased 3.0 million shares for $94.2 million at an average price
of $31.56 in 2004 compared to 2.0 million shares for $37.2 million at an average
price of $18.67 in 2003 and 2.2 million shares for $34.3 million at an average
price of $15.40 in 2002. The Company utilized cash from operations, stock
issuances and the issuance of the Convertible Notes and Senior Notes to
repurchase shares. During 2004, the Board of Directors authorized an additional
3.0 million shares to be repurchased under the buyback program. As of June 30,
2004, the Company had 1.0 million shares available for repurchase under its
buyback program.
15
As of June 30, 2004, the Company had cash and cash equivalents of $159.5 million
in addition to its senior secured credit facility. The Company believes that
existing cash balances, together with funds available under its senior secured
credit facility, will be sufficient to meet its funding requirements for the
foreseeable future.
The Company did not have any material commitments for capital expenditures as of
June 30, 2004. The Company intends to utilize cash on hand and cash generated
from operations to fulfill any capital expenditure requirements during 2005.
RECONCILIATION OF NON-GAAP MEASURES
Management believes that revenues before deferral and marketing costs before
deferral are important measures of liquidity and are significant factors in
understanding the Company's operating cash flow trends. These non-GAAP measures
are used by management and the Company's investors to understand the liquidity
trends of the Company's marketing margins related to the current period
operations which are reflected within the operating cash flow section of the
cash flow statement. GAAP revenues and marketing expenses are important measures
used to understand the marketing margins earned during the period in the income
statement. However, in order to understand the Company's operating cash flow, it
is important to understand the primary, current period drivers of that cash
flow. Two of the primary indicators of operating liquidity for the period are
revenues before deferral and marketing costs before deferral. Revenues before
deferral are revenues before the application of SAB 104 and represent the
revenues billed during the current reporting period less an allowance for
membership cancellations. That is, revenues before deferral for a reporting
period include membership fees received in the current reporting period that
will be recorded as GAAP revenues in future reporting periods and exclude
membership fees received in prior reporting periods that are recorded as GAAP
revenues in the current reporting period. Marketing costs before deferral are
marketing costs before the application of SAB 104 and SOP 93-7 and represent
marketing costs paid for or accrued for during the current reporting period.
That is, marketing costs before deferral for a reporting period include costs
paid or accrued in the current reporting period that will be recorded as GAAP
marketing expenses in future reporting periods and exclude marketing expenses
paid or accrued in prior reporting periods that are recorded as GAAP marketing
expenses in the current reporting period. Neither revenues before deferral nor
marketing costs before deferral exclude charges or liabilities that will require
cash settlement. Additionally, these measures are not a substitute for, or
superior to, Revenues and Marketing Expense prepared in accordance with
generally accepted accounting principles. In light of the difference between
revenues before deferral, marketing expenses before deferral and their most
directly comparable GAAP measures, the Company solely uses these measures as
liquidity measures and not as performance measures.
Revenues before deferral for the years ended June 30, 2004, 2003 and 2002 are
calculated as follows:
2004 2003 2002
------------ ------------ -----------
Revenues $ 488,739 $ 456,881 $ 427,602
Change in deferred revenues (32,272) (39,003) (17,116)
----------- ------------ -----------
Revenues before deferral $ 456,467 $ 417,878 $ 410,486
=========== ============ ===========
Marketing cost before deferral for the years ended June 30, 2004, 2003 and 2002
is calculated as follows:
2004 2003 2002
------------ ------------ -----------
Marketing expenses $ 255,818 $ 280,673 $ 248,974
Change in membership solicitation and other deferred costs (25,455) (51,411) (15,038)
------------ ------------ ----------
Marketing costs before deferral $ 230,363 $ 229,262 $ 233,936
============ ============ ===========
COMMITMENTS
The Company is not aware of factors that are reasonably likely to adversely
affect liquidity trends, other than the risk factors presented in the Forward
Looking Statements in this 2004 Annual Report on Form 10-K. The Company does not
have off-balance sheet arrangements, non-exchange traded contracts or material
related party transactions.
16
Future minimum payments of contractual obligations as of June 30, 2004 are as
follows (amounts in thousands):
PAYMENTS DUE BY PERIOD
----------------------------------------------------------------------------
LESS THAN AFTER
TOTAL 1 YEAR 1-3 YEARS 3-5 YEARS 5 YEARS
------------ ----------- ------------ ----------- -------------
Operating leases $ 29,293 $ 7,761 $ 10,931 $ 7,716 $ 2,885
Capital leases 1,190 326 707 157 -
Long-term debt 240,000 - - - 240,000
Purchase obligations 13,403 13,371 32 - -
Other obligations 12 12 - - -
------------ ----------- ------------- ----------- ------------
Total payments due $ 283,898 $ 21,470 $ 11,670 $ 7,873 $ 242,885
============ =========== ============= =========== ============
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. See Notes 6 and 7 of the consolidated financial statements
contained elsewhere in this 2004 Annual Report filed on Form 10-K.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which was revised in December 2003. FIN
46 clarifies the application of Accounting Research Bulletin No. 51 and provides
guidance on the identification of and reporting for variable interest entities.
FIN 46 is effective immediately for variable interest entities formed after
January 31, 2003 and is effective for periods ending after March 15, 2004 for
any variable interest entity formed prior to February 1, 2003. The adoption of
FIN 46 did not have a material impact on the Company's financial statements.
In May 2003, the FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). This statement requires that certain financial instruments that
were accounted for as equity under previous guidance be classified as
liabilities in statements of financial position. SFAS 150 is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. The adoption of SFAS 150 did not have a material impact on the
Company's financial statements.
FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements that are
based on current expectations, estimates, forecasts and projections about the
industry in which the Company operates and the Company's management's beliefs
and assumptions. These forward-looking statements include statements that do not
relate solely to historical or current facts and can be identified by the use of
words such as "believe," "expect," "estimate," "project," "continue" or
"anticipate." These forward-looking statements are made pursuant to safe harbor
provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are not guarantees of future performance and are
based on a number of assumptions and estimates that are inherently subject to
significant risks and uncertainties, many of which are beyond our control,
cannot be foreseen and reflect future business decisions that are subject to
change. Therefore, actual outcomes and results may differ materially from what
is expressed or forecasted in such forward-looking statements. Among the many
factors that could cause actual results to differ materially from the
forward-looking statements are:
o higher than expected membership cancellations or lower than expected
membership renewal rates;
o changes in the marketing techniques of credit card issuers;
o increases in the level of commission rates and other compensation required
by marketing partners to actively market with the Company;
o potential reserve requirements by business partners such as the Company's
credit card processors;
o unanticipated termination of marketing agreements;
o the extent to which the Company can continue to successfully develop and
market new products and services and introduce them in a timely basis;
o the Company's ability to integrate acquired businesses into the Company's
management and operations and operate successfully;
17
o unanticipated changes in or termination of the Company's ability to process
revenues through third parties, including credit card processors and bank
card associations;
o the Company's ability to develop and implement operational and financial
systems to manage growing operations;
o the Company's ability to recover from a complete or partial system failure
or impairment, other hardware or software related malfunctions or
programming errors;
o the degree to which the Company is leveraged;
o the Company's ability to obtain financing on acceptable terms to finance
the Company's growth strategy and to operate within the limitations imposed
by financing arrangements;
o further changes in the already competitive environment for the Company's
products or competitors' responses to the Company's strategies;
o changes in the growth rate of the overall U.S. economy, or the
international economy where the Company does business, such that credit
availability, interest rates, consumer spending and related consumer debt
are impacted;
o additional government regulations and changes to existing government
regulations of the Company's industry;
o the Company's ability to compete with other companies that have financial
or other advantages;
o adverse movement of foreign exchange rates;
o the Company's ability to attract and retain active members and users; o
adverse results of litigation or regulatory matters; and
o new accounting pronouncements.
Many of these factors are beyond the Company's control, and, therefore, its
business, financial condition, results of operations and cash flows may be
adversely affected by these factors.
The Company cautions that such factors are not exclusive. All of the
forward-looking statements made in this Annual Report on Form 10-K are qualified
by these cautionary statements and readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date of
this Annual Report on Form 10-K. Except as required by law, the Company does not
have any intention or obligation to publicly update any forward-looking
statements, whether as a result of new information, future events or otherwise.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE
The Company has a senior secured credit facility that allows borrowings of up to
$45.0 million. Borrowings under the senior secured credit facility accrue
interest at either the Eurodollar rate or the higher of the Prime rate or the
Federal Funds rate plus an applicable margin. There were no borrowings
outstanding under this senior secured credit facility as of June 30, 2004. As of
June 30, 2004, availability under the senior secured credit facility was reduced
by an outstanding letter of credit of $5.5 million and one year's worth of
interest on the Senior Notes. As of June 30, 2004, the availability under the
senior secured credit facility is approximately $25.7 million. Management
believes that an increase in the Eurodollar rate, the Prime rate or the Federal
Funds rate would not be material to the Company's financial position or its
results of operations. If the Company is not able to renew its existing credit
facility agreement, which matures on March 25, 2005, it is possible that any
replacement lending facility obtained by the Company may be more sensitive to
interest rate changes. In addition, the Company has $90.0 million aggregate
principal amount of 5.5% Convertible Notes due 2010 and $150.0 million aggregate
principal amount of 9.25% Senior Notes due 2014. The Convertible Notes and the
Senior Notes pay interest in cash semi-annually in arrears on April 1 and
October 1 of each year. The fair value of the fixed interest instruments are
affected by changes in interest rates, and with respect to the Convertible
Notes, are also affected by changes in the Company's stock price and volatility.
The Company does not currently hedge interest rates with respect to its
outstanding debt. As of June 30, 2004, the carrying value of the Convertible
Notes and the Senior Notes was $90.0 million and $147.7 million, respectively,
and the fair value of the notes were $93.3 million and $143.3 million,
respectively.
FOREIGN CURRENCY
The Company conducts business in certain foreign markets, primarily in Canada.
The Company's primary exposure to foreign currency risk relates to investments
in foreign subsidiaries that transact business in functional currency other than
the U.S. Dollar, primarily the Canadian Dollar. As the Company increases its
operations in international markets, it becomes increasingly exposed to
potentially volatile movements in currency exchange rates. The economic impact
of currency exchange rate movements on the Company are often linked to
variability in real growth, inflation, interest rates, governmental actions and
other factors. These changes, if material, could cause the Company to adjust its
financing and operating strategies. As currency exchange rates change,
translation of the income statements of the Company's international business
into U.S. dollars affects year-over-year comparability of operating results.
Historically, the Company has not hedged translation risks because cash flows
from international operations were generally reinvested locally.
18
In connection with the acquisition of Lavalife, the Company employed policies
and procedures to manage foreign currency risks associated with the purchase
price, which was denominated in Canadian dollars. The Company's objective in
managing its exposure to foreign currency exchange rate fluctuations was to
reduce the impact of adverse fluctuations on cash flows associated with foreign
currency exchange rate changes. Accordingly, the Company utilized foreign
currency option contracts and forward contracts to manage its exposure related
to the purchase price for the Lavalife acquisition. Gains and losses related to
these derivative contracts were recognized in the statement of operations in
fiscal 2004.
Foreign exchange gains and losses were not material to the Company's earnings in
2004, 2003 and 2002. However, given the currency fluctuations in 2004 and 2003
and anticipated increases in the Company's operations in international markets,
the Company is reviewing its strategy for hedging transaction risks. The
Company's objective in managing its foreign exchange risk is to reduce its
potential exposure to the changes that exchange rates might have on its
earnings, cash flows and financial position. The Company will assess the need to
utilize financial instruments to hedge currency exposures on an ongoing basis.
However, there can be no assurance that the Company's foreign currency hedging
activities will substantially offset the impact of fluctuations in currency
exchange rates on its results of operations and financial position.
FAIR VALUE OF INVESTMENTS
The Company does not have material exposure to market risk with respect to
investments, as the Company's investments are short-term in nature (original
maturities of less than one year). The Company does not use derivative financial
instruments for speculative or trading purposes. However, this does not preclude
the Company's adoption of specific hedging strategies in the future.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and related notes and report of independent public
registered accounting firm for the Company are included following Part IV,
beginning on page F-1, and identified in the index appearing at Item 15(a).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.
