<PAGE> 1
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 SEPTEMBER 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 (IRS Employer
incorporation or organization) Identification Number)
3001 MEACHAM BLVD., SUITE 100, FORT WORTH, TX 76137
(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 [X] No [ ]
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 October 31, 1999
Common Stock, No Par Value 14,226,616
1
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FLASHNET COMMUNICATIONS, INC.
INDEX
<TABLE>
<CAPTION>
Page
<S> <C>
Part I. FINANCIAL INFORMATION
ITEM 1.
CONSOLIDATED BALANCE SHEETS -
September 30, 1999 and December 31, 1998...................................................3
CONSOLIDATED STATEMENTS OF OPERATIONS -
Three and nine months ended September 30, 1999 and 1998....................................4
CONSOLIDATED STATEMENTS OF CASH FLOWS -
Nine months ended September 30, 1999 and 1998..............................................5
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT) -
Nine months ended September 30, 1999.......................................................6
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS............................................7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..................................................9
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT
MARKET RISK.........................................................................17
Part II. OTHER INFORMATION
ITEM 1. Legal Proceedings..................................................................N/A
ITEM 2. Changes in Securities and Use of Proceeds...........................................17
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......................................................................17
(b). Reports on Form 8-K...........................................................17
SIGNATURES.....................................................................................18
</TABLE>
2
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FLASHNET COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
ASSETS
September 30, December 31,
1999 1998
------------ ------------
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 25,971,000 $ 1,038,000
Accounts receivable, net 821,000 391,000
Note receivable 700,000 --
Prepaid expenses 774,000 740,000
Other assets 1,432,000 551,000
------------ ------------
Total current assets 29,698,000 2,720,000
PROPERTY AND EQUIPMENT, net 15,947,000 6,821,000
SOFTWARE LICENSES, net 387,000 6,000
CUSTOMER HARDWARE, net 8,299,000 --
OTHER ASSETS 205,000 186,000
------------ ------------
TOTAL $ 54,536,000 $ 9,733,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Current portion of capital lease obligations $ 2,603,000 $ 1,824,000
Current portion of convertible notes payable -- 186,000
Note payable -- 4,834,000
Trade accounts payable 14,722,000 5,335,000
Accrued payroll and related expenses 646,000 535,000
Other accrued expenses 1,759,000 438,000
Deferred revenue 12,458,000 12,325,000
------------ ------------
Total current liabilities 32,188,000 25,477,000
CAPITAL LEASE OBLIGATIONS, net of current portion 1,803,000 52,000
------------ ------------
Total liabilities 33,991,000 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,
14,226,616 and 5,528,868 issued and outstanding, respectively 68,514,000 3,444,000
Warrants to purchase common stock 3,157,000 3,704,000
Additional paid-in capital, stock options 1,909,000 --
Deferred compensation costs (1,523,000) --
Accumulated deficit (51,512,000) (30,855,000)
------------ ------------
Total shareholders' equity (deficit) 20,545,000 (23,707,000)
------------ ------------
TOTAL $ 54,536,000 $ 9,733,000
============ ============
</TABLE>
See Condensed Notes to Consolidated Financial Statements
3
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FLASHNET COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------- ---------------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
REVENUES:
Consumer access services $ 8,318,000 $ 5,850,000 $ 22,861,000 $ 15,545,000
Business services 569,000 456,000 1,453,000 1,167,000
Shipping revenues 1,949,000 -- 2,286,000 --
Set-up fees and other 1,791,000 947,000 3,648,000 2,657,000
------------ ------------ ------------ ------------
