SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------
FORM 10-KSB
|X| Annual Report Under Section 13 or 15(d) of the Securities Exchange Act of
1934.
For the fiscal year ended December 31, 2000
OR
| | Transition Report Under Section 13 or 15(d) of the Securities Exchange Act
of 1934.
For the transition period from _________ to ___________
Commission File Number 001-15673
FRONTLINE COMMUNICATIONS CORPORATION
(Name of Small Business Issuer in Its Charter)
Delaware 13-3950283
(State or Other Jurisdiction (I.R.S.Employer
of Incorporation or Organization) Identification No.)
One Blue Hill Plaza, P.O. Box 1548, Pearl River, New York 10965
(Address of principal executive offices) (Zip Code)
(845) 623-8553
(Issuer's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Exchange Act:
Series B Convertible Redeemable Preferred Stock, $.01 par value
Common Stock, $.01 par value
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock Purchase Warrants
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 | |
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X|
The issuer's revenues for the year ended December 31, 2000 were $5,327,316.
The aggregate market value of the voting and non-voting common equity held by
non-affiliates as of March 15, 2001 was $1,718,200. As of March 15, 2001, there
were 6,662,627 shares of the issuer's Common Stock outstanding.
Documents Incorporated by Reference:
None.
PART I
Item 1. Business.
Overview
Frontline Communications Corporation is a regional Internet service
provider ("ISP") providing Internet access, web hosting, website design, and
related services to residential and small business customers throughout the
Northeast United States and through a network partnership agreement Internet
access to customers nationwide.
Primarily through 18 acquisitions, we grew our customer base from 2,500
customers as of October, 1998 to over 25,000 customers at December 31, 2000.
During that same period, we expanded our owned Internet access geographic
footprint from the New York/New Jersey metropolitan area, to a region that now
includes Delaware, Eastern Pennsylvania, and Northern Virginia. At December 31,
2000, we owned and operated 16 points-of-presence ("POPs") which, when combined
with 1,100 POPs licensed from third parties, provide us with the capability to
serve approximately 72% of the U.S. population.
During year 2000, we enhanced our product lines with the addition of
high-speed Digital Subscriber Line (DSL) products. Through alliances with DSL
wholesalers, including Rhythms Net Communications Inc. and Network Access
Solutions, Inc., the Company added over 700 DSL customers to its subscriber
base.
We also expanded our web design and development product offerings with the
September 2000 acquisition of PNM Group, Inc. (d/b/a Planet Media)a Long
Island-based web design, consulting, development and maintenance provider with
approximately 65 corporate clients; including firms such as Denny's Inc., City
College of New York, Matchbox USA and Fancy Fixtures, Inc.
The Company was formed during February 1997 as a Delaware corporation under
the name Easy Street Online, Inc. We changed our name to Frontline
Communications Corporation in July 1997. Our principal executive offices are
located at One Blue Hill Plaza, Pearl River, New York 10965, and our telephone
number is (845) 623-8553. Our Corporate Websites are located at
www.frontline.net and www.fcc.net. PlanetMedia(SM)'s Internet website is located
at www.pnetmedia.com. Information on these Websites is not part of this report.
Unless the context indicates otherwise, the terms "Frontline," "we," "our," "the
Company" and "us" in this report include the operations of Frontline
Communications Corporation and its wholly owned subsidiaries, WowFactor, Inc.,
WebPrime, Inc. and CLEC Communications Corp.
Products and Services
The Company's products and services are focused around three key Internet
business areas - access, presence, and development.
Internet access products
o Dial-Up Accounts: Frontline offers residential and business dial-up
and ISDN Internet access on a national basis. Customers may order
these products on our websites or by calling our 800 number. Utilizing
our
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branded software, available via CD or downloadable from our website,
customers can quickly order and activate a new account, billable to
the client's credit card. The standard Frontline dial-up product
provides clients two Internet e-mail addresses, a customizable
homepage, access to our Customer Service telephone support center, and
the latest access tools including browsers from Netscape and
Microsoft.
o DSL: We are a reseller of Digital Subscriber Line high-speed Internet
access services for Rhythms Net Communications, Inc. and Network
Access Solutions, Inc., and now offer Digital Subscriber Line, ISDN
Digital Subscriber Line, Asymmetric Digital Subscriber Line and
Symmetric Digital Subscriber Line services in the Mid-Atlantic and
Northeast United States. These products provide our residential and
business customers with high-speed dedicated Internet connectivity at
an affordable cost.
o Dedicated Access: Frontline offers high-speed, high-bandwidth
dedicated leased lines to customers, principally for business users
who require high-speed internet connectivity 24 hours a day, seven
days a week.
Internet Presence Products
o Virtual Website hosting: We offer virtual website hosting services to
residential and small business customers who require 24 hour presence
on the Internet. By renting space on our Internet servers, customers
avoid costly hardware investment, maintenance, and other costs
associated with operating their own servers. Marketed partly under our
brandname FrontHost(SM), the Company's hosting services include domain
name registration, e-mail addresses, file upload and download
capability and statistical logs.
o Dedicated Hosting: Frontline offers website hosting and maintenance
services to clients wishing to rent secure web-servers. In addition,
Frontline offers co-location services to those customers preferring to
install their own equipment at our facilities and connect their
systems directly to the Internet.
Internet Development Services
o FrontHost(SM): Our do-it-yourself "Website Wizard" products assist
customers in developing their own Websites and e-commerce `stores' by
using our FrontHost(SM) user-friendly tools.
o Website design services: PlanetMedia(SM), our website design,
consulting, and development division, assists business customers with
Internet marketing strategy, graphic design and layout, writing and
editing and Website information architecture (including Website
navigation and searching systems). Our in-house professionals provide
full life-cycle support to customers: from the design phase through
website installation and maintenance.
Marketing and Sales
We currently have an in-house sales and marketing staff consisting of a
Vice President of Sales and Marketing, a Director of Sales, and several sales
representatives focused on different products (such as dial-up, dedicated and
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DSL) and marketing channels (such as resellers). During the first quarter of
2001, the Company redirected its sales focus from a direct business-to-business
selling effort to development of an extensive commissioned external reseller
network to market its products.
PlanetMedia(SM), the Company's web design and development division,
maintains a separate sales and marketing group.
Marketing activities have been designed to achieve Frontline brand name
recognition through radio, trade and local business print media and local event
marketing.
POPS and Network infrastructure
Our Internet access network is comprised primarily of a Company-managed
network and third-party POPs provided primarily through an agreement with
Megapop, Inc. The Company believes that this combination of owned and leased
access enables Frontline to most economically provide Internet access services
to its customers on a national level while leveraging the competitive advantages
associated with the Company's own, uniquely-located, POPs.
Broadband access to the internet for Company-managed POPs is provided
through high speed T1, T3, or Ethernet connections supplied under contracts with
national broadband suppliers such as Verio, Inc., Cable & Wireless, Inc. and by
certain regional broadband suppliers such as Focal, Inc., AboveNet, Inc., Exodus
Communications Inc. and Conectiv, Inc. DSL access is similarly provided through
DS3 connections to the Company from Covad, Inc. and through our reseller
agreements with Rhythms Net Communications, Inc. and Network Access Solutions,
Inc.
Network and service delivery stability is provided through the use of
redundant computing and server facilities located at our larger owned POPs. In
addition, the Company has initiated a program, expected to be completed during
April 2001, to ensure duplicate bandwidth access at each of its owned locations.
The Company has installed backup power supply, remote alarm, computer virus
protection, and monitoring software throughout its network, which is monitored
24 hours a day, 7 days-a-week.
Customer Support Services
Frontline believes that reliable customer and product support is critical
to retaining existing subscribers and in attracting new customers. We provide
the following Customer and Product support services:
o Toll-free, live telephone assistance available seven days a week,
during peak load hours (10 hours per day; 8 hours on weekends);
o Email-based assistance available seven days a week;
o Internet help at our www.fcc.net Web site;
o Fax support for higher-end business hosting customers.
We receive approximately 400 residential and business customer service
calls per day at our Customer Service call centers located at Howell, NJ and
Pearl River, NY. Task-based call tracking software applications, and
"trouble-
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ticket" reporting systems, were implemented at these centers during the
year 2000 substantially improving the Company's ability to promptly resolve
customer problems.
During November 2000, as part of our Restructuring Program, which is discussed
in detail below, we announced the consolidation of our Howell, NJ Call Center to
our Pearl River, NY headquarters. We believe that this consolidation, scheduled
for completion on March 30, 2001, and the concurrent integration of our Product
Service IT administration personnel, will significantly improve the quality of
our service.
Product and Service development
Our Product Service Division develops proprietary applications and reviews
third-party software products and technology that are incorporated into our
network and service products. A revised, interactive Company website
(www.fcc.net) was activated during February 2001. We also distributed an updated
dial-up access CD to our sales force and customers during March 2001.
During 2001, we also plan to consolidate our various email servers onto a
common platform which we anticipate will reduce maintenance and potential
customer outage issues.
Industry and Competition
The market for Internet access, hosting, and web design and development
services is highly competitive, rapidly evolving, and subject to technological
change. There are no substantial barriers to entry, and we expect that
competition will increase.
Our current and prospective competitors include many large companies that
have substantially greater market presence, financial, technical, marketing and
other resources than we have. We compete directly or indirectly with the
following categories of companies:
o Established online services, such as America Online, the Microsoft
Network, and Prodigy;
o Local, regional and national ISPs, public or privately owned;
o National and regional telecommunications companies, such as AT&T and
Verizon;
o Cable TV and online services, such as Roadrunner;
o Free ISPs such as Netzero and Juno;
o Satellite companies, such as Direct TV and Starband; and
o Large independent DSL providers, such as Telocity.
We believe that competition is likely to increase and that existing or
future competitors may develop or offer services that are superior to ours at a
lower price. These factors could have a material adverse effect on our business,
financial condition, and results of operations.
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Recent Acquisitions
Since January 1999, we have completed the following acquisitions in order
to increase our Internet access, development and presence capabilities:
o WebPrime, Inc. A Website design, Web development and software
development firm.
o Channel iShop.com. A company with a marketing concept targeting retail
businesses, which we have since divested as part of our Restructuring
Program (see below).
o United Computer Specialists, Inc.--access division. A subscriber base
of dial-up Internet access customers.
o United Computer Specialists, Inc.--web services division. Assets
relating to Web design and hosting capabilities.
o Lingua Systems, Inc. d/b/a/ Fullwave Networks. A customer base of
additional DSL customers.
o Skyhigh Information Technologies. A customer base of additional
dial-up customers.
o FrontHost, LLC. A company in the business of providing Web hosting and
design services.
o The Pressroom Online Services. A subscriber base of dial-up and DSL
customers.
o Application Resources Information Services d/b/a Way.com. A subscriber
base of dial-up, DSL and web hosting customers.
o First Street Corporation. A subscriber base of dial-up and web hosting
customers.
o Double D Network Services Inc. - acquired certain dial-up customers
pursuant to a referral plan.
o Delanet, Inc. A subscriber base of dial-up, DSL, web hosting and
dedicated line customers.
o Wizard.net, Inc. A subscriber base of dial-up, web hosting and
dedicated line customers.
o PNM Group, Inc. d/b/a Planet Media. A web development and design
company.