The Chief Executive Officer and Chief Financial Officer have evaluated the
effectiveness of the Company's disclosure controls and procedures (as defined
under Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this
report and have concluded that the Company's disclosure controls and procedures
were effective at the reasonable assurance level. The Company's disclosure
controls and procedures are designed to ensure that material information
relating to the Company and its consolidated subsidiaries that is required to be
disclosed in its reports under the Exchange Act is accumulated and communicated
to the Chief Executive Officer and Chief Financial Officer.
Notwithstanding the foregoing, although there can be no assurance that the
Company's disclosure controls and procedures will detect or uncover all failures
of persons within the Company and its consolidated subsidiaries to disclose
material information otherwise required to be set forth in the Company's
periodic reports, the Chief Executive Officer's and Chief Financial Officer's
evaluation concluded that they are reasonably effective to do so.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING.
During 2004, there were no changes in the Company's internal control over
financial reporting that could have materially affected, or are reasonably
likely to materially affect, the Company's internal control over financial
reporting.
During the quarter ended June 30, 2004, the Company completed the acquisition of
Lavalife for $114.9 million in cash. As part of the integration activities
associated with this acquisition, the Company is in the process of fully
incorporating this business into its disclosure controls and procedures.
19
ITEM 9B. OTHER INFORMATION
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 AND
RELATED STOCKHOLDER MATTERS
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.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information contained in the Company's Proxy Statement under the section
titled "Ratification of Selection of Independent Auditors" is incorporated
herein by reference in response to this item.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Index to Financial Statements and Financial Statement Schedules PAGE
(1) Report of PricewaterhouseCoopers LLP, Independent Registered Public
Accounting Firm F-1
Consolidated Balance Sheets as of June 30, 2004 and 2003 F-2
Consolidated Statements of Operations for the years ended June 30,
2004, 2003 and 2002 F-3
Consolidated Statements of Shareholders' (Deficit) Equity for the
years ended June 30, 2004, 2003 and 2002 F-4
Consolidated Statements of Cash Flows for the years ended June 30, 2004, 2003 and 2002 F-5
Notes to Consolidated Financial Statements F-6
The following Financial Statement Schedule is included:
(2) Schedule II - Valuation and Qualifying Accounts - Years ended June 30, 2004, 2003 and 2002 F-29
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
On April 5, 2004, the Company furnished on Form 8-K under Item 2
"Acquisition or Disposition of Assets" and Item 7 "Financial Statements,
Pro Forma Financial Statements and Exhibits" a press release announcing the
completion of the acquisition of Lavalife Inc.
On April 8, 2004, the Company filed on Form 8-K under Item 5 "Other Events"
and Item 7 "Financial Statements, Pro Forma Financial Statements and
Exhibits" a press release announcing the pricing of $150.0 million
aggregate principal amount of 9.25% Senior Notes due 2014 sold at 98.418%.
20
On April 28, 2004, the Company filed on Form 8-K under Item 7 "Financial
Statements, Pro Forma Financial Statements and Exhibits" and furnished Item
12 "Results of Operations and Financial Condition" a press release
announcing fiscal year 2004 third quarter and nine month results.
(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.
21
MEMBERWORKS INCORPORATED
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
MEMBERWORKS INCORPORATED
(Registrant)
By: /s/ GARY A. JOHNSON
Gary A. Johnson, President, Chief
Executive Officer and Director
Date: September 13, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the date indicated.
SIGNATURE TITLE DATE
- ---------- ------ -----
By: /s/ GARY A. JOHNSON President, Chief Executive Officer and Director September 13, 2004
- -----------------------------
Gary A. Johnson
By: /s/ JAMES B. DUFFY Executive Vice President, Chief Financial Officer September 13, 2004
- -----------------------------
James B. Duffy
By: /s/ ALEC L. ELLISON Director September 13, 2004
- -----------------------------
Alec L. Ellison
By: /s/ SCOTT N. FLANDERS Director September 13, 2004
- -----------------------------
Scott N. Flanders
By: /s/ ROBERT KAMERSCHEN Director September 13, 2004
- -----------------------------
Robert Kamerschen
By: /s/ MICHAEL T. MCCLOREY Director September 13, 2004
- -----------------------------
Michael T. McClorey
By: /s/ EDWARD M. STERN Director September 13, 2004
- -----------------------------
Edward M. Stern
By: /s/ MARC S. TESLER Director September 13, 2004
- -----------------------------
Marc S. Tesler
22
EXHIBITS
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)
*4.3 Indenture dated as of September 30, 2003 between MemberWorks
Incorporated and Deutsche Bank Trust Company Americas, or Trustee.
(filed as exhibit 4.1 to the Company's Quarterly report on Form 10-Q,
File No. 000-21527, filed on November 13, 2003)
*4.4 Registration Rights Agreement dated as of September 30, 2003 between
MemberWorks Incorporated and Lehman Brothers Inc. and CIBC World
Markets Corp. (filed as exhibit 4.2 to the Company's Quarterly report
on Form 10-Q, File No. 000-21527, filed on November 13, 2003)
*4.5 Indenture dated as of April 13, 2004 between MemberWorks Incorporated
and each of the Guarantors party thereto and LaSalle Bank National
Association, as Trustee relating to the 9.25% Senior Notes due 2014,
including the form of notes. (filed as exhibit 4.1 to the Company's
Registration Statement on Form S-4, Registration No. 333-115500, filed
on May 14, 2004)
*4.6 Registration Rights Agreement dated April 13, 2004 between MemberWorks
Incorporated and each of the Guarantors party thereto and Lehman
Brothers Inc., UBS Securities LLC and ABN AMRO Incorporated. (filed as
exhibit 4.2 to the Company's Registration Statement on Form S-4,
Registration No. 333-115500, filed on May 14, 2004)
*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)
*10.3 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 Amended and Restated 401(k) Profit Sharing Plan of the Registrant,
dated July 1, 2000. (filed as Exhibit 10.6 to the Company's Annual
Report on Form 10-K, File No. 000-21527, filed on September 6, 2001)
*10.8 Amended and Restated Credit Agreement dated March 25, 2004 among
MemberWorks Incorporated, the Lenders Parties Hereto and LaSalle Bank
National Association. (filed as exhibit 99.3 to the Company's Current
report on Form 8-K, File No.000-21527, filed on April 5, 2004)
*10.9 Master Transaction Agreement dated March 3, 2004. (filed as exhibit
99.2 to the Company's Current report on Form 8-K, File No.000-21527,
filed on April 5, 2004)
*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)
*10.20 Arena Tower II Lease Agreement by and between Arena Tower II
Corporation and the Registrant, dated February 12, 1996, as amended.
(filed as Exhibit 10.24 to the Company's Registration Statement on Form
S-1, Registration No. 333-10541, filed on October 18, 1996)
*10.23 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, File No. 000-21527, filed on
September 29, 1997)
23
*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, File No. 000-21527, 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, File No. 000-21527, filed on
September 29, 1997)
*14.1 Code of Conduct. (filed as exhibit 14 to the Company's Quarterly report
on Form 10-Q, File No. 000-21527, filed on May 14, 2004)
*18 Letter re: Change in Accounting Principle. (filed as Exhibit 18 to the
Company's Annual Report on Form 10-K, File No. 000-21527, filed on
October 8, 1998)
21 Subsidiaries of the Registrant.
23 Consent of PricewaterhouseCoopers LLP.
31.1 Rule 13a-14(a)/15d-14(a) CEO Certification.
31.2 Rule 13a-14(a)/15d-14(a) CFO Certification.
32.1 CEO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
32.2 CFO Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
- ---------------------------------------------------
*Previously filed.
24
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
of MemberWorks Incorporated
In our opinion, the consolidated financial statements listed in the index
appearing under Item 15(a)(1) present fairly, in all material respects, the
financial position of MemberWorks Incorporated and its subsidiaries at June 30,
2004 and 2003, and the results of their operations and their cash flows for each
of the three years in the period ended June 30, 2004 in conformity with
accounting principles generally accepted in the United States of America. In
addition, in our opinion, the financial statement schedule listed in the index
appearing under Item 15(a)(2) 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 based on
our audits. We conducted our audits of these statements in accordance with the
standards of the Public Company Accounting Oversight Board (United States).
Those standards 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 our opinion.
As discussed in Note 14 to the consolidated financial statements, the Company
changed its method of accounting for goodwill and other intangible assets in
fiscal 2002.
PricewaterhouseCoopers LLP
New York, New York
September 8, 2004
F-1
MEMBERWORKS INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
JUNE 30,
-------------------------
2004 2003
---------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 159,496 $ 72,260
Restricted cash 3,120 2,732
Short-term investments 7,650 -
Accounts receivable (net of allowance for doubtful accounts of $235 and $1,743 at
June 30, 2004 and 2003, respectively) 10,557 8,713
Prepaid membership materials 3,233 2,196
Prepaid expenses 4,886 7,571
Membership solicitation and other deferred costs 52,428 77,883
----------- -----------
Total current assets 241,370 171,355
Fixed assets, net 36,540 24,969
Goodwill 125,675 42,039
Intangible assets, net 38,872 6,656
Other assets 10,705 3,486
----------- -----------
Total assets $ 453,162 $ 248,505
=========== ===========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Current maturities of long-term obligations $ 338 $ 244
Accounts payable 35,185 32,644
Accrued liabilities 66,075 59,105
Deferred revenues 138,381 167,643
Deferred income taxes 12,323 879
----------- -----------
Total current liabilities 252,302 260,515
Deferred income taxes 4,354 5,145
Other long-term liabilities 4,930 3,128
Long-term debt 237,659 -
----------- -----------
Total liabilities 499,245 268,788
----------- -----------
Commitments and contingencies (Note 7) - -
Shareholders' deficit:
Preferred stock, $0.01 par value -- 1,000 shares authorized; no shares issued - -
Common stock, $0.01 par value -- 40,000 shares authorized;
19,089 shares issued (17,847 shares at June 30, 2003) 191 178
Capital in excess of par value 156,457 122,425
Accumulated earnings (deficit) 10,131 (17,829)
Accumulated other comprehensive loss (373) (469)
Treasury stock, 8,852 shares at cost (6,126 shares at June 30, 2003) (212,489) (124,588)
----------- -----------
Total shareholders' deficit (46,083) (20,283)
----------- -----------
Total liabilities and shareholders' deficit $ 453,162 $ 248,505
=========== ===========
The accompanying notes are an integral part of
these consolidated financial statements.
F-2
MEMBERWORKS INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE YEAR ENDED JUNE 30,
----------------------------------------
2004 2003 2002
-------------- ------------ ------------
Revenues $ 488,739 $ 456,881 $ 427,602
Expenses:
Marketing 255,818 280,673 248,974
Operating 91,832 78,444 78,694
General and administrative 85,826 74,085 79,211
Restructuring charges (Note 5) - - 6,893
Amortization of intangibles 2,393 1,393 1,941
-------------- ------------ ------------
Operating income 52,870 22,286 11,889
Settlement of investment related litigation (Note 10) - 19,148 -
(Loss) gain on sale of subsidiary (Note 9) - (959) 65,608
Net loss on investment (Note 9) - (206) (33,628)
Interest (expense) income, net (6,621) 570 333
Other income (expense), net 349 (244) (734)
-------------- ------------ ------------
Income before minority interest 46,598 40,595 43,468
Minority interest (Note 12) - - 450
-------------- ------------ ------------
Income before income taxes 46,598 40,595 43,918
Provision for income taxes 18,638 16,239 -
-------------- ------------ ------------
Income before cumulative effect of accounting change 27,960 24,356 43,918
Cumulative effect of accounting change (Note 14) - - (5,907)
-------------- ------------ ------------
Net income $ 27,960 $ 24,356 $ 38,011
============== ============ ============
Basic earnings per share:
Income before cumulative effect of accounting change $ 2.60 $ 1.93 $ 3.03
Cumulative effect of accounting change - - (0.41)
-------------- ------------ ------------
Basic earnings per share $ 2.60 $ 1.93 $ 2.63
============== ============ ============
Diluted earnings per share:
Income before cumulative effect of accounting change $ 2.29 $ 1.84 $ 2.95
Cumulative effect of accounting change - - (0.40)
-------------- ------------ ------------
Diluted earnings per share $ 2.29 $ 1.84 $ 2.55
============== ============ ============
Weighted average common shares used in earnings per share calculations:
Basic 10,755 12,596 14,477
============== ============ ============
Diluted 13,208 13,233 14,909
============== ============ ============
The accompanying notes are an integral part of
these consolidated financial statements.
