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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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, 1999
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 000-24223
FRONTLINE COMMUNICATIONS CORP.
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(Name of Small Business Issuer in Its Charter)
Delaware 13-3950283
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(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
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(Address of principal executive offices) (Zip Code)
(914) 623-8553
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(Issuer's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Securities registered pursuant to Section 12(g) of the Exchange Act:
Common Stock, $.01 par value
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|
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The issuer's revenues for the year ended December 31, 1999 were $2,975,213.
The aggregate market value of the voting and non-voting common equity held by
non-affiliates as of March 15, 2000 was $23,085,315. As of March 15, 2000, there
were 5,004,671 shares of the issuer's Common Stock outstanding.
Documents Incorporated by Reference:
None.
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PART I
Item 1. Business.
General
Frontline Communications Corporation (the "Company") is a full service
Internet company. We provide Internet-related services, products and solutions
to customers on a national basis. We offer our customers a single point of
contact for a complete business solution to their Internet needs. Our primary
focus is to provide small and medium-sized businesses with Internet services
designed to help these businesses maximize the potential of the Internet and
achieve a competitive advantage in their markets. We provide our customers with
a wide array of Internet access alternatives and Website development and
Internet Website presence services. Our strategy is to expand our geographic
presence, our customer and revenue base and our Web hosting and broadband
capabilities.
The broad acceptance of the Internet has created numerous opportunities
for businesses to improve their competitive position in their markets. We
believe the small and medium-sized business market generally offers significant
opportunity for the growth of our business because of the large number of these
businesses throughout the United States and their growing presence on the
Internet. Small and medium-sized businesses are increasingly seeking third-party
service providers to help them create, build and implement their Internet
strategy. The analysis, design and implementation of an effective Internet
solution requires a range of skills, expertise and technology that only a
limited number of small and medium-sized businesses possess. In response to
these needs and the growth of the Internet as a vehicle for sales and services,
we have developed a full array of services designed to address all of the
Internet service requirements of our small and medium-sized business customers.
We intend to continue to acquire additional Internet service businesses
in order to grow our access, development and presence services. Since October
1998, primarily through 11 acquisitions, including regional Internet service
providers and Web development, hosting and related companies, we increased our
customer base from 2,000 to over 16,000 customers and now have the enhanced
capability to provide the access, development and presence services necessary to
assist small and medium-sized business customers. We have expanded our access
services nationally to include approximately 800 points of presence (POPs), nine
of which we own and the rest of which we license, capable of providing Internet
access services to approximately 72% of the U.S. population. We also offer
significant national high-speed access, including Digital Subscriber Line (DSL)
though our alliances with Covad Communications Corp. and Network Access
Solutions, Inc. In addition, as one of our subsidiaries is a licensed
competitive local exchange carrier (CLEC) in New York, New Jersey and
Pennsylvania, we anticipate that we will be able to reduce, on a relative basis,
our overall communications costs by the end of 2000. We intend to expand our
network
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infrastructure and increase our Internet access subscriber base by continuing to
acquire other Internet service providers with a high concentration of small and
medium-sized business customers.
In addition to growth by acquisition, we have engaged in more
traditional marketing and advertising directed at the small and medium-sized
business market. In the northeast United States, where our sales force is
currently located and where we own nine POPs, we are building brand equity in
our Frontline.net operations, targeted at business generally. Throughout the
United States, we target women-owned businesses with our WOWFactor.com marketing
brand and Website and retail business with our iShopNetworks.com (formerly
ChanneliShop.com) marketing brand and Website. We anticipate that our
WOWFactor.com and iShopNetworks.com marketing efforts will continue nationally,
and our Frontline.net branding will grow geographically, as our POPs and sales
force expand our footprint.
We were formed in 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 (914)
623-8553. Our Internet Website is located at www.frontline.net. WOWFactor's
Website is located at www.wowfactor.com. iShopNetworks, Inc.'s Website, which we
expect to launch in the second quarter of 2000, will be located at
www.iShopNetworks.com. Information in 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 our wholly owned
subsidiaries, CLEC Communications Corporation and iShop Networks, Inc.
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. The information on our Websites is not a part of this
report.
Industry Overview
In recent years, the Internet has experienced a rapid increase in its
number of users. As a result, Internet access services is one of the fastest
growing segments of the global telecommunications services marketplace.
According to a survey conducted by NUA Ltd. Internet Surveys, there were 201
million people online worldwide as of September 1999. The same study predicts
that by 2005, the number of people online globally will increase to 350 million.
NUA Ltd. reported that business-to-business online transactions in the United
States alone were expected to reach $109 billion by the end of 1999 and $843
billion by 2002.
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The rapid development and growth of the Internet has resulted in an
industry of local, regional and national Internet service providers in the
United States. These companies provide Internet access to their subscribers
either by developing a proprietary network infrastructure or by purchasing
Internet access from a wholesale provider or through a combination of both.
Internet access services represent the means by which Internet service providers
interconnect either businesses or individual consumers to the Internet's
resources or to corporate intranets and extranets.
Recent technological advances, combined with cultural changes and
evolving business practices, have led to integration of the Internet into the
activities of individuals and the operations and strategies of commercial
organizations. Use of the Internet by individuals and small and medium-sized
businesses has been accelerated by dramatic increases in cost-effective
processing power and data storage capabilities in personal computers, as well as
widespread availability of multimedia, fax/modem, and networking capabilities.
Today, businesses are increasingly recognizing that the Internet is
fundamentally transforming the way they compete. This realization is forcing
businesses to reevaluate their Internet strategies and review their entire
operational models in order to align their business objectives more closely with
their business processing and systems. Businesses are attempting to utilize
innovative Internet solutions to improve their competitive position and take
advantage of:
o greater opportunities to attract and retain profitable customers;
o lower costs;
o improved operational efficiencies;
o strengthened supply chain partner relationships; and
o improved communications within organizations.
As a result, businesses are increasingly seeking third-party service
providers to help them create and build business-driven Internet solutions. To
service this emerging need, traditional service providers such as management
consultants, traditional information technology service providers and
advertising firms have created groups within their organizations that focus on
the Internet needs of their clients. However, many of these traditional service
providers lack the breadth of services to provide comprehensive Internet
solutions, and businesses have begun to seek new third-party providers that can
provide them with Internet solutions balancing their strategy, marketing and
technology needs. This demand has led to the emergence of integrated Internet
services firms that have the expertise to service this emerging market and can
also provide a structured approach to integrating strategy, marketing and
technology to create a single, unified Internet solution.
Management believes that all of these factors provide us with
significant opportunities for growth in this marketplace. Therefore, we intend
to continue to focus on Internet access and e-commerce services for consumers
both at home and in the workplace, and for small businesses.
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Company Strategy
Our goal is to become a leading provider of Internet access,
development and presence services for small and medium-sized businesses
throughout the United States. We intend to implement the following strategies in
order to achieve our goal:
o Increase our exposure to targeted segments of the small and
medium-sized business market and increase our customer base by
continuing to acquire and develop Websites devoted to particular
small and medium-sized business segments;
o Expand our network infrastructure and increase our Internet dial-up
access subscriber base by continuing to acquire regional Internet
service providers with a high concentration of small and medium-sized
business customers; and
o Expand our Internet development and presence services internally and
by acquiring or forming strategic partnerships with companies which
provide Internet-related services which benefit small and
medium-sized businesses.
Target small and medium-sized business segments through devoted
Websites. An essential part of our growth strategy will be the use of branded
Websites to increase the exposure of our Internet access, development and
presence services to potential small and medium-sized business customers in
particular market segments. We intend to use these Websites to target these
businesses as business owners, not as consumers, and we intend to attract
business owners to these Websites by offering them products and services
targeted to them as Internet users, based on their business segment. However,
business owners who visit these Websites will also be exposed to our array of
Internet access, presence and development services. We believe that the Internet
traffic generated by these Websites will be a valuable source of potential
customers for our Internet services.
In October 1998, we acquired WOWFactor, Inc. as the first step in our
Website marketing strategy. WOWFactor.com was launched in May 1999 to promote
e-commerce to professional women and women-owned businesses. We expect that
WOWFactor.com will become a source of revenue from advertising fees charged for
banner advertisements on its Website and revenue sharing arrangements with other
content providers that enter into strategic partnerships with us to provide
their services through the Website. Our primary purpose in developing
WOWFactor.com is to generate traffic from small and medium-sized businesses that
can then be exposed to our full array of Internet access, development and
presence services available to business owners.
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iShopNetworks, which is currently scheduled to launch during the second
quarter of 2000, will feature products listed by categories and retailers listed
by location on stand-alone sites known as "verti-ports." Each destination will
provide specific niches in the small and medium-sized business retail market
(such as retailers in specified geographic areas and specialty retailers) with
the opportunity to conduct e-commerce and build their businesses on the
Internet. The goal of iShopNetworks is to provide retailers in each category
with the specific access, development and presence services that they need in
order to have an advantage over their competitors and to succeed online.
Expand our network infrastructure and increase Internet dial-up access
subscribers. While we currently provide access services to individuals as well
as small and medium-sized businesses, we are now focusing on increasing our
customer base as we develop and enhance our Internet services targeted to these
businesses. As our dial-up access subscriber base grows, we will seek to
increase our network infrastructure so that our Internet access capacity can
meet the demands of our customers.
We intend to expand our Internet access business principally through an
acquisition strategy that will increase our customer base as well as the network
infrastructure necessary to service our growing customer base. The Internet
access market in the United States is highly fragmented and consists of a small
number of large, national companies and a large number of smaller, regional
companies. The majority of these companies are small or medium-sized businesses
which we believe lack the technological capabilities and financial resources
necessary to serve the Internet access needs of a rapidly changing market. We
believe these factors are driving a general consolidation trend in the Internet
access industry, and we believe this trend will continue for the foreseeable
future.
