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, 2003
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, 2002 was $147,737,111. 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 15, 2003 was
11,658,284.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Proxy Statement for the 2003 Annual Meeting of Stockholders of
MemberWorks Incorporated are incorporated by reference in Part 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 6
Executive Officers of the Registrant 7
Part II Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters 7
Item 6. Selected Financial Data 8
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 9
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 16
Item 8. Financial Statements and Supplementary Data 16
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 16
Item 9A. Controls and Procedures 16
Part III Item 10. Directors, Executive Officers, Promoters and Control Persons of the Registrant 17
Item 11. Executive Compensation 17
Item 12. Security Ownership of Certain Beneficial Owners and Management 17
Item 13. Certain Relationships and Related Transactions 17
Item 14. Principal Accountant Fees and Services 17
Part IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 17
Signatures 19
Exhibit listing 20
Part I
Item 1. Business
OVERVIEW
MemberWorks Incorporated ("MemberWorks" or the "Company"), a Delaware
Corporation, was organized in 1996 and did business as CardMember Publishing
Corporation from 1989 to 1996.
MemberWorks is a leader in bringing value to consumers by designing innovative
membership programs that offer members easy access to significant savings at
national brand name service providers and merchants. MemberWorks combines
marketing innovation, entrepreneurial energy and consumer insight to create
industry leading membership programs that provide substantial benefits to the
Company's members, clients and vendors. The Company's members benefit by
receiving significant discounts and insightful information on everyday items in
the areas of healthcare, personal finance, insurance, travel, entertainment,
fashion, personal security and more. In addition, members save time by
purchasing goods and services and obtaining useful information over the
telephone or the Internet. The Company's clients (organizations who offer the
membership programs to their customers) benefit by receiving royalty payments in
exchange for providing MemberWorks with members. Clients also benefit because
the membership programs are designed to strengthen the client's relationship
with its customers. For the participating vendors, the membership programs
provide the opportunity for the vendor to reach a large number of
demographically attractive members at a minimal incremental marketing cost.
The Company's programs are primarily marketed under the name of the membership
program to customers through arrangements with its clients which include banks
and other financial institutions, e-commerce companies, direct response
television companies, catalog companies, retailers, major oil companies and
other organizations with large numbers of individual customers. In many cases,
these businesses lack the core competency to successfully design, market and
manage membership programs. As a result, these businesses seek to outsource to
companies 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 programs and are able to realize economies of scale. In
addition, businesses seeking to implement membership service programs demand
that the provider of those programs has the expertise to continue to introduce
innovative new programs and has resources such as extensive vendor networks and
experienced management teams in order to market programs quickly and
successfully. MemberWorks solicits members for its programs primarily by direct
marketing methods and 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. Outbound
telemarketing is currently the source for only 20% of the Company's new member
enrollments. MemberWorks believes that it is the leading designer and provider
of innovative membership programs due to its senior management's extensive
knowledge of the industry, its extensive vendor network and its relationships
with leading consumer-driven organizations with large numbers of individual
account holders and customers.
MemberWorks possesses the in-house operational capabilities and expertise to
perform most aspects of its business with minimal reliance upon third party
outsourcing. For instance, MemberWorks generally creates most of its marketing,
creative and fulfillment materials. MemberWorks also maintains in-house call
center facilities in order to answer its members' phone calls. MemberWorks
believes this in-house approach enables the Company to provide better customer
service and market its products more efficiently.
Most of the membership programs are for one-year renewable terms and members are
generally entitled to unlimited use of the service during the membership period.
MemberWorks has traditionally marketed its membership programs which have an
up-front annual membership fee. However, during fiscal 2003, the Company
expanded its marketing of membership programs in which the membership fee is
payable in monthly installments. During the fourth quarter of fiscal 2003,
approximately half 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 fiscal 2004. In general, membership fees vary
depending upon the particular membership program. During fiscal 2003, annual
membership fees averaged approximately $112 per year and monthly membership fees
averaged $10.22 per month. The Company's membership programs had approximately
6.3 million retail members as of June 30, 2003.
PRODUCT DESCRIPTION
MemberWorks believes that it was the first membership program company to
introduce aggregated discount services in the areas of healthcare, travel and
entertainment, shopping, home improvement, financial and personal security.
MemberWorks also believes that all of its programs are innovative with respect
to the variety and quality of particular services, discounts and other features
offered. By bundling and reconfiguring various features of its standard
programs, MemberWorks can customize a program to the particular needs and
demands of its clients. MemberWorks employs a consultative process to understand
1
and define client needs and to determine how those needs can be addressed by the
membership service programs offered by MemberWorks. MemberWorks seeks to build
upon its existing customer relationships by integrating and cross-selling its
different membership service programs. MemberWorks continues to enhance its
existing membership programs to add more member value which, in turn, enables
the Company to increase the membership fee year over year. The Company's
money-saving programs fall into the following four key categories:
Health and Insurance
The Health and Fitness membership programs offer significant savings on a
comprehensive array of products including prescription drugs, vitamins and
supplements, eye glasses and contact lenses, hearing aides, durable medical
equipment and select consumer health products. Also offered are discounts on
professional services including medical, dental, chiropractic, alternative
medicine, elder care and personal health services.
The Insurance membership programs offer competitively priced, guaranteed
issue, insurance products including life, accidental death, short-term and
catastrophic disability, supplemental medical, warranty and identity theft
insurance coverage.
Travel, Entertainment and Shopping
These membership programs offer exclusive members-only savings with leading
brand name partners. Members have multiple opportunities to save on airfare,
hotel rates, car rental and cruise packages, theme and amusement parks,
restaurants and movie theaters. Members also have access to savings on a
wide range of merchandise, apparel and personal services.
Privacy, Protection and Home Improvement
These membership programs offer discounts on products and services that
enhance and improve the member's sense of security and well being. Members
have access to bundles of services that enable them to better manage their
privacy and protection such as identity theft insurance, card registration,
credit reporting, scoring and monitoring, and personal information
monitoring services, as well as, savings on security systems, 24-hour
protection services, roadside assistance, financial, tax and retirement
planning and extended warranty protection. Members also have access to
discounts on home improvement, consumer electronics and family
entertainment.
Specialty Markets and Custom Programs
MemberWorks offers a full line of membership programs in Canada, as well as,
Hispanic versions of most membership programs. Membership materials and
customer service are offered in English, Spanish and French.
MemberWorks also partners with large clients to offer custom, private label
or co-branded membership programs to meet the specific needs of a defined
customer base.
In general, members subscribe for renewable one-year memberships in the
Company's programs. When consumers agree to enroll in a program, they generally
receive a trial membership. During this time, the member may use the program's
services without obligation, as outlined in the marketing solicitation.
Membership materials, which includes a membership brochure and a membership card
with a membership identification number, is mailed 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 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
billing method. For annual members, in the event that the member does not cancel
the membership after the initial one year membership term, he or she generally
receives a renewal notice in the mail in advance of each membership year and is
charged for the succeeding year's membership fee. During the course of an
initial annual membership term or renewal term, a member may cancel his or her
membership in the program generally for a pro-rata refund of the membership fee
based on the remaining portion of the membership period. Monthly members are
billed each month after the trial period ends and continue to be billed each
month until the member cancels.
