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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 2000
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from ___ to___
Commission File Number 0-30162
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FRONTLINE CAPITAL GROUP
(exact name of registrant as specified in its charter)
DELAWARE 11-3383642
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
90 PARK AVENUE 10016
NEW YORK, NY
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 931-8000
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Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common Stock, $.01 par value NASDAQ
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K, or any
amendment to this Form 10-K. [ ]
The aggregate market value of the shares of common stock held by
non-affiliates was approximately $300 million based on the closing price on the
NASDAQ for such shares on March 27, 2001.
The number of the Registrant's shares of common stock outstanding was
36,711,171 as of March 27, 2001.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Shareholder's
Meeting to be held in June 2001 are incorporated by reference into Part III.
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TABLE OF CONTENTS
ITEM
NO. PAGE
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PART I
1. Business ................................................................................. I-1
2. Properties ............................................................................... I-7
3. Legal Proceedings ........................................................................ I-8
4. Submission of Matters to a Vote of Security Holders ...................................... I-8
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters .................... II-1
6. Selected Financial Data .................................................................. II-3
7. Management's Discussion and Analysis of Financial Condition and Results of Operations .... II-4
7a. Quantitative and Qualitative Disclosures about Market Risk ............................... II-13
8. Financial Statements and Supplementary Data .............................................. II-15
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ..... II-15
PART III
10. Directors and Executive Officers of the Registrant ....................................... III-1
11. Executive Compensation ................................................................... III-1
12. Security Ownership of Certain Beneficial Owners and Management ........................... III-1
13. Certain Relationships and Related Transactions ........................................... III-1
PART IV
14. Financial Statements and Schedules, Exhibits and Reports on Form 8-K ..................... IV-1
PART I
ITEM 1. BUSINESS
THE COMPANY
FrontLine Capital Group ("FrontLine" or the "Company") was formed on July
15, 1997 and was spun off as a separate public company from Reckson Associates
Realty Corp. ("Reckson Associates") in June 1998. FrontLine manages companies
which leverage the Internet and which service small and medium-size enterprises
("SMEs") and mobile workforces of larger companies. FrontLine has two distinct
operating segments: one holds FrontLine's interest in HQ Global Workplaces,
Inc., the world's largest provider of officing solutions, and its predecessor
companies ("HQ" or the "HQ Global Segment"), and the other consists of
FrontLine (parent company) ("FrontLine Parent") and its interests in a group of
companies which provide a wide range of services to the SME marketplace (the
"Parent and Other Interests Segment").
FrontLine was established with the purpose of identifying and acquiring
interests in operating companies that engage in businesses that provide
services to other businesses. The groundwork for this business was established
in 1997, with investments commencing in 1998. The first investments were in
executive office suites (now known as the flexible officing solutions industry)
and telecommunications infrastructure.
During 1999, the Company rapidly expanded its operations and ownership
position within the flexible officing solutions industry by orchestrating the
merger of three companies and acquiring interests in the combined company that
resulted in an 84% ownership position of the combined company, then operating
under the name of VANTAS Incorporated ("VANTAS"). In addition, FrontLine
increased its infrastructure enabling the acquisition of ownership interests in
an additional 10 companies that each had the goal of leveraging the power of
the Internet to deliver services to other businesses. The ability to deliver
this growth was primarily fueled by access to the public capital markets.
The announcement in January 2000 of the merger of VANTAS with HQ moved
FrontLine to the forefront of the flexible officing solutions industry through
the creation of the world leader in this industry. With a majority common stock
ownership position in the merged entity, the promising growth of the Internet
sector and robust capital markets, FrontLine was well-positioned to capitalize
on the potential of the resulting network of the FrontLine-owned enterprises.
However, the capital markets changed dramatically in mid-2000 and caused a
reassessment of FrontLine's business plan. In October 2000, FrontLine announced
that, as a result of changing market conditions, it was refining its strategic
plan (the "Restructuring") to highlight its holdings in HQ and to maximize the
value of its other holdings. Additionally, in conjunction with the
Restructuring, FrontLine announced that it would focus its resources and
capital on the businesses within its existing portfolio and cease pursuing new
investment activities.
In conjunction with the Restructuring, and in light of market conditions,
FrontLine reevaluated the carrying values of its ownership interests and as a
result of this reevaluation recorded an impairment charge of $25.7 million in
the fourth quarter of the year ended December 31, 2000 to reduce the carrying
values of these investments to estimated fair value.
HQ
On June 1, 2000, VANTAS, a majority-owned subsidiary of the Company,
merged with HQ Global Workplaces, Inc. ("Old HQ"), an affiliate of CarrAmerica
Realty Corporation ("CarrAmerica"), in a two-step merger (the "HQ Merger"). As
a result of the HQ Merger, the combined company became a wholly-owned
subsidiary of a newly-formed parent corporation, HQ Global Holdings Inc. ("HQ
Global"), under the name HQ Global Workplaces, Inc. See Note 3 to the financial
statements included elsewhere in this Form 10-K. For the year ended December
31, 2000, the results of operations included in the financial statements in
this Form 10-K are comprised of twelve months of VANTAS and the seven months
following the HQ Merger for HQ Global.
I-1
HQ is the largest provider of flexible officing solutions in the world
based on the number of business centers. As of December 31, 2000, HQ owned,
operated, or franchised 462 business centers in 19 countries. This included 26
business centers open for twelve months or less. Also included are six business
centers managed by HQ for unrelated third parties, seven joint venture centers
in the United Kingdom in which HQ is a 20% joint venture partner with Merrill
Lynch Asset Management and two additional joint venture centers with unrelated
third parties. HQ is the franchisor of 46 domestic and 30 international
business centers for unrelated franchisees. HQ provides a complete outsourced
office solution through furnished and equipped individual offices and
multi-office suites available on short notice with flexible contracts. HQ also
provides business support and information services including:
telecommunications; broadband Internet access; mail room and reception
services; high speed copying, faxing and printing services; secretarial,
desktop publishing and IT support services and various size conference
facilities, with multi-media presentation and, in certain cases, video
teleconferencing capabilities. HQ also provides similar services for those
businesses and individuals that do not require offices on a full-time basis.
BUSINESS STRATEGY
Workplace Solutions
- -------------------
HQ offers its clients two office solution plans based on their particular
needs and preferences. These two plans are Full Office Program and Business
Access Program. Details of these services are described below:
The Full Office Program
This program provides clients with fully furnished and equipped individual
offices and suites and a full array of business support services without
substantial investment of time and money, enabling companies to allocate
resources more effectively. In addition to a fully furnished office and access
to such business support services, clients receive the following additional
amenities and benefits:
Infrastructure:
o Desirable business addresses in prime locations
o Mail processing, courier, shipping and receiving services
o High quality full service business environments
o 24/7 access
o Client services area with essential office equipment
o Complimentary beverage service including coffee and tea
o Meeting rooms with audio-visual equipment
o Access to over 460 centers worldwide through operated and franchised
locations
People:
o Professional receptionist to greet guests
o Dedicated administrative staff proficient in business software
o Telephone answering and call screening
o Meeting planning and catering
o Responsive on site management and support teams
o IT support teams
Technology:
o High speed Internet connectivity
I-2
o Telecommunications services
o Video conferencing
o Additional technology includes: technical support, LAN and other
configurations
The Business Access Program
This program provides value to clients that need a local presence in a
particular market or access to HQ's worldwide network and utilization of the
many services offered by HQ, but do not need a full-time office. As a result,
HQ offers a part-time plan called the Business Access Program. HQ's clients
receive a prestigious address, building directory lobby listing, personalized
telephone answering, message and voice mail services, facsimile capabilities,
incoming mail handling and use of conference rooms and/or offices as needed.
The Business Access Program provides flexibility for HQ's clients. For
example, as a client grows, it can transfer into a Full Office Program.
Similarly, should a Full Office client need to downsize, it can adjust its
overhead and participate as a Business Access client in a seamless manner.
Additional Services
HQ offers a variety of additional services to its clients on an as-needed
basis and charges for these services according to a price schedule. Such
services, which may be a key determinant in a client's decision to choose a
business center, include word processing and secretarial services, desktop
publishing/graphics design, clerical services (i.e., photocopying, filing,
labeling, concierge services, etc.), and technical support services
(hardware/software).
Clients
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As of December 31, 2000, HQ had approximately 65,000 clients, including
both Full Office and Business Access clients, utilizing 52,780 workstations.
Over 60% of HQ's Full Office clients are large regional or national companies,
often purchasing HQ's services at multiple locations. National and regional
firms generally prefer doing business with a larger, well-established business
center operator, such as HQ, in order to ensure longevity and consistency of
service, as well as the ability to contract for multiple locations in multiple
markets with a single provider. In return, the largest business center
operators typically obtain more favorable lease terms than single site
operators who are unable to provide this level of service. Some of HQ's clients
include Ariba, Inc., Charles Schwab Corporation, Computer Adaptive
Technologies, Inc., Extreme Networks, Inc., Forrester Research, Inc.,
MicroStrategy, Inc., Siebel Systems, Inc., 3Com Corporation, Vignette
Corporation and Vitria Technology, Inc. No single client accounts for more than
1% of HQ's revenues.
Suppliers
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HQ's primary suppliers are its landlords from whom it leases office space.
These landlords include primarily large real estate companies from which HQ
leases space at multiple locations. HQ's landlords include Equity Office
Properties Trust ("EOP"), Reckson Associates, Boston Properties, Inc.,
Shorenstein Properties, CarrAmerica and Duke-Weeks Realty Corporation. No
single landlord accounts for more than 6% of the aggregate annual rental
payments made by HQ.
The initial terms of the agreements pursuant to which HQ leases office
space from landlords average approximately 10 years and, in most cases, carry
lease renewal options at 95% to 100% of fair market value. In any given year, a
portion of the leases held in HQ's portfolio of leases will be eligible for
renewal. This lease expiration diversity enables HQ to manage lease rates on a
portfolio basis. In the years ending December 31, 2001, 2002 and 2003, 6.7%,
9.6% and 6.2% of the leases are scheduled to expire, respectively.
I-3
HQ also contracts with highly reputable suppliers such as Airborne
Express, Everdream, Office Depot, Qwest Communications International, Inc.,
AT&T, Perot Systems and PeopleSoft, Inc. for services including shipping,
computer equipment, office supplies, long distance, systems implementation and
software. Given HQ's scale and international reach, it typically receives
favorable pricing and is generally able to negotiate volume discounts from
suppliers.
Office Service Agreements
- -------------------------
HQ provides furnished office space to clients with flexible terms. A
number of a business center's clients terminate their agreements during the
course of a year and, therefore, maintaining high occupancy requires ongoing
sales efforts. One risk HQ faces is the risk of non-renewal resulting in lower
occupancy and reduced service revenues. Despite the short-term nature of the
office service agreements, many clients elect to renew their office service
agreements and remain clients for periods of time beyond the original term of
their service agreement. HQ estimates that the historical average length of
stay of its Full Office clients is approximately two to three years. At
December 31, 2000, HQ occupancy, as measured by occupied offices, for business
centers owned and operated by HQ was approximately 85%. Although HQ's occupancy
rates vary from one period to another and are not the only determinant in its
ability to generate revenues and profits, HQ's continued ability to generate
business center operating income is dependent upon sufficiently high occupancy
rates.
Franchise Centers
- -----------------
HQ provides its clients with an additional 76 office center locations
which are operated under franchise agreements by third party owners. These
franchised centers, of which 46 are located in 11 states and 30 are located in
14 international locations, provide HQ's clients with additional solutions to
their global office needs. HQ receives a franchise royalty from these third
party owners for the use of the HQ name, with royalty percentages ranging from
1.0% to 2.5% of the franchise center's gross revenue. Franchise fees aggregated
$1.8 million for the year ended December 31, 2000, and are included in business
services revenues.
Managed and Joint Venture Centers
- ---------------------------------
HQ manages three centers in the United States and three centers in the
United Kingdom for unrelated third parties under management contracts. HQ also
manages seven joint venture centers in the United Kingdom, in which HQ is a 20%
joint venture partner with Merrill Lynch Asset Management and two additional
joint venture centers with unrelated third parties. Additionally, HQ has
entered into a joint venture agreement with EOP, however at December 31, 2000,
HQ had not opened any centers pursuant to that agreement. Management fees
generally include a base fee plus an incentive fee and certain profit
participations.
