<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 MARCH 31, 1999
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE 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 April 30, 1999
Common Stock, No Par Value 13,877,005
<PAGE>
FLASHNET COMMUNICATIONS, INC.
INDEX
<TABLE>
<CAPTION>
Page
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1.
CONSOLIDATED BALANCE SHEETS -
March 31, 1999 and December 31, 1998.......................................................3
CONSOLIDATED STATEMENTS OF OPERATIONS -
Three months ended March 31, 1999 and 1998.................................................4
CONSOLIDATED STATEMENTS OF CASH FLOWS -
Three months ended March 31, 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........................................................8
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.................................14
ITEM 5. Other Information..................................................................N/A
ITEM 6. Exhibits and Reports on Form 8-K
(a). Exhibits......................................................................15
(b). Reports on Form 8-K..........................................................N/A
SIGNATURES.....................................................................................16
</TABLE>
2
<PAGE>
FLASHNET COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
------------ ------------
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 45,802,000 $ 1,038,000
Accounts receivable, net 173,000 391,000
Prepaid expenses and other current assets 1,074,000 1,291,000
------------ ------------
Total current assets 47,049,000 2,720,000
PROPERTY AND EQUIPMENT, net 11,304,000 6,821,000
SOFTWARE LICENSES, net 2,000 6,000
OTHER ASSETS 241,000 186,000
------------ ------------
TOTAL $ 58,596,000 9,733,000
------------ ------------
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Current portion of capital lease obligations $ 2,517,000 $ 1,824,000
Current portion of convertible notes payable 154,000 186,000
Note payable - 4,834,000
Trade accounts payable 5,574,000 5,335,000
Accrued payroll and related expenses 948,000 535,000
Other accrued expenses 547,000 438,000
Deferred revenue 12,564,000 12,325,000
------------ ------------
Total current liabilities 22,304,000 25,477,000
CAPITAL LEASE OBLIGATIONS, net of current portion 669,000 52,000
------------ ------------
Total liabilities 22,973,000 25,529,000
REDEEMABLE SERIES A PREFERRED STOCK, $1.00 par
value; 1,375,000 sharesauthorized, 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,
13,844,389 and 5,528,868 issued and outstanding, respectively 67,818,000 3,444,000
Warrants to purchase common stock 3,666,000 3,704,000
Additional paid-in capital, stock options 1,909,000 -
Deferred compensation costs (1,713,000) -
Accumulated deficit (36,057,000) (30,855,000)
------------ ------------
Total shareholders' equity (deficit) 35,623,000 (23,707,000)
------------ ------------
TOTAL $ 58,596,000 $ 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 March 31,
----------------------------------
1999 1998
----------- -----------
<S> <C> <C>
REVENUES:
Consumer access services $ 7,150,000 $ 4,615,000
Business services 466,000 351,000
Set-up fees and other 473,000 919,000
----------- -----------
Total 8,089,000 5,885,000
----------- -----------
OPERATING COSTS AND EXPENSES:
Cost of recurring revenues 3,417,000 2,724,000
Cost of other revenues 119,000 98,000
Sales and marketing 2,553,000 998,000
General and administrative 1,961,000 908,000
Operations and customer support 1,981,000 1,035,000
Depreciation and amortization 889,000 748,000
----------- -----------
Total 10,920,000 6,511,000
----------- -----------
LOSS FROM OPERATIONS (2,831,000) (626,000)
INTEREST EXPENSE (712,000) (652,000)
INTEREST AND OTHER INCOME 44,000 9,000
----------- -----------
LOSS BEFORE EXTRAORDINARY ITEMS (3,499,000) (1,269,000)
EXTRAORDINARY ITEMS - LOSSES ON
EARLY EXTINGUISHMENT OF DEBT (1,656,000) -
----------- -----------
NET LOSS (5,155,000) (1,269,000)
ACCRETION ON REDEEMABLE PREFERRED STOCK (48,000) -
----------- -----------
NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS $(5,203,000) $(1,269,000)
----------- -----------
----------- -----------
NET LOSS PER SHARE, BASIC AND DILUTED:
Loss before extraordinary items $ (0.50) $ (0.23)
Extraordinary items (0.24) -
Accretion on redeemable preferred stock (0.01) -
----------- -----------
$ (0.75) $ (0.23)
----------- -----------
----------- -----------
WEIGHTED AVERAGE SHARES, BASIC AND DILUTED 7,018,000 5,500,000
----------- -----------
----------- -----------
</TABLE>