MEMBERSHIP BENEFITS
In most cases, the products and services offered to members through the
Company's programs are provided directly to members by independent benefit
providers or vendors. MemberWorks evaluates and engages only those vendors who
2
can cost-effectively deliver high quality products and services. Vendors
generally benefit by gaining significant volume with minimal marketing expense.
Accordingly, vendors gain access and marketing exposure to the Company's
membership base and in almost all cases, pursuant to contractual arrangements
with MemberWorks, provide a members-only discount on products or services.
MemberWorks generally does not receive payments from these vendors for rendering
services to the Company's members and, in certain cases, MemberWorks pays its
vendors a fee based on the volume of members in the Company's program or based
on other agreed upon factors.
The Company's contracts with its vendors are generally for one year or more,
with subsequent one-year renewal terms at the option of MemberWorks. Vendors may
cancel contracts with MemberWorks, but in most cases, only for cause and subject
to notice provisions to provide MemberWorks time to locate a substitute vendor.
Most vendor contracts are non-exclusive, but have requirements that the vendors
maintain the confidentiality of the terms of the contract.
MARKETING AND DISTRIBUTION
MemberWorks solicits members for its programs primarily by direct marketing
methods, including inbound call marketing, referred to as MemberLinkSM, online
marketing, outbound telemarketing, which it outsources to third party
contractors, and direct mail, which is mailed either at MemberWorks' own expense
or at its client's expense. MemberWorks 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.
Outbound telemarketing is currently the source for approximately 20% of the
Company's new member enrollments.
MemberLinkSM inbound call marketing occurs when inbound callers to a client
meeting certain criteria are offered the Company's membership service programs
by the client's service representative or by a MemberWorks membership service
representative through a call transfer. This type of marketing method
essentially turns the client call center into a profit center. MemberWorks pays
the client either a royalty for initial and renewal membership fees or a fee per
marketing pitch or per sale. Generally, MemberLinkSM arrangements serve as a
more efficient and cost effective way to acquire members than the Company's
traditional outbound telemarketing marketing model.
Online marketing is executed through arrangements with Internet service
providers ("ISP's"), online retailers and online marketers. The marketing
methods primarily include banner adds, pop-up boxes and e-commerce cross-sells.
MemberWorks pays the client either a royalty for membership fees or a fee per
impression or per sale.
All outbound telemarketing is outsourced to third party contractors. Under
outbound telemarketing arrangements, participating marketing partners, such as
banks and other financial institutions and other organizations with large
numbers of individual account holders and customers, provide lists of consumers
which MemberWorks inputs into its database management system to model, analyze
and identify likely members. MemberWorks only collects and maintains customer
data that is required to administer its business activities, such as a
customer's name, address and encrypted billing information. MemberWorks pays its
participating marketing partners an annual royalty for initial and renewal
membership fees received from consumers who were provided to MemberWorks by the
marketing partner.
Substantially all of the information necessary for the Company's marketing
efforts are 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 is
generally dependent upon first obtaining client approval.
The Company's contracts with its clients typically grant MemberWorks the right
to continue providing membership services directly to such clients' individual
account holders even if the client terminates the contract. 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, MemberWorks generally has the right to continue its relationship
with the client's customers that have become program members either indefinitely
or for a specified period of time, but may not re-solicit those members upon
such member's cancellation or non-renewal of the membership.
In addition to marketing its programs directly to consumers through MemberLinkSM
marketing, online marketing, outbound telemarketing and direct mail marketing,
MemberWorks also delivers its membership service programs through its wholesale
arrangements. MemberWorks works with a wholesale client to incorporate elements
from one or more of its standard service programs and designs a custom program
for the client. The client will then either provide the customized membership
program to its customers as a value-added feature or resell the customized
membership program. In some cases, the client may provide wholesale memberships
to its customers free of charge and pay the periodic membership fee to
MemberWorks for each customer's membership. In other cases, the client may
charge a reduced fee to its customer. The client pays MemberWorks the membership
fees for the customers who receive the customized membership program. Under the
3
Company's wholesale programs, MemberWorks 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 MemberWorks. Since
MemberWorks does not pay for the marketing costs, wholesale programs have
substantially lower acquisition costs, which result in higher profit margins for
MemberWorks. Notwithstanding that, MemberWorks provides membership in the
service program for a reduced fee.
MemberWorks also provides its membership programs internationally through its
subsidiary MemberWorks Canada. MemberWorks Canada provides retail membership
programs similar to those offered in the U.S. as well as credit card enhancement
services to Canadian financial institutions through wholesale arrangements. The
Company's revenues from international operations represented 3%, 3% and 2% of
total revenues for the fiscal years ended June 30, 2003, 2002 and 2001,
respectively.
Membership programs sponsored by the Company's two largest clients, Citibank and
its affiliates and West Corporation, accounted for 21% and 16% of revenue,
respectively, for the fiscal year ended June 30, 2003. A loss of either of these
clients would have a material effect on the Company's results of operations.
MEMBERSHIP SERVICE
MemberWorks 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' members that were offered the membership program. Currently,
MemberWorks maintains four call centers located in Montreal, Canada; Houston,
Texas; Omaha, Nebraska and Chicago, Illinois with a total of almost 900
membership service representatives. All new membership service representatives
are required to attend on-the-job training. Through its training programs,
systems and software, MemberWorks 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.
MemberWorks 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 MemberWorks.
TECHNOLOGY
MemberWorks has invested substantially in new technology, including a
state-of-the-art fulfillment center, a sophisticated customer service CRM
platform, data warehousing and mining capabilities, and various Internet
applications which work together to allow MemberWorks to effectively and
efficiently service its members. MemberWorks receives new member information
from its marketing partners daily, and that information is maintained on core
infrastructure systems that drive information constantly to call center,
fulfillment, billing and financial 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. MemberWorks receives confirmation of billing
data from the Company's merchant processors on a regular basis, permitting
MemberWorks 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 respond to an offer and retain their membership.
GOVERNMENT REGULATION
MemberWorks markets its membership programs through various distribution
channels including MemberLinkSM, online marketing, outbound telemarketing and
direct mail. These channels are regulated on both the state and federal levels
and the Company believes that these marketing methods will increasingly be
subject to such regulation, particularly in the area of consumer privacy. Such
regulation may limit our 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 as well as
general public scrutiny in the past several years. For example, the Federal
Telephone Consumer Protection Act of 1991 limits the hours during which
telemarketers may call consumers and prohibits the use of automated telephone
dialing equipment to call certain telephone numbers. Additionally, the Federal
Telemarketing and Consumer Fraud and Abuse Prevention Act of 1994 and Federal
Trade Commission ("FTC") regulations, 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 telemarketing activities deemed by them to be "unfair or deceptive
4
acts or practices." Further, some states have enacted laws and others are
considering enacting laws targeted directly at regulating telemarketing
practices, and there can be no assurance that any such laws, if enacted, will
not adversely affect or limit the Company's current or future operations.
