10KSB/A 1 a36265.txt FRONTLINE COMMUNICATIONS CORPORATION SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------ FORM 10-KSB/A (Amendment No. 2) [X] Annual Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934. For the fiscal year ended December 31, 2002 OR [ ] Transition Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934. For the transition period from _________ to ___________ Commission File Number 001-15673 FRONTLINE COMMUNICATIONS CORPORATION ---------------------------------------------- (Name of Small Business Issuer in Its Charter) Delaware 13-3950283 --------------------------------- ---------------- (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification No.) One Blue Hill Plaza, P.O. Box 1548, Pearl River, New York 10965 ---------------------------------------------------------- ------- (Address of principal executive offices) (Zip Code)
(845) 623-8553 ------------------------------------------------ (Issuer's Telephone Number, Including Area Code) Securities registered pursuant to Section 12(b) of the Exchange Act: Title of each class Name of each exchange on which registered Series B Convertible Redeemable American Stock Exchange Preferred Stock, $.01 par value Common Stock, $.01 par value American Stock Exchange
Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock Purchase Warrants Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [X] The issuer's revenues for the year ended December 31, 2002 were $5,047,098. The aggregate market value of the voting and non-voting common equity held by non-affiliates as of April 3, 2003 was $1,808,932. As of April 3, 2003, there were 10,169,972 shares of the issuer's Common Stock outstanding. Documents Incorporated by Reference: None. The Form 10-KSB of Frontline Communications Corp. for the year ended December 31, 2002 is being amended in response to a comment letter from the Securities and Exchange Commission staff related to another filing. Specifically, we have added additional disclosure regarding 1) the factors that led us to acquire Proyecciones y Ventas Organizadas, S.A. de C.V. and the anticipated impact of the acquisition on our business; and 2) competition in our marketplace. This amendment does not include any material changes in our financial statements other than expanded footnote disclosures. All other information in the originally filed form 10-KSB was presented as of the April 14, 2003 filing date, or earlier as indicated, and has not been updated in this amended filing. PART I Item 1. Description of Business. Overview Frontline Communications Corporation is a regional Internet service provider ("ISP") providing Internet access, web hosting, website design, and related services to residential and small business customers throughout the Northeast United States and, through a network partnership agreement, Internet access to customers nationwide. Primarily through 18 acquisitions, we grew our monthly revenue from $30,000 as of October 1998 to approximately $400,000 per month at December 31, 2002. During that same period, we expanded our owned Internet access geographic footprint from the New York/New Jersey metropolitan area, to a region that now includes Delaware, Eastern Pennsylvania, and Northern Virginia. At December 31, 2002, we owned and operated eight points-of-presence ("POPs") which, when combined with 1,100 POPs licensed from third parties, provide us with the capability to serve over 75% of the U.S. population. In 2000, the downturn in the stock market relating to Internet stocks, the growth of our competitors, and the introduction of new Internet access products, such as high-speed cable access, began to have a negative impact on our business. Specifically, the company found it increasingly difficult to raise money in the equity marketplace, and the resulting lack of capital impeded the growth of our business. During year 2002, we concentrated our efforts and resources primarily on restructuring our operations to reduce costs, increasing operating efficiency and improving customer service. As a result of our restructuring, we reduced our staff from approximately 70 employees at March 2001 to 31 as of March 31, 2003, and closed two regional offices, consolidating those functions into our Pearl River, New York headquarters. We also streamlined our product offerings in 2002, eliminating certain low margin products and services, and added a broadband one-way satellite Internet access product line to our group of services. We also standardized our product pricing, and raised the monthly rates to most of our dial-up access customers to between $17.95 and $19.95 per month, depending on the term of service purchased. After engaging in these aggressive restructuring efforts during 2000 and 2001, in 2002 our board of directors determined that the best alternative to attempt to preserve 2 the continued economic viability of the company was to acquire a company with a larger revenue base and greater potential for growth than us. In the fourth quarter of 2002, we entered into negotiations with Proyecciones y Ventas Organizadas, S.A. de C.V., a corporation organized under the laws of the Republic of Mexico ("Provo"). Provo had 2002 audited revenue of approximately $100 million, an international presence, and an expanding product line, and thus met our criteria for an acquisition candidate. In April 2003, after several months of arm's length negotiations, we completed our acquisition of Provo. See - Recent Developments, beginning on page 3. Frontline Communications Corporation was formed during February 1997 as a Delaware corporation under the name Easy Street Online, Inc. We changed our name to Frontline Communications Corporation in July 1997. Our principal executive offices are located at One Blue Hill Plaza, Pearl River, New York 10965, and our telephone number is (845) 623-8553. Our corporate websites are located at www.frontline.net and www.fcc.net. PlanetMedia'sm''s Internet website is located at www.pnetmedia.com. Information on these Websites is not part of this report. Unless the context indicates otherwise, the terms "Frontline"," "we," "our," "the Company" and "us" in this report include the operations of Frontline Communications Corporation and its wholly owned subsidiaries, WowFactor, Inc., FNT Communications Corp., Inc. and CLEC Communications Corp. Recent Developments On April 3, 2003, we completed the acquisition of all of the issued and outstanding stock of Proyecciones y Ventas Organizadas, S.A. de C.V., a corporation organized under the laws of the Republic of Mexico ("Provo"). Provo and its subsidiaries are engaged in distribution of prepaid calling card and cellular phone airtime in Mexico. We believe that our acquisition of Provo will enhance our potential to realize improved long-term operating results and to achieve a stronger financial position. We believe that our acquisition of Provo will yield the following potential benefits: o Additional significant yearly revenues and strong operating profits. Provo had 2002 audited revenue of approximately $100 million, an increase of 20x over Frontline's 2002 audited revenue. o An increased ability to participate in international transactions and allow us to expand our service offering. We believe that Provo's strong Mexican market presence will enable us to offer our Internet access products in Mexico and other Latin American markets. In addition, Provo plans to launch additional products in the U.S. and Mexico, which we expect will augment our current revenue lines. o An enhanced our ability to raise cash, which has been inhibited by the adverse market conditions for technology and Internet companies prevailing during the past 24 months. Our acquisition of Provo will result in a more diversified product portfolio, which we believe will make us more attractive to potential investors. The addition of Provo's revenue stream to our current revenue stream will also aid us in seeking additional financing. 3 o The transaction will increase our profile as a communications company. The combined product offering of Internet service bundled with telephone service will make us more competitive in the telecommunications market. We issued to the two stockholders of Provo (the "Sellers") 220,000 shares of our Series C Convertible Preferred Stock Series C Convertible Preferred Stock. Each share of Series C Convertible Preferred Stock automatically converts into 150 shares of our common stock upon receipt of the approval of our stockholders of (i) the issuance of shares of common stock upon conversion of the Series C Convertible Preferred Stock (ii) an increase in our authorized common stock to 75 million shares and (iii) a 1 for 1.5 share reverse split of our common stock. As a result, if our shareholder approvals are obtained, we will issue 33 million shares of common stock (before giving effect to the proposed reverse split) to the Sellers and a change of control of our company will occur. In the event we do not receive shareholder approval on or prior to July 18, 2003 or such later date as agreed to by the holders of a majority of the Series C Convertible Preferred Stock, and which date shall be extended for a period of up to 30 days due to the actions or inactions of the Securities and Exchange Commission or American Stock Exchange in connection with the Company seeking shareholder approval, the Series C Convertible Preferred Stock will not convert into common stock and the compensation payable to the Sellers shall be increased by $20,000,000, payable in the form of a Note. The increase in the purchase price will be effected as a result of our obligations arising under the Note. The Note is a $20,000,000 principal amount promissory note we issued to the Sellers in connection with the acquisition, which only takes effect if the Series C Convertible Preferred Stock is not converted into common stock by the date set forth in the Stock Purchase Agreement. The Note bears interest at the rate of 8% per annum, is due and payable 15 days after it becomes effective and is secured by substantially all of our assets including the capital stock of Provo issued to us in the transaction. If the repayment obligations under the Note become effective and the Company is not able to repay the Acquisition Note when due and the Sellers foreclose on the shares pledged as collateral then the Sellers will regain control of Provo. Moreover, after a foreclosure the Company may remain obligated to the Sellers if the value of the collateral is insufficient to cover the Company's obligations under the Acquisition Note. We do not believe that the collateral underlying the $20,000,000 note is sufficient to satisfy the note. If the collateral is insufficient to satisfy our obligation under the note, and we are unable to negotiate a settlement with the former stockholders of Provo, we may be forced to seek bankruptcy protection. We believe that the significant additional liabilities that we will incur if our shareholders fail to approve the items set forth above will have a material adverse effect on our business and the interests of our shareholders. Each share of Series C Convertible Preferred Stock has a liquidation preference of $.01 per share and ranks senior to our common stock but pari passu to our Series B preferred stock. The holders of Series C Convertible Preferred Stock have no voting rights, except (i) as required by law and (ii) the holders of Series C Convertible Preferred Stock vote separately as to (a) any amendment, alteration or repeal of the certificate of designation of Series C Convertible Preferred Stock if the rights, preferences or privileges of the Series C Convertible Preferred Stock are affected and (b) the creation, authorization or issuance by our company of any stock on parity with, or senior to the Series C Convertible Preferred Stock as to dividends, liquidation, redemption, conversion, voting or assets, or any increase in the amount of authorized shares of any such stock ("Senior Stock"). In addition, prior to the Conversion Date, we may not do any of the following: 4 (i) authorize any merger or certain other business combination transactions; (ii) take any action which would result in our voluntary or involuntary dissolution or winding-up; (iii) amend, repeal or add any provision to our certificate of incorporation or by-laws if it would materially adversely effect the holders of Series C Convertible Preferred Stock; (iv) issue any options, warrants or other securities convertible into or exchangeable for Senior Stock; (v) incur, refinance or amend the terms of any indebtedness or any other obligation for the payment of money in an aggregate amount of $1,000,000; or (vi) enter into any agreement for the sale of our securities or any capital financing transaction in which the Company issues capital stock or other securities at per share (or effective per share price) less than $1.50. In connection with the acquisition, we issued an aggregate of 35,500 shares of our Series D Convertible Preferred Stock (the "Series D Preferred") to certain brokers, finders and insiders in accordance with the terms of certain consulting agreements. See Item 12- Certain Relationships and Related Transactions. In April 2003, we borrowed $550,000 from an unaffiliated entity and issued a secured promissory note to the lender. The Note bears interest of 14% per annum and is secured by substantially all of our assets. Two of our officers, Mr. Nicko Feinberg and Mr. Stephen J. Cole-Hatchard have pledged shares of our common stock owned by them as additional collateral to the lender. In addition, Mr. Cole-Hatchard has personally guaranteed the repayment of the note. In connection with the financing, we issued 500,000 shares of our common stock to the lender as additional consideration. The note is repayable at the earlier of 90 days or upon financing of Provo's accounts receivable. Out of the proceeds, we used $200,000 to settle a promissory note, issued as part of a business acquisition, in the principal amount of $728,600. The balance of the $728,600 promissory note was repaid through issuance of 375,000 shares of our common stock to the promissory note