See note 2 to the Notes to Consolidated Financial Statements for the terms
of certain of our recent acquisitions.
Company Strategy and Restructuring Program
During 1998, the Company announced, as a strategic goal, to become a
leading provider of Internet access, development, and presence services for
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small and medium-sized business as throughout the United States. To achieve this
objective, we embarked on a program to expand our network infrastructure and
internet dial-up access subscriber base by acquiring local and regional ISPs,
utilizing acquired web 'portal' and e-commerce websites as a vehicle to promote
the sale of our Internet services, and developing co-marketing alliances with
value-added partners.
During the period between October 1998 and June 2000, Frontline acquired 18
companies, grew its dial-up access subscriber base from 2,500 to over 25,000
customers, and acquired two web-portal websites: WoWFactor.com(R) and
iShopNetworks(SM).
Marketplace and technological changes during this two-year period caused
the Company to refine its strategy during the last two quarters of the year
2000. The rapid increase in demand for DSL services prompted the Company to add
this high-speed access product to its offering portfolio. Similarly, the
marketplace failure of many so-called 'dot-com' companies and Frontline's
inability to cost-effectively market its core products through its owned
websites, resulted in the decision to abandon the use of web-portals as a
primary marketing tool of the Company.
As a result, during January 2001, we announced the sale of a majority of
our equity interest in iShopNetworks, Inc. and the closure of our
WoWFactor.com(R) web-portal. We also announced that we could cease funding our
subsidiary, CLEC Communications Corp.
In addition, we have adopted a restructuring program (the "Restructuring
Program") designed to consolidate our operations and improve cost-effectiveness,
combine personnel of our key products and customer service divisions to leverage
our manpower skills, and upgrade our access network infrastructure. As of March
28, 2001, we have accomplished the following in connection with our
Restructuring Program:
o Workforce reduction of about 40%, from over 120 employees to 68
employees as of March 15, 2001. We expect that the number of employees
will decrease to approximately 60 upon the closure of our Howell, NJ
customer service center, which is presently scheduled to occur on
March 30, 2001.
o Elimination of our marginal service products; reducing the number of
discrete offerings from over 100 to less than 25;
o Implementation of a user-friendly website (www.fcc.net) promoting our
products;
o Development of new version of our basic dial-up Internet access
software and activation of a third-party network for the marketing of
our products and services;
o Closure of two of our four regional offices and the consolidation of
two owned POPs;
o Integration of our Product and Customer Service Divisions at our Pearl
River, NY headquarters and the scheduled closure of our Howell, NJ
Call Center, planned for March 30, 2001; and
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o Discontinued expenditures related to our CLEC Communications Corp.
subsidiary.
We intend to continue the Restructuring Program during the first and second
quarters of 2001. This may result in additional workforce reductions and other
cost-savings related to reduction of telecommunications and lease/rental costs
associated with branch office and POP consolidations.
Trademarks and Service Marks
We have made applications for federal trademark registration and claim
rights in the following trademarks: WOWFactor; WOWFactor Women on the Web;
Frontline.net; Frontline.net Effortless E-Commerce and Internet Access (name and
logo); Effortless E-Commerce & Internet Access; and Frontline Communications
Corp. We have received a notice of allowance from the U.S. Patent and Trademark
Office with respect to the following marks: WOWFactor.com and WOWFactor design.
All other trademarks and service marks used in this report are the property of
their respective owners.
Industry Regulation
The following summary of regulatory developments and legislation does not
describe all present and proposed federal, state and local regulations and
legislation affecting us and our industry. Other federal, state and local
legislation and regulations are currently the subject of judicial proceedings,
legislative hearings and administrative proposals which could change the manner
in which our industry operates. Neither the outcome of these proceedings, nor
their impact upon us or our industry can be predicted at this time.
Internet Service Provider Regulation. Currently, few U.S. laws or
regulations specifically regulate communications or commerce over the Internet.
However, changes in the regulatory environment relating to the Internet
connectivity market, including regulatory changes which directly or indirectly
affect telecommunications costs or increase the likelihood or scope of
competition from the regional Bell operating companies or other
telecommunications carriers, could affect the prices at which we may sell our
services and impact competition in our industry. Congress and the Federal
Communications Commission will likely continue to explore the potential
regulation of the Internet. For instance, the Federal Communications Commission
may impose certain payments on Internet service providers, similar to payments
imposed on telecommunications carriers, which could cause our costs of doing
business to increase substantially.
One area in which Congress has attempted to regulate information over the
Internet involved the dissemination of obscene or indecent materials. Certain
provisions of the Telecommunications Act of 1996 relating to indecent
communication over the Internet, generally referred to as the Communications
Decency Act, were found to be unconstitutional by the U.S. Supreme Court in
1997. In October 1998, Congress enacted the Child Online Protection Act, which
requires that online material that is "harmful" to minors be restricted. This
law is currently being challenged in federal district court. On February 1,
1999, a U.S. District Court judge issued a preliminary injunction against
enforcement of portions of that act and the U.S. Department of Justice has
appealed that decision. The Protection of Children from Sexual Predators Act of
1998 creates an affirmative obligation
9
of providers of electronic communication services to report certain violations
of child pornography laws. Some states also have adopted or may adopt in the
future similar requirements. The constitutionality of such state requirements
remains unsettled at this time.
Future laws and regulations could be adopted to address matters such as
user privacy, copyright and trademark protection, pricing, consumer protection,
characteristics and quality of Internet services, libel and defamation, and
sales and other taxes. Internet-related legislation and regulatory policies are
continuing to develop, and we could be subject to increased regulation in the
future. Laws or regulations could be adopted in the future that may decrease the
growth and expansion of the Internet's use, increase our costs or otherwise
adversely affect our business.
In 1998, Congress passed the Digital Millennium Copyright Act. That act
provides numerous protections from certain types of copyright liability to
Internet service providers that comply with its requirements. To the extent that
we have not met those requirements, third parties could seek recovery from us
for copyright infringements caused by our Internet customers.
The law relating to the liability of Internet service providers for
information carried on or disseminated through their networks is currently
unsettled. It is possible that claims could be made against Internet service
providers for defamation, negligence, copyright or trademark infringement or on
other theories based on the nature and content of the materials disseminated
through their networks. We could be required to implement measures to reduce our
exposure to potential liability, which could include the expenditure of
resources or the discontinuance or modification of certain product or service
offerings. Costs that may be incurred as a result of contesting any claims
relating to our services or the consequent imposition of liability could have a
material adverse effect on our financial condition, results of operations and
cash flow.
Competitive Local Exchange Carrier Regulation. Our wholly-owned subsidiary,
CLEC Communications Corp., was granted competitive local exchange carrier status
by the New York State Public Service Commission, the New Jersey Board of Public
Utilities and the Pennsylvania Public Utility Commission in December 1998,
February 2000 and December 1999, respectively. As a certified CLEC, we are
subject to various ongoing regulatory requirements applicable to CLECs in
particular and certain other requirements applicable to all telecommunications
carriers.
In October 1999, our CLEC subsidiary entered into an interconnection
agreement with Bell Atlantic in New York. That agreement expired by its terms in
June, 2000. In November 2000, we announced that, as part of the Company's
Restructuring Program we would not invest any further capital in our CLEC
subsidiary. The Company currently plans to sell or dissolve CLEC Communications
Corp. in the second quarter of 2001, at which time the subsidiary will no longer
be subject to any regulations governing Competitive Local Exchange Carriers.
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Employees
As of March 15, 2000, we had 68 employees including our 6 executive
officers. We also engage part-time employees from time to time. None of our
employees are represented by a union. We consider our employee relations to be
good.
Item 2. Properties
Our executive offices are located in Pearl River, New York, where we lease
approximately 12,000 square feet of space through a lease that expires in May
2004.
We lease approximately 2,400 square feet in Howell, New Jersey under a
lease that expires in May 2004. We plan on closing our Howell office in March
2001, at which time we will attempt to renegotiate or sublet this space. In
connection with our purchase of Pressroom Online Service, Inc., we assumed
approximately 2,500 square feet of office space in Chantilly, Virginia under a
lease which expires in 2005. We also lease approximately 5,000 square feet of
office space in New Castle, Delaware, which served as the principal offices of
Delanet, Inc., which we acquired in June 2000. That lease expires in May 2003.
We have since closed our Delaware and Virginia offices, and we are presently in
negotiations with the owners of those premises.
We also lease approximately 2700 square feet of space in Babylon, New York
that was assumed in connection with our purchase of PNM Group, Inc. (d/b/a)
Planet Media. The aggregate annual rent for the five offices is approximately
$424,000.
We also lease space (typically, less than 100 square feet) in various
geographic locations to house the telecommunications equipment for each of our
POPs. Leased facilities for POPs have various expiration dates through April
2002. Aggregate annual rentals for POPs are approximately $12,000.
Item 3. Legal Proceedings
In February 2001, we were served with a complaint filed in the United
States Bankruptcy Court for the Eastern District of Virginia, Alexandria
Division, by Robert O. Tyler the Trustee in Bankruptcy for Double D Network
Services, Inc. entitled Robert O. Tyler, Trustee of Double D Network Services,
Inc. v. Frontline Communications Corporation. In that complaint, the Trustee
alleges that the Company owes Double D Network Services, Inc. approximately
$220,000. The claim is based upon an agreement between the Company and Double D
dated July 13, 2000. It is the Company's position that it owes Double D
approximately $15,000 under the terms of the agreement. We have not yet answered
the Complaint in that action. We do not believe that this proceeding will have a
material adverse effect on our financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
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PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Market Information. Commencing on February 7, 2000 our Common Stock has
been listed on the American Stock Exchange ("AMEX") under the symbol "FNT". From
May 14, 1998 until February 7, 2000, our Common Stock was traded the NASDAQ
SmallCap Market under the symbol "FCCN". The following table sets forth, for the
periods indicated, the range of the high and low closing prices for the Common
Stock as reported by NASDAQ and AMEX.
Fiscal Year Ended December 31, 1999 High Low
----------------------------------- ---- ---
First Quarter 16.75 5.625
Second Quarter 18.065 7.9375
Third Quarter 11.375 4.75
Fourth Quarter 8.50 3.8125
Fiscal Year Ended December 31, 2000 High Low
----------------------------------- ---- ---
First Quarter 8.00 4.25
Second Quarter 4.00 1.125
Third Quarter 1.50 1.00
Fourth Quarter 1.00 .156
The number of record holders of our Common Stock was 101 as of March 15,
2001. We believe that there are in excess of 2,300 beneficial owners of our
Common Stock.