Compliance with these regulations is generally the responsibility of the
Company, and the Company could be subject to a variety of enforcement and/or
private actions for any failure to comply with such regulations. The Company's
provision of membership programs requires the Company to comply with certain
state regulations, changes in which could materially increase the Company's
operating costs associated with complying with such regulations. The risk of
noncompliance by the Company with any rules and regulations enforced by a
federal or state consumer protection authority may subject the Company or its
management to fines or various forms of civil or criminal prosecution, any of
which could 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, and the membership programs industry is susceptible
to peremptory charges of regulatory noncompliance and unfair dealing by the
media.
The Company currently maintains rigorous security and quality controls 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 required 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 customer information that is obtained or derived in its marketing
efforts nor purchases consumer information from financial institutions.
COMPETITION
MemberWorks 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 MemberWorks. Some of these competitors have
substantially larger customer bases and greater financial and other resources
than that of the Company. To date, MemberWorks 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 MemberWorks to more directly compete with MemberWorks; provide
programs comparable or superior to those provided by MemberWorks at lower
membership prices; adapt more quickly than MemberWorks 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 MemberWorks to promote a program
if the services provided by the Company's program are similar to, or merely
overlap with, the services provided by an existing program of a competitor.
EMPLOYEES
As of June 30, 2003, MemberWorks employed 1,275 persons on a full-time basis and
135 on a part-time basis. None of the Company's employees are represented by a
labor union. MemberWorks believes that its employee relations are good.
AVAILABLE INFORMATION
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.
The Company's Internet address is http://www.memberworks.com. The reference to
the Company's website does not constitute incorporation by reference of the
information contained in the website.
5
Item 2. Properties
A summary of key information with respect to the Company's leased facilities is
as follows:
Location Square Footage Year of Lease Expiration
-------- -------------- ------------------------
Omaha, NE 93,123 2009 through 2015
Stamford, CT 54,947 2006
Montreal, Canada 48,193 2011
Houston, TX 41,591 2006
Atlanta, GA 13,717 2005
Chicago, IL 11,676 2005
White Plains, NY 4,193 2004
The Stamford, Connecticut office serves as the Company's corporate headquarters.
All other locations serve as the operational offices for MemberWorks.
MemberWorks 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 complaint includes a claim that the
suit should be certified as a class action and the plaintiff has filed a motion
for class certification to which all of the defendants have filed opposing
papers regarding the same. The Court has announced that it will deny the motion
for national class certification, but it has indicated that it would consider
certifying a class of Michigan residents. A hearing has not yet been held on
class certification, and no order has been issued. The Company believes that the
claims made against Coverdell are unfounded and Coverdell and the Company will
vigorously defend their interests against this suit.
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 MemberWorks was not liable to MedVal for
any compensatory damages, they awarded $5.5 million in punitive damages and
costs against MemberWorks solely under CUTPA. MemberWorks 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. No briefing schedule has yet been set in the appeal. 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
MemberWorks 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 on 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 and liquidity in the
period in which the final order is entered.
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, 2003.
6
Executive Officers of the Registrant
The executive officers of the registrant of MemberWorks and their respective
ages as of July 31, 2003 are as follows:
Name Age Position
- ---- --- --------
Gary A. Johnson 48 President and Chief Executive Officer, Director
Vincent DiBenedetto 46 Executive Vice President, Health and Insurance Services
James B. Duffy 49 Executive Vice President and Chief Financial Officer
William Olson 45 Executive Vice President, Sales and Client Services
David Schachne 42 Executive Vice President, Business Development
GARY A. JOHNSON, a co-founder of MemberWorks, has served as President and
Chief Executive Officer and a director of MemberWorks since its inception.
VINCENT DIBENEDETTO joined MemberWorks in October 2000 and currently serves as
Executive Vice President, Sales and Client Services. Prior to joining
MemberWorks, Mr. DiBenedetto was President of Discount Development Services,
L.L.C., a subsidiary of MemberWorks which was acquired in October 2000.
JAMES B. DUFFY joined MemberWorks in 1996 and currently serves as Executive Vice
President and Chief Financial Officer.
WILLIAM OLSON joined MemberWorks in March 2001 and currently serves as Executive
Vice President, Sales and Client Services. Prior to joining MemberWorks, Mr.
Olson served in various senior positions such as President & Chief Executive
Officer of Dunlop/Maxfli Sports Corporation, President & Chief Executive Officer
of Gold Coast Beverage Distributors and President & Chief Executive Officer of
Guinness Brewing North America Corporation.
DAVID SCHACHNE joined MemberWorks in 1990 and currently serves as Executive Vice
President, Business Development. He has held various senior management positions
at MemberWorks in Marketing and Business Development.
Part II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters
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.
High Low
---- ---
Fiscal Year Ended June 30, 2003:
First Quarter $18.80 $12.48
Second Quarter 19.53 16.65
Third Quarter 20.71 14.00
Fourth Quarter 24.00 19.30
High Low
---- ---
Fiscal Year Ended June 30, 2002:
First Quarter $25.00 $17.90
Second Quarter 21.00 7.98
Third Quarter 18.93 14.26
Fourth Quarter 18.53 16.27
As of August 15, 2003, there were 40,000,000 shares of the Company's Common
Stock authorized of which 11,658,284 shares were outstanding, held by
approximately 1,722 stockholders of record. MemberWorks 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
MemberWorks is a party and other factors considered relevant by the Board of
Directors.
Equity Compensation Plan Information
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.
7
Item 6. Selected Financial Data
The selected consolidated statements of operations data for each of the years
ended June 30, 2003 through 1999 and the selected consolidated balance sheet
data as of June 30, 2003 through 1999 set forth below are derived from the
audited consolidated financial statements of MemberWorks. The selected
consolidated financial information of MemberWorks is qualified by reference to
and should be read in conjunction with Item 8, "Consolidated Financial
Statements and Supplementary Data," and Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" appearing elsewhere
herein.