There is significant competition for acquisition candidates. However,
unlike many Internet companies which seek to acquire access providers with a
large number of residential dial-up customers, our acquisition strategy is
focused on regional access providers which have a high number of potential small
and medium-sized business customers. We believe that there will generally be
less competition for our acquisition targets because of their relatively lower
concentration of residential users.
We will focus on acquiring companies that provide services in regions
where we have identified a high concentration of potential customers based on
our demographic research. We intend to focus on expanding our business into
geographic regions where we identify demand for our Internet services based on
several factors, including the level of use of our branded e-commerce Websites
in those geographic regions. In geographic regions which we target for growth,
we will seek an initial acquisition to serve as a regional operations center and
then attempt to grow our business within those regions by acquiring additional
Internet service providers that can be consolidated into the regional operations
center. We will seek to achieve operating efficiencies and economies of scale by
eliminating or consolidating redundant aspects of subsequent acquisitions within
each region, including POPs, equipment leases and
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telecommunications and access contracts. Generally, we will seek to acquire
companies with talented management teams and compatible technology.
Expand Internet development and presence services. We will seek to
develop a full array of Internet development and presence services in addition
to our Internet access services to meet all of the Internet needs of our
customers. We will seek to customize our services to the small and medium-sized
business market, which we believe will result in higher customer loyalty and a
lower churn rate than is experienced generally in the Internet industry. We also
believe that this strategy will provide us with a competitive advantage over
many of our larger competitors, which do not focus sufficiently on the small and
medium-sized business market and therefore do not offer such customized
services.
We also believe that strategic partnerships are important to developing
a full array of Internet service offerings. We primarily select partners that
will provide us and our customers with a value-added service and then share the
revenue with us. In 1999, we developed proposals for and closed over 20 of these
partnership deals and became a premier business partner with IBM. Our premier
partner status with IBM permits us to receive products at cost, use the IBM
business partner logo and seal and earn commissions on Websites built on and
supported by IBM products.
Some of our other value added services and partnerships include the
ability to offer:
Content: from partners such as LookSmart Ltd., MyWay.com, which is
majority owned by CMGI, Inc., and ScreamingMedia.Net, Inc., which provides
Reuters and Associated Press stories;
E-commerce Tools: including IBM's Net.commerce software for online
merchandising, an easy-to-use e-commerce wizard and a merchant identification
number;
Online Office Tools: such as a video conferencing, contact sharing
technology, file back up and privacy policy tools; and
Special Offers: special benefits and promotions from other companies
exclusive to our customers.
We also enter into co-marketing agreements where organizations and
associations exclusively promote our Frontline.net and WOWFactor.com brands
through their marketing efforts. In some cases we have negotiated exclusive
arrangements for our WOWFactor.com brand. We believe that this is the only site
for women-owned businesses to offer content on CMGI's MyWay(TM) portal and on
CMGI's One-Click-Charge(TM) portal for niche content. WOWFactor has also been
exclusively promoted to women's organizations worldwide, including the Women in
Direct
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Marketing Association, the Ms. Foundation and the Women's International Chamber
of Commerce.
Recent Acquisitions
Since October 1998, we have completed the following acquisitions in
order to increase our Internet access, development and presence capabilities:
o WOWFactor, Inc. A company engaged in the business of promoting
e-commerce through its Websites primarily for women's businesses.
o Roxy Systems, Inc. d/b/a Magic Carpet. An Internet service provider
in Orange County, New York.
o US Online, Inc. A provider of Internet access, Web hosting and leased
communications lines in New York, New Jersey and Pennsylvania,
including a POP in the Philadelphia area.
o Webspan Communications, Inc. An Internet service provider in New York
and New Jersey. o WebPrime, Inc. A Website design, Web development
and software development firm.
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.
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.
Internet Services
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We have developed a variety of Internet access, development and
presence services to address the needs of our customers.
Internet Access Services. We provide a variety of competitively priced
Internet access services, including dial-up accounts and dedicated access.
o Dial-Up Accounts: We believe that dial-up accounts present not only
an attractive opportunity for growth and cash flow, but also
constitute excellent targets for our suite of e-commerce services. A
user can quickly activate an account with us and obtain two Internet
e-mail addresses and Web space and establish automatic billing to the
user's credit card. Our network supports connectivity software which
utilizes standard communication protocols such as TCP/IP, enabling a
user's computer to communicate with other computers over the
Internet. We have recently expanded our dial-up services to add
national access capability, which permits customers to access their
Frontline accounts from anywhere in the continental United States,
and control features which prevent violence, profanity and other
inappropriate materials from reaching children or business accounts.
o DSL: We are a reseller of Digital Subscriber Line high-speed Internet
access services for Covad, DSL Networks, Inc. and NAS, and now offer
Digital Subscriber Line, ISDN Digital Subscriber Line, Asymmetric
Digital Subscriber Line and Symmetric Digital Subscriber Line
services nationally. These products provide dedicated connectivity at
an affordable cost for companies that need high-performance Internet
access.
o Dedicated Access: We offer high speed, high bandwidth dedicated
leased lines principally for business users who desire to connect
their internal computer networks to the Internet, 24 hours a day,
seven days a week. Our leased line accounts are also available to
provide Internet services to businesses at various speeds, including
56K circuits, fractional T-1, full T-1 and T-3 lines, depending on
the customer's needs. Our dedicated leased lines blend security and
speed and offer commercial strength bandwidth that our business
customers can rely on for critical productivity and e-commerce
applications.
o Co-location services: Our co-location services enable our customers
to install equipment at our facilities and connect their systems
directly to the Internet. We believe many of our customers will save
money by co-locating with us because they will avoid the costs
associated with establishing and maintaining an on-site facility and
because the direct connection to our network facilities eliminates
communications charges.
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Internet Development Services. We provide our customers with Internet
Website development services. These services enable small businesses to develop
operational Internet e-commerce Websites. Our Website development services
include the following:
o Do it yourself: Our do it yourself "Website wizard" products assist
our customers in developing their own Websites by using our
user-friendly unassisted Web development tools.
o Website design services: Our in-house engineers, consultants and
designers assist our customers with marketing strategy, graphic
design and layout, writing and editing and Website information
architecture (including Website navigation and searching systems).
Our in-house professionals also have expertise in the creation of
intranets, which are secure, internal networks that allow employees
within a company to communicate and share information through the
company's Website, and extranets, which is a network that enables a
company's customers or other outside parties to gain access to the
intranet. As part of our Website design services, our customers have
access to our "toolbox" of e-commerce solutions which we have
developed through our partner programs, including technology and
services which enable online transactions, security, advertising and
promotions.
o Additional business-related services: Our Website development
services include search engine registration, domain name set up and
transfer, server set up, additional storage space for Website pages,
e-mail aliases, additional e-mail addresses and 1-800 roaming access
service.
Internet Presence Services. We provide our customers with the following
Internet Website presence services to maximize the value of their Internet
Websites:
o Website hosting: Website hosting services offer our customers the
opportunity to develop a 24 hour interactive presence on the Internet
by renting space on our Internet servers. By using our Website
hosting services, our customers can avoid the hardware investment
required to operate their own servers and the ongoing costs
associated with locating and maintaining those servers. Our Web
servers connect directly to the Internet via high speed T-1 and T-3
communications lines, which provide the maximum bandwith currently
available. Our Website hosting services include domain name
registration, e-mail addresses, file upload and download capability
and statistical logs.
o Website analysis: We offer Website analysis services which are
designed to help our customers maximize the exposure of their
Websites. We analyze our customers' access logs to determine how
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much referral traffic they receive from various search engines and
Internet directories. Our professionals also rate customer Websites
in numerous categories, including usability, information
architecture, navigation and overall appeal for the customer's target
audience. We also evaluate whether our customers' Websites can be
redesigned so that they will be more visible on Internet search
engines and directories.
o Search engine submission: We can submit our customers' Websites to
search engines, and we offer long term contracts for resubmission at
regular intervals.
o Marketing strategy consultation: Our marketing and advertising
professionals can assist customers with building a marketing plan
designed to increase the recognition and use of their Websites.
Owners of Websites have numerous marketing options available to them,
including mass distribution through faxes or e-mails, press releases,
newsgroup postings, forming strategic links with popular Websites and
posting banner advertisements on other Websites. The exposure of
Websites can also be increased by increasing their visibility on
Internet search engines and directories. We work with our customers
to identify which marketing strategies best fit their circumstances,
and we can assist them in implementing the strategy, including
negotiating with third parties on their behalf. As part of this
process, we also identify those customers that can benefit from any
of our e-commerce enabling resources which we have developed through
our partner programs.
Network Infrastructure
Our telecommunications network currently is comprised of leased high
speed data lines and numerous POPs which allow Internet access throughout the
northeast United States. These POPs permit customers in these areas to access
the Internet through a local telephone call. We currently support a variety of
modems, including 33.6 and V90 Kbps, at each of our POPs and have X2, 56K and
ISDN technologies at most of our POPs.
Our network is monitored 24 hours a day, seven days a week by our
network operations center in Pearl River, New York. The network operations
center provides network monitoring, performance support and traffic management.
It also furnishes real-time network status updates to our technical support and
customer service staff and assists with problem resolution. In addition, the
network operations center provides real-time alarms, event correlation,
forecasting and notifications of network events. Our technology team monitors
and upgrades our network technology when necessary. Access to our network
operations center requires electronic identification badges and is limited to
top security personnel and technical team members.
