<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED JUNE 30, 1999
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER 000-25477
FLASHNET COMMUNICATIONS, INC.
(Exact name of registrant as specified in its charter)
TEXAS 75-2614852
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1812 N. FOREST PARK BLVD., FORT WORTH, TX 76102
(Address of principal executive offices) (Zip Code)
(817) 820-0068
(Registrant's telephone number, including area code)
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 ( ) No (X)
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at June 30, 1999
Common Stock, No Par Value 13,952,515
<PAGE>
FLASHNET COMMUNICATIONS, INC.
INDEX
<TABLE>
<CAPTION>
Page
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1.
CONSOLIDATED BALANCE SHEETS -
June 30, 1999 and December 31, 1998.............................. 3
CONSOLIDATED STATEMENTS OF OPERATIONS -
Three and six months ended June 30, 1999 and 1998................ 4
CONSOLIDATED STATEMENTS OF CASH FLOWS -
Six months ended June 30, 1999 and 1998.......................... 5
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS................ 6
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.............................. 7
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings.........................................N/A
ITEM 2. Changes in Securities and Use of Proceeds................. 14
ITEM 3. Defaults upon Senior Securities...........................N/A
ITEM 4. Submission of Matters to a Vote of Security Holders.......N/A
ITEM 5. Other Information.........................................N/A
ITEM 6. Exhibits and Reports on Form 8-K
(a). Exhibits............................................ 14
(b). Reports on Form 8-K.................................N/A
SIGNATURES........................................................... 15
</TABLE>
2
<PAGE>
FLASHNET COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------ ------------
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 38,835,000 $ 1,038,000
Accounts receivable, net 1,042,000 391,000
Prepaid expenses and other current assets 2,048,000 1,291,000
------------ ------------
Total current assets 41,925,000 2,720,000
PROPERTY AND EQUIPMENT, net 13,891,000 6,821,000
SOFTWARE LICENSES, net 134,000 6,000
OTHER ASSETS 231,000 186,000
------------ ------------
TOTAL $ 56,181,000 $ 9,733,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Current portion of capital lease obligations $ 2,593,000 $ 1,824,000
Current portion of convertible notes payable 65,000 186,000
Note payable - 4,834,000
Trade accounts payable 6,189,000 5,335,000
Accrued payroll and related expenses 897,000 535,000
Other accrued expenses 745,000 438,000
Deferred revenue 13,455,000 12,325,000
------------ ------------
Total current liabilities 23,944,000 25,477,000
CAPITAL LEASE OBLIGATIONS, net of current portion 2,607,000 52,000
------------ ------------
Total liabilities 26,551,000 25,529,000
REDEEMABLE SERIES A PREFERRED STOCK, $1.00 par value; 1,375,000 shares
authorized, none and 1,364,085
issued and outstanding, respectively - 7,911,000
SHAREHOLDERS' EQUITY (DEFICIT):
Common stock, no par value, 50,000,000 shares authorized,
13,952,515 and 5,528,868 issued and outstanding, respectively 67,989,000 3,444,000
Warrants to purchase common stock 3,592,000 3,704,000
Additional paid-in capital, stock options 1,909,000 -
Deferred compensation costs (1,618,000) -
Accumulated deficit (42,242,000) (30,855,000)
------------ ------------
Total shareholders' equity (deficit) 29,630,000 (23,707,000)
------------ ------------
TOTAL $ 56,181,000 $ 9,733,000
============ ============
</TABLE>
See Condensed Notes to Consolidated Financial Statements
3
<PAGE>
FLASHNET COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
------------------------------ -----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
REVENUES:
Consumer access services $ 7,395,000 $ 5,080,000 $ 14,545,000 $ 9,695,000
Business services 418,000 361,000 884,000 712,000
Set-up fees and other 1,719,000 791,000 2,192,000 1,710,000
------------ ------------ ------------ ------------
Total 9,532,000 6,232,000 17,621,000 12,117,000
------------ ------------ ------------ ------------
OPERATING COSTS AND EXPENSES:
Cost of recurring revenues 3,839,000 2,956,000 7,256,000 5,680,000
Cost of other revenues 836,000 88,000 955,000 186,000
Sales and marketing 5,777,000 1,800,000 8,330,000 2,799,000
General and administrative 2,159,000 1,223,000 4,120,000 2,132,000
Operations and customer support 2,253,000 1,326,000 4,234,000 2,361,000