Marketing Alliance
- ------------------
HQ has a marketing alliance with Servcorp, a business center operator with
centers primarily located in Asia, Australia and New Zealand, whereby HQ
receives from and provides client referrals to Servcorp.
The Industry
- ------------
According to trade association estimates, there are currently
approximately 4,000 business center locations in the United States generating
in excess of $3.0 billion of annual revenues, and 1,500 locations
internationally. The industry is highly fragmented with over 10% of total
business centers owned by HQ and the next largest participant.
Several trends are driving the acceptance and usage of business centers,
including:
o the widespread use of business center facilities by national and regional
corporations to support mobile employees;
o small businesses nationwide requiring more flexible office space and
related services;
I-4
o home-based businesses and free agents utilizing part-time office
facilities for meetings and support services;
o the continuing trend of corporate downsizing which often results in the
need for temporary office space for former employees seeking new jobs
and/or starting new businesses;
o the growing use and acceptance of enhanced telecommunication and computer
technologies which can help businesses create "virtual offices" without
fixed space requirements; and
o the increased awareness by commercial real estate owners that business
centers can enhance their building's occupancy and efficiency, provide
amenities to existing tenants (such as conference facilities and offices
for visiting executives) and act as an incubator for future tenants.
Furthermore, the emergence of certain communications technologies has
played an important role in the growth of the industry. Improved
telecommunication services and Internet applications have become more
frequently utilized and integrated into business center service offerings. As
the industry continues to expand, office equipment and communications
technology will become an increasingly competitive factor. Business center
operators are likely to face pressure to invest in technology in order to offer
services such as E-mail and LANs as well as video conferencing.
Competition
- -----------
The industry is highly fragmented with approximately 10% of total business
centers owned by HQ and the next largest participant. In many markets, HQ's
largest competitor may be a locally-owned operator with several centers. HQ's
largest global competitor is Regus plc. Regus has a large international
presence and a smaller but expanding presence in the United States. HQ may
compete with these and other entities in both the search for attractive
business center locations and in attracting and retaining clients in its
business centers as well as skilled managers.
Team Members
- ------------
As of December 31, 2000, HQ employed approximately 2,800 team members
(employees) including 307 corporate team members. None of these team members is
covered by a collective bargaining agreement and HQ believes its relationship
with team members is good. HQ is continually implementing and improving its
operating systems, expanding opportunities and providing training programs for
its team members.
Management compensation consists of base salaries and incentive
compensation based upon HQ's performance and individual team member
performance. In addition, certain team members participate in a stock option
and restricted stock plan designed to motivate long-term contribution to HQ's
success.
Geographic Information
- ----------------------
Financial information by geographic area is provided in Note 3 to the
consolidated financial statements included elsewhere in this Form 10-K.
PARENT AND OTHER INTERESTS SEGMENT
The Parent and Other Interests Segment consists of FrontLine and its
interests in a group of companies which provide a wide range of services to the
SME marketplace.
These companies include:
o OnSite Access, Inc. - OnSite provides advanced telecommunications systems
and services within commercial buildings and building complexes.
o RealtyIQ Corp. - RealtyIQ created a comprehensive, proprietary, national
database of commercial real estate information for metropolitan areas
throughout the United States and provides information to the commercial
real estate and related business community. RealtyIQ has significantly
reduced its staff and is considering ways to maximize shareholder value.
I-5
As discussed above, in conjunction with the Restructuring and in light of
market conditions experienced beginning in mid-2000, FrontLine reevaluated the
carrying value of its ownership interests and, as a result of this
re-evaluation, recorded an impairment charge of $25.7 million in the fourth
quarter of the year ended December 31, 2000 to reduce the carrying values of
these investments to estimated fair value.
FrontLine also has an interest in Reckson Strategic Venture Partners, LLC,
which invests in operating companies with experienced management teams in real
estate and real estate related market sectors which are in the early stages of
their growth cycle or offer unique circumstances for attractive investments, as
well as platforms for future growth.
At December 31, 2000, FrontLine had 18 employees.
You should refer to Note 4 to the accompanying Consolidated Financial
Statements for financial information and further discussion and financial data
related to our Parent and Other Interests Segment.
I-6
ITEM 2. PROPERTIES
FrontLine's principal office is located at 90 Park Avenue, New York, New
York, 10016. Management believes that such space is sufficient to meet
FrontLine's present needs and does not anticipate any difficulty in securing
additional space, as needed, on terms acceptable to FrontLine.
HQ Business Centers at December 31, 2000
The following table sets forth the number of HQ business centers and the
related number of workstations that HQ operated as of December 31, 2000. HQ
centers are located in buildings where HQ leases office space from landlords.
See "Suppliers" in Item 1 to this Form 10-K.
LOCATION CENTERS WORKSTATIONS
- -------- --------- -------------
United States:
Alabama .................................................. 2 211
Arizona .................................................. 10 1,196
California ............................................... 71 8,588
Colorado ................................................. 9 1,207
District of Columbia ..................................... 9 1,035
Florida .................................................. 14 1,615
Georgia .................................................. 23 2,360
Illinois ................................................. 28 3,206
Indiana .................................................. 3 273
Kansas ................................................... 2 251
Kentucky ................................................. 1 112
Massachusetts ............................................ 15 1,588
Maryland ................................................. 4 486
Michigan ................................................. 6 780
Minnesota ................................................ 5 604
Missouri ................................................. 4 392
Nevada ................................................... 4 429
New Jersey ............................................... 17 1,415
New York ................................................. 37 4,933
North Carolina ........................................... 6 790
Ohio ..................................................... 10 1,053
Oklahoma ................................................. 1 103
Oregon ................................................... 5 551
Pennsylvania ............................................. 4 381
Tennessee ................................................ 1 103
Texas .................................................... 22 3,155
Utah ..................................................... 3 293
Virginia ................................................. 16 1,901
Washington ............................................... 9 1,018
Wisconsin ................................................ 1 61
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U.S. -- Operated Centers ................................. 342 40,090
International:
Argentina ................................................ 2 190
Austria .................................................. 2 154
England .................................................. 24 4,382
France ................................................... 6 552
Germany .................................................. 2 270
Mexico ................................................... 6 341
Scotland ................................................. 2 489
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International Centers ..................................... 44 6,378
Franchise Centers ......................................... 76 6,312
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Total Centers ............................................. 462 52,780
=== ======
I-7
HQ operates 146 of the centers and 17,344 workstations in the top five
markets of New York City, Los Angeles, Chicago, Washington D.C. and San
Francisco. Additionally, HQ has 76 franchised centers of which 46 are located
in 11 states and 30 are located in 14 international locations. HQ also manages
six business centers for other owners and operates nine centers in England
under joint venture arrangements. Overall, as of December 31, 2000, HQ provided
its clients officing solutions in 462 centers, with 52,780 workstations in 19
countries.
HQ's corporate headquarters is located at 15950 North Dallas Parkway,
Dallas, Texas. HQ has signed a lease for new space less than one mile from its
present headquarters. HQ believes the new headquarters space is sufficient to
meet its present needs and does not anticipate any difficulty in securing
additional office space, as needed, on terms acceptable to it.
ITEM 3. LEGAL PROCEEDINGS
On February 4, 1999, a lawsuit captioned OmniOffices, Inc. et al. v.
Joseph Kaidanow, et al., (Civil Action No. 99-0260) was filed in the United
States District Court for the District of Columbia. This litigation (the "D.C.
Action"), is with two stockholders of Old HQ (f/k/a OmniOffices, Inc.) and
involves the conversion of approximately $111 million of debt previously loaned
to Old HQ by CarrAmerica, into HQ's non-voting common stock. CarrAmerica and
Old HQ initiated the action by filing a complaint seeking declaratory judgment
that the conversion price was fair, following threats by Messrs. Kaidanow and
Arcoro to challenge the conversion price. Messrs. Kaidanow and Arcoro filed
counterclaims against CarrAmerica, Old HQ and the then current directors of Old
HQ, seeking a judgment declaring the conversion void or voidable, or in the
alternative, compensatory and punitive damages. The stockholders' counterclaim
makes no allegations against HQ. Discovery in this action was completed in late
1999. A motion for summary judgment is currently pending. The case has been
reassigned several times causing delays. It is unclear when this motion will be
acted upon or when the case would be set for trial.
Joseph Kaidanow and Robert Arcoro v. CarrAmerica Realty Corporation, HQ
Global Workplaces, Inc., Thomas A. Carr, Philip L. Hawkins, C. Ronald
Blankenship, Oliver T. Carr, and Gary Kusin. This action (the "Fiduciary
Action"), originally brought in Delaware state Chancery Court on April 17,
2000, was removed to the Federal District Court for the District of Delaware
and then remanded on plaintiffs motion back to Delaware Chancery Court. The
action alleges a breach of fiduciary duty by CarrAmerica Realty Corporation and
Old HQ's directors in approving the HQ Merger transaction. The complaint
alleges among other things that allocation of purchase price between the UK and
U.S. companies failed to meet the standard of entire fairness. The complaint
also states that CarrAmerica breached its obligations under the Tag a Long and
Sharing Agreement between plaintiffs and CarrAmerica. HQ is named as a party
because the request for injunctive and/or recissory damages would affect its
interests in the assets acquired in the HQ Merger. The plaintiffs in the
Fiduciary Action have also brought an appraisal action in the Chancery Court
requesting appraisal of the value of shares sold in the HQ Merger.
In addition to the cases set forth above, the Company and its investee
entities are party to claims and administrative proceedings arising in the
ordinary course of business or which are otherwise subject to indemnification,
some of which are expected to be covered by liability insurance (subject to
policy deductibles and limitations of liability) and all of which, including
the cases discussed above, collectively are not expected to have a material
adverse effect on the Company's financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders during the fourth
quarter of the year ended December 31, 2000.
I-8
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock traded over the counter ("OTC") under the
symbol "RSII" through August 1999 when it began trading on the NASDAQ National
Market ("NASDAQ"). In April 2000, the Company's symbol was changed to "FLCG."
The following table sets forth the quarterly high and low closing bid prices
per share of the Company's common stock reported for each respective quarter.
These OTC and NASDAQ market quotations reflect inter-dealer prices, without
retail mark-up, mark-down or commission and may not necessarily represent
actual transactions. Since inception, the Company has not paid any dividends to
its shareholders. Under the terms of the Company's credit facilities, as long
as there are outstanding advances under such facilities, the Company is
prohibited from paying dividends on any share of its common stock. In addition,
the payment of dividends on the Company's common stock is prohibited unless
full distributions have been paid on both of the Company's Series A and Series
B Preferred Stock.
HIGH LOW
----------- -----------
1999
----
March 31 ............. $ 5.718 $ 3.500
June 30 .............. $ 17.125 $ 4.062
September 30 ......... $ 19.625 $ 12.500
December 31 .......... $ 68.312 $ 15.250
2000
----
March 31 ............. $ 61.750 $ 40.875
June 30 .............. $ 44.625 $ 14.063
September 30 ......... $ 24.250 $ 14.563
December 31 .......... $ 15.750 $ 9.594
The number of registered shareholders of the Company's common stock as of
March 20, 2001 was 7,051.
UNREGISTERED SALES OF SECURITIES
In connection with acquisitions by the Company of ownership interests in
VANTAS, in May 2000 the Company issued 6,837 shares of its common stock in
transactions exempt from registration under Section 4(2) of the Securities Act
of 1933 ("Section 4(2)").
On March 7, 2000, Gotham Partners Management Co., LLC and certain
affiliates ("Gotham") purchased 1.5 million warrants for FrontLine's common
stock for a total purchase price of $30 million. The warrants had an exercise
price of $70 per share and a term of 3.25 years. FrontLine utilized
approximately half of the proceeds to reduce its then-existing credit facility
and the remaining portion was utilized for investments and working capital
purposes. On June 29, 2000, Gotham invested an additional $3.0 million to
obtain a reduction in the warrant exercise price to $47.25 per share and to
extend the expiration of the warrants to March 2005. Simultaneously with this
transaction, FrontLine issued 1,075,000 shares of its common stock to acquire
Gotham's interest in a limited liability company owned by both FrontLine and
Gotham. Such limited liability company owned 411,223 shares of common stock of
HQ Global.