holders. Provo's Business Provo was formed in 1995 as a private company with headquarters in Mexico City. Its primary business is the sale and distribution of prepaid Latadel public calling cards for Telmex, the dominant telecommunications provider in Mexico. Provo is also engaged in the sale and distribution of Multifon prepaid landline telephone time provided by Telmex and prepaid digital PCS cellular airtime provided by TelCel. TelCel is the dominant provider of cellular airtime in Mexico. Sales of Provo's pre-paid calling cards account for approximately 10% of all such sales in Mexico. Provo distributes its products through a network of approximately 60 independently-owned distributorships that collectively employ more than 400 sales people. Provo also employs its own in-house sales staff. Provo and its distributors have established a distribution network that includes over 20,000 point-of-sale locations. Provo competes with approximately 40 other distributors who also wholesale prepaid calling time purchased from Telmex and TelCel throughout Mexico. Two other distributors, Tarjetas Del Noreste and DiCasa, maintain market positions comparable to Provo's. 5 All of Provo's revenues are currently generated in Mexico. As a result, Provo's business may involve certain considerations and risks not typically associated with those of domestic origin as a result of, among other factors, the level of governmental supervision and regulation of foreign businesses, the possibilities of political or economic instability and volatility in currency exchange rates. Acquisitions in Year 2000 In 2000, we acquired substantially all of the assets of The PressRoom Online Services, Application Resources Information Services, Inc d/b/a Way Communications, The First Street Corporation, Wizardnet, Inc., Delanet, Inc. (internet access service providers) and PNM Group, Inc., a Web design company. We also acquired certain customers of Double D Network Services, Inc. pursuant to an agreement whereby we paid Double D a referral fee for each Double D customer who signed up for our dial-up service. Internet Products and Services Our products and services are focused around three key Internet business areas - access, presence, and development. Internet Access Products o Dial-Up Accounts: Frontline offers residential and business dial-up and ISDN Internet access on a national basis. Customers may order these products on our websites or by calling our 800 number. Utilizing our branded software, available via CD or downloadable from our website, customers can quickly order and activate a new account, billable to the client's credit card. The standard Frontline dial-up product provides clients two Internet e-mail addresses, a customizable homepage, access to our Customer Service telephone support center, and the latest access tools including browsers from Netscape and Microsoft. o Satellite Access: In late 2001, Frontline launched a line of broadband one-way satellite access products primarily for residential users. The satellite service provides customers with download speeds approximately 10 times faster than standard dial up accounts, uses a dial-up line for outbound service, and starts at $34.99 per month. A standard dial-up account is included with the service for outbound traffic and backup for downloading. o DSL: We are a reseller of Digital Subscriber Line high-speed Internet access services for DSL.net, Inc., and Covad Communications Company. We offer Digital Subscriber Line, ISDN Digital Subscriber Line, Asymmetric Digital Subscriber Line and Symmetric Digital Subscriber Line services in the Mid-Atlantic and Northeast United States. These products provide our residential and business customers with high-speed dedicated Internet connectivity at an affordable cost. o Dedicated Access: Frontline offers high-speed, high-bandwidth dedicated leased lines to customers, principally for business users who require high-speed internet connectivity 24 hours a day, seven days a week. Internet Presence Products o Virtual Website hosting: We offer virtual website hosting services to residential and small business customers who require 24 hour presence on the Internet. By renting space on our Internet servers, customers avoid costly hardware 6 investment, maintenance, and other costs associated with operating their own servers. Marketed partly under our brand name FrontHost'sm', the Company's hosting services include domain name registration, e-mail addresses, file upload and download capability and statistical logs. o Dedicated Hosting: Frontline offers website hosting and maintenance services to clients wishing to rent secure web-servers. In addition, Frontline offers co-location services to those customers preferring to install their own equipment at our facilities and connect their systems directly to the Internet. o FrontHost'sm': Our do-it-yourself web hosting service, which includes the "Website Wizard" products, assists customers in developing and hosting their own Websites and e-commerce `stores' by using our FrontHost'sm' user-friendly tools. The product line is simple, self service, and economical. Internet Development Services o Website design services: PlanetMedia'sm', our website design, consulting, and development division, assists business customers with Internet marketing strategy, graphic design and layout, writing and editing and Website information architecture (including Website navigation and searching systems). Our in-house professionals provide full life-cycle support to customers: from the design phase through website installation and maintenance. Marketing and Sales We currently handle sales and marketing utilizing in-house staff, including our customer service and technical groups. We market and sell our products through direct sales efforts, and a network of external, commissioned resellers we refer to as "Value Added Resellers" (VARs). Marketing activities focus primarily on regional efforts such as radio, trade and local business print media, as well as local event marketing in each of the different areas in which we have a physical presence, which includes the East coast from Virginia through the New York metropolitan area. POPS and Network infrastructure Our Internet access network is comprised primarily of a Company-managed network and third-party POPs provided primarily through an agreement with Megapop, Inc. The Company believes that this combination of owned and leased access enables Frontline to most economically provide Internet access services to its customers on a national level while leveraging the competitive advantages associated with the Company's own, uniquely-located, POPs. Broadband access to the Internet for Company-managed POPs is provided through high speed T1, T3, or Ethernet connections supplied under contracts with national broadband suppliers such as Verio, Inc. and by certain regional broadband suppliers such as Focal, Inc., and AboveNet, Inc. DSL access is similarly provided through direct connections or reseller agreements with Covad Communications Company and DSL.net, Inc. Network and service delivery stability is provided through the use of redundant computing and server facilities located at our larger owned POPs. We have duplicate bandwidth access at each of our major locations. We have installed backup power supply, 7 remote alarm, computer virus protection, and monitoring software throughout our network, which is monitored 24 hours a day, 7 days-a-week. Customer and Product Support Services We believe that reliable customer and product support is critical to retaining existing subscribers and in attracting new customers. We provide the following Customer and Product support services: o Toll-free, live telephone assistance available seven days a week, during peak load hours (10 hours per day; 8 hours on weekends); o Email-based assistance available seven days a week; o Internet help at our www.fcc.net Web site; o Fax support for higher-end business hosting customers. In 2001, we consolidated our Howell, New Jersey and Pearl River, New York customer service centers into the Pearl River location. All calls and emails for customer service are now received in Pearl River, of which we receive approximately 300, from both residential and business customers, per day. Product and Service Development Our Product Service Division develops proprietary applications, and reviews new technologies and third-party software products that are incorporated into our network and service products. A revised, interactive website (www.fcc.net) was activated by us during February 2001. In addition, a new broadband one-way satellite system was developed and launched in late 2001, and we distributed updated dial-up access CDs to our sales force and customers during March 2001, December 2001, and March 2002. Industry and Competition The market for Internet access, hosting, and web design and development services is highly competitive, rapidly evolving, and subject to technological change. There are no substantial barriers to entry, and we expect that competition will increase. Our competitors for Internet access services in the United States include national telecommunications providers such as America Online, Time Warner Cable, Verizon, Earthlink, United Online (NetZero and Juno brands) and Covad Communications, as well as regional Internet service providers, such as Best Web Corporation, Fastnet Inc. and LogicalNet Corporation. Our national competitors have significantly greater financial, technical, marketing and other resources than we do, and our share of the market is relatively small compared to theirs. Our regional competitors have market shares that our comparable to ours. Many of our current and future competitors possess a wide range of products and collective new product development capabilities that exceed ours. For example, some of our competitors, such as Time Warner Cable, offer access to the Internet via cable modem. We do not possess the technical capability to offer such a service. Increased competition could result in significant price competition, which in turn could result in significant price reductions in some of our product offerings, most notably Internet access and web hosting. In addition, increased competition for new customers could result in increased sales and marketing expenses and related customer acquisition costs, which could materially adversely affect our operating results. We 8 may not have the financial resources, technical expertise or marketing and support capabilities to compete successfully, and the software, services or technologies developed by others may render our products, services or technologies obsolete or less marketable. We believe that competition is likely to increase and that existing or future competitors may develop or offer services that are superior to ours at a lower price. These factors could have a material adverse effect on our business, financial condition, and results of operations. Company Strategy and Restructuring Program During 1998, the Company announced, as a strategic goal, to become a leading provider of Internet access, development, and presence services for small and medium-sized businesses throughout the United States. To achieve this objective, we embarked on a program to expand our network infrastructure and internet dial-up access subscriber base by acquiring local and regional ISPs, utilizing acquired web-portal and e-commerce websites as a vehicle to promote the sale of our Internet services, and developing co-marketing alliances with value-added partners. During the period between October 1998 and September 2000, Frontline acquired 18 companies, and as a result grew our monthly revenue from $30,000 to approximately $400,000 per month at December 31, 2002, and acquired two web-portal websites: WoWFactor.com'r' and iShopNetworks'sm'. Marketplace and technological changes during the year 2000 caused us to revise our strategy and restructure our operations during the last two quarters of the year 2000, in 2001 and 2002. We refined our product offerings to exclude numerous low margin products and services as well as those which were no longer in high demand, and raised our standard pricing for dial up customers to between $17.95 and $19.95 per month. As a result, our actual customer count decreased, while our revenue remained fairly constant. In an effort to offset the reduction in customers, we added a broadband satellite access product line in late 2001. In addition, the marketplace failure of many so-called dot-com companies and our inability to cost-effectively market our core products through our owned websites resulted in our decision to abandon the use of web-portals as a primary marketing tool of the Company. As a result, during January 2001, we announced the sale of a majority of our equity interest in iShopNetworks, Inc. and the closure of our WoWFactor.com'r' web-portal. We also announced that we would cease funding our subsidiary, CLEC Communications Corp. In 2001 and 2002 the DSL market also suffered turmoil with many substantial DSL providers entering bankruptcy or ceasing operations. As a result, we sustained a loss of certain DSL customers and revenues. However, we continue offering the DSL product line through Covad Communications Company and DSL.net, Inc. During the last quarter of 2000, we commenced a restructuring program (the "Restructuring Program") designed to consolidate our operations and improve cost-effectiveness, combine personnel of our key products and customer service divisions to leverage our manpower skills, and upgrade our access network infrastructure. As of March 31, 2003, we have accomplished the following in connection with our Restructuring Program: 9 o Total workforce reduction of about 75%, from a high of approximately 120 employees to 31 employees as of March 31, 2003. o Elimination of our marginal products and services, reducing the number of discrete product offerings from over 100 to approximately 25; o Upgrading and improvement of our user-friendly website (www.fcc.net) promoting our products and services, and allowing for on line ordering; o Development of a