SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED OCTOBER 31, 1998
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-22846
CMG INFORMATION SERVICES, INC.
------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 04-2921333
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
100 BRICKSTONE SQUARE, FIRST FLOOR 01810
ANDOVER, MASSACHUSETTS (Zip Code)
(Address of principal executive offices)
(978) 684-3600
(Registrant's telephone number, including area code)
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
--------- -----------
Number of shares outstanding of the issuer's
common stock, as of December 11, 1998
Common Stock, par value $.01 per share 23,083,025
- --------------------------------------- ---------------------------
Class Number of shares outstanding
CMG INFORMATION SERVICES, INC.
FORM 10-Q
INDEX
Page Number
-----------
Part I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets
October 31, 1998 and July 31, 1998 3
Consolidated Statements of Operations
Three months ended October 31, 1998 and 1997 4
Consolidated Statements of Cash Flows
Three months ended October 31, 1998 and 1997 5
Notes to Interim Consolidated Financial Statements 6-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13-16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURE 19
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands, except share and per share amounts)
October 31, July 31,
1998 1998
-------------- -----------------
ASSETS
Current assets:
Cash and cash equivalents $ 6,639 $ 61,537
Available-for-sale securities 92,287 5,764
Accounts receivable, trade, less allowance for doubtful accounts 29,222 23,960
Inventories 9,547 8,250
Prepaid expenses 3,203 3,210
Other current assets 1,991 2,364
-------- --------
Total current assets 142,889 105,085
Property and equipment, net 13,236 13,973
Investments in affiliates 115,057 66,187
Cost in excess of net assets of subsidiaries acquired, net of accumulated 48,606 49,682
amortization
Other assets 6,623 2,533
-------- --------
$326,411 $237,460
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ 24,800 $ 27,656
Current installments of long-term debt 16,966 16,594
Accounts payable 17,030 11,261
Accrued income taxes -- 10,085
Accrued expenses 22,549 20,534
Deferred revenues 10,292 4,932
Deferred income taxes 14,056 --
Other current liabilities 901 1,239
-------- --------
Total current liabilities 106,594 92,301
Long-term debt, less current installments 1,001 1,373
Deferred income taxes 23,187 10,528
Other long-term liabilities 4,482 4,428
Minority interest 33,402 11,045
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.01 par value. Authorized 5,000,000 shares; none issued -- --
Common stock, $.01 par value. Authorized 40,000,000 shares; issued 23,073,436
shares at October 31, 1998 and 23,033,943 shares at July 31, 1998 231 230
Additional paid-in capital 92,422 91,260
Net unrealized loss on available-for-sale securities (525) (436)
Deferred compensation (1,109) (1,442)
Retained earnings 66,726 28,173
-------- --------
Total stockholders' equity 157,745 117,785
-------- --------
$326,411 $237,460
======== ========
The accompanying notes are an integral part
of the consolidated financial statements.
3
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share amounts)
Three months ended October 31,
------------------------------
1998 1997
---- ----
Net revenues $ 40,005 $ 25,135
Operating expenses:
Cost of revenues 37,108 15,259
Research and development 5,491 6,174
Selling 8,979 11,040
General and administrative 8,306 4,901
----------- ---------
Total operating expenses 59,884 37,374
----------- ---------
Operating loss (19,879) (12,239)
----------- ---------
Other income (deductions):
Interest income 559 843
Interest expense (1,068) (770)
Gain on sale of data warehouse product rights -- 8,437
Gain on sale of Lycos, Inc. common stock 2,018 6,324
Gain on sale of available-for-sale securities -- 4,174
Gain (loss) on stock issuance by Lycos, Inc. 19,182 (94)
Gain on stock issuance by GeoCities 24,132 --
Gain on sale of investment in Sage Enterprises, Inc. 19,057 --
Gain on sale of investment in Reel.com, Inc. 23,158 --
Equity in losses of affiliates (2,589) (1,529)
Minority interest 101 (28)
----------- ---------
84,550 17,357
----------- ---------
Income before income taxes 64,671 5,118
Income tax expense 26,118 2,433
----------- ---------
Net income $ 38,553 $ 2,685
=========== =========
Basic earnings per share $ 1.67 $ 0.14
=========== =========
Diluted earnings per share $ 1.54 $ 0.12
=========== =========
Weighted average shares outstanding:
Basic 23,041 19,358
=========== =========
Diluted 24,966 20,633
=========== =========
The accompanying notes are an integral
part of the consolidated financial statements.
4
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Three months ended October 31,
------------------------------
1998 1997
---- ----
Cash flows from operating activities:
Net income $ 38,553 $ 2,685
Adjustments to reconcile net income to net cash used for
operating activities:
Depreciation and amortization 2,462 1,644
Deferred income taxes 29,079 (1,183)
Non-operating gains, net (87,547) (18,841)
Equity in losses of affiliates 2,589 1,529
Minority interest (101) 28
Changes in operating assets and liabilities, excluding
effects of acquired companies:
Trade accounts receivable (5,262) (1,900)
Inventories (1,297) (1,607)
Prepaid expenses 7 (1,300)
Accounts payable and accrued expenses 7,614 1,601
Deferred revenues 5,360 1,308
Refundable and accrued income taxes, net (11,517) 3,672
Other assets and liabilities (165) (6)
-------- --------
Net cash used for operating activities (20,225) (12,370)
-------- --------
Cash flows from investing activities:
Additions to property and equipment (2,182) (2,017)
Purchase of available-for-sale securities (31,123) --
Proceeds from sale of available-for-sale securities -- 7,555
Proceeds from sale of data warehouse product rights -- 9,543
Proceeds from sale of Lycos, Inc. common stock 2,520 7,149
Investments in affiliates (4,827) (3,516)
Other 1,793 (126)
-------- --------
Net cash provided by (used for) investing activities (33,819) 18,588
-------- --------
Cash flows from financing activities:
Net repayments of notes payable (2,856) (10,000)
Repayments of long-term debt -- (697)
Net proceeds from issuance of common stock 261 425
Net proceeds from issuance of stock by subsidiaries 1,945 477
Other (204) 1,061
-------- --------
Net cash used for financing activities (854) (8,734)
-------- --------
Net decrease in cash and cash equivalents (54,898) (2,516)
Cash and cash equivalents at beginning of period 61,537 59,762
-------- --------
Cash and cash equivalents at end of period $ 6,639 $ 57,246
======== ========
The accompanying notes are an integral
part of the consolidated financial statements.
