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UNITED STATES
SECURITIES AND EXCHANGE COMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
COMMISSION FILE NUMBER: 0-30162
FRONTLINE CAPITAL GROUP
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 11-3383642
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OF ORGANIZATION)
1350 AVENUE OF AMERICAS, NEW YORK, NY 10019
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE) (ZIP CODE)
(212) 931-8000
(REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE)
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INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS) YES |X| NO |_|, AND (2) HAS
BEEN SUBJECT TO SUCH FILINGS FOR THE PAST 90 DAYS, YES |X| NO |_|.
THE REGISTRANT HAS ONLY ONE CLASS OF COMMON STOCK, ISSUED AT $.01 PAR VALUE PER
SHARE WITH 36,631,278 SHARES OUTSTANDING AS OF NOVEMBER 7, 2000.
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<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
QUARTERLY REPORT
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000
TABLE OF CONTENTS
<TABLE>
<CAPTION>
INDEX PAGE
<S> <C>
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PART I. FINANCIAL INFORMATION
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Item 1 Financial Statements
Consolidated Balance Sheets as of September 30, 2000 (unaudited) and
December 31, 1999 .................................................................................................. 3
Consolidated Statements of Operations for the three and nine months
ended September 30, 2000 and 1999 (unaudited) ...................................................................... 4
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2000 and 1999 (unaudited) ............................................................................ 5
Notes to the Consolidated Financial Statements (unaudited) ......................................................... 6
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations .............................................................................................. 25
Item 3 Quantitative and Qualitative Disclosures about Market Risk ......................................................... 34
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PART II. OTHER INFORMATION
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Item 1 Legal Proceedings .................................................................................................. 35
Item 2 Changes in Securities and Use of Proceeds .......................................................................... 35
Item 3 Defaults Upon Senior Securities .................................................................................... 35
Item 4 Submission of Matters to a Vote of Securities Holders .............................................................. 35
Item 5 Other Information .................................................................................................. 35
Item 6 Exhibits and Reports on Form 8-K ................................................................................... 35
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SIGNATURES ................................................................................................................... 36
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</TABLE>
2
<PAGE>
PART 1 - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS:
Current Assets:
Cash and cash equivalents ............................................................... $ 37,310 $ 32,740
Restricted cash ......................................................................... 6,689 21,572
Accounts receivable, net of allowance for doubtful accounts of
$3,916 at September 30, 2000 and $861 at December 31, 1999............................ 25,661 8,426
Other current assets .................................................................... 20,237 16,008
----------- -----------
Total Current Assets ................................................................ 89,897 78,746
Ownership interests in and advances to unconsolidated companies .............................. 83,931 97,833
Intangible assets, net ....................................................................... 669,085 239,412
Property and equipment, net .................................................................. 210,272 80,425
Deferred financing costs, net ................................................................ 51,420 5,426
Other assets, net ............................................................................ 55,577 40,141
----------- -----------
Total Assets ........................................................................ $ 1,160,182 $ 541,983
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current Liabilities:
Accounts payable and accrued expenses ................................................... $ 52,969 $ 45,852
Current portion of senior secured debt .................................................. 16,575 12,500
Notes payable ........................................................................... 25,000 --
Deferred rent payable ................................................................... 4,131 2,165
Other current liabilities ............................................................... 2,453 1,139
----------- -----------
Total Current Liabilities ........................................................... 101,128 61,656
Credit facilities with related parties ....................................................... 132,379 121,848
Senior secured debt .......................................................................... 199,575 44,407
Subordinated notes payable ................................................................... 125,000 108,125
Deferred rent payable ........................................................................ 33,462 22,794
Other liabilities ............................................................................ 79,004 33,706
----------- -----------
Total Liabilities ................................................................... 670,548 392,536
----------- -----------
Minority interest ............................................................................ 300,508 35,338
Commitments and contingencies ................................................................ -- --
Shareholders' Equity:
8.875% Cumulative convertible preferred stock, $.01 par value, 25,000,000
shares authorized, 26,000 and -0- issued and outstanding,
at September 30, 2000 and December 31, 1999, respectively ............................. -- --
Common stock, $.01 par value, 100,000,000 shares authorized,
36,574,462 and 30,672,794 shares issued and outstanding at
September 30, 2000 and December 31, 1999, respectively ................................ 366 307
Additional paid-in capital .............................................................. 399,113 162,054
Cumulative translation adjustment ....................................................... (574) --
Accumulated deficit ..................................................................... (209,779) (48,252)
----------- -----------
Total Shareholders' Equity .......................................................... 189,126 114,109
----------- -----------
Total Liabilities and Shareholders' Equity .......................................... $ 1,160,182 $ 541,983
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- -------------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
HQ Operating Revenues:
Executive office suite income ....................... $ 97,642 $ 33,703 $ 191,798 $ 91,339
Support services and other .......................... 62,624 24,378 129,655 66,070
------------ ------------ ------------ ------------
Total HQ Operating Revenues ..................... 160,266 58,081 321,453 157,409
------------ ------------ ------------ ------------
HQ Operating Expenses:
Cost of Revenue ..................................... 106,610 43,904 225,481 117,850
General and administrative .......................... 18,811 6,602 36,097 17,493
------------ ------------ ------------ ------------
Total HQ Operating Expenses ..................... 125,421 50,506 261,578 135,343
------------ ------------ ------------ ------------
HQ Operating Income ............................. 34,845 7,575 59,875 22,066
HQ Other Expenses:
Merger and integration costs ........................ (1,707) (219) (21,148) (1,604)
Depreciation and amortization ....................... (19,069) (3,983) (35,263) (10,069)
Interest expense, net ............................... (11,827) (2,888) (22,054) (7,133)
------------ ------------ ------------ ------------
HQ Income (Loss) ................................ 2,242 485 (18,590) 3,260
Parent Income (Expenses):
General and administrative expenses ................. (4,598) (4,290) (15,568) (12,902)
Depreciation and amortization ....................... (544) (14) (943) (50)
Amortization of deferred charges .................... (5,817) -- (11,347) --
Interest expense, net ............................... (4,014) (2,543) (14,023) (4,316)
Development Stage Company Costs and
Reserves .......................................... (3,578) -- (7,285) --
------------ ------------ ------------ ------------
Loss before income taxes, minority interest
and equity losses ............................. (16,309) (6,362) (67,756) (14,008)
Provision for income taxes ............................. (1,983) (864) (2,453) (2,195)
Minority interest ...................................... (4,416) 314 (3,318) (643)
Equity in net loss of unconsolidated companies.......... (31,106) (4,828) (83,853) (6,685)
------------ ------------ ------------ ------------
Loss before extraordinary item from
early extinguishment of debt and
distribution to Preferred Shareholder ......... (53,814) (11,740) (157,380) (23,531)
Extraordinary item from early extinguishment
of debt .............................................. -- -- (2,648) --
------------ ------------ ------------ ------------
Net loss before distribution to
Preferred Shareholder ......................... (53,814) (11,740) (160,028) (23,531)
Distribution to Preferred Shareholder .................. (576) -- (1,499) --
------------ ------------ ------------ ------------
Net loss applicable to common
shareholders .................................. $ (54,390) $ (11,740) $ (161,527) $ (23,531)
============ ============ ============ ============
Basic and diluted net loss per weighted
average common share ................................. $ (1.49) $ (0.47) $ (4.71) $ (0.95)
============ ============ ============ ============
Basic and diluted weighted average common
shares outstanding .................................. 36,574,462 25,163,301 34,295,488 24,855,657
============ ============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------
2000 1999
---- ----
<S> <C> <C>
Cash Flows from Operating Activities:
Net loss before distribution to Preferred Shareholder........................ $(160,028) $(23,531)
Adjustments to reconcile net loss before distribution to Preferred
Shareholder to cash provided by (used in) operating activities:
Depreciation and amortization............................................ 36,206 10,119
Extraordinary loss on early extinguishment of debt....................... 2,648 --
Equity in net loss of unconsolidated companies........................... 83,853 6,685
Minority interest........................................................ 3,318 643
Deferred income taxes.................................................... (603) --
Amortization of deferred charges......................................... 11,347 8,846
Preferred distribution................................................... (577) --
Cumulative translation adjustment........................................ (1,013) --
Changes in operating assets and liabilities:
Accounts receivable, net............................................... (9,553) (2,015)
Acquisition costs and other assets..................................... 2,790 (3,790)
Deferred rent payable.................................................. 6,105 4,108
Accounts payable and accrued expenses.................................. (31,182) 5,423
Other liabilities...................................................... 16,122 2,738
Affiliate receivables.................................................. -- 7,427
------------ -------------
Net cash provided by (used in) operating activities.................. (40,567) 16,653
------------ -------------
Cash Flows from Investing Activities:
Acquisitions of officing solutions centers................................... (326,809) (53,044)
Equipment .................................................................. (34,686) (26,804)
Restricted cash.............................................................. 23,322 (21,799)
Acquisition of ownership interests and advances to Partner Companies......... (65,208) (17,084)
Acquisition of other ownership interests..................................... (4,743) (25,541)
------------ -------------
Net cash used in investing activities................................ (408,124) (144,272)
------------ -------------
Cash Flows from Financing Activities:
Issuance of common stock and warrants, net of costs.......................... 156,855 (99)
Issuance of preferred stock, net of costs.................................... 24,570 --
Deferred financing costs..................................................... (26,893) (3,054)
Net proceeds from credit facilities with related parties..................... 10,531 75,644
Capital leases............................................................... (2,300) (1,971)
Exercise of options.......................................................... 1,115 --
Net proceeds from secured credit facility and notes payable.................. 62,425 51,250
Net proceeds from minority interest.......................................... 226,958 5,878
------------ -------------
Net cash provided by financing activities............................ 453,261 127,648
------------ -------------
Cash and Cash Equivalents:
Net increase ................................................................ 4,570 29
Beginning of period.......................................................... 32,740 2,026
------------ -------------
End of period................................................................ $ 37,310 $2,055
============ =============
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
1. DESCRIPTION OF THE COMPANY
FrontLine Capital Group ("FrontLine" or the "Company") is a holding company
which develops and manages companies servicing small and medium-size enterprises
("SMEs") and mobile workforces of larger companies. FrontLine has two distinct
operating segments: one holds FrontLine's interest in HQ Global Holdings, Inc.
("HQ Global"), the world's largest provider of officing solutions (the "HQ
Global Segment"), and the other consists of FrontLine (parent company)
("FrontLine Parent") and its interests in a group of companies which leverage
the Internet to provide a wide range of services to the SME marketplace (the
"Parent and Other Interests Segment").