third-party network of selling agents (VARs) for the sales and marketing of our products and services, which had approximately 130 Frontline VARs registered as of March 14, 2003; o Closure of two of our four offices and the consolidation of two owned POPs; o Integration of our Product and Customer Service Divisions at our Pearl River, New York headquarters including closure of our Howell, New Jersey Call Center; and o Discontinuation of expenditures related to our CLEC Communications Corp. subsidiary. We intend to continue our efforts to reduce costs, without sacrificing the levels of service we provide to our customers, while adjusting our business strategy, where necessary, in response to changing technology, market conditions, and financial matters. Trademarks and Service Marks We have filed an application for Federal Trademark Registration and claim rights to the following mark: Frontline Communications Corp. We have been granted Federal Trademark Registrations for the following trademarks: Frontline.net and Frontline.net Effortless E-Commerce and Internet Access (name and two logos). All other trademarks and service marks used in this report are the property of their respective owners. Industry Regulation The following summary of regulatory developments and legislation relating to our Internet business does not describe all present and proposed federal, state and local regulations and legislation affecting us and our industry. Other proposed and existing federal, state and local legislation and regulations are currently the subject of judicial proceedings, legislative hearings and administrative proposals which could change the manner in which our industry operates. Neither the outcome of these proceedings, nor their impact upon us or our industry, can be predicted at this time. Internet Service Provider Regulation. Currently, few U.S. laws or regulations specifically regulate communications or commerce over the Internet. However, changes in the regulatory environment relating to the Internet connectivity market, including regulatory changes which directly or indirectly affect telecommunications costs or increase the likelihood or scope of competition from the regional Bell operating companies or other telecommunications carriers, could affect the prices at which we may 10 sell our services and impact competition in our industry. Congress and the Federal Communications Commission will likely continue to explore the potential regulation of the Internet. For instance, the Federal Communications Commission may subject certain services offered by ISPs to regulation as "telecommunications service", which could result in us being subject to universal service fees, regulatory fees and other fees imposed on regulated telecommunications providers, which could cause our costs of doing business to increase substantially. Future laws and regulations could be adopted or modified to address matters such as user privacy, copyright and trademark protection, pricing, consumer protection, child protection, characteristics and quality of Internet services, libel and defamation, and sales and other taxes. Internet-related legislation and regulatory policies are continuing to develop, and we could be subject to increased regulation in the future. Laws or regulations could be adopted in the future that may decrease the growth and expansion of the Internet's use, increase our costs, or otherwise adversely affect our business. In 1998, Congress passed the Digital Millennium Copyright Act. That act provides numerous protections from certain types of copyright liability to Internet service providers that comply with its requirements. We have adopted policies and procedures in accordance with the act, however, to the extent that we have not met those requirements, third parties could seek recovery from us for copyright infringements caused by our Internet customers. The law relating to the liability of Internet service providers for information carried on or disseminated through their networks is currently unsettled. It is possible that claims could be made against Internet service providers for defamation, negligence, copyright or trademark infringement or on other theories based on the nature and content of the materials disseminated through their networks. We could be required to implement measures to reduce our exposure to potential liability, which could include the expenditure of resources or the discontinuance or modification of certain product or service offerings. Costs that may be incurred as a result of contesting any claims relating to our services or the consequent imposition of liability could have a material adverse effect on our financial condition, results of operations and cash flow. Employees As of March 31, 2003, we had 31 full-time employees including 4 executive officers. We also engage part-time employees from time to time. None of our employees are represented by a union. We consider our employee relations to be good. Provo and its affiliates have 135 employees, 134 of whom are full time. Item 2. Description of Property Our executive offices are located in Pearl River, New York, where we lease approximately 12,000 square feet of space through a lease that expires in August of 2004. We also lease approximately 2,700 square feet of space in Babylon, New York that was assumed in connection with our purchase of PNM group, Inc. (d/b/a) Planet Media. The lease expires in August of 2003. The aggregate annual rent of the two offices is approximately $308,000. 11 In 2001, as a part of our Restructuring Program, we closed our regional offices in Delaware and Virginia and have terminated the leases with the landlords. We lease approximately 2,400 square feet in Howell, New Jersey under a lease that expires in May 2004 and provides for monthly rental of approximately $3,500. We have closed our office at this location and are attempting to terminate the lease. We also lease space (typically, less than 100 square feet) in various geographic locations to house the telecommunications equipment for each of our POPs. Leases for the POPs have various expiration dates through (June 2003). Aggregate annual rentals for POPs are approximately $6,000. Provo's principal office is a leased building located in Mexico City. Provo also leases 16 additional smaller offices at various locations throughout Mexico, where it maintains staff dedicated to sales and distribution. Item 3. Legal Proceedings The Company is subject to various proceedings in the normal course of its business. We do not anticipate any substantial impact or effect on the Company from any such proceedings. Item 4. Submission of Matters to a Vote of Security Holders Not applicable. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. Market Information. Commencing on February 7, 2000 our Common Stock has been listed on the American Stock Exchange ("AMEX") under the symbol "FNT". From May 14, 1998 until February 7, 2000, our Common Stock was traded on the NASDAQ SmallCap Market under the symbol "FCCN". The following table sets forth, for the periods indicated, the range of the high and low closing prices for the Common Stock as reported by AMEX.
Fiscal Year Ended December 31, 2002 High Low ----------------------------------- ---- --- First Quarter .29 .14 Second Quarter .31 .15 Third Quarter .43 .14 Fourth Quarter .36 .13 Fiscal Year Ended December 31, 2001 High Low ----------------------------------- ---- --- First Quarter .31 .18 Second Quarter .59 .18 Third Quarter .27 .15 Fourth Quarter .38 .15
12 The number of record holders of our Common Stock was 237 as of April 3, 2003. We believe that there are in excess of 2,700 beneficial owners of our Common Stock. Dividend Policy. To date, we have not declared or paid any cash dividends on our common stock. The payment of dividends on our common stock, if any, in the future is within the discretion of the Board of Directors and will depend upon the Company's earnings, its capital requirements and financial condition and other relevant factors such as the rights of holders of capital stock that ranks senior with respect to dividends, such as our Series B Convertible Redeemable Preferred Stock. We presently intend to retain any earnings to finance our business and do not expect to declare or pay any cash dividends on our common stock in the foreseeable future. Holders of our Series B Convertible Redeemable Preferred Stock are entitled to receive annual cumulative dividends of $.60 per share payable semi-annually in June and December of each year. The dividends are paid in cash or in shares of Common Stock, at our discretion. In June and December 2002, our directors elected not to declare a dividend on our Series B Convertible Redeemable Preferred Stock. Accrued expense at December 31, 2002 includes $297,867 representing unpaid dividends. Changes in Securities and Use of Proceeds During the three months ended December 31, 2002, we issued 51,000 shares of common stock upon conversion of 15,000 shares of Series B Convertible Redeemable preferred stock. The foregoing shares were issued pursuant to exemptions from registration under Sections 3(a)(9) and 4(2) of the Securities Act of 1933. Equity Plan Compensation Information The following table sets forth information as of December 31, 2002 regarding compensation plans under which our equity securities are authorized for issuance.
Plan Category Number of Weighted- Number of Securities to be average securities remaining issued upon exercise price available for future exercise of of outstanding issuance under outstanding options, warrants equity compensation options, warrants and rights plans (excluding and rights securities reflected in column (a)) (a) (b) (c) Equity compensation plans approved by security holders (1) 1,289,000 $2.81 556,500 Equity compensation plans not Approved by security holders (2) 1,676,300 $3.00 --------- ----- ------- Total 2,965,300 $2.92 556,500 ========= ===== =======
(1) Pursuant to our 1997 Stock Option Plan. 13 (2) Outstanding warrants to acquire shares of common stock. The warrants expire at various times through 2005 and the warrant holders have certain anti-dilution rights. Excludes warrants to acquire 1,840,000 shares of common stock sold in our initial public offering. Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations. Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995: The Statements contained in this Item 6 and elsewhere in this Form 10-KSB which are not historical facts are "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934. These "forward looking statements" are subject to a number of known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward looking statements. Such risk factors include, but are not limited to, risks associated with the Company's ability to attract and retain new subscribers, ability of the Company to successfully integrate newly acquired subscribers and business entities into its operations, ability to manage any future growth, uncertainties regarding future operating results, risks relating to changes in the market for internet services, regulatory and technological changes, possible inability to protect proprietary rights, changes in consumer preferences and demographics, competition, reliance on telecommunication carriers, ability to expand the Company's network structure, ability to obtain any necessary future financing, unfavorable general economic conditions, uncertainty of customer and supplier plans and commitments, the risks related to the acquisition of Provo and the ability to maintain the American Stock Exchange and Nasdaq Small Cap Market listing of the Company's securities and other risks detailed in this report and in the Company's other Securities and Exchange Commission filings. The words "believe", "expect", "anticipate", "intend" and "plan" and similar expressions identify forward-looking statements, which speak only as of the date they were made. We undertake no obligation to update any forward-looking statements contained in this report. Overview During 2002 and 2001, a significant part of our revenues were derived from providing Internet access services to individuals and businesses. These revenues were comprised principally of recurring revenues from our customer base, leased line connections and various ancillary services. We charge subscription fees, which are billed monthly, quarterly, semi-annually or annually in advance, typically pursuant to pre-authorized credit card accounts. The balance of our revenues during those periods were derived from website design, development and hosting services. Monthly subscription service revenue for Internet access is recognized over the period in which services are provided. Fee revenues for website design, development and hosting services are recognized as services are performed. Deferred revenue represents prepaid access fees by customers. Restructuring Program. 