Total 12,627,000 7,253,000 30,248,000 19,369,000
------------ ------------ ------------ ------------
OPERATING COSTS AND EXPENSES:
Cost of recurring revenues 4,122,000 3,004,000 11,377,000 8,684,000
Cost of other revenues 217,000 134,000 933,000 320,000
Amortization of customer hardware 399,000 -- 399,000 --
Cost of shipping 1,498,000 -- 1,737,000 --
Sales and marketing 8,907,000 2,388,000 17,238,000 5,186,000
General and administrative 2,626,000 1,397,000 6,746,000 3,529,000
Operations and customer support 3,094,000 1,681,000 7,329,000 4,042,000
Depreciation and amortization 1,501,000 774,000 3,578,000 2,286,000
------------ ------------ ------------ ------------
Total 22,364,000 9,378,000 49,337,000 24,047,000
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (9,737,000) (2,125,000) (19,089,000) (4,678,000)
INTEREST EXPENSE (47,000) (674,000) (1,011,000) (1,985,000)
INTEREST AND OTHER INCOME 514,000 33,000 1,147,000 54,000
------------ ------------ ------------ ------------
LOSS BEFORE EXTRAORDINARY ITEM (9,270,000) (2,766,000) (18,953,000) (6,609,000)
EXTRAORDINARY ITEM - LOSSES ON
EARLY EXTINGUISHMENT OF DEBT -- -- (1,656,000) --
------------ ------------ ------------ ------------
NET LOSS (9,270,000) (2,766,000) (20,609,000) (6,609,000)
ACCRETION ON REDEEMABLE
PREFERRED STOCK -- (2,687,000) (48,000) (2,687,000)
------------ ------------ ------------ ------------
NET LOSS ATTRIBUTABLE TO COMMON
SHAREHOLDERS $ (9,270,000) $ (5,453,000) $(20,657,000) $ (9,296,000)
============ ============ ============ ============
NET LOSS PER SHARE,
BASIC AND DILUTED:
Loss before extraordinary item $ (0.66) $ (0.99) $ (1.62) $ (1.69)
Extraordinary item -- -- (0.14) --
------------ ------------ ------------ ------------
$ (0.66) $ (0.99) $ (1.76) $ (1.69)
============ ============ ============ ============
WEIGHTED AVERAGE SHARES,
BASIC AND DILUTED: 14,159,000 5,515,000 11,723,000 5,497,000
============ ============ ============ ============
</TABLE>
See Condensed Notes to Consolidated Financial Statements
4
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FLASHNET COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
---------------------------------
1999 1998
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss $(20,609,000) $ (6,609,000)
Adjustments to reconcile net loss to net cash used in operating activities:
Extraordinary losses 1,656,000 --
Depreciation 3,431,000 2,248,000
Amortization of customer hardware 399,000 --
Amortization of debt discount 349,000 1,450,000
Amortization of software licenses 80,000 31,000
Amortization of other assets 67,000 7,000
Deferred compensation expense 286,000 --
Provision for allowance for uncollectible accounts 6,000 7,000
Gain on sale of equipment (59,000) --
Changes in assets and liabilities:
Increase in accounts receivable (435,000) (135,000)
Increase in note receivable (700,000) --
Increase in prepaid expenses and other current assets (1,011,000) (451,000)
Increase in customer hardware (8,697,000) --
Increase (decrease) in accounts payable and accrued liabilities 10,715,000 (1,933,000)
Increase in deferred revenue 133,000 1,205,000
------------ ------------
Net cash used in operating activities (14,389,000) (4,180,000)
------------ ------------
INVESTING ACTIVITIES:
Purchases of property and equipment (7,646,000) (652,000)
Purchases of software and other assets (553,000) (1,000)
Proceeds from sale of equipment 59,000 --
------------ ------------
Net cash used in investing activities (8,140,000) (653,000)
------------ ------------
FINANCING ACTIVITIES:
Proceeds from initial public offering, net 56,302,000 --
Proceeds from issuance of note payable 5,000,000 --
Proceeds from issuance of preferred stock -- 7,812,000
Proceeds from exercise of options 60,000 --
Principal payments under notes payable (11,500,000) (114,000)
Principal payments under capital lease obligations (2,400,000) (1,134,000)
------------ ------------
Net cash provided by financing activities 47,462,000 6,564,000
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 24,933,000 1,731,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,038,000 1,570,000
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 25,971,000 $ 3,301,000
============ ============
</TABLE>
See Condensed Notes to Consolidated Financial Statements.