Dividend Policy. To date, the Company has not declared or paid any cash
dividends on its Common Stock. The payment of dividends on its common stock, if
any, in the future is within the discretion of the Board of Directors and will
depend upon the Company's earnings, its capital requirements and financial
condition and other relevant factors such as the rights of holders of capital
stock that ranks senior with respect to dividends, such as the Company's Series
B Convertible Redeemable Preferred Stock. The Company presently intends to
retain all earnings to finance the Company's continued growth and development of
its business and does not expect to declare or pay any cash dividends on its
common stock in the foreseeable future.
Holders of the Company's Series B Convertible Redeemable Preferred Stock
are entitled to receive annual cumulative dividends of $.60 per share payable
semi-annually commencing June 30, 2000. The dividends are paid in cash or in
shares of Common Stock, in the Company's discretion. In 2000, we
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elected to pay the June 30 and December 30 dividends in cash, resulting in a
total dividend payment of $337,750.
Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Safe Harbor Statement under the Private Securities Litigation Reform Act of
1995: The Statements contained in this Item 6 and elsewhere in this Form 10-KSB
which are not historical facts are "forward looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E
of the Securities Exchange Act of 1934. These "forward looking statements" are
subject to a number of known and unknown risks, uncertainties and other factors
which may cause the actual results, performance or achievements of the Company
to be materially different from any future results, performance or achievements
expressed or implied by such forward looking statements. Such risk factors
include, but are not limited to, risks associated with the Company's ability to
attract and retain new subscribers, ability of the Company to successfully
integrate newly acquired subscribers and business entities into its operations,
ability to manage any future growth, uncertainties regarding future operating
results, risks relating to changes in the market for internet services,
regulatory and technological changes, possible inability to protect proprietary
rights, changes in consumer preferences and demographics, competition, reliance
on telecommunication carriers, ability to expand the Company's network
structure, ability to obtain any necessary future financing, unfavorable general
economic conditions, uncertainty of customer and supplier plans and commitments
and other risks detailed in this report and in the Company's other Securities
and Exchange Commission filings. The words "believe", "expect", "anticipate",
"intend" and "plan" and similar expressions identify forward-looking statements,
which speak only as of the date they were made. We undertake no obligation to
update any forward-looking statements contained in this report.
Overview
During 2000 and 1999, a significant part of our revenues were derived from
providing Internet access services to individuals and businesses. These revenues
were comprised principally of recurring revenues from our customer base, leased
line connections and various ancillary services. We charge subscription fees,
which are billed monthly or quarterly, semi-annually or annually in advance,
typically pursuant to pre-authorized credit card accounts. The balance of our
revenues during those periods were derived from Web design development and
hosting services.
Monthly subscription service revenue for Internet access is recognized over
the period in which services are provided. Fee revenues for website design
development and hosting services are recognized as services are performed.
Deferred revenue represents prepaid access fees by customers.
Acquisitions
Acquisitions have historically been an important aspect of our growth
strategy. In 2000, the Company acquired substantially all of the assets of The
PressRoom Online Services, Application Resources Information Services,
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Inc d/b/a Way Communications, The First Street Corporation, Wizardnet, Inc.,
Delanet, Inc. (internet access service providers) and PNM Group, Inc., a Web
design company. In 1999, the Company completed the following acquisitions;
Webprime, Inc., a website design, web development and software development firm;
Channel iShop.com (now iShopNetworks.com) a company with a marketing concept
targeting retail businesses; assets relating to the dial-up internet access
customer base and web design and hosting capabilities of United Computer
Specialist, Inc; a customer base of DSL customers of Lingua Systems, Inc. d/b/a
Fullwave Networks; a customer base of additional dial-up customers of Skyhigh
Information Technologies and Fronthost LLC, a company in the business of
providing web hosting and design services. We also acquired certain customers of
Double D Network Services, Inc. pursuant to an agreement whereby we paid Double
D a referral fee for each Double D customer who signed up for our dial-up
service.
All of the acquisitions were accounted for using the purchase method of
accounting with the results of each acquisition included in the consolidated
financial statements from the respective acquisition date. Our acquisitions
resulted in our recording significant intangible assets. As of December 31,
2000, we had $5,623,154 of net intangible assets, which are being amortized over
a period of three years. See Note 2 of Notes to Consolidated Financial
statements.
Restructuring Program.
In November 2000, we initiated a Restructuring Program designed to, among
other things, reduce our operating losses. The program consists of reductions of
personnel, reduction in marketing and promotional expenses, consolidation of
certain operations, exit from certain marginal products lines not related to our
core business, and closure of regional offices.
We believe that the Restructuring Program and related cost reductions, will
permit the Company to maintain service quality to our customers while our more
focused product offering portfolio will enhance the Company's ability to grow
our revenue base. To date we have realized significant cost reductions and we
hope to reduce additional costs in 2001. However, there can be no assurance that
the Restructuring Program will achieve the desired results and that there will
not be any disruption of any services or resulting loss of revenues.
Results of Operations
Comparison of Years ended December 31, 2000 and 1999
Revenues. Revenues increased for the year ended December 31, 2000 by $2,352,103
or 79.1% over the prior year. The increase was attributable mainly to an
expanded customer base. The increase in customer base was principally due to
acquisitions and due to our marketing efforts.
Cost of Revenues. For the year ended December 31, 2000, cost of revenues
increased by $1,244,975 to $3,260,799. As a percentage of revenues, cost of
revenues decreased to 61.2% from 67.8%. The absolute dollar increase in cost of
revenues was due principally to increased communication and technical personnel
expenses incurred to support the increased customer base.
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Selling, General and administrative. For the year ended December 31, 2000,
selling general and administrative expenses increased by $3,347,837. As a
percentage of revenues, selling, general and administrative expenses decreased
from 176% in 1999 to 161% in 2000. The absolute dollar increase in selling,
general and administrative expenses was attributable mainly to higher costs
incurred for advertising, promotion and sales personnel in 2000. The Company
incurred approximately $1,000,000 more for marketing activities in 2000 compared
to 1999.
Depreciation and Amortization. For the year ended December 31, 2000,
depreciation and amortization increased by $1,853,668 to $3,618,041. The
increase was due to amortization arising from acquisitions and due to
depreciation arising from additional equipment acquired in latter part of 1999
and the year 2000.
Non cash compensation charges. During 2000, we recognized a non cash
compensation charge of $63,095 for shares issued in exchange for services from
consultants and for shares repurchased from an officer. During 1999, we granted
certain employees options to purchase an aggregate of 179,768 shares of common
stock, which required stockholder approval prior to issuance. Our stockholders
approved the issuance in June 1999, and that approval date is deemed to be the
grant date. Since the fair market value of the shares at the grant date exceeded
the exercise price, compensation costs of $365,104 were recognized during the
year ended December 31, 1999. Non cash compensation charges of $389,116 was also
recognized for the year ended December 31, 1999 as a result of warrants and
stock options granted to non employees.
Impairment of intangibles.
During the year ended December 31, 2000, due to changes in circumstances, we
determined that the carrying amount of intangible assets of our subsidiaries
WoWFactor, Inc., Roxy Systems, US Online, Inc., Webspan Communications, iShop
Networks, Webprime, Inc., Skyhigh Information Technologies, UCS Web Design,
Application Resources Information Services, Inc., and The First Street
Corporation was impaired. Accordingly we recorded an impairment charge of
$2,300,000 on these assets.
Interest Income. Interest income net of interest expense for 2000 was $247,981
compared to $37,657 for 1999. The increase in interest income was due to
investment of unutilized proceeds of our public offering of Series B Convertible
Redeemable preferred stock.
Net loss. We incurred significant losses as revenues generated were not
sufficient to offset the substantial up-front expenditures and operating costs
associated with attracting and retaining additional customers. For the years
ended December 31, 2000 and 1999, we incurred a net loss of $12,235,455 and
$6,757,258, respectively.
During 2000, additional dividends (noncash) related to the beneficial
conversion feature of the preferred stock of approximately $5,856,000 were
recorded as a result of the conversion price of the preferred stock being less
than the market price of the common stock at the time of the offering. For the
year ended December 31, 2000 the net loss after adjusting for the additional
dividends and normal dividends for preferred stock resulted in a net loss of
$18,429,702 applicable to common shares.
15
Liquidity and capital resources.
Our working capital deficiency at December 31, 2000 was $585,196 compared
with a working capital deficiency of $1,640,344 at December 31, 1999. The
increase in working capital was due mainly to the receipt of the proceeds from
the public sale of the Series B Convertible Redeemable preferred stock in
February and March of 2000.
Our primary capital requirements are to fund acquisition of customer bases
and related Internet businesses, install network equipment, and working capital.
To date, we have financed our capital requirements primarily through issuance of
debt and equity securities. We currently do not have any bank lines of credit.
The availability of capital resources is dependent upon prevailing market
conditions, interest rates, and our financial condition.
In February and March 2000, we sold in a public offering 1,137,300 shares
of Series B Convertible Redeemable preferred stock at $15 per share and realized
net proceeds of approximately $14,404,000. The preferred stock can be converted
into common stock at the rate of 3.4 shares of common stock for each share of
preferred stock. Preferred stockholders are entitled to receive cumulative
annual dividends of $.60 per share payable semi-annually either in cash or
shares of common stock at our sole discretion. Further, preferred stockholders
are entitled to receive a liquidation preference of $15 per share, plus accrued
dividends. We have the option to redeem the preferred stock under certain
circumstances.
In 1999, we purchased equipment in the aggregate amount of $1,376,000 from
a major telecommunications manufacturer. The manufacturer had agreed to install,
test and provide support to make the equipment functional. The manufacturer had
also agreed to provide financing through a lease for $957,000, which would have
required the Company to pay $36,000 per month for 30 months commencing with the
installation of the equipment. The balance of $419,000 was payable over a period
of twelve months commencing with the installation of the equipment. The
manufacturer failed to install the equipment and make it functional. In
September 2000, we terminated the agreement and the manufacturer accepted the
equipment returned by us. Accordingly, equipment, capital lease obligation and
accrued costs balances have been adjusted downward by $1,376,000, $957,000 and
$419,000, respectively. We believe that based on our current strategy, return of
the equipment will not impact our current or future operations.
Our capital expenditures for 2001 are expected to range between $110,000 to
$150,000. Based on current plans, management anticipates that the cash on hand
and expected recurring revenues will satisfy the Company's capital requirements
through at least the end of 2001. However, our need for additional capital may
be affected by the outcome of our efforts to reduce our operating expenses as
part of our Restructuring Program. If we are not successful in implementing
certain cost cutting measures, we may need additional financing in 2001 to
continue operations as currently conducted. We have no available standby sources
of financing and there can be no assurance that any additional financing, if
required, will be available to us on acceptable terms, or at all.
16
Item 7. Financial Statements.
The financial statements appear in a separate section of this report
following Part III.
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Information regarding the Company's change in accountants may be found in
the Company's Form 8-K for the event dated January 10, 2001.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act.