14 In October 2000, we initiated a Restructuring Program designed to, among other things, reduce our operating losses. The program consists of reductions of personnel, reduction in marketing and promotional expenses, consolidation of certain operations, exit from certain marginal product lines not related to our core business, and closure of regional offices. We believe that the Restructuring Program and related cost reductions, will permit us to maintain service quality to our customers while our more focused product offering portfolio will enhance our ability to grow our revenue base. To date we have realized significant cost reductions. However, there can be no assurance that the Restructuring Program will achieve the desired results, that there will not be any disruption of any services offered by us, or resulting loss of revenues from reduced product lines and marketing expenditures. The restructuring program was substantially completed by December 31, 2002. Results of Operations Comparison of Years ended December 31, 2002 and 2001: Revenues. Revenues decreased for the year ended December 31, 2002 by $1,456,022 or 22.4% over the prior year. The decrease in revenues were in part due to closure of our unprofitable satellite offices and due to lesser website development work performed by us in 2002. We anticipate that our revenues will decrease in 2003. Cost of Revenues. For the year ended December 31, 2002, cost of revenues decreased by $989,617 to $2,493,337. As a percentage of revenues, cost of revenues decreased to 49.4% from 53.6%. The decrease in cost of revenues was due to cost reductions realized through our Restructuring Program. We anticipate that our cost of revenue in absolute dollars will decrease in 2003. Selling, General and Administrative. For the year ended December 31, 2002 selling, general and administrative expenses decreased by $1,414,183. As a percentage of revenues, selling, general and administrative expenses decreased from 59.4% in 2001 to 48.5% in 2002. The decrease in selling, general and administrative expenses was due to cost reductions realized through our Restructuring Program. The principal component of the decrease was in payroll and related costs due to workforce reduction. Depreciation and Amortization. For the year ended December 31, 2002, depreciation and amortization decreased by $2,198,543 to $745,135. The decrease was due to reduced amortization resulting from our intangibles written off as impaired in the fourth fiscal quarter of 2001. Non cash compensation charges. In September 2001, we granted 1,376,700 restricted shares of our common stock to our employees under the Company's 2001 Stock Incentive Plan. Accordingly, $206,505 representing the fair value of the shares granted, was charged to operations as a non-cash compensation charge. During 2002, we recognized a non-cash compensation charge of $58,500 for shares issued in exchange for services from consultants. Impairment of intangibles. During the year ended December 31, 2001, due to changes in circumstances, we determined that the carrying amount of intangible assets of The PressRoom Online Services, Wizardnet, Inc., Delanet and PNM Group, which we acquired in 2000, were impaired. Accordingly we recorded an impairment charge of approximately $2,800,000 on these assets. 15 Interest Expense. Interest expense for 2002 was $95,417 compared to an interest expense of $131,778 for 2001. Interest expense decreased in 2002 due to decreased debt levels. Net loss. As a result of the foregoing, for the year ended December 31, 2002, net loss decreased by 88.8% or $6,241,762 to $787,525 compared to a net loss of $7,029,287 in 2001. We incurred significant losses as revenues generated were not sufficient to offset the substantial up-front expenditures and operating costs associated with attracting and retaining additional customers. Liquidity and Capital Resources. Our working capital deficiency at December 31, 2002 was $2,655,722 compared with a working capital deficiency of $1,725,323 at December 31, 2001. The increase in working capital deficiency was primarily due to the effect of a promissory note that is payable in June 2003 in the principal amount of $728,600 becoming a current liability and also from operating losses. Our primary capital requirements are to fund acquisition of customer bases and related Internet businesses, install network equipment, and working capital. To date, we have financed our capital requirements primarily through issuance of debt and equity securities. We currently do not have any bank lines of credit. The availability of capital resources is dependent upon many factors, including, but not limited to, prevailing market conditions, interest rates, and our financial condition. In June 2002, we completed a private placement of 8% promissory notes and received proceeds of $200,000 (including $50,000 from our Officers and Directors). The promissory notes bear interest at 8% and mature in three years from the date of issuance. We have the option to convert the principal amount due under the promissory notes into shares of our common stock at a conversion price of $4.80 per share, under certain circumstances, as defined in the agreement with the promissory note holders, such as the market price of our common stock exceeding $6 per share. We also issued to the note holders warrants to purchase an aggregate of 1,000,000 shares of our common stock at an exercise price of $.08 per share. Out of the proceeds, $75,000 was allocated as the value of the warrants and deducted from the current value of the notes payable in the accompanying balance sheet (Discount). The debt issue discount arising from the value of the warrants is being amortized as additional interest over the life of the promissory notes. As discussed in Item 1-Business, in April 2003, we acquired Provo. If we receive the Requisite Approvals from our stockholders, which will result in the obligations under the Acquisition Note not becoming effective, we believe that the addition of Provo's operations to our operations will enable us to meet our obligations as they come due and that we will be able to continue as a going concern. If we are unable to obtain the Requisite Approvals from our stockholders which will result in our being liable to the Sellers under the Acquisition Note, then we will need additional financing in 2003 to continue operations as currently conducted. We have no available standby sources of financing and there can be no assurance that any additional financing will be available to us on acceptable terms, or at all. 16 Critical Accounting Policies and Estimates Our discussion and analysis of our financial conditions and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these financial statement requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, accounts receivable, long-lived assets and income taxes. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the current circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our significant judgment and estimates use in preparation of our consolidated financial statements. Revenue Recognition During 2002 and 2001, a significant part of our revenues were derived from providing Internet access to individuals and businesses. These revenues were comprised principally of recurring revenues from our customer base, leased line connections and various ancillary services. We charge subscription fees, which are billed monthly, quarterly, and semi-annually or annually in advance, typically pursuant to pre-authorized credit card accounts. The balance of our revenues during those periods were derived from website design, development and hosting services. Monthly subscription revenue for Internet access is recognized over the period in which services are provided. Fee revenue for website design, development and hosting services are recognized as services are performed. Deferred revenue represents prepaid access fees by customers. Accounts Receivable Accounts receivable are reported at their outstanding unpaid principal balances reduced by an allowance for doubtful accounts. We estimate doubtful accounts based on historical bad debts, factors related to specific customers' ability to pay, and current economic trends. We write off accounts receivable against the allowance when a balance is determined to be uncollectible. Long-Lived Assets We assess the impairment of long-lived assets, which include property and equipment, intangibles and customer bases when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through the estimated undiscounted future cash flows from the use of these assets. When any such impairment exists, the related assets will be written down to fair value. Income Taxes Our net deferred tax assets, consisting of primarily federal and state net operating loss carry forwards, have been offset by a full valuation allowance. In determining the 17 need for a valuation, we review both positive and negative evidence, including current and historical operating results. Based upon our assessment of all available evidence, we have concluded that it is more likely than not that deferred tax assets will not be realized. Item 7. Financial Statements. The financial statements appear in a separate section of this report following Part III. Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. Information regarding the Company's change in accountants may be found in the Company's Form 8-K for the event dated January 10, 2001. PART III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act. The directors and executive officers of the Company are as follows:
Name Age Position ---- --- -------- Ventura Martinez Del Rio, Sr. 53 Chairman of the Board Stephen J. Cole-Hatchard 45 Chief Executive Officer and Director Nicko Feinberg 31 President, U.S. Operations and Director Vasan Thatham 45 Vice President and Chief Financial Officer Amy Wagner-Mele 34 Executive Vice President, Secretary and General Counsel Ventura Martinez Del Rio, Jr. 29 President, Mexican Operations and Director Ronald C. Signore 42 Director William A. Barron 53 Director Miguel Madero 54 Director
Ventura Martinez Del Rio, Sr. has been our Chairman since April of 2003. Mr. Martinez Del Rio, Sr. earned an undergraduate degree in Economics from the Universidad Anahuac in Mexico in 1972 and an MBA from the University of Texas in 1974. He is currently the president of the Texas EX's in Mexico, a widely popular alumni 18 organization. From 1983 to 1994, Mr. Martinez Del Rio, Sr. served in many executive leadership roles for the Mexican National Lottery, developing a vast business contact network that includes numerous senior Mexican government officials and the leaders of numerous senior Mexican government officials and the leaders of numerous prominent retail organizations throughout Mexico. He founded Provo in October of 1995. Mr. Martinez Del Rio, Sr. has served as chairman of the board of Provo since its inception. Stephen J. Cole-Hatchard has been our Chief Executive Officer since August 1997. Mr. Cole-Hatchard was our Vice President of Finance from February 1997 to August 1997, our President from August 1997 to July 2001, our Chairman from August 1997 to April 2003 and has been one of our directors since February 1997. Mr. Cole-Hatchard was Chief Financial Officer of Hudson Technologies, Inc., a refrigerant services company specializing in recovery and decontamination services, from 1993 to 1996, and has been a licensed attorney since 1988. Nicko Feinberg founded our Company in 1995, has been a director since November 1996, and was appointed as President, U.S Operations in April 2003. He was our Executive Vice President of Technology from November 1996 to July 2001, Chief Information Officer from August 1997 to July 2001 and President and Chief Operating Officer from July 2001 to April 2003. Mr. Feinberg was a Sales Manager and, from April 1991 to April 1994, a Sales Account Executive for Microage Computer Outlet, Inc., a company engaged in computer sales. Vasan Thatham has been our Vice President and Chief Financial Officer since February 1999. From 1994 through 1998, Mr. Thatham was Vice President and Chief Financial Officer of Esquire Communications Ltd., a company engaged in providing legal support services. Amy Wagner-Mele has been our Vice President and General Counsel since December 1998 and our Secretary since September 1998, and was our Vice President, Secretary and Corporate Counsel from September 1998 to December 1998. From September 1997 to August 1998, Ms. Wagner-Mele was an associate with the law firm of Winston & Strawn. From 1993 to August 1997, Ms. Wagner-Mele was an associate with the law firm of Podvey, Sachs, Meanor, Catenacci, Hildner & Cocoziello, P.C. Ventura Martinez Del Rio, Jr. has been our director since April 2003 and was appointed as President, Mexican operations in April 2003. Mr. Ventura Martinez Del Rio, Jr. earned a BBA degree from the Universidad Anahuac in Mexico in 1994 and a graduate degree in business from Ipade Business School ("IBS"). IBS is a highly-regarded (business management school based in Mexico City. He joined Provo in 1996 as its Chief Operating Officer, co-led the company through its rapid growth from 1996 to 2001 and was named its Chief Executive Officer in 2001. Ronald C. Signore has been one of our directors since December 1997. Mr. Signore has been a partner in the accounting firm of Gray, Signore & Co., LLP for more than the past five years. William A. Barron has been one of our directors since January 2000. Prior to retirement, Mr. Barron served as Vice President and Chief Financial Officer of Hudson Technologies, Inc. from July 1996 to March 1997. Prior to that, Mr. Barron was President and Chief Operating Officer for Diagnostek, Inc., a pharmacy benefit management company, from May 1994 to October 1995 and Executive Vice President and 19 Chief Financial Officer for Diagnostek, Inc. from March 1993 to April 1994. From February 2001 through July 2001, as part of the Restructuring Program, Mr. Barron served as interim Vice President and Chief Operating Officer of the Company. Miguel Madero has been our director since April 2003. Mr. Miguel Madero earned a BA in Industrial Engineering from the Universidad Iberoamericana in Mexico City in 1971, and obtained an MBA from the University of Texas at Austin in 1975. In September 1985, he co-founded Fomento y Direccion Economica, S.A. de C.V., a financial advisory and investment banking firm in Mexico City where he currently serves as a Managing Director. Mr. Madero sits on the Board of Directors of Credito Inmobiliario S.A. de C.V., a real estate financing company in Mexico. All directors hold office until the next annual meeting of stockholders for the ensuing year or until their successors have been duly elected and qualified. Officers are elected annually by the Board of Directors and serve at the discretion of the Board. Item 10. Executive Compensation. The following table sets forth compensation paid to our Chief Executive Officer and our two other most highly compensated executive officers (each of whom was serving at the end of our fiscal year ended December 31, 2002) during the years ended December 31, 2002, 2001 and 2000. No other executive officer of the Company received aggregate compensation which exceeded $100,000 during the year ended December 31, 2002. We refer to these three executive officers as our "Named Executives".