5
<PAGE> 6
FLASHNET COMMUNICATIONS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT)
NINE MONTHS ENDED SEPTEMBER 30, 1999
(UNAUDITED)
<TABLE>
<CAPTION>
Common Stock APIC - Deferred
-------------------------------- Stock Compensation
Shares Amount Options Costs
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
BALANCE, December 31, 1998 5,528,868 $ 3,444,000 $ -- $ --
Shares issued with initial public offering 3,625,000 56,302,000 -- --
Conversion of Redeemable Series A preferred stock 4,637,889 7,959,000 -- --
Conversion of notes payable 67,982 201,000 -- --
Exercise of warrants 349,877 548,000 -- --
Exercise of stock options 17,000 60,000 -- --
Accretion of discount related to redeemable preferred stock -- -- -- --
Stock option grants and other -- -- 1,909,000 (1,523,000)
Net loss -- -- -- --
------------ ------------ ------------ ------------
BALANCE, September 30, 1999 14,226,616 $ 68,514,000 $ 1,909,000 $ (1,523,000)
============ ============ ============ ============
<CAPTION>
Total
Warrants to Shareholders'
Purchase Accumulated Equity
Common Stock Deficit (Deficit)
------------- ------------ ------------
<S> <C> <C> <C>
BALANCE, December 31, 1998 $ 3,704,000 $(30,855,000) $(23,707,000)
Shares issued with initial public offering -- -- 56,302,000
Conversion of Redeemable Series A preferred stock -- -- 7,959,000
Conversion of notes payable -- -- 201,000
Exercise of warrants (547,000) -- 1,000
Exercise of stock options -- -- 60,000
Accretion of discount related to redeemable preferred stock -- (48,000) (48,000)
Stock option grants and other -- -- 386,000
Net loss -- (20,609,000) (20,609,000)
------------- ------------ ------------
BALANCE, September 30, 1999 $ 3,157,000 $(51,512,000) $ 20,545,000
============= ============ ============
</TABLE>
See Condensed Notes to Consolidated Financial Statements
6
<PAGE> 7
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, consisting only of normal recurring accruals, considered 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 consolidated 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 ("IPO"), which was
declared effective by the Securities and Exchange Commission on March 16, 1999.
The results of operations for the three and nine months ended September 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. 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 assessed a $50 cancellation fee. 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 is recognized
immediately upon the shipment of the merchandise.
4. CUSTOMER HARDWARE
During the quarter ended September 30, 1999, the Company contracted with
several vendors for the purchase of both new and refurbished personal computers
("PCs"). The Company began reselling the PCs through a bundled service offering
combining Internet access with a computer in exchange for a 2 or 3 year
contractual commitment. The costs of the PCs have been capitalized and will be
amortized over the life of the subscriber contract. Amortization expense for the
three and nine months ended September 30, 1999 was approximately $399,000.
Periodically, the Company analyzes the recoverability of such capitalized costs
through the evaluation of the subscribers' financial condition and adjusts the
balances as necessary. The associated shipping fees are non-refundable and are
recognized as the PCs are shipped.
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.
7
<PAGE> 8
6. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
The following is the supplemental cash flow information for all periods
presented:
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------
1999 1998
---------- ----------
<S> <C> <C>
Cash paid for interest $ 741,000 $ 535,000
Equipment acquired under capital leases $4,908,000 $ --
Additional common stock issued upon conversion of debt $ 201,000 $ 102,000
Deemed distributions and accretion on redeemable preferred stock $ 48,000 $2,687,000
</TABLE>
7. EXTRAORDINARY LOSS
The extraordinary loss on early extinguishment of debt is related to the
write-off of unamortized debt discount costs of $1.4 million related to the
repayment of the $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 $5.0 million term loan
agreement with Goldman Sachs Credit Partners L. P.
("Goldman Sachs").
8. SUBSEQUENT EVENT
On November 8, 1999, the Company and Prodigy Communications Corporation
("Prodigy") entered into a definitive agreement whereby Prodigy will acquire the
Company in a stock-for-stock merger. Under the terms of the merger agreement,
Prodigy will issue 0.35 shares of Prodigy common stock for each share of the
Company's common stock outstanding on the closing date of the transaction.