The directors and executive officers of the Company are as follows:
Name Age Position
---- --- --------
Stephen J. Cole-Hatchard 43 Chairman of the Board, Chief
Executive Officer and President
Nicko Feinberg 29 Chief Information Officer,
Executive Vice President of Technology
Vasan Thatham 43 Vice President and Chief Financial
Officer
Amy Wagner-Mele 32 Executive Vice President,
Secretary and General Counsel
Ronald C. Signore 40 Director
William A. Barron 51 Director, Interim Vice President and
Chief Operating Officer
Stephen D. Crocker 56 Director
Stephen J. Cole-Hatchard has been our Chairman, Chief Executive Officer and
President since August 1997. Mr. Cole-Hatchard was our Vice President of Finance
from February 1997 to August 1997 and has been one of our directors since
February 1997. Mr. Cole-Hatchard was Chief Financial Officer of Hudson
Technologies, Inc., a refrigerant services company specializing in recovery and
decontamination services, from 1993 to 1996, and has been a licensed attorney
since 1988.
Nicko Feinberg founded our Company in 1995 and has been one of our
directors and our Executive Vice President of Technology since November 1996 and
our Chief Information Officer since August 1997. From April 1994 to October
1996, Mr. Feinberg was a Sales Manager and, from April 1991 to April 1994, a
Sales Account Executive for Microage Computer Outlet, Inc., a company engaged in
computer sales.
17
Vasan Thatham has been our Vice President and Chief Financial Officer since
February 1999. From 1994 through 1998, Mr. Thatham was Vice President and Chief
Financial Officer of Esquire Communications Ltd., a company engaged in providing
legal support services.
Amy Wagner-Mele has been our Executive Vice President and General Counsel
since December 1998 and our Secretary since September 1998, and was our Vice
President, Secretary and Corporate Counsel from September 1998 to December 1998.
From September 1997 to August 1998, Ms. Wagner-Mele was an associate with the
law firm of Winston & Strawn. From 1993 to August 1997, Ms. Wagner-Mele was an
associate with the law firm of Podvey, Sachs, Meanor, Catenacci, Hildner &
Cocoziello, P.C.
Ronald C. Signore has been one of our directors since December 1997. Mr.
Signore has been a partner in the accounting firm of Gray, Signore & Co., LLP
for more than the past five years.
William A. Barron has been one of our directors since January 2000. Prior
to retirement, Mr. Barron served as Vice President and Chief Financial Officer
of Hudson Technologies, Inc. from July 1996 to March 1997. Prior to that, Mr.
Barron was President and Chief Operating Officer for Diagnostek, Inc., a
pharmacy benefit management company, from May 1994 to October 1995 and Executive
Vice President and Chief Financial Officer for Diagnostek, Inc. from March 1993
to April 1994. During February 2001, as part of the Restructuring Program, Mr.
Barron was appointed interim Vice President and Chief Operating Officer of the
Company.
Stephen D. Crocker has been one of our directors since November 2000. Dr.
Crocker is one of the original computer scientists credited with the birth of
the Internet. Dr. Crocker was a member of the group of UCLA scientists that
created ARPANET, and he also invented Requests for Comments (RFC's). In 1994,
Dr. Crocker co-founded CyberCash, Inc., and served as its Chief Technical
Officer from 1994 to 1998. Since 1999, he has served as the President of
Longitude Systems, a company that builds sophisticated modeling, provisioning
and other back office software for Internet service providers.
All directors hold office until the next annual meeting of stockholders for
the ensuing year or until their successors have been duly elected and qualified.
Officers are elected annually by the Board of Directors and serve at the
discretion of the Board.
Item 10. Executive Compensation.
The following table sets forth compensation paid to our Chief Executive
Officer and our three other most highly compensated executive officers (each of
whom was serving at the end of our fiscal year ended December 31, 2000) during
the years ended December 31, 1998, 1999 and 2000, and two former executive
officers who resigned in the fourth quarter of 2000. No other executive officer
of the Company received aggregate compensation which exceeded $100,000 during
the year ended December 31, 2000. We refer to these four executive officers, as
well as the two former executives, as our "Named Executives".
18
Summary Compensation Table
Long-term
Compensation
Awards
Securities
Name and Other Annual Underlying
Principal Position Year Salary Bonus Compensation (1) Options/SAR (#)
Stephen J. Cole-Hatchard 2000 117,692 34,500 25,000
Chief Executive Officer 1999 115,256 0 0 146,000
1998 34,846 0 0 79,000
Nicko Feinberg 2000 110,000 24,500 27,000
Chief Information Officer 1999 108,615 0 0 146,000
1998 79,500 0 0 20,000
Amy Wagner-Mele 2000 110,000 32,000 0 12,000
Executive Vice President 1999 108,615 0 0 26,000
1998 29,169 0 0 75,000
Vasan Thatham 2000 110,000 18,500 12,000
1999 80,769 61,000
Michael Olbermann 2000 93,445 16,500 25,000(a) 2,000
1999 108,615 0 0 146,000
1998 95,100 0 0 20,000
Jodie Jackson 2000 136,791 16,500 26,791(a) 2,000
1999 25,385 51,000
(a) Severance paid.
The following table sets forth information regarding options granted during
the year ended December 31, 2000 to our Named Executives:
Options/SAR Grants in Year Ending December 31,2000
% of Total
Number of Shares Options/SAR
Underlying Granted to Exercise
Options/SARs Employees Price Expiration
Granted in Year ($/share) Date
Stephen J. Cole-Hatchard 25,000 11.28% $ 0.50 11/7/05
Nicko Feinberg 2,000 0.90% $ 1.44 6/1/05
25,000 11.28% $ 0.50 11/7/05
Amy Wagner-Mele 2,000 0.90% $ 1.44 6/1/05
10,000 4.52% $ 0.50 11/7/05
Vasan Thatham 2,000 0.90% $ 1.44 6/1/05
10,000 4.52% $ 0.50 11/7/05
Michael Olbermann 2,000 0.90% $ 1.44 6/1/05
Jodie Jackson 2,000 0.90% $ 1.44 6/1/05
19
All of the options granted were exercisable at December 31, 2000.
The following table sets forth information concerning the number of options
owned by our Named Executives, the value of any in-the-money unexercised options
as of December 31, 2000 and information concerning options exercised by our
Named Executives during the year ended December 31, 2000:
Aggregated Option Exercises
And Year-End Option/SAR Values
Number of Securities
Underlying Value of Unexercised
Shares Unexercised In the money
Acquired Value Options/SAR's Options/SAR's
On Exercise Realized ($) at 12/31/2000 at 12/31/2000
Exercisable Un-exercisable Exercisable Un-exercisable
Stephen J. Cole Hatchard 0 0 249,000 1,000 $ 0 $ 0
Nicko Feinberg 0 0 192,000 1,000 $ 0 $ 0
Amy Wagner-Mele 0 0 97,000 1,000 $ 0 $ 0
Vasan Thatham 0 0 72,000 1,000 $ 0 $ 0
Michael Olbermann 0 0 167,000 1,000 $ 0 $ 0
Jodie Jackson 0 0 52,000 1,000 $ 0 $ 0
The year-end values for unexercised in-the-money options represent the
positive difference between the exercise price of the options and the year-end
market value of our common stock. An option is "in-the-money" if the year-end
fair market value of our common stock exceeds the option exercise price. The
closing sale price of our common stock on December 28, 2000 was $.188. The value
realized represents the positive spread between the exercise price of the
exercised options and the market price of our common stock on the date of
exercise.
Employment Agreements
We have entered into employment agreements with Messrs. Feinberg and
Cole-Hatchard that provide for an annual base compensation of not less than
$88,000 and $45,000, respectively, and such bonuses as the Board of Directors
may, in its sole discretion, from time to time determine. We entered into an
employment agreement with Amy Wagner-Mele pursuant to which Ms. Wagner-Mele
agreed to serve as Corporate Counsel at a salary of not less than $98,000 per
annum. The employment agreements with Messrs. Feinberg and Cole-Hatchard expire
in August 2001, and the employment agreement with Ms. Wagner-Mele expires in
September 2001. All are subject to automatic successive one year
20
renewals unless either we or the employee gives notice of intention not to renew
the agreement. With the exception of Mr. Cole-Hatchard, the employment
agreements provide for employment on a full-time basis and contain a provision
that the employee will not compete or engage in a business competitive with our
current or anticipated business during the term of the employment agreement and
for a period of two years thereafter. We have entered into a month-to-month
employment agreement with Mr. Thatham that provides for a base salary at a rate
of $95,000 per year.
All of the employment agreements provide for each of the employees to be
paid additional compensation equal to 295% of their annual base salary in the
event of a change of ownership or effective control of our company (as defined
in the agreements). In November 2000, the employment agreements with Messrs.
Olbermann and Jackson were terminated by mutual agreement.
1997 Stock Option Plan
In February 1997, our Board of Directors and stockholders adopted our 1997
Stock Option Plan, pursuant to which 500,000 shares of common stock were
reserved for issuance upon exercise of options. In June 2000, the Board of
Directors and our stockholders approved an amendment to increase to 2,000,000
the number of shares of common stock available for issuance upon exercise of
options under the stock option plan. Our stock option plan is designed to serve
as an incentive for retaining qualified and competent employees, directors and
consultants.
Our Board of Directors or a committee of our Board administers our stock
option plan and is authorized, in its discretion, to grant options under our
stock option plan to all eligible employees, including our officers, directors
(whether or not employees) and consultants. Our stock option plan provides for
the granting of both "incentive stock options" (as defined in Section 422 of the
Internal Revenue Code of 1986, as amended) and non-qualified stock options.
Options can be granted under our stock option plan on such terms and at such
prices as determined by the Board of Directors or its committee, except that the
per share exercise price of options will not be less than the fair market value
of the common stock on the date of grant. In the case of an incentive stock
option granted to a stockholder who owns stock possessing more than 10% of the
total combined voting power of all of our classes of stock, the per share
exercise price will not be less than 110% of the fair market value on the date
of grant. The aggregate fair market value (determined on the date of grant) of
the shares covered by incentive stock options granted under our stock option
plan that become exercisable by a grantee for the first time in any calendar
year is subject to a $100,000 limit.
Options granted under our stock option plan will be exercisable during the
period or periods specified in each option agreement. Options granted under our
stock option plan are not exercisable after the expiration of 10 years from the
date of grant (five years in the case of incentive stock options granted to a
stockholder owning stock possessing more than 10% of the total combined voting
power of all of our classes of stock) and are not transferable other than by
will or by the laws of descent and distribution.
Item 11. Security Ownership of Certain Beneficial Owners and Management.
The following table sets forth certain information, as of March 15, 2001
relating to the beneficial ownership of shares of Common Stock by: (i)
21
each person or entity who is known by the Company to own beneficially five
percent or more of the outstanding Common Stock; (ii) each of the Named
Executives; (iii) each of the Company's directors; and (iv) all directors and
executive officers of the Company as a group.
