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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
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 June 30, 2000
Commission file number: 0-30162
FRONTLINE CAPITAL GROUP
(Exact name of registrant as specified in its charter)
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<S> <C>
Delaware 11-3383642
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(State other jurisdiction of incorporation of organization) (IRS. Employer Identification Number)
1350 Avenue of the Americas, New York, NY 10019
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(Address of principal executive office) (zip code)
</TABLE>
(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 filing requirements for the past 90 days. Yes X No___.
This company has only one class of common stock, issued at $.01 par value per
share with 36,154,524 shares outstanding as of August 8, 2000.
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<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
QUARTERLY REPORT
FOR THE THREE MONTHS ENDED JUNE 30, 2000
TABLE OF CONTENTS
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INDEX PAGE
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PART I. FINANCIAL INFORMATION
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Item 1. Financial Statements
Consolidated Balance Sheets of FrontLine Capital Group and Subsidiaries
as of June 30, 2000 (unaudited) and December 31, 1999..................... 3
Consolidated Statements of Operations of FrontLine Capital Group and
Subsidiaries for the three and six months ended June 30, 2000 and 1999
(unaudited)............................................................... 4
Consolidated Statements of Cash Flows of FrontLine Capital
Group and Subsidiaries for the six months ended June 30, 2000
and 1999 (unaudited)...................................................... 5
Notes to the Consolidated Financial Statements of FrontLine Capital Group
and Subsidiaries (unaudited).............................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................ 21
Item 3. Quantitative and Qualitative Disclosures about Market Risk................ 33
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PART II. OTHER INFORMATION
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Item 1. Legal Proceedings......................................................... 34
Item 2. Changes in Securities and Use of Proceeds................................. 34
Item 3. Defaults Upon Senior Securities........................................... 34
Item 4. Submission of Matters to a Vote of Securities Holders..................... 34
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
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PART 1 - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
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<CAPTION>
JUNE 30, 2000 DECEMBER 31, 1999
--------------- -----------------
(UNAUDITED)
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ASSETS:
Current Assets:
Cash and cash equivalents.......................................................... $25,239 $32,740
Restricted cash.................................................................... 7,525 21,572
Accounts receivable, net of allowance for doubtful accounts of
$2,949 at June 30, 2000 and $861 at December 31, 1999.............................. 22,970 8,426
Other current assets............................................................... 19,616 16,008
---------------- ----------------
TOTAL CURRENT ASSETS........................................................... 75,350 78,746
Ownership interests in and advances to unconsolidated companies.................... 99,962 97,833
Intangible assets, net............................................................. 676,457 239,412
Property and equipment, net........................................................ 210,871 80,425
Deferred financing costs, net...................................................... 44,300 --
Other assets, net.................................................................. 65,360 45,567
---------------- ----------------
TOTAL ASSETS.................................................................. $1,172,300 $541,983
================ ================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current Liabilities:
Accounts payable and accrued expenses.............................................. $51,924 $ 45,852
Current portion of Senior secured debt............................................. 35,475 12,500
Deferred rent payable ............................................................. 4,654 2,165
Other current liabilities.......................................................... 2,729 1,139
---------------- ----------------
Total Current Liabilities..................................................... 94,782 61,656
Credit facilities with related parties............................................. 131,243 121,848
Senior secured debt................................................................ 204,025 44,407
Subordinated notes payable......................................................... 125,000 108,125
Deferred rent payable ............................................................. 29,845 22,794
Other liabilities.................................................................. 75,920 33,706
---------------- ----------------
Total Liabilities............................................................. 660,815 392,536
---------------- ----------------
Minority Interest.................................................................. 276,329 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 June 30, 2000 and December 31, 1999, respectively.............................. -- --
Common stock, $.01 par value, 100,000,000 shares authorized,
36,094,529 and 30,672,794 shares issued and outstanding, at
June 30, 2000 and December 31,1999, respectively................................... 360 307
Additional paid in capital......................................................... 390,185 162,054
Accumulated deficit............................................................... (155,389) (48,252)
---------------- ----------------
TOTAL SHAREHOLDERS' EQUITY..................................................... 235,156 114,109
---------------- ----------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY..................................... $1,172,300 $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 THREE MONTHS SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 2000 JUNE 30, 1999 JUNE 30, 2000 JUNE 30, 1999
-------------- -------------- -------------- -------------
<S> <C> <C> <C> <C>
Operating Revenues:
Executive office suite income........................ $58,085 $30,572 $94,156 $57,637
Support services and other........................... 40,696 22,100 67,198 41,893
-------------- -------------- -------------- -------------
TOTAL OPERATING REVENUES........................ 98,781 52,672 161,354 99,530
-------------- -------------- -------------- -------------
OPERATING EXPENSES:
Cost of revenue...................................... 69,092 42,496 118,871 79,683
Partner Company general and administrative expenses.. 10,119 2,627 17,286 5,189
-------------- -------------- -------------- -------------
TOTAL OPERATING EXPENSES........................ 79,211 45,123 136,157 84,872
-------------- -------------- -------------- -------------
PARTNER COMPANY OPERATING INCOME................ 19,570 7,549 25,197 14,658
PARTNER COMPANY OTHER INCOME (EXPENSES):
Development stage Partner Company.................... (2,143) -- (3,706) --
Merger and integration costs......................... (18,615) (641) (19,441) (1,385)
Depreciation and amortization........................ (9,975) (3,269) (16,194) (6,085)
Interest expense, net ............................... (6,845) (2,340) (10,227) (4,245)
-------------- -------------- -------------- -------------
PARTNER COMPANY INCOME (LOSS)........................ (18,008) 1,299 (24,371) 2,943
CORPORATE INCOME (EXPENSES):
General and administrative expenses.................. (5,705) (7,373) (9,939) (8,265)
New hire expenses.................................... (294) (348) (1,032) (348)
Depreciation and amortization........................ (356) (27) (399) (35)
Amortization of deferred charges..................... (3,878) -- (5,530) --
Interest expense, net .............................. (3,388) (1,006) (10,009) (1,774)
-------------- -------------- -------------- -------------
LOSS BEFORE PROVISION FOR INCOME TAXES, MINORITY
INTEREST, EQUITY IN LOSS OF UNCONSOLIDATED
COMPANIES, EXTRAORDINARY LOSS AND DISTRIBUTION TO (31,629) (7,455) (51,280) (7,479)
PREFERRED SHAREHOLDER................................