5
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
A. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared by CMG
Information Services, Inc. ("CMG" or "the Company") in accordance with generally
accepted accounting principles. In the opinion of management, the accompanying
consolidated financial statements contain all adjustments, consisting only of
those of a normal recurring nature, necessary for a fair presentation of the
Company's financial position, results of operations and cash flows at the dates
and for the periods indicated. While the Company believes that the disclosures
presented are adequate to make the information not misleading, these
consolidated financial statements should be read in conjunction with the audited
financial statements and related notes for the year ended July 31, 1998 which
are contained in the Company's Annual Report on Form 10-K. The results for the
three month period ended October 31, 1998 are not necessarily indicative of the
results to be expected for the full fiscal year. Certain prior year amounts in
the consolidated financial statements have been reclassified in accordance with
generally accepted accounting principles to conform with current year
presentation.
B. DECONSOLIDATION OF LYCOS, INC.
During the first quarter of fiscal year 1998, the Company owned in excess of 50%
of Lycos, Inc. (Lycos) and accounted for its investment under the consolidation
method. Through the subsequent sale and distribution of Lycos shares, the
Company's ownership percentage in Lycos was reduced to below 50% beginning in
November, 1997. As such, beginning in November, 1997, the Company began
accounting for its remaining investment in Lycos under the equity method of
accounting, rather than the consolidation method. Prior to these events, the
operating results of Lycos were consolidated within the operating results of the
Company's investment and development segment, and the assets and liabilities of
Lycos were consolidated with those of CMG's other majority owned subsidiaries in
the Company's consolidated balance sheets. The Company's historical quarterly
consolidated operating results for the fiscal quarter ended October 31, 1997
included Lycos sales of $9,303,000 and operating losses of $433,000.
The following table contains summarized financial information for Lycos for the
quarter ended October 31, 1998:
(in thousands)
Condensed Statement of Operations:
Quarter
Ended
October 31,
1998
-----------
Net revenues $ 24,784
========
Operating loss $(26,673)
========
Net loss $(14,656)
========
Note: Lycos' operating and net loss for the quarter ended October 31, 1998
includes an in-process research and development charge of $15,400,000 related to
Lycos' acquisition of WhoWhere? Inc. during the quarter.
Condensed Balance Sheet:
October 31,
1998
----
Current assets $203,041
Noncurrent assets 193,454
--------
Total assets $396,495
========
Current liabilities $52,817
Noncurrent liabilities 30,750
Stockholders' equity 312,928
--------
Total liabilities and
stockholders' equity $396,495
========
6
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
C. SALE OF CMG@VENTURES INVESTMENTS AND INVESTMENT IN HOLLYWOOD
ENTERTAINMENT
In August, 1998, the Company's subsidiary, CMG@Ventures II, LLC (CMG@Ventures
II) converted its holdings in Sage Enterprises, Inc. (Sage Enterprises) into
225,558 shares of Amazon.com, Inc. (Amazon.com) common stock as part of a merger
wherein Amazon.com acquired Sage Enterprises. CMG@Ventures II invested $4.5
million in Sage Enterprises beginning in June, 1997. The Company recorded a
pre-tax gain of $19,057,000 on the conversion of its investment in Sage
Enterprises during the fiscal quarter ended October 31, 1998. Such gain was
recorded net of the 20% interest attributable to CMG@Ventures II's profit
members.
In October, 1998, CMG@Ventures II's holdings in Reel.com, Inc. (Reel.com) were
converted into 1,943,783 restricted common and 485,946 restricted, convertible
preferred shares of Hollywood Entertainment Corporation (Hollywood
Entertainment) as part of a merger wherein Hollywood Entertainment acquired
Reel.com. The preferred shares are convertible into common shares on a 1-for-1
basis, subject to approval by Hollywood Entertainment shareholders.
CMG@Ventures II invested $6.9 million in Reel.com beginning in July, 1997. The
Company recorded a pre-tax gain of $23,158,000 on the conversion of its
investment in Reel.com during the fiscal quarter ended October 31, 1998. The
gain was reported net of the 20% interest attributable to CMG@Ventures II's
profit members.
Also in October, 1998, in a separate transaction, the Company purchased
1,524,644 restricted common and 803,290 restricted, convertible preferred shares
of Hollywood Entertainment for a total cash purchase price of $31.1 million.
The preferred shares are convertible into common shares on a 1-for-1 basis,
subject to approval by Hollywood Entertainment shareholders.
D. GAIN ON STOCK ISSUANCES BY LYCOS, INC. AND GEOCITIES
In August, 1998, the Company's affiliate, GeoCities, completed its initial
public offering of common stock, issuing approximately 5.5 million shares at a
price of $17.00 per share, which raised $84.5 million in net proceeds for
GeoCities. As a result of the initial public offering, the Company's ownership
interest in GeoCities was reduced from approximately 34% to approximately 28%.