F-3
MEMBERWORKS INCORPORATED
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' (DEFICIT) EQUITY
(IN THOUSANDS)
ACCUMULATED
COMMON STOCK CAPITAL IN ACCUMULATED OTHER
------------------ EXCESS OF EARNINGS COMPREHENSIVE TREASURY
SHARES AMOUNT PAR VALUE (DEFICIT) (LOSS) GAIN STOCK TOTAL
-----------------------------------------------------------------------------------
Balance - June 30, 2001 17,308 $ 173 $ 107,835 $ (80,196) $ (370) $ (53,407) $ (25,965)
Issuance of common stock 185 2 1,462 - - -- 1,464
Issuance of treasury stock to fund 401K Plan - - (51) - - 207 156
Expense associated with the issuance of
stock options to a non-employee - - 8 - - - 8
Acquisition of treasury stock - - - - - (34,301) (34,301)
Comprehensive income:
Net income - - - 38,011 - - 38,011
Currency translation adjustment - - - - (3) - (3)
---------
Total comprehensive loss 38,008
-----------------------------------------------------------------------------------
Balance - June 30, 2002 17,493 175 109,254 (42,185) (373) (87,501) (20,630)
Issuance of common stock 354 3 4,047 - - - 4,050
Tax Benefit from employee stock options - - 9,100 - - - 9,100
Issuance of treasury stock to fund 401K Plan - - (21) - - 127 106
Expense associated with the issuance of
stock options to a non-employee - - 45 - - - 45
Acquisition of treasury stock - - - - - (37,214) (37,214)
Comprehensive income:
Net income - - - 24,356 - - 24,356
Currency translation adjustment - - - - (96) - (96)
---------
Total comprehensive income 24,260
-----------------------------------------------------------------------------------
Balance - June 30, 2003 17,847 178 122,425 (17,829) (469) (124,588) (20,283)
Issuance of common stock 1,242 13 24,551 - - - 24,564
Issuance of restricted stock - - 2,774 - - 6,306 9,080
Tax Benefit from employee stock options - - 6,520 - - - 6,520
Expense associated with the issuance of
stock options to a non-employee - - 187 - -- - 187
Acquisition of treasury stock - - - - - (94,207) (94,207)
Comprehensive income:
Net income - - - 27,960 - - 27,960
Currency translation adjustment -- - - - 105 - 105
Minimum pension liability adjustment (net
of tax) - (9) - (9)
-----------
Total comprehensive income 28,056
-----------------------------------------------------------------------------------
Balance - June 30, 2004 19,089 $ 191 $ 156,457 $ 10,131 $ (373) $ (212,489) $ (46,083)
===================================================================================
The accompanying notes are an integral part
of these consolidated financial statements.
F-4
MEMBERWORKS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEAR ENDED JUNE 30,
----------------------------------------
2004 2003 2002
----------- ----------- -----------
Operating activities
Net income $ 27,960 $ 24,356 $ 38,011
Adjustments to reconcile net income to net cash provided
by operating activities:
Change in deferred revenues (32,272) (39,003) (17,116)
Change in membership solicitation and other deferred costs 25,455 51,411 15,038
Depreciation and amortization 13,252 12,120 13,252
Deferred and other income taxes 10,254 14,182 -
Tax benefit from employee stock plans 6,520 942 -
Gain on settlement of investment related litigation - (19,148) -
Loss (gain) on sale of subsidiary - 959 (65,608)
Net loss on investment - 206 33,628
Non-cash restructuring charges - - 1,585
Minority interest - - (450)
Cumulative effect of accounting change - - 5,907
Other 890 2,485 2,605
Change in assets and liabilities:
Restricted cash (388) 2,951 (4,692)
Accounts receivable (112) 758 8,830
Prepaid membership materials (1,589) (135) 315
Prepaid expenses 5,172 (3,246) (2,217)
Other assets (461) (1,331) (251)
Related party payables - - 12
Accounts payable (10,323) (255) (10,752)
Accrued and other liabilities 3,590 1,281 (1,083)
----------- ----------- -----------
Net cash provided by operating activities 47,948 48,533 17,014
----------- ----------- -----------
Investing activities
Acquisition of fixed assets (7,057) (5,463) (5,761)
Settlement of investment related litigation - 19,148 -
Proceeds from sale of subsidiary, net of cash sold - - 45,997
Other investing activities - (1,250) -
Purchase of short-term investments (7,650) - -
Business combinations, net of cash acquired (114,916) - -
----------- ----------- -----------
Net cash (used in) provided by investing activities (129,623) 12,435 40,236
----------- ----------- -----------
Financing activities
Net proceeds from issuance of stock 33,644 4,050 1,515
Treasury stock purchases (94,207) (37,214) (34,301)
Net proceeds from issuance of debt 229,825 - -
Payments of long-term obligations (453) (1,051) (718)
----------- ----------- -----------
Net cash provided by (used in) financing activities 168,809 (34,215) (33,504)
----------- ----------- -----------
Effect of exchange rate changes on cash and cash equivalents 102 5 11
----------- ----------- -----------
Net increase in cash and cash equivalents 87,236 26,758 23,757
Cash and cash equivalents at beginning of year 72,260 45,502 21,745
----------- ----------- -----------
Cash and cash equivalents at end of year $ 159,496 $ 72,260 $ 45,502
=========== =========== ===========
The accompanying notes are an integral part
of these consolidated financial statements.
F-5
NOTE 1 - NATURE OF BUSINESS
MemberWorks Incorporated (the "Company"), a Delaware Corporation, began doing
business as Cardmember Publishing Corporation in 1986, was organized as
MemberWorks Incorporated in 1996 and has been doing business as MemberWorks
Incorporated since then. The Company is a marketing services leader, bringing
value to consumers by designing innovative membership programs that offer
members easy access to a variety of discounted products and services provided by
the Company's participating vendors. In April 2004, the Company broadened the
scope of its business by acquiring Lavalife Inc. ("Lavalife"), a personals
service. As a result of this acquisition, the Company is now a leading global
provider of web-based and interactive voice response ("IVR") based personals
services.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - CONSOLIDATION
The consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America and
include the accounts of the Company and its 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
accounting principles generally accepted in the United States of America
requires management of the Company to make estimates, judgments and assumptions
that affect the reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. The most significant judgments
and estimates include: membership cancellation rates, deferred marketing costs,
valuation of goodwill and intangible assets, estimation of remaining useful
lives of intangible assets and valuation of deferred tax assets.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year's presentation.
FOREIGN CURRENCY TRANSLATION
Assets and liabilities of foreign subsidiaries, whose assets and liabilities are
denominated in the local currency, 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 in the consolidated
statements of shareholders' deficit. Transaction gains and losses are included
in the consolidated statements of operations.
FAIR VALUE OF FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
All current assets and liabilities are carried at cost, which approximates fair
value due to the short-term maturity of those instruments. The recorded amounts
of the Company's long-term liabilities also approximate fair value except for
differences with respect to the Convertible Notes and the Senior Notes (see Note
6) which had carrying values of $90,000,000 and $147,659,000, respectively, and
fair values of $93,263,000 and $143,250,000 as of June 30, 2004, respectively.
Financial instruments which potentially subject the Company to concentration of
credit risk consist primarily of accounts receivable from credit card processors
who facilitate payment from our membership and personals customers.
FIXED ASSETS
Fixed assets, capitalized software costs and capital leases are carried at cost,
less accumulated depreciation and amortization. Depreciation is calculated using
the straight-line method over the estimated useful lives of the related assets.
Useful lives are generally 3 years for computer software and equipment,
estimated remaining useful life or the remaining life of the lease for leasehold
improvements and 5 to 10 years for furniture and fixtures. Maintenance and
repair expenditures are charged to operations as incurred.
REVENUE RECOGNITION
Revenues are billed primarily through credit and debit cards. Members who are
enrolled in a monthly payment plan may cancel their membership at any time, at
which time, the billings will be discontinued. Revenue from these membership
programs is recognized when earned. Members who are enrolled in an annual
payment plan may cancel their membership in the program at any time and will
receive a pro rata refund of the fee paid based on the remaining portion of the
membership period. In accordance with Staff Accounting Bulletin 104, "Revenue
Recognition" ("SAB 104"), deferred revenues are recorded, net of estimated
cancellations, and are amortized as revenues upon the expiration of membership
refund privileges. An allowance for membership cancellations is established
based on management's estimates and is updated regularly. In determining the
estimate of allowance for membership cancellations, management analyzes
historical cancellation experience, current economic trends and changes in
customer demand for the Company's products and services. Actual membership
refunds are charged against the allowance for membership cancellations on a
current basis. Accrued liabilities set forth in the accompanying consolidated
balance sheets as of June 30, 2004 and 2003 include an allowance for membership
cancellations of $14,156,000 and $20,934,000, respectively.
F-6
Revenues generated by the Personals business segment are recognized when earned.
Membership programs sponsored by the Company's two largest clients in 2004
accounted for 18% and 12% of revenues, respectively. For the year ended June 30,
2003, membership programs sponsored by the Company's two largest clients
accounted for 21% and 16% of revenues, respectively. For the year ended June 30,
2002, membership programs sponsored by the company's largest client accounted
for 16% of revenues.
MARKETING EXPENSES
The Company's marketing expenses are comprised of refundable royalty payments,
non-refundable royalty payments, advertising costs, telemarketing and direct
mail. Refundable royalty payments are deferred and charged to operations over
the membership period in order to match the marketing costs with the associated
revenues from membership fees. Advertising costs and non-refundable royalty
payments, which include fee per offer, fee per sale and fee per impression
marketing arrangements, are expensed when incurred. Telemarketing, which
includes the cost of third party vendors to solicit members on the Company's
behalf, and direct mail, which includes the cost of printing and mailing direct
mail pieces, are direct response advertising costs which are accounted for in
accordance with American Institute of Certified Public Accountants Statement of
Position 93-7, "Reporting on Advertising Costs" ("SOP 93-7"). Under SOP 93-7,
direct response advertising costs are deferred and charged to operations over
the membership period, which is the period of expected future benefit, as
revenues from membership fees are recognized.
Total membership solicitation costs incurred to obtain a new member are
generally less than the estimated total net membership revenues. However, if
total membership solicitation costs were to exceed total estimated net
membership revenue, an adjustment would be made to the membership solicitation
and other deferred costs balance to the extent of any impairment.
EARNINGS PER SHARE
Basic and diluted earnings per share amounts are determined in accordance with
the provisions of Financial Accounting Standards Board Statement ("SFAS") No.
128, "Earnings Per Share" ("SFAS 128"). Basic earnings per share is computed
using the weighted average number of common shares outstanding during the
reporting period. Diluted earnings per share 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.
CASH AND CASH EQUIVALENTS
The Company considers highly liquid investment instruments with original
maturity of three months or less to be cash equivalents. The Company's cash and
cash equivalents are carried at cost, which approximates fair market value, and
primarily consist of money market funds and tax-exempt notes and bonds.
RESTRICTED CASH
The Company excludes from cash and cash equivalents restricted cash which is
held in an escrow account for the payment of commissions to a client.
SHORT-TERM INVESTMENTS
Short-term investments consist of commercial paper and auction rate securities
with original maturities of more than 3 months but less than or equal to one
year. As of June 30, 2004, these investments are classified as held-to-maturity
under the provisions of SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" and are recorded at cost.
INCOME TAXES
The Company accounts for income taxes under the provisions of SFAS No. 109,
"Accounting for Income Taxes" ("SFAS 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.
F-7
VALUATION OF GOODWILL AND OTHER INTANGIBLES
The Company reviews the carrying value of its goodwill and other intangible
assets and assesses the remaining estimated useful lives of its intangible
assets in accordance with SFAS 142, "Goodwill and Other Intangible Assets"
("SFAS 142"). The Company reviews the carrying value of its goodwill and other
intangible assets for impairment by comparing such amounts to their fair values.
