Exhibit 13.2
21
MANAGEMENT'S DISCUSSION &
ANALYSIS OF FINANCIAL CONDITION
& RESULTS OF OPERATIONS
The discussion in this report contains 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 below in "Risk
Factors that May Affect Future Results", as well as those discussed in this
section and elsewhere in this report.
OVERVIEW
In 1986, CMG Information Services, Inc. was formed through the acquisition of
College Marketing Group, Inc. which had been in operation since 1968. Since its
origins, the Company has expanded the breadth and depth of its product and
service offerings to the direct marketing industry. The Company completed and
introduced the College List database in 1973, and diversified its mailing list
product offerings in 1982 through the introduction of the Information Buyers
List database. In 1992, the Company introduced its Elementary/High School List
database. In the course of creating and developing these databases and lists,
the Company also developed expertise in servicing and managing customer and
prospect lists compiled by its clients, leading to the establishment of the
Company's ListLab and ListLine services in 1987 and 1989, respectively. In
1989, the Company also completed the acquisition of the business of SalesLink
Corporation (SalesLink), which provides "fulfillment services" including sales
lead/inquiry management, product and literature fulfillment, and business-to-
business telemarketing services.
In February of 1994, the Company formed a new subsidiary, BookLink Technologies,
Inc. (BookLink), which developed InternetWorks, a PC-based viewer/browser for
the Internet. In December 1994, the Company sold all outstanding stock of
BookLink to America Online (AOL) for 1,420,000 shares of AOL common stock.
After selling its AOL stock, the Company realized a pretax gain on the
transaction in excess of $70 million.
In February 1995, the Company formed its Internet investment and development
arm, CMG @Ventures L.P., to provide intellectual and financial capital to
companies seeking to further the commercialization of the Internet and other
interactive media through the development and application of information-based
direct marketing products and services. The Company owns 100% of the capital
and is entitled to 77.5% of the net capital gains of CMG @Ventures, L.P. During
fiscal year 1995, the Company, (through CMG @Ventures) acquired, formed or
invested in four new companies, including Lycos, Inc. (Lycos), which has
developed into a leading global Internet navigation center, NetCarta Corporation
(NetCarta), a developer of Internet Web navigation and content management tools,
FreeMark Communications, Inc. (FreeMark), a developer of advertising sponsored
e-mail services, and Ikonic Interactive, Inc. (Ikonic), a Web consulting and
development company. While FreeMark suspended operations in December 1996, CMG
sold its investment in NetCarta to Microsoft in January 1997 and recognized a
pre-tax gain of $15.1 million. In fiscal year 1996, Lycos successfully
completed an initial public offering of 3,135,000 shares of its common stock,
raising net proceeds to Lycos of $46 million. CMG distributed 603,000 shares of
Lycos common stock to CMG's shareholders in the form of a dividend on July 31,
1997. As of July 31, 1997 CMG continued to own approximately 53% of Lycos and
37% of Ikonic.
The Company continued its growth and development in fiscal year 1996 with the
acquisition, formation or investment in eight new companies. CMG @Ventures
added four new investments in companies, including Blaxxun Interactive, Inc.
(Blaxxun, formerly Black Sun Interactive, Inc.), a developer of three
dimensional interactive software, GeoCities, a builder and operator of special-
interest online communities, Vicinity Corporation (Vicinity), a provider of
geographically oriented content and services for the Web, and TeleT
Communications LLC (TeleT), a marketer of products which allow direct telephone-
to-Internet access for adding or editing Web pages, and also enable users to
communicate in their own voices to other Web users. CMG @Ventures' investment
in TeleT was made in April 1996 and totaled $750,000. In September 1996, CMG
@Ventures sold its equity investment in TeleT to Premiere Technologies, Inc.
receiving cash and Premiere Technologies, Inc. common stock with a total value
of approximately $8,250,000 at the date of closing. In August 1995, CMG formed
a new subsidiary, Engage Technologies, Inc. (Engage, formerly CMG Direct
Interactive, Inc.) from the Company's former ListLab division. In addition to
the Company's traditional list management services, Engage has evolved into a
database and Internet software systems company, focusing on direct marketing
solutions. Also during fiscal 1996, the Company formed three new wholly-owned
subsidiaries, ADSmart Corporation (ADSmart), InfoMation Publishing Corporation
(InfoMation) and Planet Direct Corporation (Planet Direct). ADSmart was formed
to capitalize on Internet advertising opportunities, and InfoMation builds
knowledge management applications. Planet Direct was formed to combine and
leverage the Company's Internet technologies to provide a content based product
for Internet service providers.