The Company, through its subsidiaries, CMG@Ventures I, LLC (CMG@Ventures I) and
CMG@Ventures II, has invested a total of $5.9 million in GeoCities beginning in
January, 1996. The Company recorded a pre-tax gain of $24,132,000 on the
issuance of stock by GeoCities during the fiscal quarter ended October 31, 1998,
representing the increase in the book value of the Company's net equity in
GeoCities, primarily as a result of the initial public offering. The gain was
recorded net of the interests attributable to CMG@Ventures I's and II's profit
members.
The Company recorded a pre-tax gain of $19,182,000 in the first quarter of
fiscal 1999 resulting from the issuance of stock by Lycos. The gain for the
quarter was primarily related to the issuance of 4.1 million shares by Lycos
during August, 1998 in its acquisition of WhoWhere? Inc., net of the impact of
an in-process research and development charge recorded by Lycos related to the
acquisition. As a result of the issuance of stock by Lycos for the acquisition
of WhoWhere? Inc., the Company's ownership interest in Lycos was reduced from
approximately 24% to approximately 22%. The gain was recorded net of the
interest attributable to CMG@Ventures I's profit members.
7
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
E. INVESTMENTS IN AFFILIATES
During the first quarter of fiscal year 1999, the Company, through its limited
liability company subsidiary, CMG@Ventures III, LLC, invested a total of
$1,142,000 to acquire initial minority ownership interests in three Internet
companies, including Raging Bull, Asimba and Virtual Ink. Raging Bull is a
financial Web message board service that offers the ability to filter content
and tailor personally relevant financial information to meet users' needs.
Asimba is creating a content rich, personalized, online community for the
competitive and recreational sports market. Virtual Ink is a newly launched
company focused on the development of Digital Meeting Assistant TM (DMA)
technologies. All of the above investments are carried at cost in CMG's
consolidated financial statements. See the Company's Report on Form 10-K for
the year ended July 31, 1998 for a description of the structure of CMG@Ventures
III, LLC and @Ventures III, L.P.
Also during the first fiscal quarter of 1999, the Company invested an additional
$2 million in Magnitude Network, LLC (Magnitude Network), increasing CMG's
ownership percentage in Magnitude Network to 23% at October 31, 1998 from 5% at
July 31, 1998. Accordingly, beginning October 22, 1998, the Company began
accounting for its investment in Magnitude Network under the equity method of
accounting, rather than the cost method. The acquisition accounting and
valuation for the investment in Magnitude Network may result in a significant
portion of the investment being identified as in-process research and
development, in accordance with valuation methodologies provided by the
Securities and Exchange Commission, which will be charged to operating results
in the second quarter when the amount is determined
F. SALES OF LYCOS STOCK
During the first quarter of fiscal year 1999, CMG@Ventures I distributed
3,585,207 of its shares of Lycos common stock to the Company, and 558,317 shares
to CMG@Ventures I's profit members. During the first quarter of fiscal 1999 the
Company sold 70,000 of its Lycos shares on the open market. As a result of the
sale, the Company received proceeds of $2,520,000, and recognized a pre-tax gain
of $2,018,000, reported net of the associated interest attributed to
CMG@Ventures I's profit members, reflected as "Gain on sale of Lycos, Inc.
common stock."
G. SEGMENT INFORMATION
The Company's operations are classified in three primary business segments: (i)
investment and development, (ii) fulfillment services and (iii) lists and
database services. Summarized financial information by business segment is as
follows:
Three months ended October 31,
---------------------------------------
1998 1997
---- ----
Net revenues:
Investment and development $ 4,912,000 $ 10,571,000
Fulfillment services 32,493,000 12,024,000
Lists and database services 2,600,000 2,540,000
------------ ------------
$ 40,005,000 $ 25,135,000
============ ============
Operating income (loss):
Investment and development (19,924,000) $(13,259,000)
Fulfillment services 257,000 1,061,000
Lists and database services (212,000) (41,000)
------------ ------------
$(19,879,000) $(12,239,000)
============ ============
8
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
G. SEGMENT INFORMATION (CONTINUED)
Operating income in the fulfillment services segment was adjusted during the
fourth quarter of fiscal year 1998 to correct prior quarters' understatements of
cost of sales by SalesLink's subsidiary company, Pacific Link. The cost of
sales understatement was caused by estimates used in determining the material
content in cost of sales. As a result, previous quarterly results had
understated cost of sales and overstated inventory. Had such adjustments been
recorded in the period in which they occurred, quarterly fulfillment services
segment operating income (loss) would have been as follows:
Three Months Ended
October 31, January 31, April 30, July 31,
------------- ------------ ------------ --------------
1997 1998 1998 1998 Total
------------- ------------ ------------ -------------- --------------
As Reported $1,061,000 $1,149,000 $1,547,000 $(2,313,000) $1,444,000
========== ========== ========== =========== ==========
As Restated $ 279,000 $ 335,000 $ 656,000 $ 174,000 $1,444,000
========== ========== ========== =========== ==========
H. BORROWING ARRANGEMENTS
The Company is obligated under a collateralized corporate borrowing facility in
the amount of $20 million. This borrowing is secured by 2,511,578 of the
Company's shares of Lycos common stock and is payable in full on January 20,
1999. Under this agreement, the Company could become subject to additional
collateral requirements under certain circumstances. The Company expects to seek
the renewal of this note. SalesLink had an outstanding line of credit balance of
$3.8 million as of October 31, 1998 and an additional $1.2 million reserved in
support of outstanding letters of credit for operating leases. SalesLink also
has a $15.5 million bank term note outstanding at October 31, 1998, which
provides for repayment in quarterly installments beginning January, 1999 through
November, 2002. As of July 31, 1998 and October 31, 1998, SalesLink did not
comply with certain covenants of their borrowing arrangements. SalesLink is
working with the bank to cure the non-compliance as of October 31, 1998, and
prospectively, through waivers or amendments to the covenant terms. SalesLink
has not yet received such waivers or amendments, nor is there any assurance that
such waivers or amendments will be obtained. Accordingly, all of SalesLink's
bank borrowings have been classified as current liabilities in the October 31,
1998 balance sheet.