Unless otherwise indicated, the address of each beneficial owner is care of
Frontline Communications Corporation, One Blue Hill Plaza, 7th Floor, Pearl
River, New York 10965. Unless otherwise indicated, we believe that all persons
named in the following table have sole voting and investment power with respect
to all shares of common stock that they beneficially own.
Number of
Name of Beneficial Owner Beneficially Owned (1) Percentage
Nicko Feinberg 454,000 (2) 6.6%
Stephen J. Cole-Hatchard 511,510 (3) 7.4%
Ronald Signore 119,864 (4) 1.8%
William Barron 39,680 (5) 0.6%
Steve Crocker 25,000 (6) 0.4%
Amy Wagner-Mele 103,000 (7) 1.5%
Vasan Thatham 78,000 (8) 1.2%
As Directors and Executive
Officers as a group (seven persons) 1,331,054 (9) 17.8%
(1) The Company believes that all persons named in the table have sole
voting and investment power with respect to all shares of Common Stock
beneficially owned by them.
(2) Includes options to purchase 192,000 shares of Common Stock.
(3) Includes 144,000 shares held by the Cole-Hatchard Family Limited
Partnership, of which Mr. Cole-Hatchard is a general partner, options to
purchase 249,000 shares of Common Stock and 5,150 shares of Series B convertible
into 17,510 shares of Common Stock. Does not include 20,000 shares held by Mr.
Cole-Hatchard's mother and brother and warrants to purchase 64,000 shares held
by Mr. Cole-Hatchard's mother.
(4) Includes warrants to purchase 41,664 shares of Common Stock and options
to purchase 75,000 shares of Common Stock.
(5) Includes options to purchase 35,000 shares of Common Stock and 200
Shares of Series B Preferred convertible into 680 shares of Common Stock.
(6) Includes options to purchase 25,000 shares of Common Stock.
(7) Includes options to purchase 97,000 shares of Common Stock.
(8) Includes options to purchase 72,000 shares of Common Stock.
(9) Includes options and warrants to purchase 625,664 shares of Common
Stock and 5,350 shares of Series B Preferred convertible into 18,190 shares of
Common Stock.
Item 12. Certain Relationships and Related Transactions.
In May 1997, Messrs. Nicko Feinberg and Stephen J. Cole-Hatchard, two of
our current officers and directors, and Mr. Michael Char, a former
22
officer and director, exchanged their interests in the three predecessor
companies to whose business we succeeded for promissory notes in the principal
amounts of $141,800, $66,800 and $163,537. This indebtedness included $21,737
and $35,000 of advances previously made to us by Messrs. Char and Cole-Hatchard.
The promissory notes were issued to Messrs. Feinberg, Char and Cole-Hatchard in
partial consideration of their efforts in founding the predecessor companies. In
May 1998, we repaid all outstanding indebtedness to Mr. Char and $20,000 of
indebtedness to each of Messrs. Cole-Hatchard and Feinberg. The balance of
indebtedness owed to Messrs. Cole-Hatchard and Feinberg of $46,800 and $121,800
bears interest at the rate of 8% per annum and is payable on demand.
In August 1998, Mr. Cole-Hatchard borrowed $46,800 from us, evidenced by a
demand promissory note bearing interest at the rate of 8% per annum.
In September 1998, Mr. Feinberg borrowed $55,000 from us, evidenced by a
demand promissory note bearing interest at the rate of 8% per annum. In October
1998 and January 1999, Mr. Feinberg borrowed an additional $42,000 and $24,800
from us on the same terms.
In June 1999, Amy Wagner-Mele, an officer of the Company, exercised options
to purchase 15,000 shares of our common stock pursuant to our stock option plan
with a secured promissory note in the principal amount of $37,500. In December
2000, the Board of Directors agreed to repurchase the 15,000 shares held by Ms.
Wagner-Mele for the sum of $37,500, which sum was utilized to satisfy all
amounts due and owing under the note. The fair market value of the shares
repurchased was $3,750.
In, 1999, the Company's Board of Directors passed a resolution whereby
$168,000 of notes payable to Messrs. Cole-Hatchard and Feinberg were offset with
$168,000 of notes receivable from these same stockholders.
Item 13. Exhibits, Lists and Reports on Form 8-K.
(a) Exhibits
3.1 Certificate of Incorporation of the Company.+
3.2 Certificate of Amendment of the Certificate of Incorporation of
the Company.++++++
3.3 Certificate of Amendment of the Certificate of Incorporation of
the Company.*
3.4 By-Laws of the Company.+
4.1 Certificate of Designation of Series A preferred stock.++
4.2 Certificate of Designation of Series B preferred stock.*
10.1 Employment Agreements with Messrs. Stephen Cole-Hatchard, Nicko
Feinberg and Michael Olbermann.+
10.2 Employment Agreement with Amy Wagner-Mele.*
23
10.3 Employment Agreement with Vasan Thatham.*
10.4 Employment Agreement with Jodie L. Jackson.*
10.5 Stock Purchase Agreement dated as of October 1, 1998 by and
among the Company, WOWFactor, Inc. and the WOWFactor, Inc.
stockholders.++
10.6 Form of Registration Rights Agreement among the Company and the
WOWFactor, Inc. Stockholders.++
10.7 Letter Offer to Purchase Substantially all of the Assets of US
Online, Inc.+++
10.8 Asset Purchase Agreement dated as of November 24, 1998 by and
among the Company, Webspan, and the sole stockholder of
Webspan.++++
10.9 Amendment to Asset Purchase Agreement dated December 17, 1998 by
and among the Company, Webspan, and the sole stockholder of
Webspan.++++
10.10 Form of Registration Rights Agreement among the Company and the
sole stockholder of Webspan.++++
10.11 1997 Stock Option Plan of the Company.+
10.12 Stock Purchase Agreement dated March 25, 1999.+++++
10.13 Registration Rights Agreement dated March 25, 1999.+++++
10.14 Stock Purchase Agreement dated as of July 8, 1999.*
10.15 Registration Rights Agreement dated July 8, 1999.*
10.16 Stock Purchase Agreement dated as of October 7, 1999.*
10.17 Registration Rights Agreement dated as of October 7, 1999.*
10.18 Stock Purchase Agreement dated as of December 10, 1999.*
10.19 Registration Rights Agreement dated as of December 10, 1999.*
10.20 Office Lease between Registrant and Glorious Sun Robert Martin
LLC.+
10.21 Amendment No. 1 to Office Lease.*
10.22 Amendment No. 2 to Office Lease.*
10.23 Promissory Note of Amy Wagner-Mele dated as of June 1, 1999.*
10.24 Underwriting Agreement dated February 7, 2000 by and between the
Company and Prime Charter, Ltd.*
24
10.25 Asset Purchase Agreement dated June 20, 2000 among Frontline
Communications Corp., Delanet, Inc., Michael Brown and Donald
McIntire.**
21.1 Subsidiaries of the Company.
23.1 Consent of Goldstein Golub and Kessler LLP.
23.2 Consent of BDO Seidman, LLP.
(Footnotes from previous page)
- --------------
* Incorporated by reference to the applicable exhibit contained in the
Company's Registration Statement on Form SB-2 (file no.333-92969).
+ Incorporated by reference to the applicable exhibit contained in the
Company's Registration Statement on Form SB-2 (file no. 333-34115).
++ Incorporated by reference to the applicable exhibit contained in the
Company's Current Report on Form 8-K dated October 9, 1998.
+++ Incorporated by reference to the applicable exhibit contained in the
Company's Current Report on Form 8-K dated October 23, 1998.
++++ Incorporated by reference to the applicable exhibit contained in the
Company's Current Report on Form 8-K dated December 17, 1998.
+++++ Incorporated by referenced to the applicable exhibit contained in the
Company's Annual Report on Form 10-KSB for the year ended December 31, 1998.
++++++ Incorporated by reference to the applicable exhibit contained in the
Company's Quarterly Report on Form 10-QSB for the quarterly period ended June
30, 1999.
** Incorporated by reference to the applicable exhibit contained in the
Company's Current Report on Form 8-K dated June 20, 2000.
(b) Reports on Form 8-K filed during the quarter ended December 31, 2000:
Not applicable.
25
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly signed this report on its behalf
by the undersigned, thereunto duly authorized on the 28th day of March 2001.
FRONTLINE COMMUNICATIONS CORPORATION
By: /S/ Stephen J. Cole-Hatchard
-------------------------------------------------
Stephen J. Cole-Hatchard, Chief Executive Officer
In accordance with the requirements of the Securities Exchange Act of 1934,
this report was signed by the following persons in the capacities and on the
dates stated.
Signature Title Date
/s/ STEPHEN J. COLE HATCHARD Chief Executive Officer, President, March 28, 2001
---------------------------- and Director (Principal Executive Officer)
Stephen J. Cole-Hatchard
/s/ NICKO FEINBERG Chief Information Officer, Executive March 28, 2001
------------------- Vice President of Technology and Director
Nicko Feinberg
/s/ VASAN THATHAM Chief Financial Officer March 28, 2001
------------------ Executive Vice President
Vasan Thatham
/s/ AMY WAGNER-MELE Executive Vice President, Secretary March 28, 2001
-------------------- and General Counsel
Amy Wagner-Mele
/s/ STEPHEN D. CROCKER Director March 28, 2001
----------------------
Stephen D. Crocker
/s/ RONALD C. SIGNORE Director March 28, 2001
----------------------
Ronald C. Signore
/s/ WILLIAM A. BARRON Director March 28, 2001
---------------------
William A. Barron
26
FRONTLINE COMMUNICATIONS
CORPORATION AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Independent Auditors' Reports F-1 - F-2
Consolidated Financial Statements:
Balance Sheet F-3
Statement of Operations F-4
Statement of Stockholders' Equity F-5
Statement of Cash Flows F-6 - F-7
Notes to Consolidated Financial Statements F-8 - F-19
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
Frontline Communications Corporation
We have audited the accompanying consolidated balance sheet of Frontline
Communications Corporation and Subsidiaries (the "Company") as of December 31,
2000 and the related consolidated statements of operations, stockholders'
equity, and cash flows for the year then ended. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the Company
as of December 31, 2000, and the results of its operations and its cash flows
for the year then ended, in conformity with accounting principles generally
accepted in the United States of America.
/s/ Goldstein Golub Kessler LLP
GOLDSTEIN GOLUB KESSLER LLP
New York, New York
February 28, 2001
F-1
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Frontline Communications Corporation
We have audited the consolidated statements of operations, stockholders' equity
and cash flows of Frontline Communications Corporation and subsidiaries for the
year ended December 31, 1999. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of operations of Frontline
Communications Corporation and its cash flows for the year ended December 31,
1999, in conformity with accounting principles generally accepted in the United
States of America.