Year Ended June 30,
--------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
(In thousands, except per share data)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Revenues $ 456,881 $ 427,602 $ 475,726 $ 330,107 $ 218,086
Total expenses 434,595 415,713 509,050 331,547 212,292
------------ ----------- ----------- ----------- ----------
Operating income (loss) 22,286 11,889 (33,324) (1,440) 5,794
Settlement of investment related litigation 19,148 - - - -
(Loss) gain on sale of subsidiary (959) 65,608 - - -
Net (loss) gain on investment (206) (33,628) (2,172) 8,854 -
Other income (expense), net 326 (401) (450) 873 2,154
------------ ----------- ----------- ----------- ----------
Income (loss) before equity in affiliate and minority interest 40,595 43,468 (35,946) 8,287 7,948
Equity in income (loss) of affiliate - - 83 19 (1,912)
Minority interest - 450 9,106 2,027 -
------------ ----------- ----------- ----------- ----------
Net income (loss) before provision for income taxes 40,595 43,918 (26,757) 10,333 6,036
Provision for income taxes 16,239 - - - -
------------ ----------- ----------- ----------- ----------
Net income (loss) before cumulative effect of accounting
change 24,356 43,918 (26,757) 10,333 6,036
Cumulative effect of accounting change - (5,907) (25,730) - (3,367)
------------ ----------- ----------- ----------- ----------
Net income (loss) $ 24,356 $ 38,011 $ (52,487) $ 10,333 $ 2,669
============ =========== =========== =========== ==========
Basic earnings (loss) per share:
Income (loss) before cumulative effect of accounting
change $ 1.93 $ 3.03 $ (1.75) $ 0.68 $ 0.39
Cumulative effect of accounting change - (0.41) (1.69) - (0.22)
------------ ----------- ----------- ----------- ----------
Basic earnings (loss) per share 1.93 $ 2.63 $ (3.44) $ 0.68 $ 0.17
============ =========== =========== =========== ==========
Diluted earnings (loss) per share:
Income (loss) before cumulative effect of accounting
change $ 1.84 $ 2.95 $ (1.75) $ 0.61 $ 0.35
Cumulative effect of accounting change - (0.40) (1.69) - (0.20)
------------ ----------- ----------- ----------- ----------
Diluted earnings (loss) per share $ 1.84 $ 2.55 $ (3.44) $ 0.61 $ 0.16
============ =========== =========== =========== ==========
Weighted average common shares outstanding
Basic 12,596 14,477 15,248 15,162 15,361
============ =========== =========== =========== ==========
Diluted 13,233 14,909 15,248 16,993 17,124
============ =========== =========== =========== ==========
June 30,
--------------------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents $ 72,260 $ 45,502 $ 21,745 $ 30,169 $ 50,939
Total assets 248,505 280,817 348,461 316,772 209,827
Long-term liabilities 8,273 3,627 3,057 1,083 6
Shareholders' (deficit) equity (20,283) (20,630) (25,965) 19,021 30,287
Cash flow provided by operating activities 48,533 17,014 12,022 44,910 50,573
8
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
----------------------------------------------------------------------
OVERVIEW
MemberWorks designs and manages innovative membership programs and provides
organizations with an opportunity to leverage the expertise of an outside
provider in offering these membership programs. Membership service programs
offer selected products and services from a variety of vendors for an annual fee
or a monthly fee. MemberWorks derives its revenues principally from annually
renewable membership fees which are billed to the customer 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 revenue as the member's refund privilege expires. Membership fees
that are billed monthly are generally 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.
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 all require the use of judgments and
estimates: membership cancellation rates, deferred marketing costs, valuation of
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 MemberWorks believes are
appropriate. Actual results may differ from these estimates. MemberWorks
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 of the Notes to the
consolidated financial statements located in this 2003 Annual Report on Form
10-K.
Revenue recognition
Membership fees are billed through clients of the Company primarily through
credit cards. During an initial annual membership term or renewal term, a member
may cancel his or her membership in the program generally for a prorata refund
of the membership fee based on the remaining portion of the membership period.
Revenue from members who are charged on a monthly payment program is recognized
as the membership fees are earned. In accordance with Staff Accounting Bulletin
101, "Revenue Recognition in Financial Statements" ("SAB 101"), deferred
membership fees are recorded, net of estimated cancellations, and are amortized
as revenues from membership fees 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. Actual membership cancellations 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 telemarketing, direct mail,
refundable royalty payments, non- refundable royalty payments and advertising
costs. Telemarketing and direct mail 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 as revenues from membership
fees are recognized. Refundable royalty payments are also 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 pitch, fee per sale and
fee per impression marketing arrangements, are expensed when incurred.
Total membership solicitation costs incurred to obtain a new member are
generally less than the estimated total membership fees. However, if total
membership solicitation costs were to exceed total estimated membership margins,
an adjustment would be made to the membership solicitation and other deferred
costs balance to the extent of any impairment.
9
Valuation of goodwill and other intangibles
MemberWorks 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. MemberWorks 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, MemberWorks would then be required to record
a corresponding charge which would negatively impact earnings. Goodwill at July
1, 2002 and 2001, was tested for impairment during the quarters ended September
30, 2002 and 2001, respectively. The Company concluded that none of its goodwill
was impaired as of July 1, 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 fiscal 2001.
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.
FISCAL 2003 COMPARED TO FISCAL 2002
REVENUES. Revenues increased 7% to $456.9 million in 2003 from $427.6 million in
2002. Excluding $9.4 million of revenue generated from iPlace, Inc., which was
sold in the first quarter of fiscal 2002, revenues would have increased 9% over
the prior year. The increase in revenues is due to the effect of the Company's
strategic initiative to migrate its members that participate in a
full-money-back refund policy program to a prorata refund policy program, in
addition to increased levels of monthly member marketing and an increase in the
average program price point. As of December 31, 2002, virtually all of the
Company's membership base was enrolled in a prorata refund policy program. As a
result of the Company's strategic initiative to move its members to a prorata
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 101. This strategic move to
prorata refund policy programs increased the revenue recognized in fiscal 2003
under SAB 101. Revenue from members who are charged on a monthly payment program
increased to $76.9 million from $41.3 million due to an increase in members
enrolled in a monthly payment plan. As a percentage of total revenues, renewal
revenues from annual payment programs were 45% in 2003 and 48% in 2002.
OPERATING EXPENSES. Operating expenses consist of member service call center
costs, membership benefit costs and membership program fulfillment costs.
Operating expenses decreased slightly to $78.4 million in 2003 from $78.7
million in 2002 primarily due to the sale of iPlace, Inc., offset by an increase
in costs to support the Company's strategy to improve member satisfaction. As a
percentage of revenues, operating expenses decreased to 17.2% in 2003 from 18.4%
in 2002 primarily due to the cost savings initiatives implemented in the
beginning of the December 2001 quarter and operating expense leverage gained
from increased revenues.
MARKETING EXPENSES. Marketing expenses consist of costs incurred to obtain new
members and royalties paid to clients. Those costs that are considered direct
response advertising costs and refundable royalties paid to clients are
generally amortized in the same manner as the related revenue as required by SOP
93-7 and SAB 101. Marketing expenses increased 13% to $280.7 million in 2003
from $249.0 million in 2002. As a percent of revenue, marketing expenses
increased to 61.4% in 2003 from 58.2% in 2002 primarily due to a higher level of
non-refundable royalties and advertising costs incurred during fiscal 2003 due
to the Company's shift away from telemarketing.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
primarily include personnel-related costs, occupancy costs and other overhead
costs. General and administrative expenses decreased 7% to $74.1 million in 2003
from $79.2 million in 2002. As a percentage of revenues, general and
administrative expenses decreased to 16.2% in 2003 from 18.5% in 2002. These
decreases were primarily due to the sale of iPlace, Inc. and the closing of the
United Kingdom operations.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. Intangible amortization
decreased to $1.4 million in 2003 from $1.9 million in 2002 primarily due to the
effect of the sale of iPlace, Inc.
10
Settlement of investment related litigation. During fiscal 2003, MemberWorks,
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 MemberWorks received $19.1 million.
GAIN ON SALE OF SUBSIDIARY. During fiscal 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. The Company reported a gain of $65.6 million
on the sale. During fiscal 2003, the Company settled with Homestore.com, Inc.
all issues pending related to amounts held in escrow in connection with the
sale. The Company recorded a net loss of $1.0 million related to this settlement
in fiscal 2003.
NET LOSS ON INVESTMENT. During fiscal 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. During fiscal 2003, the Company sold
all of its Homestore.com, Inc. common stock and recognized a loss of $0.2
million.