I. EARNINGS PER SHARE
During the quarter ended January 31, 1998, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 128, "Earnings per Share". SFAS No.
128 required the Company to change the method formerly used to compute earnings
per share and to restate all prior periods presented. Basic earnings per share
is computed based on the weighted average number of common shares outstanding
during the period. Weighted average common equivalent shares outstanding during
the period, using the "treasury stock method", are included in the calculation
of diluted earnings per share only when the effect of their inclusion would be
dilutive.
9
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
I. EARNINGS PER SHARE (CONTINUED)
If a subsidiary has dilutive stock options or warrants outstanding, diluted
earnings per share is computed by first deducting from net income (loss), the
income attributable to the potential exercise of the dilutive stock options or
warrants of the subsidiary. The effect of income attributable to dilutive
subsidiary stock equivalents was immaterial for the three months ended
October 31, 1998.
The following table sets forth the reconciliation of the net income per share
calculation per SFAS No. 128:
(in thousands, except per share amounts)
Three months ended October 31,
------------------------------
1998 1997
---- ----
Basic net income per share:
- ---------------------------
Net income $38,553 $ 2,685
======= =======
Weighted average shares outstanding 23,041 19,358
======= =======
Basic net income per share $ 1.67 $ 0.14
======= =======
Diluted net income per share:
- -----------------------------
Net income $38,553 $ 2,685
Net effect of income attributable to dilutive
subsidiary stock equivalents -- (237)
------- -------
Net income available to common stockholders $38,553 $ 2,448
======= =======
Weighted average shares outstanding 23,041 19,358
Weighted average number of dilutive common stock
equivalents outstanding 1,925 1,275
------- -------
Shares used in computing diluted net income per
share 24,966 20,633
======= =======
Diluted net income per share $ 1.54 $ 0.12
======= =======
J. COMPREHENSIVE INCOME
As of August 1, 1998, the Company adopted Statement of Financial Accounting
Standard ("SFAS") No. 130, "Reporting Comprehensive Income". SFAS No. 130
establishes new rules for the reporting and display of comprehensive income and
its components; however, it has no impact on the Company's net income or
shareholders' equity. SFAS No. 130 requires all changes in equity from nonowner
sources to be included in the determination of comprehensive income.
The components of comprehensive income, net of tax, are as follows:
(in thousands) Three months ended October 31,
------------------------------
1998 1997
---- ----
Net income $38,553 $2,685
Net unrealized holding loss on
available-for-sale securities (89) --
------- ------
Comprehensive income $38,464 $2,685
======= ======
10
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
K. CONSOLIDATED STATEMENTS OF CASH FLOWS SUPPLEMENTAL INFORMATION
(in thousands) Three months ended October 31,
------------------------------
1998 1997
---- ----
Cash paid during the period for:
Interest $ 868 $ 717
====== =====
Income taxes $8,567 $ 83
====== =====
During the first quarter of fiscal year 1999, significant non-cash investing
activities included the sale of the Company's equity interest in Reel.com in
exchange for Hollywood Entertainment available-for-sale securities valued at
$32,801,000, as well as the sale of the Company's minority investment in Sage
Enterprises in exchange for Amazon.com available-for-sale securities valued at
$26,519,000 (See Note C).
L. AVAILABLE-FOR-SALE SECURITIES
At October 31, 1998, available-for-sale securities consist of the following
securities held by CMG directly: 238,160 shares of Red Brick Systems, Inc.
common stock; 386,473 shares of Open Market, Inc. common stock; and 1,524,644
common and 803,290 convertible preferred shares of Hollywood Entertainment
stock. Also at October 31, 1998, available-for-sale securities consist of the
following securities held by CMG@Ventures II: 192,094 shares of Amazon.com
common stock, as well as 1,943,783 common and 485,946 convertible preferred
shares of Hollywood Entertainment stock. Subject to the terms of CMG@Ventures
II's operating agreement, certain of the shares held by CMG@Ventures II may be
allocated to CMG@Ventures II's profit members in the future.
Available-for-sale securities are carried at fair value as of October 31, 1998,
based on quoted market prices, net of a market value discount to reflect the
remaining restrictions on transferability on certain of these securities. A net
unrealized holding loss of $525,000 has been reflected in the equity section of
the consolidated balance sheet based on the change in market value of the
available-for-sale securities from dates of acquisition to October 31, 1998.
CMG@Ventures II's shares of Amazon.com stock include 22,556 shares which are
being held in escrow by Amazon.com until August 27, 1999 as indemnification
related to Amazon.com's acquisition of Sage Enterprises. CMG@Ventures II also
holds 33,463 shares of Amazon.com stock at October 31, 1998 which were allocated
to its profit members in October, 1998 and, therefore, have not been classified
as available-for-sale securities in the accompanying consolidated balance sheet.
The Hollywood Entertainment common and convertible preferred shares held by CMG
and CMG@Ventures II are subject to restrictions on transferability until
September 1, 1999.