The Company is required to perform this comparison at least annually or more
frequently if circumstances indicate possible impairment. When determining fair
value, the Company utilizes various assumptions, including projections of future
cash flows. A change in these underlying assumptions could cause a change in the
results of the tests and, as such, could cause fair value to be less than the
carrying amounts. In such an event, the Company would then be required to record
a corresponding charge which would negatively impact earnings. Goodwill at July
1, 2003 and 2002 was tested for impairment during the quarters ended September
30, 2003 and 2002, respectively. The Company concluded that none of its goodwill
was impaired as of July 1, 2003 and 2002. As of July 1, 2001, the Company
determined that there was an impairment of goodwill of $5,907,000 at one of its
reporting units (see Note 14) due to the change in methodology of calculating
impairment under SFAS 142 concurrent with downward trends in the operations of
the reporting unit. This amount was recorded as a cumulative effect of
accounting change in the statement of operations in 2002.
Intangible assets principally include member and customer relationships and a
trade name that arose in connection with business acquisitions. Acquired
intangibles, except member relationships, are recorded at cost and are amortized
on a straight-line basis over their estimated useful lives ranging from 3 to 20
years. The value of member relationships is amortized using an accelerated
method based on estimated future cash flows.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company accounts for the impairment and disposition of long-lived assets in
accordance with SFAS 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." The Company reviews its intangible and other long-lived
assets for impairment whenever events or changes in circumstances indicate that
the carrying value may not be recoverable, as determined based on the projected
undiscounted future cash flows. If this review indicates that the carrying value
will not be recoverable, the carrying value is reduced to its estimated fair
value. As of June 30, 2004, no impairment has been indicated.
TREASURY STOCK
Treasury stock is accounted for under the cost method.
CONTINGENT LIABILITIES
In accordance with SFAS 5, "Accounting for Contingencies," and Financial
Accounting Standards Interpretation 14, "Reasonable Estimation of the Amount of
a Loss," the Company may have certain contingent liabilities with respect to
material existing or potential claims, lawsuits and other proceedings. The
Company accrues liabilities when it is probable that future costs will be
incurred and such costs can be reasonably estimated and measured.
F-8
STOCK-BASED COMPENSATION
In accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"), the Company applies the intrinsic value
method in accounting for employee stock options. Accordingly, the Company
generally does not recognize compensation expense with respect to stock-based
awards to employees. If compensation cost for the Company's stock-based
compensation plans had been determined based on the fair value method (estimated
using the Black-Scholes option-pricing model) at the grant dates in accordance
with SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), and
SFAS No. 148, "Accounting for Stock-Based Compensation Transition and
Disclosure" ("SFAS 148"), the Company's pro forma net income and earnings per
share would have been as follows ($ in thousands, except per share data):
YEAR ENDED JUNE 30,
----------------------------------------
2004 2003 2002
------------ ----------- ------------
Net income reported $ 27,960 24,356 $ 38,011
Add: Stock-based employee compensation expense determined under the intrinsic
value based method for all awards, net of related tax effects - - 8
Deduct: Stock-based employee compensation expense determined under the fair
value based method for all awards, net of related tax effects (4,762) (6,055) (11,406)
------------ ------------ -----------
Pro forma net income $ 23,198 18,301 $ 26,613
============ ============ ===========
Earnings per share:
As reported
Basic $ 2.60 1.93 $ 2.63
Diluted 2.29 1.84 2.55
Pro forma
Basic $ 2.16 1.45 $ 1.84
Diluted 1.90 1.38 1.79
Under the Company's stock option plans the fair value of each option grant
calculated under the provisions of SFAS 123 is estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions for the years ended June 30:
2004 2003 2002
------- ------- -------
Dividend yield 0% 0% 0%
Expected volatility 74% 69% 50%
Risk free interest rate 2.9% 3.5% 4.8%
Expected lives 5 years 5 years 5 years
The weighted average fair value per share of options granted at market value
were $14.98, $7.95 and $9.55 for the years ended June 30, 2004, 2003 and 2002,
respectively. For pro forma purposes, the estimated fair value of the Company's
stock-based awards to employees is amortized over the options' vesting period of
four to five years and the estimated fair value of the Company's awards issued
under the Employee Stock Purchase Plan are recognized in the period the stock is
issued.
For purposes of calculating the pro forma SFAS 123 compensation expense under
the iPlace Inc. stock option plan, the fair value of each option grant was
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted average assumptions for the year ended June 30, 2002:
dividend yield of 0%; volatility of 50%; risk free interest rate of 4.6%; and
expected life of 5 years. The weighted average fair value of options granted at
market value during 2002 was $1.34.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which was revised in December 2003. FIN
46 clarifies the application of Accounting Research Bulletin No. 51 and provides
guidance on the identification of and reporting for variable interest entities.
FIN 46 is effective immediately for variable interest entities formed after
January 31, 2003 and is effective for periods ending after March 15, 2004 for
any variable interest entity formed prior to February 1, 2003. The adoption of
FIN 46 did not have a material impact on the Company's financial statements.
F-9
In May 2003, the FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). This statement requires that certain financial instruments that
were accounted for as equity under previous guidance be classified as
liabilities in statements of financial position. SFAS 150 is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. The adoption of SFAS 150 did not have a material impact on the
Company's financial statements.
NOTE 3 - FIXED ASSETS
Fixed assets, net are comprised of the following at June 30, (in thousands):
2004 2003
------------- -------------
Computer software and equipment $ 62,501 $ 44,535
Furniture and fixtures 8,246 8,161
Leasehold improvements 6,622 6,356
------------- -------------
77,369 59,052
Accumulated depreciation (40,829) (34,083)
------------- -------------
$ 36,540 $ 24,969
============= =============
Depreciation and amortization expense was $10,189,000, $10,818,000 and
$11,311,000 for the years ended June 30, 2004, 2003 and 2002, respectively.
NOTE 4 - GOODWILL AND OTHER INTANGIBLE ASSETS
The gross carrying value and accumulated amortization of goodwill and other
intangibles are as follows (in thousands):
AS OF JUNE 30, 2004 AS OF JUNE 30, 2003
----------------------------------- --------------------------------
GROSS CARRYING ACCUMULATED GROSS CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
----------------- ----------------- ------------------ -------------
Amortizable intangible assets:
Membership and client relationships $ 27,999 $ (8,686) $ 13,195 $ (6,730)
Trade name 18,543 (310) - -
Other 1,162 (886) 950 (759)
------------- ------------- -------------- -------------
Total amortizable intangible assets 47,704 (9,882) $ 14,145 $ (7,489)
------------- -------------- ------------- -------------
Amortizable intangible assets, net $ 37,822 $ 6,656
============= =============
Unamortizable intangible assets:
Goodwill $ 125,675 $ 42,039
Intangible asset related to minimum
pension liability $ 1,050 $ -
The future intangible amortization expense for the next five years is estimated
to be as follows (in thousands):
FISCAL YEAR
2005 $ 6,104
2006 5,959
2007 5,173
2008 3,171
2009 2,754
The changes in the carrying amount of goodwill for the year ended June 30, 2004
are as follows (in thousands):
Balance at June 30, 2003 $ 42,039
Arising from completed acquisition 83,636
-------------
Balance at June 30, 2004 $ 125,675
=============
F-10
As part of the purchase of Lavalife Inc. in April 2004, the Company acquired
intangible assets of $116,983,000. Of that amount, $14,804,000 has been assigned
to membership and client relationships and $18,543,000 has been assigned to
trade name, both of which are subject to periodic amortization over the weighted
average estimated useful lives ranging from 3 years to 15 years. Goodwill of
$83,636,000, which is not subject to amortization, also arose in connection with
the acquisition.
Goodwill was tested for impairment during the quarters ended September 30, 2003
and 2002 as required by SFAS 142. The Company concluded that none of its
goodwill was impaired. Fair value was estimated using discounted cash flow
methodologies. Goodwill was tested at July 1, 2002 for impairment during the
quarter ended September 30, 2002 in connection with the adoption of SFAS 142
(see Note 14). In addition, the Company reassessed the estimated useful lives of
its indefinite lived intangible assets and determined that the lives were
appropriate. The Company will continue to test the goodwill of each of its
reporting units annually or more frequently if impairment indicators exist.
NOTE 5 - RESTRUCTURING CHARGES
During 2002, the Company announced the implementation of several cost saving
initiatives due to a slowdown in consumer response rates and increased economic
uncertainty in both the U.S. and abroad. This restructuring program included a
workforce reduction, the closing of the Company's United Kingdom operations and
the downsizing of the operational infrastructure throughout the Company. As a
result of the restructuring program, the Company recorded restructuring charges
of $6,893,000 during 2002.
The following is a rollforward of the major components of the restructuring
reserve which is recorded in accrued liabilities and other long-term liabilities
(in thousands):
WORKFORCE LEASE
REDUCTION OBLIGATIONS TOTAL
-------------- ----------------- --------------
Reserve balance at June 30, 2002 $ 391 $ 2,546 $ 2,937
Additions to the reserve - - -
Cash charges to the reserve 300 836 1,136
-------------- ----------------- --------------
Reserve balance at June 30, 2003 91 1,710 1,801
Additions to the reserve - - -
Cash charges to the reserve 91 66 157
-------------- ----------------- --------------
Reserve balance at June 30, 2004 $ - $ 1,644 $ 1,644
============== ================= ==============
Workforce Reduction
As part of the restructuring plan, the Company reduced its workforce by
approximately 190 regular employees, consisting of membership service
representatives and other professional personnel. All 190 employees have been
terminated.
Lease Obligations and Asset Disposals
In connection with the closing of the United Kingdom offices and the downsizing
of the Company's infrastructure, the Company recorded $73,000 for lease
terminations, $3,021,000 for non-cancelable lease obligations and $1,585,000 for
asset disposals. The reserve for lease obligations has been reduced by
anticipated sublease income. Charges against the reserve are expected to
continue for the remaining life of the lease.
NOTE 6 - LONG-TERM LIABILITIES
Long-term liabilities are summarized as follows at June 30, (in thousands):
2004 2003
----------- -----------
Senior Notes $ 147,659 $ -
Convertible Notes 90,000 -
Other long-term obligations 5,268 3,372
----------- -----------
242,927 3,372
Less: current maturities 338 244
-----------
-----------
Long-term liabilities $ 242,589 $ 3,128
=========== ===========
F-11
In April 2004, the Company issued $150,000,000 aggregate principal amount of
unsecured 9.25% senior notes due 2014 ("Senior Notes"). These Senior Notes were
sold at 98.418% of the principal amount which results in an effective yield of
9.5%. Interest is payable in cash semi-annually in arrears on April 1 and
October 1 of each year, with the first payment due on October 1, 2004. A portion
of the proceeds from the offering of these Senior Notes was used to repay
amounts borrowed under the senior secured credit facility to fund a portion of
the Lavalife acquisition. At any time prior to April 1, 2007, the Company may
redeem up to 35% of the Senior Notes with net cash proceeds of certain equity
offerings, as long as at least 65% of the aggregate principal amount of the
Senior Notes issued remains outstanding after the redemption. The Company may
redeem all or part of the Senior Notes prior to April 1, 2009 by paying a
make-whole premium. At any time on or after April 1, 2009, the Company may
redeem some or all of the Senior Notes at certain redemption prices plus accrued
and unpaid interest and liquidation damages, if any, to the date of redemption.
The offering of Senior Notes was made solely by means of private placement to
qualified institutional buyers pursuant to Rule 144A under the Securities Act of
1933, as amended, and to certain persons in offshore transactions pursuant to
Regulation S under the Securities Act. In connection with the private placement
of the Senior Notes, the Company entered into a registration rights agreement
pursuant to which the Company will use its reasonable efforts to have a
registration statement declared effective within 210 days from the issue date of
the Senior Notes. Debt issuance costs and debt discount associated with this
issuance were $5,256,000 during 2004. Debt issuance costs and debt discount are
capitalized and amortized as interest expense, net over the term of the Senior
Notes using the effective interest method.
In September 2003, the Company issued $90,000,000 aggregate principal amount of
5.5% convertible senior subordinated notes due 2010 ("Convertible Notes") in a
private offering pursuant to Rule 144A of the Securities Act of 1933, as
amended. The Convertible Notes bear interest at the rate of 5.5% per year, which
is payable in cash semi-annually in arrears on April 1 and October 1 of each
year. The first payment was paid on April 1, 2004. Holders of the Convertible
Notes may convert their notes into shares of the Company's common stock at any
time prior to maturity at an initial conversion price of approximately $40.37
per share, which is equivalent to an initial conversion rate of approximately
24.7739 shares per $1,000 principal amount of the Convertible Notes. There are
no beneficial conversion features related to these Convertible Notes. In
accordance with Accounting Principles Board Opinion No. 14, "Accounting for
Convertible Notes and Debt Issued with Stock Purchase Warrants," these
Convertible Notes have been classified as a liability. Debt issuance costs
associated with this issuance were $3,432,000 during 2004. Debt issuance costs
are capitalized and amortized as interest expense over the term of the
Convertible Notes using the effective interest method.