Depreciation and amortization 1,190,000 764,000 2,079,000 1,512,000
------------ ------------ ------------ ------------
Total 16,054,000 8,157,000 26,974,000 14,670,000
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (6,522,000) (1,925,000) (9,353,000) (2,553,000)
INTEREST EXPENSE (252,000) (659,000) (964,000) (1,311,000)
INTEREST AND OTHER INCOME 589,000 12,000 633,000 21,000
------------ ------------ ------------ ------------
LOSS BEFORE EXTRAORDINARY ITEMS (6,185,000) (2,572,000) (9,684,000) (3,843,000)
EXTRAORDINARY ITEMS - LOSSES ON
EARLY EXTINGUISHMENT OF DEBT - - (1,656,000) -
------------ ------------ ------------ ------------
NET LOSS (6,185,000) (2,572,000) (11,340,000) (3,843,000)
ACCRETION ON REEMABLE
PREFERRED STOCK - - (48,000) -
------------ ------------ ------------ ------------
NET LOSS ATTRIBUTABLE TO COMMON
SHAREHOLDERS $ (6,185,000) $ (2,572,000) $(11,388,000) $ (3,843,000)
============ ============ ============ ============
NET LOSS PER SHARE,
BASIC AND DILUTED:
Loss before extraordinary items $ (0.45) $ (0.47) $ (0.93) $ (0.70)
Extraordinary items - - (0.16) -
------------ ------------ ------------ ------------
$ (0.45) $ (0.47) $ (1.09) $ (0.70)
============ ============ ============ ============
WEIGHTED AVERAGE SHARES,
BASIC AND DILUTED: 13,913,000 5,487,000 10,485,000 5,487,000
============ ============ ============ ============
</TABLE>
See Condensed Notes to Consolidated Financial Statements
4
<PAGE>
FLASHNET COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended June 30,
----------------------------
1999 1998
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss $(11,340,000) $ (3,843,000)
Adjustments to reconcile net loss to net cash provided (used) in
Operating activities:
Extraordinary losses 1,656,000 -
Depreciation 2,038,000 1,487,000
Amortization of debt discount 345,000 972,000
Amortization of software licenses 5,000 20,000
Amortization of prepaid expenses 36,000 4,000
Deferred compensation expense 191,000 -
Provision for allowance for uncollectible accounts 6,000 7,000
Changes in assets and liabilities:
(Increase) decrease in accounts receivable (657,000) 127,000
Increase in prepaid expenses and other current assets (845,000) (247,000)
Increase (decrease) in accounts payable and accrued liabilities 1,422,000 (2,275,000)
Increase in deferred revenue 1,130,000 199,000
------------ ------------
Net cash used in operating activities (6,013,000) (3,549,000)
------------ ------------
INVESTING ACTIVITIES:
Purchases of property and equipment, net (4,199,000) (380,000)
Purchases of software (224,000) -
------------ ------------
Net cash used in investing activities (4,423,000) (380,000)
------------ ------------
FINANCING ACTIVITIES:
Proceeds from initial public offering, net 56,337,000 -
Proceeds from issuance of note payable 5,000,000 -
Proceeds from issuance of preferred stock - 4,162,000
Principal payments under notes payable (11,500,000) -
Principal payments under capital lease obligations (1,604,000) (789,000)
------------ ------------
Net cash provided by financing activities 48,233,000 3,373,000
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 37,797,000 (556,000)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,038,000 1,570,000
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 38,835,000 $ 1,014,000
============ ============
SUPPLEMENTAL INFORMATION:
Cash paid for interest $ 620,000 $ 340,000
Equipment acquired under capital leases 4,908,000 -
Additional common stock issued upon conversion of debt 137,000 -
</TABLE>
See Condensed Notes to Consolidated Financial Statements
5
<PAGE>
FLASHNET COMMUNICATIONS, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
In the opinion of management of FlashNet Communications, Inc. ("FlashNet"
or the "Company"), the accompanying consolidated financial statements, which
have not been audited by independent public accountants, contain all adjustments
necessary to present fairly the Company's consolidated financial position, the
results of its operations and its cash flows for the periods reported. The
consolidated financial statements include the accounts of the Company and its
subsidiaries. All significant intercompany balances and transactions are
eliminated. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to Article 10 of Regulation
S-X of the Securities and Exchange Commission. These condensed financial
statements should be read in conjunction with the financial statements and notes
thereto included in the Company's Registration Statement on Form S-1 (File No.