See Condensed Notes to Consolidated Financial Statements
4
<PAGE>
FLASHNET COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended March 31,
-----------------------------------
1999 1998
------------ -----------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss $ (5,155,000) $(1,269,000)
Adjustments to reconcile net loss to net cash provided (used) in
operating activities:
Extraordinary losses 1,656,000 -
Depreciation 878,000 738,000
Amortization of debt discount 329,000 486,000
Amortization of software licenses 5,000 8,000
Amortization of organizational costs 6,000 2,000
Deferred compensation expense 95,000 -
Provision for allowance for uncollectible accounts (44,000) 4,000
Changes in assets and liabilities:
Decrease in accounts receivable 262,000 92,000
(Increase) decrease in prepaid expenses and other current assets 135,000 (146,000)
Increase (decrease) in accounts payable and accrued liabilities 660,000 (1,128,000)
Increase in deferred revenue 239,000 176,000
------------ -----------
Net cash provided (used) by operating activities (934,000) (1,037,000)
INVESTING ACTIVITIES:
Purchases of property and equipment, net (3,158,000) (132,000)
Purchases of software (84,000) -
------------ -----------
Net cash used in investing activities (3,242,000) (132,000)
------------ -----------
FINANCING ACTIVITIES:
Proceeds from initial public offering, net 56,337,000 -
Proceeds from issuance of note payable 5,000,000 -
Principal payments under notes payable (11,500,000) -
Principal payments under capital lease obligations (897,000) (361,000)
------------ -----------
Net cash provided (used) by financing activities 48,940,000 (361,000)
------------ -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 44,764,000 (1,530,000)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,038,000 1,570,000
------------ -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 45,802,000 $ 40,000
------------ -----------
------------ -----------
SUPPLEMENTAL INFORMATION:
Cash paid for interest $ 384,000 $ 49,000
Equipment acquired under capital leases 2,197,000 -
Additional common stock issued upon conversion of debt 40,000 -
</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 months ended March 31, 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
On January 15, 1999, the Company granted stock options to purchase 150,943
and 15,890 shares of Common Stock at $5.88 and $8.82 per share, respectively.
On March 16, 1999, the Company granted stock options to purchase 220,185
shares of Common Stock at $17.00 per share. The options were granted under
the Company's 1997 Stock Incentive Plan (the "Plan"). On March 26, 1999, the
Company granted additional stock options to purchase 10,000 shares of Common
Stock at $30.00 per share. During February 1999, the Company's Board of
Directors and shareholders approved a change in the number of authorized
shares of common stock to 50,000,000, and increased the number of shares
authorized and reserved under the Plan to 1,327,230 shares.
4. GOLDMAN SACHS TERM LOAN AGREEMENT
During January 1999, the Company entered into a $5.0 million term loan
agreement with Goldman Sachs Credit Partners L. P. ("Goldman Sachs"). The
term loan's stated maturity was January 15, 2000. It bore interest at 13%,
was subject to a repayment fee of 1.13% to 4.50% of the repaid principal and
was secured by a second lien on the Company's assets. As part of this
financing, a Goldman Sachs affiliate obtained the right to acquire within
180 days of the consummation of an initial public offering up to $5.0 million
of the Company's common stock at the initial public offering price. This
right was assigned a value of $0.1 million and was netted against the loan
amount. The term loan plus accrued interest of $0.1 million was repaid in
March 1999 (see "LIQUIDITY AND CAPITAL RESOURCES").
5. INITIAL PUBLIC OFFERING
On March 16, 1999 the Company effected its initial public offering
("IPO"). The IPO consisted of 3,000,000 shares of Common Stock issued at
$17.00 per share. Concurrently with the IPO, the Company sold an additional
175,000 shares of Common Stock to SBC Communications Inc. at $17.00 per
share. Net proceeds to the Company were approximately $49.2 million. Upon
consummation of the IPO, 1,364,085 shares of the Company's Redeemable Series
A Preferred Stock were automatically converted to 4,637,889 shares of Common
Stock. On March 29, 1999 the Underwriter exercised its over-allotment option
and
6
<PAGE>
purchased 450,000 shares of the Company's Common Stock at the IPO price of
$17.00 per share. Net proceeds to the Company from this exercise were
approximately $7.1 million.