The Boards of Directors of both Prodigy and the Company unanimously
approved the merger; however, the merger is also subject to approval by the
Company's shareholders and to customary regulatory approvals. Closing of the
merger is expected in the first quarter of the year 2000. A significant
percentage of the Company's shareholders have agreed to vote in favor of the
merger. In connection with the merger agreement, the Company has granted Prodigy
an option to purchase up to 19.9% of the outstanding shares of the Company's
common stock, which may be exercised in certain circumstances. Based on the
number of shares of FlashNet and Prodigy currently outstanding, Prodigy will
issue approximately 5.0 million shares to complete the merger, representing
approximately 7% of Prodigy's then outstanding shares (assuming no additional
issuances of Prodigy common stock prior to completion of the proposed merger).
8
<PAGE> 9
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 1,475 total POPs across 804 cities
throughout the United States. As of September 30, 1999, the Company had
accumulated a subscriber base of approximately 244,000 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.
During the quarter ended September 30, 1999, the Company contracted with
several vendors for the purchase of both new and refurbished PCs. The Company
began reselling the PCs through a bundled service offering combining Internet
access with a computer in exchange for a 2 or 3 year contractual commitment. In
addition, the Company also resold PCs without Internet access. On September 30,
1999, the Company discontinued its program of reselling refurbished PCs with
bundled internet service due to cash considerations. However, the Company
expects to continue to sell new PCs with bundled internet service on a limited
basis.
REVENUES.
The Company's revenues generally are composed of:
o Consumer access services revenues;
o Business services revenues;
o Shipping revenues; and
o Set-up fees and other revenues.
Consumer access services revenues are composed 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 a $50 cancellation
9
<PAGE> 10
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 business services revenues are
recognized as services are provided.
Shipping revenues are derived primarily from the shipment of refurbished or
new PCs issued in connection with the Company's new bundled service offering.
The fees are non-refundable and are recognized as the PCs are shipped.
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, 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)
amortization of PCs issued to customers; (iv) selling, customer support and
general and administrative expenses that are associated more generally with
operations; and (v) 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 and the cost of user guides
and other materials for representatives and distributors involved in the
Company's network marketing program.
Amortization of customer hardware is the result of amortizing the cost of
capitalized PCs issued to customers, over the life of the subscriber contract.
Cost of shipping is related primarily to the cost incurred by the Company
to have PCs shipped by a third-party distributor, in connection with the
Company's new bundled service offering.
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
10
<PAGE> 11
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 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, customer base and
internal staffing, develop its systems and expand into new markets. The Company
expects to continue to focus on increasing its subscriber base. 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.
11
<PAGE> 12
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 September 30, Nine Months Ended September 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 $ 8,318 66% $ 5,850 81% $ 22,861 75% $ 15,545 80%
Business services 569 5 456 6 1,453 5 1,167 6
Shipping revenues 1,949 15 -- -- 2,286 8 -- --
Set-up fees and other 1,791 14 947 13 3,648 12 2,657 14
-------- -------- -------- -------- -------- -------- -------- --------
Total 12,627 100 7,253 100 30,248 100 19,369 100
-------- -------- -------- -------- -------- -------- -------- --------
OPERATING COSTS AND EXPENSES:
Cost of recurring revenues 4,122 33 3,004 41 11,377 38 8,684 45
Cost of other revenues 217 2 134 2 933 3 320 2
Amortization of customer hardware 399 3 -- -- 399 1 -- --
Cost of shipping 1,498 12 -- -- 1,737 6 -- --
Sales and marketing 8,907 70 2,388 33 17,238 57 5,186 26
General and administrative 2,626 21 1,397 19 6,746 22 3,529 18
Operations and customer support 3,094 25 1,681 23 7,329 24 4,042 21
Depreciation and amortization 1,501 12 774 11 3,578 12 2,286 12
-------- -------- -------- -------- -------- -------- -------- --------
Total 22,364 178 9,378 129 49,337 163 24,047 124
-------- -------- -------- -------- -------- -------- -------- --------
LOSS FROM OPERATIONS (9,737) (78) (2,125) (29) (19,089) (63) (4,678) (24)
INTEREST EXPENSE (47) -- (674) (9) (1,011) (4) (1,985) (10)
INTEREST AND OTHER INCOME 514 4 33 -- 1,147 4 54 --
-------- -------- -------- -------- -------- -------- -------- --------
LOSS BEFORE EXTRAORDINARY
ITEM (9,270) (74) (2,766) (38) (18,953) (63) (6,609) (34)
EXTRAORDINARY ITEM - LOSSES
ON EARLY EXTINGUISHMENT
OF DEBT -- -- -- -- (1,656) (5) -- --
-------- -------- -------- -------- -------- -------- -------- --------
NET LOSS (9,270) (74) (2,766) (38) (20,609) (68) (6,609) (34)
ACCRETION ON REDEEMABLE
PREFERRED STOCK -- -- (2,687) (37) (48) -- (2,687) (14)
-------- -------- -------- -------- -------- -------- -------- --------
NET LOSS ATTRIBUTABLE TO
COMMON SHAREHOLDERS $ (9,270) (74)% $ (5,453) (75)% $(20,657) (68)% $ (9,296) (48)%
======== ======== ======== ======== ======== ======== ======== ========
</TABLE>
12
<PAGE> 13
REVENUES.