Provision for income taxes........................... (280) (581) (470) (1,331)
Minority interest.................................... 196 (407) 1,098 (957)
Equity in loss of unconsolidated companies .......... (34,536) (1,393) (52,914) (2,024)
-------------- -------------- -------------- -------------
LOSS BEFORE EXTRAORDINARY LOSS AND DISTRIBUTION TO
PREFERRED SHAREHOLDER................................ (66,249) (9,836) (103,566) (11,791)
Extraordinary loss on extinguishment of debt ........ -- -- (2,648) --
-------------- -------------- -------------- -------------
NET LOSS BEFORE DISTRIBUTION TO PREFERRED SHAREHOLDER (66,249) (9,836) (106,214) (11,791)
Distribution to Preferred Shareholder................ (577) -- (923) --
-------------- -------------- -------------- -------------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS.......... $(66,826) $(9,836) $(107,137) $(11,791)
============== ============== ============== =============
BASIC AND DILUTED NET LOSS PER WEIGHTED AVERAGE
COMMON SHARE......................................... $(1.92) $(0.40) $(3.22) $(0.48)
============== ============== ============== =============
BASIC AND DILUTED WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING.......................................... 34,889,374 24,712,383 33,300,693 24,699,285
============== ============== ============== =============
</TABLE>
(See accompanying notes to consolidated financial statements)
4
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FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
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<CAPTION>
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 2000 JUNE 30,1999
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss before distribution to Preferred Shareholder $(106,214) $ (11,791)
Adjustments to reconcile net loss before distribution to Preferred Shareholder to
net cash provided by (used in) operating activities:
Depreciation and amortization ................................................ 16,593 6,387
Extraordinary loss on early extinguishment of debt............................. 2,648 --
Equity in loss of unconsolidated companies..................................... 52,914 2,024
Minority interest.............................................................. (1,098) 957
Provision for income taxes..................................................... 470 1,331
Non-cash compensation.......................................................... 5,530 3,720
Changes in operating assets and liabilities:
Accounts receivable, net....................................................... (6,862) (1,027)
Acquisition costs and other assets............................................. (2,366) (639)
Deferred rent payable.......................................................... 3,012 2,470
Accounts payable and accrued expenses.......................................... (20,949) 3,990
Other liabilities.............................................................. 4,681 2,523
Affiliate receivables.......................................................... (268) 7,445
---------------- ---------------
Net cash provided by (used in) operating activities................................. (51,909) 17,390
---------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of Executive Office Suite Centers................................. (280,311) (28,929)
Equipment...................................................................... (26,717) (13,507)
Restricted cash................................................................ 23,311 8,747
Acquisition of ownership interests and advances to unconsolidated companies.... (94,740) (32,070)
---------------- ---------------
Net cash used in investing activities............................................... (378,457) (65,759)
---------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock and warrants, net of costs............................ 157,481 39
Issuance of preferred stock, net of costs...................................... 24,530 --
Deferred financing costs....................................................... (23,774) (905)
Net proceeds from credit facilities with related parties....................... 9,395 26,025
Net proceeds from notes payable................................................ 86,758 24,675
Capital leases................................................................. (938) (1,295)
Exercise of options............................................................ 395 --
Net proceeds from minority interest............................................ 213,425
Net proceeds from secured credit facility...................................... (44,407) --
---------------- ---------------
Net cash provided by financing activities...................................... 422,865 48,539
---------------- ---------------
CASH AND CASH EQUIVALENTS:
Net increase (decrease)............................................................. (7,501) 170
Beginning of period................................................................. 32,740 2,026
---------------- ---------------
End of period....................................................................... $25,239 $ 2,196
================ ===============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest........................................ $11,393 $ 3,194
================ ===============
Cash paid during the year for income taxes...................................... $942 --
================ ===============
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS:
Contribution of assets from Interoffice Superholdings Corporation and Reckson
Executive Centers, Inc. to predecessor entity....................................... $ -- $ (21,409)
================ ===============
</TABLE>
(See accompanying notes to consolidated financial statements)
5
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
1. DESCRIPTION OF THE COMPANY
FrontLine Capital Group ("FrontLine" or the "Company") is building a
collaborative network of companies that use the Internet and new technologies to
empower small to medium size enterprises ("SME's"), entrepreneurs, and the
mobile workforce, the fastest growing segment of the new economy. FrontLine
provides its Partner Companies with the capital, customer base, management
resources, and relationships they need for fast-growth and long-term success.
The Partner Companies in turn provide small to medium size business customers
with the information, tools and services they need to become more competitive,
at a price they can afford. In this way, FrontLine achieves its vision along two
parallel tracks: FrontLine empowers the entrepreneurs that make up its network
of Partner Companies, and empowers the entrepreneurs that make up its customer
base.
The Company acquires significant, long-term stakes in targeted Partner
Companies, which it incorporates into a collaborative network of e-commerce and
e-services companies, seeking to accelerate their growth and increasing their
likelihood of success. FrontLine has developed an extensive e-Cooperative
platform that allows its Partner Companies to benefit from its operational and
management resources and experience, the Company's extensive customer base as
well as gain significant synergies from other existing and future Partner
Companies. The e-Cooperative consists of the:
o enterprise Development Group ("eDG") - eDG offers strategic planning,
project management and functional expertise in areas of organizational
design, recruiting, finance and technology strategy.
o Advisory Board - a group of recognized business and academic leaders
provides strategic insight, expertise, relationships and access to new
opportunities and potential alliances for the Company and its Partner
Companies.
o Network of Partner Companies - facilitates learning and collaboration among
all Partner Companies and provides access to the customer base, resources
and relationships of the entire network. It also facilitates business
partnerships among Partner Companies, including cross-selling and
cross-marketing opportunities.
o Virtual and Physical - Global workplace solutions provider which offers the
Partner Companies the ability to access the virtual and physical global
infrastructure as well as a distribution network to a customer base of
SME's.
The Company's strategy is to continue to expand its network of Partner Companies
and its e-Cooperative platform by pursuing additional acquisitions that
complement and enhance the overall network. FrontLine seeks to add significant
value to its Partner Companies with the goal of creating industry leaders that
have the potential to become public companies, act as industry consolidators or
merge with the proper strategic partners. FrontLine targets early stage
companies that can benefit from FrontLine's entire franchise and therefore have
the potential to create significant value for FrontLine.
FrontLine seeks to focus its future acquisitions in the Internet sector by
targeting three types of e-commerce and e-services companies:
o e-commerce and infrastructure: companies that primarily deliver or enable
the delivery of goods and services over the Internet;
o Virtual brick and mortar: companies that combine a physical infrastructure
with an Internet enable model to enhance the delivery of their services;
and
o Internet-based outsourcing: companies that utilize the Internet to enable
the outsourcing of non-core business functions.
Although the Company refers to the companies in which it has acquired an equity
and cost ownership interest as its "Partner Companies" and that it has a
"partnership" with these companies, it does not act as an agent or legal
representative for any of these companies, it does not have the power or
authority to legally bind any of its Partner Companies and it does not have the
types of liabilities in relation to its Partner Companies that a general partner
of a partnership would have.
6
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FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
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, HQ Global
Holdings, Inc. ("HQ Global") and Confidant Inc. ("Confidant"), and the results
of their operations and their cash flows. 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 (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and six month periods ended June
30, 2000, are not necessarily indicative of the results that may be expected for
the year ended 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.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Company's annual report on Form 10-K for the
year ended December 31, 1999.
ACCOUNTING FOR OWNERSHIP INTERESTS IN PARTNER COMPANIES AND OTHER OWNERSHIP
INTEREST
The interests that FrontLine acquires in its Partner Companies and other
ownership interest 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 a Partner
Company.
Consolidation. Partner Companies in which the Company directly or indirectly
owns more than 50% of the outstanding voting securities 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 inter-company accounts and
transactions have been eliminated. Participation of other Partner Company
shareholders in the earnings or losses of a consolidated Partner Company are
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.
7
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FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Equity Method. Partner Companies and other ownership interests 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 a Partner Company or other
ownership interest depends on an evaluation of several factors including, among
others, representation on the Partner Company's or other ownership interest's
Board of Directors and ownership level, which is generally a 20% to 50% interest
in the voting securities of the Partner Company and other ownership interests,
including voting rights associated with the Company's holdings in common,
preferred and any other convertible instruments in the Partner Company and other
ownership interests. Under the equity method of accounting, a Partner Company's
or other ownership interest's accounts are not reflected within the Company's
Consolidated Statements of Operations; however, FrontLine's share of the
earnings or losses of the Partner Company or other ownership interest is
reflected in the caption "Equity in loss of unconsolidated companies" in the
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
consolidation or equity method of accounting is amortized on a straight-line
basis over 20 years which adjusts 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 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 also recognizes income from dividends on distributed earnings of its
Partner Companies. However, cost method impairment charges are recognized in the
Consolidated Statement of Operations with the new cost basis not written-up if
circumstances suggest that the value of the Partner Company has subsequently
recovered.