6. 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.
7. 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.
7
<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 637 total POPs across 476 cities throughout the United States.
As of March 31, 1999, the Company had accumulated a subscriber base of
approximately 190,000 users, including approximately 3,000 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, to a
lesser extent, 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 set-up 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 other business services typically involve set-up
fees, which are included in set-up fees and other
8
<PAGE>
revenues in the consolidated statement of operations, and a service contract
that provides for monthly billing. These 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, consulting services, sign-up and renewal fees
for independent representatives in the Company's network marketing program
and advertising revenues. Set-up fees are charged to new customers of monthly
consumer access and to business services customers, other than prepaid annual
dedicated access customers. These one-time set-up fees are non-refundable and
are deferred and amortized over a one-year period. 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 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 sold 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
9
<PAGE>
the Company had developed its own POPs in such new markets. Once a new market
matures, costs of 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.
RESULTS OF OPERATIONS
The following table sets forth certain unaudited financial data for the
quarters ended March 31, 1999 and 1998. 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 Three Months Ended
March 31, 1999 March 31, 1998
----------------------------- -----------------------------
% of % of
(000's) Revenues (000's) Revenues
------- -------- ------- --------
<S> <C> <C> <C> <C>
REVENUES:
Consumer access services $ 7,150 88% $ 4,615 78%
Business services 466 6 351 6
Set-up fees and other 473 6 919 16
------- -------- ------- --------
Total 8,089 100 5,885 100
------- -------- ------- --------
OPERATING COSTS AND EXPENSES:
Cost of recurring revenues 3,417 42 2,724 46
Cost of other revenues 119 1 98 2
Sales and marketing 2,553 32 998 17
General and administrative 1,961 24 908 15
Operations and customer support 1,981 25 1,035 18
Depreciation and amortization 889 11 748 13
------- -------- ------- --------
Total 10,920 135 6,511 111
------- -------- ------- --------
LOSS FROM OPERATIONS (2,831) (35) (626) (11)
INTEREST EXPENSE (712) (9) (652) (11)
INTEREST AND OTHER INCOME 44 1 9 -
------- -------- ------- --------
LOSS BEFORE EXTRAORDINARY ITEMS (3,499) (43) (1,269) (22)
EXTRAORDINARY ITEMS - LOSSES ON EARLY
EXTINGUISHMENT OF DEBT (1,656) (20) - -
------- -------- ------- --------
NET LOSS (5,155) (63) (1,269) (22)
ACCRETION ON REDEEMABLE
PREFERRED STOCK (48) (1) - -
------- -------- ------- --------
NET LOSS ATTRIBUTABLE TO
COMMON SHAREHOLDERS $(5,203) (64)% $(1,269) (22)%
------- -------- ------- --------
------- -------- ------- --------
</TABLE>
10
<PAGE>
QUARTER ENDED MARCH 31, 1999 COMPARED TO QUARTER ENDED MARCH 31, 1998
REVENUES.
Total revenues increased $2.2 million, or 37%, to $8.1 million in 1999
from $5.9 million in 1998. Subscriptions and renewals increased $2.7 million,
as reflected by the increase in consumer access services revenues. These
increases were partially offset by a decrease of $0.5 million in subscriber
set-up fees and other 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. However, as a result of the Company's revenue recognition policy
noted above, set-up fees related to 1997 were deferred and recognized over
the twelve-month period following their receipt. The number of subscribers
who use the Company's services increased from approximately 160,000 at
March 31, 1998 to 190,000 at March 31, 1999. Consumer access services
revenues increased 55% in 1999 over 1998, primarily as a result of the
increase in the Company's subscriber base. Business services revenues
increased 33% in 1999 from 1998 as the Company expanded its offerings of
dedicated and broadband access and other business services in response to
escalating customer demand.
COST OF RECURRING REVENUES.
Cost of recurring revenues increased $0.7 million, or 25%, to $3.4 million
in 1999 from $2.7 million in 1998. Of this increase, $0.5 million was
attributable to an increase in dial tone costs associated with a higher level
of subscribers on the Company's network. As a percentage of total revenues,
cost of recurring revenues decreased to 42% in 1999 from 46% in 1998
primarily due to the increases in total revenues and also as a result of
greater network efficiencies.