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Our network equipment receives conditioned, or regulated, power to
protect it from damaging voltage spikes and brownouts. Backup power systems
automatically supply emergency power to our network equipment in the event of a
total power outage. Our network operations center contains a separate dedicated
industrial-size air conditioner to reduce the heat generated by our equipment in
order to prevent shut downs and overheating of critical equipment and to allow
our servers to operate at peak efficiency. In addition, we are in the process of
installing a FM-200 fire suppression system at our new network operations center
guaranteed by its manufacturer to fill the entire room with a gas which will
extinguish a fire within 10 seconds. This fire suppression system does not
contain water sprinklers, which could damage equipment or cause electrical
fires, and covers the actual room, the ceiling and the floor beneath the room.
Internet Access Providers and Suppliers
We currently rely on a limited number of suppliers to provide Internet
access via leased telecommunications lines on a cost-effective and continuous
basis. We have not entered into any long term agreements with such suppliers.
Although we believe that we currently have sufficient access to
telecommunications networks on favorable terms and believe that our relationship
with such suppliers is satisfactory, any increase in rates charged by such
suppliers would materially adversely affect our operating margins. Failure to
obtain continuing access to such networks would also have a material adverse
effect on us, including possibly requiring us to significantly curtail or cease
our operations.
We are also dependent on third-party manufacturers of hardware
components. Certain components used by the Company in providing its networking
services are acquired from only one source, including high performance routers
manufactured by Cisco Systems, Inc. and remote access servers manufactured by
3Com (formerly U.S. Robotics, Inc). In 1999, we acquired $1.3 million worth of
communications equipment from a major telecommunications equipment manufacturer.
The manufacturer provided the financing through a lease for $957,000. The lease
requires us to pay $36,000 a month for 30 months commencing February 2000. In
addition, $419,000 due to the manufacturer is payable over four quarterly
installments commencing March 2000. Although we believe that network equipment
is currently available from numerous sources, failure by manufacturers to
deliver quality products on a timely basis or the inability to develop
alternative sources if and as required, could result in delays which could
materially adversely affect our business and limit our ability to expand our
operations.
Marketing and Sales
Although we continue to provide Internet services to a growing number
of individuals, our primary focus has shifted to providing Internet service to
small and medium-sized businesses. We currently obtain new individual customers
by (1) responding to telephone calls and e-mails which are largely generated
from referrals
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from existing customers and (2) acquiring other Internet service providers. Our
marketing programs include a retention program to maintain our current customer
base and a referral program to generate new customers.
The primary methods planned for targeting new small business customers
include direct response marketing programs such as radio, promotions, print
advertising, telemarketing, online marketing and broadcast fax. Affiliate
marketing programs, such as those with online book and record sellers, will also
be employed. In a highly competitive industry such as this one, we believe that
name recognition is essential. Our marketing personnel are actively working to
achieve name recognition through radio, trade and local business print media
advertising and local event marketing. We believe that this will also aid in the
development of a quality, value added reseller and affiliate channel. We have
adopted the slogan "Effortless E-Commerce & Internet Access" for which we have a
pending trademark application with the United States Patent and Trademark
Office. This slogan is intended to communicate our focus to potential small
business customers.
We currently have an in-house sales and marketing staff consisting of a
Director of Marketing, a Director of Sales, inbound sales representatives and
brand and marketing managers. We are currently exploring the advantages of
outsourcing our telemarketing.
Our investment in WOWFactor was our initial step in our efforts to
reach small businesses. We believe that WOWFactor, with its focus on women
business owners nationally, will be a potent distribution channel for our
services. We also believe that marketing, development, and infrastructure are
providing substantial economic leverage to both companies.
In furtherance of our efforts to reach small businesses, we also plan
to launch our iShopNetworks.com Website in the second quarter 2000. Like
WOWFactor, iShopNetworks will focus on a specific segment of the small business
market (in this case, retail businesses) and will market our access, development
and presence services to those businesses.
Customer Support
We believe that providing prompt and effective technical assistance to
our subscribers and customers is essential for retention of our customers, cost
containment and quality improvement efforts. We provide network monitoring and
emergency subscriber assistance services 24 hours a day, seven days a week.
Regular support and technical assistance is available 16 hours per day, seven
days per week. We plan to implement 24-hour technical support during 2000. In
house technical personnel respond to telephone and E-mail inquiries. All
customer service is handled in-house in order to maintain the support levels
required to retain customers in a competitive market. There can be no assurance,
however, that our customer support resources will be sufficient to manage any
expansion in our subscriber base. Any failure to adequately
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match customer support resources to projected increases in subscribers could
adversely affect us.
Competition
Internet Access Services. The market for Internet access services is
highly competitive, rapidly evolving and subject to technological change. There
are no substantial barriers to entry, and we expect that competition will
intensify in the future. Our ability to compete successfully is significantly
affected by numerous factors, including price, ease of use, reliability,
customer support, geographic coverage, and industry and general economic trends,
particularly unfavorable economic conditions adversely affecting consumer
discretionary spending. Our competitors include many large companies that have
substantially greater market presence and financial, technical, marketing and
other resources than we do, including:
o international, national and regional Internet service providers;
o established online services companies that currently offer Internet access;
o computer hardware and software and other technology companies;
o national long distance carriers;
o regional Bell operating companies; and
o cable operators.
Advances in technology and changes in the marketplace and the regulatory
environment will continue, and we cannot predict the effect that ongoing or
future developments may have on us or our competitors, or on the pricing of our
products and services.
Internet Services. The market for Internet services is relatively new, intensely
competitive, quickly evolving and subject to rapid technological change. We
expect competition to intensify as the market evolves. We believe that the
competitors fall into several categories, including Internet service firms,
technology integrators and strategic consulting firms.
Many of our competitors have longer operating histories, larger client
bases, longer relationships with clients, greater brand or name recognition and
significantly greater financial, technical, marketing and public relations
resources than we do. While we believe that only a few of these competitors
offer an integrated package of Internet services, several competitors have
announced their intent to offer a broader range of services than they currently
provide. We believe that the principal competitive factors in the Internet
services market are the provision of an integrated services capability, breadth
of service offerings, cost certainty and a customer base to which high-end
products can be marketed, and we believe that our service model will allow us to
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compete favorably against these competitors. There are relatively low barriers
to entry into the Internet services market. As a result, new market entrants
pose a threat to our business. Existing or future competitors may develop or
offer services that are comparable or superior to ours at a lower price, which
could have a material adverse effect on our business, financial condition and
results of operations.
Competitive Local Exchange Services. As we increase our CLEC services, we will
be subject to competition from other CLECs and local telephone companies. The
local exchange industry is competitive, evolving, and subject to technological
change, and competition is expected to increase in the future. Many of the
competitors in the CLEC industry have greater financial, personnel, brand name
recognition, and other resources than we do.
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
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Act of 1998 creates an affirmative obligation 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 in December 1998
and has been granted provisional authority to operate as a competitive local
exchange carrier by the Pennsylvania Board of Public Utilities. We also have a
CLEC application pending in New Jersey.
In October 1999, our subsidiary entered into an interconnection
agreement with Bell Atlantic which sets forth the parameters within which we may
subscribe to and resell all forms of local telephone service in New York. In
order to benefit from the reduced pricing structure provided in the
interconnection agreement, we must demonstrate our ability to provide the
interconnection services described in the agreement. We must also order and
install certain telecommunications services and equipment. We expect that we
will be able to benefit from the reduced pricing set forth in the agreement by
the end of 2000.
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<PAGE>
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. As we become certified as a CLEC
in other states, we will become subject to the regulatory requirements in those
states. Most states impose tariff filing requirements on carriers and require
that telecommunications carriers charge just and reasonable rates and not
discriminate among similarly situated customers. Some states also require the
filing of periodic reports, the payment of various regulatory fees and
surcharges, and compliance with service standards and consumer protection rules.
States often require prior approvals or notifications for certain transfers of
assets (such as fiber optic cable or other telecommunications facilities),
customers, or ownership. Some states also require approval or notice of the
issuance of securities or debt or for name changes of a certificated carrier. We
intend to seek CLEC authority in additional states. We cannot guarantee that we
will be able to obtain such approvals.
States generally retain the right to sanction a telecommunications
carrier or to revoke certifications if a carrier violates relevant laws and/or
regulations. If any state regulatory agency concluded that we provide intrastate
service without the appropriate authority, or that we are not otherwise in
compliance with state public utility commission laws and rules, that agency
could initiate enforcement actions, potentially including the imposition of
fines, the disgorging of revenues or the refusal to grant the regulatory
authority necessary for the future provision of intrastate telecommunications
services.
Employees
As of March 1, 2000, we had 60 employees in addition to our 6 executive
officers. We 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 at an annual rent of
approximately $275,000 pursuant to an amended lease which expires in May 2004.
Our customer service center is located in Howell, New Jersey where we lease
approximately 2,400 square feet under a lease that expires in May 2004. 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
We are not party to any legal proceedings other than ordinary course
routine litigation incidental to our business. We do not believe that any of
these proceedings will have a material adverse effect on our financial condition
or results of operations.
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Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Market Information. On February 7, 2000 our Common Stock was 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, 1998 High Low
- ----------------------------------- ---- ---
Second Quarter
(commencing May 14, 1998) $ 5.375 $4.25
Third Quarter 8.125 2.125
Fourth Quarter 8.2188 2.375
Fiscal Year Ended December 31, 1999
- -----------------------------------
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
First Quarter
(through March 15, 2000) 8.00 4.375
The number of record holders of our Common Stock was 84 as of March 15,
2000. We believe that there are in excess of 2,300 beneficial owners of our
Common Stock.
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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. 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 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 will be paid in
cash or in shares of Common Stock, in the Company's discretion. We anticipate
that payment of dividends on our Preferred Stock will be made by issuing
additional shares of Common Stock for the foreseeable future.
Sales of Unregistered Securities During Fourth Quarter of 1999.
In September 1999, the Company issued 5,974 shares of common stock to
Martin Janis & Co. in exchange for services rendered pursuant to a consulting
agreement.