As dividends on its Series A 8.875% Convertible Cumulative Preferred Stock
(the "Series A Preferred Stock") which were payable in August 2000, November
2000 and February 2001, FrontLine issued 38,172, 37,566 and 43,227 shares of its
common stock, respectively, to the institutional investor that holds the Series
A Preferred Stock in transactions exempt from registration under Section 4(2).
In December 2000, FrontLine issued 15,000 shares of its common stock to an
affiliate of Reckson in a transaction exempt from registration under Section
4(2), as reimbursement for the 15,000 shares of FrontLine common stock paid by
the affiliate of Reckson to a non-executive employee on FrontLine's behalf.
II-1
On December 13, 2000, FrontLine obtained a $25.0 million preferred equity
facility, initially issuing 15,000 shares of Series B Convertible Cumulative
Preferred Stock (the "Series B Preferred Stock") for net proceeds of $13.9
million. On February 1, 2001, FrontLine drew the remaining $10.0 million of the
facility, issuing 10,000 shares of Series B Preferred Stock for net proceeds of
$10.0 million. These transactions were exempt from registration under Section
4(2).
II-2
ITEM 6. SELECTED FINANCIAL DATA
PERIOD FROM
JULY 15,1997
YEAR ENDED DECEMBER 31, (INCEPTION) TO
------------------------------------------- DECEMBER 31,
2000(2) 1999(3) 1998 1997
------------- ------------- ----------- ---------------
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
OPERATIONS SUMMARY:
HQ operating revenues .................... $ 483,962 $ 214,445 $ -- $ --
HQ operating income ...................... 97,329 27,527 -- --
Corporate general and administrative (16,478) (9,509) (2,613) (479)
Equity in net loss and impairment of
unconsolidated companies ............... (125,928) (10,266) (3,630) 223
Net loss applicable to common
shareholders ........................... $ (234,897) $ (39,847) $ (8,147) $ (258)
PER SHARE DATA(1):
Basic and diluted net loss ............... $ (6.73) $ (1.56) $ (0.56) $ --
BALANCE SHEET DATA (PERIOD END):
Cash and cash equivalents ................ $ 23,105 $ 32,740 $ 2,026 $ 130
Working capital (deficit) ................ (27,208) 17,090 132 11
Ownership interests in and advances
to unconsolidated companies(4) ......... 39,845 97,833 45,838 5,845
Intangible assets ........................ 667,936 239,412 -- --
Total assets ............................. 1,132,360 541,983 58,843 7,519
Long-term debt ........................... 440,449 274,380 40,981 --
Total shareholders' equity(5) ............ $ 120,706 $ 114,109 $ 15,968 $4,222
- ----------
(1) Based on 34,880,709, 25,600,985 and 14,522,513 weighted average shares of
common stock outstanding for the years ended December 31, 2000, 1999 and
1998, respectively.
(2) Reflects the operating results of HQ Global Workplaces, Inc. ("Old HQ") for
the period subsequent to June 1, 2000, the date of the merger of Old HQ
with VANTAS Incorporated ("VANTAS"). See Note 3 to the accompanying
consolidated financial statements for further discussion.
(3) Reflects the Company's acquisition and consolidation of a majority
ownership interest in VANTAS as of January 1, 1999.
(4) Includes the carrying value of investments in Reckson Strategic Venture
Partners, LLC of $28,969,000, $36,626,000, $15,561,000 and $5,520,000 as
of December 31, 2000, 1999, 1998 and 1997, respectively.
(5) No dividends on the common stock were paid in any of the periods presented.
During the year ended December 31, 2000, the Company recognized $2,119,000
of dividends on and accretion of preferred stock.
NOTE: Certain prior period amounts have been reclassified to conform to the
current year presentation.
II-3
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
accompanying financial statements of FrontLine Capital Group (the "Company" or
"FrontLine") and related notes thereto.
The Company considers certain statements set forth in this Annual Report on
Form 10-K to be forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, with respect to the Company's expectations for future
periods. Certain forward-looking statements, including, without limitation,
statements relating to the achievement of our refocused business plan and our
future operating performance and the future operating performance of HQ Global
Holdings, Inc. ("HQ Global"), the financing of the Company's operations and the
operations of its investee entities and the ability to integrate and manage
effectively its various acquisitions, involve certain risks and uncertainties.
Although the Company believes that the expectations reflected in such
forward-looking statements are based on reasonable assumptions, the actual
results may differ materially from those set forth in the forward-looking
statements and the Company can give no assurance that such expectations will be
achieved. Certain factors that might cause the results of the Company to differ
materially from those indicated by such forward-looking statements include,
among other factors, negative changes in the executive office suites industry,
changes in the market valuation or growth rate of comparable companies in the
office suites industry, a downturn in general economic conditions, increases in
interest rates, a lack of capital availability, competition, reduced demand or
decreases in rental rates for executive office suites and other real
estate-related risks such as timely completion of projects under development,
our dependence upon key personnel, FrontLine's dependence upon financing from
Reckson Operating Partnership, L.P. ("Reckson"), a subsidiary of Reckson
Associates, conflicts of interest of management, and the ability to finance
business opportunities and other risks detailed in FrontLine's and HQ Global's
reports and other filings made with the Securities and Exchange Commission.
Consequently, such forward-looking statements should be regarded solely as
reflections of the Company's current operating and development plans and
estimates. These plans and estimates are subject to revision from time to time
as additional information becomes available, and actual results may differ from
those indicated in the referenced statements.
OVERVIEW AND BACKGROUND
FrontLine develops and manages companies servicing small and medium-size
enterprises ("SMEs") and mobile workforces of larger companies. FrontLine has
two distinct operating segments: one (the "HQ Global Segment") holds
FrontLine's interest in HQ, the world's largest provider of officing solutions,
and the other (the "Parent and Other Interests Segment") consists of FrontLine
(parent company) and its interests in a small group of technology-based
companies.
In October 2000, FrontLine announced that, as a result of changing capital
market conditions, it was refining its strategic plan (the "Restructuring"- see
Note 13 to the accompanying consolidated financial statements for further
discussion) to highlight its holdings in HQ and to maximize the value of its
other holdings. Additionally, in conjunction with the Restructuring, FrontLine
announced that it would focus its resources and capital on the businesses
within its existing portfolio and cease pursuing new investment activities.
In conjunction with the Restructuring, FrontLine re-evaluated the carrying
values of its investments and recorded aggregate impairment charges of $25.7
million in the fourth quarter of the year ended December 31, 2000 in order to
reduce the carrying value of these investments to fair value.
The presentation and content of the Company's financial statements is
largely a function of the presentation and content of the financial statements
of HQ and its predecessor companies and the other investee entities. As a
result, to the extent these entities change the presentation or content of
their financial statements, as may be required by the Securities and Exchange
Commission or changes in accounting literature, the presentation and content of
the Company's financial statements may also change.
II-4
EFFECT OF VARIOUS ACCOUNTING METHODS ON RESULTS OF OPERATIONS
The interests that FrontLine owns in its investee entities have
historically been accounted for under one of three methods: consolidation,
equity method and cost method. The applicable accounting method is generally
determined based on the Company's voting interest and rights in each investee.
Consolidation. Where the Company directly or indirectly owns more than 50%
of the outstanding voting securities of an entity or controls the board of
directors, the consolidation method of accounting is applied. Under this
method, an entity's results of operations are reflected within the Company's
Consolidated Statements of Operations. The entities whose results are
consolidated by the Company are comprised of VANTAS Incorporated ("VANTAS") and
effective with the June 1, 2000 merger (the "Merger") of VANTAS with HQ Global
Workplaces, Inc. ("Old HQ"). The entity representative of Old HQ and its
predecessors, such as VANTAS, is referred to herein as HQ. (See Note 3 to the
accompanying consolidated financial statements for further discussion).
Participation of other shareholders in the earnings or losses of the
consolidated entities is reflected in the caption "Minority interest" in the
Consolidated Statements of Operations. Minority interest adjusts the
consolidated net results of operations to reflect only the Company's share of
the earnings or losses of the consolidated entities.
To understand the Company's results of operations and financial position
without the effect of the consolidation of HQ, Note 4 to the accompanying
consolidated financial statements presents the balance sheets, statements of
operations and cash flows of the Company without the consolidation of
FrontLine's ownership interest in HQ.
Equity Method. Investees whose results are not consolidated, but over whom
the Company exercises significant influence, have been accounted for under the
equity method of accounting. Investments which were accounted for under the
equity method of accounting included: EmployeeMatters, Inc. ("EmployeeMatters"-
sold in December 2000), OnSite Access, Inc., RealtyIQ Corp., UpShot.com and
Reckson Strategic Venture Partners, LLC ("Reckson Strategic").
Cost Method. Investees not accounted for under either the consolidation or
the equity method of accounting are accounted for under the cost method of
accounting. Under this method, the Company's share of the earnings or losses of
these companies is not included in the Consolidated Statements of Operations.
Impairment charges recognized on cost method investments are included in
"Equity in net loss and impairment of unconsolidated companies" in the
accompanying Consolidated Statements of Operations.
RESULTS OF OPERATIONS
The reportable segments in FrontLine's financial statements are the HQ
Segment and the Parent and Other Interests Segment. The following discussion
should be read in conjunction with the accompanying consolidated financial
statements and notes thereto.
HQ
As of December 31, 2000, HQ owned or operated 386 business centers
throughout the United States, the United Kingdom, Europe and Latin America.
This included 26 business centers that had been open for twelve months or less.
Additionally, this includes six business centers managed for unrelated third
parties and nine joint venture business centers. Additionally, HQ has 76
franchised centers of which 46 are located in 11 states and 30 are located in
14 international locations.
II-5
The following table represents certain information relating to business
centers under management as of:
DECEMBER 31,
-----------------------
2000 1999 1998
------ ------ -----
Owned and operated:
Operated more than 12 months ............................. 345 190 97
Operated less than 12 months ............................. 26 11 1
Managed (1) ............................................... 6 5 5
Joint venture (1) ......................................... 9 -- --
Franchised centers (1) .................................... 76 -- --
--- --- ---
Total business centers .................................... 462 206 103
=== === ===
- ----------
(1) These centers are not consolidated in the financial results of HQ
HQ has grown through an aggressive acquisition strategy beginning in 1997.
As of December 31, 2000, HQ had acquired or merged with 37 entities which
operated 353 business centers with a total purchase price of approximately $588
million.
The following table represents a summary of information regarding HQ
acquisitions of business centers:
YEAR ENDED DECEMBER 31,
---------------------------------------
2000 1999 1998
------------ ----------- ----------
Business centers acquired ................................. 181 86 48
Purchase price (in millions) .............................. $ 397.1 $ 108.5 $ 45.8
Number of acquisitions .................................... 2 12 16
In the early stages of development of a Development Center, expenses are
incurred with minimal corresponding revenues. Once a Development Center reaches
occupancy levels above 70%, generally within twelve months of its initial
operations, it is expected to have a positive impact on HQ's results of
operations.
The acquisition and development activities have had a material impact on
HQ's results of operations and financial position and significantly affect the
comparability of the respective prior periods.
All of FrontLine's operating revenues and operating expenses for the years
ended December 31, 2000 and 1999 were attributable to HQ. The following is a
discussion of HQ's results of operations for the years ended December 31, 2000
and 1999.
YEARS ENDED DECEMBER 31, 2000 AND 1999
Revenues. Total business center revenues for the year ended December 31,
2000 were $484.0 million, representing an increase of $269.6 million, or
125.7%, from the year ended December 31, 1999.
Business centers with twelve months of activity for both periods under
comparison ("Same Centers") had revenues for the years ended December 31, 2000
and 1999 of $206.7 million and $178.3 million, respectively, representing an
increase in 2000 of $28.4 million, or 15.9%, compared with 1999. The increase
in revenues in 2000 is attributable to an increase in workstation revenues of
$15.8 million, or 14.8%, and an increase in support service revenues of $12.6
million, or 17.6%, from 1999. Workstation revenues increased due to more
favorable office pricing as well as an increase in occupancy levels. The
increase in support services is primarily attributable to an increase in
broadband Internet access, information technology support services and other
business support services.
Business centers that were acquired during the periods under comparison
("Acquired Centers") had revenues for the years ended December 31, 2000 and
1999 of $254.5 million and $28.8 million, respectively, representing an
increase in 2000 of $225.7 million compared with 1999. The increase in
II-6
revenues resulted primarily from the HQ Merger on June 1, 2000, which
contributed an additional $214.6 million of revenue to fiscal 2000 results. The
remaining $11.0 million increase in revenues resulted from realizing a full
year of 2000 results from business centers acquired during 1999 and more
favorable office pricing as well as an increase in occupancy levels.