333-69277) relating to the Company's initial public offering, which was declared
effective by the Securities and Exchange Commission on March 16, 1999. The
results of operations for the three and six months ended June 30, 1999 and 1998
are not necessarily indicative of the results to be expected for a full year.
2. ACCOUNTING ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those amounts.
3. STOCK OPTION GRANTS
During May 1999, the Company granted stock options to purchase 48,264
shares of Common Stock at prices ranging from $17.00 to $20.50 per share. The
options were granted under the Company's 1997 Stock Incentive Plan.
4. REVENUE RECOGNITION
Amounts received upon the sale or renewal of prepaid annual and monthly
subscriptions are recorded as deferred revenue through a 30-day money back
cancellation period and then amortized over the remaining period in which
service is provided. Annual subscribers canceling after the initial 30-day
period are treated as monthly subscribers. Such subscribers are refunded the
difference between their prepaid amounts and retroactive set-up fees and monthly
rates for the period of service. Distributor sign-up and renewal fees are also
recorded as deferred revenue and amortized over the life of the related
agreements. Revenue from the sale of merchandise and hardware, including the
associated non-refundable shipping fees, is recognized immediately upon the
shipment of the merchandise.
5. NET LOSS PER SHARE
Share and per share amounts have been adjusted retroactively for the
3.4-for-1 stock split which was approved in February 1999, and became effective
March 11, 1999. Basic loss per share is computed using the weighted average
number of common shares outstanding. Options, warrants and convertible
securities are not included in the computation of diluted loss per share as the
effects would be antidilutive.
6
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This report contains certain forward-looking statements with respect to the
Company's operations, industry, financial condition and liquidity. These
statements reflect management's best current assessment of a number of risks and
uncertainties. The Company's actual results could differ materially from the
results anticipated in these forward-looking statements as a result of certain
factors described in this report and other risks indicated in the Company's
other filings with the Securities and Exchange Commission.
OVERVIEW
FlashNet is a nationwide provider of consumer Internet access services and
business services. Founded in September 1995, the Company initially served as an
Internet access provider for consumers located primarily in the Dallas/Fort
Worth area. To provide Internet access throughout the southwestern United States
and selected central and northeastern states, the Company expanded its
operations during 1996 and 1997 through the installation of 182 Company-owned
points of presence ("POPs") where subscribers can access its services through a
local telephone call. These POPs are supported by a network operations center in
Fort Worth, Texas and 28 additional remote facilities where Company-owned
equipment has been deployed within third-party networking or data centers.
During 1998, the Company signed a national network access agreement with PSINet
that provides access to PSINet's POPs. This agreement, combined with the
Company's agreement with Level 3 Communications, has transformed FlashNet into a
national Internet service provider with 1,440 total POPs across 808 cities
throughout the United States. As of June 30, 1999, the Company had accumulated a
subscriber base of approximately 219,000 users, including approximately 3,100
customers for its business services.
In addition to access services as a national Internet service provider, the
Company offers a broad range of business services that enable businesses to
outsource their Internet and electronic commerce activities. The Company expects
that business services revenues will increase in future periods, particularly in
view of its strategy to increase the size of its corporate sales department and
expand its offerings of business services. The Company believes that attracting
additional business customers will result in a more stable, higher quality
customer base. The Company further believes that its business services enable it
to acquire new corporate customers more effectively and provide many
cross-selling opportunities.
REVENUES.
The Company's revenues generally are composed of:
- Consumer access services revenues;
- Business services revenues; and
- Set-up fees and other revenues.
Consumer access services revenues consist of annual prepaid and monthly
subscriptions for consumer dial-up access to the Internet. The Company offers
prepaid and monthly subscribers a full money-back guarantee upon cancellation of
their service if made within 30 days of initiating service. Amounts received
upon the sale or renewal of prepaid annual and monthly subscriptions are
recorded as deferred revenue through the 30-day money-back cancellation period
and then amortized over the remaining period in which service is provided.
Subscribers may cancel their subscriptions at any time following the initial
30-day period, in which case the Company charges the subscriber according to its
monthly service rates for services provided through the end of the month in
which the cancellation occurs plus an additional cancellation fee, and refunds
any remaining prepaid amounts after such charges. Cash received from subscribers
is applied to working capital when received, and no cash reserves are maintained
for potential refund obligations.
Business services consisting of dedicated access services also are offered
on a prepaid annual and monthly subscription basis. The revenue recognition
policies and customer guarantee practices described above for consumer access
services also apply to dedicated access business services. Revenues from the
sale of business services involve set-up fees, which are included in set-up fees
and other revenues in the consolidated statement of operations, and a service
contract that provides for monthly billing. These
7
<PAGE>
business services revenues are recognized as services are provided.