During fiscal year 1997, CMG completed its $35 million commitment to fund CMG
@Ventures L.P. and formed a new limited liability company subsidiary, CMG
@Ventures II LLC. During fiscal 1997, through CMG @Ventures L.P and CMG
@Ventures II LLC, CMG acquired minority investment interests in six new
companies, including a 46% investment interest in Parable LLC (Parable), a
software firm developing multimedia tools and technology, a 23% interest in
Silknet Software, Inc. (Silknet), a provider of Web-based customer service
software, a 15% interest in Sage Enterprises, Inc. (Sage Enterprises), the
innovator of the Planet All service which helps Internet users stay in touch
with the people and groups they care about, a 9% interest in Softway Systems,
Inc. (Softway Systems), a provider of UNIX system products for Windows NT, a 31%
interest in Reel.com LLC (Reel.com), a marketer of video sales and rentals
through Web-based and traditional retail channels, and a 15% interest in KOZ,
inc., a provider of an integrated set of Web-based publishing solutions that
allow organizations or groups to share information with their members and the
community at large. Also during fiscal year 1997, the Company's subsidiary,
SalesLink acquired Pacific Direct Marketing Corporation (Pacific Link), lending
substantial revenue growth to the Company's fulfillment
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MANAGEMENT'S DISCUSSION &
ANALYSIS OF FINANCIAL CONDITION
& RESULTS OF OPERATIONS (CONT'D.)
services segment. In addition, the Company formed NaviSite Internet Services
Corporation (NaviSite) to provide Web hosting and Internet server management,
and formed CMG Direct, Inc. to provide solutions for integrating traditional
direct marketing with Internet marketing.
The Company has adopted a strategy of seeking opportunities to realize
significant gains through the selective sale of investments or having separate
subsidiaries or affiliates sell minority interests to outside investors. The
Company believes that this strategy provides the ability to significantly
increase shareholder value as well as provide capital to support the growth in
the Company's subsidiaries and investments. Additionally, in fiscal year 1998,
the Company will continue to develop and refine the products and services of its
businesses, with the goal of significantly increasing revenue as new products
are commercially introduced, and will continue to pursue a strong pace of
investing in new Internet opportunities.
RESULTS OF OPERATIONS
The following table sets forth, for the years indicated, certain items from the
Company's Consolidated Statements of Operations expressed as a percentage of net
revenues.
Fiscal Year Ended July 31,
1997 1996 1995
---- ---- ----
Net revenues 100% 100% 100%
Cost of revenues 60 63 58
Research and development expenses 35 24 --
In-process research and development expenses 2 9 --
Selling, general and administrative expenses 78 76 29
---- ---- ----
Operating income (loss) (75) (72) 13
Interest income, net 3 9 1
Gain on sale of NetCarta Corporation 21 -- --
Gain on dividend distribution of Lycos, Inc.
common stock 12 -- --
Gain on sale of investment in TeleT Communications 5 -- --
Gain on sale of available-for-sale securities -- 105 21
Gain on issuance of stock by subsidiary -- 69 --
Equity in losses of affiliates (8) (10) (1)
Minority interest 7 8 --
Income tax benefit (expense) 4 (59) (13)
---- ---- ----
Income (loss) from continuing operations (31)% 50% 21%
==== ==== ====
The Company's operations have been classified into three business segments (i)
investment and development, (ii) fulfillment services, and (iii) lists and
database services. (See note 3 of Notes to Consolidated Financial Statements.)
Fiscal 1997 Compared to Fiscal 1996
Net revenues increased $42,122,000, or 148%, to $70,607,000 in 1997 from
$28,485,000 in 1996. The increase was attributable to increases of $24,069,000
and $18,252,000 in net revenues for the Company's fulfillment services and
investment and development segments, respectively. The fulfillment services
segment increase is primarily due to the acquisition of Pacific Link on October
24, 1996 as well as the addition of several new SalesLink accounts closed in the
second half of fiscal year 1996. The increase in net revenues for the
investment and development segment primarily reflects increased revenues by the
Company's subsidiary, Lycos, whose net revenues for the 1997 fiscal year
increased by $16,996,000 in comparison with 1996. Net revenues in the lists and
database services segment decreased by $199,000 during 1997 due to continued
consolidation in the educational publishing industry and competitive pricing
pressure. The Company expects that net revenues for the fulfillment services
segment in the first quarter of fiscal 1998 will be significantly higher than
the corresponding quarter of fiscal 1997 due to the addition of Pacific Link at
the end of the first quarter of fiscal 1997. Additionally, 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 1998.
Therefore, the Company expects to report future revenue growth.
Cost of revenues increased $24,243,000, or 135%, to $42,152,000 in 1997 from
$17,909,000 in 1996, primarily due to increases of $18,740,000 and $4,911,000 in
the fulfillment services and investment and development segments, respectively,
resulting from higher revenues. In the fulfillment services segment, cost of
revenues as a percentage of net revenues increased to 74% in 1997 from 65% in
1996 due to the mix of services associated with the acquisition of Pacific Link
at the end of the first quarter of fiscal 1997. In the investment and
development segment, cost of revenues as a percentage of net revenues decreased
to 35% in 1997 from 60% in 1996 due to the ability to spread fixed costs, such
as facilities and equipment costs, over a larger revenue base.