SALES AND MARKETING EXPENSES.
Sales and marketing expenses increased $1.6 million, or 156%, to
$2.6 million in 1999 from $1.0 million in 1998. As a percentage of total
revenues, sales and marketing expenses increased to 32% in 1999 from 17% in
1998. This increase, both in absolute dollars and as a percentage of total
revenues, was attributable to a $0.7 million increase in media expenses, a
$0.5 million increase in personnel costs and a $0.4 million increase in
expenses associated with our network marketing program. The Company suspended
much of its advertising efforts in 1998 to conserve cash resources.
GENERAL AND ADMINISTRATIVE EXPENSES.
General and administrative expenses increased $1.1 million, or 116%, to
$2.0 million in 1999 from $0.9 million in 1998. General and administrative
expenses increased primarily due to an increase in the number of staff
members, an increase in credit card processing fees and increased spending on
facilities and supplies. In addition, the Company recognized deferred
compensation expense of $0.1 million during 1999 related to stock options
granted in January 1999. As a percentage of total revenues, general and
administrative expenses increased to 24% in 1999 from 15% in 1998.
OPERATIONS AND CUSTOMER SUPPORT EXPENSES.
Operations and customer support expenses increased $1.0 million, or 91%,
to $2.0 million in 1999 from $1.0 million in 1998. As a percentage of total
revenues, operations and customer support expenses increased to 25% in 1999
from 18% in 1997. These 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 $0.1 million, or 19%, to
$0.9 million in 1999 from $0.8 million in 1998. This increase primarily
resulted from additional purchases of capital equipment and software that
were needed to support the Company's expanding network. As a percentage of
total revenues, depreciation and amortization expense decreased 11% in 1999
from 13% in 1998.
11
<PAGE>
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 a $6.5 million Secured Promissory Note payable to Ascend
Communications, Inc. (the "Ascend Note"), and $0.3 million of unamortized
debt discount and other costs related to the repayment of the Goldman Sachs
term loan.
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
$0.9 million and $1.0 million during the quarters ended March 31, 1999 and
1998, respectively. During the quarter ended March 31, 1999, net cash used in
operations resulted primarily from net losses, adjusted for the extraordinary
losses, depreciation and amortization expense and increases in trade accounts
payable. During the quarter ended March 31, 1998, net cash used in operations
resulted from net losses.
Cash used by investing activities has consisted primarily of equipment
purchases for POP and network expansion. For the quarters ended March 31,
1999 and 1998, capital expenditures amounted to approximately $3.2 million
and $0.1 million, respectively. In addition, the Company spent approximately
$2.2 million for equipment acquired under capital leases in 1999.
Cash from financing activities provided the Company with approximately
$48.9 million during the quarter ended March 31, 1999, compared to cash used
by financing activities of $0.4 million during the quarter ended March 31,
1998. 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.
The offering consisted of 3,175,000 shares of common stock issued at $17 per
share. Net proceeds to the Company were approximately $49.2 million. On
March 29, 1999, the Underwriters exercised their over-allotment option and
purchased 450,000 shares at the IPO price of $17.00. Net proceeds to the
Company were approximately $7.1 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, plus $0.9 million for
principal payments under capital lease obligations.
As of March 31, 1999, the Company had cash and cash equivalents on hand
of approximately $45.8 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.
12
<PAGE>
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
July 1999. However, 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 is in
the final stages of conducting an audit of its telecommunications providers
and third-party suppliers as to the Year 2000 compliance of their systems,
and plans to complete this audit in the second quarter of 1999. To date, the
Company has verbally contacted all of its major telecommunications,
information systems and software vendors concerning their Year 2000
compliance and plans to obtain written responses from them prior to 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 mid-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.
