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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
Commission File No. 0-21527
MEMBERWORKS INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 06-1276882
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(State of Incorporation) (I.R.S. Employer
Identification No.)
9 West Broad Street;
Stamford, Connecticut 06902
- --------------------- -----
(Address of principal executive offices) (Zip Code)
(203) 324-7635
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(Registrant's telephone number,
including area code)
Indicate by checkmark 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, and (2) has been subject to such filing requirements
for the past 90 days.
Yes /X/ No / /
The number of shares outstanding of the Registrant's capital stock:
15,576,950 shares of Common Stock, $0.01 par value as of October 30, 1998.
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MEMBERWORKS INCORPORATED
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PAGE
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<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of September 30, 1998
and June 30, 1998. 3
Condensed Consolidated Statements of Operations for the three
month periods ended September 30, 1998 and 1997. 4
Condensed Consolidated Statements of Cash Flows for the three
month periods ended September 30, 1998 and 1997. 5
Notes to Condensed Consolidated Financial Statements. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7 - 9
Certain Factors That May Affect Future Results 9
PART II. OTHER INFORMATION
Item 2. Changes in Securities 10
Item 6. Exhibits and Reports on Form 8-K 11
</TABLE>
2
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MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
<TABLE>
<CAPTION>
September 30, June 30,
1998 1998
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(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 34,815 $ 35,933
Accounts receivable 9,099 7,107
Prepaid membership materials 3,401 2,931
Prepaid expenses 1,438 1,060
Membership solicitation and other deferred costs 52,457 51,771
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Total current assets 101,210 98,802
Fixed assets, net 13,139 9,677
Intangible and other assets 25,147 25,450
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Total assets $ 139,496 $ 133,929
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term obligations $ 218 $ 380
Accounts payable 17,318 21,967
Accrued liabilities 25,781 20,680
Deferred membership fees 69,466 61,753
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Total current liabilities 112,783 104,780
Long-term obligations 43 69
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Total liabilities 112,826 104,849
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Shareholders' equity:
Common stock, $0.01 par value --
40,000 shares authorized; 15,744 shares issued
(15,653 shares at June 30, 1998) 157 156
Capital in excess of par value 74,846 74,478
Deferred compensation (861) (978)
Accumulated deficit (42,151) (40,073)
Treasury stock, 405 shares at cost (377 shares at June 30, 1998) (5,321) (4,503)
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Total shareholders' equity 26,670 29,080
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$ 139,496 $ 133,929
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
3
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MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three months ended
September 30,
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1998 1997
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<S> <C> <C>
Revenues $ 44,453 $ 24,553
Expenses:
Operating 8,236 5,087
Marketing 26,407 14,656
General and administrative 8,955 4,861
Other income, net principally interest (434) (398)
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Total expenses 43,164 24,206
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Income before income taxes 1,289 347
Provision for income taxes -- --
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Net income before cumulative effect of accounting change $ 1,289 $ 347
Cumulative effect of accounting change (note 4) (3,367) --
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Net (loss) income $ (2,078) $ 347
======== ========
Basic (loss) earnings per share:
Income before cumulative effect of accounting change $ 0.08 $ 0.02
Cumulative effect of accounting change (0.22) --
-------- --------
Basic (loss) earnings per share $ (0.14) $ 0.02
======== ========
Diluted (loss) earnings per share:
Income before cumulative effect of accounting change $ 0.08 $ 0.02
Cumulative effect of accounting change (0.20) --
-------- --------
Diluted (loss) earnings per share $ (0.12) $ 0.02
======== ========
Pro forma amounts assuming new accounting principle
is applied retroactively-
Net income $ 1,289 $ 382
Earnings per share assuming no dilution $ 0.08 $ 0.03
Earnings per share assuming full dilution $ 0.08 $ 0.02
Shares used in earnings per share calculation (note 2):
Basic 15,303 14,736
======== ========
Diluted 16,801 16,160
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
4
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MEMBERWORKS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
<TABLE>
<CAPTION>
Three months ended
September 30,
-------------------------
1998 1997
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<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ (2,078) $ 347
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Cumulative effect of change in accounting principle 3,367 --
Membership solicitation and other deferred costs (28,056) (17,665)
Amortization of membership solicitation and other deferred costs 24,003 16,184
Deferred membership fees 7,713 2,558
Depreciation and amortization 1,150 362
Other 117 164
Change in assets and liabilities affecting operating cash flows:
Accounts receivable (1,992) (3,594)
Prepaid membership materials (470) 68
Prepaid expenses (378) (49)
Other assets (213) (83)
Accounts payable (4,649) (1,711)
Accrued liabilities 5,101 2,635
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Net cash provided by (used in) operating activities 3,615 (784)
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INVESTING ACTIVITIES
Acquisition of fixed assets (4,096) (513)
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Net cash used in investing activities (4,096) (513)
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FINANCING ACTIVITIES
Payments of long-term obligations (188) (172)
Treasury stock purchases (818) (1,145)
Proceeds from issuance of Common Stock 369 161
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Net cash used in financing activities (637) (1,156)
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Net decrease in cash and cash equivalents (1,118) (2,453)
Cash and cash equivalents at beginning of period 35,933 40,758
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Cash and cash equivalents at end of period $ 34,815 $ 38,305
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
5
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MEMBERWORKS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information. Accordingly, such statements do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the three month period
ended September 30, 1998 are not necessarily indicative of the results that may
be expected for the fiscal year ended June 30, 1999. For further information,
refer to the financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K with respect to the fiscal year ended June
30, 1998.