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
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.
8
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9
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FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
The Company's operating revenues for the three and six months ended June 30,
2000 were attributable to HQ Global. HQ Global's revenue is derived primarily
from the operation of their executive office suites and the range of
telecommunication and business support services provided to clients, and are
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 June 30, 2000, and December 31, 1999, accumulated depreciation and
amortization were approximately $23.8 million and $14.0 million, respectively.
INTANGIBLE ASSETS
Intangible assets consist primarily of goodwill which is 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.
As of June 30, 2000, and December 31, 1999, accumulated amortization were
approximately $15.5 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 for 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, if
necessary, to reflect an 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" ("APB 25") and related
interpretations in accounting for its employee stock options and grants because
the alternative fair value accounting provided for under Statement of Financial
Accounting Standard ("SFAS") No. 123, "Accounting for Stock-Based Compensation,"
("SFAS 123") 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 year in
which the differences are expected to reverse. For the three months ended June
30, 2000 and 1999, the Company recognized a current state income tax provision
of approximately $0.3 million and $0.6 million, respectively, and approximately
$0.5 million and $1.3 million for the six months ended June 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
10
<PAGE>
recognized.
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments" requires
FrontLine to disclose the estimated fair values of its financial instrument
assets and liabilities. The carrying amounts approximate fair value for cash and
cash equivalents 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 as of the beginning of any fiscal quarter after its
issuance. The Company expects to adopt the new Statement effective January 1,
2001. The Company does not anticipate that the adoption of this Statement 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 year amounts have been reclassified to conform to the current year
presentation.
11
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FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
3. OWNERSHIP INTERESTS IN PARTNER COMPANIES
Partner Companies at June 30, 2000 and December 31, 1999 included:
<TABLE>
<CAPTION>
VOTING OWNERSHIP ON A BASIC BASIS VOTING OWNERSHIP ON A DILUTED BASIS
Partner Applicable --------------------------------- -----------------------------------
Company Accounting DECEMBER 31, DECEMBER 31,
Since Method JUNE 30, 2000 1999 JUNE 30, 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%
HQ Global 1998 Consolidation 57% 84% 42% * 76%
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% 21% 22%
Opus360 Corporation 1999 Cost < 1% < 1% < 1% < 1%
PIPE9 Corporation 1999 Equity 31% 31% 26% 26%
RealtyIQ.com 1999 Equity 68% 68% 54% 54%
UpShot.com 2000 Equity 20% N/A 17% N/A
</TABLE>
* Includes preferred equity interests which are not yet convertible into
common and which have no set conversion price.
The Company's ownership interests in Partner Companies are classified according
to the applicable accounting method utilized at June 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 Partner Companies'
income or loss. The cost basis represents the Company's acquisition costs less
any impairment charges in such Partner Companies. The Company's ownership
interests in and advances to Partner Companies accounted for under the equity
method or cost method of accounting are as follows (in thousands):
<TABLE>
<CAPTION>
JUNE 30, 2000 DECEMBER 31, 1999
---------------- -------------------
Carrying Value Cost Carrying Value Cost Basis
-------------- ---- -------------- -----------
<S> <C> <C> <C> <C>
Equity Method $53,619 $116,043 $54,807 $65,741
Cost Method 16,900 16,900 6,400 6,400
------- ------
$70,519 $61,207
======= =======
</TABLE>
The following are the Company's summarized losses on ownership interests in
unconsolidated companies (in thousands):
<TABLE>
<CAPTION>
FOR THE THREE FOR THE THREE FOR THE SIX FOR THE SIX
MONTHS ENDED MONTHS ENDED MONTHS ENDED MONTHS ENDED
JUNE 30, 2000 JUNE 30, 1999 JUNE 30, 2000 JUNE 30, 1999
--------------- ---------------- ---------------- ---------------
<S> <C> <C> <C> <C>
OnSite Access, Inc. and predecessor entity....... $(12,161) $(48) $(20,789) $(70)
EmployeeMatters, Inc. ........................... (7,346) -- (10,225) --
PIPE9 Corporation................................ (3,526) -- (5,549) --
RealtyIQ.com..................................... (9,591) -- (13,850) --
UpShot.com....................................... (771) -- (1,075) --
Other ownership interest......................... (1,141) (1,345) (1,426) (1,954)
--------------- ---------------- ---------------- ---------------
EQUITY IN LOSS OF UNCONSOLIDATED COMPANIES $(34,536) $(1,393) $(52,914) $(2,024)
=============== ================ ================ ===============
</TABLE>
12
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
3. OWNERSHIP INTERESTS IN PARTNER COMPANIES (CONTINUED)
The Company's ownership interests in Partner Companies are summarized as
follows:
EXECUTIVE OFFICE SUITES AND VIRTUAL OFFICE SERVICES
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
Incorporated ("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 stepped 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 consolidating during the fourth quarter of 1999 and
subsequently 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
Holdings, Inc. ("HQ Global"). As of June 30, 2000, FrontLine's ownership
interest was approximately 57% on a basic basis and on a fully diluted basis,
assuming the outstanding preferred stock converts at the merger conversion
price, approximately 42%.
HQ Global is the largest provider of flexible officing solutions in the world.
As of June 30, 2000, HQ Global owned and operated 400 business centers in 29
states, the District of Columbia, and 8 additional countries. This included 7
business centers under development and 15 business centers open for nine months
or less. Also included are 6 business centers managed by HQ Global for unrelated
third parties and 9 international joint-venture business centers that HQ Global,
through its European subsidiary HQ Holdings Limited, is a partner with Mercury
Asset Management. HQ Global is also the franchiser of 45 domestic and 33
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.
In connection with the Merger, (i) each share of the Class A Common Stock of
VANTAS ("VANTAS Common Stock") was converted into the right to receive $8.00 per
share in cash; (ii) each option and warrant to purchase the common stock of
VANTAS, were converted into the right to receive a per share cash amount equal
to $8.00, less the exercise price for such options or warrants, and (iii) each
share of the convertible preferred stock of VANTAS outstanding was converted
into .2569 shares of Voting Common Stock of HQ Global ("Voting Common Stock").
The payment to cancel the outstanding options held by officers and employees was
charged to merger and integration expenses in the three months ended June 30,
2000. The holders of the VANTAS preferred stock received an aggregate of
8,663,315 shares of Voting Common Stock upon conversion of the preferred stock.
In June 2000, 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 investment
agreement with an investment partnership, which had originally owned VANTAS
preferred stock.