In October 1999, the Company issued 33,065 shares of common stock in
connection with the acquisition of assets of United Computer Specialists, Inc.
In October 1999, the Company issued 105,263 shares of common stock and
warrants to purchase 11,483 shares of common stock to two investors for
aggregate consideration of $500,000, and issued warrants to purchase 2,871
shares of common stock to the placement agent for the offering.
In December 1999, the Company issued 26,538 shares of common stock in
connection with the acquisition of FrontHost, LLC.
In December 1999, the Company issued 135,870 shares of common stock and
warrants to purchase 14,847 shares of common stock to two investors for
aggregate consideration of $750,000, and issued warrants to purchase 3,707
shares of common stock to the placement agent for the offering.
In December 1999, the Company converted 10 shares of Series A Preferred
Stock previously issued to shareholders of WOWFactor, Inc., into 98,462 shares
of Common Stock of the Company.
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<PAGE>
In December 1999, the Company issued an aggregate of 25,000 shares of
common stock pursuant to repricing rights.
From February 1997 to January 2000, the Company issued an aggregate of
129,916 shares of common stock upon the exercise of options granted under its
stock option plan.
Each of the above investors had full access to information relating to
the Company and represented to the Company that he or she had the required
investment intent. Each of the above investors was sophisticated in that he or
she had such knowledge and experience in financial and business matters that he
or she was capable of evaluating the merits and risks of the investment. In
addition, the above-referenced securities bear appropriate restrictive legends,
and stop transfer orders were placed against such securities.
In connection with these issuances, the Company relied on the exemption
from registration offered by Section 4(2) of the Securities Act of 1933 for
transactions by an issuer not involving any public offering.
Use of Proceeds of Registered Securities. In May 1998, the Company
consummated an initial public offering of 1,840,000 shares of Common Stock and
warrants to purchase 1,840,000 shares of Common Stock (including 240,000 shares
and 240,000 warrants issued pursuant to the exercise of an over-allotment
option) and received net proceeds of approximately $5,800,000, after payment of
underwriting discounts and commissions, fees and offering expenses. Since May
19, 1998 (the date of the closing of the initial public offering) through June
30, 1999, the Company used approximately $1,934,000 of the net proceeds for
acquisitions and related expenses, $264,113 for a stock repurchase; $443,000 for
the repayment of indebtedness (including $185,848 to affiliates); $629,000 for
equipment and POP upgrades; and approximately $596,000 for marketing,
promotional and web development expenses. The balance was utilized to fund
operating losses.
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, business entities and
personnel 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.
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Overview
During 1998 and 1999, approximately 90% of our revenues were derived
from providing Internet access services to individuals and businesses. These
revenues are 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, in advance, typically pursuant to
pre-authorized credit card accounts. The remaining 10% of our revenues during
those periods were derived from Web development and hosting services. Our
business strategy is to increase the percentage of revenues we derive from Web
development and hosting services. We have not yet generated any revenues as a
CLEC reseller of telephone access.
Monthly subscription service revenue for Internet access is recognized
over the period in which services are provided. Fee revenues for website
development and Internet website presence services are recognized as services
are performed. Deferred revenue represents prepaid access fees by customers.
Acquisitions
Acquisitions have historically been and will continue to be an
important aspect of our growth strategy. In 1999, we completed the following
acquisitions: WebPrime, Inc. website design, web development and software
development firm; Channel iShop.com (now iShopNetworks.com) a company with
marketing concept targeting retail businesses; assets relating to the dial-up
internet access customer base and web design and hosting capabilities of United
Computer Specialists, Inc; 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 and Fronthost LLC, a company in
the business of providing web hosting and design services. In 1998 we completed
the following acquisitions: WOWFactor, Inc., a company engaged in the business
of promoting e-commerce through its Websites primarily for women's businesses;
Roxy Systems, Inc. d/b/a Magic Carpet, an Internet service provider in Orange
County, New York; US Online, Inc., a provider of Internet access, webhosting and
leased communications lines in New York, New Jersey and Pennsylvania; Webspan
Communications, Inc. an Internet service provider in New York and New Jersey.
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,
1999, we had $4,146,107 of net intangible assets, which are being amortized over
a period of three years. See
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Note 2 of Notes to Consolidated Financial statements.
Results of Operations
Comparison of years ended December 31, 1999 and 1998
Revenues. Revenues increased for the year ended December 31, 1999 by
$2,400,249 or 417.5% over the prior year. The increase was attributable to an
expanded customer base. The increase in customer base was principally due to
acquisitions. We had approximately 16,000 customers at December 31, 1999
compared to 2,000 customers during most of 1998.
Cost of Revenues. For the year ended December 31, 1999, cost of
revenues increased by $1,429,064 to $2,015,824. As a percentage of revenues,
cost of revenues decreased to 67.8% from 102.0%. The absolute dollars increase
in cost of revenues was due to increased communication and technical personnel
expenses incurred to support the increased customer base and in anticipation of
future growth. We expect these costs to increase in absolute dollars as
additional customers are added.
Selling, General and Administrative. For the year ended December 31,
1999, selling general and administrative expenses increased by $3,822,776. As a
percentage of revenues, selling, general and administrative expenses decreased
from 245.7% in 1998 to approximately 176% in 1999. The absolute dollar increase
in selling, general and administrative expenses was attributable to higher
payroll, advertising, promotion and professional fees incurred in 1999 due to
the increased revenue base and in anticipation of growth. We anticipate future
increases in operating expenses related to advertising, promotion, payroll and
professional services.
Depreciation and Amortization. For the year ended December 31, 1999,
depreciation and amortization increased by $1,543,798 to $1,764,373. The
increase was due to amortization arising from acquisitions and due to
depreciation arising from additional equipment acquired in 1999.
Non-cash compensation charges. We granted certain employees options to
purchase an aggregate of 245,768 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 $712,220 were recognized during the year ended December
31, 1999. Non cash compensation charges of $42,000 and $175,137 for the years
ended December 31, 1999 and 1998 were recognized as a result of stock options
granted to non employees.
Interest Income. Interest income net of interest expense for 1999 was
$37,657 compared to $76,344 for 1998. As a significant portion of the unutilized
proceeds of the Company's initial public offering, completed in May 1998, was
used to fund operating losses in 1999, net interest income decreased during
1999.
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<PAGE>
Net loss. We incurred significant losses and anticipate that we will
continue to incur losses until sufficient revenues are generated to offset the
substantial up-front expenditures and operating costs associated with attracting
and retaining additional customers. For the years ended December 31, 1999 and
1998, we incurred net losses of $6,757,258 and $1,744,099, respectively.
Liquidity and Capital Resources. Our working capital deficiency at
December 31, 1999 was $1,640,344 compared to positive working capital of
$1,245,536 at December 31, 1998. The decrease in working capital was due to
operating losses, the purchase of communications equipment and acquisitions of
businesses.
In 1998, we completed an initial public offering of our common stock
and warrants and received net proceeds of approximately $5.8 million. $443,000
of the proceeds was used for repayment of indebtedness (including $185,848 to
affiliates), and $264,113 was used to repurchase 231,520 shares of common stock.
We completed four acquisitions in 1998 and used approximately $1,482,000 of the
public offering proceeds for the cash portion of the purchase price and related
expenses.
In 1999, we sold through private placements 499,899 shares of common
stock to two investors for an aggregate price of $4,250,000, with net proceeds
of $3,795,000. Each purchaser is also entitled to receive additional shares of
common stock if the market price for common stock falls below specified price
levels. As December 31, 1999, the purchaser exercised repricing rights that
resulted in our issuing additional 239,716 shares of common stock. We may be
required to issue up to additional 207,161 shares of common stock to satisfy the
remaining repricing rights.
In 1999, we acquired $1.3 million worth of communications equipment
from a major telecommunications equipment manufacturer. The manufacturer
provided the financing through a lease for $957,000. The lease requires us to
pay $36,000 a month for 30 months commencing February 2000. In addition,
$419,000 due to the manufacturer is payable over four quarterly installments
commencing March 2000.
In February and March 2000, we sold in a public offering 1,137,300
shares of Series B convertible redeemable preferred stock at $15 a share and
received net proceeds, after deducting commissions and related expenses, of
$14,600,000. The preferred stock can be converted into common stock at the rate
of 3.4 shares of common stock for each share of preferred shares. Preferred
Stockholders are entitled to receive cumulative annual dividend of $.60 per
share payable semi-annually either cash or shares of our common stock at our
sole discretion. Further preferred stock holders 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 the first quarter of 2000, additional dividends (non-cash) of
approximately $6,148,000 will be 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.
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Our primary capital requirements are to fund acquisitions of subscriber
bases and related Internet businesses, install network equipment and for working
capital. To date, we have financed our capital requirements primarily through
issuance of debt and equity securities. We do not have any lines of credit. The
availability of capital resources is dependent upon prevailing market
conditions, interest rates, and our financial condition.
Our capital expenditures for 2000 are expected to range between
$240,000 to $300,000. Based on our current plans and assumptions relating to our
business strategy, we anticipate that our cash on hand, expected revenues and
proceeds from our preferred stock offering completed in February and March 2000,
will satisfy our capital requirements through at least the end of 2000.
Effect of Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." ("SFAS No. 133"), which requires companies
to recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. SFAS No. 133 is
effective for fiscal years beginning after June 15, 2000. We do not presently
enter into any transactions involving derivative financial instruments and,
accordingly, does not anticipate the new standard will have any effect on its
financial statements.
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.
None.
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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 .... 42 Chairman of the Board, Chief Executive
Officer and President
Jodie L. Jackson ............ 45 Chief Operations Officer and General
Manager
Nicko Feinberg............... 28 Chief Information Officer, Executive Vice
President of Technology and Director
Michael Olbermann ........... 43 Executive Vice President of Operations, and
Director
Vasan Thatham ............... 42 Vice President and Chief Financial Officer
Amy Wagner-Mele.............. 31 Executive Vice President, Secretary and
General Counsel
Ronald C. Signore ........... 39 Director
William A. Barron............ 50 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.