Research and development expenses increased $18,087,000, or 260%, to $25,058,000
in fiscal 1997 from $6,971,000 in fiscal 1996. The increase consists primarily
of an increase of $12,516,000 in research and development expenses for the
investment and development segment as product development activities continued
at all of the Company's consolidated Internet investments. Also, research and
development expenses increased $5,732,000 in the lists and database services
segment reflecting the continued development of Engage Technologies' data
mining, querying, analysis and targeting products and services. The Company
recorded $1,312,000 of in-process research and development expenses related to
investments in Parable and Silknet during 1997, compared with $2,691,000 of in-
process research and development expenses recorded in 1996 related to the
acquisition of several Internet investments during 1996. The Company
anticipates it will continue to devote substantial resources to product
development and that these costs may substantially increase in future periods.
23
MANAGEMENT'S DISCUSSION &
ANALYSIS OF FINANCIAL CONDITION
& RESULTS OF OPERATIONS (CONT'D.)
Selling expenses increased $25,917,000, or 222% to $37,583,000 in 1997 from
$11,666,000 in 1996. This increase was primarily attributable to a $22,609,000
selling expense increase in the Company's investment and development segment,
reflecting the sales and marketing efforts related to several product launches
and continued growth of sales and marketing infrastructures by the subsidiaries
of this segment. Also, during 1997, Lycos launched a national television
advertising campaign which contributed to the increased selling expenses in the
investment and development segment. Selling expenses in the lists and database
services segment increased by $1,982,000 versus 1996 due to product launch
expenses and the continued building of sales and marketing infrastructure for
Engage Technologies. Selling expenses in the fulfillment services segment
increased by $1,326,000 in comparison with 1996 due to the acquisition of
Pacific Link. Selling expenses increased as a percentage of net revenues to 53%
in 1997 from 41% in 1996. The Company anticipates that its subsidiaries will
continue to introduce new products and expand revenues and, therefore, expects
to incur significant promotional expenses, increased advertising expenses, as
well as expenses related to the hiring of additional sales and marketing
personnel, and anticipates that these costs may substantially increase in
absolute dollar amounts in future periods.
General and administrative expenses increased $7,789,000, or 79%, to $17,611,000
in 1997 from $9,822,000 in 1996. The investment and development segment and
lists and database services segment experienced increases of $4,884,000 and
$1,505,000, respectively, due to the addition of management personnel and
administrative infrastructure in several of the Company's Internet investments
and Engage Technologies. General and administrative expenses in the fulfillment
services segment increased by $1,400,000 in comparison with fiscal 1996 due to
the acquisition of Pacific Link, including approximately $804,000 of goodwill
amortization charges. General and administrative expenses decreased as a
percentage of net revenues to 25% in 1997 from 35% in 1996 due to the
significant increase in net revenues in fiscal year 1997. The Company
anticipates that its general and administrative expenses will continue to
increase in absolute dollar amounts as the Company's subsidiaries, particularly
in the investment and development segment, continue to expand their
administrative staffs and infrastructures.
Gain on sale of NetCarta Corporation in fiscal 1997 reflects the Company's pre-
tax gain of $15,111,000 on the sale of this subsidiary to Microsoft Corporation
on January 31, 1997. Gain on distribution of Lycos stock of $8,413,000 in
fiscal 1997 resulted from the dividend distribution of 603,000 shares of Lycos
common stock to CMG shareholders on July 31, 1997. This distribution
represented the first dividend under the Company's venture dividend program
which was announced in May 1997 (see further description of this program in the
Liquidity and Capital Resources section below). Gain on sale of investment in
TeleT Communications of $3,616,000 in fiscal 1997 resulted when the Company sold
its equity interest in TeleT to Premiere Technologies, Inc. (Premiere) in
exchange for $550,000 and 320,833 shares of Premiere stock in September 1996.
Gain on sale of available-for-sale securities in fiscal 1996 occurred when the
Company sold its remaining 1,020,000 shares of AOL common stock, realizing a
gain of $30,049,000 in October 1995. Gain on issuance of stock by subsidiary in
fiscal 1996 represented the Company's $19,575,000 gain recorded as a result of
the sale of stock by Lycos in an initial public offering in April 1996. The
gain from the Lycos stock offering reflected the increase in the Company's
proportionate share of Lycos' equity.