13
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
To effectuate the Merger, FrontLine contributed approximately $17 million in
cash and its ownership interest in VANTAS.
e-BUSINESSES
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>
BALANCE SHEETS JUNE 30, 2000 DECEMBER 31, 1999
---------------- ----------------
<S> <C> <C>
Current assets $54,013 $25,535
---------------- ----------------
Total Assets $206,837 $74,774
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT):
Current liabilities $38,826 $13,702
---------------- ----------------
Total Liabilities 118,876 15,615
---------------- ----------------
Total Redeemable Preferred Stock and Stockholders' Equity (deficit) 87,961 59,159
---------------- ----------------
Total Liabilities and Stockholders' Equity (deficit) $206,837 $74,774
================ ================
</TABLE>
14
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
3. OWNERSHIP INTERESTS IN PARTNER COMPANIES (CONTINUED)
ONSITE ACCESS (CONTINUED)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
JUNE 30, 2000 JUNE 30, 2000
----------------- ----------------
<S> <C> <C>
Revenues $2,223 $3,974
Net loss $(30,531) $(52,059)
Other interests' share of net loss $(18,370) $(31,270)
FrontLines' share of net loss $(12,161) $(20,789)
</TABLE>
In June 2000, OnSite secured $50 million in a senior secured financing and $20
million from the sale of preferred stock with several private equity investors.
OnSite has currently filed for an initial public offering of its common stock.
OTHER E-BUSINESSES
During the six months ended June 30, 2000, the Company invested approximately
$23.5 million to purchase ownership interests in two new e-business companies
and funded $37.0 million of commitments to existing Partner Companies.
Subsequent to June 30, 2000, the Company funded an additional $7.5 million to
existing Partner Companies.
4. PARENT COMPANY FINANCIAL INFORMATION
The Company's consolidated financial statements reflect HQ Global and Confidant
accounted for under the consolidation method of accounting at June 30, 2000 and
December 31, 1999 and for the three and six months ended June 30, 2000 and 1999.
Parent Company financial information is provided to present the financial
position and results of operations of the Company as if HQ Global and Confidant
were accounted for under the equity method of accounting for all periods
presented. The Company's share of HQ Global and Confidant losses are included in
"Equity in loss unconsolidated companies" in the Parent Company Statements of
Operations for all periods presented based on the Company's ownership percentage
in each period.
15
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
4. PARENT COMPANY FINANCIAL INFORMATION (CONTINUED)
PARENT COMPANY BALANCE SHEETS (IN THOUSANDS)
<TABLE>
<CAPTION>
ASSETS JUNE 30, 2000 DECEMBER 31, 1999
---------------- -----------------
<S> <C> <C>
Current assets $16,774 $28,933
Ownership interests in and advances to unconsolidated companies 347,525 234,340
Other assets 23,217 30,463
---------------- ----------------
TOTAL ASSETS $387,516 $293,736
================ ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities $8,396 $7,841
Non-current liabilities 143,964 171,786
Shareholders' equity 235,156 114,109
---------------- ----------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $387,516 $293,736
================ ================
</TABLE>
PARENT COMPANY STATEMENTS OF OPERATIONS (IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE THREE FOR THE THREE FOR THE SIX FOR THE SIX
MONTHS ENDED MONTHS ENDED MONTHS ENDED MONTHS ENDED
JUNE 30, 2000 JUNE 30, 1999 JUNE 30, 2000 JUNE 30, 1999
----------------- ----------------- ---------------- ----------------
<S> <C> <C> <C> <C>
REVENUES $83 $83 $167 $167
----------------- ----------------- ---------------- ----------------
Operating expenses (5,999) (7,722) (10,971) (8,614)
Other expenses (4,234) (27) (5,929) (35)
Interest expense, net (3,388) (1,006) (10,009) (1,774)
----------------- ----------------- ---------------- ----------------
TOTAL EXPENSES (13,621) (8,755) (26,909) (10,423)
----------------- ----------------- ---------------- ----------------
LOSS BEFORE EQUITY IN LOSS OF
UNCONSOLIDATED COMPANIES, EXTRAORDINARY
LOSS AND DISTRIBUTION TO PREFERRED
SHAREHOLDER (13,538) (8,672) (26,742) (10,256)
Equity in loss of unconsolidated companies (52,711) (1,164) (76,824) (1,535)
----------------- ----------------- ---------------- ----------------
LOSS BEFORE EXTRAORDINARY LOSS AND DISTRIBUTION
TO PREFERRED SHAREHOLDER (66,249) (9,836) (103,566) (11,791)
Extraordinary loss on early extinguishment of
debt -- -- (2,648) --
Distribution to Preferred Shareholder (577) -- (923) --
----------------- ----------------- ---------------- ----------------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS $(66,826) $(9,836) $(107,137) $(11,791)
================= ================= ================ ================
</TABLE>
16
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 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 June 30, 2000, there was $219.4
million in outstanding borrowings under the term loans and $20.1 million in
borrowings outstanding under one revolver. At June 30, 2000, $10.5 million was
available for additional borrowings under the revolving loan commitments.
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 June 30, 2000 was approximately 11.48%. HQ
Global converted to a LIBOR option on July 3, 2000. HQ Global pays a commitment
fee of 1/2 of 1.0% per annum on the unused portion of the Credit Facility. As of
June 30, 2000, HQ Global had hedged the interest rate on approximately $46.0
million of borrowings under the Credit Facility using various instruments. These
instruments lock in the maximum underlying 30 day LIBOR rate at levels between
5.95% and 7.93% through July 31, 2002. The Credit Facility contains certain
financial covenants related to interest coverage, leverage ratios and other
limitations. At June 30, 2000, HQ Global was in compliance with all of its
covenants.
Maturities of term loans subsequent to June 30, 2000 are as follows:
Twelve months ending June 30:
2001 $15.4 million
2002 $23.6 million
2003 $23.5 million
2004 $47.1 million
2005 $70.9 million
Thereafter $39.0 million
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% which matures 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
Preferred 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.
As of June 30, 2000, HQ Global had letters of credit outstanding in the
aggregate amount of $26.9 million, of which HQ Global pledged $5.5 million and
$21.4 million were supported by FrontLine.
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 statements of operations.
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 ongoing 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 approved by shareholders in
connection with their approval of the 2000 Stock Option Plan at the Company's
annual meeting. These awards vest evenly through December 31, 2000.
Additionally, tax loans relating to these awards 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.
During the three months and six months ended June 30, 2000, results include
approximately $3.9 and $5.5 million (or
17
<PAGE>
$.11 and $.17 per basic and diluted share), respectively, associated with the
above awards, the majority of which is non-cash in nature. In addition,
FrontLine has $8.5 million of deferred compensation, net of amortization, as of
June 30, 2000.
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 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 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 share 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 incurred in connection with the
establishment of 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.
7. LONG TERM INCENTIVE PLAN
In March 2000, the Compensation Committee 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 portion
of the securities acquired by the Company. The plan contemplates the allocation
to such partnerships of up to a 12.5% 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.
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 $92.7 million at June 30, 2000. These
advances bear interest at 12% per annum. Additionally, FrontLine has a $100
million facility with Reckson for funding the Reckson Strategic Venture
Partners, LLC ("Reckson Strategic") investments ("Reckson Strategic Facility").
As of June 30, 2000, Reckson has advanced FrontLine approximately $38.5 million
under the Reckson Strategic Facility and has invested approximately $29.4
million under the facility in joint ventures with Reckson Strategic. The total
outstanding at June 30, 2000, owed by FrontLine under both credit facilities was
approximately $131.2 million. Interest accrued on these facilities at June 30,
2000, was approximately $12.7 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, which have been utilized as
consideration for future FrontLine investment acquisitions. 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
18
<PAGE>
its capital. The earned fee for the three and six months ended June 30, 2000 and
1999 was approximately $0.1 million and $0.3 million, respectively.
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
8. TRANSACTIONS WITH RELATED PARTIES (CONTINUED)
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 and accounting
services. During the three and six months ended June 30, 2000, the Company
reimbursed approximately $0.4 million and $0.8 million, respectively, for such
activities.