Long-Term Compensation Awards Securities Underlying Name and Principal Position Year Salary Bonus Options/SAR (#) --------------------------- ---- ------ ----- --------------- Stephen J. Cole-Hatchard 2002 $112,482 Chief Executive Officer 2001 114,423 67,725 (1) 52,000 2000 117,692 34,500 25,000 Nicko Feinberg 2002 $107,761 President 2001 109,518 49,175 (2) 52,000 2000 110,000 24,500 27,000 Vasan Thatham 2002 $105,265 Chief Financial Officer 2001 109,518 15,051 (3) 27,000 2000 110,000 18,500 12,000
(1) Includes $43,725 representing the fair market value on the date of the award of 291,500 shares of common stock issued under our 2001 Stock Incentive Plan. (2) Includes $35,175 representing the fair market value on the date of the award of 234,500 shares of common stock issued under our 2001 Stock Incentive Plan. 20 (3) Includes $13,425 representing the fair market value on the date of the award of 89,500 shares of common stock issued under our 2001 Stock Incentive Plan. The following table sets forth information regarding options granted during the year ended December 31, 2002 to our Named Executives: Options/SAR Grants in Year Ending December 31, 2002
Number of Shares % of Total Underlying Options/SAR Options/ SARs Granted Exercise Price Expiration Granted in Year $/share) Date ------- ------- -------- ---- Stephen J.Cole-Hatchard _ _ _ _ Nicko Feinberg _ _ _ _ Vasan Thatham _ _ _ _
The following table sets forth information concerning the number of options owned by our Named Executives, the value of any in-the-money unexercised options as of December 31, 2002 and information concerning options exercised by our Named Executives during the year ended December 31, 2002: Aggregated Option Exercises and Year-End Option/SAR Values
Shares Number of Securities Value of Unexercised Acquired Value Underlying Unexercised In-The-Money On Exercise Realized ($) Options/SARs at 12/31/2002 Options/SARs at 12/31/2002 ----------- ------------ -------------------------- -------------------------- Exercisable Unexercisable Exercisable Unexercisable ----------- ------------- ----------- ------------- Stephen J.Cole-Hatchard 0 $0 302,000 $2,080 Nicko Feinberg 0 $0 245,000 $2,080 Vasan Thatham 0 $0 100,000 $1,080
The year-end values for unexercised in-the-money options represent the positive difference between the exercise price of the options and the year-end market value of our common stock. An option is "in-the-money" if the year-end fair market value of our common stock exceeds the option exercise price. The closing sale price of our common stock on December 31, 2002 was $.26. Employment Agreements 21 The Board of Directors has approved the adoption of employment agreements between the Company and/or its affiliates and Messrs. Thatham, Feinberg, Martinez del Rio Jr., Cole-Hatchard and Martinez del Rio Sr. that provide for an annual base compensation of not less than $115,000, $120,000, $120,000, $150,000 and $150,000, respectively. The agreements will provide for certain base salary increases in the event the Company completes an equity financing in excess of $7,000,000, and for certain bonuses in the event the Company achieves certain revenue objectives. The agreements will also allow for such bonuses as the Board of Directors may, in its sole discretion, from time to time determine. The employment agreements with Messrs. Thatham, Feinberg, Martinez Del Rio Jr., Cole-Hatchard and Martinez Del Rio Sr. will expire in April 2005 subject to automatic successive one year renewals unless either we or the employee gives notice of intention not to renew the agreement. With the exception of Mr. Martinez del Rio Sr., the employment agreements will provide for employment on a full-time basis, and each of the agreements will contain a provision that the employee will not compete or engage in a business competitive with our current or anticipated business during the term of the employment agreement and for a period of two years thereafter. All of the employment agreements will provide that the employees shall be paid additional compensation equal to 295% of their annual base salary in the event of a change of ownership or effective control of our company (as defined in the agreements). The anticipated change in control as a result of the acquisition of Provo will not trigger the additional compensation clauses of the employment agreements. Director Compensation Each of our non-employee directors received $6,000 in 2002 for attending Board Meetings. 1997 Stock Option Plan In February 1997, our Board of Directors and stockholders adopted our 1997 Stock Option Plan, pursuant to which 500,000 shares of common stock were reserved for issuance upon exercise of options. In June 2000, the Board of Directors and our stockholders approved an amendment to increase to 2,000,000 the number of shares of common stock available for issuance upon exercise of options under the stock option plan. Our stock option plan is designed to serve as an incentive for retaining qualified and competent employees, directors and consultants. Our Board of Directors or a committee of our Board administers our stock option plan and is authorized, in its discretion, to grant options under our stock option plan to all eligible employees, including our officers, directors (whether or not employees) and consultants. Our stock option plan provides for the granting of both "incentive stock options" (as defined in Section 422 of the Internal Revenue Code of 1986, as amended) and non-qualified stock options. Options can be granted under our stock option plan on such terms and at such prices as determined by the Board of Directors or its committee, except that the per share exercise price of options will not be less than the fair market value of the common stock on the date of grant. In the case of an incentive stock option granted to a stockholder who owns stock possessing more than 10% of the total combined voting power of all of our classes of stock, the per share exercise price will not be less than 110% of the fair market value on the date of grant. The aggregate fair market value (determined on the date of grant) of the shares 22 covered by incentive stock options granted under our stock option plan that become exercisable by a grantee for the first time in any calendar year is subject to a $100,000 limit. Options granted under our stock option plan will be exercisable during the period or periods specified in each option agreement. Options granted under our stock option plan are not exercisable after the expiration of 10 years from the date of grant (five years in the case of incentive stock options granted to a stockholder owning stock possessing more than 10% of the total combined voting power of all of our classes of stock) and are not transferable other than by will or by the laws of descent and distribution. 2001 Stock Incentive Plan In June and July 2001, our Board of Directors and stockholders, respectively, adopted our 2001 Stock Incentive Plan ("Incentive Plan") pursuant to which the grant of any or all of the following types of awards may be made under the Incentive Plan (collectively, "Awards"): (1) stock options, (ii) restricted stock, (iii) deferred stock and (iv) other stock-based awards. Awards may be granted singly, in combination, or in tandem, as determined by the administrators of the Incentive Plan. A total of 1,800,000 shares of our common stock, subject to anti-dilution adjustment as provided in the Incentive Plan, have been reserved for distribution pursuant to the Incentive Plan. The maximum number of shares of common stock that may be issued upon the grant of an Award to any individual participant cannot exceed 500,000 shares during the term of the Incentive Plan. The Incentive Plan can be administered by our Board of Directors or a committee consisting of two or more non-employee members of the Board of Directors appointed by the Board. The Board or the committee will determine, among other things, the persons to whom Awards will be granted, the type of Awards to be granted, the number of shares subject to each Award and the share price. The Board or the committee will also determine the term of each Award, the restrictions or limitations thereon, and the manner in which each such Award may be exercised or, if applicable, the extent and circumstances under which common stock and other amounts payable with respect to an Award will be deferred. Unless sooner terminated, the Incentive Plan will expire at the close of business on June 20, 2011. The Incentive Plan provides for the grant of both incentive stock options and non-qualified stock options. The exercise price of an incentive stock option or a non-qualified stock option will not be less than the fair market value of the shares underlying the option on the date the option is granted, provided, however, that the exercise price of an incentive stock Option granted to a stockholder who possesses more than 10% of the combined voting power of all classes of our stock may not be less than 110% of such fair market value. The aggregate fair market value (determined at the time the option is granted) of the shares of common stock covered by an incentive stock option granted under the Incentive Plan that become exercisable by a grantee for the first time in any calendar year cannot exceed $100,000. The Incentive Plan contains anti-dilution provisions authorizing appropriate adjustments in certain circumstances. Shares of Common Stock subject to Awards which expire without being exercised or which are cancelled as a result of the cessation of employment are available for further grants. Options become exercisable in such amounts, at such intervals and upon such terms and conditions as the Board of Directors or the Committee provides. 23 Under the Incentive Plan, the Board or the Committee may grant shares of restricted Common Stock either alone or in tandem with other Awards. Restricted and Deferred Stock awards give the recipient the right to receive a specified number of shares of common stock, subject to such terms, conditions and restrictions as the Board or the Committee deems appropriate. Other Stock-Based Awards, which may include performance shares and shares valued by reference to the performance of the Company or any parent or subsidiary of the Company, may be granted under the Incentive Plan either alone or in tandem with other Awards. Item 11. Security Ownership of Certain Beneficial Owners and Management. The following table sets forth certain information, as of April 3, 2003 relating to the beneficial ownership of shares of Common Stock by: (i) each person or entity who is known by the Company to own beneficially five percent or more of the outstanding Common Stock; (ii) each of the Named Executives; (iii) each of the Company's directors; and (iv) all directors and executive officers of the Company as a group.
Name of Beneficial Owner Number of Shares Percentage Beneficially Owned (1) Nicko Feinberg 866,500 (2) 8.2% Stephen J. Cole-Hatchard 1,066,718 (3) 10.0% Ronald Signore 329,032 (4) 3.2% William Barron 178,972 (5) 1.7% Ventura Martinez Del Rio, Sr. - - Ventura Martinez Del Rio, Jr. - - Miguel Madero - - Vasan Thatham 195,500 (6) 1.9% All Directors and Executive Officers as a group (nine persons) 2,942,222 (7) 25.5%
(1) Unless otherwise indicated, we believe that all persons named in the table have sole voting and investment power with respect to all shares of Common Stock beneficially owned by them. (2) Includes warrants to purchase 125,000 shares of Common Stock and options to purchase 245,000 shares of Common Stock. The address of Mr. Feinberg is c/o the Company at One Blue Hill Plaza, 7th Floor, Pearl River, New York 10965 (3) Includes 144,000 shares held by the Cole-Hatchard Family Limited Partnership, of which Mr. Cole-Hatchard is a general partner, options to purchase 302,000 shares of Common Stock and 171,530 shares of Common Stock issuable upon exercise of 50,450 shares of Series B Preferred Stock. The address of Mr. Cole-Hatchard is c/o the Company. (4) Includes warrants to purchase 125,000 shares of Common Stock and options to purchase 80,000 shares of Common Stock. (5) Includes options to purchase 87,000 shares of Common Stock and 680 shares of Common Stock issuable upon conversion of 200 Shares of Series B Preferred Stock. (6) Includes options to purchase 100,000 shares of Common Stock. (7) Includes options and warrants to purchase 1,214,000 shares of Common Stock and 172,210 shares of Common Stock issuable upon exercise of 50,650 shares of Series B Preferred Stock. 24 Item 12. Certain Relationships and Related Transactions. In June 2002, Mr. Nicko Feinberg and Mr. Ronald Signore, our current directors, purchased $50,000 in aggregate principal amount of promissory notes pursuant to our June 2002 private placement, and received warrants to purchase 250,000 shares, in aggregate, of our common stock at an exercise price $.08 per share. These purchases were all on terms and conditions identical to those of the other investors in the private placement. In connection with the acquisition of Provo, we issued to 18 individuals an aggregate of 35,500 shares of our Series D Convertible Preferred Stock including 10,000 shares to Stephen J. Cole-Hatchard, our Chairman of the Board and Chief Executive Officer, 10,000 shares to Nicko Feinberg, our President U.S Operations, and a director, 5,000 shares of Series D to Joseph Donohue, a then director, 1,000 shares to Vasan Thatham, our Vice President and Chief Financial Officer and 1,000 shares to Amy Wagner-Mele, our Executive Vice President and General Counsel. Each share of Series D Convertible Preferred Stock is convertible into 150 shares of common stock upon receipt of the approval by our shareholders of (i) the issuance of common stock upon conversion of the Series D Convertible Preferred Stock, (ii) an increase in our authorized common shares to 75 million and (iii) a 1 for 1.5 reverse split of our common stock . Accordingly, if our shareholders approvals are obtained, the Series D Preferred will convert into an aggregate of 5,325,000 shares of common stock (without giving effect to the proposed reverse split), of which 1,500,000 shares will be issued to Mr. Cole-Hatchard, 1,500,000 shares will be issued to Mr. Feinberg, 750,000 shares will be issued to Mr. Donahue, 150,000 shares to Mr. Thatham and 150,000 shares to Ms. Mele. In April 2003, we borrowed $550,000 from an unaffiliated entity ("Lender") and issued a secured promissory note ("Note") to the lender. The Note bears interest of 14% and is secured by substantially all of our assets. Two of our officers, Messrs. Nicko Feinberg and Stephen J. Cole-Hatchard have pledged shares of common stock owned by them in our company as additional collateral to the lender. In addition, Mr. Cole-Hatchard has personally guaranteed the repayment of the Note. Item 13. Exhibits, Lists and Reports on Form 8-K. (a) Exhibits 2.1 Amended and Restated Stock Purchase Agreement between Frontline Communications Corporation, Proyecciones y Ventas Organizadas, S.A., Ventura Martinez del Rio Requejo and Ventura Martinez del Rio Arrangoz dated April 3, 2003. **** 3.1 Certificate of Incorporation of the Company.