In October 2000, FrontLine announced that, as a result of changing market
conditions, it was refining its strategic plan (the "Restructuring"- see Note 10
for further discussion) to, in part, report the operations of HQ Global as a
separate operating segment and was in the process of exploring alternatives for
separating FrontLine into two companies. Additionally, in conjunction with the
Restructuring, FrontLine announced that it would focus its resources and capital
on the businesses within its existing portfolio and cease pursuing new
investment activities.
The Company refers to the companies in which it has acquired an equity interest
as its "Partner Companies" (except for Reckson Strategic Venture Partners, LLC
("Reckson Strategic") - see Note 4). However, the Company does not act as an
agent or legal representative for any of them, it does not have the power or
authority to legally bind any of them and it does not have the types of
liabilities in relation to them that a general partner of a partnership would
have.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements present the consolidated
financial position of the Company and its majority-owned subsidiaries. The
financial position, results of operations and cash flows of the HQ Global
Segment are presented in Note 3. The financial position, results of operations
and cash flows of the Parent and Other Interests Segment are summarized in Note
4. All significant intercompany balances and transactions have been eliminated
in the consolidated financial statements.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments
(substantially consisting of normal recurring accruals) considered necessary for
a fair presentation have been included. Operating results for the three and
nine-month periods ended September 30, 2000 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2000.
The balance sheet at December 31, 1999 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
6
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
For further information, refer to the consolidated financial statements and
notes thereto included in the Company's annual report on Form 10-K for the year
ended December 31, 1999.
ACCOUNTING FOR OWNERSHIP INTERESTS
The interests that FrontLine owns are accounted for under one of three methods:
consolidation, equity method and cost method. The applicable accounting method
is generally determined based on the Company's voting interest and rights in
each investee.
Consolidation. Partner Companies in which the Company directly or indirectly
owns more than 50% of the outstanding voting securities or controls the board of
directors are generally accounted for under the consolidation method of
accounting. Under this method, a Partner Company's results of operations are
reflected within the Company's Consolidated Statements of Operations. All
significant intercompany accounts and transactions have been eliminated.
Participation of other Partner Company shareholders in the earnings or losses of
a consolidated Partner Company is reflected in the caption "Minority interest"
in the Company's Consolidated Statements of Operations. Minority interest
adjusts the Company's consolidated results of operations to reflect only the
Company's share of the earnings or losses of the consolidated Partner Company.
Equity Method. Partner Companies and the other investee whose results are not
consolidated, but over whom the Company exercises significant influence, are
accounted for under the equity method of accounting. Whether or not the Company
exercises significant influence with respect to the investee depends on an
evaluation of several factors including, among others, representation on the
investee's Board of Directors and ownership level, which is generally a 20% to
50% interest in the voting securities of the investee, including voting rights
associated with the Company's holdings in common, preferred and any other
convertible securities in the investee. Under the equity method of accounting,
an investee's accounts are not reflected within the Company's Consolidated
Statements of Operations; however, FrontLine's share of the earnings or losses
of the investee is reflected in the caption "Equity in net loss of
unconsolidated companies" in the accompanying Consolidated Statements of
Operations.
The amount by which the Company's carrying value exceeds its share of the
underlying net assets of unconsolidated companies accounted for under the equity
method of accounting is amortized on a straight-line basis over 20 years as an
adjustment to the Company's share of the unconsolidated companies' earnings or
losses.
Cost Method. Partner Companies not accounted for under the consolidation or the
equity method of accounting, which are generally those in which the Company has
less than 20% interest in the voting securities of the investee, are accounted
for under the cost method of accounting. Under this method, the Company's share
of the earnings or losses of such companies is not included in the Consolidated
Statements of Operations. The Company recognizes income from dividends from its
Partner Companies.
The Company records its ownership interest in debt securities of Partner
Companies accounted for under the cost method at cost as it has the ability and
intent to hold these securities until maturity. The Company records its
ownership interests in equity securities of Partner Companies accounted for
under the cost method at cost, unless these securities have readily determinable
fair values based on quoted market prices, in which case these interests would
7
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
be classified as available-for-sale securities or some other classification in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." In addition
to the Company's investments in voting and non-voting equity and debt
securities, it also periodically makes advances to its Partner Companies in the
form of promissory notes which are accounted for in accordance with SFAS No.
114, "Accounting by Creditors for Impairment of a Loan."
The Company continually evaluates the carrying value of its ownership interests
in and advances to each of its Partner Companies for possible impairment based
on achievement of business plan objectives and milestones, the value of each
ownership interest in the Partner Company relative to carrying value, the
financial condition and prospects of the Partner Company and other relevant
factors. The business plan objectives and milestones the Company considers
include, among others, those related to financial performance such as
achievement of planned financial results or completion of capital raising
activities, and those that are not primarily financial in nature such as the
launching of a web site, business development activities, or the hiring of key
employees. The fair value of the Company's ownership interests in and advances
to privately held Partner Companies is generally determined based on the value
at which independent third parties have invested or have committed to invest in
the Partner Companies.
CASH AND CASH EQUIVALENTS
The Company considers highly liquid investments with a maturity of three months
or less when purchased to be cash equivalents.
REVENUE RECOGNITION
The Company's operating revenues for the three and nine months ended September
30, 2000 were attributable to HQ Global. HQ Global's revenue is derived
primarily from the operation of executive office suites and the range of
telecommunication and business support services provided to clients, and is
recognized as the related services are provided.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is calculated on the
straight-line method over the estimated useful lives of the assets which range
from five to seven years. Leasehold improvements are amortized over the lesser
of the term of the related lease or the estimated useful lives of the assets. As
of September 30, 2000 and December 31, 1999, the related accumulated
depreciation and amortization was $48.5 million and $14.0 million, respectively.
INTANGIBLE ASSETS
Intangible assets consist primarily of goodwill representing the excess of the
purchase price over the net assets of acquired companies by FrontLine. In
connection with the merger of HQ Global and VANTAS Incorporated ("VANTAS"), the
Company reassessed the estimated life of goodwill resulting from the merger. As
a result, the amortization period for goodwill was reduced from 30 to 20 years.
8
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
As of September 30, 2000 and December 31, 1999, the related accumulated
amortization was $24.1 million and $9.0 million, respectively.
If there is an event or change in circumstances that indicates that the basis of
FrontLine's long-lived intangibles may not be recoverable, FrontLine's policy is
to assess any impairment in value by making a comparison of the current and
projected operating cash flows of the business center to which the intangible
relates over its remaining useful life, on an undiscounted basis, to the
carrying amount of the intangible. Such carrying amount would be adjusted to
fair value, if necessary, to reflect any impairment in the value of the
intangible assets.
STOCK-BASED COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for its employee stock options and grants because the alternative
fair value accounting provided for under SFAS No. 123, "Accounting for
Stock-Based Compensation," requires the use of option valuation models that were
not developed for use in valuing employee stock options.
INCOME TAXES
The Company accounts for income taxes under the liability method which requires
recognition of deferred tax assets and liabilities based upon the expected
future tax consequences of events included in the Company's financial statements
and tax returns. Under this method, deferred tax assets and liabilities are
determined based on the difference between the financial statement and tax bases
of assets and liabilities using enacted tax rates in effect for the years in
which the differences are expected to reverse. For the three months ended
September 30, 2000 and 1999, the Company recognized current state and foreign
income tax provisions of $2.0 million and $0.9 million, respectively, and $2.5
million and $2.2 million for the nine months ended September 30, 2000 and 1999,
respectively.
Additionally, deferred tax assets are recognized for temporary differences that
will result in deductible amounts in future years. A valuation allowance is
recognized if it is more likely than not that some portion of the deferred asset
will not be realized. As of September 30, 2000, the Company's deferred tax
assets have been fully reserved because of the uncertainty of the timing and
amount of future taxable income.
SEGMENT REPORTING
The segment information for the three and nine months ended September 30, 2000
and 1999, as required by SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information," relating to the HQ Segment and the Parent
and Other Interests Segment is presented in Notes 3 and 4, respectively.
Each of the segments has a FrontLine senior professional assigned for purposes
of monitoring performance and carrying out operating activity. These
professionals report directly to the Chief Executive Officer and Chief Financial
Officer, who along with the Board of Directors/Executive Committees have been
identified as the Chief Operating Decision Makers ("CODM") because of their
final authority over resource allocation decisions and performance assessment.
9
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FrontLine's governance and control rights are generally exercised through Board
of Directors seats and through representation on the executive committees of the
various segment entities.
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments" requires
the Company to disclose the estimated fair values of its financial instrument
assets and liabilities. The carrying amounts approximate fair value for cash and
cash equivalents, accounts receivable and accounts payable because of the short
maturity of those instruments. For the loans payable to affiliates and others,
the estimated fair value approximates the recorded balance.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In June 1999, SFAS No. 137 was issued, amending SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which extended the required date
of adoption for fiscal years beginning after June 15, 2000. The Statement
permits early adoption of the derivative standards as of the beginning of any
fiscal quarter after its issuance. The Company expects to adopt the new
standards effective January 1, 2001. The Company does not currently anticipate
that such adoption will have any effect on its results of operations or
financial position.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
RECLASSIFICATIONS
Certain prior period amounts and segment disclosures have been reclassified to
conform to the current period presentation.
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES
In the first quarter of 2000, the Company paid approximately $43.3 million in
cash and issued 1,294,103 shares of its common stock in connection with the
completion of all remaining stock purchase agreements with other VANTAS
stockholders to increase its ownership interest in VANTAS to approximately 84%
on a basic basis and 76% on a diluted basis.
As a result of the step acquisition during 1999 of a controlling interest in
VANTAS, the Company changed the accounting method for its investment in VANTAS
from the equity method to consolidation during the fourth quarter of 1999 and
retroactively restated all 1999 quarters.
On June 1, 2000, VANTAS merged with HQ Global Workplaces, Inc. ("Old HQ"), in a
two-step merger (the "Merger"). As a result of the Merger, the combined company
became a wholly-owned subsidiary of a newly-formed parent corporation, HQ
Global. As of September 30, 2000, FrontLine's ownership interest was
approximately 57% on a basic basis. Although FrontLine's percentage ownership
may vary depending on the actual preferred stock conversion price, on a
fully-diluted basis, assuming the outstanding preferred stock converted at the
Merger conversion price, and assuming that certain warrants to purchase HQ
Global stock become exercisable,
10
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES (CONTINUED)
FrontLine would own approximately 38% of the common stock of HQ Global. To
effectuate the Merger, FrontLine contributed approximately $17 million in cash
and its ownership interest in VANTAS. Additionally, FrontLine holds an option it
purchased in January 1999, to acquire another HQ Global shareholder's 3.1% basic
basis interest for $4.3 million at any time between July 8, 2001 and January 7,
2002.