Business centers with less than 12 months of activity during one of the
periods under comparison ("Development Centers") had revenues for the years
ended December 31, 2000 and 1999 of $19.2 million and $0.8 million,
respectively, representing an increase in 2000 of $18.4 million compared with
1999. At December 31, 2000 and 1999, there were 18 and six Development Centers,
respectively, excluding acquired centers open for less than 12 months.
Business centers that were closed during the period under comparison
("Closed Centers") had revenues for the years ended December 31, 2000 and 1999
of $3.6 million and $6.5 million, respectively. Subsequent to January 1, 1999,
HQ closed ten business centers, which had been acquired in previous years. The
Closed Centers were largely focused in major markets and were replaced with
Development Centers where existing clients were serviced in the new centers.
Expenses. Total business center expenses for the year ended December 31,
2000 were $331.9 million, representing an increase of $162.9 million, or 96.4%,
from 1999.
Same Center expenses for the years ended December 31, 2000 and 1999 were
$143.0 million and $137.4 million, respectively, representing an increase in
2000 of $5.6 million, or 4.1%, compared with 1999. The increase in expenses is
attributable to inflation adjusted lease increases and support service expenses
associated with increased support service revenues, partially offset by lower
center general and administrative expenses due to synergies realized in the HQ
Merger.
Acquired Center expenses for the years ended December 31, 2000 and 1999
were $168.5 million and $22.8 million, respectively, representing an increase
in 2000 of $145.7 million, or 639.0%, compared with 1999. The increase in
expenses resulted primarily from the HQ Merger on June 1, 2000, which
contributed an additional $138.0 million of business center expenses to fiscal
2000 results. The remaining $7.7 million increase in expenses resulted from
realizing a full year of 2000 results from business centers acquired during
1999.
Development Center expenses for the years ended December 31, 2000 and 1999
were $17.0 million and $3.1 million, respectively, representing an increase in
2000 of $13.9 million, compared with 1999.
Closed Center expenses for the years ended December 31, 2000 and 1999 were
$3.4 million and $5.6 million, respectively. Subsequent to January 1, 1999, HQ
closed ten business centers, which had been acquired in previous years. The
Closed Centers were largely focused in major markets and were replaced with
Development Centers where existing clients were serviced in the new centers.
Business Center Operating Income ("BCOI"). For the year ended December 31,
2000, BCOI was $152.0 million as compared with $45.5 million for 1999. The BCOI
as a percentage of total revenues ("BCOI Margin") was 31.4% for the year ended
December 31, 2000 as compared to 21.2% for 1999. The increase in BCOI Margin is
primarily attributable to more favorable office pricing, increased volume of
business services, and synergies realized from the HQ Merger.
Same Center BCOI was $63.7 million and $40.9 million for the years ended
December 31, 2000 and 1999, respectively, representing an increase in 2000 of
$22.8 million, or 55.7%, from 1999. The BCOI Margin from Same Centers for the
year ended December 31, 2000 was 30.8% as compared with 22.9% in 1999. The
increase in BCOI margin is primarily attributable to more favorable office
pricing, increased volume of business services, and synergies realized in the
HQ Merger.
Acquired Center BCOI was $85.9 million for the year ended December 31,
2000, an increase in 2000 of $79.9 million from $6.0 million in 1999. The BCOI
Margin for Acquired Centers for the year ended December 31, 2000 was 33.8% as
compared with 20.8% in 1999. The increase in BCOI margin is primarily
attributable to more favorable office pricing, increased volume of business
services, and synergies realized in the HQ Merger.
II-7
Development Center BCOI was $2.2 million and negative $2.3 million for the
years ended December 31, 2000 and 1999, respectively, representing an increase
in 2000 of $4.5 million from 1999. The transition to positive BCOI Margin from
Development Centers resulted from centers opened in 1999 reaching maturity, and
exceptional performance for centers opened in 2000, several of which
contributed positive BCOI in their first twelve months of operations.
Closed Center BCOI was $0.2 million and $0.9 million for the years ended
December 31, 2000 and 1999, respectively. Subsequent to January 1, 1999, HQ
closed ten business centers, which had been acquired in previous years. The
Closed Centers were largely focused in major markets and were replaced with
Development Centers where existing clients were serviced in the new centers.
Corporate General and Administrative Expenses. For the years ended
December 31, 2000 and 1999, corporate general and administrative expenses were
$54.7 million and $18.0 million, respectively. Stated as a percentage of total
revenue, such expenses were 11.3% and 8.4%, respectively. The increase in
corporate general and administrative expenses was primarily attributable to an
increase in corporate office staff and related office space costs associated
with HQ's growth created by the HQ Merger completed June 1, 2000. HQ's
transition progressed during the remainder of fiscal 2000 and its corporate
general and administrative costs decreased as a percentage of revenue during
the months subsequent to the HQ Merger.
Merger and Integration Charges. For the years ended December 31, 2000 and
1999, merger and integration charges were $25.4 million and $26.7 million,
respectively. For fiscal 2000, merger and integration charges related to the HQ
Merger consisted of $11.4 million of payments to cancel options to purchase
common stock held by officers and employees, $10.1 million of charges related
to severance, retention incentives and other benefits, and $3.9 million of
professional fees and other expenses. For 1999, merger and integration charges
related to certain transactions with FrontLine. Such charges related to
acquisitions in 1999, and consisted of $23.7 million of compensation expense
and $3.0 million of professional fees, business process reengineering and other
integration costs related to the acquisitions.
Depreciation and Amortization. For the years ended December 31, 2000 and
1999, depreciation and amortization expenses were $54.8 million and $15.0
million, respectively. The increase in depreciation and amortization relates to
goodwill associated with mergers and acquisitions, fixed assets acquired, and
an increase in capital expenditures associated with technology infrastructure
additions and leasehold improvements for Development Centers and Same Centers.
Interest Expense, Net. For the years ended December 31, 2000 and 1999,
respectively, net interest expense was $34.7 million and $10.2 million,
respectively. The increase in interest expense is related to an increase in
borrowing as a result of the HQ Merger.
Benefit (Provision) for Income Taxes. HQ's provision for income taxes
consisted of $5.4 million in expense and $2.8 million in benefit for the years
ended December 31, 2000 and 1999, respectively. The provision is comprised
entirely of state and foreign taxes.
Minority Interest. Minority interest was expense of $7.7 million and
income of $18.8 million in the years ended December 31, 2000 and 1999,
respectively. This change was principally due to accretion on HQ's preferred
stock not held by FrontLine.
PARENT AND OTHER INTERESTS
YEARS ENDED DECEMBER 31, 2000 AND 1999
As a result of the Restructuring discussed above, FrontLine has changed
from a company which invested in early stage companies which leveraged the
Internet into one which is focused on maximizing the value of HQ.
Parent expenses increased $46.8 million to $73.6 million in the year ended
December 31, 2000 as compared to 1999, principally due to $12.8 million of
costs related to the Restructuring in 2000, a $10.7 million increase in net
interest expense reflecting higher average borrowings, $10.0 million of costs
attributable to a development stage company in 2000, a $7.0 million increase in
general and administrative expenses and a $5.9 million increase in the
amortization of stock compensation and related awards.
II-8
The restructuring costs recognized in 2000 consist of (1) $4.6 million of
accelerated amortization of stock compensation and related awards that resulted
from the termination of certain employees in connection with the Restructuring,
(2) $3.4 million of severance and related payments made to employees who were
terminated in 2000 in connection with the Restructuring and (3) $4.8 million of
writedowns of assets determined to be impaired as a result of the Restructuring.
In connection with the Restructuring, FrontLine has adopted a severance plan for
its remaining employees.
FrontLine's general and administrative expenses were $16.5 million in 2000
compared to $9.5 million in 1999, reflecting the growth in FrontLine's
infrastructure during the second half of 1999 and early 2000 to support its
operations. Since the Restructuring, the Company has substantially reduced its
workforce and related recurring general and administrative expenses have been
decreasing and are expected to continue to decrease to approximately $250,000
per month in the second quarter of 2001.
A significant portion of FrontLine's net loss is derived from companies in
which it held minority ownership interests. The equity in net loss and
impairment of unconsolidated companies increased $115.7 million to $125.9
million in 2000 as compared to 1999. The equity in net loss and impairment of
unconsolidated companies in 2000 consisted of $108.5 million of equity in net
losses and $25.7 million of impairment charges reflecting estimated decreases
in the fair value of certain of the Company's investments, partially offset by
an $8.3 million gain on the December 2000 sale of the investment in
EmployeeMatters. The impairment charges in 2000 were determined in recognition
of both the lack of continuing support FrontLine planned to provide to certain
investee entities following the Restructuring and the difficult market
conditions experienced beginning in mid-2000. Such loss for the year ended
December 31, 1999 was entirely comprised of equity in the net losses of
unconsolidated companies. Equity losses fluctuate with the number of investee
entities accounted for under the equity method, FrontLine's voting ownership
percentage in these companies, the amortization of goodwill related to newly
acquired equity method entities, and the results of operations of these
companies. In 2000, FrontLine had interests in 12 equity method investees for
the entire year, as compared to two interests for the entire year of 1999. All
of these companies incurred losses in 2000 and 1999. The results of operations
of these entities are not consolidated within the Consolidated Statements of
Operations; however, FrontLine's share of these companies' losses, as well as
all estimated impairment charges, are reflected in the caption "Equity in net
loss and impairment of unconsolidated companies" in the Consolidated Statements
of Operations. (See Note 4 to the accompanying consolidated financial
statements).
The extraordinary item of $2.6 million in 2000 resulted from the write-off
of deferred financing costs relating to the early extinguishment of a $60.0
million credit facility in March 2000.
Dividends on, and accretion of, preferred stock of $2.1 million in 2000
represents dividends on FrontLine's 8.875% Series A Convertible Cumulative
Preferred Stock, which was issued in the first quarter of 2000 and accretion of
FrontLine's Series B Convertible Cumulative Preferred Stock which was issued in
the fourth quarter of 2000.
YEAR ENDED DECEMBER 31, 1998
The Company commenced operations on July 15, 1997 and primarily incurred
startup costs through December 31, 1998. Accordingly, results for the year
ended December 31, 1998 are not comparable to the results for the years ended
December 31, 1999 and 2000. The Company's net loss of $8.1 million for the year
ended December 31, 1998 was comprised of $2.6 million of general and
administrative expenses, $1.3 million of depreciation and amortization, $0.6
million of net interest expense and $3.6 million of equity in net loss of
unconsolidated subsidiaries.
LIQUIDITY AND CAPITAL RESOURCES
HQ
Historically, HQ has primarily relied upon cash flows generated from
operations, borrowings from its lenders and sales of its securities to satisfy
its liquidity and capital requirements. Principal liquidity needs have included
the acquisition and development of new business centers, debt service
requirements and other capital expenditures necessary to maintain existing
business centers as well as upgrade and build the corporate infrastructure to
manage HQ's operations effectively.
II-9
On May 31, 2000, HQ amended and increased its $157.9 million credit
facility to $275.0 million (the "HQ Credit Facility"). The HQ Credit Facility
provides for $219.4 million under four term loans (the "Term Loans"), all of
which are repayable in various quarterly installments through November 2005.
The HQ Credit Facility also provides for borrowings of up to an additional
$55.6 million in two revolving loan commitments (the "Revolver Loans").
Availabilities under the Revolver Loans are formula based. As of December 31,
2000, there was $212.9 million in outstanding borrowings under the Term Loans
and no borrowings outstanding under the Revolver Loans. As of December 31,
2000, HQ had letters of credit outstanding in the aggregate amount of $33.4
million. Such letters of credit are collateralized by $5.6 million in cash and
$27.8 million of Revolver Loans, leaving $27.8 million available under the
Revolver Loans for additional borrowings.
Borrowings under the HQ Credit Facility bear interest ranging from prime
plus 2.25% to 3.00% or LIBOR plus 3.25% to 4.0% for one, three or nine-month
periods at HQ's election. The weighted average interest rate on borrowings
under the Term Loans at December 31, 2000 was approximately 10.7%. HQ pays a
commitment fee of 1/2 of 1.0% per annum on the unused portion of the HQ Credit
Facility. As of December 31, 2000, HQ had hedged the interest rates on
approximately $103.5 million of borrowings under the HQ Credit Facility using
various instruments with various expiration dates through July 31, 2002. These
instruments lock in the maximum underlying three-month LIBOR rate at levels
between 7.93% and 9.00%.