13
<PAGE>
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. The
managing underwriters of the offering were BancBoston Robertson Stephens,
J.C. Bradford & Co. and EVEREN Securities, Inc. (the "Underwriters"). All
3,175,000 shares of Common Stock registered under the Registration Statement
were sold at a price of $17.00 per share. The Underwriters also exercised an
over-allotment option of 450,000 shares on March 29, 1999. All 450,000
over-allotment shares were sold at a price of $17.00 per share. The aggregate
price of the offering amount registered and sold was approximately
$61.6 million. In connection with the Offering, the Company paid
approximately $4.1 million in underwriting discounts and commissions to the
Underwriters. Offering proceeds, net of aggregate expenses to the Company of
approximately $1.2 million, were approximately $56.3 million. As of March 31,
1999, 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 repaid notes payable totaling $11.5 million. The
Company will also use the proceeds for the expansion of its sales and
marketing operations, for enhancements to its network infrastructure and to
develop further its business service offerings. The balance of the proceeds
will be used for working capital, general corporate purposes and potential
acquisitions. None of the Company's net proceeds of the Offering were paid
directly or indirectly to any director, officer of the Company or their
associates, persons owning 10% or more of any class of equity securities of
the Company, or an affiliate of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On February 22, 1999, the Company held its 1999 annual meeting of
shareholders. The number of shares outstanding on the record date of the
meeting and the number of shares represented in person or by proxy at the
meeting, were as follows:
<TABLE>
<CAPTION>
Class of Stock Number of Shares Outstanding Number of Shares Present
- -------------- ---------------------------- ------------------------
<S> <C> <C>
Common 1,626,838 1,502,513
Preferred 1,364,085 1,331,136
</TABLE>
At the meeting, John B. Kleinheinz, Kevin A. Stadtler, James B.
Francis, Jr., M. Scott Leslie and A. Lee Thurburn were elected as directors
of the Company. Mr. Kleinheinz and Mr. Stadtler were designated as
representatives of the holders of shares of the Company's Preferred Stock and
only holders of the Preferred Stock voted in respect of their election. The
remaining shareholders voted in respect of the election of the other three
individuals. All shares represented at the meeting and entitled to vote in
respect of the election of the directors were voted in favor of their
election, with the exception of 5,780 shares for which authority to vote was
withheld.
The remaining matters acted upon at the annual meeting were:
- A proposal to approve a Plan of Recapitalization and Restated Articles
of Incorporation of the Company to effect a 3.4-for-1 split of the
outstanding shares of the Company's Common Stock;
- A proposal to approve an increase in the number of shares reserved for
issuance under the Company's 1997 Stock Incentive Plan;
- A proposal to approve the Company's Employee Stock Discount Purchase
Plan; and
- Ratification of the appointment by the Board of Directors of
independent public accountants of the Company for the fiscal year
ending December 31, 1998.
All shares represented at the meeting were voted in favor of the proposals
and ratification. There were no votes against or withheld and there were no
abstentions.
14
<PAGE>
By written consent of the shareholders dated March 10, 1999, the Company's
shareholders approved Articles of Amendment to the Company's Restated Articles
of Incorporation for the purpose of causing the Company's 3.4-for-1 stock split
to become effective on March 11, 1999. Holders of in excess of two-thirds of
the outstanding shares entitled to vote in respect of the Articles of Amendment
signed the consent. In accordance with the Company's Restated Articles of
Incorporation and Texas law, prompt notice of the taking of the action by the
shareholders without a meeting was given to the shareholders who did not sign
the consent.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a). Exhibits
27.1 Financial Data Schedule
(b). Reports on Form 8-K
None.
15
<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: May 12, 1999 /s/ ANDREW N. JENT
-----------------------------
Andrew N. Jent
Executive Vice President and
Chief Financial Officer
16
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 45,302
<SECURITIES> 0
<RECEIVABLES> 173
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 47,049
<PP&E> 17,728
<DEPRECIATION> (6,424)
<TOTAL-ASSETS> 58,596
<CURRENT-LIABILITIES> 22,304
<BONDS> 0
0
0
<COMMON> 67,818
<OTHER-SE> (32,195)
<TOTAL-LIABILITY-AND-EQUITY> 58,596
<SALES> 0
<TOTAL-REVENUES> 8,089
<CGS> 0
<TOTAL-COSTS> 3,536
<OTHER-EXPENSES> 7,384
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 712
<INCOME-PRETAX> (3,499)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,499)
<DISCONTINUED> 0
<EXTRAORDINARY> (1,656)
<CHANGES> 0
<NET-INCOME> (5,203)
<EPS-PRIMARY> (0.75)
<EPS-DILUTED> (0.75)
</TABLE>