Interest income increased $618,000 to $3,368,000 in 1997 from $2,750,000 in
1996. The increase in interest income primarily reflects income earned by Lycos
from the investment of the proceeds of their initial public offering, which
occurred in April 1996, partially offset by the impact of lower corporate cash
balances in fiscal 1997 as compared with fiscal 1996. Interest expense
increased $1,560,000 to $1,619,000 in 1997 from $59,000 in 1996. The increase
in interest expense was primarily due to borrowings incurred to finance the
Company's acquisition of Pacific Link and interest expense related to the
Company's $10,000,000 collateralized corporate note payable to a bank which was
issued in January 1997.
Equity in losses of affiliates resulted from the Company's minority ownership in
certain investments which 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. The results for fiscal 1996 reflect five minority
investments: FreeMark, Ikonic, GeoCities, Vicinity and TeleT. During the
fourth quarter of fiscal 1996, the Company increased its ownership in FreeMark
and GeoCities above 50% and, accordingly, began including their operating
results in the Company's consolidated operating results. FreeMark was
consolidated through December 1996 when it suspended operations. Equity in
losses of affiliates for fiscal 1997 include the results from the Company's
minority ownership in Ikonic, Vicinity, Parable, Silknet, Reel.com and TeleT
(through the date of the sale of TeleT in September 1996). Also, in January
1997, GeoCities successfully completed a $9 million equity financing round in
which CMG @Ventures contributed $2 million. With this round of financing, CMG
@Ventures' ownership in GeoCities decreased from approximately 61% to
approximately 41%, and the Company began accounting for its investment in
GeoCities under the equity method of accounting, rather than the consolidation
method and, accordingly, began including the results of its ownership in
GeoCities in equity in losses of affiliates. In the fourth quarter of fiscal
1997, Vicinity repurchased certain shares of its common stock which had
previously been outstanding. The repurchase of shares by Vicinity increased the
Company's ownership in Vicinity above 50% and, accordingly, the Company began
including Vicinity's operating results in the Company's consolidated operating
results beginning in the fourth quarter of fiscal 1997. The Company expects its
portfolio companies to continue to invest in the development of 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.
24
MANAGEMENT'S DISCUSSION &
ANALYSIS OF FINANCIAL CONDITION
& RESULTS OF OPERATIONS (CONT'D.)
Minority interest increased to $4,787,000 in 1997 from $2,169,000 in 1996
reflecting minority interest in net losses of consolidated subsidiaries within
the Company's investment and development segment.
The Company's effective tax rates for fiscal 1997 and 1996 were 12% and 54%,
respectively. The effective tax rates in fiscal 1997 and fiscal 1996 differed
from the federal statutory rate of 35% primarily due to the provision for state
income taxes and the Company's inability to record a tax benefit from operating
losses of certain subsidiaries and affiliates not included in the Company's
consolidated federal income tax return.
Fiscal 1996 Compared To Fiscal 1995
Net revenues increased $6,192,000, or 28%, to $28,485,000 in 1996 from
$22,293,000 in 1995. The increase was primarily attributable to a revenues
increase of $5,660,000 from the Company's investment and development segment
which was formed during the third quarter of fiscal 1995 and includes fiscal
1996 revenues of $5,257,000 from Lycos, Inc. Additionally, fulfillment services
segment revenues increased $984,000 reflecting several new hi-tech and
healthcare customers, and lists and database services segment revenues declined
$452,000 due to consolidation in the educational publishing industry and
curtailed direct mail activity due to high paper and postage costs in the first
half of the year.
Cost of revenues increased $4,895,000, or 38%, to $17,909,000 in 1996 from
$13,014,000 in 1995, due primarily to an increase of $3,382,000 in costs related
to the Company's new investment and development segment, an increase of $574,000
in the fulfillment services segment resulting from higher revenues, and an
increase of $939,000 in the cost of revenues for the lists and database services
segment. In the lists and database services segment, cost of revenues as a
percentage of net revenues increased to 62% in 1996 from 51% in 1995. This
increase was primarily attributable to increases in operating expenses related
to the launching of the Company's Elementary/High School Database product line.
Prior to fiscal 1996 all costs related to the development of the Elementary/High
School Database product were capitalized.
Research and development expenses totaled $6,971,000 in 1996, consisting of
$5,219,000 related to the operations of the investment and development segment,
$1,559,000 incurred by Engage within the lists and database services segment and
$193,000 relating to the fulfillment services segment. In addition, the Company
recorded $2,691,000 of in-process research and development expenses related to
the acquisition of several Internet investments. No research and development
costs were incurred in fiscal year 1995.
Selling expenses increased $8,641,000, or 286%, to $11,666,000 in 1996 from
$3,025,000 in 1995. This increase was primarily attributable to a $7,954,000
selling expense increase in the Company's new investment and development
segment, reflecting the sales and marketing efforts related to various product
launches. Additionally, selling expense increases of $541,000 and $146,000 were
incurred by the lists and database services and fulfillment services segments,
respectively. Selling expenses increased as a percentage of net revenues to 41%
in fiscal 1996 from 14% in fiscal 1995.