Other long-term obligations are comprised of the long-term portion of the
restructuring reserve (see Note 5), minimum pension liability (see Note 17),
lease incentives related to certain operating leases and consulting agreements
which expire during 2005. The lease incentives are amortized as a reduction to
rent expense over the terms of the leases.
In March, 2004, the Company entered into an amended and restated senior secured
credit facility that allows borrowings of up to $45,000,000. Borrowings under
the senior secured credit facility accrue interest at either the Eurodollar
rate, or the higher of the Prime rate or the Federal Funds rate, plus an
applicable margin. The availability under the senior secured credit facility is
reduced by an outstanding letter of credit of $5,459,000 and by one years' worth
of interest on the Senior Notes. There were no borrowings outstanding under this
bank credit facility as of June 30, 2004 or 2003. As of June 30, 2004, the
availability under the senior secured credit facility is $25,666,000. The senior
secured credit facility has certain financial covenants, including a maximum
debt coverage ratio, potential restrictions on additional borrowings and
potential restrictions on additional stock repurchases. For the periods ended
June 30, 2004 and 2003, the Company was in compliance with all financial and
restrictive loan covenants. The senior secured credit facility is secured by all
of the Company's assets, including the stock of its subsidiaries. Debt issuance
costs associated with this amendment and restatement of the senior secured
credit facility were $494,000 during 2004. Debt issuance costs are deferred and
amortized over the term of the senior secured credit facility using the
effective interest method.
Interest (expense) income, net as shown in the statements of operations for the
years ended June 30, 2004, 2003 and 2002, includes interest expense of
$7,715,000, $238,000 and $435,000, respectively and interest income of
$1,094,000, $808,000 and $768,000, respectively. Interest expense, net in 2004
includes $742,000 of amortization of debt issuance costs and $32,000 of
amortization of debt discount.
NOTE 7 - 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 $6,779,000, $7,671,000
and $6,508,000 for the years ended June 30, 2004, 2003 and 2002, respectively.
F-12
The Company has certain capital leases for equipment. Lease amortization for the
years ended June 30, 2004, 2003 and 2002 was $193,000, $55,000 and $62,000,
respectively, and is included in depreciation and amortization expense. The
incremental borrowing rate on the capital lease is 5.5%.
The future minimum lease payments under operating and capital lease as of June
30, 2004 are as follows (in thousands):
OPERATING CAPITAL
FISCAL YEAR LEASES LEASE
- ------------ ------------ -----------
2005 $ 7,761 $ 383
2006 6,808 383
2007 4,123 383
2008 3,970 159
2009 3,746 -
Thereafter 2,885 -
------------ ----------
Total minimum lease payments $ 29,293 1,308
============
ess amount representing interest 118
-----------
Present value of net minimum obligations 1,190
Less current portion 326
-----------
Long-term capital lease obligation $ 864
===========
As of June 30, 2004, the Company had outstanding purchase obligations of
$13,403,000 which primarily relate to marketing agreements and maintenance
contracts on Company's software, equipment and other assets.
LEGAL PROCEEDINGS
Except as set forth below, in management's opinion, there are no significant
legal proceedings to which the Company or any of its subsidiaries is a party or
to which any of their properties are subject. The Company is involved in other
lawsuits and claims generally incidental to its business including, but not
limited to, various suits, including previously disclosed suits, brought against
the Company by individual consumers seeking monetary and/or injunctive relief
relating to the marketing of the Company's programs. In addition, from time to
time, and in the regular course of its business, the Company receives inquiries
from various federal and/or state regulatory authorities.
In March 2001, an action was instituted by plaintiff Teresa McClain against
Coverdell & Company ("Coverdell"), a wholly-owned subsidiary of the Company,
Monumental Life Insurance Company and other defendants in the United States
District Court for the Eastern District of Michigan, Southern Division. The
suit, which seeks unspecified monetary damages, alleges that Coverdell and the
other defendants violated the Michigan Consumer Protection Act and other
applicable Michigan laws in connection with the marketing of Monumental Life
Insurance Company insurance products. The Court certified a class of Michigan
residents. The Court has now signed an Order granting preliminary approval of a
settlement agreement that has been signed by all parties. The Court will hold
the Fairness/Approval hearing on November 22, 2004. The settlement agreement
will have no financial or other material impact on Coverdell's business.
On January 24, 2003, the Company filed a motion with the Superior Court for the
Judicial District of Hartford, Connecticut to vacate and oppose the confirmation
of an arbitration award issued in December 2002. The arbitration, filed against
the Company by MedValUSA Health Programs, Inc. ("MedVal") in September 2000,
involved claims of breach of contract, breach of the duty of good faith and fair
dealing, and violation of the Connecticut Unfair Trade Practices Act ("CUTPA").
Even though the arbitrators found that the Company was not liable to MedVal for
any compensatory damages, they awarded $5,495,000 in punitive damages and costs
against the Company solely under CUTPA. The Company believes that this
arbitration award is unjustified and not based on any existing legal precedent.
Specifically, the Company is challenging the award on a number of grounds,
including that it violates a well defined public policy against excessive
punitive damage awards, raises constitutional issues and disregards certain
legal requirements for a valid award under CUTPA. The hearing on the Company's
motion was held on February 10, 2003. On June 22, 2003, the Superior Court
denied the Company's motion to vacate the award, and the Company filed an appeal
of that decision. While the Company intends to take action to prevent the
enforcement of the award by, among other things, vigorously pursuing an appeal,
there can be no assurance that the Company will be successful in its efforts.
The Company has made no provision in its financial statements for this
contingency because it believes that a loss is not probable. If the Company was
ultimately unsuccessful in this or other available appeals, and a final
non-appealable court order confirming the arbitration award is rendered, the
payment of the award could have a material adverse effect on the Company's
results of operations in the period in which the final order is entered.
F-13
On October 21, 2003, the Florida Attorney General's Office filed a civil
complaint against the Company based upon concerns that some of its past
marketing practices may have violated various consumer laws. On June 28, 2004,
the Company announced that it had reached a voluntary settlement with the
Florida Attorney General's office to alleviate concerns that some of its past
marketing practices may have confused some consumers. In connection with the
settlement, the Company agreed to formalize its existing national Best Marketing
Practices in the state of Florida and to pay the state of Florida costs of
investigation of $950,000. The Company expects that the agreement will have
little new effect on its business in Florida as the agreement serves to
formalize the Company's already existing national marketing best practices in
the state.
NOTE 8 - BUSINESS COMBINATIONS
On April 1, 2004, the Company completed the acquisition of all of the assets and
outstanding capital stock of Lavalife Inc., a leading provider of online and
IVR-based interactive personals services. The Company acquired Lavalife in order
to broaden the scope of services offered to include personals services. The
acquisition of Lavalife benefits the Company by providing access to one of the
largest and fastest growing consumer categories on the internet while expanding
its target market. In addition, it is the Company's intention to cross-market
the products and services of the Company and Lavalife. Lavalife operates as a
wholly-owned subsidiary of the Company. The purchase price, excluding fees and
expenses, was Cdn$152,500,000, or $116,300,000, and is subject to certain
purchase price adjustments. In connection with this acquisition, the Company
received $9,080,000 related to the issuance of the Company's restricted common
stock to Lavalife's senior management. The acquisition was funded with cash on
hand and borrowings under the Company's $45,000,000 senior secured credit
facility. The acquisition was accounted for under the purchase method of
accounting. The Company obtained an independent valuation of the identifiable
intangible assets acquired in conjunction with the acquisition of Lavalife which
identified $33,347,000 of intangible assets other than goodwill. The $83,636,000
of unallocated excess merger consideration over the net assets acquired was
allocated to goodwill. The amount of tax deductible goodwill was $77,436,000.
See Note 4 for a detailed description of the identified intangible assets and
goodwill identified in connection with this business combination. The fair
values of the acquired assets and liabilities assumed at the date of
acquisition are as follows (in thousands):
Current assets $ 6,160
Fixed assets 14,730
Goodwill arising in the acquisition 83,636
Intangible assets 33,347
Current liabilities (19,990)
Other long-term obligations (2,498)
--------------
Net assets acquired $ 115,385
==============
PRO FORMA RESULTS
The following unaudited pro forma results of operations for the years ended June
30, 2004 and 2003 have been prepared assuming the Lavalife acquisition had
occurred on July 1, 2003 for the year ended June 30, 2004 and on July 1, 2002
for the year ended June 30, 2003. These pro forma results are not necessarily
indicative of the results of future operations or results that would have
occurred had the acquisition been consummated as of that date (in thousands,
except per share data).
YEAR ENDED JUNE 30,
-------------------------
2004 2003
---------- ----------
Revenues $ 542,766 $ 527,736
Net income 28,979 25,879
Basic earnings per share $ 2.58 $ 1.98
Diluted earnings per share 2.28 1.89
NOTE 9 - (LOSS) GAIN ON SALE OF SUBSIDIARY/LOSS ON INVESTMENT
During 2002, the Company sold its investment in and advances to iPlace, Inc. in
exchange for $50,111,000 in cash, including $3,703,000 held in escrow, and
1,601,000 shares of Homestore.com, Inc. common stock, including 451,000 shares
held in escrow. The Company reported a gain of $65,608,000 on the sale.
Subsequent to the date of sale, the investment in Homestore.com, Inc. declined
in value and management determined that the decline was other than temporary. As
a result, the Company wrote down its investment in Homestore.com, Inc. to its
fair value and recognized a loss of $33,628,000 during 2002. As of June 30,
2002, the Company's investment in Homestore.com, Inc. was valued at $912,000.
During 2002, 84,000 shares of Homestore.com, Inc. were released from the escrow.
During 2003, the Company settled with Homestore.com, Inc. all pending issues
related to amounts held in escrow in connection with the sale. The Company
returned cash and stock to Homestore.com, Inc., which resulted in a net loss of
$959,000. During 2003, the Company sold all of its Homestore.com, Inc. common
stock and recognized a loss of $206,000 in connection with this sale.
F-14
NOTE 10 - SETTLEMENT OF INVESTMENT RELATED LITIGATION
During 2003, the Company, along with certain of the other former shareholders of
iPlace, Inc., settled their lawsuit against Homestore.com, Inc. The total
settlement amount in favor of the plaintiffs was $23,000,000 of which the
Company received $19,148,000 (see Note 9).
NOTE 11 - FOREIGN CURRENCY INSTRUMENTS
The Company used purchased option contracts and forward contracts to protect
against the foreign currency exchange risk inherent in the purchase price for
its acquisition of Lavalife, which was denominated in Canadian dollars (see Note
8). The risk of loss associated with purchased options was limited to premium
amounts paid for the option contracts. The risk of loss associated with forward
contracts is equal to the exchange rate differential from the time the contract
is entered into until the time it is settled. These contracts expired on April
1, 2004 concurrent with the closing of the Lavalife acquisition.
The change in the fair value of these derivative contracts was recognized in
earnings as a component of other income, net and amounted to $353,000 in 2004.
As of June 30, 2004, the Company did not hold any foreign currency instruments.
NOTE 12 - MINORITY INTEREST
Prior to the sale of iPlace, Inc. in August 2001, the Company was the majority
shareholder of iPlace, Inc. with an approximate 58% ownership share. Minority
interest in the statement of operations for the year ended June 30, 2002
represents approximately 42% of iPlace's losses incurred through the date of the
sale of iPlace, Inc. in August 2001.
NOTE 13- INCOME TAXES
The provision for income taxes is as follows as of June 30, (in thousands):
2004 2003 2002
------------- ----------- -----------
CURRENT
Federal $ 7,219 $ 1,635 $ -
State 2,245 422 -
Foreign 1,028 - -
------------ ----------- -----------
Total $ 10,492 $ 2,057 $ -
============ =========== ===========
DEFERRED
Federal $ 8,673 $ 11,642 $ -
State 140 2,540 -
Foreign (667) - -
------------ ----------- -----------
Total $ 8,146 $ 14,182 $ -
============ =========== ===========
There was no current or deferred provision for income taxes for the years ended
June 30, 2002 due to the utilization of the Company's net operating loss carry
forwards against which the Company had carried a full valuation allowance.