NOTE 2 - EARNINGS PER SHARE
Basic and diluted earnings per share amounts are determined in accordance with
the provision of FASB Statement No. 128 "Earnings per Share" (FAS 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):
<TABLE>
<CAPTION>
Three Months Ended September 30,
1998 1997
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<S> <C> <C>
Numerator for basic and diluted earnings per share:
Net income before cumulative effect
of accounting change $ 1,289 $ 347
Cumulative effect of accounting change (3,367) --
-------- --------
(Loss) income available to common shareholders $ (2,078) $ 347
Denominator for basic earnings per share:
Weighted average shares outstanding 15,303 14,736
Effect of dilutive securities:
Options and warrants 1,498 1,424
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Denominator for diluted earnings per share - adjusted
weighted average shares and assumed conversions 16,801 16,160
Basic (loss) earnings per share $ (0.14) $ 0.02
Diluted (loss) earnings per share $ (0.12) $ 0.02
</TABLE>
NOTE 3 - ALLOWANCE FOR MEMBERSHIP CANCELLATIONS
Accrued liabilities set forth in the accompanying condensed consolidated balance
sheets as of September 30, 1998 and June 30, 1998 include an allowance for
membership cancellations of $19,894,550 and $16,362,000 respectively.
NOTE 4 - CUMULATIVE EFFECT OF ACCOUNTING CHANGE
Effective July 1, 1998, the Company changed its method of accounting for
printing and mailing membership materials. Historically, the Company has
accounted for the costs of printing and mailing of membership materials by
amortizing these costs ratably over the membership period as revenue is
recognized. Effective July 1, 1998, the Company started expensing these costs
upon the mailing of membership materials. The cumulative effect of this change
in accounting principle as of July 1, 1998 of $3.4 million was recorded in the
first fiscal quarter ended September 30, 1998 as a reduction of membership
solicitation and other deferred costs and net income.
6
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MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
MemberWorks addresses the needs of organizations seeking to leverage the
expertise of an outside provider in offering membership service programs.
Membership service programs offer selected products and services from a variety
of vendors intended to enhance its existing relationships between businesses and
consumers. The Company derives its revenues principally from annually renewable
membership fees. The Company receives full payment of annual fees at or near the
beginning of the membership period, but recognizes revenue ratably over the
membership period. Similarly, the costs associated with soliciting each new
member, as well as the cost of royalties, printing and mailing of membership
materials are amortized ratably over the same period. Profitability and cash
flow generated from renewal memberships exceed that of new memberships due to
the absence of solicitation cost associated with new member procurement.
On September 1, 1998, the Company issued a press release that stated it had
contacted the Securities and Exchange Commission ("SEC") to determine whether
the SEC staff's view regarding the timing of revenue recognition for companies
such as MemberWorks Incorporated that sell services has changed in the wake of
Cendant Corporation's agreement (announced on August 27, 1998) with the SEC to
modify its revenue recognition practices. The Company had requested the SEC
staff to comment on and has provided the SEC staff with information
demonstrating the continued appropriateness of its revenue recognition
practices. The Company has consistently followed these practices in accordance
with generally accepted accounting practices and with the concurrence of
PricewaterhouseCoopers LLP, its independent accountants. As a result of this
review and several discussions with the SEC staff, the staff has not objected to
the Company's decision to presently continue to follow its revenue recognition
practices, as described above. The SEC staff did request the Company to change
its method of accounting for printing and mailing of membership materials,
beginning as of July 1, 1998. The Company has recorded the cumulative effect of
this change in accounting principle in the first quarter of fiscal 1999. See
footnote 4 for a description of the change and its financial impact.