General and administrative expenses increased $6,460,000, or 192%, to $9,822,000
in fiscal 1996 from $3,362,000 in fiscal 1995. This increase was attributable
to the creation of the investment and development business segment during the
third quarter of fiscal 1995, which had expense increases of $5,729,000,
including payroll, facilities, goodwill amortization, legal and accounting,
depreciation and other general and administrative costs. Additionally, lists
and database services segment general and administrative expenses increased
$471,000, reflecting the strengthening of Engage's management infrastructure,
and general and administrative costs for the Company's fulfillment services
segment increased $260,000 over fiscal 1995. General and administrative
expenses increased as a percentage of net revenues to 35% from 15% in fiscal
1995.
Equity in losses of affiliates resulted from the Company's minority ownership in
certain investments, which were made through CMG @Ventures and 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. The 1995 results reflect one
investment, FreeMark, which was acquired during the third quarter of 1995, with
$306,000 equity in losses being recognized in fiscal 1995, compared with
$2,915,000 for fiscal 1996, which included results from the Company's minority
ownership in FreeMark, Ikonic, GeoCities, Vicinity, and TeleT. During the
fourth quarter of fiscal 1996, the Company increased its ownership in FreeMark
and GeoCities above 50% and, accordingly, began including their operating
results in the Company's consolidated operating results beginning on the dates
on which controlling interests were obtained.
Gain on sale of available-for-sale securities occurred when the Company sold its
remaining 1,020,000 shares of America Online common stock, realizing a gain of
$30,049,000 in October 1995. Gain on issuance of stock by subsidiary represents
the Company's $19,575,000 gain recorded as a result of the sale of stock by its
subsidiary, Lycos, in an initial public offering in April 1996. This gain from
the Lycos stock offering reflects the increase in the Company's proportionate
share of Lycos' equity. See Note 9 of Notes to Consolidated Financial
Statements for a more complete description of this transaction. Interest income
increased primarily due to income from investment of the proceeds from the sale
of the AOL stock and the Lycos public offering.
Minority interest increased to $2,169,000 in fiscal 1996 from $14,000 in fiscal
1995, reflecting minority interest in net losses of consolidated subsidiaries
within the Company's investment and development business segment.
The Company's effective tax rates for the fiscal years ended July 31, 1996 and
1995 were 54% and 37%, respectively. The effective rate in fiscal 1996 differed
from the federal statutory rate of 35% primarily due to the provision for state
income taxes and the Company's inability to record a tax benefit from operating
25
MANAGEMENT'S DISCUSSION &
ANALYSIS OF FINANCIAL CONDITION
& RESULTS OF OPERATIONS (CONT'D.)
losses of certain entities not included in the Company's consolidated income tax
return. The effective rate in fiscal 1995 differed from the federal statutory
rate of 34% primarily due to the provision for state income taxes.
LIQUIDITY AND CAPITAL RESOURCES
Working capital at July 31, 1997 decreased to $38.6 million compared to $72.0
million at July 31, 1996. The Company's principal uses of capital during fiscal
1997 were for funding of start-up activities in the Company's investment and
development segment and lists and database services segment, the acquisition of
Pacific Link, investments by CMG @Ventures L.P. and CMG @Ventures II LLC in
several Internet companies, purchases of property and equipment, and purchases
of treasury stock. The Company's principal sources of capital during fiscal
1997 were from short and long term borrowings, the sale of NetCarta and the sale
of common stock. The Company intends to continue to fund existing and future
Internet and interactive media investment and development efforts.
The Company received net cash proceeds of $18,468,000 from the sale of NetCarta
on January 31, 1997, of which $2 million is being held by an outside escrow
agent through February 1998. Prior to the sale of NetCarta, CMG @Ventures had
funded an additional $3.8 million to NetCarta during fiscal 1997. Additionally,
the Company received proceeds of $550,000 in cash and 320,833 shares of
Premiere common stock from the sale of its investment in TeleT in September
1996. The Company is subject to restrictions, which expire in September 1997
and September 2002, on selling 283,333 and 37,500 of the Premiere shares,
respectively.
On October 24, 1996, the Company's wholly-owned subsidiary, SalesLink, acquired
100% of the outstanding stock of Pacific Link for a purchase price of
$17,000,000. The Company's acquisition of Pacific Link was financed through
$3,000,000 from corporate funds, a $5,500,000, five year bank loan, a
$7,500,000, three year seller's note, and a $1,000,000 seller's note which was
paid in February 1997.