The costs of the Merger have been allocated to the respective assets acquired
and liabilities assumed, with the remainder recorded as goodwill, based on
preliminary estimates of fair values as follows (in thousands):
Working capital.................... $ (14,841)
Favorable operating leases......... 22,900
Property and equipment............. 107,047
Goodwill........................... 396,404
Other assets....................... 32,504
Other liabilities.................. (13,200)
Notes payable...................... (138,693)
---------
$ 392,121
=========
The estimates of fair value were determined by HQ Global's management. The
goodwill recorded in the Merger is being amortized over a 20-year period based
on management's assessment of the significant barriers to entry due to the rapid
consolidation in the executive suites business and the lack of exposure to
technological obsolescence in the global officing solutions business. HQ Global
engages in lease commitments ranging from 10-15 years, typically with 5-year
renewal options. The results of operations of operations of Old HQ are included
in the consolidated results of HQ Global for periods subsequent to June 1, 2000.
The Merger was financed through a combination of debt and HQ Global preferred
stock and warrants. Subsequent to the Merger, HQ Global sold an additional $25.0
million of preferred stock and issued additional warrants.
HQ Global is the largest provider of flexible officing solutions in the world.
As of September 30, 2000, HQ Global owned, operated, or franchised 469 business
centers in 17 countries. Also included are 6 business centers managed by HQ
Global for unrelated third parties and 9 international joint-venture business
centers with which HQ Global, through its European subsidiary, HQ Holdings
Limited, is a joint venture partner with Mercury Asset Management. HQ Global's
wholly-owned subsidiary, HQ Network Systems, Inc., is the franchiser of 46
domestic and 30 international business centers for unrelated franchisees. HQ
Global provides a complete outsourced office solution through furnished and
equipped individual offices and multi-office suites available on short notice
with flexible contracts. HQ Global also provides business support and
information services including: telecommunications; broadband Internet access;
mail room and reception services; high-speed copying, faxing and printing
services; secretarial, desktop publishing and IT support services and various
size conference facilities, with multi-media presentation and, in certain cases,
video teleconferencing capabilities. HQ Global also provides similar services
for those businesses and individuals that do not require offices on a full-time
basis.
11
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES (CONTINUED)
FINANCIAL STATEMENTS
The following statements present the portion of the Company's financial
position, results of operations and cash flows represented by HQ Global and
predecessor entities as of and for the periods indicated.
HQ GLOBAL AND PREDECESSOR ENTITIES
BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
--------------- ---------------
<S> <C> <C>
ASSETS:
Current Assets:
Cash and cash equivalents.................................................. $15,898 $3,807
Restricted cash............................................................ 6,689 21,572
Accounts receivable, net of allowance for doubtful accounts of
$3,916 at September 30, 2000 and $861 at December 31, 1999.............. 25,661 8,426
Other current assets....................................................... 20,237 16,008
-------------- --------------
Total Current Assets................................................... 68,485 49,813
Intangible assets, net.......................................................... 669,085 239,412
Property and equipment, net..................................................... 207,940 80,064
Deferred financing costs, net................................................... 50,262 5,426
Other assets, net............................................................... 37,811 10,039
-------------- --------------
Total Assets........................................................... $1,033,583 $384,754
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current Liabilities:
Accounts payable and accrued expenses...................................... $43,139 $38,010
Current portion of senior secured debt..................................... 16,575 12,500
Deferred rent payable...................................................... 4,131 2,165
Other current liabilities.................................................. 2,453 1,139
-------------- --------------
Total Current Liabilities.............................................. 66,298 53,814
Senior secured debt............................................................. 199,575 --
Subordinated notes payable...................................................... 125,000 108,125
Deferred rent payable........................................................... 33,462 22,794
Other liabilities............................................................... 65,584 28,176
-------------- --------------
Total Liabilities...................................................... 489,919 212,909
Minority interest............................................................... 300,508 35,338
Cumulative translation adjustment............................................... (574) --
Net business unit equity........................................................ 243,730 136,507
-------------- --------------
Total Liabilities and Net Business Unit Equity......................... $1,033,583 $384,754
============== ==============
</TABLE>
12
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES (CONTINUED)
HQ GLOBAL AND PREDECESSOR ENTITIES
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- -------------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
HQ Operating Revenues:
Executive office suite income............ $97,642 $33,703 $191,798 $91,339
Support services and other............... 62,624 24,378 129,655 66,070
------------- -------------- ------------- -------------
Total HQ Operating Revenues.......... 160,266 58,081 321,453 157,409
------------- -------------- ------------- -------------
HQ Operating Expenses:
Cost of Revenue.......................... 106,610 43,904 225,481 117,850
General and administrative.............. 18,811 6,602 36,097 17,493
------------- -------------- ------------- -------------
Total HQ Operating Expenses.......... 125,421 50,506 261,578 135,343
------------- -------------- ------------- -------------
HQ Operating Income.................. 34,845 7,575 59,875 22,066
HQ Other Expenses:
Merger and integration costs............. (1,707) (219) (21,148) (1,604)
Depreciation and amortization............ (19,069) (3,983) (35,263) (10,069)
Interest expense, net.................... (11,827) (2,888) (22,054) (7,133)
------------- -------------- ------------- -------------
Income (loss) before income taxes and
minority interest.................... 2,242 485 (18,590) 3,260
Provision for income taxes.................. (1,983) (864) (2,453) (2,195)
Minority interest........................... (4,416) 314 (3,318) (643)
------------- -------------- ------------- -------------
Net income (loss) applicable to common
shareholders attributable to HQ.... $(4,157) $(65) $(24,361) $422
============= ============== ============= =============
Basic and diluted net income (loss)
attributable to HQ per weighted $(0.11) $(0.00) $(0.71) $0.02
average common share...................... ============= ============== ============= =============
Basic and diluted weighted average common
shares of FrontLine outstanding.......... 36,574,462 25,163,301 34,295,488 24,855,657
============= ============== ============= =============
</TABLE>
13
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES (CONTINUED)
HQ GLOBAL AND PREDECESSOR
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------
2000 1999
---- ----
<S> <C> <C>
Cash Flows from Operating Activities:
Net loss income (loss) applicable to common shareholders attributable to HQ . $ (24,361) $ 422
Adjustments to reconcile net income (loss) applicable to common
shareholders attributable to HQ to cash provided by (used in) operating
activities:
Depreciation and amortization ........................................... 35,263 10,083
Minority interest ....................................................... 3,318 643
Deferred income taxes ................................................... (603) --
Cumulative translation adjustment ....................................... (1,013) --
Changes in operating assets and liabilities:
Accounts receivable, net .............................................. (9,553) (2,015)
Acquisition costs and other assets .................................... (6,898) (3,930)
Deferred rent payable ................................................. 6,105 4,108
Accounts payable and accrued expenses ................................. (29,081) 2,299
Other liabilities ..................................................... 8,232 2,738
--------- ---------
Net cash provided by (used in) operating activities ................. (18,591) 14,348
--------- ---------
Cash Flows from Investing Activities:
Acquisitions of officing solutions centers .................................. (260,047) (40,130)
Equipment ................................................................... (31,771) (26,644)
Restricted cash ............................................................. 23,322 (21,799)
--------- ---------
Net cash used in investing activities ............................... (268,496) (88,573)
--------- ---------
Cash Flows from Financing Activities:
Net proceeds from Parent .................................................... 18,424 23,817
Deferred financing costs .................................................... (25,736) (3,054)
Net proceeds from notes payable ............................................. 81,832 51,250
Capital leases .............................................................. (2,300) (1,971)
Net proceeds from minority interest ......................................... 226,958 5,878
--------- ---------
Net cash provided by financing activities ........................... 299,178 75,920
--------- ---------
Cash and Cash Equivalents:
Net increase ................................................................ 12,091 1,695
Beginning of period ......................................................... 3,807 --
--------- ---------
End of period ............................................................... $ 15,898 $ 1,695
========= =========
</TABLE>
14
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
4. OTHER OWNERSHIP INTERESTS
Other ownership interests at September 30, 2000 and December 31, 1999 were
comprised of:
<TABLE>
<CAPTION>
VOTING OWNERSHIP ON A VOTING OWNERSHIP ON A
BASIC BASIS DILUTED BASIS
------------------------- -------------------------
FRONTLINE APPLICABLE
INVESTEE ACCOUNTING SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, DECEMBER 31,
SINCE METHOD 2000 1999 2000 1999
----------- ------------- ---------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
AdOutlet.com............. 1999 Cost 10% 12% 9% 10%
Confidant Inc............ 1998 Consolidation 93% 93% 80% 80%
DigitalWork.com.......... 1999 Cost <1% <1% <1% <1%
EmployeeMatters, Inc..... 1999 Equity 53% 53% 45% 45%
Giftcertificates.com..... 1999 Cost <1% <1% <1% <1%
LiveCapital.com.......... 2000 Cost 4% N/A 4% N/A
NeoCarta Ventures........ 1999 Cost 4% 4% 4% 4%
OnSite Access, Inc....... 1997 Equity 22% 37% 17% 22%
Opus360 Corporation...... 1999 Cost <1% <1% <1% <1%
PIPE9 Corporation........ 1999 Equity 25% 31% 29% 26%
RealtyIQ.com............. 1999 Equity 66% 68% 54% 54%
Upshot.com............... 2000 Equity 20% N/A 17% N/A
Reckson Strategic........ 1998 Equity 33% 33% 33% 33%
</TABLE>
The Company's ownership interests in its investees are classified according to
the applicable accounting method utilized at September 30, 2000 and December 31,
1999. The carrying value represents the Company's acquisition cost less any
impairment charges, plus or minus the Company's share of such investees' income
or loss. The cost basis represents the Company's acquisition costs less any
impairment charges in such investees. The Company's ownership interests in and
advances to investees accounted for under the equity method or cost method of
accounting are as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, 2000 DECEMBER 31, 1999
------------------------------- -------------------------------
CARRYING VALUE COST BASIS CARRYING VALUE COST BASIS
-------------- -------------- ------------- -------------
<S> <C> <C> <C> <C>
Equity Method............................... $66,581 $166,922 $91,433 $107,245
Cost Method................................. 17,350 17,350 6,400 6,400
-------- --------
$83,931 $97,833
======== ========
</TABLE>
The following are the Company's summarized losses on ownership interests in
unconsolidated companies (in thousands):
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- -------------------------------
2000 1999 2000 1999
------------- -------------- ------------- -------------
<S> <C> <C> <C> <C>
OnSite Access, Inc. and predecessor entity . $(12,459) $ (2,735) $(33,248) $ (2,805)
EmployeeMatters, Inc. ...................... (4,914) (819) (15,139) (819)
PIPE9 Corporation .......................... (4,165) -- (9,714) --
RealtyIQ.com ............................... (7,395) -- (21,245) --
UpShot.com ................................. (1,078) -- (2,153) --
Reckson Strategic .......................... (1,095) (1,274) (2,354) (3,061)
-------- -------- -------- --------
Equity in net loss of unconsolidated
companies ............................. $(31,106) $ (4,828) $(83,853) $ (6,685)
======== ======= ======== ========
</TABLE>
15
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
4 OTHER OWNERSHIP INTERESTS (CONTINUED)
ONSITE ACCESS
Summarized financial information, a summary of the Company's investment in and
advances to OnSite Access, Inc. ("OnSite") and FrontLine's share of its loss, is
as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
BALANCE SHEET DATA: 2000 1999
---- ----
<S> <C> <C>
Current assets.................................................................. $54,809 $25,535
-------- -------
Total Assets............................................................... $242,564 $74,774
======== =======
Current liabilities............................................................. $42,588 $13,702
-------- -------
Total Liabilities.......................................................... 136,897 15,615
-------- -------
Total Redeemable Preferred Stock and Stockholders' Equity (Deficit)........ 105,667 59,159
-------- -------
Total Liabilities and Stockholders' Equity (Deficit)....................... $242,564 $74,774
======== =======
</TABLE>
<TABLE>
<CAPTION>
FOR THE THREE FOR THE NINE
MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
STATEMENTS OF OPERATIONS DATA: 2000 2000
---- ----
<S> <C> <C>
Revenues........................................................................ $2,962 $6,936
======== ========
Net loss........................................................................ $(33,315) $(85,374)
Other interests' share of net loss.............................................. (20,856) (52,126)
-------- --------
FrontLine's share of net loss................................................... $(12,459) $(33,248)
======== ========
</TABLE>
In June 2000, OnSite obtained $50 million in a senior secured financing and $20
million from the sale of preferred stock with several private equity investors.