9. OTHER OWNERSHIP INTEREST
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. 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 (the "Preferred Equity Facility") 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. For the three months ended June 30,
2000 and 1999, FrontLine's share of Holdings' losses was approximately $1.1
million and $1.3 million, respectively. For the six months ended June 30, 2000
and 1999, FrontLine's share of Holdings' losses was approximately $1.4 million
and $2.0 million, respectively.
10. SEGMENT DISCLOSURE
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.
The CODM evaluate the operating performance of these segments based on sectors.
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.
The following table sets forth the Company's segments and their revenues and
expenses and other related disclosures as required by SFAS No. 131, "Disclosure
about Segments of an Enterprise and Related Information" ("SFAS 131") for the
three months ended June 30, 2000 and 1999 (in thousands).
19
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
10. SEGMENT DISCLOSURE (CONTINUED)
<TABLE>
<CAPTION>
JUNE 30, 2000
-------------
EXECUTIVE OFFICE
SUITES AND
VIRTUAL OFFICE OTHER
SERVICES E-BUSINESSES OPERATIONS TOTAL
------------------ ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Total Assets $960,915 $70,519 $140,866 $1,172,300
------------------ ---------------- ---------------- ----------------
Total Operating Revenues 98,698 -- 83 98,781
------------------ ---------------- ---------------- ----------------
Total Operating Expenses 79,211 -- -- 79,211
------------------ ---------------- ---------------- ----------------
Other Income (Expenses),
Provision for Income Taxes, and
Minority Interest (35,031) (2,315) (13,937) (51,283)
------------------ ---------------- ---------------- ----------------
Equity in Loss of unconsolidated
companies -- (33,395) (1,141) (34,536)
------------------ ---------------- ---------------- ----------------
Distribution to Preferred
shareholder -- -- (577) (577)
------------------ ---------------- ---------------- ----------------
Net Loss $ (15,544) $(35,710) $(15,572) $(66,826)
------------------ ---------------- ---------------- ----------------
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1999
-------------
EXECUTIVE
OFFICE SUITES
AND VIRTUAL OTHER
OFFICE SERVICES E-BUSINESSES OPERATIONS TOTAL
----------------- --------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Total Operating Revenues $52,589 $ -- $83 $52,672
----------------- --------------- --------------- ----------------
Total Operating Expenses 45,123 -- -- 45,123
----------------- --------------- --------------- ----------------
Other Income (Expenses),
Provision for Income Taxes, and
Minority Interest (7,238) -- (8,754) (15,992)
----------------- --------------- --------------- ----------------
Equity in Loss of unconsolidated
companies -- (48) (1,345) (1,393)
----------------- --------------- --------------- ----------------
Net Income (Loss) $228 $(48) $(10,016) $(9,836)
----------------- --------------- --------------- ----------------
</TABLE>
20
<PAGE>
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(UNAUDITED)
10. SEGMENT DISCLOSURE (CONTINUED)
The following table sets forth the Company's segments and their revenues and
expenses and other related disclosures as required by SFAS 131 for the six
months ended June 30, 2000 and 1999 (in thousands).
<TABLE>
<CAPTION>
JUNE 30, 2000
-------------
EXECUTIVE OFFICE
SUITES AND
VIRTUAL OFFICE OTHER
SERVICES E-BUSINESSES OPERATIONS TOTAL
------------------ ---------------- --------------- ----------------
<S> <C> <C> <C> <C>
Total Operating Revenues $161,188 $ -- $166 $161,354
------------------ ---------------- --------------- ----------------
Total Operating Expenses 136,157 -- -- 136,157
------------------ ---------------- --------------- ----------------
Other Income (Expenses),
Provision for Income Taxes, and
Minority Interest (43,986) (3,899) (27,964) (75,849)
------------------ ---------------- --------------- ----------------
Equity in Loss of unconsolidated
companies -- (51,488) (1,426) (52,914)
------------------ ---------------- --------------- ----------------
Extraordinary Loss from Early
Extinguishment of Debt -- -- (2,648) (2,648)
------------------ ---------------- --------------- ----------------
Distribution to Preferred
shareholder -- -- (923) (923)
------------------ ---------------- --------------- ----------------
Net Loss $(18,955) $(55,387) $(32,795) $(107,137)
------------------ ---------------- --------------- ----------------
</TABLE>
<TABLE>
JUNE 30, 1999
-------------
EXECUTIVE
OFFICE SUITES
AND VIRTUAL OTHER
OFFICE SERVICES E-BUSINESSES OPERATIONS TOTAL
----------------- --------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Total Operating Revenues $99,364 $ -- $166 $99,530
----------------- --------------- --------------- ----------------
Total Operating Expenses 84,872 -- -- 84,872
----------------- --------------- --------------- ----------------
Other Income (Expenses),
Provision for Income Taxes,
and Minority Interest (14,003) -- (10,422) (24,425)
----------------- --------------- --------------- ----------------
Equity in Loss of unconsolidated
companies -- (70) (1,954) (2,024)
----------------- --------------- --------------- ----------------
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
JUNE 30, 1999
-------------
EXECUTIVE
OFFICE SUITES
AND VIRTUAL OTHER
OFFICE SERVICES E-BUSINESSES OPERATIONS TOTAL
----------------- --------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Net Income (Loss) $489 $(70) $(12,210) $(11,791)
----------------- --------------- --------------- ----------------
</TABLE>
22
<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 ability to
identify and acquire interest in new Partner Companies, consummation of the
merger with HQ Global Workplaces, Inc, the financing of the Company's and
Partner Companies', operations, the timing and success of such acquisitions and
the ability to integrate and manage effectively its various acquisitions,
involve certain risks and uncertainties. Although the Company believes that the
expectation 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 its 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,
general economic conditions, a lack of attractive business opportunities or
suitable acquisitions, the Company's dependence upon financing from Reckson
Operating Partnership, L.P., ("Reckson") conflicts of interest of management,
competition for targeted acquisitions and the ability to otherwise finance
business opportunities. 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 building a collaborative network of companies that use the Internet
and new technologies to empower small to medium size enterprises ("SME's"),
entrepreneurs, and the mobile workforce, the fastest growing segment of the new
economy. FrontLine provides its Partner Companies with the capital, customer
base, management resources, and relationships they need for fast-growth and
long-term success. The Partner Companies in turn provide small to medium size
business customers with the information, tools and services they need to become
more competitive, at a price they can afford. In this way, FrontLine achieves
its vision along two parallel tracks: FrontLine empowers the entrepreneurs that
make up its network of Partner Companies, and empowers the entrepreneurs that
make up its customer base.
The Company is to acquire significant, long-term stakes in targeted Partner
Companies, which will be incorporated into a collaborative network of e-commerce
and e-services companies, in effect to accelerate their growth and increase
their likelihood of success. FrontLine has developed an extensive e-Cooperative
platform that allows its Partner Companies to benefit from its operational and
management resources and experience and the Company's extensive customer base as
well as gain significant synergies from other existing and future Partner
Companies. The e-Cooperative consists of the:
o enterprise Development Group or eDG - eDG offers strategic planning,
project management and functional expertise in the areas of organizational
design, recruiting, finance and technology strategy.
o Advisory Board - a group of recognized business and academic leaders
provides strategic insight, expertise, relationships and access to new
opportunities and potential alliances for the Company and its Partner
Companies.
o Network of Partner Companies - facilitates learning and collaboration among
all Partner Companies and provides access to the customer base, resources
and relationships of the entire network. It also facilitates business
partnerships among Partner Companies, including cross-selling and
cross-marketing opportunities.
o Virtual and Physical - Global workplace solutions provider which offers the
Partner Companies the ability to access the virtual and physical global
infrastructure as well as a distribution network to a customer base of
SMEs.