11
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
M. NEW ACCOUNTING PRONOUNCEMENTS
In March, 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants, issued SOP 98-1, "Accounting for the
Cost of Computer Software Developed or Obtained for Internal Use," which
requires the capitalization of certain internal costs related to the
implementation of computer software obtained for internal use. The Company is
required to adopt this standard in the first quarter of fiscal year 2000. The
Company expects that the adoption of SOP 98-1 will not have a material impact on
the Company's financial position or its results of operations.
In June, 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities. SFAS No.
133 requires the recognition of all derivatives as either assets or liabilities
in the statement of financial position and the measurement of those instruments
at fair value. The Company is required to adopt this standard in the first
quarter of fiscal year 2000. The Company expects that the adoption of SFAS No.
133 will not have a material impact on the Company's financial position or its
results of operations.
N. SUBSEQUENT EVENTS
In November, 1998, CMG received a distribution of 169,538 shares of Amazon.com
stock from CMG@Ventures II. CMG sold these shares for total proceeds of
$27,177,169 in November, 1998.
In October, 1998, Lycos announced it had entered into a definitive agreement to
acquire Wired Digital, Inc. in exchange for consideration including newly issued
Lycos stock. Upon completion of this transaction and issuance of additional
Lycos shares, the Company's ownership interest in Lycos will fall below 20% of
Lycos' outstanding shares. Accordingly, CMG will begin accounting for its
investment in Lycos as available-for-sale securities, carried at fair value,
rather than under the equity method.
Beginning in November, 1998, CMG's ownership interest in Vicinity was reduced to
below 50% as a result of employee stock option exercises. As such, beginning in
November, 1998, the Company will begin to account for its remaining investment
in Vicinity under the equity method of accounting, rather than the consolidation
method. Prior to these events, the operating results of Vicinity were
consolidated within the operating results of the Company's investment and
development segment, and the assets and liabilities of Vicinity were
consolidated with those of CMG's other majority owned subsidiaries in the
Company's consolidated balance sheets.
In December, 1998, CMG@Ventures III, LLC acquired a minority interest in
Ancestry.com, with a total committed investment of up to $2.9 million.
Ancestry.com features the Web's largest and fastest-growing collection of
searchable genealogy data.
12
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The matters discussed in this report contain forward-looking statements that
involve risks and uncertainties. The Company's actual results could differ
materially from those discussed herein. Factors that could cause or contribute
to such differences include, but are not limited to, those discussed in this
section and elsewhere in this report, and the risks discussed in the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" section included in the Company's Annual Report on Form 10-K for the
year ended July 31, 1998.
DECONSOLIDATION OF LYCOS
During the first fiscal quarter ended October 31, 1997 the Company owned
in excess of 50% of Lycos and accounted for its investment under the
consolidation method. Through the subsequent sale and distribution of Lycos
shares, the Company's ownership percentage in Lycos was reduced to below 50%
beginning in November, 1997. As such, beginning in November, 1997, the Company
began accounting for its remaining investment in Lycos under the equity method
of accounting, rather than the consolidation method. Prior to these events, the
operating results of Lycos were consolidated within the operating results of the
Company's investment and development segment, and the assets and liabilities of
Lycos were consolidated with those of CMG's other majority owned subsidiaries in
the Company's consolidated balance sheets. The Company's historical quarterly
consolidated operating results for the fiscal quarter ended October 31, 1997
included Lycos sales of $9,303,000 and operating losses of $433,000.
FISCAL 1998 FULFILLMENT SEGMENT RESULTS
Operating income in the fulfillment services segment was adjusted during
the fourth quarter of fiscal year 1998 to correct prior quarters'
understatements of cost of sales by SalesLink's subsidiary company, Pacific
Link. The cost of sales understatement was caused by estimates used in
determining the material content in cost of sales. As a result, previous
quarterly results had understated cost of sales and overstated inventory. Had
such adjustments been recorded in the period in which they occurred, quarterly
fulfillment services segment operating income (loss) would have been as follows:
Three Months Ended
October 31, January 31, April 30, July 31,
-------------------------------------------------
1997 1998 1998 1998 Total
---- ---- ---- ---- -----
As Reported $1,061,000 $1,149,000 $1,547,000 $(2,313,000) $1,444,000
========== ========== ========== =========== ==========
As Restated $279,000 $335,000 $656,000 $174,000 $1,444,000
========== ========== ========== =========== ==========
THREE MONTHS ENDED OCTOBER 31, 1998 COMPARED TO THREE MONTHS ENDED
OCTOBER 31, 1997
Net revenues for the quarter ended October 31, 1998 increased $14,870,000,
or 59%, to $40,005,000 from $25,135,000 for the quarter ended October 31, 1997.
The increase was largely attributable to an increase of $20,469,000 in net
revenues for the Company's fulfillment services segment, reflecting the
acquisitions of On-Demand Solutions and InSolutions during the fourth quarter of
fiscal 1998. Additionally, net revenues in the Company's investment and
development segment decreased $5,659,000 primarily reflecting the impact of the
deconsolidation of Lycos. Lycos net revenues for the quarter ended October 31,
1997 were $9,303,000. Absent the impact of Lycos, net revenues in the
investment and development segment increased by $3,644,000 reflecting improved
sales by Engage, Navisite, Planet Direct, ADSmart and Vicinity. Net revenues in
the Company's lists and database services segment increased by $60,000,
essentially level compared to the corresponding period in fiscal 1998. The
Company believes that its portfolio of companies will continue to develop and
introduce their products commercially, actively pursue increased revenues from
new and existing customers, and look to expand into new market opportunities
during fiscal 1999. Therefore, the Company expects to report future revenue
growth.
13
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
Cost of revenues increased $21,849,000, or 143%, to $37,108,000 in the
first quarter of fiscal 1999 from $15,259,000 for the corresponding period in
fiscal 1998, primarily reflecting increases of $19,315,000 and $2,555,000 in the
fulfillment services and investment and development segments, respectively.