The following is a reconciliation of the Company's effective tax rate and the
U.S. statutory rate for the years ended June 30:
2004 2003
---------- -----------
Statutory rate 35.0% 35.0%
State and local 3.3% 3.4%
Foreign (0.5)% 0.0%
Other 2.2% 1.6%
---------- ----------
Effective rate 40.0% 40.0%
========== ==========
F-15
Consolidated U.S. income before taxes and the cumulative effect of accounting
change was $44,861,000, $37,236,000 and $45,956,000 in 2004, 2003 and 2002,
respectively. The corresponding amounts for non-U.S.-based operations were
income of $1,737,000, $3,359,000 and a loss of $2,038,000, respectively.
U.S. income taxes were not provided on certain unremitted earnings from foreign
subsidiaries since the Company intends to permanently reinvest substantially all
of such earnings outside the U.S. However, if some portion of these earnings is
remitted, the Company expects the effect of any remittance after considering
available tax credits and amounts previously accrued not to be significant to
the consolidated results of operations. A calculation has not been performed to
determine the amount of unremitted earnings.
The following is a summary of the Company's deferred tax assets and liabilities
as of June 30, 2004 and 2003 (in thousands):
2004 2003
------------- --------------
DEFERRED TAX ASSETS:
Benefit of federal and state net operating loss carry forwards $ 3,093 $ 16,163
Alternative minimum tax credits 1,380 716
Deferred revenues - 2,965
Allowance for membership cancellations 5,728 8,361
Other deferred tax assets 5,252 1,281
------------- -------------
Gross deferred tax assets 15,453 29,486
Less: Valuation allowance - -
------------- -------------
Deferred tax assets after valuation allowance 15,453 29,486
------------- -------------
DEFERRED TAX LIABILITIES:
Membership solicitation and other deferred costs (20,503) (30,266)
Deferred revenues (1,468) -
Goodwill and other intangibles (6,721) (3,204)
Depreciation (3,438) (2,040)
------------- -------------
Gross deferred tax liabilities (32,130) (35,510)
------------- -------------
Net deferred tax liability $ (16,677) $ (6,024)
============= =============
As of June 30, 2004, the Company had federal net operating loss carry forwards
of $6,512,000 expiring at various dates from June 30, 2020 to June 30, 2021. 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 available to reduce future state taxable income which expire beginning
June 30, 2005 through June 30, 2006.
As of June 30, 2004, the Company had alternative minimum tax credits of
approximately $1,380,000. Credits of $664,000 and $716,000 were generated in the
years ended June 30, 2004 and 2003, respectively, and can be carried forward
indefinitely. The Company expects to fully utilize these credits during the year
ended June 30, 2005.
Tax benefits resulting from the exercise of nonqualified stock options and the
disqualifying dispositions of shares issued under the Company's stock-based
compensation plans reduced taxes payable by $6,520,000 and $942,000 in 2004 and
2003, respectively. Such benefits were credited to additional paid-in capital.
There was no tax benefit recognized in income during 2003 for the reversal of
the valuation allowance of $8,158,000 that was attributable to prior period
disqualifying dispositions. These amounts were credited to additional paid-in
capital.
The valuation allowance recognized in prior periods was fully reversed in 2003
based upon the Company's belief that it was more likely than not that it will
realize its deferred tax assets.
NOTE 14 - CUMULATIVE EFFECT OF ACCOUNTING CHANGE
ADOPTION OF SFAS 142
The Company adopted SFAS 142 effective July 1, 2001. With the adoption of SFAS
142, the Company reassessed the useful lives and residual values of all acquired
intangible assets to make any necessary valuation or amortization period
adjustments. Based on that assessment, only goodwill was determined to have an
indefinite useful life and no adjustments were made to the amortization period
or residual values of other intangible assets. The Company determined that at
July 1, 2001, there was an impairment of goodwill of $5,907,000 at one of its
reporting units due to the change in methodology of calculating impairment under
SFAS 142 concurrent with recent downward trends in the operations of the
reporting unit. This amount was recorded as a cumulative effect of accounting
change in the statement of operations during 2002.
F-16
NOTE 15 - EARNINGS PER SHARE
Basic and diluted earnings per share amounts are determined in accordance with
the provisions SFAS 128. The following table sets forth the reconciliation of
the numerators and denominators in the computation of basic and diluted earnings
per share (in thousands, except per share data):
2004 2003 2002
----------- ----------- ----------
Numerator:
Income available to common shareholders used in basic earnings per share $ 27,960 $ 24,356 $ 43,918
Add Back: Interest expense on convertible securities 2,236 - -
Cumulative effect of accounting change - - (5,907)
----------- ----------- ----------
Income available to common shareholders after assumed conversion of dilutive securities
and cumulative effect of accounting change for diluted earning per share $ 30,196 $ 24,356 $ 38,011
=========== ========== ==========
Denominator :
Weighted average number of common shares outstanding- basic 10,755 12,596 14,477
Effect of dilutive securities:
Convertible securities 1,678 - -
Stock options 775 637 432
----------- --------- ---------
Weighted average number of common shares outstanding- diluted 13,208 13,233 14,909
=========== =========== ==========
Basic earnings per share $ 2.60 $ 1.93 $ 2.63
=========== =========== ==========
Diluted earnings per share $ 2.29 $ 1.84 $ 2.55
=========== =========== ==========
The diluted earnings per common share calculation excludes the effect of
potentially dilutive shares when their effect is antidilutive. Excluded from the
diluted share calculation above for the years ended June 30, 2004, 2003 and 2002
are incremental weighted average stock option shares of approximately 26,000,
2,838,000, and 3,383,000, respectively.
NOTE 16 - SHAREHOLDERS' EQUITY
The Company has a stock repurchase program. During 2004, the Board of Directors
authorized the Company to repurchase up to an additional 3,000,000 shares of the
Company's Common Stock. As of June 30, 2004, approximately 994,000 shares were
authorized for repurchase under the stock repurchase program. The Company
repurchased 2,985,000 shares for $94,207,000, an average price of $31.56 per
share, in 2004, 1,993,000 shares for $37,214,000, an average price of $18.67 per
share, in 2003 and 2,227,000 shares for $34,301,000, an average price of $15.40
per share, in 2002.
NOTE 17 - EMPLOYEE BENEFIT PLANS
All employees over the age of 18 may participate in the Company's defined
contribution 401(k) profit sharing plan. Employees may contribute up to 20% of
their compensation subject to certain limitations. Effective July 1, 2000, the
Company began making quarterly matching contributions in Common Stock based on
qualified employee contributions. Treasury stock, calculated under the cost
method, was used to match qualified employee contributions. Effective January 1,
2004, the Company began making matching contributions in cash. Matching
contributions were $168,000, $153,000 and $156,000 for 2004, 2003 and 2002,
respectively.
Effective January 1, 2004, the Company has an unfunded, nonqualified defined
benefit pension plan that benefits certain executives selected by the
Compensation Committee of the Board of Directors. This plan provides for fixed
annual payments for 10 years upon retirement after attaining the age of 55 and
10 years of service. Pension expense was $212,000 during 2004.
F-17
The following are reconciliations of the pension benefit obligation and the
value of plan assets for 2004. The Company used a weighted-average discount rate
of 6% in its 2004 assumptions.
JUNE 30, 2004
---------------
PENSION BENEFIT OBLIGATION (in thousands)
Balance, beginning of year $ -
Interest cost 35
Service cost 71
Amendment 1,156
Actuarial loss 14
------------
Balance, end of year $ 1,276
------------
At June 30, 2004 the funded status of the plan was as follows (in thousands):
Excess of the benefit obligation over the value of plan assets $ 1,276
Unrecognized net actuarial loss (14)
Unrecognized prior service cost (1,050)
------------
Accrued benefit costs $ 212
------------
Pension expense for 2004 was comprised of the following (in thousands):
Interest cost $ 35
Service cost 71
Amortization of prior service cost 106
------------
Pension expense $ 212
------------
The net amount recognized in the balance sheet for 2004 were classified as
follows (in thousands):
Intangible asset $ (1,050)
Other long-term liabilities 1,276
Accumulated other comprehensive loss (14)
------------
Net amount recognized $ 212
------------
No benefits are expected to be paid by the plan during the next four years. The
Company expects to pay $60,000 of benefits in 2009. Subsequent to fiscal 2009,
the Company expects to pay benefits of $4,490,000.
NOTE 18 - STOCK-BASED COMPENSATION
STOCK COMPENSATION PLANS
As of June 30, 2004, the company had five stock-based compensation plans which
are described below.
During 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. 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 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. During 2002, the Company added an additional 2,000,000 options, which
may be granted using treasury stock.
During 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.
Under the stock option plans described above, options generally become
exercisable over a four to five year period and expire at the earlier of
termination of employment or ten years from the date of grant.
F-18
At June 30, 2004, 4,206,000 shares of common stock were reserved for issuance
under the stock option plans, of which 900,000 shares were available for future
grant.
Information with respect to options to purchase shares issued under these plans
is as follows:
2004 2003 2002
---- ---- ----
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
(Shares in thousands) SHARE PRICE SHARES PRICE SHARES PRICE
-------- -------- ------ -------- ------- --------
Outstanding at beginning of year 4,532 $ 19.88 4,341 $ 20.82 3,815 $ 21.45
Granted at market value 240 24.92 850 13.42 1,128 19.36
Exercised (1,227) 19.78 (338) 11.30 (127) 21.29
Forfeited (240) 22.48 (321) 24.53 (475) 25.31
-------- ----- ------
Outstanding at end of year 3,305 $ 20.10 4,532 $ 19.88 4,341 $ 20.82
======== ===== ======
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------- ---------------------------
SHARES AVERAGE AVERAGE SHARES AVERAGE
OUTSTANDING REMAINING EXERCISE OUTSTANDING EXERCISE
(Shares in thousands) AT 6/30/04 LIFE (YEARS) PRICE AT 6/30/04 PRICE
---------- ------------ --------- ------------- -----------
$2.78 to $8.00 246 2.96 $ 4.55 210 $ 3.96
$13.00 to $15.00 850 7.03 13.50 311 14.19
$16.00 to $20.86 1,156 6.90 19.67 523 19.07
$21.88 to $30.97 986 5.67 29.25 791 29.16
$31.25 to $36.75 67 9.68 33.78 - -
---------- ------------
3,305 6.33 $ 20.10 1,835 $ 20.87
========== ============
Options exercisable as of June 30, 2003 and 2002 were 2,305,000 and 1,876,000
respectively.
IPLACE STOCK OPTION PLANS
The iPlace options were issued at the estimated fair value of the underlying
common stock and generally vested 25% per year beginning one year from the date
of grant. During 2002, 470,000 options were granted at an average exercise price
of $2.74 and 205,000 options were forfeited at an average exercise price of
$2.40. In August 2001, the Company sold iPlace (see Note 9). Therefore, there
were no stock options outstanding under this plan as of June 30, 2004, 2003 or
2002.
EMPLOYEE STOCK PURCHASE PLAN
During 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 2004, 2003, and 2002 14,000,
16,000 and 18,000 shares were purchased under the plan, respectively.
NOTE 19 - STATEMENT OF CASH FLOWS
Supplemental disclosure of cash flow information (in thousands):
YEAR ENDED JUNE 30,
-----------------------------------
2004 2003 2002
-------- -------- --------
Cash paid during the period for interest $ 3,417 $ 241 $ 377
Cash paid during the period for income taxes 5,568 411 43
NOTE 20 - BUSINESS SEGMENTS
The operating business segments reported below are the business segments of the
Company for which separate financial information is available and for which
operating results are evaluated regularly by executive management in deciding
how to allocate resources and in assessing performance. Prior to the acquisition
of Lavalife in April 2004, the Company operated as one reportable business
segment. Subsequent to the acquisition of Lavalife, the Company operates as two
reportable business segments: Membership and Personals. The Membership business
segment is primarily involved in the marketing of membership programs to
consumers. The Personals business segment is primarily involved in providing
both web-based and IVR-based personals services to its customers.