In September 2000, AT&T Corp. ("AT&T") invested $50 million in OnSite through a
combination of preferred stock and senior secured debt. In connection with this
investment, OnSite and AT&T signed a three-year commercial agreement, under
which AT&T will provide OnSite with advanced communication services.
OTHER PARTNER COMPANIES
During the nine months ended September 30, 2000, the Company invested
approximately $23.5 million to purchase ownership interests in two new
e-business companies and funded $51.5 million to existing Partner Companies.
OTHER INTERESTS
Reckson Strategic invests in operating companies with experienced management
teams in real estate and real estate related market sectors which are in the
early stages of their growth cycle or offer unique circumstances for attractive
investments, as well as platforms for future growth.
16
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
4. OTHER OWNERSHIP INTERESTS (CONTINUED)
Through RSVP Holdings, LLC ("Holdings"), the Company is a managing member and
100% owner of the common equity of Reckson Strategic. New World Realty, LLC, an
entity owned by two individuals retained by Holdings, (the "RSVP Managing
Directors"), acts as a managing member of Holdings, and have a carried interest
which provides for the RSVP Managing Directors to receive a share in the profits
of Reckson Strategic after the Company, Paine Webber Real Estate Securities,
Inc., ("Paine Webber") and Stratum Realty Fund, L.P. ("Stratum") have received
certain minimum returns and a return of capital. Paine Webber and Stratum are
non-managing members and preferred equity owners who have committed $150 million
and $50 million, respectively, in capital and shares in profits and losses of
Reckson Strategic with the Company, subject to a maximum internal rate of return
of 16% of invested capital.
17
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
4. OTHER OWNERSHIP INTERESTS (CONTINUED)
FINANCIAL STATEMENTS
The following statements present the portion of the Company's financial
position, results of operations and cash flows represented by FrontLine Parent
and other interests as of and for the periods indicated.
FRONTLINE PARENT AND OTHER INTERESTS
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
--------------- ---------------
<S> <C> <C>
ASSETS:
Current Assets:
Cash and cash equivalents.................................................. $21,412 $28,933
------- --------
Total Current Assets................................................... 21,412 28,933
Ownership interests in and advances to unconsolidated companies................. 83,931 97,833
Ownership interests in HQ Global and predecessor entities....................... 243,730 136,507
Property and equipment, net..................................................... 2,333 361
Deferred financing costs, net................................................... 1,157 --
Other assets, net............................................................... 17,766 30,102
-------- --------
Total Assets........................................................... $370,329 $293,736
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current Liabilities:
Accounts payable and accrued expenses...................................... $9,830 $7,842
Notes payable.............................................................. 25,000 --
-------- --------
Total Current Liabilities.............................................. 34,830 7,842
Credit facilities with related parties.......................................... 132,379 121,848
Senior secured debt............................................................. -- 44,407
Other liabilities............................................................... 13,420 5,530
-------- --------
Total Liabilities...................................................... 180,629 179,627
-------- --------
Shareholders' Equity:
8.875% Cumulative convertible preferred stock, $.01 par value, 25,000,000
shares authorized, 26,000 and -0- issued and outstanding,
at September 30, 2000 and December 31, 1999, respectively............... -- --
Common stock, $.01 par value, 100,000,000 shares authorized,
36,574,462 and 30,672,794 shares issued and outstanding at
September 30, 2000 and December 31, 1999, respectively.................. 366 307
Additional paid-in capital................................................. 399,113 162,054
Accumulated deficit........................................................ (209,779) (48,252)
-------- --------
Total Shareholders' Equity............................................. 189,700 114,109
-------- --------
Total Liabilities and Shareholders' Equity............................. $370,329 $293,736
======== ========
</TABLE>
18
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
4. OTHER OWNERSHIP INTERESTS (CONTINUED)
FRONTLINE PARENT AND OTHER INTERESTS
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- --------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Parent Income (Expenses):
General and administrative expenses ....... $ (4,598) $ (4,290) $ (15,568) $ (12,902)
Depreciation and amortization ............. (544) (14) (943) (50)
Amortization of deferred charges .......... (5,817) -- (11,347) --
Interest expense, net ..................... (4,014) (2,543) (14,023) (4,316)
Development Stage Company Costs and
Reserves ................................ (3,578) -- (7,285) --
------------ ------------ ------------ ------------
Loss before equity losses ............. (18,551) (6,847) (49,166) (17,268)
------------ ------------ ------------ ------------
Equity in net loss of unconsolidated
companies.............................. (31,106) (4,828) (83,853) (6,685)
Loss before extraordinary item from
early extinguishment of debt and
distribution to Preferred Shareholder (49,657) (11,675) (133,019) (23,953)
Extraordinary item from early extinguishment
of debt .................................. -- -- (2,648) --
------------ ------------ ------------ ------------
Net loss before distribution to
Preferred Shareholder ............... (49,657) (11,675) (135,667) (23,953)
Distribution to Preferred Shareholder ........ (576) -- (1,499) --
------------ ------------ ------------ ------------
Net loss applicable to common
Shareholders attributable to Parent
and Other Interests ................. $ (50,233) $ (11,675) $ (137,166) $ (23,953)
============ ============ ============ ============
Basic and diluted net loss attributable to
Parent and Other Interests per weighted
average common share .................... $ (1.37) $ (0.46) $ (4.00) $ (0.96)
============ ============ ============ ============
Basic and diluted weighted average common
shares of FrontLine outstanding ........... 36,574,462 25,163,301 34,295,488 24,855,657
============ ============ ============ ============
</TABLE>
19
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
4. OTHER OWNERSHIP INTERESTS (CONTINUED)
FRONTLINE PARENT AND OTHER INTERESTS
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------------
2000 1999
---- ----
<S> <C> <C>
Cash Flows from Operating Activities:
Net loss before distribution to Preferred Shareholder ....................... $(135,667) $ (23,953)
Adjustments to reconcile net loss before distribution to Preferred
Shareholder to cash provided by (used in) operating activities:
Depreciation and amortization ........................................... 943 36
Extraordinary loss on early extinguishment of debt ...................... 2,648 --
Equity in net loss of unconsolidated companies........................... 83,853 6,685
Amortization of deferred charges......................................... 11,347 8,846
Preferred distribution .................................................. (577) --
Changes in operating assets and liabilities:
Acquisition costs and other assets .................................... 9,688 140
Accounts payable and accrued expenses ................................. (2,101) 3,124
Affiliate receivables ................................................. -- 7,427
Other liabilities ..................................................... 7,890 --
--------- ---------
Net cash provided by (used in) operating activities ................. (21,976) 2,305
--------- ---------
Cash Flows from Investing Activities:
Acquisitions of officing solutions centers .................................. (85,186) (36,731)
Equipment ................................................................... (2,915) (160)
Acquisition of ownership interests and advances to unconsolidated companies . (65,208) (17,084)
Acquisition of other ownership interest ..................................... (4,743) (25,541)
--------- ---------
Net cash used in investing activities ............................... (158,052) (79,516)
--------- ---------
Cash Flows from Financing Activities:
Issuance of common stock and warrants, net of costs ......................... 156,855 (99)
Issuance of preferred stock, net of costs ................................... 24,570 --
Deferred financing costs .................................................... (1,157) --
Exercise of options ......................................................... 1,115 --
Net proceeds from credit facilities with related parties .................... 10,531 75,644
Net proceeds from notes payable ............................................. (19,407) --
--------- ---------
Net cash provided by financing activities ........................... 172,507 75,545
--------- ---------
Cash and Cash Equivalents:
Net decrease ................................................................ (7,521) (1,666)
Beginning of period ......................................................... 28,933 2,026
--------- ---------
End of period ............................................................... $ 21,412 $ 360
========= =========
</TABLE>
20
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
5. NOTES PAYABLE
On May 31, 2000, HQ Global completed a transaction which increased its $157.9
million credit facility (the amended and restated "Credit Facility") to $275.0
million. The Credit Facility provides for $219.4 million under four term loans,
all of which are repayable in various quarterly installments through November
2005. The Credit Facility also provides for borrowings up to $55.6 million in
two revolving loan commitments. Availabilities under the revolving portion of
the Credit Facility are formula based. As of September 30, 2000, there was
$216.2 million in outstanding borrowings under the term loans and no borrowings
outstanding under either revolver. As of September 30, 2000, HQ Global had
letters of credit outstanding in the aggregate amount of $28.5 million, against
which HQ Global pledged $5.7 million in cash and $22.8 million were supported by
the two revolving loan commitments, leaving $32.8 million available for
additional borrowings.