BDO Seidman, LLP
New York, New York
February 25, 2000
F-2
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
--------------------------------------------------------------------------------
December 31, 2000
--------------------------------------------------------------------------------
ASSETS
Current:
Cash and cash equivalents $ 781,082
Marketable securities 1,808,210
Accounts receivable, less
allowances for doubtful
accounts of $251,587 576,824
Prepaid expenses and other 126,698
---------------------------------------------------------------
Total current assets 3,292,814
Property and Equipment, net 2,041,010
Intangibles, net 5,623,154
Other 116,090
---------------------------------------------------------------
Total Assets $ 11,073,068
===============================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 668,052
Accrued expenses 1,756,727
Current portion of long-term debt 363,027
Deferred revenue 1,090,204
---------------------------------------------------------------
Total current liabilities 3,878,010
Long-term Debt, less current portion 1,438,459
---------------------------------------------------------------
Total liabilities 5,316,469
---------------------------------------------------------------
Commitments and Contingencies
Stockholders' Equity:
Preferred stock - $.01 par value;
authorized 2,000,000 shares, issued and
outstanding 597,800 shares (liquidation
preference of $8,967,000) 5,978
Common stock - $.01 par value; authorized
25,000,000 shares, issued 7,164,793 shares 71,648
Additional paid-in capital 35,570,119
Accumulated deficit (29,030,607)
---------------------------------------------------------------
6,617,138
Treasury stock, at cost, 609,846 shares (860,539)
---------------------------------------------------------------
Stockholders' equity 5,756,599
---------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 11,073,068
===============================================================
See Notes to Consolidated Financial Statements
F-3
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
------------------------------------------------------------------------------------------------
Year ended December 31, 2000 1999
------------------------------------------------------------------------------------------------
Revenue $ 5,327,316 $ 2,975,213
------------------------------------------------------------------------------------------------
Costs and expenses:
Cost of revenue 3,260,799 2,015,824
Selling, general and administrative 8,583,548 5,235,711
Depreciation and amortization 3,618,041 1,764,373
Impairment of intangibles 2,285,269 --
Noncash compensation charge 63,095 754,220
------------------------------------------------------------------------------------------------
17,810,752 9,770,128
------------------------------------------------------------------------------------------------
Loss from operations (12,483,436) (6,794,915)
Other income (expense):
Interest income 408,356 82,411
Interest expense (160,375) (44,754)
------------------------------------------------------------------------------------------------
Net loss (12,235,455) (6,757,258)
Beneficial conversion feature of Series B preferred stock 5,856,497 --
Preferred dividends 337,750 --
------------------------------------------------------------------------------------------------
Net loss available to common shareholders $(18,429,702) $ (6,757,258)
================================================================================================
Loss per share - basic and diluted $ (3.25) $ (1.90)
================================================================================================
Weighted-average number of shares outstanding - basic and diluted 5,676,129 3,550,231
================================================================================================
See Notes to Consolidated Financial Statements
F-4
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
--------------------------------------------------------------------------------
Years ended December 31, 2000 and 1999
Additional
Preferred Stock Common Stock Paid-in
Shares Amount Shares Amount Capital
--------- --------- --------- --------- ------------
Balance at December 31, 1998 10 -- 3,361,364 $ 33,614 $ 9,121,533
Private sale of common stock and
related repricing -- -- 739,605 7,396 3,787,604
Common stock issued to acquire businesses -- -- 120,039 1,200 1,126,901
Exercise of stock options and warrants -- -- 158,616 1,586 358,334
Conversion Series A preferred stock (10) -- 98,462 985 (985)
Common stock options and common stock issued
for services -- -- 5,974 60 754,160
Net loss -- -- -- -- --
-----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 -- -- 4,484,060 44,841 15,147,547
Public offering of Series B preferred stock, net 1,137,300 $ 11,373 -- -- 14,392,187
Purchase of treasury stock, at cost
(378,326 shares) -- -- -- -- --
Common stock issued for services -- -- 9,094 91 29,254
Exercise of stock options and warrants -- -- 2,500 25 --
Conversion of Series B preferred stock (539,500) (5,395) 1,834,300 18,343 (12,948)
Beneficial conversion feature of Series B
preferred stock -- -- -- -- 5,856,497
Dividends on preferred stock -- -- -- -- --
Payments for repricing rights -- -- 465,961 4,659 (470,019)
Common stock issued to acquire businesses -- -- 368,878 3,689 627,601
Net loss -- -- -- -- --
-----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 597,800 $ 5,978 7,164,793 $ 71,648 $ 35,570,119
=============================================================================================================================
Accumulated Stock, Note Equity
Deficit at Cost Receivable (Deficiency)
------------ ---------- ---------- -------------
Balance at December 31, 1998 $ (3,843,647) $ (264,113) -- $ 5,047,387
Private sale of common stock and
related repricing -- -- -- 3,795,000
Common stock issued to acquire businesses -- -- -- 1,128,101
Exercise of stock options and warrants -- -- $ (37,500) 322,420
Conversion Series A preferred stock -- -- -- --
Common stock options and common stock issued
for services -- -- -- 754,220
Net loss (6,757,258) -- -- (6,757,258)
------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 (10,600,905) (264,113) (37,500) 4,289,870
Public offering of Series B preferred stock, net -- -- -- 14,403,560
Purchase of treasury stock, at cost
(378,326 shares) -- (596,426) 37,500 (558,926)
Common stock issued for services -- -- -- 29,345
Exercise of stock options and warrants -- -- -- 25
Conversion of Series B preferred stock -- -- -- --
Beneficial conversion feature of Series B
preferred stock (5,856,497) -- -- --
Dividends on preferred stock (337,750) -- -- (337,750)
Payments for repricing rights -- -- -- (465,360)
Common stock issued to acquire businesses -- -- -- 631,290
Net loss (12,235,455) -- -- (12,235,455)
------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 $(29,030,607) $ (860,539) $ - 0 - $ 5,756,599
==================================================================================================================
See Notes to Consolidated Financial Statements
F-5
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
--------------------------------------------------------------------------------------
Year ended December 31, 2000 1999
--------------------------------------------------------------------------------------
Cash flows from operating activities:
Net loss $(12,235,455) $ (6,757,258)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 3,618,041 1,764,373
Noncash compensation charge 63,095 754,220
Impairment of intangibles 2,285,269 --
Allowance for doubtful accounts -- 81,429
Changes in operating assets and liabilities,
net of effects from acquisitions:
Increase in marketable securities (1,808,210) --
Increase in accounts receivable (83,540) (366,438)
Increase in notes receivable from stockholders -- (24,800)
Increase in prepaid expenses and other (4,390) (64,027)
Increase in other assets (7,352) (267,556)
Increase in accounts payable and accrued expenses 120,973 1,234,117
Decrease in deferred revenue (127,328) (12,658)
--------------------------------------------------------------------------------------
Net cash used in operating activities (8,178,897) (3,658,598)
--------------------------------------------------------------------------------------
Cash flows from investing activities:
Acquisition of property and equipment (353,727) (915,411)
Acquisition of businesses, net of cash acquired (3,767,447) (816,228)
--------------------------------------------------------------------------------------
Net cash used in investing activities (4,121,174) (1,731,639)
--------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from exercise of stock options and warrants -- 322,420
Proceeds from sale of common stock -- 3,795,000
Principal payments on long-term debt (735,839) (106,704)
Proceeds from public offering of preferred stock 14,597,588 --
Payments for repricing rights (465,360) --
Dividends paid (337,750) --
Payments to acquire treasury stock (592,676) --
--------------------------------------------------------------------------------------
Net cash provided by financing activities 12,465,963 4,010,716
--------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 165,892 (1,379,521)
Cash and cash equivalents at beginning of year 615,190 1,994,711
--------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 781,082 $ 615,190
======================================================================================
Supplemental disclosure of cash flow information:
Cash paid for interest $ 160,375 $ 44,639
======================================================================================
(continued)
See Notes to Consolidated Financial Statements
F-6
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
--------------------------------------------------------------------------------
Year ended December 31, 2000 1999
-------------------------------------------------------------------------------------
Supplemental schedule of noncash investing
and financing activities:
Common stock issued (returned) for stockholder loan $ (37,500) $ 37,500
=====================================================================================
Capital lease obligations incurred $ 127,747 $ 1,432,568
=====================================================================================
Termination of capital lease:
Equipment returned $ 1,376,037 --
=====================================================================================
Capital lease obligation $ 957,327 --
=====================================================================================
Accrued expenses $ 418,710 --
=====================================================================================
Common stock issued to acquire businesses $ 631,290 $ 1,128,101
=====================================================================================
Notes payable to stockholders offset
with notes receivable from stockholders -- $ 168,600
=====================================================================================
Notes payable issued in connection
with business acquisitions $ 1,093,857 $ 425,000
=====================================================================================
See Notes to Consolidated Financial Statements
F-7
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Frontline Communications Corporation ("Frontline" or the "Company") is
an Internet company that offers Internet access, Web site development and
Internet presence services.
The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. Intercompany balances and
transactions have been eliminated.
In preparing the consolidated financial statements in conformity with
generally accepted accounting principles, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the
date of the consolidated financial statements, and the reported amount of
revenue and expenses during the reporting period. Actual results could
differ from those estimates. Many of the Company's estimates and
assumptions used in the financial statements are related to the Company's
industry which is subject to rapid technological change. It is reasonably
possible that changes may occur in the near term that would affect
management's estimates with respect to the carrying values of property and
equipment and intangibles.
Monthly subscription service revenue for Internet access is recognized
over the period in which services are provided. Fee revenue for Web site
development and Internet Web site presence services are recognized as
services are performed. Deferred revenue represents prepaid access fees by
subscribers.
Property and equipment is stated at cost, less accumulated
depreciation and amortization. Depreciation and amortization is computed
over the estimated useful lives of the assets using the straight-line
method.
The following estimated useful lives are applied in the computation of
depreciation and amortization:
Years
------------------------------------------------------------------------
Computer and office equipment 3 to 5
Furniture and fixtures 5
Leasehold improvements Lease term
------------------------------------------------------------------------
Intangible assets include goodwill (the excess of the cost of
purchased businesses over the fair value of the net assets acquired) and
purchased customer bases. Amortization is computed using the straight-line
basis over three years, the expected benefit period.
Long-lived assets, such as property and equipment, intangibles and
customer bases, are evaluated for impairment when events or changes in
circumstances indicate that the carrying amount of the assets may not be
recoverable through the estimated undiscounted future cash flows from the
use of these assets. When any such impairment exists, the related assets
will be written down to fair value. During the year ended December 31,
2000, goodwill and purchased customer bases were written down by $2,285,269
due to impairment of such assets. No write-down was necessary for the year
ended December 31, 1999.
F-8
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Deferred income taxes are provided on differences between the
financial reporting and income tax bases of assets and liabilities based
upon statutory tax rates enacted for future periods. Valuation allowances
are established when necessary to reduce deferred tax assets to the amount
expected to be realized.
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of temporary cash
investments, marketable securities and trade accounts receivable. The
Company's cash investments are placed with high credit quality financial
institutions and may, at times, exceed the amount of federal deposit
insurance. Concentrations of credit risk with respect to trade receivables
are limited due to the large number of customers comprising the Company's
customer base.