Adjusted for the $782,000 impact of prior year understatements, cost of sales
increased $18,533,000 in the fulfillment services segment resulting from higher
revenues, the acquisitions of On-Demand Solutions and InSolutions, and
incremental costs incurred in fiscal 1999 associated with relocating SalesLink's
Boston operations to a more efficient facility. Investment and development
segment cost of sales increases were primarily attributable to higher revenues
and the acceleration of operations in the segment, partially offset by
$1,878,000 lower cost of sales resulting from the deconsolidation of Lycos
beginning in the second quarter of fiscal 1998. The start up of Internet
operations with minimal revenues during early stages, and the impact of
deconsolidating Lycos, are the primary reasons cost of revenues as a percentage
of revenues in the investment and development segment increased to 145% in the
first quarter of fiscal 1999 from 43% in the prior year. After adjusting for
prior year understatements, fulfillment services segment cost of revenues as a
percentage of net revenues increased to 88% in the first quarter of fiscal 1999
from 82% in the first quarter of fiscal 1998, reflecting operating
inefficiencies during a period of high volume growth and the impact of
facilities relocation costs incurred. Compared with the first quarter of fiscal
year 1998, cost of revenues as a percentage of net revenues in the lists and
database services segment decreased slightly from 62% to 60% in the first
quarter of fiscal 1999.
Research and development expenses decreased $683,000, or 11%, to $5,491,000
in the quarter ended October 31, 1998 from $6,174,000 in the prior year's first
quarter. In the investment and development segment, research and development
expenses decreased $694,000, primarily reflecting a $1,436,000 reduction due to
the deconsolidation of Lycos, offset by an increase in expenditures primarily
associated with the development of NaviNet's technology platform. Of the
Company's investments made during the first quarter of fiscal year 1999, the
acquisition accounting and valuation for the investment of $2.0 million in
Magnitude Network may result in a significant portion of the purchase price
being identified as in-process research and development, in accordance with
valuation methodologies provided by the Securities and Exchange Commission,
which will be charged to operating results in the second quarter when the amount
is determined. The Company anticipates it will continue to devote substantial
resources to product development and that these costs may substantially increase
in future periods.
Selling expenses decreased $2,061,000 or 19% to $8,979,000 in the first
quarter ended October 31, 1998 from $11,040,000 for the corresponding period in
fiscal 1998, primarily reflecting a $2,556,000 decrease in the Company's
investment and development segment. Investment and development results include
a $5,479,000 decrease due to the deconsolidation of Lycos, offset by sales and
marketing efforts related to several product launches and continued growth of
sales and marketing infrastructures. Selling expenses in the fulfillment
services segment increased by $257,000 in comparison with last year's first
quarter due to the acquisitions of On-Demand Solutions and Insolutions, and
selling expenses in the lists and database services segment increased by
$238,000 versus the first quarter of fiscal 1998, reflecting costs associated
with CMG Direct's CMGexpress.net "opt-in" email list service. Selling expenses
decreased as a percentage of net revenues to 22% in the first quarter of fiscal
1999 from 44% for the corresponding period in fiscal 1998, primarily reflecting
the impact of increased revenues. As the Company's subsidiaries continue to
introduce new products and expand sales, the Company expects to incur
significant promotional expenses, as well as expenses related to the hiring of
additional sales and marketing personnel and increased advertising expenses, and
anticipates that these costs will substantially increase in future periods.
General and administrative expenses increased $3,405,000, or 69%, to
$8,306,000 in the first quarter of fiscal 1999 from $4,901,000 for the
corresponding period in fiscal 1998. The investment and development segment
experienced an increase of $1,701,000, primarily due to the building of
management infrastructures in several of the Company's Internet investments.
Such increases were somewhat offset by reductions associated with the
deconsolidation of Lycos in the amount of $944,000. General and administrative
expenses in the fulfillment services segment increased by $1,701,000 in
comparison with last year's first quarter, largely due to the acquisitions of
On-Demand Solutions and InSolutions, including $381,000 higher goodwill charges,
and general and administrative expenses in the lists and database services
segment were essentially level. General and administrative expenses increased as
a percentage of net sales to 21% in the first quarter of fiscal 1999 from 20% in
the first quarter of fiscal 1998. The Company anticipates that its general and
administrative
14
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
expenses will continue to increase significantly as the Company's subsidiaries,
particularly in the investment and development segment, continue to grow and
expand their administrative staffs and infrastructures.
Gain on stock issuance by Lycos, Inc. resulted primarily from the issuance
of stock by Lycos for the fiscal 1999 acquisition of WhoWhere? Gain on stock
issuance by GeoCities in fiscal 1999 arose as a result of the sale of stock by
GeoCities in an initial public offering in August, 1998. Gain on sale of
investment in Sage Enterprises, Inc. occurred during the first quarter of fiscal
year 1999 when CMG@Ventures II's holdings in Sage Enterprises were converted
into 225,558 shares of Amazon.com, Inc. common stock as part of a merger wherein
Amazon.com, Inc. acquired Sage Enterprises. Gain on sale of investment in
Reel.com, Inc. occurred in October, 1998, when CMG@Ventures II's holdings in
Reel.com were converted into 1,943,783 restricted common and 485,946 restricted,
convertible preferred shares of Hollywood Entertainment Corporation (Hollywood
Entertainment) as part of a merger wherein Hollywood Entertainment acquired
Reel.com. Gain on sale of Lycos, Inc. common stock reflects the Company's net
gain realized on the sale of 70,000 shares in the first quarter of fiscal 1999
and 219,900 shares in the first quarter of fiscal 1998. Gain on sale of data
warehouse product rights occurred when the Company's subsidiary, Engage, sold
certain rights to its Engage.Fusion(TM) and Engage.Discover(TM) data warehouse
products to Red Brick Systems, Inc. (Red Brick) for $9.5 million and 238,160
shares of Red Brick common stock. Gain on sale of available-for-sale securities
reflects the Company's net gain realized on the sale of 224,795 shares of
Premiere Technologies, Inc. stock during the first quarter of fiscal year 1998.