Jodie L. Jackson has been our General Manager since September 1999 and
our Chief Operations Officer since January 2000. From October 1996 to April
1999, Mr. Jackson served as a Chief Operating Officer at Paperless Adjudication
LLC, a developer of network solutions and proprietary software for processing
electronic transactions. From 1993 through September 1996, Mr. Jackson was the
Director of Marketing at Theratronics International Ltd., a manufacturer of
medical equipment, hardware and software.
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.
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Michael Olbermann has been our Executive Vice President of Operations
since September 1997 and one of our directors since February 1997. Mr. Olbermann
was also our Chief Operations Officer from September 1997 until December 1999
and our Vice President of Business Development from February 1997 until
September 1997. From 1986 to 1997, Mr. Olbermann owned and operated Rock House
Construction Co., Inc., a company engaged in commercial and residential
construction.
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 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 Robert Gray & 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. Mr. Barron is currently a defendant in two related
class actions, Freedman et. al. v. Value Health et. al. and Bash et. al. v.
Value Health, Inc. et. al., pending in the United States District Court in
Bridgeport, Connecticut arising from the acquisition of Diagnostek, Inc. by
Value Health, Inc. The plaintiffs' claims in these actions include claims
against certain former officers of Diagnostek, including Mr. Barron, under
Section 15 of the Securities Act and Sections 10(b) and 20 of the Exchange Act,
Rule 10b-5 of the Exchange Act and certain attendant claims for common law fraud
and negligent misrepresentation and violations of state securities laws,
relating to, among other things, certain alleged inaccuracies regarding
Diagnostek's financial condition contained in the joint merger proxy statement
and a joint press release relating to the merger.
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.
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<PAGE>
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, 1999) during
the years ended December 31, 1997, 1998 and 1999. No other executive officer of
the Company received aggregate compensation which exceeded $100,000 during the
year ended December 31, 1999. We refer to these four executive officers as our
"Named Executives."
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Annual Compensation Compensation
--------------------------------------- Awards
Name and Principal Position Year Salary Bonus Other Annual Securities
- --------------------------- ---- ------ ----- Compensation (1) Underlying
---------------- Options/SAR's (#)
-----------------
<S> <C> <C> <C> <C> <C>
Stephen J. Cole-Hatchard ...... 1999 $115,256 $ 0 $ 0 146,000(2)
Chief Executive Officer 1998 34,846 0 0 79,000(2)
1997 0 0 0
Nicko Feinberg ................ 1999 $108,615 $ 0 $ 0 146,000(2)
Chief Information Officer 1998 79,500 0 0 20,000(2)
1997 29,000 0 0
Michael Olbermann ............. 1999 $108,615 $ 0 $ 0 146,000(2)
Chief Operations Officer 1998 95,100 0 0 20,000(2)
1997 49,730 0 0
Amy Wagner-Mele ............... 1999 $108,615 $ 0 $ 0 26,000(2)
Executive Vice President(3) 1998 29,169 0 0 75,000(2)
</TABLE>
- ---------------
(1) The aggregate value of benefits to be reported under the "Other Annual
Compensation" column did not exceed the lesser of $50,000 or 10% of the
total of annual salary and bonus for any named executive officer.
(2) Represents stock options granted under our 1997 Stock Option Plan.
(2) Ms. Wagner-Mele joined us in September 1998.
The following table sets forth information regarding options granted
during the year ended December 31, 1999 to our Named Executives:
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Option/SAR Grants in Year Ended December 31, 1999
<TABLE>
<CAPTION>
Name Number of Shares % of Total
- ---- Underlying Options/SARs
Options/SARs Granted to Exercise Expiration
Granted Employees in Year Price Date
---------------- ----------------- ($/share) ----------
----------
<S> <C> <C> <C> <C>
Stephen J. Cole-Hatchard ...... 20,000 2.18% $6.06 1/13/04
1,000xx 0.11 5.65 9/20/04
25,000 2.73 4.75 9/30/04
100,000x 10.91 5.25 12/22/04
Nicko Feinberg .................. 20,000 2.18 6.06 1/13/04
1,000xx 0.11 5.65 9/20/04
25,000 2.73 4.75 9/30/04
100,000x 10.91 5.25 12/22/04
Michael Olbermann .............. 20,000 2.18 6.06 1/13/04
1,000xx 0.11 5.65 9/20/04
25,000 2.73 4.75 9/30/04
100,000x 10.91 5.25 12/22/04
Amy Wagner-Mele .............. 1,000xx 0.11 5.65 9/20/04
25,000 2.73 5.25 12/22/04
</TABLE>
[ADD FOOTNOTE WHEN OPTIONS VEST]
The following table sets forth information concerning the number of
options owned by our Named Executives, the value of any in-the-money unexercised
options as of December 31, 1999 and information concerning options exercised by
our Named Executives during the year ended December 31, 1999:
All of the options granted were exercisable at December 21, 1999 except
for:
(i) x 50,000 of the options are exercisable from 12/23/2000.
(ii) xx Options are exercisable from 9/21/2002.
-29-
<PAGE>
Aggregated Option Exercises
And Year-End Option/SAR Values
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money
Options/SARs Options/SARs
at December 31, 1999(#) at December 31, 1999($)
Name Shares ----------------------- -----------------------
- ---- Acquired on Value
Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
(#) ($) ----------- ------------- ----------- -------------
----------- --------
<S> <C> <C> <C> <C> <C> <C>
Stephen J. Cole-Hatchard 0 0 174,000 51,000 $637,762 $123,938
Nicko Feinberg 0 0 115,000 51,000 331,670 123,938
Michael Olbermann 0 0 115,000 51,000 331,670 123,938
Amy Wagner-Mele 15,000 $161,250 50,000 36,000 190,650 183,618
</TABLE>
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 31, 1999 was $7.688. 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 each of Messrs.
Feinberg, Cole-Hatchard and Olbermann which provide for an annual base
compensation of not less than $88,000, $45,000, and $88,000, 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. We also entered into an employment
agreement with Jodie L. Jackson pursuant to which Mr. Jackson agreed to serve as
Chief Operations Officer and General Manager at a salary of not less than
$110,000 per annum. The employment agreements with Messrs. Feinberg,
Cole-Hatchard and Olbermann expire in August 2000, and the employment agreements
with Ms. Wagner-Mele and Mr. Jackson expire in September 2001 and September
2000, all subject to automatic successive one year renewals unless either we or
the employee gives notice of intention not to renew the agreement. 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 which 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
-30-
<PAGE>
event of a change of ownership or effective control of our company (as defined
in the agreements).
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 1999, the Board of
Directors and our stockholders approved an amendment to increase to 1,400,000
the number of shares of common stock available for issuance upon exercise of
options under the stock option plan. In the fourth quarter of 1999, we issued an
additional 79,868 stock options which are subject to stockholder approval of an
increase in our stock option reserve. 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,
2000 relating to the beneficial ownership of shares of Common Stock by: (i) each
person or entity who is known by the Company to own beneficially five percent or
more of the outstanding
-31-
<PAGE>
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.
<TABLE>
<CAPTION>
Number of Shares Percentage of Shares
Name and Address of Beneficial Owner Beneficially Owned Beneficially Owned
------------------------------------ ------------------ ------------------
<S> <C> <C>
Stephen J. Cole-Hatchard .................... 371,000 7.2%
Nicko Feinberg .............................. 371,000 7.2
Michael Olbermann ........................... 303,000 5.9
Amy Wagner-Mele ............................. 65,000 1.3
Ronald Signore .............................. 94,864 1.9
William Barron .............................. 10,000 *
All directors and executive officers as a
group (seven persons) ....................... 1,259,864 22.5%
</TABLE>
- --------------
* Less than 1%.
The shares beneficially owned by Mr. Cole-Hatchard include 144,000
shares held by the Cole-Hatchard Family Limited Partnership, of which Mr.
Cole-Hatchard is the general partner, and options to purchase 174,000 shares of
common stock. This 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.
The shares beneficially owned by Mr. Feinberg and Mr. Olbermann each
includes 115,000 shares of common stock which may be purchased under immediately
exercisable options.
The shares beneficially owned by Ms. Wagner-Mele include 50,000 shares
of common stock which may be purchased under immediately exercisable options.
The shares beneficially owned by Mr. Signore include shares issuable
upon the exercise of (1) warrants to purchase 41,664 shares of common stock and
(2) immediately exercisable options to purchase 50,000 shares of common stock.
The shares beneficially owned by Mr. Barron are 10,000 shares of common
stock which may be purchased under immediately exercisable options.
The shares beneficially owned by all directors and executive officers
as a group include options and warrants to purchase an aggregate of 600,664
shares of common stock.
-32-
<PAGE>
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 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 1997, we borrowed $60,000 from Mr. Cole-Hatchard, which
indebtedness bore interest at the rate of 9.25% per annum. We repaid $30,000 of
this indebtedness to Mr. Cole-Hatchard in December 1997 and the balance directly
to Mr. Cole-Hatchard's lender in May 1998.
In February 1997, we issued 256,000 shares of our common stock to each
of Messrs. Char, Feinberg and Cole-Hatchard, and 188,000 shares of our common
stock to Mr. Olbermann in consideration of $.01 per share. In December 1997, we
issued 100,000 shares of our common stock to Ronald Shapss, a former director,
in consideration of $.01 per share.
In December 1997, we entered into a consulting agreement with Mr.
Shapss pursuant to which we paid Mr. Shapss $2,000 per month through December
1999. In addition, we issued Mr. Shapss 100,000 shares of common stock, options
to purchase 80,000 shares of common stock at an exercise price of $2.00 per
share and options to purchase 20,000 shares of common stock at an exercise price
of $2.50 per share pursuant to the agreement. The agreement with Mr. Shapss has
been terminated.