Set-up fees and other revenues are derived through a variety of sources,
including set-up fees for subscribers to the Company's consumer access
services and business services, sales of merchandise and hardware and
associated non-refundable shipping fees, sign-up and renewal fees for
independent representatives in the Company's network marketing program and
advertising revenues. Set-up fees are charged to all new customers of
consumer access and to business services customers. These one-time set-up
fees are non-refundable and are deferred and amortized over a one-year
period. Sales of merchandise and hardware and associated non-refundable
shipping fees are recognized as earned. Consulting services have been
provided from time to time on a limited basis by the Company on both a fixed
fee and a time-and-materials basis and are recognized as the services are
performed. Non-refundable fees are paid by representatives in the Company's
network marketing program at the commencement of participation in the program
and for renewal of participation on each anniversary of the representative's
commencement date. Such fees are deferred and amortized over a one-year
period following the month of initial sign-up or renewal, as the case may be.
Advertising revenues are recognized as advertising services are provided.
COSTS AND EXPENSES.
The Company's costs include (i) costs of revenue that are primarily related
to the number of subscribers; (ii) costs related to merchandise and hardware
sold and cost of material for the Company's network marketing program; (iii)
selling, customer support and general and administrative expenses that are
associated more generally with operations; and (iv) depreciation and
amortization, which are related to the size of the Company's network and capital
lease obligations.
Costs of revenue that are primarily related to the number of subscribers
are recurring costs. Cost of recurring revenues is comprised of the costs
incurred in providing consumer access services and business services. These
costs include costs for providing local telephone lines into each Company-owned
POP, the use of third-party networks and the use of leased lines to connect each
Company-owned POP and third-party POP to its hub and to connect its hub to the
Internet backbone.
Cost of other revenues consists of costs of installation software, premium
support costs, cost of merchandise and hardware sold, including associated
shipping and handling charges and the cost of user guides and other materials
for representatives and distributors involved in the Company's network marketing
program.
Selling, general and administrative costs are incurred in the areas of
sales and marketing, customer support, network operations and maintenance,
engineering, accounting and administration. Sales and marketing expenses consist
primarily of media and production costs, commissions and expenses related to the
Company's network marketing program, sales and marketing overhead, and personnel
costs. General and administrative expenses consist of personnel and related
costs associated with the Company's executive and administrative functions and
other miscellaneous expenses. Operations and customer support expenses consist
primarily of expenses associated with daily support of the Company's subscriber
base, including customer service and technical support. Selling, general and
administrative costs will increase over time as the Company's scope of
operations increases. However, the Company expects that such costs will be more
than offset by anticipated increases in revenue attributable to overall
subscriber growth. In addition, significant levels of marketing activity may be
necessary in order for the Company to build or increase its subscriber base in a
given market to a size large enough to generate sufficient revenue to offset
such marketing expenses. The Company may determine to significantly increase the
level of marketing activity in order to increase the rate of subscription
growth. Any such increase would have a short-term negative impact on earnings.
The Company does not defer any start-up expenses related to entering new
markets.
As the Company expands into new markets, both costs of revenue and selling,
general and administrative expenses will increase. To the extent the Company
opens FlashNet POPs in new markets, such expenses may also increase as a
percentage of revenue in the short-term after a new FlashNet POP is opened
because many of the fixed costs of providing service in a new market are
incurred before significant revenue can be expected from that market. However,
to the extent that the Company expands into new markets by using third-party
POPs instead of opening its own POPs, the Company's incremental monthly
recurring costs will consist primarily of the fees to be paid to third parties
pursuant to network service agreements. The margins on subscribers serviced by
using third party POPs will initially be lower than if the Company had developed
its own POPs in such new markets. Once a new market matures, costs of
8
<PAGE>
revenue as a percentage of revenue will tend to be higher in markets served
through utilization of purchased network services rather than Company-owned
POPs. Costs of utilizing purchased network services are generally higher
because all of these costs are included in costs of revenue, while a portion
of the costs of utilizing Company-owned POPs is included in depreciation and
amortization. Also, assuming favorable local area telecommunications charges,
the Company can provide services at a lower cost on its own POPs once a
sufficient subscriber base relative to such POPs is achieved.