OTHER INCOME/EXPENSE, NET. Other income/expense, net is primarily composed of
interest income from cash and cash equivalents and bank fees related to the
Company's line of credit. Other income increased to $0.3 million in 2003 from
expense of $0.4 million in 2002 due to the increase in the Company's cash
balance.
PROVISION FOR INCOME TAXES. For the year ended June 30, 2003, the Company
recorded a provision for income taxes of $16.2 million based on an effective tax
rate of 40%. The effective tax rate was higher than the U.S. federal statutory
rate for the year ended June 30, 2003 primarily due to state taxes and other
non-deductible items. During fiscal 2002, MemberWorks was not required to record
a provision for income taxes due to the ability to utilize net operating loss
carryforwards against which the Company had carried a full valuation allowance.
The valuation allowance recognized in prior periods has been fully reversed in
2003 based upon the Company's belief that it is more likely than not that it
will realize its deferred tax assets. As of June 30, 2003, MemberWorks had
accumulated federal net operating loss carryforwards of $41.4 million.
FISCAL 2002 COMPARED TO FISCAL 2001
REVENUES. Revenues decreased 10% to $427.6 million in 2002 from $475.7
million in 2001. Excluding iPlace, Inc. revenues of $9.4 million and $42.4
million in 2002 and 2001, respectively, revenues would have decreased 3%. The
decrease in revenues is due to the controlled slow down in new member marketing
implemented in the beginning of fiscal 2002. This controlled slow down was a
reaction to decreased consumer response rates. Revenue from members who are
charged on a monthly payment program increased to $41.3 million in 2002 from
$27.6 million in 2001. As a percentage of total revenues, renewal revenues from
annual payment programs were 48% in 2002 and 41% in 2001. The increase in
renewal revenues as a percentage of total revenues is due to the controlled slow
down in new member marketing implemented in the beginning of the fiscal year.
OPERATING EXPENSES. Operating expenses decreased 13% to $78.7 million in 2002
from $90.4 million in 2001 primarily due to the sale of iPlace, Inc., the
closing of the United Kingdom operations and lower revenues during the year. As
a percentage of revenues, operating expenses decreased to 18.4% in 2002 from
19.0% in 2001 primarily due to the effect of lower revenues reported in 2002
resulting from the sale of iPlace, Inc.
MARKETING EXPENSES. Marketing expenses decreased 18% to $249.0 million in 2002
from $305.0 million in 2001 primarily due to the effect of the controlled slow
down in new member marketing implemented in the beginning of fiscal 2002 and the
effect of the sale of iPlace, Inc. As a percent of revenue, marketing expenses
decreased to 58.2% in 2002 from 64.1% in 2001 primarily due to the increase in
the mix of renewal revenue as a percent of total revenue. The lower level of new
member marketing resulted in an increase in the ratio of renewal member revenues
to total revenues. Marketing expenses related to renewal revenues are typically
significantly lower than expenses related to new member revenues. Expenses
related to new member marketing, as a percent of new member revenues, increased
in 2002 compared to 2001 primarily due to a decrease in consumer response rates.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased 21% to $79.2 million in 2002 from $99.7 million in 2001, and as a
percentage of revenues, decreased to 18.5% in 2002 from 21.0% in 2001. These
decreases were primarily due to the sale of iPlace, Inc. and the effect of cost
saving initiatives related to the restructuring, as described below.
11
RESTRUCTURING CHARGES. In October 2001, the Company implemented certain 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 of approximately 190 employees, the closing of
the Company's United Kingdom operations and the downsizing of the operational
infrastructure throughout the Company. As a result of this restructuring
program, the Company recorded restructuring charges of $6.9 million during the
second quarter ended December 31, 2001. See Note 12 of the condensed
consolidated financial statements contained in the 2003 Annual Report filed on
Form 10-K.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. Intangible amortization
decreased to $1.9 million in 2002 from $10.9 million in 2001 due to the adoption
of SFAS 142, which no longer requires the amortization of indefinite lived
intangible assets, and the sale of iPlace, Inc. Excluding the amortization of
indefinite lived intangible assets of $7.8 million in 2001, amortization of
goodwill and other intangibles would have been $3.1 million. This decrease was
due to the sale of iPlace, Inc.
GAIN ON SALE OF SUBSIDIARY. During the quarter ended September 30, 2001, the
Company sold its investment in iPlace, Inc. for $50.1 million in cash and 1.6
million shares of Homestore.com, Inc. stock. The Company reported a gain of
$65.6 million on the sale.
NET LOSS ON INVESTMENT. During fiscal 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.
OTHER EXPENSE, NET. Other expense, net is primarily composed of interest income
from cash and cash equivalents, bank fees related to the Company's borrowings
under its line of credit and interest expense related to its notes payable.
Other expense decreased to $0.4 million in 2002 from $0.5 million in 2001. The
Company had no borrowings outstanding under its line of credit as of June 30,
2002.
PROVISION FOR INCOME TAXES. MemberWorks was not required to record a provision
for income taxes for the year ended June 30, 2002 due to the ability to utilize
net operating loss carryforwards against which the Company had carried a full
valuation allowance. MemberWorks was not required to record a provision for
income taxes for the year ended June 30, 2001, due to tax losses realized. As of
June 30, 2002, MemberWorks had accumulated federal net operating loss
carryforwards of $68.7 million.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities was $48.5 million, $17.0 million and
$12.0 million for the years ended June 30, 2003, 2002 and 2001, respectively.
The increase in operating cash flow in fiscal 2003 was due to a shift in the
marketing mix to more profitable marketing channels, cost savings as a result of
the restructuring plan and the actual costs incurred in December 2001 related to
the restructuring plan. The shift in marketing mix to more profitable marketing
channels is demonstrated by the decrease in marketing costs before deferral as a
percentage of revenues before deferral.
The Company's management believes that revenues before deferral and marketing
costs before deferral are important measures of liquidity. Revenue before
deferral are revenues before the application of SAB 101 and represent the actual
membership fees billed during the current reporting period less an allowance for
membership cancellations. Marketing costs before deferral are marketing costs
before the application of SAB 101 and SOP 93-7 and represent the Company's
obligation for marketing efforts that occurred during the current reporting
period.
Revenues before deferral for the years ended June 30, 2003, 2002 and 2001 are
calculated as follows:
2003 2002 2001
------------- ------------- ------------
Revenues $ 456,881 $ 427,602 $ 475,726
Change in deferred membership fees (39,003) (17,116) 9,266
------------- ------------- ------------
Revenues before deferral $ 417,878 $ 410,486 $ 484,992
============= ============= ============
Revenues before deferral were $417.9 million, $410.5 million and $485.0
million for the years ended June 30, 2003, 2002 and 2001, respectively. Revenues
before deferral increased 2% in fiscal 2003 from the prior year. Excluding
revenue from iPlace, Inc. of $11.0 million and the United Kingdom of $1.9
million from the prior year, revenue before deferral increased 5% in fiscal
2003. The United Kingdom operations were closed in fiscal 2002. Revenues before
deferral increased in fiscal 2003 compared to the prior year primarily due to an
increase in the average program price point. As a percentage of total revenues
before deferral, renewal revenues from annual payment programs were 45% in 2003,
51% in 2002 and 44% in fiscal 2001. The decrease in renewal revenues from annual
payment prgrams
12
in fiscal 2003 is due to the controlled marketing slow down implemented in
the beginning of fiscal 2002, the growth in monthly payment programs and the
sale of iPlace, Inc. Revenue from members who are charged on a monthly payment
program were $76.9 million, $41.3 million and $26.7 million in fiscal 2003, 2002
and 2001, respectively. This shift to monthly payment programs has a near-term
negative impact on operating cash flow.