On September 28, 1998, the SEC issued a press release and stated the "SEC will
formulate and augment new and existing accounting rules and interpretations
covering revenue recognition, restructuring reserves, materiality, and
disclosure;" for all publicly-traded companies. Until such time as the SEC staff
issues such interpretative guidelines, it is unclear what, if any, impact such
interpretative guidance will have on the Company's current accounting practices.
However, the potential changes in accounting practice being considered by the
SEC staff could have a material impact on the manner in which the Company
recognizes revenue. Any such changes would have no effect on reported cash flow
or the economic value of the Company's memberships.
THREE MONTHS ENDED SEPTEMBER 30, 1998 VS. THREE MONTHS ENDED SEPTEMBER 30, 1997
REVENUES. Revenues increased 81% to $44.5 million for the quarter ended
September 30, 1998 from $24.6 million for the quarter ended September 30, 1997
due to an increase in the Company's membership base and an increase in the
weighted average program fee. The Company's membership base increased to
approximately 3.9 million members at September 30, 1998 from 2.2 million members
at September 30, 1997. If revenues from Coverdell and Company, acquired on April
2, 1998, were included in both periods on a pro-forma basis, first quarter
revenues would have increased 60%. The increase in the Company's membership base
was due to an increase in the members enrolled in existing programs and the
roll-out of new programs introduced in fiscal 1998, as well as members acquired
through the Coverdell acquisition. The increase in the weighted average program
fee was due to an increase in the percentage of members enrolled in programs
with higher fees. Revenues from renewals increased to $18.8 million in 1998 from
$9.7 million in 1997. As a percentage of individual membership revenues, these
amounts represented 45% in 1998 and 42% in 1997 due to the leverage effect of
the increased revenues.
7
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MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
OPERATING EXPENSES. Operating expenses consist of costs incurred in
servicing the Company's membership base, including personnel, telephone and
computer processing costs, as well as expenses associated with the production
and distribution of membership information kits. Operating expenses increased
62% to $8.2 million in 1998 from $5.1 million in 1997 due to the servicing
requirements of the larger membership base of the Company. As a percentage of
revenues, operating expenses decreased to 18.5% in 1998 from 20.7% in 1997.
MARKETING EXPENSES. Marketing expenses consist of fees to telemarketers to
solicit potential members, royalties to clients, direct mail costs and other
solicitation expenses. Marketing expenses increased 80% to $26.4 million from
$14.7 million in 1997 due to increased telemarketing and royalty expenses
associated with the larger membership base. As a percentage of revenues,
market ing expenses decreased to 59.4% in 1998 from 59.7% in 1997. The decrease
was due to the favorable effect of an increase in the weighted average program
fee, improved member retention rates and an increase in revenues generated from
wholesale arrangements.
In addition to marketing expenses, the Company also monitors the spending
for membership solicitation and other deferred costs. These costs increased 59%
to $28.1 million in 1998 from $17.7 million in 1997 primarily due to increased
marketing efforts incurred to grow the membership base.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist of personnel and facilities expenses associated with the Company's
executive, sales, marketing, finance, product and account management functions.
General and administrative expenses increased 84% to $9.0 million in 1998 from
$4.9 million in 1997. This increase was attributable to the costs incurred for
additional personnel in all areas and related facilities costs as well as
amortization expense of intangibles related to the Coverdell acquisition. As a
percentage of revenues, general and administrative expenses increased to 20.1%
in 1998 from 19.8% in 1997. Excluding the amortization expense related to the
Coverdell acquisition in April 1998, general and administrative expenses would
have decreased to 19.0% in 1998 from 19.8% in 1997.
OTHER INCOME, NET. Other income, net is primarily composed of interest
income from cash and cash equivalents. Other income of $0.4 million was reported
in 1998 and 1997.
PROVISION FOR INCOME TAXES. The Company was not required to record a
provision for income taxes for the quarter ended September 30, 1998 due to the
tax losses realized.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $3.6 million in 1998
compared to net cash used in operating activities of $0.8 million in 1997. These
results were attributable to improved operating results as well as improved
member acquisition costs.
The Company's capital expenditures were $4.1 million in 1998 and $0.5
million in 1997. The increase in capital expenditures is due to a computer
system upgrade and expansion of the Company's call centers.