+ 25 3.2 Certificate of Amendment of the Certificate of Incorporation of the Company.+++ 3.3 Certificate of Amendment of the Certificate of Incorporation of the Company.* 3.4 By-Laws of the Company.+ 4.1 Certificate of Designation of Series A preferred stock.++ 4.2 Certificate of Designation of Series B cumulative convertible preferred stock.* 4.3 Certificate of Designation of Series C convertible preferred stock.**** 4.4 Certificate of Designation of Series D convertible preferred stock.**** 10.1 Employment Agreements with Messrs. Stephen Cole-Hatchard and Nicko Feinberg.+# 10.2 Employment Agreement with Vasan Thatham.*# 10.3 2001 Stock Incentive Plan.***# 10.4 1997 Stock Option Plan.+# 10.5 Office Lease between the Company and Glorious Sun Robert Martin LLC.+ 10.6 Amendment No. 1 to Office Lease.* 10.7 Amendment No. 2 to Office Lease.* 10.8 Asset Purchase Agreement dated June 20, 2000 among Frontline Communications Corp., Delanet, Inc., Michael Brown and Donald McIntire.** 10.9 Asset Purchase Agreement dated June 20, 2000 among Frontline Communications Corp., Delanet, Inc., Michael Brown and Donald McIntire.** 10.10 Addendum to Amended and Restated Stock Purchase Agreement between Frontline Communications Corporation, Proyecciones y Ventas Organizadas, S.A., Ventura Martinez Del Rio, Sr. and Ventura Martinez Del Rio, Jr. dated April 3, 2003. **** 10.11 Registration Rights Agreement dated April 3, 2003 between Frontline Communications, Ventura Martinez Del Rio, Sr. and Ventura Martinez Del Rio, Jr..**** 10.12 Security Agreement dated April 3, 2003 between Frontline Communications, Ventura Martinez Del Rio, Sr. and Ventura Martinez Del Rio Jr.. **** 26 10.13 Secured Promissory Note dated April 3, 2003 between Frontline Communications, Ventura Martinez Del Rio, Sr. and Ventura Martinez Del Rio, Jr.. **** 10.14 Term Loan and Security Agreement among Frontline Communications, Proyecciones y Ventas Organizadas, S.A., and IIG Equity Opportunities Fund Ltd. **** 10.15 Pledge Agreement between Stephen J. Cole-Hatchard, Nicko Feinberg, Elizabeth Feinberg and IIG Equity Opportunities Fund Ltd Dated April 3, 2003. **** 10.16 Registration Rights Agreement between Frontline Communications Corporation and IIG Equity Opportunities Fund Ltd dated April 3, 2003. **** 10.17 Limited guarantee agreement dated April 3, 2003 between Stephen J. Cole-Hatchard and IIG Equity Opportunities Fund Ltd dated April 3, 2003. **** 10.18 Mortgage by Stephen J. Cole-Hatchard in favor of IIG Equity Opportunities Fund Ltd dated April 3, 2003.**** 10.19 Mortgage and Security Agreement by Stephen J. Cole-Hatchard in favor of IIG Equity Opportunities Fund Ltd dated April 3, 2003. **** 10.20 Subordination Agreement between 8% Promissory Note Holders and IIG Equity Opportunities Fund Ltd dated April 3, 2003. **** 21.1 Subsidiaries of the Company. 23.1 Consent of Goldstein Golub and Kessler LLP. 31.1 Certification by Stephen J. Cole-Hatchard pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. 31.2 Certification by Vasan Thatham pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. 32.1 Certification of Stephen J. Cole-Hatchard pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Vasan Thatham pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Footnotes from previous page) --------------- * Incorporated by reference to the applicable exhibit contained in the Company's Registration Statement on Form SB-2 (file no.333-92969). + Incorporated by reference to the applicable exhibit contained in the Company's Registration Statement on Form SB-2 (file no. 333-34115). ++ Incorporated by reference to the applicable exhibit contained in the Company's Current Report on Form 8-K dated October 9, 1998. 27 +++ Incorporated by reference to applicable exhibit contained in the Company's Quarterly Report on Form 10-QSB for the quarterly period ended June 30, 1999. ** Incorporated by reference to the applicable exhibit contained in the Company's Current Report on Form 8-K dated June 20, 2000. *** Incorporated by reference to Appendix B to the Registrant's definitive proxy statement on Schedule 14A filed with the SEC on July 3, 2001. **** Incorporated by reference to applicable exhibit contained in the Company's Annual Report on Form 10-KSB for the fiscal year ended December 31, 2002. # Denotes a management compensation plan or arrangement. (b) Reports on Form 8-K filed during the quarter ended December 31, 2002: Not applicable. Item 14. Controls and Procedures Within 90-day period prior to the filing of this report, an evaluation was carried out under the supervision and with participation of our management, including the Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of our disclosure controls and procedures. Based on that evaluation, the CEO and CFO have concluded that our disclosure controls and procedures are effective to ensure that the information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Subsequent to the date of their evaluation, there were no significant changes in our internal controls or other factors that could significantly affect the internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses. 28 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly signed this report on its behalf by the undersigned, thereunto duly authorized on the 6th day of October 2003. FRONTLINE COMMUNICATIONS CORPORATION By: /s/ Stephen J. Cole-Hatchard ------------------------------------------------- Stephen J. Cole-Hatchard, Chief Executive Officer In accordance with the requirements of the Securities Exchange Act of 1934, this report was signed by the following persons in the capacities and on the dates stated.
Signature Title Date --------- ----- ---- /s/ Ventura Martinez Del Rio, Sr. -------------------------------- Ventura Martinez Del Rio, Sr. Chairman of the Board October 6 2003 /s/ Stephen J. Cole-Hatchard -------------------------------- Chief Executive Officer, October 6, 2003 Stephen J. Cole-Hatchard and Director (Principal Executive Officer) /s/ Nicko Feinberg -------------------------------- President U.S. Operations October 6, 2003 Nicko Feinberg and Director /s/ Vasan Thatham -------------------------------- Chief Financial Officer October 6, 2003 Vasan Thatham and Vice President (Principal Financial and Accounting Officer) /s/ Ventura Martinez Del Rio, Jr. -------------------------------- Ventura Martinez Del Rio, Jr. President Mexico Operations October 6, 2003 and Director /s/ Ronald C. Signore -------------------------------- Director October 6, 2003 Ronald C. Signore /s/ William A. Barron -------------------------------- Director October 6, 2003 William A. Barron
29 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Independent Auditor's Report F-1 Consolidated Financial Statements: Balance Sheet F-2 Statement of Operations F-3 Statement of Stockholders' Equity (Deficiency) F-4 Statement of Cash Flows F-5 - F-6 Notes to Consolidated Financial Statements F-7 - F-18
INDEPENDENT AUDITOR'S REPORT To the Board of Directors Frontline Communications Corporation We have audited the accompanying consolidated balance sheet of Frontline Communications Corporation and Subsidiaries (the "Company") as of December 31, 2002 and the related consolidated statements of operations, stockholders' equity (deficiency), and cash flows for each of the two years in the period then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Frontline Communications Corporation and Subsidiaries as of December 31, 2002, and the results of their operations and their cash flows for each of the two years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. In April 2003, as discussed in note 10 of the notes to consolidated financial statements, the Company entered into an agreement with the stockholders of Proyecciones y Ventas Organizadas, S.A. de C.V. ("Provo"), a corporation organized under the laws of the Republic of Mexico to acquire Provo. Upon completion of the transaction described in note 10 and the approval of the proposed stock conversion by the Company's stockholders, it is expected that the stockholders of Provo will control the Company. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in note 1 of the notes to consolidated financial statements, the Company has suffered recurring losses from operations, has a working capital deficiency and a stockholders' deficiency, which raise substantial doubt about its ability to continue as a going concern. Management's plans regarding those matters are also described in note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ Goldstein Golub Kessler LLP ------------------------------- GOLDSTEIN GOLUB KESSLER LLP New York, New York February 20, 2003, except for note 10, as to which the date is April 3, 2003 F-1 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET
-------------------------------------------------------------------------------------------------------------------- December 31, 2002 -------------------------------------------------------------------------------------------------------------------- ASSETS Current: Cash and cash equivalents $ 208,502 Accounts receivable, less allowances for doubtful accounts of $25,000 212,397 Prepaid expenses and other 57,778 -------------------------------------------------------------------------------------------------------------------- Total current assets 478,677 Property and Equipment, net 671,013 Other 108,877 -------------------------------------------------------------------------------------------------------------------- Total Assets $ 1,258,567 ==================================================================================================================== LIABILITIES AND STOCKHOLDERS' DEFICIENCY Current Liabilities: Accounts payable $ 765,749 Accrued expenses 903,710 Current portion of long-term debt 940,202 Deferred revenue 524,738 -------------------------------------------------------------------------------------------------------------------- Total current liabilities 3,134,399 Long-term Debt, less current portion 11,453 Promissory notes Payable (face value $200,000, including $50,000 payable to officers and directors), net of unamortized discount of $58,333 141,667 -------------------------------------------------------------------------------------------------------------------- Total liabilities 3,287,519 -------------------------------------------------------------------------------------------------------------------- Commitments and Contingencies Stockholders' Deficiency: Preferred stock - $.01 par value; authorized 2,000,000 shares, issued and outstanding 496,445 shares (liquidation preference of $7,446,675) 4,964 Common stock - $.01 par value; authorized 25,000,000 shares, issued 9,940,424 shares 99,404 Additional paid-in capital 36,204,292 Accumulated deficit (37,466,196) -------------------------------------------------------------------------------------------------------------------- (1,157,536) Treasury stock, at cost, 645,452 shares (871,416) -------------------------------------------------------------------------------------------------------------------- Stockholders' deficiency (2,028,952) -------------------------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Deficiency $ 1,258,567 =====================================================================================================================
See notes to Consolidated Financial Statements F-2 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS
------------------------------------------------------------------------------------------------------------------- Year ended December 31, 2002 2001 ------------------------------------------------------------------------------------------------------------------- Revenue $ 5,047,098 $ 6,503,120 ------------------------------------------------------------------------------------------------------------------- Costs and expenses: Cost of revenue 2,493,337 3,482,954 Selling, general and administrative 2,446,816 3,860,999 Depreciation and amortization, includes $175,238 and $185,311 related to costs of revenue 745,135 2,943,678 Impairment of intangibles -- 2,827,993 Noncash compensation charge 58,500 206,505 ------------------------------------------------------------------------------------------------------------------- 5,743,788 13,322,129 ------------------------------------------------------------------------------------------------------------------- Loss from operations (696,690) (6,819,009) Other income (expense): Interest income 7,796 53,887 Interest expense (95,417) (131,778) Loss on disposal of property and equipment (3,214) (132,387) ------------------------------------------------------------------------------------------------------------------- Net loss (787,525) (7,029,287) Preferred dividends 297,867 320,910 ------------------------------------------------------------------------------------------------------------------- Net loss available to common stockholders $(1,085,392) $(7,350,197) =================================================================================================================== Loss per share - basic and diluted $ (0.12) $ (1.00) =================================================================================================================== Weighted-average number of shares outstanding - basic and diluted 9,119,533 7,333,221 ===================================================================================================================
See notes to Consolidated Financial Statements F-3 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIENCY)