The Company experienced substantial growth in revenues for the three and
nine-month periods ended September 30, 1999 as compared to the corresponding
periods of 1998. Total revenues increased 74% to $12.6 million from $7.3 million
during the three months ended September 30, 1999 and 1998, respectively, and 56%
to $30.2 million from $19.4 million during the nine months ended September 30,
1999 and 1998, respectively.
As reflected by the increase in consumer access and business services
revenues, subscriptions and renewals increased 41% to $8.9 million from $6.3
million during the three months ended September 30, 1999 and 1998, respectively,
and 45% to $24.3 million from $16.7 million during the nine months ended
September 30, 1999 and 1998, respectively. The increase in access service
revenues was primarily due to an increase in the Company's subscriber base of
47% to 244,000 at September 30, 1999 from 166,000 at September 30, 1998.
Shipping revenues of $1.9 million and $2.3 million for the three and nine
months ended September 30, 1999, respectively, were the result of the Company's
PC offer which began in June. Subsequent to September 30, 1999, the Company
discontinued its program of reselling refurbished PCs with bundled internet
service due to cash considerations. The Company expects to continue to resell
new computers with bundled internet service but anticipates less volume under
this product offering.
Subscriber set-up fees and other revenues increased 89% to $1.8 million
from $0.9 million during the three months ended September 30, 1999 and 1998,
respectively, and 37% to $3.7 million from $2.7 million during the nine months
ended September 30, 1999 and 1998, respectively. The increase was primarily the
result of the reintroduction of set-up fees on all products in March 1999. 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 37% to $4.1 million from $3.0 million
during the three months ended September 30, 1999 and 1998, respectively, and 31%
to $11.4 million from $8.7 million during the nine months ended September 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 33% from 41%
during the three months ended September 30, 1999 and 1998, respectively, and to
38% from 45% during the nine months ended September 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 $0.2 million from $0.1 million during
the three months ended September 30, 1999 and 1998, respectively, and to $0.9
million from $0.3 million during the nine months ended September 30, 1999 and
1998, respectively. Cost of other revenues as a percentage of total revenues
remained constant at approximately 2% for all periods reported.
COST OF SHIPPING AND AMORTIZATION OF CUSTOMER HARDWARE
In June 1999, the Company began reselling PCs through a bundled service
offering combining Internet access with a computer in exchange for a 2 or 3 year
contractual commitment. The costs of the PCs have been capitalized and will be
amortized over the life of the subscriber contract. Amortization expense for the
three and nine months ended September 30, 1999 was approximately $399,000. The
associated shipping fees are non-refundable and are recognized as the PCs are
shipped. Subsequent to September 30, 1999, the Company discontinued its program
of reselling refurbished PCs with bundled internet service due to cash
considerations. The Company expects to continue to resell new computers with
bundled internet service but anticipates less volume under this product
offering.
SALES AND MARKETING EXPENSES.