On May 31, 2000, HQ entered into a Senior Subordinated Credit Facility
(the "UBSW Loan") in the amount of $125.0 million with UBS Warburg LLC
("UBSW"). The UBSW Loan carried an interest rate of LIBOR plus 6.5% and was to
mature on May 31, 2007. On August 11, 2000, HQ replaced the UBSW Loan with a
$125.0 million Senior Subordinated Note Agreement (the "Mezzanine Loan") with a
group of lenders arranged by UBSW. The Mezzanine Loan bears interest at 13.5%
per annum and matures on May 31, 2007.
The HQ Credit Facility and Mezzanine Loan contain certain covenants,
including a defined maximum ratio of consolidated indebtedness to consolidated
earnings before interest, income taxes, depreciation and amortization. In
addition, there are other covenants pertaining to financial ratios and
limitations on capital expenditures. Also, the HQ Credit Facility and Mezzanine
Loan prohibit the declaration or payment of dividends by HQ Global or any of
its subsidiaries, except for the payment of dividends in kind on HQ Global's
preferred stock. At December 31, 2000, HQ was in compliance with these
covenants, as amended.
To finance a portion of the consideration in the HQ Merger, HQ Global
issued 4,782,692 shares of Series A Preferred Stock, 1,445,358 Series A
Warrants and 697,964 Series B Warrants for a total consideration of $195.0
million. On August 11, 2000, HQ Global issued an additional 613,166 shares of
Series A Preferred Stock, 312,274 Series A Warrants and 164,902 Series B
Warrants for a total consideration of $25.0 million.
HQ had working capital deficit of $21.8 million at December 31, 2000 as
compared to a working capital deficit of $4.0 million at December 31, 1999.
This decrease in working capital of $17.8 million is primarily attributable to
increases in the balances of accounts payable and the current portion of the
notes payable.
Cash flows provided by operating activities for the year ended December
31, 2000 were $27.8 million, representing an increase of $3.2 million from
1999. This increase is attributable to the decrease in HQ's net loss and an
increase in noncash charges, partially offset by changes in the components of
working capital. Cash flows from operations absorbed $34.3 million of cash
merger and integration costs in 2000 compared with $3.3 million in 1999.
Cash used in investing activities for the year ended December 31, 2000 was
$288.7 million, an increase of $189.5 million from 1999. This increase is
attributable to the HQ Merger and purchases of property and equipment,
partially offset by a reduction in restricted cash in conjunction with the HQ
Merger.
Cash provided by financing activities for the year ended December 31, 2000
was $273.3 million, an increase of $198.5 million from 1999. During the year
ended December 31, 2000, HQ completed equity
II-10
transactions whereby it raised $181.0 million in net proceeds from the issuance
of its convertible preferred stock and $64.3 million from the issuance of
warrants. Also, in connection with the HQ Merger, HQ increased borrowings under
the HQ Credit Facility by $78.6 million.
In the fourth quarter of 2000, and continuing into the first quarter of
2001, the United States economy has begun to decline. HQ's occupancy rates have
declined along with the decline in the economy. It is likely that the economic
decline will continue to have an adverse effect on the results of HQ's
operations and its cash flows. In light of the slowing economy and the decline
in occupancy, HQ is taking actions which it believes will generate additional
revenues, reduce expenses and improve its liquidity. However, there can be no
assurance that the economy will not slow at a rate greater than anticipated, or
that these actions will be successful. HQ currently anticipates that cash flows
from operations and amounts available under the revolving loan portion of the
Credit Facility will continue to provide adequate capital to fund HQ's expenses
and regular debt service obligations in addition to the necessary capital
required to fund both new center development and renovate existing centers along
with various technology projects during 2001.
FRONTLINE
FrontLine has funded operations and investing activities through a
combination of borrowings under various credit facilities, issuances of the
Company's equity securities and sales of assets. FrontLine invested
approximately $152.5 million in cash and issued $48.1 million of the Company's
common stock to acquire interests in or make advances to its equity investees
during the year ended December 31, 2000; approximately 55% of such aggregate
amount related to investments in HQ and its predecessor company.
The Company has a credit facility with Reckson in the amount of $100
million (the "FrontLine Facility"). Additionally, Reckson Strategic has a $100
million facility (the "Reckson Strategic Facility") with Reckson to fund Reckson
Strategic investments. Note 15 to the consolidated financial statements
summarizes the terms of the FrontLine Facility and Reckson Strategic Facility
(collectively, the "Credit Facilities"). The Company had $93.4 million
outstanding under the FrontLine Facility at December 31, 2000, and due to
outstanding letters of credit and accrued interest, has no remaining
availability. The Company had $42.1 million outstanding under the Reckson
Strategic Facility at December 31, 2000. These borrowings were utilized to fund
Reckson Strategic investments and its general operations. Taking into account
certain investments made directly by Reckson in Reckson Strategic projects which
reduce the amounts available under the Reckson Strategic Facility, $17.5 million
was available under the Reckson Strategic Facility at December 31, 2000. As long
as there are outstanding amounts under the Credit Facilities, the Company is
prohibited from paying dividends on shares of its common stock or, subject to
certain exceptions, incurring additional debt. The Credit Facilities are subject
to certain other covenants and prohibit advances thereunder to the extent the
advances could, in Reckson's determination, endanger the status of Reckson
Associates as a REIT. Under the Credit Facilities, additional indebtedness may
be incurred by the Company's subsidiaries. The Credit Facilities also contain
covenants prohibiting the Company from entering into any merger, consolidation
or similar transaction and from selling all or any substantial part of its
assets, or allowing any subsidiary to do so, unless approved by the lender. On
March 28, 2001, the Company's Board of Directors approved amendments to the
Credit Facilities pursuant to which (i) interest is payable only at maturity and
(ii) Reckson may transfer all or any portion of its rights or obligations under
the Credit Facilities to its affiliates. These changes were requested by Reckson
as a result of changes in REIT tax laws. In addition, the Reckson Strategic
Facility was amended to increase the amount available thereunder to up to $110
million.
FrontLine's secured credit facility for $60 million was fully drawn and
then repaid and terminated during the first quarter of 2000, and is therefore no
longer available. On September 11, 2000, FrontLine amended its $25.0 million
credit agreement (the "FrontLine Bank Credit Facility"). Borrowings under the
FrontLine Bank Credit Facility are secured by shares of HQ and bear interest, at
the election of FrontLine, at LIBOR for one, two, three or six-month periods,
plus 5%. Any outstanding borrowings under the FrontLine Bank Credit Facility are
currently due on June 11, 2001, subject to a three-month extension at
FrontLine's option. At December 31, 2000, FrontLine had borrowed $25.0 million
under the FrontLine Bank Credit Facility and subsequent to December 31, 2000,
repaid the entire outstanding
II-11
balance principally from the proceeds from the sale of marketable equity
securities and the issuance of redeemable preferred stock during the first
quarter of 2001. The FrontLine Bank Credit Facility contains, among others,
covenants prohibiting the Company from (i) transferring, conveying, disposing
of, pledging or granting a security interest in any of the collateral
previously pledged under the FrontLine Bank Credit Facility, (ii) terminating,
amending or modifying any organizational or other governing documents without
first obtaining the lender's prior written consent, (iii) violating certain
specified financial ratios, (iv) exceeding $25,000,000 of new indebtedness, and
(v) declaring or paying cash dividends on any class of the Company's stock.
In the aggregate, FrontLine raised approximately $195 million during the
year ended December 31, 2000 through the issuance of equity. Approximately $91
million of such amount was used to acquire interests in HQ Global. The balance
was used for other investments, to repay debt and for operating costs.
While the Company's Series B Preferred Stock is outstanding, the Company
is prohibited from (i) incurring any additional indebtedness, or, subject to
certain exceptions, permitting HQ Global to incur any additional indebtedness
and (ii) issuing any equity securities that are senior to, or an parity with,
the Series B Preferred Stock or permitting HQ Global to issue any preferred
stock, in either case, without the consent of a majority of the holders of the
Series B Preferred Stock. In addition, the consent of two-thirds of the holders
of the Company's Series A Preferred Stock is necessary in order to issue any
equity securities ranking senior to the Series A Preferred Stock. The Company
is also prohibited from paying dividends on its common stock unless full
distributions have been paid on both the Series A Preferred Stock and Series B
Preferred Stock.
Currently, the Company has two short-term letters of credit totaling $3.2
million, which have been utilized as security deposits.
The Company has entered into a stockholders agreement (the "HQ Stockholders
Agreement") with certain of the stockholders of HQ Global which provides them
with a right to put up to approximately 3.1 million shares of HQ Global (the "HQ
Shares") to the Company during the two years subsequent to the HQ Merger if HQ
Global has not completed an initial public offering of its shares. The put right
provides that up to 50% of the HQ Shares may be put to the Company in December
2001 and any remaining HQ Shares may be put to the Company in July 2002. The put
is payable in cash or FrontLine common stock (valued at the time of closing
under the put) at the Company's option.
FrontLine's operations do not require significant capital expenditures.
There were no significant capital expenditure commitments as of December 31,
2000.
As a result of the Restructuring, FrontLine's cash requirements have been
substantially reduced. The Company believes that it will be able to meet its
future cash requirements through cash on hand, availability under the FrontLine
Bank Credit Facility and additional bank or other financing. If additional
funds are raised through the issuance of equity securities, existing
shareholders may experience significant dilution. Although management believes
that it will continue to have sufficient access to the capital markets in order
to execute its restructured business plan, the availability and amount of funds
is subject to numerous factors including some that are beyond the Company's
control, and therefore is not assured.
On October 17, 2000, the Company's Board of Directors announced that it
adopted a Shareholder Rights Plan (the "Rights Plan") designed to protect
shareholders from various abusive takeover tactics, including attempts to
acquire control of the Company at an inadequate price, depriving shareholders
of the full value of their investment. A description of the Rights Plan is
included in Note 11 to the consolidated financial statements included elsewhere
in this Form 10-K.
INFLATION
FRONTLINE
Management believes that inflation did not have a significant effect on
its results of operations during any of the periods presented.
II-12
HQ
Certain of HQ's leases include increases in annual rent based on changes
in the consumer price index or similar inflation indices. HQ's contracts with
its clients generally range from six to twelve months in duration. Accordingly,
HQ has the ability to pass on its increased costs at the time of renewal of
such contracts.
Interest on HQ's borrowings under the HQ Credit Facility is based on
floating interest rates. HQ periodically evaluates its exposure to short-term
interest rates and will, from time to time, enter into interest rate protection
agreements, that mitigate, but do not eliminate, the effect of changes in
interest rates on its floating-rate indebtedness under the HQ Credit Facility.
These rates of interest will be influenced by changes in short-term rates and
are sensitive to inflation and other factors. A significant increase in
interest rates may have a negative impact on the earnings of HQ due to the
variable interest rates under the HQ Credit Facility.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
HQ
The primary market risk facing HQ is interest rate risk on the HQ Credit
Facility. HQ mitigates this risk by entering into hedging instruments on a
portion of its outstanding balances. In addition, HQ may elect to enter into
LIBOR contracts on portions of the HQ Credit Facility, which locks in the
interest rate on those portions for 30, 60 or 90-day periods. The HQ Credit
Facility bears interest ranging from either 3.25% to 4.00% over applicable
LIBOR, or alternatively 2.25% to 3.00% over prime, generally at HQ's election.
As of December 31, 2000, HQ had hedged the interest rates on approximately
$103.5 million of the HQ Credit Facility using various instruments with various
expiration dates through September 30, 2002. These instruments lock in the
maximum underlying three-month LIBOR at levels between 7.93% and 9.00%.
An increase in interest rates will have a negative impact on the net
income of HQ due to the variable interest component of the HQ Credit Facility.
Based on current interest rate levels, a 10% increase in underlying interest
rates will have a 6.3% increase in interest expense, ignoring the short-term
impact of remaining terms under current LIBOR hedge contracts.
Following the HQ Merger, HQ is conducting more of its operations in
foreign currencies, primarily the British Pound. Due to the nature of foreign
currency markets, there is potential risk for foreign currency losses as well
as gains. Currently, HQ has not hedged our foreign currency risk.