CMG @Ventures L.P. invested a total of $10.8 million in five companies during
fiscal year 1997, including an initial investment of $2 million for a 46%
ownership interest in Parable, $1.2 million for 153,192 additional shares of
Lycos, $3.8 million for additional funding of NetCarta, and follow on
investments of $1.8 million in Vicinity and $2 million in GeoCities. The
Company's investment in Vicinity was made during the second quarter as part of a
$5 million equity round, including outside investors, and reduced the Company's
ownership in Vicinity from 47% to 45%. With the repurchase of certain
outstanding shares by Vicinity during the fourth quarter of fiscal 1997, CMG
@Ventures L.P.'s ownership increased to 53% and the Company began accounting for
its investment in Vicinity on the consolidation method of accounting rather than
the equity method. The additional investment in GeoCities was made in January
1997 as part of a $9 million equity round, including outside investors, and
reduced the Company's ownership in GeoCities from approximately 61% to
approximately 41%. This reduction in ownership caused the Company to change its
method of accounting for its investment in GeoCities to the equity method rather
than the consolidation method beginning in January 1997. In December 1996, the
Company's consolidated subsidiary, FreeMark suspended operations of its free
email service. Prior to the reduction in the Company's ownership in GeoCities
and the suspension of operations at FreeMark, the operating results of GeoCities
and FreeMark were consolidated within the operating results of the Company's
investment and development segment.
The Company's investments in Parable, GeoCities, Vicinity, NetCarta, FreeMark,
Blaxxun, Ikonic, TeleT and Vicinity were made through its majority-owned limited
partnership, CMG @Ventures L.P and its wholly-owned subsidiary CMG @Ventures,
Inc. The Company owns 100% of the capital interest and has all voting rights,
and is entitled to 77.5% of the net capital gains, as defined, of these
investments. The remaining 22.5% interest in the net capital gains on these
investments are attributed to profit partners, including the President and Chief
Executive Officer and the Chief Financial Officer of the Company. The Company
is responsible for all operating expenses of CMG @Ventures L.P. and CMG
@Ventures, Inc. CMG @Ventures L.P.'s interest in Lycos (consisting of 7,389,248
shares of common stock at July 31, 1997) is subject to further reduction because
CMG @Ventures L.P. is obligated, as of July 31, 1997, to sell to Lycos up to a
total of 780,804 shares of common stock of Lycos, as necessary, to provide for
shares issuable upon exercise of options granted by Lycos under its 1995 stock
option plan. Of these 780,804 shares, CMG @Ventures L.P. is obligated to sell
522,680 shares to Lycos at a price of $0.01 per share and 258,124 shares at
prices ranging from $0.29 to $9.60 per share.
During fiscal 1997, the Company completed its original commitment of $35 million
in capital to its limited partnership subsidiary, CMG @Ventures L.P., and formed
a new limited liability company subsidiary, CMG @Ventures II LLC, to continue
the Company's model of providing intellectual and financial capital to companies
seeking to further the commercialization of the Internet and other interactive
media through the development and application of direct marketing products and
services. CMG @Ventures II LLC invested a total of $8.3 million in five
companies during fiscal year 1997, including initial investments of $1.3 million
for a 26% ownership interest in Silknet, $2 million for a 15% interest in KOZ,
inc., $1 million for a 9% interest in Softway Systems, $1 million for a 15%
interest in Sage Enterprises, $2.3 million for a 31% interest in Reel.com, and
$743,000 for a follow on investment in Silknet. The follow on investment in
Silknet was part of a $5 million equity round, including outside investors, and
reduced the Company's ownership in Silknet from 26% to 23%. The Company owns
100% of the capital interest and has all voting rights, and is entitled to 80%
of the net capital gains, as defined, of the investments made by CMG @Ventures
II LLC. The remaining 20% interest in the net capital gains on these
investments are attributed to profit partners, including the President and Chief
Executive Officer and the Chief Financial Officer of the Company.
26
MANAGEMENT'S DISCUSSION &
ANALYSIS OF FINANCIAL CONDITION
& RESULTS OF OPERATIONS (CONT'D.)
During fiscal year 1997, the Company also formed NaviSite to provide Web hosting
and Internet server management to companies that depend on the Internet as a
critical business tool. CMG has begun funding and intends to provide all
required funding for start-up costs of this new venture.
The Company's subsidiary, Lycos, entered into a joint venture agreement with
Bertelsmann Internet Services, Gmbh (Bertelsmann) dated as of May 1, 1997, to
create Internet navigation centers throughout Eastern and Western Europe.
Bertelsmann will provide $5 million in equity capital, and an additional $5
million loan facility to the venture and Lycos will contribute its technology
and Internet expertise. Lycos and Bertelsmann will each own a 50% stake in the
new venture, named Lycos-Bertelsmann. The venture has commenced operations in
Germany, the United Kingdom and France and is expected to establish operations
by September in Italy, Belgium, Netherlands, Luxembourg and Spain. Lycos
accounts for its investment in this joint venture under the equity method.