In March 1998, we entered into a settlement agreement with Mr. Char
pursuant to which Mr. Char discontinued a lawsuit against us and released us
from all claims (including for monies owed) in consideration of (i) an up-front
payment of $65,000 and (ii) a payment of $435,000 in May 1998 to (a) satisfy
$240,000 of existing obligations due to Mr. Char (including $15,000 of legal
fees) and (b) to repurchase 231,520 shares of our common stock from Mr. Char.
Mr. Cole-Hatchard's mother and brother purchased 12,000 and 8,000
shares of our common stock at $2.00 per share pursuant to our May 1997 private
placement. William A. Barron, a director, purchased 20,000 shares of common
stock in our May 1997 private placement. The Rough Group, a general partnership
of which Mr. Signore, a director, is a general partner, purchased 16,000 shares
of common stock
-33-
<PAGE>
pursuant to our May 1997 private placement. In addition, Mr. Cole-Hatchard's
mother and the Rough Group purchased $40,000 and $85,000 principal amount of
promissory notes pursuant to our December 1997 private placement, and received
warrants to purchase 64,000 and 196,000 shares of our common stock at an
exercise price of $5.00 per share. The notes were repaid in May 1998. These
purchases were all on terms and conditions identical to those of the other
investors in these private placements.
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.
This note bears interest at a rate of 6%, is due on June 1, 2002 and is secured
by personal assets of Ms. Wagner-Mele and the shares of our common stock that
she acquired.
Prior to December 31, 1999, the Company's Board of Directors passed a
resolution whereby $168,000 of notes payable to certain stockholders were offset
with $168,000 of notes receivable from these same stockholders. The financial
statements for the year ended December 31, 1999 have been adjusted to reflect
this transaction as if it had occurred on December 31, 1999.
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.*
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
-34-
<PAGE>
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.*
21.1 Subsidiaries of the Company.
27.1 Financial Data Schedule (SEC use only).
(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
-35-
<PAGE>
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.
(b) Reports on Form 8-K filed during the quarter ended December 31,
1999:
Not applicable.
-36-
<PAGE>
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 27th day of March 2000.
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.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/S/ Stephen J. Cole-Hatchard Chief Executive Officer, March 27, 2000
- ------------------------ President, and Director (Principal
Stephen J. Cole-Hatchard Executive Officer)
/s/ Nicko Feinber
- ------------------------ Chief Information Officer, March 27, 2000
Nicko Feinberg Executive Vice President of
Technology and Director
/s/ Michael Olbermann
- ------------------------ Executive Vice President and March 27, 2000
Michael Olbermann Director
/s/ Vasan Thatham
- ------------------------ Chief Financial Officer and March 27, 2000
Vasan Thatham Executive Vice President
/s/ Amy Wagner-Mele
- ------------------------ Executive Vice President, March 27, 2000
Amy Wagner-Mele Secretary and General Counsel
/s/ Ronald C. Signore
- ------------------------ Director March 27, 2000
Ronald C. Signore
/s/ William A. Barron
- ------------------------ Director March 27, 2000
William A. Barron
</TABLE>
-37-
<PAGE>
Frontline Communications
Corporation
Consolidated Financial Statements
Years Ended December 31, 1999 and 1998
F-1
<PAGE>
Frontline Communications Corporation
Contents
- --------------------------------------------------------------------------------
Report of independent certified public accountants F-3
Consolidated financial statements:
Balance sheet F-4
Statements of operations F-5
Statements of stockholders' equity (deficit) F-6
Statements of cash flows F-7
Notes to consolidated financial statements F-8 - F-24
F-2
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors of
Frontline Communications Corporation
We have audited the accompanying consolidated balance sheet of Frontline
Communications Corporation and its wholly-owned subsidiaries (the "Company") as
of December 31, 1999, and the related consolidated statements of operations,
stockholders' equity (deficit) and cash flows for the years ended December 31,
1999 and 1998. 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 audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits 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 audits provide 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, 1999, and the results of its operations and its cash flows for the
years ended December 31, 1999 and 1998, in conformity with generally accepted
accounting principles.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
New York, New York
February 25, 2000
F-3
<PAGE>
Frontline Communications Corporation
Consolidated Balance Sheet
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31, 1999
- ------------------------------------------------------------------------------------------------------------------
<S> <C>
Assets
Current:
Cash and cash equivalents $ 615,190
Accounts receivable, less allowances for doubtful accounts of $86,955 288,337
Prepaid expenses and other 122,308
- ------------------------------------------------------------------------------------------------------------------
Total current assets 1,025,835
Property and equipment, net (Note 3) 2,944,948
Intangibles, net (Note 2) 4,146,107
Other (Note 9) 297,742
- ------------------------------------------------------------------------------------------------------------------
$ 8,414,632
- ------------------------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 415,745
Accrued expenses 713,588
Accrued equipment installation costs (Note 4) 418,710
Current portion of long-term debt (Note 4) 433,917
Deferred revenue 684,219
- ------------------------------------------------------------------------------------------------------------------
Total current liabilities 2,666,179
Long-term debt, less current portion (Note 4) 1,458,583
- ------------------------------------------------------------------------------------------------------------------
Total liabilities 4,124,762
- ------------------------------------------------------------------------------------------------------------------
Commitments and contingencies (Notes 5 and 6)
Stockholders' equity (Notes 1, 2, 6, 7 and 9):
Preferred stock, $.01 par value, 1,000,000 shares authorized; no shares outstanding
(Note 9) -
Common stock, $.01 par value, 25,000,000 shares authorized; 4,484,060 issued 44,841
Additional paid-in capital 15,147,547
Accumulated deficit (10,600,905)
- ------------------------------------------------------------------------------------------------------------------
4,591,483
Note receivable (37,500)
Treasury stock, at cost, 231,520 shares (264,113)
- ------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 4,289,870
- ------------------------------------------------------------------------------------------------------------------
$ 8,414,632
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
Frontline Communications Corporation
Consolidated Statements of Operations
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year ended December 31, 1999 1998
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Revenues $ 2,975,213 $ 574,964
- ------------------------------------------------------------------------------------------------------------------
Costs and expenses:
Cost of revenues 2,015,824 586,760
Selling, general and administrative 5,235,711 1,412,935
Depreciation and amortization 1,764,373 220,575
Non-cash compensation charge (Note 6) 754,220 175,137
- ------------------------------------------------------------------------------------------------------------------
9,770,128 2,395,407
- ------------------------------------------------------------------------------------------------------------------
Loss from operations (6,794,915) (1,820,443)
Other income (expense):
Interest income 82,411 108,194
Interest expense (44,754) (31,850)
- ------------------------------------------------------------------------------------------------------------------
Net loss $(6,757,258) $(1,744,099)
- ------------------------------------------------------------------------------------------------------------------
Loss per share - basic and diluted $ (1.90) $ (.72)
- ------------------------------------------------------------------------------------------------------------------
Weighted average number of shares outstanding - basic and diluted 3,550,231 2,435,035
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
Frontline Communications Corporation
Consolidated Statements of Stockholders' Equity (Deficit)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Years ended December 1999 and 1998
- ------------------------------------------------------------------------------------------------------------------------------------
Preferred stock Common stock Additional
------------------- ------------------- Paid-in
Shares Amount Shares Amount capital
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1997 - $- 1,408,000 $14,080 $ 1,646,520
Payment of stock subscription - - - - -
Initial public offering of common stock, net (Note 7) - - 1,840,000 18,400 5,792,005
Purchase of treasury stock, at cost (231,520 shares)
(Note 7) - - - - -
Common stock options issued for services (Note 6) - - - - 175,137
Preferred stock issued for acquisition of subsidiary
(Note 2) 10 - - - 1,000,000
Common stock issued to acquire business (Note 2) - - 113,364 1,134 507,871
Net loss - - - - -
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 10 - 3,361,364 33,614 9,121,533
Private sale of common stock and related repricing
(Note 7) - - 739,605 7,396 3,787,604
Common stock issued to acquire businesses (Note 2) - - 120,039 1,200 1,126,901
Exercise of stock options and warrants (Note 6) - - 158,616 1,586 358,334
Conversion Series A preferred stock (Note 2) (10) - 98,462 985 (985)
Common stock options and common stock, issued for
services (Note 6) - - 5,974 60 754,160
Net loss - - - - -
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 - $- 4,484,060 $44,841 $15,147,547
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
Stock Treasury Total
Accumulated subscriptions stock, Note stockholder's
deficit receivable at cost receivable equity (deficit)
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1997 $ (2,099,548) $(6,000) $ $ - $ (444,948)
Payment of stock subscription - 6,000 - - 6,000
Initial public offering of common stock, net (Note 7) - - - - 5,810,405
Purchase of treasury stock, at cost (231,520 shares)
(Note 7) - - (264,113) - (264,113)
Common stock options issued for services (Note 6) - - - - 175,137
Preferred stock issued for acquisition of subsidiary
(Note 2) - - - - 1,000,000
Common stock issued to acquire business (Note 2) - - - - 509,005
Net loss (1,744,099) - - - (1,744,099)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1998 (3,843,647) - (264,113) - 5,047,387
Private sale of common stock and related repricing
(Note 7) - - - - 3,795,000
Common stock issued to acquire businesses (Note 2) - - - - 1,128,101
Exercise of stock options and warrants (Note 6) - - - (37,500) 322,420
Conversion Series A preferred stock (Note 2) - - - - -
Common stock options and common stock, issued for
services (Note 6) - - - - 754,220
Net loss (6,757,258) - - - (6,757,258)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1999 $(10,600,905) $ - $(264,113) $(37,500) $ 4,289,870
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated inancial statements.