The Company has experienced operating losses since its inception as a
result of efforts to build its network infrastructure and internal staffing,
develop its systems and expand into new markets. The Company expects to continue
to focus on increasing its subscriber base and geographic coverage. Accordingly,
the Company expects that its cost of revenues, sales and marketing expenses,
general and administrative expenses, operations expenses and capital
expenditures will continue to increase, all of which may have a negative impact
on short-term operating results.
9
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth the percentage of total revenues represented
by certain items on the Company's unaudited consolidated statements of
operations for the periods indicated. Operating results for any period are not
necessarily indicative of results for any future period. Dollar amounts are
shown in thousands.
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
------------------------------------------ -----------------------------------------
1999 1998 1999 1998
-------------------- ------------------ ------------------ --------------------
% of % of % of % of
(000's) Revenues (000's) Revenues (000's) Revenues (000's) Revenues
--------- -------- ------- -------- ------- -------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
REVENUES:
Consumer access services $ 7,395 78% $ 5,080 82% $ 14,545 83% $ 9,695 80%
Business services 418 4 361 5 884 5 712 6
Set-up fees and other 1,719 18 791 13 2,192 12 1,710 14
--------- -------- ------- -------- -------- -------- ------- --------
Total 9,532 100 6,232 100 17,621 100 12,117 100
--------- -------- ------- -------- -------- -------- ------- --------
OPERATING COSTS AND EXPENSES:
Cost of recurring revenues 3,839 40 2,956 48 7,256 41 5,680 47
Cost of other revenues 836 9 88 1 955 5 186 2
Sales and marketing 5,777 60 1,800 29 8,330 48 2,799 23
General and administrative 2,159 23 1,223 20 4,120 23 2,132 18
Operations and customer support 2,253 24 1,326 21 4,234 24 2,361 19
Depreciation and amortization 1,190 12 764 12 2,079 12 1,512 12
--------- -------- ------- -------- -------- -------- ------- --------
Total 16,054 168 8,157 131 26,974 153 14,670 121
--------- -------- ------- -------- -------- -------- ------- --------
LOSS FROM OPERATIONS (6,522) (68) (1,925) (31) (9,353) (53) (2,553) (21)
INTEREST EXPENSE (252) (3) (659) (10) (964) (6) (1,311) (11)
INTEREST AND OTHER INCOME 589 6 12 - 633 4 21 -
--------- -------- ------- -------- -------- -------- ------- --------
LOSS BEFORE EXTRAORDINARY
ITEMS (6,185) (65) (2,572) (41) (9,684) (55) (3,843) (32)
EXTRAORDINARY ITEMS - LOSSES
ON EARLY EXTINGUISHMENT
OF DEBT - - - - (1,656) (9) - -
--------- -------- ------- -------- -------- -------- ------- --------
NET LOSS (6,185) (65) (2,572) (41) (11,340) (64) (3,843) (32)
ACCRETION ON REDEEMABLE
PREFERRED STOCK - - - - (48) - - -
--------- -------- ------- -------- -------- -------- ------- --------
NET LOSS ATTRIBUTABLE TO
COMMON SHAREHOLDERS $ (6,185) (65)% $(2,572) (41)% $(11,388) (64)% $(3,843) (32)%
========= ======== ======= ======== ======== ======== ======= ========
</TABLE>
10
<PAGE>
REVENUES.
The Company experienced substantial growth in revenues for the three and
six-month periods ended June 30, 1999 as compared to the corresponding periods
of 1998. Total revenues increased 53% to $9.5 million from $6.2 million during
the three months ended June 30, 1999 and 1998, respectively, and 45% to $17.6
million from $12.1 million during the six months ended June 30, 1999 and 1998,
respectively.
As reflected by the increase in consumer access services revenues,
subscriptions and renewals increased 44% to $7.8 million from $5.4 million
during the three months ended June 30, 1999 and 1998, respectively, and 48% to
$15.4 million from $10.4 million during the six months ended June 30, 1999 and
1998, respectively. The increase in access service revenues was primarily due to
an increase in the Company's subscriber base of 38% to 220,000 at June 30, 1999
from 160,000 at June 30, 1998.
Subscriber set-up fees and other revenues increased 117% to $1.7 million
from $0.8 million during the three months ended June 30, 1999 and 1998,
respectively, and 28% to $2.2 million from $1.7 million during the six months
ended June 30, 1999 and 1998, respectively. The increase was primarily the
result of the reintroduction of set-up fees on all products in March 1999 and
non-refundable shipping revenues. In the fourth quarter of 1997, the Company
eliminated set-up fees applicable to annual prepaid consumer accounts in
connection with a price increase for all consumer access and business access
services. Under the Company's revenue recognition policy noted above, set-up
fees are deferred and recognized over the twelve-month period following their
receipt.