Borrowings under the Credit Facility bear interest ranging from LIBOR plus 3.25%
to 4.0% or the prime rate plus 2.25% to 3.00% for a one, three or nine-month
period at the election of HQ Global. HQ Global's weighted average interest rate
on borrowings under the term loans at September 30, 2000 was 11.04%. HQ Global
pays a commitment fee of 1/2 of 1.0% per annum on the unused portion of the
Credit Facility. As of September 30, 2000, HQ Global had hedged the interest
rates on approximately $93.0 million of its credit facility using various
instruments with various expiration dates through July 31, 2002. These
instruments lock in the maximum underlying 30-day LIBOR at levels between 7.93%
and 9.00%. The Credit Facility contains certain financial covenants related to
interest coverage, leverage ratios and other limitations. At September 30, 2000,
HQ Global was in compliance with all of its covenants.
Maturities of borrowings under the Credit Facility subsequent to September 30,
2000 are as follows (in millions):
Twelve months ending September 30:
2001.............. $16.6
2002.............. 24.1
2003.............. 25.2
2004.............. 56.4
2005.............. 74.4
Thereafter........ 19.5
-------
Total............. $216.2
=======
In connection with the financing of the Merger transaction, on June 1, 2000, HQ
Global obtained a Senior Subordinated Credit Facility (the "Bridge Loan") of
$125.0 million bearing interest at LIBOR plus 6.5% and was scheduled to mature
on May 31, 2007.
On August 11, 2000, HQ Global replaced the Bridge Loan with a $125.0 million
Senior Subordinated Note Agreement (the "Mezzanine Loan"). The Mezzanine Loan
bears interest at 13.5% per annum and matures on May 31, 2007. The Mezzanine
lenders also received Class A warrants and Class B warrants.
21
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
5. NOTES PAYABLE (CONTINUED)
The terms of the Class A warrants and Class B warrants are identical except that
Class A warrants are exercisable at the option of the holder at any time and
Class B warrants are exercisable on or after March 1, 2002, but only in the
event that a Qualified Initial Public Offering (as defined in the Purchase
Agreements) has not occurred prior to that date.
The fair value of the warrants to purchase Common Stock issued to the lenders
was recorded as debt issuance costs and is being amortized over the terms of the
related loan. Such amortization is included as a component of interest expense
in the accompanying Consolidated Statements of Operations.
On September 11, 2000, FrontLine entered into a $25.0 million line of credit
agreement (the "FrontLine Bank Credit Facility"). Borrowings under the FrontLine
Bank Credit Facility bear interest, at the election of FrontLine, at either
LIBOR for one, two, three or six-month periods or the prime rate, plus 5%. Any
outstanding borrowings under the FrontLine Bank Credit Facility will be due on
March 11, 2001, although FrontLine has the ability to extend the maturity date
to September 11, 2001. At September 30, 2000, FrontLine had borrowed $25.0
million under the FrontLine Bank Credit Facility. Such amount is classified as
current in the accompanying Consolidated Balance Sheet. The weighted average
interest rate of the outstanding borrowings at such date was 11.63%.
6. SHAREHOLDERS' EQUITY
In January 2000, the Board of Directors for the Company approved the 2000 Stock
Option Plan and reserved 2,500,000 shares of common stock for issuance.
During 2000, as part of the Company's investment in organizational
infrastructure and the retention of high quality senior management, incentive
stock awards of 140,000 shares of common stock were granted on April 13, 2000 at
a price of $24.875. These compensation awards were awarded from the 2000 Stock
Option Plan which was approved by shareholders at the Company's annual meeting.
These awards vest evenly through December 31, 2000. Additionally, loans arising
from tax liabilities have been made and will be forgiven over the same period.
During 1999, 550,000 shares of common stock and various stock option awards were
granted under the 1999 Stock Option Plan. These awards vest over various periods
ranging from six months to three years. Certain of the stock awards include tax
loans which will be forgiven one year thereafter. To the extent that any vesting
periods changed due to the effect of employee terminations, the Company has
adjusted the amortization of the expense related to such awards accordingly.
During the three months and nine months ended September 30, 2000, results
include $5.8 million and $11.3 million (or $0.16 and $0.33 per share),
respectively, of amortization of deferred charges principally associated with
the above awards, the majority of which is non-cash in nature. As of September
30, 2000, there remains $6.8 million of unamortized deferred stock compensation.
The expense in the three months ended September 30, 2000 reflected $2.8 million
relating to the departure of two employees during such period.
22
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
6. SHAREHOLDERS' EQUITY (CONTINUED)
During the three months ended March 31, 2000, the Company completed preferred
stock offerings of 26,000 shares of 8.875% Cumulative Convertible Preferred
Stock at a price of $1,000 per share with net proceeds of $24.6 million. These
shares are convertible into the Company's common stock at a price of $70.48.
On March 7, 2000, an investment partnership invested $30 million to purchase 1.5
million warrants to acquire FrontLine's common stock at an exercise price of $70
per share. The warrants have a term of 3.25 years. On June 29, 2000, the
investment partnership invested an additional $3.0 million to obtain a reduction
in the warrant exercise price to $47.25 per share and to extend the expiration
of the warrant to March 2005. Simultaneously with this transaction, the Company
issued 1,075,000 shares of its common stock for an additional 2.5% ownership
interest in HQ Global in connection with an agreement with the investment
partnership, which had originally owned preferred stock of VANTAS.
On March 31, 2000, the Company sold approximately 2.6 million shares of its
common stock at a price of $47.25 per share for an aggregate consideration of
approximately $122.6 million. Proceeds from the sale were utilized to repay the
remaining portion of a then existing credit facility. As a result, certain
deferred financing costs of approximately $2.6 million incurred in connection
with the establishment of such credit facility were expensed as an extraordinary
loss in the accompanying Consolidated Statements of Operations. As a part of
this transaction, the Company issued 128,750 warrants with an exercise price of
$47.25 per share for 3 years.
On September 20, 2000, the Company issued 331,400 shares of its common stock at
a price of $15.0875 per share for gross proceeds of $5.0 million.
7. LONG-TERM INCENTIVE PLAN
In March 2000, the Compensation Committee of the Board of Directors adopted a
long-term incentive plan. Under the long-term incentive plan, participants may
purchase or be granted interests in limited partnerships established by the
Company to hold a profit participation interest in the investments made by the
Company. The plan contemplates the allocation to such partnerships of up to a
12.5% profits interest in each investment made by the Company. FrontLine,
through a wholly-owned subsidiary, will act as the general partner of each
partnership and will retain an 87.5% or greater interest in each partnership
depending upon the vesting and type of interest participants receive. FrontLine
generally must receive a minimum return on its holdings in a particular
partnership, typically two times the cost of its investment, before participants
receive distributions from such partnership. It is anticipated that partnership
interest will vest 25% each year, but the Compensation Committee has the
authority to accelerate vesting. A partnership will generally distribute the
securities or cash it holds to its partners after five to ten years, but may
distribute securities or cash earlier if the company has completed an initial
public offering or been sold. The plan also permits the award of equivalent
grants without the use of a limited partnership.
23
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2000
(UNAUDITED)
8. TRANSACTIONS WITH RELATED PARTIES
The Company has a credit facility with Reckson Operating Partnership, L.P.
("Reckson") in the amount of $100 million ("FrontLine Facility"). Reckson has
advanced the Company approximately $92.5 million at September 30, 2000. These
advances bear interest at 12% per annum.
Additionally, FrontLine has a $100 million facility with Reckson for funding the
Reckson Strategic investments ("Reckson Strategic Facility"). As of September
30, 2000, Reckson has advanced FrontLine $39.9 million under the Reckson
Strategic Facility and has also directly invested $37.6 million of the facility
in joint ventures with Reckson Strategic. The total outstanding at September 30,
2000, owed by FrontLine under both credit facilities was $132.4 million.
Interest accrued on these facilities at September 30, 2000, was $13.5 million.
Both of the FrontLine and Reckson Strategic Facilities expire in June 2003.
Currently, the Company has two short-term open letters of credit totaling $3.2
million. These letters of credit decrease the availability under the FrontLine
Facility.
The Company is entitled to a cumulative annual management fee of $2 million with
respect to Reckson Strategic, of which $1.5 million is subordinate to Paine
Webber receiving an annual minimum rate of return of 16% and a return of its
capital. The earned fees for the three and nine months ended September 30, 2000
and 1999 were $0.1 million and $0.4 million, respectively.
The Company reimburses Reckson with respect to general and administrative
expenses (including payroll expenses) incurred by Reckson for the benefit of the
Company. These services include payroll, human resources, accounting and other
advisory services. During the three and nine months ended September 30, 2000,
the Company reimbursed $0.2 million and $1.1 million, respectively, for such
activities.
9. CONTINGENCIES
Other than as previously disclosed in HQ Global's public filings, HQ Global is
not presently subject to any material litigation nor, to HQ Global's knowledge,
is any litigation threatened against HQ Global, other than claims and
administrative proceedings arising in the ordinary course of business or which
are otherwise subject to indemnification, some of which are expected to be
covered by liability insurance (subject to policy deductibles and limitations of
liability) and all of which collectively are not expected to have a material
adverse effect on the liquidity, results of operations or business or financial
condition of HQ Global.
10. RESTRUCTURING
On October 18, 2000, FrontLine announced a refinement of its strategic plan, the
steps under which are collectively referred to herein as the Restructuring (see
further discussion in Note 1). In connection with the Restructuring,
approximately 75% of FrontLine's headquarters personnel will be terminated
during a transition period in the fourth quarter of 2000 and the first quarter
of 2001. As a result of the Restructuring and transition-related transactions,
FrontLine expects that it will recognize cash and non-cash future charges, the
amount of which has yet to be determined. These charges represent the expenses
during the transition period that FrontLine will incur in excess of the
stabilized operating cost level after the transition is completed.
24
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the accompanying
financial statements of FrontLine Capital Group (the "Company" or "FrontLine")
and related notes thereto.