HQ has not, and does not plan to, enter into any derivative financial
instruments for trading or speculative purposes. As of December 31, 2000, HQ
had no other material exposure to market risk.
FRONTLINE
Interest Rate Risk
FrontLine faces interest rate risk on its Credit Facilities and the
FrontLine Bank Credit Facility. The Company has not hedged interest rate risk
using financial instruments. The Credit Facilities bear interest at the greater
of the prime rate plus 2% or 12% (with interest on balances outstanding more
than one year increasing by 4% of the previous year's rate). The FrontLine Bank
Credit Facility bears interest at LIBOR plus 5% for one, two, three or six-month
interest periods, as elected by Frontline. The rates of interest on the Credit
Facilities and the FrontLine Bank Credit Facility will be influenced by changes
in the prime rate and LIBOR. A significant increase in interest rates may have a
negative impact on the financial results of the Company due to the variable
interest rate (in excess of 12%) under the Credit Facilities and if FrontLine
ultimately needs to draw on the FrontLine Bank Credit Facility.
II-13
The following table sets forth FrontLine's obligations with respect to the
Credit Facilities and the FrontLine Bank Credit Facility, principal cash flows
by scheduled maturity, weighted average interest rates and estimated fair
market value at December 31, 2000 (in thousands, except rates).
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------
2001 2002 2003 2004 2005 THEREAFTER TOTAL FAIR VALUE
------------ ------ ------------- ------ ------ ------------ ----------- -----------
Variable rate ............... $ 25,000 -- $ 135,523 -- -- -- $160,523 $157,600
Average interest rate ....... 11.67% -- 12.14% -- -- -- 12.07% --
Equity Market Risk
FrontLine faces equity market risk in its ownership interests in its
unconsolidated companies. During the year ended December 31, 2000, FrontLine
recognized impairment charges to reflect decreased valuations for certain of
its investments as a result of unfavorable market conditions and other factors
(see Note 4 to the accompanying consolidated financial statements for further
discussion). As a result of such impairment charges, along with the recognition
of FrontLine's equity in the net losses of certain ownership interests, the
carrying value of FrontLine's ownership interests in and advances to
unconsolidated companies, at December 31, 2000 was $39.8 million, less than 4%
of total assets, thereby mitigating FrontLine's future equity market risk
related to these interests.
FrontLine also held marketable equity securities with a carrying value of
$21.9 million as of December 31, 2000. In the first quarter of 2001, FrontLine
sold substantially all of these securities at an average price similar to the
per share carrying value at December 31, 2000, thereby mitigating the equity
market risk related to these securities.
II-14
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is included in Item 14 of this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
II-15
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information contained in the section captioned "Proposal I: Election
of Directors" of the Company's definitive proxy statement for the 2001 annual
meeting of shareholders is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information contained in the section captioned "Executive
Compensation" of the Company's definitive proxy statement for the 2001 annual
meeting of shareholders is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information contained in the section captioned "Principal and
Management Stockholders" of the Company's definitive proxy statement for the
2001 annual meeting of shareholders is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained in the section captioned "Certain Relationships
and Related Transactions" of the Company's definitive proxy statement for the
2001 annual meeting of the shareholders in incorporated herein by reference.
III-1
PART IV
ITEM 14. FINANCIAL STATEMENTS AND SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K
(a) (1 and 2) Financial Statements and Schedules
The following consolidated financial information is included as a separate
section of this annual report on Form 10-K:
PAGE
------
Report of Independent Auditors ........................................ IV-5
Consolidated Balance Sheets as of December 31, 2000 and 1999 .......... IV-6
Consolidated Statements of Operations for the years ended
December 31, 2000, 1999 and 1998 .................................... IV-7
Consolidated Statements of Shareholders' Equity for the years
ended December 31, 2000, 1999 and 1998 .............................. IV-8
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998 .................................... IV-9
Notes to Consolidated Financial Statements ............................ IV-10
All schedules are omitted since the required information is not present in
amounts sufficient to require submission of the schedule or because the
information required is included in the financial statements and notes thereto.
IV-1
(a)(3) Exhibits
EXHIBIT FILING
NUMBER REFERENCE DESCRIPTION
- --------- ----------- ------------------------------------------------------------------------------------------
3.1 6 First Amended and Restated Certificate of Incorporation
3.2 15 Amended and Restated By-Laws of Registrant
4.1 16 Specimen Common Stock Share Certificate
4.2 Form of Series A Preferred Stock Certificate
4.3 22 Form of Series B Preferred Stock Certificate (included in Exhibit 4.5)
4.4 Certificate of Designations establishing the Company's Series A Convertible Cumulative
Preferred Stock
4.5 22 Certificate of Designations establishing the Company's Series B Convertible Cumulative
Preferred Stock
4.6 20 Rights Agreement, dated as of October 19, 2000, between the Company and American Stock
Transfer & Trust Company, which includes as Exhibit B thereto, the Form of Rights
Certificates
4.7 15 Warrant, dated December 7, 1999, to purchase 100,000 shares of common stock
4.8 15 Warrant, dated December 7, 1999, to purchase 100,000 shares of common stock
4.9 Warrant, dated June 29, 2000, to purchase 1,000,000 shares of common stock
4.10 Warrant, dated June 29, 2000, to purchase 450,000 shares of common stock
4.11 Warrant, dated June 29, 2000, to purchase 50,000 shares of common stock
4.12 Form of Warrant for the Company's outstanding public warrants
10.1 15 Amended and Restated Credit Agreement between Reckson Operating Partnership, L.P.
("ROP") and the Company relating to the operations of Reckson Strategic Venture Partners,
LLC, dated August 4, 1999
10.2 15 Amended and Restated Credit Agreement between ROP and the Company relating to the
operations of the Company, dated August 4, 1999
10.3 18 Amendment to the Amended and Restated Credit Agreements between ROP and the
Company, dated November 30, 1999
10.4 Second Amendment to the Amended and Restated Credit Agreements between ROP and the
Company
10.5 20 Amended and Restated Revolving Line of Credit Agreement together with the Amended and
Restated Revolving Promissory Note, each dated September 11, 2000, among the Company
and Bankers Trust Company
10.6 20 Equity Interest Pledge and Security Agreement, dated as of May 31, 2000, between the
Company and Bankers Trust Company
10.7 20 Confirmation and Amendment of Equity Interest Pledge and Security Agreement, dated as of
September 11, 2000
10.8 22 Securities Purchase Agreement, dated as of December 13, 2000, by and between the
Company and Deutsche Bank Sharps Pixley Inc.
10.9 22 Registration Rights Agreement, dated as of December 13, 2000, by and between the
Company and Deutsche Bank Sharps Pixley Inc.
10.10 6 Intercompany Agreement, between the Company and ROP, dated May 13, 1998
10.11 1 1998 Stock Option Plan
10.12 6 1998 Employee Stock Option Plan
10.13 8 1999 Stock Option Plan
10.14 15 2000 Employee Stock Option Plan
10.15 Long-Term Incentive Plan
10.16 1 Employment Agreement of Steven H. Shepsman
10.17 1 Employment Agreement of Seth B. Lipsay
10.18 5 Limited Liability Company Agreement of Interoffice Superholdings, LLC
10.19 1 Limited Liability Company Agreement of OnSite Ventures, LLC
10.20 1 Limited Liability Company Agreement of RSVP Holdings, LLC
10.21 1 Operating Agreement of Reckson Strategic Venture Partners, LLC ("RSVP")
10.22 1 Supplemental Agreement to Operating Agreement of RSVP
10.23 3 Operating Agreement of Dominion Venture Group LLC
10.24 7 Investor Rights Agreement, by and among OnSite Access, Inc. and certain investors and
individuals within management
10.25 7 Voting Agreement, by and among OnSite Access, Inc. and certain investors
10.26 7 Purchase Agreement regarding Series B, Series C and Series D Preferred Stock of OnSite
Access, Inc.
10.27 7 Certificate of Designation of Series A, Series B, Series C and Series D Preferred Stock of
OnSite Access, Inc.
10.28 9 Series D Convertible Preferred Stock Securities Purchase Agreement, dated as of July 29,
1999 by and among VANTAS Incorporated and several Purchasers
10.29 11 Letter Agreement, dated as of September 29, 1999, among the Company, RSI I/O Holdings,
Inc., RSI-OnSite Holdings LLC, RSI-OSA Holdings, Inc., JAH Realties, L.P., Veritech
Ventures LLC and JAH I/O LLC
10.30 11 Letter of Amendment to Letter Agreement, dated as of September 23, 1999, among the
Company, RSI I/O Holdings, Inc., RSI-OnSite Holdings LLC, RSI-OSA Holdings, Inc., JAH
Realties, L.P., Veritech Ventures LLC and JAH I/O LLC
10.31 13 Agreement and Plan of Merger by and among HQ Global Workplaces, Inc. and CarrAmerica
Realty Corporation and VANTAS Incorporated and the Company, dated as of January 20,
2000
10.32 13 Stock Purchase Agreement between CarrAmerica Realty Corporation and the Company,
dated as of January 20, 2000
10.33 13 Stock Purchase Agreement among CarrAmerica Realty Corporation, OmniOffices (UK)
Limited and OmniOffices (Lux) 1929 Holding Company S.A. and VANTAS Incorporated
and the Company, dated as of January 20, 2000
10.34 15 Subscription Agreement, dated as of February 7, 2000 between the Company and VANTAS
Incorporated
10.35 17 First Amendment to Agreement and Plan of Merger by and among VANTAS Incorporated
and the Company, on the one hand, and HQ Global Workplaces, Inc. and CarrAmerica
Realty Corporation, on the other hand.
10.36 17 First Amendment to the Stock Purchase Agreement by and between CarrAmerica Realty
Corporation and the Company
10.37 17 First Amendment to the Stock Purchase Agreement by and between CarrAmerica Realty
Corporation, OmniOffices (UK) Limited, OmniOffices (Lux) 1929 Holding Company S.A.,
VANTAS Incorporated and the Company
10.38 19 Second Amendment to the Agreement and Plan of Merger by and among VANTAS
Incorporated and the Company, on the one hand, and HQ Global Workplaces, Inc. and
CarrAmerica Realty Corporation, on the other hand, dated as of May 31, 2000
10.39 19 Stockholders Agreement by and among the Company, HQ Global Workplaces, Inc.,
CarrAmerica Realty Corporation and the other parties named therein, dated as of June 1,
2000
10.40 19 Registration Rights Agreement by and among the Company and CarrAmerica Realty
Corporation, dated as of June 1, 2000
IV-2
EXHIBIT FILING
NUMBER REFERENCE DESCRIPTION
- ---------- ----------- -------------------------------------------------------------------------------------------
10.41 19 Agreement and Plan of Merger by and among HQ Global Workplaces, Inc., HQ Global
Holdings, Inc. and HQ Merger Subsidiary, Inc., dated as of June 1, 2000
10.42 19 Exchange Agreement by and between the Company and HQ Global Holdings, Inc., dated as
of May 31, 2000
10.43 19 Indemnification and Escrow Agreement by and among the Company, CarrAmerica Realty
Corporation and the other parties named therein, dated as of June 1, 2000
10.44 19 Purchase Agreement by and among the Company, HQ Global Holdings, Inc. and EOP
Operating Limited Partnership, dated as of May 31, 2000
10.45 19 Purchase Agreement by and among the Company and Fortress HQ LLC, dated as of May 31,
2000
10.46 19 Purchase Agreement by and among the Company and Stichting Pensioenfonds ABP, dated as
of May 31, 2000
10.47 19 Purchase Agreement by and among the Company and First Union Real Estate Equity and
Mortgage Investments, dated as of May 31, 2000
10.48 19 Purchase Agreement by and among the Company and CIBC WMC Inc., dated as of May 31,
2000
10.49 19 Purchase Agreement by and among the Company and CIBC Employee Private Equity Fund
Partners, dated as of May 31, 2000
10.50 19 Purchase Agreement by and among the Company and AEW Targeted Securities Fund, L.P.,
dated as of May 31, 2000
10.51 19 Purchase Agreement by and among the Company and AEW Targeted Securities Fund II,
L.P., dated as of May 31, 2000
10.52 19 Purchase Agreement by and among the Company and Blackacre Capital Partners, L.P., dated
as of May 31, 2000
10.53 19 Purchase Agreement by and among the Company and Paribas North America, Inc., dated as
of May 31, 2000
10.54 19 Stockholders Agreement by and among the Company, HQ Global Holdings, Inc. and certain
holders of Series A Preferred Stock of HQ Global Holdings, Inc. named therein, dated as of
May 31, 2000
10.55 19 Registration Rights Agreement by and between HQ Global Holdings, Inc. and the investors
named therein, dated as of May 31, 2000
10.56 21 Agreement and Plan of Merger entered into as of November 15, 2000, by and among Intuit
Inc., Echo Acquisition Corp., EmployeeMatters, Inc., the Company and the stockholders of
the Company signatory thereto.