COST OF RECURRING REVENUES.
Cost of recurring revenues increased 30% to $3.8 million from $3.0 million
during the three months ended June 30, 1999 and 1998, respectively, and 28% to
$7.3 million from $5.7 million during the six months ended June 30, 1999 and
1998, respectively, primarily due to an increase in dial tone costs associated
with a higher level of subscribers on the Company's network. Cost of recurring
revenues as a percentage of total revenues decreased to 40% from 48% during the
three months ended June 30, 1999 and 1998, respectively, and to 41% from 47%
during the six months ended June 30, 1999 and 1998, respectively, primarily due
to the increases in total revenues and also as a result of greater network
efficiencies.
COST OF OTHER REVENUES.
Cost of other revenues increased to $0.8 million from $0.1 million during
the three months ended June 30, 1999 and 1998, respectively, and to $1.0 million
from $0.2 million during the six months ended June 30, 1999 and 1998,
respectively. Cost of other revenues as a percentage of total revenues increased
to 9% from 1% during the three months ended June 30, 1999 and 1998,
respectively, and to 5% from 2% during the six months ended June 30, 1999 and
1998, respectively. The increases were due primarily to costs of hardware
related to the Company's "Upgrade Your Modem" promotion and shipping expense
related to the Company's "Free PC" promotion of $284,000 and $235,000,
respectively. These promotions were initiated during the second quarter of 1999.
SALES AND MARKETING EXPENSES.
Sales and marketing expenses increased 221% to $5.8 million from $1.8
million during the three months ended June 30, 1999 and 1998, respectively, and
198% to $8.3 million from $2.8 million during the six months ended June 30, 1999
and 1998, respectively. Sales and marketing expenses as a percentage of total
revenues increased to 60% from 29% during the three months ended June 30, 1999
and 1998, respectively, and to 48% from 23% during the six months ended June 30,
1999 and 1998, respectively. The increases, both in absolute dollars and as a
percentage of total revenues, were primarily due to increased television
advertising, direct marketing in non-core markets, increased expenses associated
with our network marketing program and increased marketing personnel headcount.
The Company suspended much of its advertising efforts in 1998 to conserve cash
resources.
GENERAL AND ADMINISTRATIVE EXPENSES.
General and administrative expenses increased 77% to $2.2 million from $1.2
million during the three months ended June 30, 1999 and 1998, respectively, and
93% to $4.1 million from $2.1 million during the
11
<PAGE>
six months ended June 30, 1999 and 1998, respectively. General and
administrative expenses as a percentage of total revenues increased to 23%
from 20% during the three months ended June 30, 1999 and 1998, respectively,
and to 23% from 18% during the six months ended June 30, 1999 and 1998,
respectively. The increases were primarily due to increases in payroll,
credit card fees and spending on facilities and supplies. The rise in payroll
costs was primarily due to growth in headcount. The increase in credit card
processing fees was due to the increase in the Company's subscriber base. In
addition, the Company recognized deferred compensation expense of $0.2
million during the six months ended June 30, 1999, related to stock options
granted in January 1999.
OPERATIONS AND CUSTOMER SUPPORT EXPENSES.
Operations and customer support expenses increased 70% to $2.3 million from
$1.3 million during the three months ended June 30, 1999 and 1998, respectively,
and 79% to $4.2 million from $2.4 million during the six months ended June 30,
1999 and 1998, respectively. Operations and customer support expenses as a
percentage of total revenues increased to 24% from 21% during the three months
ended June 30, 1999 and 1998, respectively, and to 24% from 19% during the six
months ended June 30, 1999 and 1998, respectively. The increases were primarily
due to the addition of new customer care and technical personnel to support a
larger subscriber base.
DEPRECIATION AND AMORTIZATION.
Depreciation and amortization expense increased 56% to $1.2 million from
$0.8 million during the three months ended June 30, 1999 and 1998, respectively,
and 38% to $2.1 million from $1.5 million during the six months ended June 30,
1999 and 1998, respectively. The increase primarily resulted from additional
purchases of capital equipment and software and equipment acquired under capital
leases needed to support the Company's expanding network. Depreciation and
amortization expense as a percentage of total revenues remained constant at 12%
for all periods reported.