The Company considers certain statements set forth to be 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, with respect to
the Company's expectations for future periods. Certain forward-looking
statements, including, without limitation, statements relating to the
achievement of our refocused business plan and our future operating performance
and the future operating performance of HQ Global Holdings, Inc. ("HQ Global"),
the financing of the Company's and Partner Companies' operations and the ability
to integrate and manage effectively its various acquisitions, involve certain
risks and uncertainties. Although the Company believes that the expectations
reflected in such forward-looking statements are based on reasonable
assumptions, the actual results may differ materially from those set forth in
the forward-looking statements and the Company and Partner Companies can give no
assurance that such expectations will be achieved. Certain factors that might
cause the results of the Company and Partner Companies to differ materially from
those indicated by such forward-looking statements include, among other factors,
negative changes in the executive office suite industry, changes in the market
valuation or growth rate of comparable companies in the office suites industry,
a downturn in general economic conditions, increases in interest rates, a lack
of capital availability, competition, reduced demand or decreases in rental
rates for executive office suites and other real estate-related risks such as
timely completion of projects under development, our dependence upon our key
personnel, FrontLine's dependence upon financing from Reckson Operating
Partnership, L.P., ("Reckson"), conflicts of interest of management, and the
ability to finance business opportunities and other risks detailed in
FrontLine's and HQ Global's reports and other filings made with the Securities
and Exchange Commission. Consequently, such forward-looking statements should be
regarded solely as reflections of the Company's and Partner Companies current
operating and development plans and estimates. These plans and estimates are
subject to revision from time to time as additional information becomes
available, and actual results may differ from those indicated in the referenced
statements.
OVERVIEW AND BACKGROUND
FrontLine is a holding company which develops and manages companies servicing
small and medium-size enterprises ("SMEs") and mobile workforces of larger
companies. FrontLine has two distinct operating segments: one (the "HQ Segment")
holds FrontLine's interest in HQ Global, the world's largest provider of
officing solutions, and the other (the "Parent and Other Interests Segment")
consists of FrontLine (parent company) and its interests in a group of companies
which leverage the Internet to provide a wide range of services to the SME
marketplace.
In October 2000, FrontLine announced that, as a result of changing capital
market conditions, it was refining its strategic plan (the "Restructuring"- see
Note 10 to the accompanying consolidated financial statements for further
discussion) to, in part, report the operations of HQ Global as a separate
operating segment and was in the process of exploring alternatives for
separating FrontLine into two companies. Additionally, in conjunction with the
Restructuring, FrontLine announced that it would focus its resources and capital
on the businesses within its existing portfolio and cease pursuing new
investment activities.
The Company refers to the companies in which it has acquired an equity interest
as its "Partner Companies" (except for Reckson Strategic Venture Partners, LLC
("Reckson Strategic") - see Note 4 to the accompanying consolidated financial
statements). However, the Company does not act as an agent or legal
representative for any of them, it does not have the power or authority to
legally bind any of them and it does not have the types of liabilities in
relation to them that a general partner of a partnership would have.
The presentation and content of the Company's financial statements is largely a
function of the presentation and content of the financial statements of HQ
Global and the other Partner Companies. As a result, to the extent HQ Global or
other Partner Companies change the presentation or content of their financial
statements, as may be required by the Securities and Exchange Commission or
changes in accounting literature, the presentation and content of the Company's
financial statements may also change.
25
<PAGE>
EFFECT OF VARIOUS ACCOUNTING METHODS ON RESULTS OF OPERATIONS
The interests that FrontLine owns in its Partner Companies and Reckson Strategic
are accounted for under one of three methods: consolidation, equity method and
cost method. The applicable accounting method is generally determined based on
the Company's voting interest and rights in each investee.
Consolidation. Partner Companies in which the Company directly or indirectly
owns more than 50% of the outstanding voting securities or controls the board of
directors are generally accounted for under the consolidation method of
accounting. Under this method, a Partner Company's results of operations are
reflected within the Company's Consolidated Statements of Operations. On June 1,
2000, VANTAS Incorporated ("VANTAS"), a previously consolidated entity, merged
with HQ Global Workplaces, Inc. ("Old HQ"), in a two-step merger (the "Merger").
As a result of the Merger, the combined company became a wholly-owned subsidiary
of a newly-formed parent corporation, HQ Global. (See Note 3 to the accompanying
consolidated financial statements). Participation of other Partner Company
shareholders in the earnings or losses of a consolidated Partner Company is
reflected in a caption "Minority interest" in the Consolidated Statements of
Operations. Minority interest adjusts the consolidated net results of operations
to reflect only the Company's share of the earnings or losses of the
consolidated Partner Company.
The effect of a Partner Company's results of operations on FrontLine's results
of operations is generally the same under either the consolidation method of
accounting and the equity method of accounting, because under each of these
methods only FrontLine's share of the earnings or losses of a Partner Company is
reflected in the results of operations in the Consolidated Statements of
Operations.
Equity Method. Partner Companies and the other investee whose results are not
consolidated, but over whom the Company exercises significant influence, are
accounted for under the equity method of accounting. Whether or not the Company
exercises significant influence with respect to the investee depends on an
evaluation of several factors including, among others, representation on the
investee's board of directors and ownership level, which is generally a 20% to
50% interest in the voting securities of the investee, including voting rights
associated with the Company's holdings in common, preferred and any other
convertible securities in the investee. Under the equity method of accounting,
an investee's accounts are not reflected within the Company's Consolidated
Statements of Operations; however, FrontLine's share of the earnings or losses
of the investee is reflected in the caption "Equity in net loss of
unconsolidated companies" in the accompanying Consolidated Statements of
Operations.
Other ownership interests accounted for under the equity method of accounting
were compromised of:
<TABLE>
<CAPTION>
VOTING OWNERSHIP ON A BASIC BASIS VOTING OWNERSHIP ON A DILUTED BASIS
--------------------------------- -----------------------------------
FRONTLINE
INVESTEE SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, DECEMBER 31,
SINCE 2000 1999 2000 1999
------------- ------------- -------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
EmployeeMatters, Inc....... 1999 53% 53% 45% 5%
OnSite Access, Inc......... 1997 22% 37% 17% 22%
PIPE9 Corporation.......... 1999 25% 31% 29% 26%
RealtyIQ.com............... 1999 66% 68% 54% 54%
UpShot.com................. 2000 20% N/A 17% N/A
Reckson Strategic.......... 1998 33% 33% 33% 33%
</TABLE>
26
<PAGE>
FrontLine has representation on the boards of directors of all of the above
investees, and as of September 30, 2000, generally owned voting convertible
preferred stock in all of them. Most of FrontLine's equity method Partner
Companies are in a very early stage of development and have not generated
significant revenues. In addition, equity method Partner Companies have incurred
substantial losses since their inception and are expected to continue to incur
substantial losses for the remainder of 2000 and beyond.
Cost Method. Partner Companies not accounted for under either the consolidation
or the equity method of accounting are accounted for under the cost method of
accounting. Under this method, the Company's share of the earnings or losses of
these companies is not included in the Consolidated Statements of Operations.
Partner Companies accounted for under the cost method of accounting included:
<TABLE>
<CAPTION>
VOTING OWNERSHIP ON A BASIC BASIS VOTING OWNERSHIP ON A DILUTED BASIS
--------------------------------- -----------------------------------
FRONTLINE
INVESTEE SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30, DECEMBER 31,
SINCE 2000 1999 2000 1999
------------- ------------- -------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
AdOutlet.com............... 1999 10% 12% 9% 10%
DigitalWork.com............ 1999 <1% <1% <1% <1%
Giftcertificates.com....... 1999 <1% <1% <1% <1%
LiveCapital.com............ 2000 4% N/A 4% N/A
NeoCarta Ventures.......... 1999 4% 4% 4% 4%
Opus 360 Corporation....... 1999 <1% <1% <1% <1%
</TABLE>
The cost method Partner Companies are in an early stage of development and have
not generated significant revenues.
EFFECT OF CONSOLIDATION ON THE PRESENTATION OF FRONTLINE'S FINANCIAL STATEMENTS
The presentation of FrontLine's financial statements may differ from period to
period primarily due to whether or not the consolidation method of accounting or
the equity method of accounting is applied. To understand the Company's results
of operations and financial position without the effect of the consolidation of
HQ Global, Note 4 to the accompanying consolidated financial statements presents
the Balance Sheets and Statements of Operations of the Company without the
consolidation of FrontLine's ownership interest in HQ Global.
RESULTS OF OPERATIONS
The reportable segments in FrontLine's financial statements are the HQ Segment
and the Parent and Other Interests Segment.
HQ GLOBAL
FrontLine's operating revenues and operating expenses for the three and nine
months ended September 30, 2000 and 1999 were attributable to HQ Global and
VANTAS. The following is a discussion of HQ Global's and VANTAS' results of
operations for the three and nine months ended September 30, 2000 and 1999.
THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
Total business center revenues for the three months ended September 30, 2000
were $160.3 million, an increase of $102.2 million or 175.9% from the
corresponding period in 1999. Included in revenues were $4.6 and $0.2 million of
management, franchise, and joint venture fees for the three-month periods ended
on September 30, 2000 and 1999, respectively.
27
<PAGE>
Business centers that were acquired with effective dates after July 1, 1999
("Acquired Centers") had revenues for the three months ended September 30, 2000
of $87.6 million, an increase of $87.6 million from the corresponding period in
1999. This increase in revenues resulted from the acquisition of business
centers during the 12 months ended September 30, 2000. The Acquired Centers
include all the Old HQ business centers.
Business centers open less than nine months as of the beginning of the periods
under comparison ("Developing Centers") are generally in maturation process
during the period. For the nine months ended September 30, 2000, there were 29
Developing Centers as compared to 13 for the same period in 1999.
Business centers, excluding Acquired and Developing Centers, that were operating
for the entire comparable period of the prior year ("Same Centers"), had
revenues for the three months ended September 30, 2000 of $65.3 million, an
increase of $8.3 million, or 14.5% from the corresponding period in 1999. While
average office occupancy levels have elevated to 91%, an increase of 2% from the
corresponding period in 1999, the increase in workstation revenue of $4.9
million, or 14.8%, was primarily due to more favorable office pricing. The
increase in support service revenues of $3.4 million, or 14.1% from 1999 is
partially attributable to an increase in broadband Internet access, information
technology support services and administrative support services.
Developing Center revenues were $7.4 million for the three months ended
September 30, 2000, an increase of $6.3 million from the corresponding period in
1999. For the three months ended September 30, 2000 and 1999, there were 21 and
9 Developing Centers that were open, respectively. This increase is primarily
due to the greater number of Developing Centers open during the three months
ended September 30, 2000.
Total business center expenses for the three months ended September 30, 2000
were $106.6 million, representing an increase of $62.7 million or 142.8% from
the corresponding period in 1999.
Acquired Center expenses for the three months ended September 30, 2000 were
$54.8 million, an increase of $54.8 million from the corresponding period in
1999. This increase resulted from the acquisition of business centers during the
12 months ended September 30, 2000. The Acquired Centers include all the Old HQ
business centers.