During fiscal year 1997, SalesLink secured a $4.5 million revolving credit note
agreement with a bank which expires on October 1, 1998. As of July 31, 1997,
$2.5 million in borrowings were outstanding under this agreement. On May 14,
1997, CMG entered into a one year revolving credit note agreement with a bank
which provides for borrowings up to $10 million. As of July 31, 1997, $10
million in borrowings were outstanding under this agreement. The agreement
expires on May 14, 1998. In January 1997, the Company issued a collateralized
note payable to a bank for $10 million. The note is collateralized by 784,314
Lycos common shares owned by the Company and the note is payable in full on
January 17, 1998. The Company is considering either seeking the renewal of this
note, or repaying it using future proceeds from the sale of stock of certain
investee companies.
On May 28, 1997, the Company announced a new venture dividend program in
connection with the Company's CMG@Ventures Internet investments. Subject to
restrictions on transfer, the program envisions that it may distribute up to 10%
of the stock held by CMG @Ventures following an initial public offering by any
one of the companies in which it holds an investment. The Company may also
announce from time to time other stock dividends in connection with its Internet
investments. Such dividends are subject to approval of the Company's Board of
Directors and subject to holding requirements by regulatory agencies such as the
Securities and Exchange Commission. The program may be altered or discontinued
at any time at the discretion of the Company. The Company also announced its
first dividend under the new program, of one share of Lycos common stock for
every sixteen shares of the Company's common stock held by stockholders of
record on June 5, 1997. The Company distributed 603,000 shares of Lycos common
stock, with a market value of $11,008,000 at the date of distribution, to the
Company's stockholders on July 31, 1997 as payment of this dividend. The
payment of this dividend reduced the Company's ownership interest in Lycos to
53% as of July 31, 1997.
During the first quarter of fiscal 1997, the Company's Board of Directors
authorized the Company to buy back up to 500,000 shares of its common stock.
During the first and second quarters of fiscal 1997, 100,000 shares were
repurchased at an average cost of $9.84 per share, for a total of $984,000. On
January 31, 1997, the Company sold 470,477 shares of its common stock, including
the 100,000 treasury shares acquired in fiscal 1997, to Microsoft at a price of
$14.50 per share. The shares sold to Microsoft represented 4.9% of the
Company's total outstanding shares of common stock following the sale, with
proceeds to the Company totaling $6,822,000.
The Company's consolidated capital expenditures were $6,939,000 in fiscal 1997.
Concurrent with its growth and the commencement of start-up operations, the
Company has experienced a substantial increase in its capital expenditures and
operating lease arrangements in fiscal year 1997 and anticipates that this will
continue in the future. The Company's accounts receivable, accounts payable and
accrued expenses increased $9,203,000, $2,542,000 and $12,186,000, respectively,
primarily as a result of the acquisition of Pacific Link and significant growth
in several of the Company's subsidiaries in the investment and development
segment during fiscal 1997. Costs in excess of net assets of subsidiaries
acquired, net of accumulated amortization, in the Company's July 31, 1997
Consolidated Balance Sheet increased $14,644,000 in comparison with July 31,
1996, primarily due to $17,229,000 of goodwill recorded relating to the
acquisition of Pacific Link in October 1996, offset by amounts amortized during
fiscal 1997.
Of the Company's consolidated cash and available-for-sale securities at July 31,
1997, 64% was held by subsidiaries that are not wholly-owned by the Company.
This percentage may vary significantly over time. The Company's ability to
access assets held by its majority-owned subsidiaries through dividends, loans,
or other transactions is subject in each instance to a fiduciary duty owed to
minority shareholders of the relevant subsidiary. In addition, dividends
received from a subsidiary that does not consolidate with the Company for tax
purposes are subject to tax. Therefore, under certain circumstances, a portion
of the Company's consolidated cash and available-for-sale securities may not be
readily available to the Company or certain of its subsidiaries.
Subsequent to July 31, 1997, the Company's wholly-owned subsidiary, Engage
Technologies, sold certain rights to its Engage.FusionTM and Engage.DiscoverTM
products to Red Brick Systems, Inc. (Red Brick) for cash and Red Brick common
stock valued at approximately $11.5 million. Also subsequent to July 31, 1997,
the Company exercised options to purchase additional Lycos shares and filed with
the SEC on Form 144 to sell up to 300,000 shares of Lycos stock on the open
market. The Company exercised 96,000 Lycos options for an investment of
$192,000 and sold 219,900 of its shares of Lycos common stock for total proceeds
of $7.1 million in September and October 1997. Through the subsequent sale of
Lycos shares, the Company's ownership percentage in Lycos was reduced from 53%
at July 31, 1997, to just in excess of 50% in October 1997.