Marketing costs before deferral for the years ended June 30, 2003, 2002 and 2001
are calculated as follows:
2003 2002 2001
------------- ------------- ------------
Marketing expenses $ 280,673 $ 248,974 $ 305,032
Change in membership solicitation and other deferred costs (51,411) (15,038) (17,177)
------------- ------------- ------------
Marketing costs before deferral $ 229,262 $ 233,936 $ 287,855
============= ============= ============
Marketing costs before deferral were $229.3 million, $233.9 million and $287.9
million in 2003, 2002 and 2001, respectively. Marketing costs before deferral
decreased 2.0% in fiscal 2003 from the prior year. As a percent of revenues
before deferral, marketing expenses before deferral were 54.9% in 2003, 57.0% in
2002 and 59.4% in 2001. These decreases were primarily due to a shift in the
marketing mix to more profitable marketing channels and have a direct positive
impact on the Company's net cash flow provided by operating activities.
Net cash provided by investing activities was $12.4 million in 2003 and $40.2
million in 2002, while net cash used in investing activities was $18.2 million
in 2001. In fiscal 2003, MemberWorks, 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 MemberWorks received $19.1 million. In addition, in fiscal 2003, the
Company settled with Homestore.com, Inc. all pending issues related to amounts
held in escrow in connection with the sale and, as a result, the Company paid
$0.8 million from the escrow account related to the settlement. In fiscal 2003,
the Company made a $0.5 million investment in a small business outsource
marketing company. Net cash provided by investing activities in 2002 reflects
the receipt of $46.0 million in net proceeds from the sale of iPlace, Inc. In
fiscal 2001, MemberWorks paid $8.2 million in cash to acquire the remaining 81%
of DDS. In addition, during fiscal 2001, MemberWorks received $4.1 million in
proceeds from the sale of its investment in 24/7 Media, Inc. Capital
expenditures were $5.5 million, $5.8 million and $15.1 million in 2003, 2002 and
2001, respectively.
Net cash used in financing activities was $34.2 million, $33.5 million and $2.1
million in 2003, 2002 and 2001, respectively. The increase in cash used in
financing activities was primarily due to an increase in spending under the
Company's stock repurchase program. The Company purchased 2.0 million shares for
$37.2 million, an average price of $18.67, during the year ended June 30, 2003
compared to 2.2 million shares for $34.3 million, an average price of $15.40,
during the year ended June 30, 2002 and compared to 0.3 million shares for $8.9
million, an average price of $26.23, during the year ended June 30, 2001. The
Company utilizes cash from operations to repurchase shares, as the Company
believes this enhances shareholder value. During fiscal 2003, the Board of
Directors authorized an additional 2.5 million shares to be repurchased under
the buyback program. As of June 30, 2003, the Company had 1.0 million shares
available for repurchase under its buyback program. In July 2003, the Board of
Directors authorized an additional 1.0 million shares to be repurchased under
its buyback program which increased the number of shares available for
repurchase to 2.0 million.
As of June 30, 2003, the Company had cash and cash equivalents of $72.3 million.
In addition, the Company has a $28.0 million bank credit facility which bears
interest at the higher of the base commercial lending rate for the bank or the
Federal Funds Rate plus 0.5% per annum. As of June 30, 2003, availability under
the bank credit facility was reduced by an outstanding letter of credit of $5.5
million. As of June 30, 2003, the effective interest rate for borrowings was
4.0%. The bank credit facility has certain financial covenants, including a
maximum debt coverage ratio, a minimum fixed charge ratio, potential
restrictions on additional borrowings and potential restrictions on additional
stock repurchases. As of June 30, 2003, the Company was in compliance with all
such debt covenants. 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.
The Company did not have any material commitments for capital expenditures as of
June 30, 2003. The Company intends to utilize cash generated from operations to
fulfill any capital expenditure requirements during fiscal 2004.
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 2003 Annual Report on Form 10-K. The Company does not
have off-balance sheet arrangements, non-exchange traded contracts or material
related party transactions.
13
Future minimum payments of contractual obligations as of June 30, 2003 are as
follows (amounts in thousands):
Payments Due by Period
-------------------------------------------------------------------------------
Less than
Total 1 year 1-3 years 4-5 years After 5 years
-------------- ------------- -------------- -------------- ---------------
Operating leases 27,162 6,620 11,137 4,909 4,496
Capital leases 8 8 - - -
Notes payable - - - - -
Purchase obligations 1,000 1,000 - - -
Other obligations 299 236 63 - -
-------------- ------------- -------------- -------------- ---------------
Total payments due 28,469 7,864 11,200 4,909 4,496
============== ============= ============== ============== ===============
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 10 and 11 of the consolidated financial statements
contained in this 2003 Annual Report filed on Form 10-K.
NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"), which is effective
for exit or disposal activities that are initiated after December 31, 2002. SFAS
146 requires companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a commitment to an
exit or disposal plan and nullifies Emerging Issues Task Force Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (Including Certain Costs in a Restructuring)." The adoption
of SFAS 146 did not have a material impact on the Company's financial
statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"). FIN 45 requires a guarantor to include
disclosure of certain obligations, and if applicable, at the inception of the
guarantee, recognize a liability for the fair value of other certain obligations
undertaken in issuing a guarantee. The recognition requirement is effective for
guarantees issued or modified after December 31, 2002. The adoption of FIN 45
did not have a material impact on the Company's financial statements.
In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure - an Amendment of FASB Statement No.
123." This Statement amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for stock-based
employee compensation. It also amends the disclosure provisions of that
Statement to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. Finally, this Statement amends APB Opinion No. 28,
"Interim Financial Reporting," to require disclosure about those effects in
interim financial information. The transition provisions of this statement are
effective for financial statements with fiscal years ending after December 15,
2002. The disclosure provisions of this statement are effective for financial
reports containing condensed financial statements for interim periods beginning
after December 15, 2002. The Company will continue to account for its stock
based compensation according to the provisions of APB Opinion No. 25.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 clarifies the application of
Accounting Research Bulletin No. 51 and applies immediately to any variable
interest entities created after January 31, 2003 and to variable interest
entities in which an interest is obtained after that date. For variable interest
entities created or acquired prior to February 1, 2003, the provisions of FIN 46
must be applied for the first interim or annual period beginning after June 15,
2003. While it will continue to evaluate the requirements of FIN 46, MemberWorks
does not believe that the adoption of FIN 46 will have a material impact on the
Company's financial statements.
In May 2003, the FASB issued SFAS 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. MemberWorks does not
believe that the adoption of SFAS 150 will have a material impact on Company's
financial statements.