Sales and marketing expenses increased 273% to $8.9 million from $2.4
million during the three months ended September 30, 1999 and 1998, respectively,
and 232% to $17.2 million from $5.2 million during the nine months ended
September 30, 1999 and 1998, respectively. Sales and marketing expenses
13
<PAGE> 14
as a percentage of total revenues increased to 70% from 33% during the three
months ended September 30, 1999 and 1998, respectively, and to 57% from 26%
during the nine months ended September 30, 1999 and 1998, respectively. The
increases, both in absolute dollars and as a percentage of total revenues, were
primarily due to increased advertising, increased telephone charges and
increased contract labor costs associated with the Company's "Free Web PC" offer
which began in June 1999 and was discontinued September 30, 1999 with respect to
refurbished PCs. The Company aggressively marketed the "Free Web PC" offer
during the quarter. As a result of the tremendous response to the offer, the
Company increased the number of full-time and contract employees in the sales
department by approximately 18 personnel during the third quarter ended 1999. In
addition, the Company spent $1.2 million outsourcing the excess call volume to
third party call centers. The Company projects a slowdown in advertising
expenditures for the fourth quarter of 1999. The Company suspended much of its
advertising efforts in 1998 to conserve cash resources.
GENERAL AND ADMINISTRATIVE EXPENSES.
General and administrative expenses increased 88% to $2.6 million from $1.4
million during the three months ended September 30, 1999 and 1998, respectively,
and 91% to $6.7 million from $3.5 million during the nine months ended September
30, 1999 and 1998, respectively. General and administrative expenses as a
percentage of total revenues increased to 21% from 19% during the three months
ended September 30, 1999 and 1998, respectively, and to 22% from 18% during the
nine months ended September 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 as a result of the Company's continued growth. The increase in
credit card processing fees was due to the increase in sales as a result of the
growth in the Company's subscriber base.
OPERATIONS AND CUSTOMER SUPPORT EXPENSES.
Operations and customer support expenses increased 84% to $3.1 million from
$1.7 million during the three months ended September 30, 1999 and 1998,
respectively, and 81% to $7.3 million from $4.0 million during the nine months
ended September 30, 1999 and 1998, respectively. Operations and customer support
expenses as a percentage of total revenues increased to 25% from 23% during the
three months ended September 30, 1999 and 1998, respectively, and to 24% from
21% during the nine months ended September 30, 1999 and 1998, respectively. The
increases, both in absolute dollars and as a percentage of total revenues, were
primarily due to increased labor costs and increased telephone charges
associated with the Company's "Free Web PC" offer. Due to the significant
increase in call volume as a result of the offer, the Company increased the
number of full-time and contract employees in the customer support department by
approximately 127 personnel during the third quarter ended 1999. The Company
also added additional technical personnel to support the larger subscriber base.
DEPRECIATION AND AMORTIZATION.
Depreciation and amortization expense increased 94% to $1.5 million from
$0.8 million during the three months ended September 30, 1999 and 1998,
respectively, and 57% to $3.6 million from $2.3 million during the nine months
ended September 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 approximately 12% for all periods reported.
INTEREST EXPENSE
Interest expense decreased 93% to $0.1 million from $0.7 million during the
three months ended September 30, 1999 and 1998, respectively, and 49% to $1.0
million from $2.0 million during the nine months ended September 30, 1999 and
1998, respectively. Interest expense as a percentage of total revenues decreased
to nil from 9% during the three months ended September 30, 1999 and 1998,
respectively, and to 4% from 10% during the nine months ended September 30, 1999
and 1998, respectively. During March 1999, the Company repaid the $6.5 million
Ascend Note. As a result of the repayment, debt discount amortization on the
Ascend Note decreased $0.4 million and $1.0 million respectively, for the three
and nine months ended September 30, 1999 compared to the same periods in 1998.
14
<PAGE> 15
INTEREST INCOME
Interest income as a percentage of total revenues increased to 4% from nil
during the three and nine months ended September 30, 1999 and 1998,
respectively. The increase is due to interest earned on the net proceeds from
the Company's IPO effected March 16, 1999, which the Company has used for
working capital and 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 LOSS
The extraordinary loss on early extinguishment of debt is 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 $5.0 million 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 $8.4
million and $14.4 million during the three and nine month periods ended
September 30, 1999, respectively. During the three months ended September 30,
1999, net cash used in operations resulted primarily from net losses, adjusted
for depreciation and amortization expense, the purchase of PCs included in the
Company's new bundled service offering and the decrease in deferred revenue. In
addition, the Company funded a $0.7 million note receivable bearing interest at
12% maturing in April 2000, which is convertible, at the option of the Company,
into common stock of an upstart company focused on developing communication
services.