27
MANAGEMENT'S DISCUSSION &
ANALYSIS OF FINANCIAL CONDITION
& RESULTS OF OPERATIONS (CONT'D.)
During the first quarter of fiscal 1998, the Company also sold 224,795 shares of
Premiere common stock for total proceeds of $7.6 million.
The Company believes that existing working capital, available borrowings under
revolving credit note agreements, proceeds from Engage's sale of certain rights
to two of its products to Red Brick Systems subsequent to July 31, 1997,
proceeds from the sale of Lycos and Premiere stock subsequent to July 31, 1997,
and additional Lycos shares which could be sold or posted as collateral for
additional loans, will be sufficient to fund its operations, investments and
capital expenditures for the foreseeable future. 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. Further, the Company
continues to see a strong flow of strategic opportunities that fit within its
investment and development business model and expects to seek to secure
additional financing commitments from third parties to pursue additional
investment opportunities in the future.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
The Company operates in a rapidly changing environment that involves a number of
risks, some of which are beyond the Company's control. Forward-looking
statements in this document and those made from time to time by the Company
through its senior management are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. Forward-looking
statements concerning the expected future revenues or earnings or concerning
projected plans, performance, product development, product release or product
shipment, as well as other estimates related to future operations are
necessarily only estimates of future results and there can be no assurance that
actual results will not materially differ from expectations. The Company
undertakes no obligation to publicly release the results of any revisions to
forward-looking statements which may be made to reflect events or circumstances
occurring after the date such statements were made or to reflect the occurrence
of unanticipated events.
Factors that could cause actual results to differ materially from results
anticipated in forward-looking statements include, but are not limited to the
following:
. The development of the Internet, the level of usage of the Internet, future
acceptance of the Company's Internet related products and services, demand
for Internet advertising, the introduction of new products and services by
the Company and its affiliates or its competitors and potential expense
increases associated with the Company's investments at the early stages of
development may materially affect the Company's operations. As a result, the
Company's mix of services and products may undergo substantial changes as the
Company reacts to competitive and other developments in the overall Internet
market. If widespread commercial use of the Internet does not develop, or if
the Internet does not develop as an effective advertising medium, the
Company's business, results of operations and financial condition will be
materially adversely affected.
. The Company's business model envisions additional opportunities to realize
value through gains on its strategic investment and development activities
over the next few years. Historically, such gains have been substantial in
certain periods. Additionally, the Company's business model envisions
potentially leveraging its investment in present and future Internet
development opportunities through public and private placement of portions of
such investments with outside investors. The size and timing of these
transactions are dependent on market and other conditions that are beyond the
Company's control. Accordingly, there can be no assurance that the Company
will be able to generate gains from such transactions in the future. These
same factors, along with potential restrictions from regulatory agencies,
such as holding requirements by the Securities and Exchange Commission, could
also effect the Company's ability to provide future distributions under its
venture dividend program.
. The Company has made and continues to make numerous early-stage investments
in companies with little or no revenues, and has realized several significant
gains through the selective sale or distribution of investments or, as in the
case of Lycos, selling minority interests through initial public offering of
stock. For these reasons, the Company's operating results have varied
significantly from quarter to quarter, and are likely to continue to do so.
In addition, the Company's operating results may vary significantly from
quarter to quarter as a result of several other factors, including but not
limited to: the timing of new product announcements and introductions by the
companies in which CMG has invested or will invest, or their competitors,
market acceptance of the Company's products or services, and changes in the
product mix of sales. All of the above factors can materially adversely
affect the Company's business and operating results for one quarter or a
series of quarters, and are difficult to forecast.
. Along with its investment and development segment, the Company's lists and
database services and fulfillment services segments are subject to industry
related risks, including continued acceptance of the Company's products and
services, the introduction of new products and services by the Company or its
competitors, changes in the mix of services sold and the channels through
which those services are sold, product pricing and changes, general economic
conditions and specific economic conditions in the direct marketing and
Internet industries.
. During fiscal year 1997 a significant portion of the Company's revenues were
derived from a limited number of customers, including Cisco Systems, Inc.
(Cisco), which accounted for 24% of total revenues and 47% of fulfillment
services segment fiscal year 1997 revenues. While the Company is actively
pursuing increasing the number of fulfillment services customers, the Company
believes that its dependence on Cisco will continue. This concentration of
customers may cause net sales and operating results to fluctuate from quarter
to quarter based on Cisco's requirements and the timing of their orders and
shipments. The Company does not have agreements in place with Cisco to ensure
minimum purchase commitments or exclusivity for purchase of a particular
product or service. The Company's operating results could be materially
affected if Cisco were to choose to reduce its level of orders, were to
change to another vendor, were to experience financial, operational, or other
difficulties, or were to delay paying or fail to pay amounts due to the
Company.