The Company considers all highly liquid money market instruments
purchased with an original maturity of three months or less to be cash
equivalents.
Statement of Financial Accounting Standards ("SFAS") No. 123,
Accounting for Stock-Based Compensation, establishes a fair value method
for accounting for stock-based compensation plans either through
recognition or disclosure. The Company adopted the employee stock-based
compensation provisions of SFAS No. 123 by disclosing the pro forma net
income and pro forma net income or loss per share amounts assuming the fair
value method. Stock arrangements with nonemployees, if applicable, are
recorded at fair value.
All costs associated with advertising services are expensed in the
period incurred. Advertising expense was approximately $840,000 and
$282,000 for the years ended December 31, 2000 and 1999, respectively.
The Company follows SFAS No. 128, Earnings per Share, which provides
for the calculation of "basic" and "diluted" earnings per share ("EPS").
Basic EPS includes no dilution and is computed by dividing income or loss
available to common shareholders by the weighted-average number of common
shares outstanding for the period. Diluted earnings per share reflect the
potential dilution that could occur through the effect of common shares
issuable upon exercise of stock options and warrants and convertible
securities. Potential common shares have not been included in the
computation of diluted EPS since the effect would be antidilutive.
The Company does not believe that any recently issued, but not yet
effective, accounting standards, if currently adopted, will have a material
effect on the Company's consolidated financial position, results of
operations or cash flows.
2. ACQUISITION OF BUSINESSES:
At December 31, 2000, intangibles were as follows:
Customer
Goodwill Bases Total
----------------------------------------------------------------------------------------
Intangibles $ 723,645 $ 6,136,759 $ 6,860,404
Less accumulated amortization (60,304) (1,176,946) (1,237,250)
----------------------------------------------------------------------------------------
$ 663,341 $ 4,959,813 $ 5,623,154
========================================================================================
F-9
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
During 2000, the Company acquired substantially all of the assets of The
PressRoom Online Services, Application Resources Information Services, Inc.
d/b/a Way Communication, The First Street Corporation, Wizardnet, Inc. (all
Internet service providers) and PNM Group, Inc., a web development company.
The aggregate consideration for these acquisitions consisted of
approximately $1,694,000 cash (including transaction-related costs),
168,878 shares of common stock (approximately $369,000) and $365,000 in
promissory notes. In addition, if certain performance criteria are met
during the 24-month period ending October 31, 2002, the former stockholders
of PNM Group Inc. are entitled to a contingent payment of up to $800,000 in
cash and promissory notes.
During 2000, the Company also acquired substantially all of the assets of
Delanet, Inc. ("Delanet"), an Internet service provider, in consideration
of $2,100,000 in cash (including transaction-related costs), assumption of
approximately $1,354,000 of liabilities, 200,000 shares of common stock
(approximately $321,000) and promissory note in the principal amount of
approximately $729,000. This acquisition resulted in the recording of
approximately $4,034,000 of intangible assets.
All of the 2000 acquisitions were accounted for using the purchase method
of accounting with the results of operations of each acquisition included
in the consolidated financial statements from the respective acquisition
date. The acquisitions resulted in the recording of intangibles of
approximately $6,802,000 and are being amortized over the expected benefit
period of three years.
A summary of the assets acquired, liabilities assumed and the resulting
intangible assets are as follows:
Purchase price $5,299,000
Acquisition costs 220,000
--------------------------------------------------------------------------
5,519,000
--------------------------------------------------------------------------
Assets acquired 733,000
Liabilities assumed 2,016,000
--------------------------------------------------------------------------
1,283,000
--------------------------------------------------------------------------
Intangible assets $6,802,000
==========================================================================
During 1999, the Company completed the following acquisitions:
WebPrime, Inc. ("Webprime"), a Web site design, web development and
software development firm; Channel iShop.com (now iShopNetworks.com)
("I-Shop"), a company with a marketing concept targeting retail businesses
(disposed in 2001 - see Note 11); assets relating to the dial-up Internet
access customer base and web design and hosting capabilities of United
Computer Specialists, Inc. ("UCS"); a customer base of additional DSL
customers of Lingua Systems, Inc. d/b/a/ Fullwave Networks; a customer base
of additional dial-up customers of Skyhigh Information Technologies
("Skyhigh"); and Fronthost, LLC, a company in the business of providing web
hosting and design services. The aggregate consideration for these
acquisitions consisted of $478,000 cash (including
F-10
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
transaction-related costs), 120,039 shares of common stock (approximately
$1,128,000) and $425,000 in noninterest-bearing promissory notes.
All of the 1999 acquisitions were accounted for using the purchase
method of accounting with the results of operations of each acquisition
included in the consolidated financial statements from the respective
acquisition date. The acquisitions resulted in the recording of intangible
assets of approximately $2,081,000, which are being amortized over their
expected benefit period of three years.
During the year ended December 31, 2000, due to changes in
circumstances, the Company determined that the carrying amount of
intangible assets of WoWFactor(TM), Inc., Magic Carpet, US Online, Inc.,
Webprime, I-Shop, Skyhigh, Way and First Street was impaired. Accordingly,
the Company recorded an impairment charge of approximately $2,300,000 on
these assets.
The following pro forma consolidated financial information has been
prepared to reflect the 2000 and 1999 acquisitions. The pro forma financial
information is based on the historical financial statements of the Company
and those of the acquired businesses. The accompanying pro forma operating
statements are presented as if the acquisitions occurred on January 1,
1999. The pro forma financial information is unaudited and is not
necessarily indicative of what the actual results of operations of the
Company would have been assuming the acquisitions had been completed as of
January 1, 1999, and neither is it necessarily indicative of the results of
operations for future periods.
Year ended December 31, 2000 1999
----------------------------------------------------------------------------
Revenue $ 7,606,595 $ 6,307,608
Net loss (19,676,989) (9,699,774)
Net loss per share - basic and diluted (3.35) (2.48)
----------------------------------------------------------------------------
The above unaudited pro forma consolidated financial information has been
adjusted to reflect amortization of intangibles as generated by the
acquisitions over a three-year period.
3. MARKETABLE SECURITIES:
The Company accounts for marketable securities under the provisions of
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities. The Company has classified its
entire investment portfolio as trading securities. Trading securities are
stated at fair value with unrealized gains and losses included in the
statement of operations. The cost of securities is based on the
specific-identification method. Unrealized gains and losses are not
material at December 31, 2000. Quoted market prices have been used in
determining the fair value of these investments. Trading securities at
December 31, 2000 consisted of U.S. government obligations, maturing within
one year, with a fair value at $1,808,210.
F-11
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
4. PROPERTY AND EQUIPMENT:
Property and equipment consists of the following:
December 31, 2000
------------------------------------------------------------------------------
Computer and office equipment $2,786,073
Furniture and fixtures 81,806
Leasehold improvements 206,372
------------------------------------------------------------------------------
3,074,251
Less accumulated depreciation and amortization (1,033,241)
------------------------------------------------------------------------------
$2,041,010
==============================================================================
5. ACCRUED EXPENSES:
Accrued expenses consist of the following:
Accrued Internet connection and telephone $ 450,899
Lease cancellations and related costs 406,330
Accrued equipment installation costs 235,988
Accrued professional fees 213,564
Accrued wages and salaries 157,591
Other 292,355
------------------------------------------------------------------------------
$1,756,727
==============================================================================
6. LONG-TERM DEBT:
Long-term debt consists of the following:
Present value of net minimum lease payments (a) $ 687,979
Promissory notes payable (b) 1,044,892
Mortgage payable (c) 68,615
------------------------------------------------------------------------------
1,801,486
------------------------------------------------------------------------------
Less:
Current portion of present value of net minimum lease payments 346,035
Current portion of mortgage and promissory notes payable 16,992
------------------------------------------------------------------------------
363,027
------------------------------------------------------------------------------
$1,438,459
==============================================================================
(a) The Company leases computer and other equipment under capital leases. The
assets acquired under capital leases have a cost of approximately
$1,281,000 and accumulated depreciation of approximately $340,000 as of
December 31, 2000.
F-12
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
The following is a schedule of future minimum lease payments under
capitalized leases, together with the present value of the net minimum
lease payments at December 31, 2000.
Payments for the year ending:
2001 $432,420
2002 271,239
2003 112,798
2004 3,543
----------------------------------------------------
Total minimum lease payments 820,000
Less amount representing interest 132,021
----------------------------------------------------
Present value of net minimum lease payments 687,979
Less current portion 346,035
----------------------------------------------------
Long-term lease obligations $341,944
====================================================
(b) Promissory notes, issued as part of business acquisition costs, are made up
of the following:
i. A noninterest-bearing promissory note having a balance of $16,292,
consisting of three remaining monthly payments of $5,431 each, ending
in March 2001.
ii. A promissory note in the principal amount of $728,600. The promissory
note bears interest at 4% and is payable in June of 2003. The Company
has the option to convert the principal amount due under the
promissory note to shares of its common stock at a conversion price of
$8 per share (significantly greater than the market value of the
common stock at the acquisition date), under certain circumstances, as
defined in the acquisition agreement.
iii. A promissory note in the principal amount of $300,000. The promissory
note bears interest at 3% and is payable in September of 2003. The
Company has the option of converting the principal amount due under
the promissory note to shares of its common stock at a conversion
price of $6 per share (significantly greater than the market value of
the common stock at the acquisition date), under certain
circumstances, as defined in the acquisition agreement.
(c) Mortgage payable, secured by property, payable in equal monthly
installments of $514, including interest at 8% per year, through September
2003, with the balance of approximately $66,500 due September 2003.
Maturities of long-term debt are as follows:
Year ending December 31,
2001 $ 363,027
2002 234,920
2003 1,200,103
2004 3,436
-----------------------------
$1,801,486
=============================
The carrying amount of the Company's long-term debt approximates fair
value using the Company's estimated incremental borrowing rate.
F-13
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In 1999, the Company purchased equipment in the aggregate amount of
$1,376,000 from a major telecommunications manufacturer. The manufacturer
had agreed to install, test and provide support to make the equipment
functional. The manufacturer had agreed to provide financing through a
lease for $957,000 which would have required the Company to pay $36,000 per
month for 30 months commencing with the installation of the equipment. The
balance of $419,000 was payable over a period of 12 months from
installation of the equipment. The manufacturer failed to install the
equipment and make it functional. In September 2000, the Company terminated
the agreement and the manufacturer has accepted equipment returned by the
Company. Accordingly, equipment, capital lease obligation and accrued cost
balances have been reduced by $1,376,000, $957,000 and $419,000,
respectively. The management believes that, based on the Company's current
strategy, return of the equipment will not impact its current or future
operations.
7. COMMITMENTS AND CONTINGENCIES:
The Company rents office space and equipment under operating lease
agreements expiring at various dates through 2005.