Cash used by investing activities has consisted primarily of equipment
purchases for POP and network expansion. For the three and nine month periods
ended September 30, 1999, capital expenditures amounted to approximately $3.6
million and $8.1 million, respectively. In addition, the Company acquired
approximately $4.9 million of equipment under capital leases during the nine
months ended September 30, 1999.
Cash used in and provided by financing activities was approximately $0.8
million and $47.5 million during the three and nine month periods ended
September 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 $0.8 million and $2.4 million for the three and nine months
ended September 30, 1999.
As of September 30, 1999, the Company had cash and cash equivalents on hand
of approximately $26.0 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. In October 1999, the
Company entered into a capital financing arrangement with a major financial
services company. The agreement provides a lease facility up to $6.0 million for
the sale/leaseback of technology equipment the Company has purchased in 1999.
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.
15
<PAGE> 16
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, remediation and testing of all material
information technology systems, and it is currently implementing the changes
necessary to make its computer systems Year 2000 compliant by December 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 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 December 31, 1999
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 Company provides its customers with many services, such as email,
internet news and web page hosting, that rely on internally supported server
computers that are controlled by third-party-written operating systems running
third-party and internally written applications. The Company has evaluated all
internally written applications and made all necessary date manipulation program
code changes. Additionally, the Company has contacted all vendors that support
operating systems and applications to verify Year 2000 compliance. To date, all
updates to these third-party systems have been identified and scheduled for
installation in accordance with the Company's goal of full compliance by
December 1999. Any application or hardware component that has not been
identified as compliant now or by December 1999 will be deactivated and removed
from the production environment until such time that upgrades or fixes can be
made to make the item fully Year 2000 compliant. In addition, the Company
initiated a bundled service offering in June 1999 which included Internet access
and a refurbished computer in exchange for a 2 or 3 year contractual commitment
for access services. The Company's vendor is required to warranty the computers
from defects for the life of the contractual commitment. If any of the computers
are determined to not be Year 2000 compliant the vendor is required to service
those computers under its warranty. The Company and its vendor are currently
conducting audits of all of the computers that were shipped to end-users under
this bundled service program. At this time, the Company believes that all of the
computers are Year 2000 compliant or that the appropriate software updates have
been identified to make those computers Year 2000 compliant. The Company
discontinued selling refurbished PCs with bundled internet access on September
30, 1999.
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 assets. 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 the end of 1999.
16
<PAGE> 17
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 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.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to interest rate risk on its capital lease
obligations. However, as such obligations have fixed interest rates, the Company
does not believe interest rate risks are material.
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
working capital and 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
On August 26, 1999, the Company filed a Current Report on Form 8-K to
report that on August 20, 1999, the Company dismissed Deloitte & Touche LLP as
its independent accountants and appointed Ernst & Young LLP as auditors of the
Company for the year ending December 31, 1999. The Audit Committee of the
Company's Board of Directors recommended the change in independent accountants
and the change was approved by the Board of Directors.
17
<PAGE> 18
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: November 11, 1999 /s/ ANDREW N. JENT
----------------- ------------------------------------
Andrew N. Jent
Executive Vice President and
Chief Financial Officer
18
<PAGE> 19
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 25,971
<SECURITIES> 0
<RECEIVABLES> 1,555
<ALLOWANCES> (34)
<INVENTORY> 0
<CURRENT-ASSETS> 29,698
<PP&E> 25,017
<DEPRECIATION> (8,683)
<TOTAL-ASSETS> 54,536
<CURRENT-LIABILITIES> 32,188
<BONDS> 0
0
0
<COMMON> 68,514
<OTHER-SE> (47,969)
<TOTAL-LIABILITY-AND-EQUITY> 54,536
<SALES> 0
<TOTAL-REVENUES> 30,248
<CGS> 0
<TOTAL-COSTS> 14,446
<OTHER-EXPENSES> 34,891
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,011
<INCOME-PRETAX> (18,953)
<INCOME-TAX> 0
<INCOME-CONTINUING> (18,953)
<DISCONTINUED> 0
<EXTRAORDINARY> (1,656)
<CHANGES> 0
<NET-INCOME> (20,657)
<EPS-BASIC> (1.76)
<EPS-DILUTED> (1.76)
</TABLE>