INTEREST EXPENSE
Interest expense decreased 62% to $0.3 million from $0.7 million during the
three months ended June 30, 1999 and 1998, respectively, and 26% to $1.0 million
from $1.3 million during the six months ended June 30, 1999 and 1998,
respectively. Interest expense as a percentage of total revenues decreased to 3%
from 10% during the three months ended June 30, 1999 and 1998, respectively, and
to 6% from 11% during the six months ended June 30, 1999 and 1998, respectively.
During March 1999, the Company repaid the $6.5 million Secured Promissory Note
payable to Ascend Communications, Inc. (the "Ascend Note") and the $5.0 million
term loan agreement with Goldman Sachs Credit Partners L. P. ("Goldman Sachs").
As a result of the repayments, debt discount amortization on the Ascend Note
decreased $0.3 million and interest on the Goldman Sachs term loan decreased
$0.1 million during the quarter ended June 30, 1999.
INTEREST INCOME
Interest income as a percentage of total revenues increased to 6% from nil
during the three months ended June 30, 1999 and 1998, respectively, and to 4%
from nil during the six months ended June 30, 1999 and 1998, respectively. The
increase is due to interest earned on the net proceeds from the Company's
initial public offering ("IPO") effected March 16, 1999, which the Company has
used for the purchase of temporary investments consisting of cash, cash
equivalents, and short-term investments with original maturity dates of three
months or less at date of purchase.
EXTRAORDINARY LOSSES.
The extraordinary losses on early extinguishment of debt are related to the
write-off of unamortized debt discount costs of $1.4 million related to the
repayment of the $6.5 million Ascend Note and $0.3 million of unamortized debt
discount and other costs related to the repayment of the Goldman Sachs term
loan.
12
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The capital needs of the Company have historically been met, in large part,
by receipts from its prepaid subscriber customer base, which, in turn, increased
its deferred revenue liability. Commencing in 1996, as the Company placed
greater emphasis on developing and expanding its network infrastructure, it
sought additional capital from other sources, including vendor capital leases
and other vendor financing arrangements and through private placements of its
securities. The Company's IPO, completed in March 1999, provided the Company
with additional capital of $56.3 million.
The Company's operating activities used net cash of approximately $5.1
million and $6.0 million during the three and six-month periods ended June 30,
1999, respectively. During the three months ended June 30, 1999, net cash used
in operations resulted primarily from net losses, adjusted for the extraordinary
losses, depreciation and amortization expense and the increase in deferred
revenue.
Cash used by investing activities has consisted primarily of equipment
purchases for POP and network expansion. For the three and six-month periods
ended June 30, 1999, capital expenditures amounted to approximately $1.2 million
and $4.4 million, respectively. In addition, the Company spent approximately
$2.7 million and $4.9 million during the three and six-month periods ended June
30, 1999, respectively, for equipment acquired under capital leases.
Cash used in and provided by financing activities was approximately $0.7
million and $48.2 million during the three and six-month periods ended June 30,
1999, respectively. During January 1999, the Company received proceeds of $5.0
million from the Goldman Sachs term loan. During March 1999, the Company
effected its IPO. Net proceeds to the Company were approximately $56.3 million.
Cash used for financing activities included $6.5 million and $5.0 million for
the repayment of the Ascend Note and the Goldman Sachs term loan, respectively,
during March 1999. Principal payments under capital lease obligations were $1.6
million for the six months ended June 30, 1999.
As of June 30, 1999, the Company had cash and cash equivalents on hand of
approximately $38.8 million. The Company estimates that its cash and financing
needs for the next twelve months, assuming reasonable internal growth, can be
met by cash on hand and cash flow from operations. The Company's future capital
requirements depend on several factors, including the rate of market acceptance
of the Company's services, the Company's ability to maintain and expand its
subscriber base, the rate of expansion of the Company's network infrastructure,
the level of resources required to expand the Company's marketing and sales
efforts, the availability of hardware and software provided by third-party
vendors and other factors. If capital requirements vary materially from those
currently planned, the Company may require additional financing. The Company has
no commitments for any additional financing, and there can be no assurance that
any such commitments can be obtained on favorable terms, if at all. Any
additional equity financing may be dilutive to the Company's stockholders. Debt
financing, if available, may involve restrictive covenants with respect to
dividends, raising future capital and other financial and operational matters
and may otherwise limit the Company's ability to raise additional capital.