Same Center expenses for the three months ended September 30, 2000 were $45.8
million, an increase of $3.9 million or 9.4% from the corresponding period in
1999. This increase is primarily attributable to higher rent expense and support
service expenses associated with increased support service revenues.
Developing Center expenses for the three months ended September 30, 2000 were
$5.9 million, an increase of $3.9 million from the corresponding period in 1999.
This increase is due to a total of 26 Developing Centers during the three months
ended September 30, 2000 as compared to 9 Developing Centers during the three
months ended September 30, 1999.
For the three months ended September 30, 2000, other expenses were $51.4
million, representing an increase of $37.6 million or 273.2% from the
corresponding period in 1999. This increase is primarily attributable to greater
corporate general and administrative expenses, merger and integration expenses,
depreciation and amortization and interest expense of $12.2 million, $1.5
million, $15.0 million and $8.9 million or 185.0%, 678.8%, 368.7% and 309.5%,
respectively.
The increase in corporate general and administrative expenses was attributable
to increases in the corporate personnel infrastructure and its associated travel
and related expenses, related office expansion, and professional and consulting
fees associated with HQ Global's growth. The increase in corporate general and
administration expenses were also attributed to the corporate general and
administration expenses of Old HQ. The increase in merger and integration
expenses is attributable to the Merger. The increase in depreciation and
amortization relates to fixed assets acquired and goodwill associated with HQ
28
<PAGE>
Global's acquisitions. It is also attributable to an increase in capital
expenditures associated with leasehold improvements for Developing Centers and
technology infrastructure additions. Interest expense is primarily related to HQ
Global's credit facility. This increase resulted from interest expense on
borrowings related to HQ Global's acquisitions as well as increases in interest
rates.
HQ Global's effective income tax rate for the three months ended September 30,
2000 was 88.5% as compared to 216.0% for the three months ended September 30,
1999. Tax expense is recognized primarily due to international tax obligations,
state and local tax obligations, and non-deductible goodwill amortization.
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
Total business center revenues for the nine months ended September 30, 2000 were
$321.5 million, an increase of $164.0 million or 104.2% from the corresponding
period in 1999. Included in revenues were $6.2 and $0.6 million of management,
franchise, and joint venture fees for the nine-month periods ended on September
30, 2000 and 1999, respectively.
Business centers that were acquired with effective dates after January 1, 1999
("Acquired Centers") had revenues for the nine months ended September 30, 2000
of $149.6 million, an increase of $131.8 million from the corresponding period
in 1999. This increase in revenues resulted primarily from the acquisition of
business centers during the nine months ended September 30, 2000. The Acquired
Centers include all the Old HQ business centers.
Business centers, excluding Acquired and Developing Centers, that were operating
for the entire comparable period of the prior year ("Same Centers"), had
revenues for the nine months ended September 30, 2000 of $154.6 million, an
increase of $18.6 million, or 13.7% from the corresponding period in 1999. While
average office occupancy levels have grown to 90%, an increase of 1% from the
corresponding period in 1999, the increase in workstation revenue of $9.7
million, or 12.5%, was primarily due to more favorable office pricing. The
increase in support service revenues of $8.8 million, or 15.2% from 1999 is
partially attributable to an increase in broadband Internet access, information
technology support services and administrative support services.
Developing Center revenues were $17.3 million for the nine months ended
September 30, 2000, an increase of $13.6 million from the corresponding period
in 1999. For the nine months ended September 30, 2000 and 1999, there were 24
and 12 Developing Centers that were open, respectively. This increase is
primarily due to the greater number of Developing Centers open during the nine
months ended September 30, 2000.
Total business center expenses for the nine months ended September 30, 2000 were
$225.5 million, representing an increase of $107.6 million or 91.3% from the
corresponding period in 1999.
Acquired Center expenses for the nine months ended September 30, 2000 and 1999
were $99.0 million and $13.4 million respectively, representing an increase of
$85.5 million from the corresponding period in 1999. This increase resulted
primarily from the acquisition of business centers during the nine months ended
September 30, 2000. The Acquired Centers include all the Old HQ business
centers.
Same Center expenses for the nine months ended September 30, 2000 were $109.6
million, an increase of $10.8 million or 10.9% from the corresponding period in
1999. This increase is primarily attributable to higher rent expense and support
service expenses associated with increased support service revenues.
Developing Center expenses for the nine months ended September 30, 2000 were
$16.9 million, an increase of $11.3 million from the corresponding period in
1999. This increase is due to a total of 29 Developing Centers during the nine
months ended September 30, 2000 as compared to 13 Developing Centers during the
nine months ended September 30, 1999.
29
<PAGE>
For the nine months ended September 30, 2000, other expenses were $114.6
million, representing an increase of $78.2 million or 215.6% from the
corresponding period in 1999. This increase is primarily attributable to greater
corporate general and administrative expenses, merger and integration expenses,
depreciation and amortization and interest expense of $18.6 million, $19.5
million, $25.2 million, and $14.9 million or 106.4%, 1,218.4%, 229.5% and
209.2%, respectively.
The increase in corporate general and administrative expenses was attributable
to increases in the corporate personnel infrastructure and its associated travel
and related expenses, related office expansion, and professional and consulting
fees associated with HQ Global's growth. The increase in corporate general and
administration expenses were also attributed to the corporate general and
administration expenses of Old HQ. The increase in merger and integration
expenses is attributable to the Merger. The increase in depreciation and
amortization relates to fixed assets acquired and goodwill associated with HQ
Global's acquisitions. It is also attributable to an increase in capital
expenditures associated with leasehold improvements for Developing Centers and
technology infrastructure additions. Interest expense is primarily related to HQ
Global's credit facility. This increase resulted from interest expense on
borrowings related to HQ Global's acquisitions as well as increases in interest
rates.
HQ Global's effective income tax rate for the nine months ended September 30,
2000 reflects tax expense and also a book pre-tax loss. Tax expense is
recognized primarily due to international tax obligations, state and local tax
obligations, and non-deductible goodwill amortization. The effective tax rate
for the nine months ended September 30, 1999 was 73.0%.
PARENT AND OTHER INTERESTS
THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
Net parent expenses increased $11.7 million to $18.6 million in the three months
ended September 30, 2000 as compared to the same period in 1999, principally due
to $5.8 million of amortization of stock compensation awards in the 2000 period,
$3.6 million of losses associated with costs and reserves attributable to a
development stage company in the 2000 period and a $1.5 million increase in
interest expense. FrontLine's general and administrative expenses, which were
$4.6 million in the three months ended September 30, 2000 compared to $4.3
million in the same period in 1999, are expected to decrease as a result of the
Restructuring. However, as a result of the Restructuring and transition-related
transactions, the Company expects that it will recognize cash and non-cash
future charges, the amount of which has yet to be determined.
A significant portion of FrontLine's net loss is derived from companies which it
holds a significant minority ownership interest accounted for under the equity
method of accounting. The equity in net loss of unconsolidated companies
increased $26.3 million to $31.1 million in the three months ended September 30,
2000 as compared to the same period in 1999. Equity losses fluctuate with the
number of Partner Companies accounted for under the equity method, FrontLine's
voting ownership percentage in these companies, the amortization of goodwill
related to newly acquired equity method Partner Companies, and the results of
operations of these companies. As of September 30, 2000, FrontLine accounted for
five of its Partner Companies and Reckson Strategic under this method as
compared to two Partner Companies and Reckson Strategic during the three months
ended September 30, 1999. All five of these companies incurred losses for the
three months ended September 30, 2000. Under this method, the results of
operations of these entities are not consolidated within the Consolidated
Statements of Operations; however, FrontLine's share of these companies' losses
is reflected in the caption "Equity in net loss of unconsolidated companies" in
the Consolidated Statements of Operations. (See Note 3 to the accompanying
consolidated financial statements).
Distribution to preferred shareholders of $0.6 million in the three months ended
September 30, 2000 represents dividends on FrontLine's 8.875% Cumulative
Convertible Preferred Stock which was issued in the first quarter of 2000.
30
<PAGE>
NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
Net parent expenses increased $31.9 million to $49.2 million in the nine months
ended September 30, 2000 as compared to the same period in 1999 principally due
to $11.3 million of amortization of stock compensation awards in the 2000
period, a $9.7 million increase in interest expense due to an increase in
average borrowings under FrontLine's credit facilities, $7.3 million of losses
associated with a development stage company in the 2000 period and a $2.7
million increase in general and administrative expenses. FrontLine's general and
administrative expenses, which were $15.6 million in the nine months ended
September 30, 2000 compared to $12.9 million in the same period in 1999, are
expected to decrease as a result of the Restructuring.
The equity in net loss of unconsolidated companies increased $77.2 million to
$83.9 million in the nine months ended September 30, 2000 as compared to the
same period in 1999. Equity losses fluctuate with the number of Partner
Companies accounted for under the equity method, FrontLine's voting ownership
percentage in these companies, the amortization of goodwill related to newly
acquired equity method Partner Companies, and the results of operations of these
companies. As of September 30, 2000, FrontLine accounted for five of its Partner
Companies and Reckson Strategic under this method as compared to either one or
two Partner Companies and Reckson Strategic during the three and nine months
ended September 30, 1999. All five of these companies incurred losses for the
nine months ended September 30, 2000.
The extraordinary item of $2.6 million in the nine months ended September 30,
2000 resulted from the write-off of deferred financing costs relating to
FrontLine's then existing credit facility due to its early extinguishment in
March 2000.
Distribution to preferred shareholders of $1.5 million in the nine months ended
September 30, 2000 represents dividends on FrontLine's 8.875% Cumulative
Convertible Preferred Stock which was issued in the first quarter of 2000. A
portion of these dividends were paid in the form of common stock.
LIQUIDITY AND CAPITAL RESOURCES
HQ GLOBAL
On May 31, 2000, HQ Global completed a transaction which increased its $157.9
million credit facility (the amended and restated "Credit Facility") to $275.0
million. The Credit Facility provides for $219.4 million under four term loans,
all of which are repayable in quarterly installments through November 2005. The
Credit Facility also provides for borrowings up to $55.6 million in two
revolving loan commitments. Availabilities under the revolving portion of the
Credit Facility are formula based. As of September 30, 2000, there was $216.2
million in outstanding borrowings under the term loans and no borrowings
outstanding under either revolver. As of September 30, 2000, HQ Global had
letters of credit outstanding in the aggregate amount of $28.5 million, against
which HQ Global pledged $5.7 million in cash and $22.8 million were supported by
the two revolving loan commitments, leaving $32.8 million available for
additional borrowings.