14
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 MemberWorks 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;
o 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 MemberWorks;
o Potential reserve requirements by business partners such as the
Company's payment processors;
o Unanticipated cancellation or termination of marketing agreements and
the extent to which MemberWorks can continue successful development
and marketing of new products and services;
o Unanticipated changes in or termination of the Company's ability to
process membership fees through third parties, including clients,
payment processors and bank card associations;
o The Company's ability to introduce new programs on a timely basis;
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 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 The Company's ability to integrate acquired businesses into the
Company's management and operations and operate successfully;
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 MemberWorks 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, including the Federal Trade
Commission's 2003 Amendment to its Telemarketing Sales Rule which
creates a national do-not-call list effective October 1, 2003; and
o New accounting pronouncements.
Many of these factors are beyond MemberWorks' control, and, therefore, its
ability to generate predictable revenue and income growth may be adversely
affected by these factors.
MemberWorks 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, MemberWorks 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.
15
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate
The Company has a $28.0 million bank credit facility which bears interest at the
higher of the base commercial lending rate for the bank or the Federal Funds
Rate plus 0.5% per annum. There were no borrowings outstanding under this bank
credit facility as of June 30, 2003. As of June 30, 2003, availability under the
bank credit facility was reduced by an outstanding letter of credit of $5.5
million. Management believes that an increase in the commercial lending 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 29, 2004, it is possible that
any replacement lending facility obtained by the Company may be more sensitive
to interest rate changes. The Company does not currently hedge interest rates
with respect to its outstanding debt.
Foreign Currency
The Company has international sales and facilities in Canada and therefore, is
subject to foreign currency rate exposure. Canadian sales have been denominated
in the Canadian dollar and its functional currency is the local currency. Assets
and liabilities of the Canadian subsidiary are translated into U.S. dollars at
the exchange rate in effect as of the balance sheet date. Income and expense
items are translated at the average exchange rate for the period. Accumulated
net translation adjustments are recorded in shareholders' equity. Foreign
exchange transaction gains and losses are included in the results of operations,
and were not material for all periods presented. As a result, the Company's
financial results could be affected by factors such as changes in foreign
currency exchange rates or weak economic condition. To the extent the Company
incurs expenses that are based on locally denominated sales volume paid in local
currency, the exposure to foreign exchange risk is reduced. The Company has
determined that the impact of a near-term 10% appreciation or depreciation of
the U.S. dollar would have an insignificant effect on its financial position,
results of operations and cash flows. The Company does not maintain any
derivative instruments to mitigate the exposure to translation and transaction
risk. However, this does not preclude the Company's adoption of specific hedging
strategies in the future. MemberWorks will assess the need to utilize financial
instruments to hedge currency exposures on an ongoing basis.
Fair Value
The Company does not have material exposure to market risk with respect to
investments, as the Company does not hold any marketable securities as of June
30, 2003. MemberWorks 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 accountants
for MemberWorks 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 15-d-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. The Company's disclosure controls and procedures are
designed to ensure that material information relating to MemberWorks 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.
16
Changes in internal control over financial reporting.
During the fourth quarter of fiscal 2003, 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 our internal control over
financial reporting.
Part III
Item 10. Directors, Executive Officers, Promoters and Control Persons 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 MemberWorks is
furnished in Part I of this Annual Report on form 10-K under the heading
"Executive Officers of the Registrant."
Item 11. Executive Compensation
The information contained in the Company's Proxy Statement under the section
titled "Executive Compensation" is incorporated herein by reference in response
to this item.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information contained in the Company's Proxy Statement under the section
titled "Security Ownership of Certain Beneficial Owners and Management" is
incorporated herein by reference in response to this item.
Item 13. Certain Relationships and Related Transactions
The information contained in the Company's Proxy Statement under the section
titled "Certain Relationships and Related Transactions" is incorporated herein
by reference in response to this item.
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, Financial Statement Schedules and Reports on Form 8-K
(a) Index to Financial Statements and Financial Statement Schedules Page
--------------------------------------------------------------- ----
Report of PricewaterhouseCoopers LLP, Independent Auditors F-1
Consolidated Balance Sheets as of June 30, 2003 and 2002 F-2
Consolidated Statements of Operations for the years ended June 30, 2003, 2002 and 2001 F-3
Consolidated Statements of Shareholders' Deficit for the years ended June 30, 2003,
2002 and 2001 F-4
Consolidated Statements of Cash Flows for the years ended June 30, 2003, 2002 and 2001 F-5
Notes to Consolidated Financial Statements F-6
The following Financial Statement Schedule is included:
Schedule II - Valuation and Qualifying Accounts - Years ended June 30, 2003, 2002 and 2001 F-20
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 14, 2003, the Company filed on Form 8-K under Item 5 "Other
Events" and Item 7 "Financial Statements and Exhibits" a Press Release
providing additional financial details and announcing fiscal year 2003
third quarter conference call.
On April 29, 2003, the Company filed on Form 8-K under Item 7
"Financial Statements and Exhibits" and Item 9 "Regulation FD
Disclosure (and information furnished under Item 12)" a Press Release
announcing fiscal year 2003 third quarter and nine month results.
17
(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.
MEMBERWORKS INCORPORATED
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
MEMBERWORKS INCORPORATED
(Registrant)
By: /s/ GARY A. JOHNSON
---------------------------------
Gary A. Johnson, President, Chief
Executive Officer and Director
Date: September 15, 2003
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 15, 2003
- --------------------------
Gary A. Johnson
By: /s/ James B. Duffy Executive Vice President, Chief Financial Officer September 15, 2003
- ---------------------------
James B. Duffy
By: /s/ Alec L. Ellison Director September 15, 2003
- ---------------------------
Alec L. Ellison
By: /s/ Scott N. Flanders Director September 15, 2003
- ---------------------------
Scott N. Flanders
By: /s/ Robert Kamerschen Director September 15, 2003
- ---------------------------
Robert Kamerschen
By: /s/ Michael T. McClorey Director September 15, 2003
- ---------------------------
Michael T. McClorey
By: /s/ Edward M. Stern Director September 15, 2003
- ---------------------------
Edward M. Stern
By: /s/ Marc S. Tesler Director September 15, 2003
- ---------------------------
Marc S. Tesler
18
Exhibit
No. Description
- ------- ------------
*3.1 Restated Certificate of Incorporation of the Registrant. (filed as Exhibit 3.3 to the Company's
Registration Statement on Form S-1, Registration No. 333-10541, filed on October 18, 1996)
*3.2 Restated By-laws of the Registrant. (filed as Exhibit 3.4 to the Company's Registration Statement on
Form S-1, Registration No. 333-10541, filed on October 18, 1996)
*4.1 Amended and Restated Registration Rights Agreement, dated as of September 9, 1994 between the
Registrant and Brown Brothers Harriman & Co. (filed as Exhibit 4.3 to the Company's Registration
Statement on Form S-1, Registration No. 333-10541, filed on October 18, 1996)
*4.2 Registration Rights Agreement, dated September 20, 1995 among the Registrant and the Stockholders set
forth on Schedule I thereto. (filed as Exhibit 4.4 to the Company's Registration Statement on Form
S-1, Registration No. 333-10541, filed on October 18, 1996)
*10.1 Amended Employee Incentive Stock Option Plan. (filed as Exhibit 10.1 to the Company's Registration
Statement on Form S-1, Registration No. 333-10541, filed on October 18, 1996)
*10.3 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 Credit Agreement dated March 31, 2003 among MemberWorks Incorporated, the Lenders Parties Hereto and
Brown Brothers Harriman & Co.