Interest income decreased $284,000 to $559,000 in the first fiscal quarter
of 1999 from $843,000 in fiscal 1998, reflecting a $540,000 decrease from the
deconsolidation of Lycos, partially offset by increased income associated with
higher average corporate cash equivalent balances compared with prior year.
Interest expense increased $298,000 compared with the first quarter of fiscal
1998, primarily due to higher corporate collateralized borrowings and borrowings
incurred in conjunction with the Company's acquisition of InSolutions.
Equity in losses of affiliates resulted from the Company's minority
ownership in certain investments that are accounted for under the equity method.
Under the equity method of accounting, the Company's proportionate share of each
affiliate's operating losses and amortization of the Company's net excess
investment over its equity in each affiliate's net assets is included in equity
in losses of affiliates. Equity in losses of affiliates for the quarter ended
October 31, 1998 include the results from the Company's minority ownership in
Lycos, GeoCities, ThingWorld.com (formerly Parable), Silknet, Speech Machines,
Mother Nature and Magnitude Network. Equity in losses of affiliates for the
quarter ended October 31, 1997 included the results from the Company's minority
ownership in Ikonic Interactive, Inc., ThingWorld.com, Silknet, GeoCities,
Reel.com, and Speech Machines. The Company expects its portfolio companies to
continue to invest in development of their products and services, and to
recognize operating losses, which will result in future charges recorded by the
Company to reflect its proportionate share of such losses.
Income tax expense in the first quarter of fiscal 1999 was $26,118,000.
Exclusive of taxes provided for significant, unusual or extraordinary items that
will be reported separately, the Company provides for income taxes on a year to
date basis at an effective rate based upon its estimate of full year earnings.
In determining the Company's effective rate for the first quarter of fiscal
1999, Gains on stock issuances by Lycos and GeoCities, Gains on sales of
investments in Sage Enterprises, Inc. and Reel.com, Inc., and gain on sale of
Lycos, Inc. common stock were excluded.
LIQUIDITY AND CAPITAL RESOURCES
Working capital at October 31, 1998 increased to $36.3 million compared to
$12.8 million at July 31, 1998. The Company's principal uses of capital during
the first quarter of fiscal 1999 were $20.2 million for funding of operations,
primarily those of start-up activities in the Company's investment and
development segment, $31.1 million or the purchase of Hollywood Entertainment
stock, $4.8 million for investments in affiliates, $2.9 million for net
repayments of notes payable, and $2.2 million for purchases of property and
equipment. The Company's principal sources of capital during the first quarter
of fiscal 1999 were $2.5 million received from the sale of 70,000 shares of
Lycos stock and $1.9 million net proceeds from issuance of stock by
subsidiaries.
15
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(CONTINUED)
The Company is obligated under a collateralized corporate borrowing
facility in the amount of $20 million. This borrowing is secured by 2,511,578
of the Company's shares of Lycos common stock and is payable in full on January
20, 1999. The Company expects to seek the renewal of this note. SalesLink had
an outstanding line of credit balance of $3.8 million as of October 31, 1998 and
an additional $1.2 million reserved in support of outstanding letters of credit
for operating leases. SalesLink also has a $15.5 million bank term note
outstanding at October 31, 1998, which provides for repayment in quarterly
installments beginning January, 1999 through November, 2002. As of July 31,
1998 and October 31, 1998, SalesLink did not comply with certain covenants of
their borrowing arrangements. SalesLink is working with the bank to cure the
non-compliance as of October 31, 1998, and prospectively, through waivers or
amendments to the covenant terms. SalesLink has not yet received such waivers
or amendments, nor is there any assurance that such waivers or amendments will
be obtained. Accordingly, all of SalesLink's bank borrowings have been
classified as current liabilities in the October 31, 1998 balance sheet.
Subsequent to October 31, 1998, CMG@Ventures III, LLC acquired a minority
interest in Ancestry.com with a total committed investment of up to $2.9
million. Ancestry.com features the Web's largest and fastest-growing collection
of searchable genealogy data.
The Company intends to continue to fund existing and future Internet and
interactive media investment and development efforts, and to actively seek new
CMG@Ventures investment opportunities. The Company believes that existing
working capital, proceeds from sales of Amazon.com stock subsequent to quarter
end, and the availability of additional Lycos, GeoCities and Hollywood
Entertainment shares which could be sold or posted as additional collateral for
additional loans, will be sufficient to fund its operations, investments and
capital expenditures for the foreseeable future. Additionally, the Company is
currently seeking to raise additional capital through private placement. Should
additional capital be needed to fund future investment and acquisition activity,
the Company may seek to raise additional capital through public or private
offerings of the Company's or its subsidiaries' stock, or through debt
financings.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded
to accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. As a result, many companies' software and computer systems
may need to be upgraded or replaced in order to comply with such "Year 2000"
requirements. CMG is in the process of evaluating and correcting the Year 2000
compliance of its proprietary products and services and third party equipment
and software that it uses, as well as its non-information technology systems,
such as building security, voice mail and other systems. The Company's Year
2000 compliance efforts will consist of the following phases: (i) identification
of all software products, information technology systems and non-information
technology systems; (ii) assessment of repair or replacement requirements; (iii)
repair or replacement; (iv) testing; (v) implementation; and (vi) creation of
contingency plans in the event of Year 2000 failures. The Company has
substantially completed phases (i) and (ii) and is currently working on phase
(iii) of its Year 2000 efforts. The Company expects to complete its Year 2000
compliance efforts by the end of June, 1999.