Future minimum rental payments required under operating leases are
approximately as follows:
2001 $ 509,000
2002 472,000
2003 417,000
2004 278,000
2005 12,000
----------
$1,688,000
==========
Rental expense was approximately $409,000 and $248,000 for the years ended
December 31, 2000 and 1999, respectively.
The Company has entered into three-year employment agreements with certain
officers and employees which provide for aggregate annual base compensation
of approximately $429,000, and such bonuses as the board of directors may,
in its sole discretion, from time to time determine. These employment
agreements expire through September 2001.
In connection with the Company's lease for its main office space, the
Company has opened an irrecoverable letter of credit with a bank for
approximately $65,000 in lieu of a security deposit.
The Company is involved in various claims and legal actions arising from
the ordinary course of business. The Company's management is of the opinion
that the ultimate outcome of these matters would not have a material
adverse impact on the financial position of the Company.
F-14
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
8. STOCK OPTIONS:
The Company has a stock option plan (the "Plan"), which authorizes the
issuance of incentive options and nonqualified options to purchase up to
2,000,000 shares of common stock. The Plan has a 10-year term. The Board
retained the authority to determine the individuals to whom, and the times
at which, stock options would be granted, along with the number of shares,
vesting schedule and other provisions related to the stock options.
The Company applies Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations by recording
compensation expense for the excess of fair market value over the
exercisable price per share, as of the date of the grant, in accounting for
its stock options. During 1999, the Company granted to certain employees
options to purchase an aggregate amount of 179,768 shares of its common
stock, which required shareholder approval prior to its issuance. The
shareholders approved the issuance in June 1999 and, accordingly, the
approval date is deemed to be the grant date at which date the aggregate
fair value of these shares exceeded the fair value at the date of issuance
by $365,104. The noncash compensation charge of $754,220 includes the
$365,104 and $389,116 representing the fair value of services received by
the Company in exchange for stock options and warrants granted and shares
of common stock issued to consultants.
SFAS No. 123 requires the Company to provide pro forma information
regarding net loss and net loss per share as if compensation cost for the
Company's stock options had been determined in accordance with the fair
value-based method prescribed in SFAS No. 123. The Company estimates the
fair value of each stock option at the date of the grant using the Black
Scholes option-pricing model with the following weighted-average
assumptions used for options in 2000 and 1999:
2000 1999
-------------- --------------
Risk-free interest rate 5.78% to 7.15% 4.50% to 6.14%
Expected life 5 years 5 years
Expected volatility 168.7% 97.50%
Dividend yield None None
Under the accounting provisions of SFAS No. 123, the Company's net loss and
loss per share would have been increased to the pro forma amounts indicated
below:
2000 1999
-------------- --------------
Net loss available to common shareholders:
As reported $ (18,429,702) $ (6,757,258)
Pro forma (19,858,249) (9,575,653)
Net loss per share (basic and diluted):
As reported (3.25) (1.90)
Pro forma (3.50) (2.70)
F-15
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
A summary of the status of the Company's stock option plan as of
December 31, 2000 and 1999, and changes during the years ended on those
dates, is presented below:
December 31, 2000 1999
-----------------------------------------------------------------------------------------------
Weighted- Weighted-
average average
Exercise Exercise
Shares Price Shares Price
--------- -------- --------- --------
Outstanding at beginning of year 1,327,868 $ 4.71 583,000 $ 2.73
Granted 221,600 1.06 916,868 5.57
Exercised (2,500) 2.50 (152,000) 2.48
Forfeited (199,200) 2.05 (20,000) 2.50
---------------------------------------------------------------------------------------
Outstanding at end of year 1,347,768 $ 4.19 1,327,868 $ 4.71
=======================================================================================
Options exercisable at year-end 1,304,969 $ 3.98 885,601 $ 4.44
=======================================================================================
Weighted-average fair value of
options granted during the year -- $ 1.00 -- $ 4.58
=======================================================================================
The following table summarizes information about stock options
outstanding and exercisable at December 31, 2000:
Options Outstanding Options Exercisable
------------------- -------------------
Weighted-
Number average Weighted- Number Weighted-
Outstanding at Remaining average Exercisable at average
Range of December 31, Contractual Exercise December 31, Exercise
Exercise Prices 2000 Life Price 2000 Price
-------------------------------------------------------------------------------------------------
$0.50 to $1.50 196,400 4.8 $ 0.72 196,400 $ 0.73
$1.50 to $3.00 246,600 2.4 $ 2.37 246,600 $ 2.37
$3.00 to $4.50 107,000 2.9 $ 3.66 107,000 $ 3.66
$4.50 to $6.00 658,000 3.9 $ 5.17 626,867 $ 5.17
$6.00 to $8.50 139,768 3.1 $ 6.60 128,102 $ 6.47
-------------- --------- --- ------- --------- -------
1,347,768 1,304,969
========= =========
9. CAPITAL STOCK:
In June 1999, the Company's shareholders approved an amendment to the
Certificate of Incorporation of the Company increasing the number of
authorized shares of common stock to 25,000,000.
In January 2000, the Company's shareholders approved an amendment to the
Certificate of Incorporation of the Company increasing the number of
authorized shares of preferred stock to 2,000,000.
In 1999, the Company sold through private placements 499,889 shares of its
common stock to two investors for an aggregate price of $4,250,000 with net
proceeds to the Company of $3,795,000. The Company issued warrants to
purchase 68,175 shares of common stock at prices ranging from $5.23 to
$13.85
F-16
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
per share. The Company had granted the investors repricing and redemption
rights based on the future market price of its common shares. In March
2000, the Company issued 65,961 shares of common stock pursuant to the
repricing rights. In May 2000, the Company acquired 16,312 shares of common
stock for $34,663 from the private investors. In addition, the Company paid
$165,359 for repricing rights, which has been charged to additional paid-in
capital. In September 2000, the Company entered into an agreement with the
two private investors whereby the Company agreed to pay $300,000 in cash
and issue 400,000 shares of common stock to resolve certain issues of
interpretation that arose out of redemption and repricing rights. This
agreement eliminated any additional rights the parties had for additional
common stock or cash under the original agreement. The amount paid pursuant
to the agreement has been charged to additional paid-in capital.
In 1999, an officer of the Company exercised options granted under the
Company's stock option plan and acquired 15,000 shares for $37,500. The
payment was made by an interest-bearing secured promissory note. In 2000,
the Company acquired 15,000 shares back from the officer and canceled the
promissory note. $33,750, representing the difference between fair market
value of the shares and the consideration paid to reacquire the shares, was
charged as noncash compensation.
In February and March 2000, the Company sold in a public offering 1,137,300
shares of Series B Convertible Redeemable preferred stock at $15 per share
and realized net proceeds of approximately $14,404,000. Approximately
$194,000 of the offering costs were incurred in 1999. The preferred stock
can be converted into common stock at the rate of 3.4 shares of common
stock for each share of preferred stock. Preferred stockholders are
entitled to receive cumulative annual dividends of $.60 per share payable
semiannually either in cash or shares of the Company's common stock at the
sole discretion of the Company. Further, preferred stockholders are
entitled to receive a liquidation preference of $15 per share, plus accrued
dividends. The Company has the option to redeem the preferred stock under
certain circumstances.
In connection with the offering, the Company sold to the underwriter, for
nominal consideration, warrants to purchase an aggregate of 100,000 shares
of Series B Convertible Redeemable preferred stock. The warrants will be
exercisable for a four-year period commencing one year after the date of
the consummation of the offering at an exercise price of $24.75 per share.
In 2000, additional dividends (noncash) related to beneficial conversion
feature of the preferred stock of approximately $5,856,000 were recorded as
a result of the conversion price of the preferred stock being less than the
market price of the common stock at the time of the offering.
During 1999, the Company issued: (a) 120,039 shares of common stock in
connection with the acquisitions of the businesses, (b) 158,616 shares of
common stock upon exercise of stock options (including 15,000 by an
officer) and warrants, and (c) 98,462 shares of common stock upon
conversion of outstanding shares of Series A convertible preferred stock.
In addition, the Company issued 5,974 shares of common stock and warrants
to purchase 25,000 shares of common stock at an exercise price of $8.50 for
services rendered.
F-17
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
In April 2000, the Company's board of directors authorized the Company to
purchase up to $1,000,000 worth of its common stock from time to time, as
the Company deems appropriate, through open market purchases or in
privately negotiated transactions. As of December 31, 2000, the Company had
acquired 378,326 shares of common stock including 16,312 shares from the
private placement investors for an aggregate consideration of approximately
$596,000.
During 2000, the Company issued: (i) 1,834,300 shares of common stock upon
conversion of 539,500 shares of Series B Convertible Redeemable preferred
stock, (ii) 11,594 shares of common stock for services rendered and upon
exercise of stock options, (iii) 65,691 shares of common stock pursuant to
repricing rights, (iv) 368,878 shares of common stock for acquisition of
businesses and (v) 400,000 shares of common stock to resolve certain issues
of interpretation that arose out of redemption and repricing rights.
At December 31, 2000, there were warrants outstanding to purchase an
aggregate of 2,878,475 shares of common stock at exercise prices ranging
between $4.80 and $13.85 per share, expiring at various times through 2004.
10. INCOME TAXES:
At December 31, 2000, the tax effects of loss carryforwards and the
valuation allowance that give rise to deferred tax assets are as follows:
Net operating losses $ 5,270,000
Less valuation allowance (5,270,000)
-----------
Deferred tax assets $ - 0 -
===========
At December 31, 2000, the provision (benefit) for income taxes differs from
the amount computed using the federal statutory rate of 34% as a result of
the following:
Federal statutory rate (34)%
Increase in valuation allowance 34
-------
- 0 - %
=======
The Company had net operating loss carryforwards of approximately
$15,500,000 at December 31, 2000, which expire through 2020. The tax
benefit of these losses has been completely offset by a valuation allowance
due to the uncertainty of its realization.
Internal Revenue Code Section 382 provides for limitations on the use of
net operating loss carryforwards in years subsequent to a more than 50%
changes in ownership (as defined by Section 382), which limitations can
significantly impact the Company's ability to utilize its net operating
loss carryforwards. As a result of the sale of the preferred shares in the
public offering in February and March 2000, changes in ownership may have
occurred which might result in limitations of the utilization of the net
operating loss carryforwards. The extent of any limitations as a result of
changes in ownership has not been determined by the Company.
F-18
FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
11. SUBSEQUENT EVENTS:
During January 2001, the Company announced the sale of a majority of its
equity interest in iShopNetworks, Inc. and the closure of its
WoWFactor(TM)Web-portal. The Company also announced that it would cease
funding its subsidiary, CLEC Communications Corp.
12. MANAGEMENT'S PLANS:
The Company has initiated a restructuring program designed, among other
things, to reduce its operating losses. The program requires reduction of
personnel, reduction in marketing and promotional expenses, consolidation
of certain operations and closure of regional offices. Additionally, the
Company is in the process of obtaining additional financing to improve
working capital.
F-19