---------------------------------------------------------------------------------------------------------------------------- Years ended December 31, 2002 and 2001 ---------------------------------------------------------------------------------------------------------------------------- Preferred Stock Common Stock --------------- ---------------- Total Additional Treasury Stockholders' Paid-in Accumulated Stock Equity Shares Amount Shares Amount Capital Deficit at Cost (Deficiency) --------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 2000 597,800 $5,978 7,164,793 $71,648 $35,570,119 $(29,030,607) $(860,539) $5,756,599 Purchase of treasury stock, at cost (6,800 shares) -- -- -- -- -- -- (4,113) (4,113) Conversion of Series B preferred stock (70,700) (707) 240,380 2,404 (1,697) -- -- -- Common stock issued for services -- -- 1,376,700 13,767 192,738 -- -- 206,505 Dividends on preferred stock -- -- 779,324 7,793 313,117 (320,910) -- -- Net loss -- -- -- -- -- (7,029,287) -- (7,029,278) --------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 2001 527,100 5,271 9,561,197 95,612 36,074,277 (36,380,804) (864,652) (1,070,296) Purchase of treasury stock, at cost (28,806 shares) -- -- -- -- -- -- (6,764) (6,764) Common stock issued for services -- -- 275,000 2,750 55,750 -- -- 58,500 Conversion of Series B preferred stock (30,655) (307) 104,227 1,042 (735) -- -- -- Dividends on preferred stock -- -- -- -- -- (297,867) -- (297,867) Warrants issued with promissory notes payable -- -- -- -- 75,000 -- -- 75,000 Net loss -- -- -- -- -- (787,525) -- (787,525) --------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 2002 496,445 $4,964 9,940,424 $99,404 $36,204,292 $(37,466,196) $(871,416) $(2,028,952) ===========================================================================================================================
See notes to Consolidated Financial Statements F-4 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS
----------------------------------------------------------------------------------------------------------------- Year ended December 31, 2002 2001 ----------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net loss $(787,525) $(7,029,287) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization 745,135 2,943,678 Debt discount amortization 16,667 -- Noncash compensation charge 58,500 206,505 Impairment of intangibles -- 2,827,993 Loss on disposal of property and equipment 3,214 132,387 Changes in operating assets and liabilities: Decrease in marketable securities -- 1,808,210 Decrease in accounts receivable 51,860 312,567 (Increase) decrease in prepaid expenses and other (24,755) 93,675 (Increase) decrease in other assets (4,488) 10,597 Decrease in accounts payable and accrued expenses (390,355) (563,729) Decrease in deferred revenue (90,612) (474,854) ----------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) operating activities (422,359) 267,742 ----------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Acquisition of property and equipment (14,895) (51,148) Proceeds from disposal of property and equipment 5,000 51,886 ----------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) investing activities (9,895) 738 ----------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Principal payments on long-term debt (155,014) (442,915) Proceeds from issuance of promissory notes payable 200,000 -- Payments to acquire treasury stock (6,764) (4,113) ----------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities 38,222 (447,028) ----------------------------------------------------------------------------------------------------------------- Net decrease in cash and cash equivalents (394,032) (178,548) Cash and cash equivalents at beginning of year 602,534 781,082 ----------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 208,502 $ 602,534 ================================================================================================================= Supplemental disclosure of cash flow information: Cash paid during the year for interest $ 83,000 $ 132,000 =================================================================================================================
(continued) See notes to Consolidated Financial Statements F-5 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS
----------------------------------------------------------------------------------------------------------------- Year ended December 31, 2002 2001 ----------------------------------------------------------------------------------------------------------------- Supplemental schedule of noncash investing and financing activities: Warrants issued with promissory notes payable $ 75,000 -- ================================================================================================================= Capital lease obligations incurred -- $ 48,098 ================================================================================================================= Dividends on Series B preferred stock paid in common stock or accrued $297,867 $320,910 ================================================================================================================= Common stock issued for services $ 58,500 -- =================================================================================================================
See notes to Consolidated Financial Statements F-6 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTE TO CONSOLIDATED FINANCIAL STATEMENT -------------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT Frontline Communications Corporation ("Frontline" ACCOUNTING POLICIES: or the "Company") is an Internet company that offers Internet access; Web site development and Internet presence services. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. The Company has suffered recurring losses from operations, has a net working capital deficiency of $2,655,722 and a stockholders' deficiency of $2,028,952 at December 31, 2002. These factors raise substantial doubt about its ability to continue as a going concern. Management has entered into an agreement with the stockholders of Proyecciones y Ventas Organizadas, S.A. de C.V. ("Provo"), a corporation organized under the laws of the Republic of Mexico to acquire Provo. This agreement, which is discussed in note 10, is expected to transfer control of the Company to the stockholders of Provo upon approval by the Frontline stockholders. The Company's operations will then include the historical operations of the Company and the operations of Provo, which is engaged in the distribution of calling card and cellular phone airtime in Mexico. Management of the Company feels that the addition of Provo to the operations of the Company will enable it to continue to meet its obligations as they come due and to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Intercompany balances and transactions have been eliminated. In preparing the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amount of revenue and expenses during the reporting period. Actual results could differ from those estimates. Many of the Company's estimates and assumptions used in the financial statements are related to the Company's industry, which is subject to rapid technological change. It is reasonably possible that changes may occur in the near term that would affect management's estimates with respect to the carrying values of property and equipment and intangibles. Monthly subscription service revenue for Internet access is recognized over the period in which services are provided. Fee revenue for Web site development and Internet Web site presence services are recognized as services are performed. Deferred revenue represents prepaid access fees by subscribers. F-7 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTE TO CONSOLIDATED FINANCIAL STATEMENT -------------------------------------------------------------------------------- Accounts receivable are reported at their outstanding unpaid principal balances reduced by an allowance for doubtful accounts. The Company estimates doubtful accounts based on historical bad debts, factors related to specific customers' ability to pay, and current economic trends. The Company writes off accounts receivable against the allowance when a balance is determined to be uncollectible. Property and equipment is stated at cost, less accumulated depreciation and amortization. Depreciation and amortization is computed over the estimated useful lives of the assets using the straight-line method. Intangible assets consisted of purchased customer bases. Amortization was computed using the straight-line basis over three years. The intangible was fully amortized at December 31, 2002. Amortization expense for the years ended December 31, 2002 and 2001 amounted to $140,738 and $2,255,310, respectively. Long-lived assets, such as property and equipment, intangibles and customer bases, are evaluated for impairment when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable through the estimated undiscounted future cash flows from the use of these assets. When any such impairment exists, the related assets will be written down to fair value. During the year ended December 31, 2001, goodwill and purchased customer bases were written down by $2,827,993, due to impairment of such assets. Intangible assets consisted primarily of purchased customer base. The Company reviewed each acquisition separately to determine the number of customers remaining from the original purchase date. For acquisitions where less than 50% of the original customers remained, the intangible asset was deemed impaired. Discounted cash flows of the remaining customers were then used to determine fair value. In all instances, the expected cash flow from such customers was less than the expected cost of sales. Therefore, the intangible assets of $2,705,868 representing purchased customer base was deemed fully impaired and written down to zero. Additionally, there was unamortized goodwill remaining on the our purchase of PNET of $422,125. PNET has had a lack of operating profit from the date of acquisition and was not expected to generate positive cash flows. Accordingly, the remaining goodwill has been written down to zero, after reducing goodwill by a $300,000 gain on the settlement of a note payable to the former owners of PNET. F-8 Deferred income taxes are provided on differences between the financial reporting and income tax bases of assets and liabilities based upon statutory tax rates enacted for future periods. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and trade accounts receivable. The Company's cash investments are placed with high credit quality financial institutions and may, at times, exceed the amount of federal deposit insurance. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising the Company's customer base. F-9 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTE TO CONSOLIDATED FINANCIAL STATEMENT -------------------------------------------------------------------------------- The Company considers all highly liquid money market instruments purchased with an original maturity of three months or less to be cash equivalents. The Company applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations by recording compensation expense for the excess of fair market value over the exercisable price per share, as of the date of the grant, in accounting for its stock options. SFAS No. 123 requires the Company to provide pro forma information regarding net loss and net loss per share as if compensation cost for the Company's stock options had been determined in accordance with the fair-value-based method prescribed in SFAS No. 123. The Company estimates the fair value of each stock option at the date of the grant using the Black Scholes option-pricing model with the following weighted-average assumptions used for options in 2001:
Year ended December 31, 2001 -------------------------------------------------- Risk-free interest rate 4.65% Expected life 5 years Expected volatility 169% Dividend yield None --------------------------------------------------
No stock options were issued to employees during 2002. Accordingly, no Black Scholes assumptions were used in 2002. Under the accounting provisions of SFAS No. 123, the Company's net loss and loss per share would have been increased to the pro forma amounts indicated below:
Year ended December 31, 2002 2001 ------------------------------------------------------------------------- Netloss available to common stockholders: As reported $(1,085,392) $(7,350,197) Stock-based compensation using the fair value method (55,991) (100,110) ------------------------------------------------------------------------- Pro forma (1,141,383) (7,450,307) Net loss per share (basic and diluted): As reported (0.12) (1.00) Pro forma (0.13) (1.02) -------------------------------------------------------------------------
All costs associated with advertising services are expensed in the period incurred. Advertising expense was approximately $43,000 and $130,000 for the years ended December 31, 2002 and 2001, respectively. The Company follows SFAS No. 128, Earnings per Share, which provides for the calculation of "basic" and "diluted" earnings per share ("EPS"). Basic EPS includes no dilution and is computed by dividing income or loss available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution that could occur through the effect of common shares issuable upon exercise of stock options and warrants and convertible securities. F-10 Potential common shares have not been included in the computation of diluted EPS since the effect would be antidilutive. At December 31, 2002, there were 4,862,100 options and warrants outstanding and preferred stock convertible into 1,687,963 shares of common stock that could potentially dilute basic EPS in the future. F-11 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTE TO CONSOLIDATED FINANCIAL STATEMENT -------------------------------------------------------------------------------- In November 2002, the EITF issued EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, which addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. Specifically, EITF Issue No. 00-21 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. EITF Issue No. 00-21 is effective for the Company for revenue arrangements entered into beginning July 1, 2003. The Company does not expect the adoption of EITF Issue No. 00-21 to have a material impact on its 2003 consolidated financial statements. The Company does not believe that any other recently issued, but not yet effective, accounting standards, if currently adopted, will have a material effect on the Company's consolidated financial position or results of operations. 2. PROPERTY AND Property and equipment, at cost, consists of the EQUIPMENT: following at December 31, 2002:
Estimated Useful Life -------------------------------------------------------------------- Computer and office equipment $ 2,611,297 3 to 5 years Furniture and fixtures 74,825 5 years Leasehold improvements 149,365 Lease term -------------------------------------------------------------------- 2,835,487 Less accumulated depreciation and amortization (2,164,474) -------------------------------------------------------------------- $ 671,013 ====================================================================