The Company's strategy is to continue to expand its network of Partner Companies
and its e-Cooperative platform by pursuing additional acquisitions that
complement and enhance the overall network. FrontLine seeks to add significant
value to its Partner Companies with the goal of creating industry leaders that
have the potential to become public companies, act as industry consolidators or
merge with the proper strategic partners. FrontLine targets early stage
companies that can benefit from FrontLine's entire franchise and therefore have
the potential to create significant value
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for FrontLine.
FrontLine seeks to focus its future acquisitions in the Internet sector by
targeting three types of e-commerce and e-services companies:
o e-Commerce and infrastructure: companies that deliver or enable the
delivery of goods and services over the Internet;
o Virtual brick and mortar: companies that combine a physical infrastructure
with an Internet-enabled model to enhance the delivery of their services;
and
o Internet-based outsourcing: companies that utilize the Internet to enable
the outsourcing of non-core business functions.
Although the Company refers to the companies in which it has acquired an equity
and cost ownership interest as its "Partner Companies" and that it has a
"partnership" with these companies, it does not act as an agent or legal
representative for any of these companies, it does not have the power or
authority to legally bind any of its Partner Companies and it does not have the
types of liabilities in relation to its Partner Companies that a general partner
of a partnership would have.
Because FrontLine acquires significant interests in e-commerce companies, many
of which generate net losses, FrontLine has experienced, and expects to continue
to experience, significant volatility in the quarterly results. Management does
not know if the Company will report net income in any period, and expects to
report net losses for the foreseeable future. While most Partner Companies have
consistently reported losses, the Company may experience significant volatility
from period to period due to one-time transactions and other events incidental
to the ownership interests in and advances to Partner Companies. On a continuous
basis, but no less frequently than at the end of each quarterly reporting
period, management evaluates the carrying value of the ownership interests in
and advances to each of the Partner Companies for possible impairment based on
achievement of business plan objectives and milestones, the fair value of each
ownership interest and advance 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 that are taken
into consideration 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 more operational in nature such as the
launching of a web site or the hiring of key employees. The fair value of the
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 Partner Companies.
The presentation and content of the Company's financial statements is largely a
function of the presentation and content of the financial statements of the
Partner Companies. As a result, to the extent 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.
EFFECT OF VARIOUS ACCOUNTING METHODS ON RESULTS OF OPERATIONS
The various interests that FrontLine acquires in Partner Companies 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 in a Partner Company.
Consolidation. Partner Companies in which the Company directly or indirectly
owns more than 50% of the outstanding voting securities and 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 Holdings, Inc.
("HQ Global"). (See Note 3 to the Consolidated Financial Statements).
Additionally, the Company consolidates Confidant, Inc. with FrontLine's
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
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Consolidated Statements of Operations. Minority interest adjusts the
consolidated net results of operations to reflect only FrontLine'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 whose results are not consolidated, but over
whom the Company exercises significant influence, are generally accounted for
under the equity method of accounting. Whether or not the Company exercises
significant influence with respect to a Partner Company depends on an evaluation
of several factors including; among others, representation on the Partner
Company's board of directors and ownership level, which is generally a 20% to
50% interest in the voting securities of the Partner Company, including voting
rights associated with the Company's holdings in common, preferred and other
convertible instruments in the Partner Company. Under the equity method of
accounting, a Partner Company's accounts are not reflected within the Company's
Consolidated Statements of Operations; however, FrontLine's share of the
earnings or losses of the Partner Company is reflected in the caption "Equity in
loss of unconsolidated companies" in the Consolidated Statements of Operations.
Partner Companies accounted for under the equity method of accounting included:
<TABLE>
<CAPTION>
PARTNER VOTING OWNERSHIP ON BASIC BASIS VOTING OWNERSHIP ON DILUTED BASIS
COMPANY ------------------------------- ---------------------------------
SINCE JUNE 30, 2000 DECEMBER 31, 1999 JUNE 30, 2000 DECEMBER 31, 1999
------- ------------- ----------------- --------------- -----------------
<S> <C> <C> <C> <C> <C>
EmployeeMatters, Inc. 1999 53% 53% 45% 45%
OnSite Access, Inc. 1997 22% 37% 21% 22%
PIPE9 Corporation 1999 31% 31% 26% 26%
RealtyIQ.com 1999 68% 68% 54% 54%
UpShot.com 2000 20% N/A 17% N/A
</TABLE>
FrontLine has representation on the board of directors of all of the above
Partner Companies, and as of June 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 in 2000.
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>
PARTNER VOTING OWNERSHIP ON BASIC BASIS VOTING OWNERSHIP ON DILUTED BASIS
COMPANY ------------------------------- -----------------------------------
SINCE JUNE 30, 2000 DECEMBER 31, 1999 JUNE 30, 2000 DECEMBER 31, 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>
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The cost method Partner Companies are in a very early stage of development and
have not generated significant revenues. In addition, FrontLine's cost method
Partner Companies incurred substantial losses since their inception and are
expected to continue to incur substantial losses in 2000.
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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 consolidated financial statements summarizes the
Company's Statements of Operations and Balance Sheets treating the ownership
interest in HQ Global as if it were accounted for under the equity method of
accounting for all periods presented. FrontLine's share of HQ Global's losses is
included in "Equity in loss of unconsolidated companies."
RESULTS OF OPERATIONS
The reportable segments in FrontLine's financial statements are Executive Office
Suites and Virtual Office Services, e-Businesses and Other Operations. Executive
Office Suites and Virtual Office Services includes the effect of consolidating
the operations of HQ Global. e-Businesses includes the effect of transactions
and other events incidental to the ownership interest in FrontLine's Partner
Companies, excluding HQ Global. Other Operations represents the expenses of
providing strategic and operational support to the Partner Companies, the
administrative costs related to these expenses and FrontLine's operations in
general.
EXECUTIVE OFFICE SUITES AND VIRTUAL OFFICE SERVICES
FrontLine's operating revenues and operating expenses for the three and six
months ended June 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 six months ended June 30, 2000 and 1999.
THREE MONTHS ENDED JUNE 30, 2000 AND 1999
Total business center revenues for the three months ended June 30, 2000 were
$98.7 million, an increase of $46.1 million or 87.8% from the corresponding
period in 1999. Included in revenues was $1.3 and $.2 million of management,
franchise, and joint venture fees for the three month periods ended on June 30,
2000 and 1999, respectively. The increase includes having one month of the
merged HQ Global entity.
Business centers that were acquired with effective dates after April 1, 1999
("Acquired Centers") had revenues for the three months ended June 30, 2000 of
$36.2 million, an increase of $32.1 million from the corresponding period in
1999. This increase in revenues resulted primarily from the acquisition of
business centers during the 12 months ended June 30, 2000. The acquired centers
include all the Old HQ business centers.
Developing Centers ("Developing Centers") are those centers that are in the
early stages of operation when expenses are incurred with minimal corresponding
revenues. Once a Developing Center reaches occupancy levels above 70%, generally
with nine to twelve months of its initial start, it is expected to have a
positive impact on the results of HQ Global.