F-6
<PAGE>
Frontline Communications Corporation
Consolidated Statements of Cash Flows
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year ended December 31, 1999 1998
-----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(6,757,258) $ (1,744,099)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 1,764,373 220,575
Noncash compensation charge 754,220 175,137
Allowance for doubtful accounts 81,429 (11,140)
Changes in assets and liabilities, net of effects from
acquisitions:
Accounts receivable (366,438) 25,561
Notes receivable from stockholders (24,800) (143,800)
Prepaid expenses and other (64,027) (49,754)
Other assets (267,556) (5,206)
Accounts payable and accruals 1,234,117 (58,012)
Deferred revenue (12,658) 46,467
-----------------------------------------------------------------------------------------------------------------
Net cash used in operating activities (3,658,598) (1,544,271)
-----------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Acquisition of property and equipment (915,411) (423,297)
Acquisition of businesses (816,228) (1,481,820)
-----------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (1,731,639) (1,905,117)
-----------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from exercise of stock options and warrants 322,420 -
Proceeds from sale of common stock 3,795,000 6,000
Principal payments on long-term debt (106,704) -
Proceeds from initial public offering of common stock - 6,041,476
Repayments of stockholder loans - (378,989)
Payments to acquire treasury stock - (264,113)
-----------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 4,010,716 5,404,374
-----------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (1,379,521) 1,954,986
Cash and cash equivalents, beginning of year 1,994,711 39,725
-----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 615,190 $ 1,994,711
-----------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Cash paid for interest $ 44,639 $ 31,000
Noncash investing and financing activities:
Common stock issued for stockholder loan 37,500 -
Capital lease obligations incurred 1,432,568 207,725
Preferred stock issued to acquire subsidiary - 1,000,000
Common stock issued to acquire businesses 1,128,101 509,005
Conversion of preferred stock into common stock 1,000,000 -
Notes payable to stockholders offset with notes receivable from
stockholders 168,600 -
Notes payable issued in connection with business acquisitions 425,000 -
-----------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Summary of Business
Significant Frontline Communications Corporation ("Frontline" or
Accounting the "Company") is an internet company and Competitive
Policies Local Exchange Carrier ("CLEC") that offers internet
access, website development and internet presence
services. The Company operates in one business
segment.
Principles of Consolidation
The consolidated financial statements include the
accounts of the Company and its wholly-owned
subsidiaries. Intercompany balances and transactions
have been eliminated.
Use of Estimates
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 revenues 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.
Revenue Recognition
Monthly subscription service revenue for internet
access is recognized over the period in which
services are provided. Fee revenues for website
development and internet website presence services
are recognized as services are performed. Deferred
revenue represents prepaid access fees by
subscribers.
F-8
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Property, Equipment and Depreciation
Property and equipment is stated at cost, less
accumulated depreciation and amortization.
Depreciation and amortization is computed over the
shorter of estimated useful lives of the assets or
lease term using the straight-line method.
The following estimated useful lives are applied in
the computation of depreciation and amortization:
Years
-----------------------------------------------------
Computer and office equipment 3-5
Furniture and fixtures 5
Leasehold improvements Lease term
-----------------------------------------------------
Intangible Assets
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
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. No write downs were
necessary for the years ended December 31, 1999 and
1998.
F-9
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Income Taxes
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.
Credit Risk
Financial instruments which potentially subject the
Company to concentrations of credit risk consist
principally of temporary cash investments 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 is limited due
to the large number of customers comprising the
Company's customer base.
Cash and Cash Equivalents
The Company considers all highly liquid money market
instruments purchased with an original maturity of
three months or less to be cash equivalents.
Financial Instruments
The carrying amounts of financial instruments
including cash, accounts receivable, and accounts
payable approximated fair value as of December 31,
1999, because of the relatively short maturity of
these instruments.
Stock-Based Compensation
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 loss and pro
forma net loss per share amounts assuming the fair
value method. Stock arrangements with non-employees,
if applicable, are recorded at fair value.
F-10
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Advertising
All costs associated with advertising services are
expensed in the period incurred. Advertising expense
was approximately $282,264 and $ 136,000 for the
years ended December 31, 1999 and 1998, respectively.
Loss Per Share
The Company follows SFAS No. 128, "Earnings per
Share," which provides for the calculation of "basic"
and "diluted" earnings per share. Basic earnings per
share includes no dilution and is computed by
dividing income available to common shareholders by
the weighted average number of common shares
outstanding for the period. Diluted earnings per
share reflect, in periods in which they have a
dilutive effect, the effect of common shares issuable
upon exercise of stock options and warrants. Diluted
earnings per share amounts have not been reported
because the Company has a net loss and the impact of
the assumed exercise of stock options and warrants
would be anti-dilutive.
Effect of Recent Accounting Pronouncement
In June 1998, the Financial Accounting Standards
Board issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which requires
companies to recognize all derivatives as either
assets or liabilities in the statement of financial
position and measure those instruments at fair value.
SFAS No. 133, as amended by SFAS No. 137 is effective
for fiscal years beginning after June 15, 2000. The
Company does not presently enter into any
transactions involving derivative financial
instruments and, accordingly, does not anticipate the
new standard will have any effect on its financial
statements.
Reclassifications
Certain amounts relating to 1998 have been
reclassified to conform to the current year
presentation.
F-11
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. Acquisition of At December 31, 1999, intangibles were as follows:
Business
<TABLE>
<CAPTION>
Customer
Goodwill bases Total
----------------------------------------------------------------------------
<S> <C> <C> <C>
Intangibles $2,317,294 $3,338,911 $ 5,656,205
Less: Accumulated amortization (606,648) (903,450) (1,510,098)
----------------------------------------------------------------------------
$1,710,646 $2,435,461 $ 4,146,107
----------------------------------------------------------------------------
</TABLE>
During 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 Specialists, Inc.; 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; 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
transaction-related costs), 120,039 shares of common
stock (approximately $1,128,000) and $425,000 in
noninterest-bearing promissory notes.
All of the 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 3 years.
During 1998, the Company made the following
acquisitions, all of which 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. The acquisition resulted in the recording of
intangible assets of $3,215,226 in 1998 and $360,000
in 1999, which are being amortized over their
expected benefit period of 3 years.
F-12
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
WOWFactor
On October 9, 1998, the Company acquired all of the
issued and outstanding capital stock of WOWFactor,
Inc. ("WOWFactor"), a New Jersey corporation engaged
in the business of promoting e-commerce through its
web sites primarily for women's businesses. The
Company issued to the stockholders of WOWFactor ten
shares of newly created Series A preferred stock,
which was convertible on July 15, 1999 into common
stock with a market value of $1,000,000, subject to a
maximum issuance of 250,000 shares. In December 1999,
the Company issued 98,462 shares of common stock upon
the conversion of the Series A preferred stock.
Roxy Systems d/b/a Magic Carpet
On October 9, 1998, the Company acquired
substantially all of the assets used in the business
of Roxy Systems, Inc. d/b/a Magic Carpet ("Roxy") in
consideration of $75,000 in cash and the assumption
of approximately $60,000 of liabilities. Roxy is an
internet service provider which, at the date of
acquisition, had approximately 1,000 individual and
business subscribers in Orange County, New York.
US Online
Pursuant to an order of the United States Bankruptcy
Court, District of New Jersey, on October 23, 1998,
the Company acquired substantially all of the assets
used in the business of US Online, Inc. ("US
Online"), including a point of presence in the
Philadelphia area, and assumed two of US Online's
executory contracts for consideration of $570,000 in
cash paid upon closing. At the time of the
acquisition, US Online was engaged in the business of
providing internet access, web hosting and leased
communications lines to approximately 3,500
subscribers in New York, New Jersey and Pennsylvania.
F-13
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Webspan
On December 17, 1998, the Company acquired
substantially all of the assets used in the business
of Webspan Communications, Inc. ("Webspan") in
consideration of $500,000 in cash, assumption of
approximately $544,000 of liabilities and an
aggregate of 113,364 shares of the Company's common
stock (approximately $509,000). At the time of the
acquisition, Webspan was an internet service provider
with approximately 9,000 individual and business
subscribers in New York and New Jersey.
The following pro forma consolidated financial
information has been prepared to reflect the 1999 and
1998 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, 1998. 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,
1998, and neither is it necessarily indicative of the
results of operations for future periods.
<TABLE>
<CAPTION>
Year ended December 31, 1998 1999 1998
----------------------------------------------------------------
<S> <C> <C>
Revenues $ 3,497,213 $ 3,344,923
Net loss (7,031,258) (4,968,399)
Net loss per share - basic and diluted (1.95) (1.87)
-----------------------------------------------------------------
</TABLE>
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.
F-14
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
3. Property and Property and equipment consisted of the following:
Equipment
<TABLE>
<CAPTION>
December 31, 1999
------------------------------------------------------------------
<S> <C>
Computer and office equipment $3,213,831
Furniture and fixtures 81,806
Leasehold improvements 177,176
------------------------------------------------------------------
3,472,813
Less: Accumulated depreciation and
amortization (527,865)
------------------------------------------------------------------
$2,944,948
------------------------------------------------------------------
</TABLE>
4. Long-term Debt Long-term debt consists of the following:
<TABLE>
------------------------------------------------------------------
<S> <C>
Present value of net minimum lease payments
(a) $1,398,239
Promissory notes payable (b) 425,000
Mortgage payable (c) 69,261
1,892,500
------------------------------------------------------------------
Less:
Current portion of present value of net minimum
lease payments 433,214
Current portion of mortgage payable 703
------------------------------------------------------------------
433,917
------------------------------------------------------------------
$1,458,583
------------------------------------------------------------------
</TABLE>
------------
(a) The Company leases computer and other
equipment under capital leases. The assets
acquired under capital leases have a cost of
$1,639,000, excluding installation costs of
approximately $418,000. Accumulated depreciation
of such assets is $154,215 as of December 31,
1999.