*10.15 Warrant Agreement dated as of September 9, 1994, between the
Registrant and Brown Brothers Harriman & Co. (filed as Exhibit 10.12
to the Company's Registration Statement on Form S-1, Registration
No.
333-10541, filed on October 18, 1996)
*10.16 Form of Stock Subscription Warrant with Voting Rights, dated August 3, 1995. (filed as Exhibit 10.15
to the Company's Registration Statement on Form S-1, Registration No. 333-10541, filed on October 18,
1996)
*10.18 Lease Agreement between Stamford Towers Limited Partnership and the Registrant, dated January 15,
1996. (filed as Exhibit 10.22 to the Company's Registration Statement on Form S-1, Registration No.
333-10541, filed on October 18, 1996)
*10.20 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)
*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)
*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.
19
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.
20
MEMBERWORKS INCORPORATED
Report of Independent Auditors
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) on page 17 present fairly, in all material respects,
the financial position of MemberWorks Incorporated and its subsidiaries at June
30, 2003 and 2002, and the results of their operations and their cash flows for
each of the three years in the period ended June 30, 2003 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
aforementioned index presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 4 to the consolidated financial statements, the Company
changed its method of accounting for membership fee revenue in fiscal 2001 and
goodwill and other intangible assets in fiscal 2002.
PricewaterhouseCoopers LLP
New York, New York
July 28, 2003
F-1
MEMBERWORKS INCORPORATED
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
June 30,
---------------------------
2003 2002
------------ -------------
Assets
Current assets:
Cash and cash equivalents $ 72,260 $ 45,502
Restricted cash 2,732 5,683
Marketable securities - 912
Accounts receivable (net of allowance for doubtful accounts of $1,743 and $914,
at June 30, 2003 and 2002, respectively) 8,713 9,831
Prepaid membership materials 2,196 2,061
Prepaid expenses 7,571 4,325
Membership solicitation and other deferred costs 77,883 129,085
------------- -------------
Total current assets 171,355 197,399
Fixed assets, net 24,969 31,420
Goodwill 42,039 42,039
Intangible assets, net 6,656 8,049
Other assets 3,486 1,910
------------- -------------
Total assets $ 248,505 $ 280,817
============= =============
Liabilities and Shareholders' Deficit
Current liabilities:
Current maturities of long-term obligations $ 244 $ 1,070
Accounts payable 32,644 32,769
Accrued liabilities 59,105 57,709
Deferred membership fees 167,643 206,272
Deferred income taxes 879 -
------------- -------------
Total current liabilities 260,515 297,820
Deferred income taxes 5,145 -
Long-term liabilities 3,128 3,627
------------- -------------
Total liabilities 268,788 301,447
------------- -------------
Commitments and contingencies (Note 11) - -
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;
17,847 shares issued (17,493 shares at June 30, 2002) 178 175
Capital in excess of par value 122,425 109,254
Accumulated deficit (17,829) (42,185)
Accumulated other comprehensive loss (469) (373)
Treasury stock, 6,126 shares at cost (4,139 shares at June 30, 2002) (124,588) (87,501)
------------- -------------
Total shareholders' deficit (20,283) (20,630)
------------- -------------
Total liabilities and shareholders' deficit $ 248,505 $ 280,817
============= =============
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,
----------------------------------------
2003 2002 2001
-------------- ------------ ------------
Revenues $ 456,881 $ 427,602 $ 475,726
Expenses:
Marketing 280,673 248,974 305,032
Operating 78,444 78,694 90,368
General and administrative 74,085 79,211 99,732
Restructuring charges (Note 12) - 6,893 -
Non-recurring charge (Note 11) - - 3,000
Amortization of intangibles 1,393 1,941 10,918
-------------- ------------ ------------
Operating income (loss) 22,286 11,889 (33,324)
Settlement of investment related litigation (Note 7) 19,148 - -
(Loss) gain on sale of subsidiary (Note 6) (959) 65,608 -
Net (loss) gain on investment (Note 6) (206) (33,628) (2,172)
Other income (expense), net 326 (401) (450)
-------------- ------------ ------------
Income (loss) before equity in affiliate and minority interest 40,595 43,468 (35,946)
Equity in income of affiliate - - 83
Minority interest (Note 15) - 450 9,106
-------------- ------------ ------------
Income (loss) before income taxes 40,595 43,918 (26,757)
Provision for income taxes 16,239 - -
-------------- ------------ ------------
Income (loss) before cumulative effect of accounting change 24,356 43,918 (26,757)
Cumulative effect of accounting change (Note 4) - (5,907) (25,730)
-------------- ------------ ------------
Net income (loss) $ 24,356 $ 38,011 $ (52,487)
============== ============ ============
Basic earnings (loss) per share:
Income (loss) before cumulative effect of accounting change $ 1.93 $ 3.03 $ (1.75)
Cumulative effect of accounting change - (0.41) (1.69)
-------------- ------------ ------------
Basic earnings (loss) per share $ 1.93 $ 2.63 $ (3.44)
============== ============ ============
Diluted earnings (loss) per share:
Income (loss) before cumulative effect of accounting change $ 1.84 $ 2.95 $ (1.75)
Cumulative effect of accounting change - (0.40) (1.69)
-------------- ------------ ------------
Diluted earnings (loss) per share $ 1.84 $ 2.55 $ (3.44)
============== ============ ============
Pro forma assuming accounting changes are retroactively applied:
Net income (loss) $ 24,356 $ 43,918 $ (18,978)
Basic earnings (loss) per share 1.93 3.03 (1.24)
Diluted earnings (loss) per share 1.84 2.95 (1.24)
Weighted average common shares used in earnings (loss) per share calculations:
Basic 12,596 14,477 15,248
============== ============ ============
Diluted 13,233 14,909 15,248
============== ============ ============
The accompanying notes are an integral part of
these consolidated financial statements.
F-3
MEMBERWORKS INCORPORATED
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIT
(In thousands)
Accumulated
Capital in Other
Common Stock Excess of Deferred Accumulated Comprehensive Treasury
------------------
Shares Amount Par Value Compensation Deficit Loss Stock Total
--------------------------------------------------------------------------------------------
Balance - June 30, 2000 16,507 $ 165 $ 91,398 $ (44) $ (27,709) $ (145) $(44,644) $ 19,021
Issuance of common stock 376 4 3,234 3,238
Issuance of common stock for
an acquisition 425 4 12,880 12,884
Issuance of treasury stock to fund
401K Plan (28) 154 126
Acquisition of treasury stock (8,917) (8,917)
Deferred compensation 351 44 395
Comprehensive loss:
Net loss (52,487)
Currency translation adjustment (225)
Total comprehensive loss (52,712)
--------------------------------------------------------------------------------------------
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