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 June 30, 2000 of $55.1 million, an increase
of $8.0 million, or 17.0% 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 office rental revenue of $3.6
million, or 13.2%, was primarily due to more favorable office pricing. The
increase in support service revenues of $4.4 million, or 22.3% from 1999 is
partially attributable to an increase in broadband Internet access, information
technology support services and administrative support services.
Developing Center revenues were $6.1 million for the three months ended June 30,
2000, an increase of $4.9 million from the corresponding period in 1999. For the
three months ended June 30, 2000 and 1999, there were 22 and 13 Developing
Centers that were open, respectively. This increase is primarily due to the
greater number of Developing Centers open during the three months ended June 30,
2000.
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Total business center expenses for the three months ended June 30, 2000 were
$69.1 million, representing an increase of $29.5 million or 74.8% from the
corresponding period in 1999.
Acquired Center expenses for the three months ended June 30, 2000 and 1999 were
$24.8 million and $3.1 million respectively, representing an increase of $21.7
million from the corresponding period in 1999. This increase resulted primarily
from the acquisition of business centers during the 12 months ended June 30,
2000. The acquired centers include all the Old HQ business centers.
Same Center expenses for the three months ended June 30, 2000 were $38.4
million, an increase of $3.8 million or 11.0% 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 June 30, 2000 were $5.9
million, an increase of $4.0 million from the corresponding period in 1999. This
increase is due to a total of 28 Developing Centers during the three months
ended June 30, 2000 as compared to 13 Developing Centers during the three months
ended June 30, 1999.
For the three months ended June 30, 2000, other expenses were $45.1 million,
representing an increase of $33.2 million or 279.0% from the corresponding
period in 1999. This increase is primarily attributable to greater corporate
general and administrative expenses, depreciation and amortization and interest
expense of $4.7 million, $6.1 million and $4.5 million or 83.6%, 182.9% and
192.5%, respectively. Other expenses also include merger and integration charges
of $18.6 million, related primarily to the June 1, 2000 HQ Merger.
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 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.
SIX MONTHS ENDED JUNE 30, 2000 AND 1999
Total business center revenues for the six months ended June 30, 2000 were
$161.2 million, an increase of $61.9 million or 62.3% from the corresponding
period in 1999. Included in revenues was $1.5 and $0.4 million of management,
franchise, and joint venture fees for the six month periods ended on June 30,
2000 and 1999, respectively.
Business centers that were acquired with effective dates after January 1, 1999
("Acquired Centers") had revenues for the six months ended June 30, 2000 of
$49.4 million, an increase of $42.2 million from the corresponding period in
1999. This increase in revenues resulted primarily from the acquisition of
business centers during the 12 months ended June 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 six months ended June 30, 2000 of $101.1 million, an increase
of $11.5 million, or 12.8% 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 office rental revenue of $5.5
million, or 10.6%, was primarily due to more favorable office pricing. The
increase in support service revenues of $6.0 million, or 15.8% from 1999 is
partially attributable to an increase in broadband Internet access, information
technology support services and administrative support services.
Developing Center revenues were $9.2 million for the six months ended June 30,
2000, an increase of $7.1 million from the corresponding period in 1999. For the
six months ended June 30, 2000 and 1999, there were 22 and 13 Developing
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Centers that were open, respectively. This increase is primarily due to the
greater number of Developing Centers open during the six months ended June 30,
2000.
Total business center expenses for the six months ended June 30, 2000 were
$118.9 million, representing an increase of $44.9 million or 60.8% from the
corresponding period in 1999.
Acquired Center expenses for the six months ended June 30, 2000 and 1999 were
$35.5 million and $5.5 million respectively, representing an increase of $30.0
million from the corresponding period in 1999. This increase resulted primarily
from the acquisition of business centers during the 12 months ended June 30,
2000. The acquired centers include all the Old HQ business centers.
Same Center expenses for the six months ended June 30, 2000 were $73.0 million,
an increase of $7.6 million or 11.6% 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 six months ended June 30, 2000 were $10.4
million, an increase of $7.3 million from the corresponding period in 1999. This
increase is due to a total of 28 Developing Centers during the six months ended
June 30, 2000 as compared to 13 Developing Centers during the six months ended
June 30, 1999.
For the six months ended June 30, 2000, other expenses were $61.9 million,
representing an increase of $39.1 million or 171.8% from the corresponding
period in 1999. This increase is primarily attributable to greater corporate
general and administrative expenses, depreciation and amortization and interest
expense of $6.4 million, $8.7 million and $6.0 million or 58.9%, 139.0% and
140.9%, respectively. Other expenses also include merger and integration charges
of $19.4 million related primarily to the June 1, 2000 HQ Merger.
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 depreciation and amortization
relates to fixed assets acquired and goodwill associated with the Company'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 the 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.
e-BUSINESSES
A significant portion of FrontLine's net loss is derived from corporations in
which it holds a significant minority ownership interest accounted for under the
equity method of accounting. Equity loss fluctuates 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 June 30, 2000, FrontLine accounted for five of its Partner
Companies under this method as compared to one Partner Company during the three
and six months ended June 30, 1999. All five of these companies incurred losses
for the three and six months ended June 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 loss of unconsolidated companies" in the
Consolidated Statements of Operations. (See Note 3 of the Consolidated Financial
Statements).
In addition, the consolidated results of Confidant, have been expensed as
development stage company due to its early phase of existence. No revenues have
been generated since its inception.
OTHER OPERATIONS
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FrontLine's Other Operations consist primarily of general and administrative
cost for compensation, office costs, and outside services such as legal,
accounting and travel related costs. As the number of FrontLine's employees grow
to support its operations and those of its Partner Company, its general and
administrative costs will increase. As a result of the increase in the number of
employees from 11 to 37 between June 30, 1999 and June 30, 2000 and the increase
in the acquisition of interests in Partner Companies, general and administrative
costs for the three and six months ended June 30, 2000 decreased by $1.7 million
and increased by $1.7 million, respectively, as compared to the same period in
1999. FrontLine plans to continue to build and enhance its overall
infrastructure. These costs are expected to continue to be higher compared to
historical periods. During the three and six months ended June 30, 2000, the
Company recorded amortization of compensation awards of approximately $3.9
million and $5.5 million, respectively, in connection with incentive stock
awards to management and $ 0.3 million and $1.0 million, respectively,
associated with new hire costs.
FrontLine's interest expense for the three and six months ended June 30, 2000
was approximately $3.4 million and $10.0 million, respectively, compared to
approximately $1.0 million and $1.8 million for the three and six months ended
June 30, 1999. The increase is due to an increase in the amounts borrowed under
the Company's existing credit facilities and the $60 million Secured Credit
Facility.
Included in Other Operations is FrontLine's ownership interest in RSVP Holdings,
LLC. For the three and six months ended June 30, 2000, FrontLine's share of RSVP
Holdings, LLC's loss was approximately $1.1 million and $1.4 million,
respectively.
LIQUIDITY AND CAPITAL RESOURCES
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 $122.1 million in cash and issued $47.1 million
of the Company's common stock to acquire interests in or make advances to new
and existing Partner Companies during the six months ended June 30, 2000. These
companies include: AdOutlet.com, EmployeeMatters, Inc., LiveCapital.com,
NeoCarta Ventures, Pipe 9 Corporation, RealtyIQ.com, UpShot.com and HQ Global.