To date, the Company has not incurred any material expenditures in
connection with identifying or evaluating Year 2000 compliance issues.
Preliminary estimates regarding expected costs to CMG for evaluating and
correcting Year 2000 issues are in the range of $3 million to $5 million, but
there can be no assurance that the costs will not exceed such amounts. The
Company's expectations regarding Year 2000 remediation efforts will evolve as it
continues to analyze and correct its systems. The Company has not yet developed
a formal Year 2000-specific contingency plan. The Company expects that a formal
Year 2000 contingency plan will evolve as it completes its Year 2000 compliance
efforts. Failure by the Company to resolve Year 2000 issues with respect to its
proprietary products and services could have a material adverse effect on the
Company's business, results of operations and financial condition. Furthermore,
failure of third-party equipment or software to operate properly with regard to
the year 2000 and thereafter could require CMG to incur significant
unanticipated expenses to remedy any problems.
16
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
PART I: FINANCIAL INFORMATION (CONTINUED)
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
-----------------------------------------------------------
The Company is exposed to equity price risks on the marketable portion of
its equity securities. The Company's available-for-sale securities at October
31, 1998 includes investments in companies in the Internet industry sector,
including Amazon.com, Inc. and Open Market, Inc., many of which have experienced
significant historical volatility in their stock prices. The Company typically
does not attempt to reduce or eliminate its market exposure on these securities.
A 20% adverse change in equity prices, based on a sensitivity analysis of the
Company's available-for-sale securities portfolio as of October 31, 1998, would
result in an approximate $18.5 million decrease in the fair value of the
Company's available-for-sale securities.
The carrying values of financial instruments including cash and cash
equivalents, accounts receivable, accounts payable and notes payable,
approximate fair value because of the short maturity of these instruments. The
carrying value of long-term debt approximates its fair value, as estimated by
using discounted future cash flows based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements.
The Company uses derivative financial instruments primarily to reduce
exposure to adverse fluctuations in interest rates on its borrowing
arrangements. The Company does not enter into derivative financial instruments
for trading purposes. As a matter of policy all derivative positions are used
to reduce risk by hedging underlying economic exposure. The derivatives the
Company uses are straightforward instruments with liquid markets. At October
31, 1998, the Company was primarily exposed to the London Interbank Offered Rate
(LIBOR) interest rate on the outstanding borrowings under its line of credit and
other bank borrowing arrangements.
The Company has historically had very low exposure to changes in foreign
currency exchange rates, and as such, has not used derivative financial
instruments to manage foreign currency fluctuation risk. As the Company expands
globally, the risk of foreign currency exchange rate fluctuation may
dramatically increase. Therefore, in the future, the Company may consider
utilizing derivative instruments to mitigate such risks.
17
CMG INFORMATION SERVICES, INC. AND SUBSIDIARIES
PART II: OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
---------------------------------
(A) Exhibits
The following exhibits are filed herewith or incorporated by reference
pursuant to Rule 12b-32 under the Securities Exchange Act of 1934:
EXHIBIT NO. TITLE METHOD OF FILING
----------- ----- ----------------
3 (i) (1) Amendment to the Restated Certificate of Incorporated by reference to Exhibit 3
Incorporation (i) (1) to the Registrant's quarterly
report on Form 10-Q for the quarter ended
April 30, 1996.
3 (i) (2) Restated Certificate of Incorporation Incorporated by reference from
Registration Statement on Form S-1, as
amended, filed on November 10, 1993
(Registration No. 33-71518).
3 (ii) Restated By-Laws Incorporated by reference from
Registration Statement on Form S-1, as
amended, filed on November 10, 1993
(Registration No. 33-71518).
4 Specimen stock certificate representing Incorporated by reference from
the common stock Registration Statement on Form S-1, as
amended, filed on November 10, 1993
(Registration No. 33-71518).
27.1 Restated Financial Data Schedule for Filed herewith.
the three months ended October 31, 1997.
27.2 Financial Data Schedule for the three Filed herewith.
months ended October 31, 1998.
(B) Reports on Form 8-K.
None.
18
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CMG Information Services, Inc.
By: /s/ Andrew J. Hajducky III
--------------------------
Date: December 15, 1998 Andrew J. Hajducky III, CPA
Chief Financial Officer and Treasurer
(Principal Financial and Accounting
Officer)
19
5
1,000
3-MOS
JUL-31-1998
AUG-01-1997
OCT-31-1997
57,246
1,200
21,383
0
4,685
103,111
11,193
0
146,763
65,410
0
0
0
97
31,919
146,763
25,135
25,135
15,259
15,259
22,115
0
770
5,118
2,433
2,685
0
0
0
2,685
0.14
0.12
RESTATEMENT REFLECTED HEREIN IS THE RESULT OF RECLASSIFICATION TO PRIOR
PERIOD'S FINANCIAL STATEMENTS TO CONFORM TO THE CURRENT PERIOD PRESENTATION.
5
1,000
3-MOS
JUL-31-1999
AUG-01-1998
OCT-31-1998
6,639
92,287
29,222
0
9,547
142,889
13,236
0
326,411
106,594
0
0
0
231
157,514
326,411
40,005
40,005
37,108
37,108
22,776
0
1,068
64,671
26,118
38,553
0
0
0
38,553
1.67
1.54