Net cash used in financing activities was $0.6 million in 1998 and $1.2
million in 1997. This decrease is primarily related to a reduction in treasury
share repurchases made under the Company's stock repurchase program. The Company
purchased 28,000 shares during the quarter ended September 30, 1998 versus
57,000 shares during the quarter ended September 30, 1997.
8
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MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Because of ongoing costs in connection with soliciting new members, the Company
expects to continue to utilize net cash generated from operating activities, if
any, to increase the Company's membership base. The Company believes that
existing cash balances together with its available bank credit facility, will be
sufficient to meet its funding requirements for at least the next twelve months.
YEAR 2000 ISSUES
The Company has completed an analysis of its software and hardware to
determine if its systems are Year 2000 compliant. The Company's project to
evaluate, modify, and test its systems is substantially complete and involved
communication and testing with all of the Company's clients and vendors. This
testing has involved processing of customer files both by the Company and its
clients and vendors and the results have been positive.
The cost of the project has not been material to the Company and has been
funded through operating cash flows. The Company has expensed all costs
associated with this project as incurred.
Although management believes the Company's systems will be Year 2000
compliant, the Company has begun developing contingency plans to address any
possible system failures. Because the Company uses multiple vendors to process
its billing transactions, its external risk is mitigated as vendors may be used
interchangeably. However, there can be no assurance that these, or other
companies on which the Company relies will be timely converted or that any such
failure to convert would not have an adverse effect on the Company's systems and
operations.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
This Quarterly Report contains forward-looking statements that involve
risks and uncertainties, including the statements in Liquidity and Capital
Resources regarding the adequacy of funds to meet funding requirements. The
Company's actual results may differ significantly from the results discussed in
the forward-looking statements. A number of uncertainties exist that could
affect the Company's future operating results, including, without limitation,
the Company's history of losses, the Company's ability to retain existing
clients and attract new clients, the Company's dependence on membership
renewals, intense competition, the Company's continuing ability to develop new
programs which generate consumer interest, and general economic factors. The
Company has incurred significant operating losses since its inception. Although
the Company has experienced revenue growth and has reported net income in recent
quarterly periods, such growth rates and favorable results may not be
sustainable and may not be indicative of future operating results. There can be
no assurance that the Company will be able to maintain profitability in the
future.
9
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PART II. OTHER INFORMATION
Item 5. Changes in Securities
The effective date of the registration statement pursuant to which the Company
conducted the public offering of its Common Stock was October 18, 1996 and the
file number was 333-10541. The Company filed its initial report on Form SR on
January 27, 1997 for the period ended January 18, 1997.
From the effective date of the registration statement filed in connection with
the offering to September 30, 1998, the net proceeds of the offering were used
as follows (in thousands):
<TABLE>
<S> <C>
Acquisitions of other businesses $ 5,804
Purchase and installation of machinery and equipment 11,012
Repayment of indebtedness 2,818
Working capital 4,264
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$23,898
=======
</TABLE>
The remaining $12,502,000 of the proceeds has been invested in short-term,
highly rated money market funds, government securities and commercial paper. Of
the $2,818,000 used to repay indebtedness, $1,855,000 represented direct or
indirect payments to directors, officers, general partners of the issuer or
their associates; to persons owning ten percent or more of any class of equity
securities of the issuer; and to affiliates of the issuer.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27 - Financial Data Schedule (included in EDGAR copy
only)
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during
the quarter ended September 30, 1998.
10
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MEMBERWORKS INCORPORATED
(Registrant)
Date: November 13, 1998 By: /s/ Gary A. Johnson
-------------------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
Date: November 13, 1998 By: /s/ James B. Duffy
-------------------------------
James B. Duffy, Senior Vice President,
Chief Financial Officer
11
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 34,815
<SECURITIES> 0
<RECEIVABLES> 9,099
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 101,210
<PP&E> 18,823
<DEPRECIATION> 5,684
<TOTAL-ASSETS> 139,496
<CURRENT-LIABILITIES> 112,783
<BONDS> 0
0
0
<COMMON> 157
<OTHER-SE> 26,513
<TOTAL-LIABILITY-AND-EQUITY> 139,496
<SALES> 0
<TOTAL-REVENUES> 44,453
<CGS> 0
<TOTAL-COSTS> 43,164
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,289
<INCOME-TAX> 0
<INCOME-CONTINUING> 1,289
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (3,367)
<NET-INCOME> (2,078)
<EPS-PRIMARY> (0.14)
<EPS-DILUTED> (0.12)
</TABLE>