Borrowings under the Credit Facility bear interest ranging from LIBOR plus 3.25%
to 4.0% or prime plus 2.25% to 3.00% for a one, three or nine-month period at
the election of HQ Global. HQ Global's weighted average interest rate on
borrowings under the term loans at September 30, 2000 was 11.04%. HQ Global pays
a commitment fee of 1/2 of 1.0% per annum on the unused portion of the Credit
Facility. As of September 30, 2000, HQ Global had hedged the interest rates on
approximately $93.0 million of the Credit Facility using various instruments
with various expiration dates through July 31, 2002. These instruments lock in
the maximum underlying 30-day LIBOR at levels between 7.93% and 9.00%. The
Credit Facility contains certain financial covenants related to interest
coverage, leverage ratios and other limitations. At September 30, 2000, HQ
Global was in compliance with all of its covenants.
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<PAGE>
On June 1, 2000, HQ Global entered into a Senior Subordinated Credit Facility
(the "Bridge Loan") of $125.0 million provided by UBS Warburg, LLC. The Bridge
Loan bears interest at LIBOR plus 6.5% and was scheduled to mature on May 31,
2007.
On August 11, 2000, HQ Global replaced the Bridge Loan with a $125.0 million
Senior Subordinated Note Agreement (the "Mezzanine Loan"). The Mezzanine Loan
bears interest at 13.5% per annum and matures on May 31, 2007. The Mezzanine
lenders received 503,545 Class A warrants and 227,163 Class B warrants.
On August 11, 2000, HQ Global issued 613,166 additional shares of Series A
Cumulative Convertible Preferred Stock in the amount of $25.0 million. In
connection with this sale, HQ Global issued 312,274 Class A warrants and 164,902
Class B warrants.
The terms of the Class A warrants and Class B warrants are identical except that
Class A warrants are exercisable at the option of the holder at any time and
Class B warrants are exercisable on or after March 1, 2002, but only in the
event that a Qualified Initial Public Offering (as defined in the Purchase
Agreements) has not occurred prior to that date.
HQ Global anticipates that cash flows from operations and amounts available
under the revolving loan portion of its Credit Facility will continue to provide
adequate capital to fund its operating and administrative expenses and regular
debt service obligations in addition to the necessary capital required to
sustain its current operations. HQ Global's covenants under its Credit Facility
provide for the expenditure in 2001 of up to $50.0 million for maintenance
capital and new center development.
FRONTLINE
FrontLine has funded operations and investing activities through a combination
of borrowings under various credit facilities and issuances of the Company's
equity securities. FrontLine funded approximately $173.6 million in cash and
issued $47.4 million of the Company's common stock to acquire interests in or
make advances to new and existing Partner Companies during the nine months ended
September 30, 2000. In addition to HQ Global, these companies include:
AdOutlet.com, EmployeeMatters, Inc., LiveCapital.com, NeoCarta Ventures, PIPE9
Corporation, RealtyIQ.com and UpShot.com.
The Company has a credit facility with Reckson in the amount of $100 million
("FrontLine Facility"). Additionally, Reckson Strategic has a $100 million
facility ("Reckson Strategic Facility") with Reckson to fund Reckson Strategic
investments. Note 8 to the consolidated financial statements summarizes the
outstanding amounts and terms of the FrontLine and Reckson Strategic Facilities
(collectively, the "Credit Facilities"). The Company had approximately $92.5
million outstanding under the FrontLine Facility at September 30, 2000 and due
to outstanding letters of credit and accrued interest, has no remaining
availability. Borrowings were primarily used to fund acquisitions of ownership
interests in Partner Companies and general operations. Approximately $39.9
million was outstanding under the Reckson Strategic Facility at September 30,
2000. These borrowings were utilized to fund Reckson Strategic investments and
general operations. At September 30, 2000, $22.5 million was available under the
Reckson Strategic Facility.
FrontLine's secured credit facility for $60 million was fully drawn and repaid
during the three months ended March 31, 2000, and is therefore no longer
available. On September 11, 2000, FrontLine entered into a $25.0 million line of
credit agreement (the "FrontLine Bank Credit Facility"). Borrowings under the
FrontLine Bank Credit Facility bear interest, at the election of FrontLine, at
either LIBOR for one, two, three or six-month periods or the prime rate, plus
5%. Any outstanding borrowings under the FrontLine Bank Credit Facility will be
due on March 11, 2001, although FrontLine has the ability to extend the maturity
date to September 11, 2001. At September 30, 2000, FrontLine had borrowed $25.0
million under the FrontLine Bank Credit Facility.
The Company also funded investing activities for the nine months ended September
30, 2000 with net proceeds of approximately $24.6 million from the completion of
26,000 shares of privately placed Convertible Preferred Stock offerings. On May
6, 2000, the Company paid a preferred dividend to the preferred shareholder of
approximately $0.6 million. The preferred dividend with respect to the August 6
distribution was satisfied through the issuance of 38,172 shares of the
Company's common stock.
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<PAGE>
On March 7, 2000, an investment partnership invested $30 million to purchase 1.5
million warrants to acquire FrontLine's common stock at an exercise price of $70
per share. The warrants have a term of 3.25 years. On June 29, 2000, the
investment partnership invested an additional $3.0 million to obtain a reduction
in the warrant exercise price to $47.25 per share and to extend the expiration
of the warrant to March 2005. Simultaneously with this transaction, the Company
issued 1,075,000 shares of its common stock for an additional 2.5% ownership
interest in HQ Global in connection with an agreement with the investment
partnership, which had originally owned VANTAS preferred stock.
On March 31, 2000, the Company sold approximately 2.6 million shares of its
common stock at a price of $47.25 per shares for an aggregate consideration of
approximately $122.6 million. Proceeds from the sale were utilized to repay the
remaining portion of the Credit Facility. As a result, certain deferred
financing costs of approximately $2.6 million were incurred in connection with
the Credit Facility were expensed as an extraordinary loss in the accompanying
consolidated statements of operations. As a part of this transaction, the
Company issued 128,750 warrants with an exercise price of $47.25 per share for 3
years. On September 20, 2000, the Company issued 331,400 shares of its common
stock at a price of $15.0875 per share for gross proceeds of $5.0 million.
Currently, the Company has two short-term letters of credit totaling $3.2
million, which have been utilized as security deposits.
FrontLine's operations do not require intensive capital expenditures. There were
no significant capital expenditure commitments as of September 30, 2000.
As a result of the Restructuring, FrontLine's cash requirements have been
substantially reduced. The Company believes that it will be able to meet its
future cash requirements through cash on hand, additional bank or other
financing. If additional funds are raised through the issuance of equity
securities, existing shareholders may experience significant dilution. Although
management believes that it will continue to have sufficient access to the
public and private markets in order to execute its restructured business plan,
the availability and amount of funds from these markets is subject to numerous
factors including some that are beyond the Company's control, and therefore is
not assured.
33
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
HQ GLOBAL
The primary market risk facing HQ Global is interest rate risk on its Credit
Facility. HQ Global mitigates this risk by entering into hedging instruments on
a portion of its outstanding balances. In addition, HQ Global may elect to enter
into LIBOR contracts on portions of the Credit Facility, which locks in HQ
Global's interest rate on those portions for 30, 60 or 90-day periods. The
Credit Facility bears interest ranging from either 3.25% to 4.00% over
applicable LIBOR, or alternatively 2.25% to 3.00% over prime, generally at HQ
Global's election. As of September 30, 2000, HQ Global had hedged the interest
rates on approximately $93.0 million of its Credit Facility using various
instruments with various expiration dates through July 31, 2002. These
instruments lock in the maximum underlying 30-day LIBOR rate at levels between
7.93% and 9.00%.
An increase in interest rates will have a negative impact on the net income of
HQ Global due to the variable interest component of the Credit Facility. Based
on current interest rate levels, a 10% increase in underlying interest rates
will have approximately a 6.3% increase in interest expense, ignoring the
short-term impact of remaining terms under current LIBOR hedge contracts.
Following the Merger, HQ Global is conducting more of its operations in foreign
currencies, primarily the British Pound. Due to the nature of foreign currency
markets, there is potential risk for foreign currency losses as well as gains.
HQ Global has not, and does not plan to, enter into any derivative financial
instruments for trading or speculative purposes. As of September 30, 2000, HQ
Global had no other material exposure to market risk.
FRONTLINE
The primary market risk facing FrontLine is interest rate risk on its Credit
Facilities and the FrontLine Bank Facility. The Company does not hedge interest
rate risk using financial instruments. The Credit Facilities bear interest at
the greater of the prime rate plus 2% or 12% (with interest on balances
outstanding more than one year increasing by 4% of the previous year's rate).
The FrontLine Bank Credit Facility bears interest, at the election of FrontLine,
at either LIBOR for one, two, three or six-month periods or the prime rate, plus
5%. The rates of interest on the Credit Facilities and the FrontLine Bank Credit
Facility will be influenced by changes in the prime rate and LIBOR and is
sensitive to inflation and other economic factors. A significant increase in
interest rates may have a negative impact on the earnings of the Company due to
the variable interest rate under the Credit Facilities.
The following table sets forth FrontLine's obligations with respect to Credit
Facilities and the FrontLine Bank Credit Facility, principal cash flows by
scheduled maturity, weighted average interest rates and estimated fair market
value ("FMV") at September 30, 2000 (in thousands, except rates).
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------
2000 2001 2002 2003 2004 THEREAFTER TOTAL FMV
------ --------- ------ ------ ------ --------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Variable rate...... $ -- $25,000 $ -- $132,379 $ -- $ -- $157,379 $157,379
Average interest
rate............ -- 11.63% -- 12.14% -- -- 12.06% --
</TABLE>
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings--None
Item 2. Changes in Securities and Use of Proceeds--None
Item 3. Defaults Upon Senior Securities--None
Item. 4 Submission of Matters to a Vote of Securities Holders--None
Item. 5. Other Information--None
Item 6. Exhibits and Reports on Form 8-K
Form 8-K/A, dated August 15, 2000
Relating to the filing of financial
statements with respect to the Company's
execution of merger agreements with VANTAS
Incorporated and HQ Global Workplaces, Inc.
35
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FRONTLINE CAPITAL GROUP
By: \s\ Scott H. Rechler
--------------------
Scott H. Rechler, President
and Chief Executive Officer
(Principal Executive Officer)
\s\ Michael Maturo
------------------
Michael Maturo, Executive
Vice President and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
Date: November 14, 2000
36