The Company has a credit facility with Reckson in the amount of $100 million
("FrontLine Facility"). Additionally, Reckson Strategic Venture Partners, LLC
("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. The Company had approximately $92.7
million outstanding under the FrontLine Facility at June 30, 2000. Borrowings
were primarily used to fund acquisitions of ownership interests in Partner
Companies and general operations. Approximately $38.5 million was outstanding
under the Reckson Strategic Facility at June 30, 2000. These borrowings were
utilized to fund Reckson Strategic investments and general operations. At June
30, 2000, $36.2 million was available on these Facilities.
FrontLine's secured credit facility for $60.0 million was fully drawn and repaid
during the three months ended March 31, 2000, and is therefore no longer
available.
On June 1, 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 August 11, 2000, there was $242.5
million in outstanding borrowings under the term loans and $23.1 million in
borrowings outstanding under one revolver. At August 11, 2000, $7.5 million was
available for additional borrowings under the revolving loan commitments.
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
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month period at the election of HQ Global. HQ Global's weighted average interest
rate on borrowings under the term loans at June 30, 2000 was approximately
11.48%. HQ Global converted to a LIBOR option on July 5, 2000. HQ Global pays a
commitment fee of 1/2 of 1.0% per annum on the unused portion of the Credit
Facility. The Credit Facility contains certain financial covenants related to
interest coverage, leverage ratios and other limitations. At June 30, 2000, HQ
Global was in compliance with all of its covenants.
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 matures 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.
As of August 11, 2000, HQ Global had letters of credit outstanding in the
aggregate amount of $25.9 million, against which HQ Global pledged $5.5 million
in cash and $20.4 million were supported by a backstop letter of credit by
FrontLine.
The Company also funded investing activities for the six months ended June 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.
On March 7, 2000, an investment partnership invested $30.0 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 warrants 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.
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Subsequent to June 30, 2000, the Company funded an additional $7.5 million to
existing Partner Companies.
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 June 30, 2000.
FrontLine will continue to evaluate acquisition opportunities and may acquire
additional ownership interests in new and existing Partner Companies in the next
12 months, all of which could make it necessary for the Company to raise
additional funds. The Company may not be able to obtain additional bank or other
financing beyond this period, or may only be able to do so on terms not
favorable or acceptable to the Company. 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
access to the public and private markets, 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.
INFLATION
The Credit Facilities generally bear interest at variable rates. These rates
will be influenced by changes in the prime rate 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.
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ITEM 3. QUANTITIVE AND QUALITIVE DISCLOSURES ABOUT MARKET RISK
The primary market risk facing the Company is interest rate risk on its Credit
Facilities. 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 rate of interest on the
Credit Facilities will be influenced by changes in the prime rate 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 the Company's Credit Facilities obligations,
principal cash flows by scheduled maturity, weighted average interest rates and
estimated fair market value ("FMV") at June 30, 2000 (in thousands).
<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 $ -- $ -- $ -- $131,243 $ -- $ -- $131,243 $131,243
Average
interest rate -- -- -- 12.14% -- -- 12.14% --
</TABLE>
The primary market risk facing HQ Global is interest rate risk on the 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 August 11, 2000, HQ Global had hedged 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 4.8% increase in interest expense, ignoring the short
term impact of remaining terms under current LIBOR hedge contracts.
Following the HQ 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 June 30, 2000,
HQ Global had no other material exposure to market risk.
33
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities and Use of Proceeds
The following securities were issued in transactions pursuant to the exemption
from registration under Section 4(2) of the Securities Act of 1933 and involved
only accredited investors.
On April 14, 2000, the Company exchanged an aggregate of 26,000 shares of its 8
7/8% Series A-1 through A-6 Convertible Cumulative Preferred Stock for 26,000
shares of its 8 7/8% Series A Convertible Cumulative Preferred Stock. The sole
purpose of this transaction was to combine the six series of Preferred Stock
into a single series.
Dividends on the Series A Preferred Stock are payable quarterly in cash or, at
the Company's election, in common stock, provided certain conditions have been
satisfied. The Series A Preferred Stock is redeemable on or after the third
anniversary of the date of issuance and is convertible at any time, at the
option of the holder, on or after the one year anniversary of the date of
issuance. The Series A Preferred Stock is convertible at a conversion rate of
14.1884 shares of common stock for each share of Series A Preferred Stock,
subject to adjustment.
On March 7, 2000, an investment partnership invested $30.0 million to purchase
1.5 million warrants to acquire the Company's common stock at an exercise price
of $70 per share. The warrants have a term of 3.25 years. The Company utilized
approximately half of these proceeds to reduce its $60.0 million Secured Credit
Facility with a significant financial institution. 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 April 12, 2000, Winstar Communications, Inc. ("Winstar") acquired 63,492
shares of the Company's common stock in connection with a contract pursuant to
which the Company and its affiliates will have the right to purchase, license,
lease or otherwise acquire any products, equipment and/or services which are
offered by Winstar or its affiliates for three years from the date of the
contract. The products, equipment or services available include (i) software,
(ii) advertising on a Winstar affiliate portal or a Winstar affiliate web site
on which advertising is sold, (iii) content provided by a Winstar affiliate and
(iv) any product, equipment or service sold or offered by Winstar or an
affiliate on a non-exclusive basis to unaffiliated parties. In addition, Winstar
agreed to terminate its lawsuit against OnSite Access, Inc., a company in which
the Company has invested $46.0 million.
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Securities Holders - None
On June 22, 2000, the Company held its annual meeting of stockholders. The
matters on which the stockholders voted, in person or by proxy, were (1) the
election of three nominees as Class II Directors to serve until the 2003 annual
meeting of stockholders, or until their respective successors are duly elected
and qualified, (2) to ratify the selection of the independent auditors of the
Company and (3) to ratify the adoption of the Company's 2000 Employee Stock
Option Plan. The three nominees were elected, the auditors were ratified and the
2000 Employee Stock Option Plan was approved. The results of the voting are set
forth below: Election of Directors Votes Cast For Votes Cast Against
<TABLE>
<CAPTION>
ELECTION OF DIRECTORS VOTES CAST FOR VOTES CAST AGAINST
--------------------- -------------- ------------------
<S> <C> <C>
Michael Maturo 27,825,491 51,308
Mitchell Rechler 27,825,491 51,308
Roger Rechler 27,825,491 51,308
</TABLE>
<TABLE>
<CAPTION>
RATIFICATION OF AUDITORS
--------------------------------------------------------------------------
VOTES CAST FOR VOTES CAST AGAINST
------------------------- ---------------------
<S> <C>
27,843,805 12,653
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
APPROVAL OF 2000 EMPLOYEE STOCK OPTION PLAN
--------------------------------------------------------------------------
VOTES CAST FOR VOTES CAST AGAINST
------------------------- ---------------------
<S> <C>
14,143,909 2,646,212
</TABLE>
Item 5. Other information
On June 22, 2000 the resignations of two Directors, Donald Rechler and Gregg
Rechler, were accepted by the Board of Directors and Douglas A. Sgarro and
Sidney Braginsky were appointed as Directors Mr. Sgarro currently serves as
Senior Vice President - Administration and Chief Legal Officer of CVS
Corporation. Sidney Braginsky currently serves as President of Olympus America
Inc. Also on such date Scott Rechler was appointed Chairman of the Board.
Item 6. Exhibits and Reports on Form 8-K
Form 8K dated May 12, 2000 Relating to the extension of the closing
date of the merger with VANTAS
Incorporated and HQ Global
Workplaces, Inc.
Form 8K dated June 16, 2000 Relating to the Company's completion
of the merger of VANTAS Incorporated
with and into 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: August 14, 2000
36