10.57 14 Warrant Registration Rights Agreement, dated December 7, 1999, by and among Reckson
Service Industries, Inc., Elliot S. Cooperstone and H. Thach Pham
21.0 Statement of Subsidiaries
23.0 Consent of Independent Auditors
24.0 Powers of Attorney (included in Part IV of this Form 10-K)
- ----------
(1) Previously filed as an exhibit to Registration Statement on Form S-1
(No.333-44419) and incorporated herein by reference.
(2) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on September 8, 1998 and incorporated herein by reference.
(3) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on September 11, 1998 and incorporated herein by reference.
(4) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on December 1, 1998 and incorporated herein by reference.
(5) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on January 25, 1999 and incorporated herein by reference.
(6) Previously filed as an exhibit to the Company's Form 10-K filed with the
SEC on March 31, 1999 and incorporated herein by reference.
(7) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on July 16, 1999 and incorporated herein by reference.
(8) Previously filed as an exhibit to Registration Statement on Form S-8 filed
with the SEC on July 29, 1999 and incorporated herein by reference.
(9) Previously filed as an exhibit to the Company's Form 8-K filed with the SEC
on August 15, 1999 and incorporated herein by reference.
(10) Previously filed as an exhibit to the Company's Form 8-K filed with the
SEC on September 1, 1999 and incorporated herein by reference.
(11) Previously filed as an exhibit to the Company's Form 8-K filed with the
SEC on October 12, 1999 and incorporated herein by reference.
(12) Previously filed as an exhibit to the Company's Form 8-K filed with the
SEC on December 13, 1999 and incorporated herein by reference.
(13) Previously filed as an exhibit to the Company's Form 8-K filed with the
SEC on January 25, 2000 and incorporated herein by reference.
(14) Previously filed as an exhibit to the Company's Form 8-K filed with the
SEC on March 28, 2000 and incorporated herein by reference.
(15) Previously filed as an exhibit to the Company's Form 10-K filed with the
SEC on March 29, 2000 and incorporated herein by reference.
(16) Previously filed as an exhibit to Registration Statement on Form S-3
(No.333-34246) and incorporated herein by reference.
(17) Previously filed as an exhibit to the Company's Form 8-K filed with the
SEC on May 12, 2000 and incorporated herein by reference.
(18) Previously filed as an exhibit to the Company's Form 10-Q filed with the
SEC on May 15, 2000 and incorporated herein by reference.
(19) Previously filed as an exhibit to the Company's Form 8-K filed with the
SEC on June 16, 2000 and incorporated herein by reference.
(20) Previously filed as an exhibit to the Company's Form 8-K filed with the
SEC on October 24, 2000 and incorporated herein by reference.
(21) Previously filed as an exhibit to the Company's Form 8-K filed with the
SEC on November 22, 2000 and incorporated herein by reference.
(22) Previously filed as an exhibit to the Company's Form 8-K filed with the
SEC on December 15, 2000 and incorporated herein by reference.
(b) Reports on Form 8-K
1. On October 24, 2000 the Registrant filed a report on Form 8-K relating to:
(i) the announcement of a refinement of the Registrant's business
strategy in order to highlight its holdings in HQ Global Holdings,
Inc. and to maximize the value of its other holdings.
(ii) the authorization by the Registrant's Board of Directors of a
dividend distribution of one preferred share purchase right for each
outstanding share of common stock of the Registrant pursuant to a
shareholder rights plan.
(iii) the Registrant entering into a secured revolving line of credit of
up to $25 million with Bankers Trust Company.
2. On November 7, 2000, the Registrant submitted a report on Form 8-K under
Item 9 thereof in order to submit its third quarter presentation.
3. On November 22, 2000, the Registrant filed a report on Form 8-K relating
to the execution of an Agreement and Plan of Merger with Intuit Inc., Echo
Acquisition Corp., EmployeeMatters, Inc. and certain stockholders of
EmployeeMatters, Inc.
4. On December 15, 2000, the Registrant filed a report on Form 8-K relating
to the closing on a $25 million preferred equity facility with Deutsche
Bank Sharps Pixley Inc.
IV-3
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized on March 30, 2001.
FRONTLINE CAPITAL GROUP
By: /s/ Scott Rechler
-------------------------------------
(Scott Rechler)
President, Chief Executive
Officer and Director
KNOW ALL MEN BY THESE PRESENTS, that we, the undersigned officers and directors
of FrontLine Capital Group, hereby severally constitute Scott H. Rechler and
Mitchell D. Rechler, and each of them singly, our true and lawful attorneys
with full power to them, and each of them singly, to sign for us and in our
names in the capacities indicated below, the Form 10-K filed herewith and any
and all amendments to said Form 10-K, and generally to do all such things in
our names and in our capacities as officers and directors to enable FrontLine
Capital Group to comply with the provisions of the Securities Exchange Act of
1934, and all requirements of the Securities and Exchange Commission, hereby
ratifying and confirming our signatures as they may be signed by our said
attorneys, or any of them, to said Form 10-K and any and all amendments
thereto.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
- ------------------------- ----------------------------------------------------- ---------------
/s/ Scott H. Rechler Chairman of the Board, President, Chief Executive March 30, 2001
- --------------------- Officer and Director (Principal Executive Officer)
(Scott H. Rechler)
/s/ Michael Maturo Director and Treasurer (Principal Financial Officer March 30, 2001
- --------------------- and Accounting Officer)
(Michael Maturo)
/s/ Roger M. Rechler Director March 30, 2001
- ---------------------
(Roger M. Rechler)
/s/ Mitchell D. Rechler Director and Secretary March 30, 2001
- ---------------------
(Mitchell D. Rechler)
/s/ Paul F. Amoruso Director March 30, 2001
- ---------------------
(Paul F. Amoruso)
/s/ Sidney Braginsky Director March 30, 2001
- ---------------------
(Sidney Braginsky)
/s/ Ronald Cooper Director March 30, 2001
- ---------------------
(Ronald Cooper)
/s/ Douglas A. Sgarro Director March 30, 2001
- ---------------------
(Douglas A. Sgarro)
IV-4
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
FrontLine Capital Group
We have audited the accompanying consolidated balance sheets of FrontLine
Capital Group and Subsidiaries as of December 31, 2000 and 1999, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 2000. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of FrontLine
Capital Group and Subsidiaries at December 31, 2000 and 1999, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States.
ERNST & YOUNG LLP
New York, New York
February 26, 2001
IV-5
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31,
----------------------------
2000 1999
------------- ------------
ASSETS:
Current Assets:
Cash and cash equivalents ............................................ $ 23,105 $ 32,740
Restricted cash ...................................................... 6,625 21,572
Accounts receivable, net of allowance for doubtful accounts of
$3,393 and $861 at December 31, 2000 and 1999, respectively......... 38,791 8,426
Other current assets ................................................. 35,092 16,008
---------- ---------
Total Current Assets ............................................... 103,613 78,746
Ownership interests in and advances to unconsolidated companies
(Note 4) ............................................................. 39,845 97,833
Intangible assets, net (Note 6) ....................................... 667,936 239,412
Property and equipment, net (Note 5) .................................. 221,677 80,425
Deferred financing costs, net ......................................... 48,875 5,426
Investments in joint ventures ......................................... 30,531 --
Other assets, net ..................................................... 19,883 40,141
---------- ---------
TOTAL ASSETS ....................................................... $1,132,360 $ 541,983
========== =========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current Liabilities:
Accounts payable and accrued expenses (Note 7) ....................... $ 67,412 $ 45,852
Current portion of senior secured debt (Note 9) ...................... 32,999 12,500
Notes payable (Note 9) ............................................... 25,000 --
Deferred rent payable ................................................ 2,852 2,165
Other current liabilities ............................................ 2,558 1,139
---------- ---------
Total Current Liabilities .......................................... 130,821 61,656
Credit facilities with related parties (Note 15) ..................... 135,523 121,848
Senior secured debt (Note 9) ......................................... 179,926 44,407
Subordinated notes payable (Note 9) .................................. 125,000 108,125
Deferred rent payable ................................................ 38,562 22,794
Other liabilities .................................................... 82,305 33,706
---------- ---------
TOTAL LIABILITIES .................................................. 692,137 392,536
---------- ---------
MINORITY INTEREST ..................................................... 305,577 35,338
REDEEMABLE CONVERTIBLE PREFERRED STOCK (AGGREGATE LIQUIDATION
PREFERENCE $15,000) (NOTE 10) ........................................ 13,940 --
COMMITMENTS AND CONTINGENCIES ......................................... -- --
SHAREHOLDERS' EQUITY (NOTE 11):
8.875% convertible cumulative preferred stock, $.01 par value,
25,000,000 shares authorized, 26,000 and -0- issued and
outstanding, at December 31, 2000 and 1999, respectively ........... -- --
Common stock, $.01 par value, 100,000,000 shares authorized,
36,625,847 and 30,672,794 shares issued and outstanding at
December 31, 2000 and 1999, respectively ........................... 366 307
Additional paid-in capital ........................................... 400,916 162,054
Accumulated deficit .................................................. (281,030) (48,252)
Accumulated other comprehensive income ............................... 454 --
---------- ---------
TOTAL SHAREHOLDERS' EQUITY ......................................... 120,706 114,109
---------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ......................... $1,132,360 $ 541,983
========== =========
See accompanying notes to consolidated financial statements.
IV-6
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
----------------------------------------------
2000 1999 1998
------------- ------------- --------------
HQ OPERATING REVENUES:
Workstation revenue .................................................. $ 296,136 $ 129,026 --
Support services ..................................................... 187,826 85,419 --
----------- ----------- -----------
TOTAL HQ OPERATING REVENUES ........................................ 483,962 214,445 --
----------- ----------- -----------
HQ OPERATING EXPENSES:
Rent ................................................................. 178,981 87,775 --
Support services ..................................................... 56,267 26,345 --
Center general and administrative .................................... 96,682 54,839 --
General and administrative ........................................... 54,703 17,959 --
----------- ----------- -----------
TOTAL HQ OPERATING EXPENSES ........................................ 386,633 186,918 --
----------- ----------- -----------
HQ OPERATING INCOME ................................................ 97,329 27,527 --
----------- ----------- -----------
HQ OTHER EXPENSES:
Merger and integration costs (Note 12) ............................... (25,369) (26,730) --
Depreciation and amortization (Note 2) ............................... (54,762) (15,004) --
Interest expense, net ................................................ (34,663) (10,199) --
----------- ----------- -----------
HQ Loss ............................................................ (17,465) (24,406) --
----------- ----------- -----------
Parent Expenses:
General and administrative expenses .................................. (16,478) (9,509) (2,613)
Depreciation and amortization ........................................ (1,123) (676) (1,260)
Amortization of deferred charges ..................................... (14,330) (8,455) --
Restructuring costs (Note 13) ........................................ (12,788) -- --
Interest expense, net ................................................ (18,903) (8,166) (644)
Development stage company costs ...................................... (9,999) -- --
----------- ----------- -----------
LOSS BEFORE INCOME TAXES, MINORITY INTEREST AND EQUITY IN NET LOSS
AND IMPAIRMENT OF UNCONSOLIDATED COMPANIES ........................ (91,086) (51,212) (4,517)
(Provision for) benefit from income taxes (Note 8) .................... (5,428) 2,841 --
Minority interest ..................................................... (7,688) 18,790 --
Equity in net loss and impairment of unconsolidated companies (Note 4) (125,928) (10,266) (3,630)
----------- ----------- -----------
LOSS BEFORE EXTRAORDINARY ITEM FROM EARLY EXTINGUISHMENT OF DEBT ... (230,130) (39,847) (8,147)
Extraordinary item from early extinguishment of debt .................. (2,648) -- --
----------- ----------- -----------
NET LOSS ........................................................... (232,778) (39,847) (8,147)
Dividends on and accretion of preferred stock ......................... (2,119) -- --
----------- ----------- -----------
Net loss applicable to common shareholders ......................... $ (234,897) $ (39,847) $ (8,147)
=========== =========== ===========
Basic and diluted net loss per weighted average common share .......... $ (6.73) $ (1.56) $ (.56)
=========== =========== ===========
Basic and diluted weighted average common shares outstanding .......... 34,880,709 25,600,985 14,522,513
=========== =========== ===========
See accompanying notes to consolidated financial statements.