The Company frequently evaluates potential business acquisitions. Depending
on the circumstances, the Company may not disclose a material acquisition until
completion of a definitive agreement. The Company may determine to raise
additional debt or equity capital to finance potential acquisitions and/or to
fund accelerated growth. Any significant acquisitions or increases in the
Company's growth rate could materially affect the Company's operating and
financial expectations and results, liquidity and capital resources.
YEAR 2000
The Company recognizes the need to ensure that the provisioning of access
services and business services, as well as its internal systems, will not be
adversely affected by Year 2000 software failures. The Company currently does
not believe that the Year 2000 issue will have a material effect on its internal
network, computer systems or operations. However, the Company is continuing to
assess the potential impact of the Year 2000 issue. In particular, the Company
has established procedures for evaluating and managing the risks and costs
associated with this problem. The Company's plan to resolve Year 2000 issues
involves four phases: assessment, remediation, testing and implementation. The
Company has completed its assessment of all material information technology
systems, and based on this assessment, it currently expects that its computer
systems will be Year 2000 compliant by September 1999. However,
13
<PAGE>
notwithstanding its assessment, the Company may experience degradation in the
performance of its network or other systems, or complete system failure if
its expectations are not realized or it encounters unforeseen difficulties.
Any performance degradation or system failure, whether of the Company's
internal systems or of the systems of its customers, likely would have a
material adverse effect on its business, financial condition and results of
operations.
The Company's customers maintain their Internet operations on commercially
available operating systems, which may be impacted by Year 2000 complications.
In addition, the Company relies on telecommunications providers and third-party
vendors for certain equipment and software included within its services that may
not be Year 2000 compliant. The Company has completed an audit of its
telecommunications providers and third-party suppliers as to the Year 2000
compliance of their systems. To date, the Company has verbally contacted all of
its major telecommunications, information systems and software vendors
concerning their Year 2000 compliance and has obtained written responses from
most of them as of July 31, 1999 indicating that they will be Year 2000
compliant prior to December 1999. The Company has not obtained legally binding
representations from any of these third-party vendors with respect to their Year
2000 compliance. Communications to date from such third parties indicate that
these third parties expect, at this time, to be compliant by the Year 2000 based
on their progress to date. However, the inability of a substantial number of
third parties to complete their Year 2000 resolution process on a timely basis
and in a manner compatible with the Company's systems could materially and
adversely affect the operation of its internal systems or its ability to provide
consumer access services and business services.
The total cost of completing the Company's Year 2000 plan is estimated to
be less than $1.0 million and is being expensed as incurred and funded through
operating cash flows. The Company expects that its expenses in 1999 related to
all phases of its Year 2000 project will not be material. The Company has not
established contingency plans in case of failure of its information technology
systems since it currently expects that such systems will be Year 2000 compliant
by fall 1999. In connection with its assessment of third-party readiness and
operating equipment, in the third quarter of 1999 the Company plans to evaluate
the necessity of contingency plans based on the level of uncertainty regarding
third-party compliance. In the event its telecommunications providers or
third-party suppliers do not expect to be Year 2000 compliant, the Company's
contingency plans may include replacing such third parties or performing the
particular services provided by such parties itself.
The Company's Year 2000 plans are based on management's best estimates,
which were derived utilizing numerous assumptions of future events, including
the continued availability of certain resources and other factors. Estimates on
the status of completion and the expected completion dates are based on progress
to date compared to the timetable established by the Company's Year 2000
committee. The Company has not employed the services of independent contractors
to verify its assessment and estimates related to the Year 2000 problem. There
can be no guarantee that these estimates will be achieved and actual results
could differ materially from these plans. Specific factors that might cause such
material differences include, but are not limited to, the availability and cost
of personnel trained in this area, the ability to locate and correct all
relevant computer codes and similar uncertainties.
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company's registration statement on Form S-1 (Registration No.
333-69277) under the Securities Act of 1933, as amended, for its initial public
offering (the "Offering") became effective on March 16, 1999. Offering proceeds,
net of aggregate expenses to the Company of approximately $1.2 million, were
approximately $56.3 million. The Company has used the net offering proceeds for
the purchase of temporary investments consisting of cash, cash equivalents, and
short-term investments. The Company also repaid notes payable totaling $11.5
million.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a). Exhibits
27.1 Financial Data Schedule
(b). Reports on Form 8-K
None.
14
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FLASHNET COMMUNICATIONS, INC.
(Registrant)
Date: August 3, 1999 /s/ ANDREW N. JENT
---------------------- ----------------------------------
Andrew N. Jent
Executive Vice President and
Chief Financial Officer
15
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THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
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