Depreciation and amortization for the years ended December 31, 2002 and 2001 amounted to approximately $604,000 and $689,000, respectively. 3. ACCRUED EXPENSES: Accrued expenses consist of the following at December 31, 2002: Accrued Internet connection and $355,363 telephone Lease cancellations and related costs 98,750 Dividends payable 297,867 Accrued professional fees 46,268 Accrued wages and salaries 82,896 Other 22,566 ----------------------------------------------------- $903,710 =====================================================
4. LONG-TERM DEBT: Long-term debt consists of the following at December 31, 2002: Present value of net minimum lease $223,055 payments (a) Promissory note payable (b) 728,600 ------------------------------------------------------ 951,655 Less current portion 940,202 ------------------------------------------------------ $ 11,453 ======================================================
F-12 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTE TO CONSOLIDATED FINANCIAL STATEMENT -------------------------------------------------------------------------------- (a) The Company leases computer and other equipment under capital leases. The assets acquired under capital leases have a cost of approximately $1,155,000 and accumulated depreciation of approximately $887,000 as of December 31, 2002. The following is a schedule of future minimum lease payments under capitalized leases, together with the present value of the net minimum lease payments at December 31, 2002:
Year ending December 31, ------------------------ 2003 $222,073 2004 10,958 2005 1,279 ------------------------------------------------------- Total minimum lease payments 234,310 Less amount representing interest 11,255 ------------------------------------------------------- Present value of net minimum lease 223,055 payments Less current portion 211,602 ------------------------------------------------------- Long-term lease obligations $ 11,453 =======================================================
(b) A promissory note, issued as part of a business acquisition, in the principal amount of $728,600. The promissory note bears interest at 4% and is payable in June 2003. The Company has the option to convert the principal amount due under the promissory note to shares of its common stock at a conversion price of $8 per share (significantly greater than the market value of the common stock at the acquisition date), under certain circumstances, as defined in the acquisition agreement, such as the market price of the Company's common stock exceeding $10 per share. See note 10. The carrying amount of the Company's long-term debt approximates fair value using the Company's estimated incremental borrowing rate. F-13 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTE TO CONSOLIDATED FINANCIAL STATEMENT -------------------------------------------------------------------------------- 5. PROMISSORY NOTES: In June 2002, the Company completed a private placement of 8% promissory notes and received proceeds of $200,000 (including $50,000 from officers and directors). The promissory notes bear interest at 8% and mature in three years from the date of issuance. The Company has the option to convert the principal amount due under the promissory notes into shares of its common stock at a conversion price of $4.80 per share, under certain circumstances, as defined in the agreement with the promissory note holders, such as the market price of the Company's common stock exceeding $6 per share. The Company also issued to the note holders warrants to purchase an aggregate of 1,000,000 shares of its common stock at an exercise price of $.08 per share. Out of the proceeds, $75,000 was allocated as the value of the warrants and is recorded as a discount on the notes payable in the accompanying consolidated balance sheet. The discount is being amortized as additional interest over the terms of the promissory notes. At December 31, 2002, the promissory notes payable included on the accompanying consolidated balance sheet amounting to $141,667 are net of unamortized discounts of $58,333. The fair value of the notes approximates the carrying amount based on rates available to the Company. 6. COMMITMENTS AND The Company rents office space and equipment under CONTINGENCIES: operating lease agreements expiring at various dates through 2005. Future minimum rental payments required under operating leases are approximately as follows:
Year ending December 31, ------------------------ 2003 $379,000 2004 226,000 2005 5,000 ------------------------------------------------------ $610,000 ======================================================
Rental expense was approximately $341,000 and $438,000 for the years ended December 31, 2002 and 2001, respectively. In connection with the Company's lease for its main office space, the Company has opened an irrecoverable letter of credit with a bank for approximately $65,000 in lieu of a security deposit. 7. STOCK OPTIONS: The Company has a stock option plan (the "Plan") which authorizes the issuance of incentive options and nonqualified options to purchase up to 2,000,000 shares of common stock. The Plan has a 10-year term. The board retained the authority to determine the individuals to whom, and the times at which, stock options would be granted, along with the number of shares, vesting schedule and other provisions related to the stock options. A summary of the status of the Company's stock option plan as of December 31, 2002 and 2001, and changes during the years ended on those dates, is presented below: F-14 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTE TO CONSOLIDATED FINANCIAL STATEMENT --------------------------------------------------------------------------------
December 31, 2002 2001 ------------------------------------------------------------------------ Weighted- Weighted- average average Exercise Exercise Shares Price Shares Price ---------- ---------- ---------- ----------- Outstanding at beginning of year 1,458,900 $2.67 1,347,768 $4.19 Granted 445,000 0.22 Forfeited (169,900) 1.68 (333,868) 4.97 ------------------------------------------------------------------------ Outstanding at end of year 1,289,000 $2.81 1,458,900 $2.67 ======================================================================== Options exercisable at year-end 1,289,000 $2.81 1,442,900 $2.64 ======================================================================== Weighted-average fair value of options granted during the year -- -- -- $0.21 ========================================================================
The following table summarizes information about stock options outstanding and exercisable at December 31, 2002:
Options Outstanding and Exercisable ---------------------------------------- Weighted- Outstanding at Remaining average Range of December 31, Contractual Exercise Exercise Prices 2002 Life Price ------------------------------------------------------------------- $0.22 to $1.00 501,000 3.1 years $0.31 $1.00 to $2.50 184,800 .9 2.37 $2.50 to $4.00 97,000 .8 3.58 $4.00 to $6.00 433,200 1.95 5.16 $6.00 to $6.75 73,000 1.1 6.10 ------------------------------------------------------------------- 1,289,000 $2.81 ===================================================================
8. STOCKHOLDERS' EQUITY In April 2000, the Company's board of directors (DEFICIENCY): authorized the Company to purchase up to $1,000,000 worth of its common stock from time to time, as the Company deems appropriate, through open market purchases or in privately negotiated transactions. As of December 31, 2002, the Company had acquired 413,932 shares of common stock for an aggregate consideration of approximately $607,000. In September 2001, the Company granted 1,376,700 restricted shares of its common stock to its employees under the Company's 2001 Stock Incentive Plan. Accordingly, $206,505, representing the fair value of the shares granted, was charged to operations as a noncash compensation charge. During 2001, the Company issued: (i) 240,380 shares of common stock upon conversion of 70,700 shares of Series B Convertible Redeemable preferred stock, and (ii) 779,324 shares of common stock as dividends to the holders of Series B Convertible Redeemable preferred stock. F-15 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTE TO CONSOLIDATED FINANCIAL STATEMENT -------------------------------------------------------------------------------- In May 2002, the Company entered into a consulting agreement for marketing services and issued to the consultant 250,000 shares of common stock as consideration for the services rendered by the consultant. Accordingly, $50,000, representing the fair value of the shares issued, was charged to operations. In June 2002, the Company issued, in a private sale of 8% promissory notes, warrants to purchase an aggregate of 1,000,000 shares of its common stock at an exercise price of $.08 per share. In August 2002, the Company entered into a consulting agreement for marketing services and issued to the consultant 25,000 shares of common stock as consideration for the services rendered by the consultant. Accordingly, $8,500, representing the fair value of the shares issued, was charged to operations. During 2002, the Company issued 104,227 shares of common stock upon conversion of 30,655 shares of Series B Convertible Redeemable preferred stock. In addition, at December 31, 2002, other warrants to purchase 2,516,300 shares of common stock were outstanding and exercisable at prices ranging between $4.80 and $8.50 per share, expiring at various times through 2004. 9. INCOME TAXES: At December 31, 2002, the tax effects of loss carryforwards and the valuation allowance that give rise to deferred tax assets are as follows: Net operating losses $ 7,650,000 Less valuation allowance (7,650,000) -------------------------------------------------------- Deferred tax assets $ - 0 - ========================================================
The provision (benefit) for income taxes differs from the amount computed using the federal statutory rate of 34% as a result of the following:
December 31, 2002 2001 ------------------------------------------------------------------- Federal statutory rate (34)% (34)% Increase in valuation allowance 34 34 ------------------------------------------------------------------- - 0 -% - 0 -% ===================================================================
The Company had net operating loss carryforwards of approximately $22,500,000 at December 31, 2002, which expire through 2022. The tax benefit of these losses has been completely offset by a valuation allowance due to the uncertainty of its realization. F-16 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTE TO CONSOLIDATED FINANCIAL STATEMENT -------------------------------------------------------------------------------- Internal Revenue Code Section 382 provides for limitations on the use of net operating loss carryforwards in years subsequent to a more than 50% change in ownership (as defined by Section 382), which limitations can significantly impact the Company's ability to utilize its net operating loss carryforwards. As a result of the sale of the preferred shares in the public offering in February and March 2000, changes in ownership may have occurred which might result in limitations of the utilization of the net operating loss carryforwards. The extent of any limitations as a result of changes in ownership has not been determined by the Company. 10. SUBSEQUENT EVENT: In April 2003, the Company entered into an amended and restated stock purchase agreement with the two stockholders of Provo, a corporation organized under the laws of the Republic of Mexico, to acquire from them all the issued and outstanding shares of Provo. As consideration, the Company issued 220,000 shares of Series C Convertible Preferred Stock ("Series C Preferred") of the Company to the two stockholders of Provo. Provo and its subsidiaries are engaged in the distribution of prepaid calling cards and cellular phone airtime in Mexico. Each share of Series C Preferred will automatically convert into 150 shares of the Company's common stock after the transaction is approved by the Company's stockholders. In connection with the transaction, the Company will require stockholder approval for (i) the issuance of shares of common stock upon conversion of Series C Preferred, (ii) the change in control contemplated by the Provo transaction, (iii) an increase in authorized common stock to 75,000,000 shares, and (iv) a reverse split of all of the issued and outstanding shares of common stock. Upon such approval, Series C Preferred will convert into common stock representing approximately 66% of the combined Company. The Company issued 35,500 Series D Preferred shares ("Series D Preferred") to certain brokers, finders and certain of the Company's officers and directors in accordance with the terms of certain consulting agreements. Each share of Series D Preferred can be converted into 150 shares of the Company's common stock after the stockholder approval is obtained for (i) the issuance of the shares of common stock upon conversion of the Series D Preferred, (ii) an increase in the Company's authorized common stock to 75,000,000 and (iii) a reverse split of the common stock. In the event the Company's stockholders do not approve the conversion of Series C Preferred into the Company's common stock, the Company will be obligated to pay $20,000,000 to the Series C Preferred stockholders. F-17 FRONTLINE COMMUNICATIONS CORPORATION AND SUBSIDIARIES NOTE TO CONSOLIDATED FINANCIAL STATEMENT -------------------------------------------------------------------------------- In April 2003, the Company borrowed $550,000 from an unaffiliated entity (the "Lender") and issued a secured promissory note (the "note") to the Lender. The note bears interest of 14% and is secured by substantially all of the Company's assets. Two officers have pledged shares of the Company's common stock owned by them as additional collateral to the Lender. In connection with the financing, the Company issued 500,000 shares of common stock to the Lender as additional consideration. The note is payable at the earlier of 90 days or upon financing of Provo's accounts receivable. Out of the proceeds, the Company used $200,000 to settle a promissory note, issued as a part of a business acquisition, in the principal amount of $728,600. The balance of the promissory note was settled through issuance of 375,000 shares of common stock to the promissory note holders. F-18 STATEMENT OF DIFFERENCES ------------------------ The registered trademark symbol shall be expressed as.................. 'r' The service mark symbol shall be expressed as.......................... 'sm'