F-19
Management evaluates the operating results of each of its reportable business
segments based upon revenue and operating income. The following is a summary of
revenues, operating income, capital expenditures, depreciation and amortization
and assets by business segment for the years ended June 2004, 2003 and 2002 (in
thousands):
YEARS ENDED JUNE 30,
---------------------------------------------
2004 2003 2002
--------- --------- ----------
Revenues:
Membership $ 471,049 $ 456,881 $ 427,602
Personals 17,690 -- --
--------- --------- ---------
Total $ 488,739 $ 456,881 427,602
========= ========= =========
Operating Income:
Membership $ 52,533 $ 22,286 $ 18,782
Personals 337 -- --
Corporate and other (1) -- -- (6,893)
--------- --------- ---------
Total $ 52,870 $ 22,286 $ 11,889
========= ========= =========
Capital expenditures:
Membership $ 6,486 $ 5,463 $ 5,761
Personals 571 -- --
--------- --------- ---------
Total $ 7,057 $ 5,463 $ 5,761
========= ========= =========
Depreciation and amortization:
Membership $ 10,149 $ 12,120 $ 13,252
Personals 2,327 -- --
Corporate and other (2) 776 -- --
--------- --------- ---------
Total $ 13,252 $ 12,120 $ 13,252
========= ========= =========
JUNE 30,
-------------------------
2004 2003
------------ ----------
Assets:
Membership $ 178,723 $ 205,331
Personals 136,874 -
Corporate and other (3) 137,565 43,174
------------ ---------
Total $ 453,162 $ 248,505
============ =========
(1) Represents the restructuring charge incurred in 2002.
(2) Represents unallocated amortization of unallocated non-operating assets
and liabilities.
(3) Represents unallocated non-operating assets including non-operating
cash, short-term investments, debt issuance costs and other.
During 2004, 2003 and 2002, the Company maintained offices in the United States,
Canada, Australia and the United Kingdom. Geographic information by country for
the years ended June 30, 2004, 2003 and 2002 is presented below (in thousands).
YEARS ENDED JUNE 30,
--------------------------------------------
2004 2003 2002
----------- ------------ -----------
Revenues:
United States $ 460,606 $ 443,909 $ 413,025
Canada 27,450 11,859 11,028
Other foreign countries 683 1,113 3,549
----------- ------------ -----------
Total $ 488,739 $ 456,881 $ 427,602
=========== ============ ===========
F-20
JUNE 30,
----------------------------
2004 2003
------------ -----------
Long lived assets:
United States $ 119,764 $ 68,190
Canada 89,543 8,960
Other foreign countries 2,485 -
------------ -----------
Total $ 211,792 $ 77,150
============ ===========
NOTE 21 - QUARTERLY FINANCIAL DATA (UNAUDITED)
(In thousands, except per share amounts):
YEAR ENDED JUNE 30, 2004
--------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------------------------------------------------
Revenues $ 113,824 $ 123,164 $ 118,519 $ 133,232
Operating income 6,620 13,911 14,558 17,781
Net income 3,895 7,665 8,379 8,021
Diluted earnings per share 0.30 0.60 0.68 0.66
YEAR ENDED JUNE 30, 2003
--------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER (1) QUARTER QUARTER QUARTER
--------------------------------------------------
Revenues $ 105,004 $ 114,045 $ 118,647 $ 119,185
Operating income 2,125 5,858 5,516 8,787
Net income 12,136 3,647 3,332 5,241
Diluted earnings per share 0.89 0.27 0.25 0.41
(1) Results of operations for this period include a $19,148,000 gain
related to the settlement of investment related litigation (see Note
10), a $959,000 loss related to the sale of iPlace, Inc. (see Note 9)
and a $206,000 loss on investment (see Note 9).
NOTE 22 - GUARANTOR AND NONGUARANTOR FINANCIAL INFORMATION
In April 2004, the Company issued $150,000,000 aggregate principal amount of
9.25% Senior Notes in a private placement pursuant to Rule 144A (see Note 6).
The Senior Notes are unsecured obligations and will rank pari passu in right of
payment to all of the Company's existing and future senior unsecured
indebtedness and senior in right of payment to all of the Company's existing and
future subordinated indebtedness that expressly provides for its subordination
to the Notes. The Senior Notes are fully and unconditionally guaranteed by all
of the Company's existing and future domestic subsidiaries and certain of the
Company's existing and future foreign subsidiaries.
The following consolidating financial information presents the consolidating
balance sheets as of June 30, 2004 and 2003, the related statements of
operations for each of the three year periods ended June 30, 2004, 2003 and 2002
and the related statements of cash flows for the years ended June 30, 2004, 2003
and 2002. The information includes the elimination entries necessary to
consolidate the Company ("Parent") with the guarantor and nonguarantor entities.
Investments in subsidiaries are accounted for by the Parent using the equity
method of accounting. The guarantor and nonguarantor subsidiaries are presented
on a combined basis. The principal elimination entries eliminate investments in
subsidiaries and intercompany balances and transactions.
F-21
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2004
----------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
---------- ----------- ------------- ------------ -----------
ASSETS (in thousands)
Current assets:
Cash and cash equivalents $ 130,581 $ 26,657 $ 2,258 $ -- $ 159,496
Restricted cash -- 3,120 -- -- 3,120
Short-term investments 7,650 -- -- -- 7,650
Accounts receivable 2,418 5,413 2,726 -- 10,557
Intercompany receivable 4,655 632 1,285 (6,572) --
Prepaid membership materials 1,775 269 1,189 -- 3,233
Prepaid expenses and other current assets 3,240 1,157 489 -- 4,886
Membership solicitation and other deferred costs 43,908 5,707 2,813 -- 52,428
--------- --------- -------- --------- ---------
Total current assets 194,227 42,955 10,760 (6,572) 241,370
Fixed assets, net 19,675 14,823 2,042 -- 36,540
Goodwill -- 118,956 6,719 -- 125,675
Intangible assets, net 1,050 37,822 -- -- 38,872
Other assets 10,666 39 -- -- 10,705
Intercompany notes receivable 95,543 -- -- (95,543) --
Investment in subsidiaries 78,633 -- -- (78,633) --
--------- --------- -------- --------- ---------
Total assets $ 399,794 $ 214,595 $ 19,521 $(180,748) $ 453,162
========= ========= ======== ========= =========
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
Current liabilities:
Current maturities of long-term obligations $ 325 $ 13 $ -- $ -- $ 338
Accounts payable 10,407 22,685 2,093 -- 35,185
Accrued liabilities 54,630 6,841 4,604 -- 66,075
Intercompany payable -- 6,572 -- (6,572) --
Deferred revenues 129,675 3,993 4,713 -- 138,381
Deferred income taxes 11,878 445 -- -- 12,323
--------- --------- -------- --------- ---------
Total current liabilities 206,915 40,549 11,410 (6,572) 252,302
Deferred income taxes (2,402) 6,647 109 -- 4,354
Other long-term liabilities 3,705 -- 1,225 -- 4,930
Intercompany notes payable -- 95,543 -- (95,543) --
Long-term debt 237,659 -- -- -- 237,659
--------- --------- -------- --------- ---------
Total liabilities 445,877 142,739 12,744 (102,115) 499,245
--------- --------- -------- --------- ---------
Shareholders' (deficit) equity:
Preferred stock -- -- -- -- --
Common stock 191 6 3 (9) 191
Capital in excess of par value 156,457 71,744 9,564 (81,308) 156,457
Accumulated (deficit) earnings 10,131 (15) (2,305) 2,320 10,131
Accumulated other comprehensive loss (373) 121 (485) 364 (373)
Treasury stock (212,489) -- -- -- (212,489)
--------- --------- -------- --------- ---------
Total shareholders' (deficit) equity (46,083) 71,856 6,777 (78,633) (46,083)
--------- --------- -------- --------- ---------
Total liabilities and shareholders' (deficit)
equity $ 399,794 $ 214,595 $ 19,521 $(180,748) $ 453,162
========= ========= ======== ========= =========
F-22
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2003
---------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
------------ ----------- ------------ ------------ ------------
ASSETS (in thousands)
Current assets:
Cash and cash equivalents $ 51,895 $ 18,716 $ 1,649 $ -- $ 72,260
Restricted cash -- 2,732 -- -- 2,732
Accounts receivable 2,811 3,907 1,995 -- 8,713
Intercompany receivable 686 298 -- (984) --
Prepaid membership materials 1,762 170 264 -- 2,196
Prepaid expenses and other current assets 6,032 1,031 508 -- 7,571
Membership solicitation and other deferred costs 73,856 1,853 2,174 -- 77,883
---------- --------- -------- -------- ---------
Total current assets 137,042 28,707 6,590 (984) 171,355
Fixed assets, net 22,193 535 2,241 -- 24,969
Goodwill -- 35,320 6,719 -- 42,039
Intangible assets, net -- 6,656 -- -- 6,656
Other assets 3,426 60 -- -- 3,486
Investment in subsidiaries 56,419 -- -- (56,419) --
---------- --------- -------- -------- ---------
Total assets $ 219,080 $ 71,278 $ 15,550 $(57,403) $ 248,505
========== ========= ======== ======== =========
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
Current liabilities:
Current maturities of long-term obligations $ -- $ 244 $ -- $ -- $ 244
Accounts payable 17,678 13,018 1,948 -- 32,644
Accrued liabilities 53,692 3,333 2,080 -- 59,105
Intercompany payable -- 804 180 (984) --
Deferred revenues 163,276 1,007 3,360 -- 167,643
Deferred income taxes 662 (1,701) 1,918 -- 879
---------- --------- -------- -------- ---------
Total current liabilities 235,308 16,705 9,486 (984) 260,515
Deferred income taxes 2,456 3,260 (571) -- 5,145
Other long-term liabilities 1,599 63 1,466 -- 3,128
---------- --------- -------- -------- ---------
Total liabilities 239,363 20,028 10,381 (984) 268,788
---------- --------- -------- -------- ---------
Shareholders' (deficit) equity
Preferred stock -- -- -- -- --
Common stock 178 6 3 (9) 178
Capital in excess of par value 122,425 52,296 9,564 (61,860) 122,425
Accumulated (deficit) earnings (17,829) (1,052) (3,929) 4,981 (17,829)
Accumulated other comprehensive loss (469) -- (469) 469 (469)
Treasury stock (124,588) -- -- -- (124,588)
---------- --------- -------- -------- ---------
Total shareholders' (deficit) equity (20,283) 51,250 5,169 (56,419) (20,283)
---------- --------- -------- -------- ---------
Total liabilities and shareholders' (deficit)
equity $ 219,080 $ 71,278 $ 15,550 $(57,403) $ 248,505
========== ======== ======== ========= =========
F-23
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR YEAR ENDED JUNE 30, 2004
----------------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
------- ----------- ------------ ------------ ------------
(in thousands)
Revenues $ 395,074 $ 75,985 $ 19,220 $ (1,540) $ 488,739
Expenses:
Marketing 213,884 36,969 4,965 -- 255,818
Operating 69,222 16,358 7,792 (1,540) 91,832
General and administrative 65,640 16,346 3,840 -- 85,826
Amortization of intangible assets -- 2,393 -- -- 2,393
--------- --------- -------- --------- ---------
Operating income 46,328 3,919 2,623 -- 52,870
Equity in income of subsidiary 2,661 -- -- (2,661) --
Interest (expense) income, net (4,613) (2,113) 105 -- (6,621)
Other income (expense), net 447 (77) (21) -- 349
--------- --------- --------- --------- ---------
Income before income taxes 44,823 1,729 2,707 (2,661) 46,598
Provision for income taxes 16,863 692 1,083 -- 18,638
--------- --------- -------- --------- ---------
Net income $ 27,960 $ 1,037 $ 1,624 $ (2,661) $ 27,960
========= ========= ========= ========= =========
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED JUNE 30, 2003
----------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
---------- ------------ --------------- ------------- -----------
(in thousands)
Revenues $ 393,958 $ 50,787 $ 12,972 $ (836) $ 456,881
Expenses:
Marketing 253,389 23,198 4,086 - 280,673
Operating 64,539 11,639 3,102 (836) 78,444
General and administrative 60,553 10,381 3,151 - 74,085
Amortization of intangible assets - 1,393 - - 1,393
---------- ----------- -------------- ------------ -----------
Operating income 15,477 4,176 2,633 - 22,286
Settlement of investment related litigation 19,148 - - - 19,148
Loss on sale of subsidiary (959) - - - (959)