F-15
<PAGE>
Frontline Communications Corporation
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, 1999.
<TABLE>
--------------------------------------------------------------
<S> <C> <C>
Payments for the year ending:
2000 $ 559,849
2001 554,714
2002 477,234
2003 43,981
--------------------------------------------------------------
Total minimum lease payments 1,635,778
Less: Amount representing interest 237,539
--------------------------------------------------------------
Present value of net minimum lease payments 1,398,239
Less: Current portion 433,214
--------------------------------------------------------------
Long-term lease obligations $ 965,025
--------------------------------------------------------------
</TABLE>
(b) Noninterest-bearing promissory notes issued
to former owners of two acquired businesses. The
terms of the notes provided for payment of
$100,000 in April 2000, $150,000 in June 2000 and
$175,000 in October 2000, or the entire amount
within five days after the closing of any
financing in which the Company receives over $5
million. Since the Company repaid the notes from
the proceeds of its public offering (see Note 11)
in February 2000, they are classified as
long-term debt in the accompanying balance sheet.
(c) Mortgage payable, secured by property payable
in equal monthly installments of $514, including
interest at 8% per year, through August 2003,
with the balance of approximately $66,500 due
September 2003.
F-16
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Maturities of long-term debt excluding the repayment
of the promissory notes from the proceeds of the
public offering, are as follows:
Year ending December 31
-----------------------------------------------------
2000 $ 433,917
2001 476,583
2002 447,617
2003 109,383
-----------------------------------------------------
$ 1,467,500
-----------------------------------------------------
5. Commitments and Leases
Contingencies
The Company rents office space and equipment under
operating lease agreements expiring at various dates
through 2004.
Future minimum rental payments required under
operating leases are approximately as follows:
Year ended December 31,
-----------------------------------------------------
2000 $ 340,000
2001 336,000
2002 325,000
2003 323,000
2004 226,000
-----------------------------------------------------
Total $ 1,550,000
-----------------------------------------------------
Rental expense was $248,409 and $134,249 for the
years ended December 31, 1999 and 1998, 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
in August 2000 and September 2001.
F-17
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
6. Stock Options The Company has a stock option plan (the "Plan"),
which authorized the issuance of incentive options
and non-qualified options to purchase up to 1,400,000
shares of common stock. The plan has a ten year term.
The Board retained the authority to determine the
individuals to whom, and the times at which, stock
options would be made, 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 date of
issuance by $365,104. The non-cash 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. During 1998, the Company had recognized
$175,137 as the fair value of services received for
the 103,000 options granted to non-employees during
1998.
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 fair value of each stock based
option at the date of the grant using the Black
Scholes option-pricing model with the following
weighted average assumptions used for options in 1999
and 1998:
<TABLE>
<CAPTION>
1999 1998
---------------------------------------------------------------
<S> <C> <C>
Risk-free interest rate 4.50% - 6.14% 4.29% - 5.48%
Expected life 5 years 5 years
Expected volatility 97.50% 46.10%
Dividend yield None None
-----------------------------------------------------------------
</TABLE>
F-18
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
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:
<TABLE>
<CAPTION>
1999 1998
---------------------------------------------------------------------
<S> <C> <C>
Net loss:
As reported $(6,757,258) $(1,744,099)
Pro forma (9,575,653) (2,060,753)
Net loss per share (basic and diluted):
As reported (1.90) (.72)
Pro forma (2.70) (.85)
---------------------------------------------------------------------
</TABLE>
F-19
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
A summary of the status of the Company's stock option plan as of December 31,
1999 and 1998, and changes during the years ended on those dates, is presented
below:
<TABLE>
<CAPTION>
December 31, 1999 1998
- ---------------------------------------------------------------------------------------------------------------------------
Weighted average Weighted average
Shares exercise price Shares exercise price
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 583,000 $2.73 165,600 $ 2.00
Granted 916,868 5.57 426,200 3.00
Exercised (152,000) 2.48 - -
Forfeited (20,000) 2.50 (8,800) (2.00)
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 1,327,868 $4.71 583,000 $ 2.73
- ---------------------------------------------------------------------------------------------------------------------------
Options exercisable at year-end 885,601 $4.44 457,000 $ 2.66
- ---------------------------------------------------------------------------------------------------------------------------
Weighted average fair value of options
granted during the year $4.58 $ 1.62
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
F-20
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The following table summarizes information about stock options outstanding at
December 31, 1999.
<TABLE>
<CAPTION>
Options outstanding Options exercisable
---------------------------------------------- --------------------------------
Weighted
average Weighted Number
Number remaining average exercisable at Weighted
outstanding at contractual exercise December 31, average
Range of exercise prices December 31, 1999 life price 1999 exercise price
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$2.00 to $3.00 271,600 3.3 $2.35 236,600 $2.33
$3.00 to $4.00 125,000 3.8 $3.51 92,000 $3.56
$4.00 to $5.00 140,000 4.8 $4.77 110,000 $4.75
$5.00 to $6.00 586,000 4.9 $5.35 306,733 $5.32
$6.00 to $8.50 205,268 4.2 $6.72 140,268 $6.43
- --------------------------------- ------------------ --------------- ---------------- --- ----------------- ---------------
</TABLE>
F-21
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
7. Capital Stock In March 1998, the Company effected a 4 for 5 reverse
split. All shares and per share data in the
consolidated financial statements have been adjusted
to give retroactive effect to the reverse split.
In connection with a settlement of all disputes with
a former officer, in 1998 the Company purchased
231,520 shares of common stock owned by that officer
for $264,113. This amount is accounted for as
treasury stock in the accompanying consolidated
balance sheet.
The Company consummated an initial public offering
("IPO") in May 1998 and sold 1,840,000 shares of
common stock and realized net proceeds of $5,810,405.
As a part of the IPO, the Company sold warrants (the
"Public Warrants") to purchase 1,840,000 shares, at
an exercise price of $4.80 per share, expiring in May
2003. Additionally, during May 1998, the Company sold
to the underwriter of the IPO, warrants to purchase
160,000 shares, at an exercise price of $6.60 per
share, and 160,000 shares at an exercise price of
$7.92 per share. These warrants expire in May 2003.
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 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. The
Company granted repricing rights with respect to the
shares and anti-dilution rights with respect to the
warrants. As of December 31, 1999, the Company had
issued 239,716 additional shares of common stock
pursuant to the repricing rights. The Company may be
required to issue up to 207,161 additional shares of
common stock to satisfy the remaining repricing
rights.
F-22
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
In 1999, an officer of the Company exercised options
granted under the Company's stock option plan and
acquired 15,000 shares of common stock for $37,500.
The payment was made by an interest-bearing secured
promissory note. The amounts due under the note are
secured by certain personal assets of the officer in
addition to the shares of common stock acquired by
the officer.
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.
At December 31, 1999, there were an aggregate of
2,539,475 warrants outstanding at exercise prices
ranging between $4.80 and $13.85 per shares, expiring
at various times through 2004.
8. Income Taxes The Company had net operating loss carryforwards of
approximately $6,500,000 at December 31, 1999, which
expire beginning in 2018. The tax benefit of these
losses, approximately $2,600,000, has been completel
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%
change 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 (see Note 11) 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-23
<PAGE>
Frontline Communications Corporation
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
9. Subsequent Events 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 February 2000, the Company sold in a public
offering 1,075,000 shares of Series B Convertible
Redeemable preferred stock at $15 per share and
realized gross proceeds, before deducting commissions
and related expenses, of $16,125,000. In March 2000,
the Company sold an additional 62,300 shares of
Series B convertible redeemable preferred stock at
$15 per share for gross proceeds of $934,500. The
underwriter has the option to purchase an additional
12,700 shares to cover overallotments. Included in
other assets at December 31, 1999 are approximately
$194,000 deferred registration costs incurred in
connection with this offering which together with
additional related costs will be charged to
additional paid in capital in the first quarter of
2000.
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 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 the first quarter of 2000, additional dividends
(noncash) of approximately $6,148,000 will be
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.
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.
F-24
<PAGE>
Exhibit 21.1
Subsidiaries of Frontline Communications Corporation
Name Ownership Jurisdiction
iShop Networks, Inc. wholly-owned Delaware
WOW Factor, Inc. wholly-owned New Jersey
CLEC Communications Corporation wholly-owned Delaware
Web Prime, Inc. wholly-owned New York
-37-
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE COMPANY'S
FINANCIAL STATEMENTS INCLUDED IN THIS ANNUAL REPORT ON FORM 10-KSB AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS
</LEGEND>
<MULTIPLIER> 1
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<EXCHANGE-RATE> 1.000
<CASH> 615,190
<SECURITIES> 0
<RECEIVABLES> 375,292
<ALLOWANCES> 86,955
<INVENTORY> 0
<CURRENT-ASSETS> 1,025,835
<PP&E> 3,472,813
<DEPRECIATION> 527,865
<TOTAL-ASSETS> 8,414,632
<CURRENT-LIABILITIES> 2,666,179
<BONDS> 1,458,583
0
0
<COMMON> 44,841
<OTHER-SE> 4,245,029
<TOTAL-LIABILITY-AND-EQUITY> 8,414,632
<SALES> 0
<TOTAL-REVENUES> 2,975,213
<CGS> 2,015,824
<TOTAL-COSTS> 2,015,824
<OTHER-EXPENSES> 2,518,593<F1>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (6,757,258)
<INCOME-TAX> 0
<INCOME-CONTINUING> (6,757,258)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,757,258)
<EPS-BASIC> (1.90)
<EPS-DILUTED> (1.90)
<FN>
<F1>
Item consists of: (i) depreciation and amortization and
(ii) non-cash compensation charge
</FN>
</TABLE>