Loss on investment (206) - - - (206)
Equity in income of subsidiaries 4,600 - - (4,600) -
Interest income, net 421 126 23 - 570
Other (expense) income, net (953) (2) 711 - (244)
---------- ----------- -------------- ------------ -----------
Income before income taxes 37,528 4,300 3,367 (4,600) 40,595
Provision for income taxes 13,172 1,720 1,347 - 16,239
---------- ----------- -------------- ------------ -----------
Net income $ 24,356 $ 2,580 $ 2,020 $ (4,600) $ 24,356
========== =========== ============== ============ ===========
F-24
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED JUNE 30, 2002
-----------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
---------- ------------ -------------- -------------- -------------
(in thousands)
Revenues $ 358,283 $ 55,380 $ 14,576 $ (637) $ 427,602
Expenses:
Marketing 220,224 22,867 5,883 - 248,974
Operating 59,286 13,650 6,395 (637) 78,694
General and administrative 60,815 13,600 4,796 - 79,211
Restructuring charge 4,720 - 2,173 - 6,893
Amortization of intangible assets - 1,941 - - 1,941
---------- ----------- -------------- ----------- -----------
Operating income (loss) 13,238 3,322 (4,671) - 11,889
Gain (loss) on sale of subsidiary 69,379 (3,771) - - 65,608
Loss on investment (33,628) - - - (33,628)
Equity in income of subsidiaries 3,769 - - (3,769) -
Interest income, net 209 96 28 - 333
Other (expense) income, net (14,956) (232) 14,454 - (734)
---------- ----------- -------------- ----------- -----------
Income (loss) before minority interest 38,011 (585) 9,811 (3,769) 43,468
Minority interest - 450 - - 450
---------- ----------- -------------- ----------- -----------
Income (loss) before income taxes 38,011 (135) 9,811 (3,769) 43,918
Provision for income taxes - - - - -
---------- ----------- -------------- ----------- -----------
Income (loss) before cumulative effect of accounting
change 38,011 (135) 9,811 (3,769) 43,918
Cumulative effect of accounting change - (5,907) - - (5,907)
---------- ----------- -------------- ----------- -----------
Net income (loss) $ 38,011 $ (6,042) $ 9,811 $ (3,769) $ 38,011
========== =========== ============== ============ ===========
F-25
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED JUNE 30, 2004
------------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
--------- ------------- ------------- ---------------- -----------
(in thousands)
Operating activities
Net income $ 27,960 $ 1,037 $ 1,624 $ (2,661) $ 27,960
Adjustments to reconcile net income to net cash
provided by operating activities:
Change in deferred revenues (33,601) (32) 1,361 -- (32,272)
Change in membership solicitation and other
deferred costs 29,948 (3,854) (639) -- 25,455
Depreciation and amortization 8,865 3,714 673 -- 13,252
Deferred income and other taxes 6,363 3,514 377 -- 10,254
Tax benefit from employee stock plans 6,520 -- -- -- 6,520
Other 1,137 (247) -- -- 890
Change in assets and liabilities:
Restricted cash -- (388) -- -- (388)
Accounts receivable 393 226 (731) -- (112)
Intercompany receivable & payable (99,512) 100,977 (1,465) -- --
Prepaid membership materials (565) (99) (925) -- (1,589)
Prepaid expenses and other current assets 4,107 1,046 19 -- 5,172
Other assets (487) 26 -- -- (461)
Accounts payable (7,271) (3,193) 141 -- (10,323)
Accrued and other liabilities 1,113 1,709 768 -- 3,590
---------- --------- --------- --------- ----------
Net cash provided by operating activities (55,030) 104,436 1,203 (2,661) 47,948
---------- --------- --------- --------- ---------
Investing activities
Acquisition of fixed assets (5,599) (883) (575) -- (7,057)
Purchase of short-term investments (7,650) -- -- -- (7,650)
Business combinations, net of cash acquired -- (114,916) -- -- (114,916)
Investment in subsidiaries (22,109) 19,448 -- 2,661 --
---------- --------- --------- --------- ---------
Net cash used in by investing activities (35,358) (96,351) (575) 2,661 (129,623)
---------- --------- --------- --------- ---------
Financing activities
Net proceeds from issuance of stock 33,644 -- -- -- 33,644
Treasury stock purchases (94,207) -- -- -- (94,207)
Net proceeds from issuance of debt 229,825 -- -- -- 229,825
Payments of long-term obligations (188) (265) -- -- (453)
---------- --------- --------- --------- ---------
Net cash provided by (used in) financing activities 169,074 (265) -- -- 168,809
---------- --------- --------- --------- ---------
Effect of exchange rate changes on cash and cash
equivalents -- 121 (19) -- 102
---------- --------- --------- --------- ---------
Net increase (decrease) in cash and cash equivalents 78,686 7,941 609 -- 87,236
Cash and cash equivalents at beginning of period 51,895 18,716 1,649 -- 72,260
---------- --------- --------- --------- ---------
Cash and cash equivalents at end of period $ 130,581 $ 26,657 $ 2,258 $ -- $ 159,496
========== ========= ========= ========= =========
F-26
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED JUNE 30, 2003
-----------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
---------- ------------ -------------- -------------- -------------
(in thousands)
Operating activities
Net income $ 24,356 $ 2,580 $ 2,020 $ (4,600) $ 24,356
Adjustments to reconcile net income to net cash
provided by operating activities:
Change in deferred revenues (37,705) (741) (557) - (39,003)
Change in membership solicitation and other deferred
costs 50,675 304 432 - 51,411
Depreciation and amortization 9,390 1,750 980 - 12,120
Deferred income and other taxes 11,276 1,559 1,347 - 14,182
Tax benefit from employee stock plans 942 - - - 942
Gain on settlement of investment related litigation (19,148) - - - (19,148)
Loss on sale of subsidiary 959 - - - 959
Net loss on investment 206 - - - 206
Other 2,635 - (150) - 2,485
Change in assets and liabilities:
Restricted cash - 2,951 - - 2,951
Accounts receivable 504 220 34 - 758
Intercompany receivable & payable 2,852 1,364 (4,216) - -
Prepaid membership materials (86) 10 (59) - (135)
Prepaid expenses and other current assets (2,799) (311) (136) - (3,246)
Other assets (1,387) 56 - - (1,331)
Accounts payable (2,457) 2,082 120 - (255)
Accrued and other liabilities 2,003 (332) (390) - 1,281
---------- ------------ -------------- ----------- -------------
Net cash provided by (used in) operating activities 42,216 11,492 (575) (4,600) 48,533
---------- ------------ -------------- ----------- -------------
Investing activities
Acquisition of fixed assets (4,931) (188) (344) - (5,463)
Settlement of investment related litigation 19,148 - - - 19,148
Investment in subsidiaries (4,600) - - 4,600 -
Other investments (1,250) - - - (1,250)
---------- ------------- -------------- ----------- -------------
Net cash provided by (used in) investing activities 8,367 (188) (344) 4,600 12,435
---------- ------------- -------------- ----------- -------------
Financing activities
Net proceeds from issuance of stock 4,050 - - - 4,050
Treasury stock purchases (37,214) - - - (37,214)
Payments of long-term obligations - (1,051) - - (1,051)
---------- ------------- -------------- ----------- -------------
Net cash used in financing activities (33,164) (1,051) - - (34,215)
---------- ------------- -------------- ----------- -------------
Effect of exchange rate changes on cash and cash
equivalents - - 5 - 5
---------- ------------- -------------- ----------- -------------
Net increase (decrease) in cash and cash equivalents 17,419 10,253 (914) - 26,758
Cash and cash equivalents at beginning of period 34,476 8,463 2,563 - 45,502
---------- ------------- -------------- ----------- -------------
Cash and cash equivalents at end of period $ 51,895 $ 18,716 $ 1,649 $ - $ 72,260
========== ============= ============== =========== =============
F-27
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED JUNE 30, 2002
-----------------------------------------------------------------------
GUARANTOR NONGUARANTOR CONSOLIDATED
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS TOTAL
--------- ------------- -------------- ------------- -------------
(in thousands)
Operating activities
Net income (loss) $ 38,011 $ (6,042) $ 9,811 $ (3,769) $ 38,011
Adjustments to reconcile net income to net cash
provided by operating activities:
Change in deferred revenues (18,701) 1,721 (136) - (17,116)
Change in membership solicitation and other deferred
costs 16,485 (2,641) 1,194 - 15,038
Depreciation and amortization 9,452 2,544 1,256 - 13,252
Gain (loss) on sale of subsidiary (69,378) 3,770 - - (65,608)
Loss on investment 33,628 - - - 33,628
Non-cash restructuring charges - - 1,585 - 1,585
Minority interest - (450) - - (450)
Cumulative effect of accounting change - 5,907 - - 5,907
Other 2,435 54 116 - 2,605
Change in assets and liabilities:
Restricted cash - (4,692) - - (4,692)
Accounts receivable 2,837 4,573 1,420 - 8,830
Intercompany receivable & payable 24,764 (13,280) (11,484) - -
Prepaid membership materials 560 11 (256) - 315
Prepaid expenses and other current assets (1,832) (613) 228 - (2,217)
Other assets (337) 86 - - (251)
Related party payables - 12 - - 12
Accounts payable (10,783) 2,524 (2,493) - (10,752)
Accrued and other liabilities (199) (807) (77) - (1,083)
---------- ------------- -------------- ----------- -------------
Net cash provided by (used in) operating activities 26,942 (7,323) 1,164 (3,769) 17,014
---------- ------------- -------------- ----------- -------------
Investing activities
Acquisition of fixed assets (5,074) (262) (425) - (5,761)
Investment in subsidiaries (3,769) - - 3,769 -
Proceeds from sale of subsidiary, net of cash sold 35,582 ` 10,415 - - 45,997
Other investing activities 1,499 (1,499) - - -
---------- ------------- -------------- ----------- -------------
Net cash provided by (used in) investing activities 28,238 8,654 (425) 3,769 40,236
---------- ------------- -------------- ----------- -------------
Financing activities
Net proceeds from exercise of stock options 1,461 54 - - 1,515
Treasury stock purchases (34,301) - - - (34,301)
Payments of long-term obligations - (718) - - (718)
---------- ------------- -------------- ----------- -------------
Net cash used in financing activities (32,840) (664) - - (33,504)
---------- ------------- -------------- ----------- -------------
Effect of exchange rate changes on cash and cash
equivalents - - 11 - 11
---------- ------------- -------------- ----------- -------------
Net increase in cash and cash equivalents 22,340 667 750 - 23,757
Cash and cash equivalents at beginning of period 12,136 7,796 1,813 - 21,745
---------- ------------- -------------- ----------- -------------
Cash and cash equivalents at end of period $ 34,476 $ 8,463 $ 2,563 $ - $ 45,502
========== ============= ============== =========== =============
F-28
MEMBERWORKS INCORPORATED
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT CHARGED TO COSTS CHARGED TO OTHER BALANCE AT END
BEGINNING OF AND ACCOUNTS -- DEDUCTIONS -- OF
DESCRIPTION PERIOD EXPENSE DESCRIBE DESCRIBE PERIOD
- ------------ -------------- --------------- ----------------- --------------- -------------
YEAR ENDED JUNE 30, 2004
Allowance for membership cancellations $ 20,934,000 $ - $ 183,086,000A $ 189,864,000 B $ 14,156,000
YEAR ENDED JUNE 30, 2003
Allowance for membership cancellations $ 23,753,000 $ - $ 281,250,000A $ 284,069,000 B $ 20,934,000
Valuation allowance for deferred tax
assets 6,581,000 - (6,581,000)C - -
YEAR ENDED JUNE 30, 2002
Allowance for membership cancellations $ 30,004,000 $ - $ 277,412,000A $ 283,663,000 B $ 23,753,000
Valuation allowance for deferred tax
assets 22,690,000 - (16,109,000)C - 6,581,000
(A) Charged to balance sheet account "Deferred revenues."
(B) Charges for refunds upon membership cancellations. In addition, the
allowance was reduced by $2,082,000 in connection with the sale of iPlace
in 2002.
(C) Decrease in the valuation allowance was due to current utilization of
deferred tax assets as well as management's belief that the Company will
more likely than not realize its deferred tax assets in the future.
F-29