IV-7
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN ACCUMULATED COMPREHENSIVE SHAREHOLDERS'
STOCK CAPITAL DEFICIT INCOME EQUITY
-------- ------------ ------------- --------------- --------------
SHAREHOLDERS' EQUITY, JANUARY 1, 1998 .............. $ -- $ 4,480 $ (258) -- $ 4,222
Distribution of shares ............................ 41 -- -- -- 41
Proceeds from rights offering, net of costs of
$1,296 .......................................... 206 19,646 -- -- 19,852
Net loss .......................................... -- -- (8,147) -- (8,147)
---- -------- ---------- ------ ----------
SHAREHOLDERS' EQUITY, DECEMBER 31, 1998 ............ 247 24,126 (8,405) -- 15,968
Issuance of common stock .......................... 44 71,923 -- -- 71,967
Proceeds from the exercise of employee stock
options ......................................... 2 274 -- -- 276
Issuance of warrants .............................. -- 2,172 -- -- 2,172
Proceeds from public offering, net of costs of
$4,348 .......................................... 14 63,559 -- -- 63,573
Net loss .......................................... -- -- (39,847) -- (39,847)
---- -------- ---------- ------ ----------
SHAREHOLDERS' EQUITY, DECEMBER 31, 1999 ............ 307 162,054 (48,252) -- 114,109
Issuance of common stock .......................... 31 66,019 -- -- 66,050
Issuance of common stock and warrants in a
public offering, net of costs of $6,667 ......... 26 115,920 -- -- 115,946
Issuance of preferred stock, net .................. -- 24,459 -- -- 24,459
Proceeds from the exercise of employee stock
options ......................................... 2 1,163 -- -- 1,165
Issuance of warrants .............................. -- 33,420 -- -- 33,420
Dividends on and accretion of redeemable
preferred stock ................................. -- (2,119) -- -- (2,119)
Unrealized gain on marketable equity
securities ...................................... -- -- -- 591 591
Cumulative translation adjustment ................. -- -- -- (137) (137)
Net loss .......................................... -- -- (232,778) -- (232,778)
---- -------- ---------- ------ ----------
SHAREHOLDERS' EQUITY, DECEMBER 31, 2000 ............ $366 $400,916 $ (281,030) $ 454 $ 120,706
==== ======== ========== ====== ==========
See accompanying notes to consolidated financial statements.
IV-8
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
---------------------------------------------
2000 1999 1998
-------------- ------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ............................................................ $ (232,778) $ (39,847) $ (8,147)
Adjustments to reconcile net loss to cash provided by (used in)
operating activities:
Depreciation and amortization ..................................... 55,885 15,680 1,260
Amortization of deferred financing costs .......................... 5,720 719 --
Extraordinary loss on early extinguishment of debt ................ 2,648 -- --
Equity in net loss and impairment of unconsolidated companies 125,928 10,266 3,630
Minority interest ................................................. 7,688 (18,790) --
Deferred income taxes ............................................. -- (3,541) --
Amortization of deferred charges .................................. 15,188 30,493 --
Non-cash restructuring costs ...................................... 8,875 -- --
Cumulative translation adjustment ................................. (247) -- --
Changes in operating assets and liabilities:
Accounts receivable, net ......................................... (24,493) (1,328) --
Acquisition costs and other assets ............................... 9,406 (7,251) (795)
Deferred rent payable ............................................ 16,455 6,024 --
Accounts payable and accrued expenses ............................ (29,103) 19,834 1,774
Other liabilities ................................................ 18,069 88 --
Affiliate receivables ............................................ -- 7,759 (12,626)
---------- ---------- ---------
Net cash provided by (used in) operating activities ............. (20,759) 20,106 (14,904)
---------- ---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of officing solutions centers .......................... (323,653) (47,329) --
Equipment ........................................................... (63,487) (41,882) (115)
Restricted cash ..................................................... 22,866 (10,318) --
Acquisition of ownership interests and advances to unconsolidated
companies ......................................................... (68,322) (132,332) (43,959)
---------- ---------- ---------
Net cash used in investing activities ........................... (432,596) (231,861) (44,074)
---------- ---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock and warrants, net of costs ................. 156,957 60,812 --
Issuance of preferred and redeemable preferred stock, net of costs 38,510 -- --
Deferred financing costs ............................................ (27,161) (4,398) --
Net proceeds from credit facilities with related parties ............ 13,675 128,492 40,982
Capital leases ...................................................... (2,657) (2,226) --
Exercise of options ................................................. 1,165 3,125 --
Net proceeds from secured credit facility and notes payable ......... 55,615 44,407 --
Preferred dividends ................................................. (577) -- --
Net proceeds from rights offering ................................... -- -- 19,893
Net proceeds from minority interest ................................. 208,193 8,642 --
---------- ---------- ---------
Net cash provided by financing activities ....................... 443,720 238,854 60,875
---------- ---------- ---------
CASH AND CASH EQUIVALENTS:
Net increase (decrease) ............................................. (9,635) 27,099 1,897
Beginning of period ................................................. 32,740 5,641 129
---------- ---------- ---------
End of period ....................................................... $ 23,105 $ 32,740 $ 2,026
========== ========== =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for:
Interest .......................................................... $ 58,245 $ 14,253 $ 816
========== ========== =========
Income taxes ...................................................... $ 907 $ 2,009 --
========== ========== =========
See accompanying notes to consolidated financial statements.
IV-9
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000
1. DESCRIPTION OF THE COMPANY
FrontLine Capital Group ("FrontLine" or the "Company") was formed on July
15, 1997 and was spun off from Reckson Associates Realty Corp. ("Reckson
Associates") in June 1998. FrontLine manages companies servicing small and
medium-size enterprises ("SMEs") and mobile workforces of larger companies.
FrontLine has two distinct operating segments: one holds FrontLine's interest
in HQ Global Workplaces, Inc., the world's largest provider of officing
solutions (see Note 3 for further discussion), and its predecessor companies
("HQ" or the "HQ Global Segment"), and the other consists of FrontLine (parent
company) ("FrontLine Parent") and its interests in a group of technology-based
companies (the "Parent and Other Interests Segment").
In October 2000, FrontLine announced that, as a result of changing market
conditions, it was refining its strategic plan (the "Restructuring"- see Note 13
for further discussion) to highlight its holdings in HQ and to maximize the
value of its other holdings. Additionally, in conjunction with the
Restructuring, FrontLine announced that it would focus its resources and capital
on the businesses within its existing portfolio and cease pursuing new
investment activities.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying consolidated financial statements present the consolidated
financial position of the Company and its majority-owned subsidiaries. The
financial position, results of operations and cash flows of the HQ Global
Segment are presented in Note 3. The financial position, results of operations
and cash flows of the Parent and Other Interests Segment are summarized in Note
4. All significant intercompany balances and transactions have been eliminated
in the consolidated financial statements.
ACCOUNTING FOR OWNERSHIP INTERESTS
The interests that FrontLine owns are accounted for under one of three
methods: consolidation, equity method and cost method. The applicable
accounting method is generally determined based on the Company's voting
interest and rights in each investee.
Consolidation. Entities in which the Company directly or indirectly owns
more than 50% of the outstanding voting securities or controls the board of
directors are generally accounted for under the consolidation method of
accounting. Under this method, an investee's results of operations are
reflected within the Company's Consolidated Statements of Operations.
Participation of other (non-FrontLine) shareholders in the earnings or losses
of a consolidated company is reflected in the caption "Minority interest" in
the Company's Consolidated Statements of Operations. Minority interest adjusts
the Company's consolidated results of operations to reflect only the Company's
share of the earnings or losses of the consolidated company.
Equity Method. Investees whose results are not consolidated, but over whom
the Company exercises significant influence, are accounted for under the equity
method of accounting. Under the equity method of accounting, an investee's
accounts are not reflected within the Company's Consolidated Statements of
Operations; however, FrontLine's share of the earnings or losses of the
investee is reflected in the caption "Equity in net loss and impairment of
unconsolidated companies" in the accompanying Consolidated Statements of
Operations.
Cost Method. Investees not accounted for under the consolidation or the
equity method of accounting, which are generally those in which the Company has
less than a 20% interest in the voting securities of the investee, are
accounted for under the cost method of accounting. Under this method, the
Company's share of the earnings or losses of such companies is not included in
the Consolidated Statements of Operations.
IV-10
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
CASH AND CASH EQUIVALENTS
The Company considers highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
HQ's and FrontLine's cash balances are each held primarily at one
financial institution and may, at times, exceed insurable amounts. The Company
believes it mitigates its risk by investing in or through a major financial
institution.
MARKETABLE EQUITY SECURITIES
Available-for-sale marketable equity securities held by FrontLine at
December 31, 2000 are reported at fair market value, with the resulting net
unrealized gain or loss reported within shareholders' equity.
RECEIVABLES
HQ leases office space and provides support services to clients in various
industries, ranging in size from small entrepreneurial entities to local
offices of international corporations. HQ performs credit evaluations of its
clients and generally requires at least two months' rent as a security deposit.
HQ's business centers are located primarily throughout the United States and
Europe, which limits HQ's exposure to certain economic risks, based upon local
economic conditions. HQ records an allowance for doubtful accounts which
reflects management's estimate of the risk of uncollectible accounts
receivable. Losses in excess of management's estimates have not been
significant.
PROPERTY AND EQUIPMENT
Property and equipment consists primarily of property and equipment owned
by HQ, and is stated at cost less accumulated depreciation and amortization.
Effective January 1, 1999, the Company adopted Statement of Position ("SOP")
98-1, Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use, which requires the capitalization of certain costs incurred in
connection with developing or obtaining internal use software. During 1999 and
2000, HQ capitalized $5.5 million and $5.7 million, respectively, related to
the development of its enterprise resource system.
Office equipment, furniture and fixtures are depreciated using the
straight-line method over the estimated useful lives of the assets, which range
from three to seven years. The cost of HQ's enterprise resource system is being
amortized over seven years. Leasehold improvements are amortized over the
lesser of the term of the related lease or the estimated useful lives of the
assets.
DEFERRED FINANCING COSTS
The Company amortizes deferred financing costs over the term of the
related debt. As of December 31, 2000 and 1999, accumulated amortization was
$7.1 million and $2.0 million, respectively. Amortization of deferred financing
costs is included as a component of interest expense in the accompanying
consolidated statement of operations.
INTANGIBLE ASSETS
Intangible assets consist primarily of goodwill representing the excess of
the purchase price over the net assets of VANTAS Incorporated ("VANTAS") and
HQ. In connection with the merger of HQ and VANTAS (see Note 3), the Company
reassessed the estimated life of goodwill resulting from the merger. As a
result, the amortization period for goodwill was reduced from 30 to 20 years,
resulting in additional amortization expense of $2.1 million for the year ended
December 31, 2000. The goodwill recorded in the
IV-11
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
merger is being amortized using the straight-line method over a 20-year period
based on management's assessment of the significant barriers to entry due to
the rapid consolidation in the officing solutions business and the lack of
exposure to technological obsolescence in the global officing solutions
business. HQ engages in lease commitments ranging from 10-15 years, typically
with 5-year renewal options.
IMPAIRMENTS
Ownership Interests and Advances to Unconsolidated Companies
The Company continually evaluates the carrying value of its ownership
interests in and advances to each of its investments in unconsolidated
companies for possible impairment based on achievement of business plan
objectives and milestones, the value of each ownership interest in the
unconsolidated company relative to carrying value, the financial condition and
prospects of the company and other relevant factors. The fair value of the
Company's ownership interests in and advances to privately held companies is
generally determined based on the value at which independent third parties have
invested or have committed to invest in the companies. In connection with the
Restructuring, the Company recorded a $25.7 million charge during the year
ended December 31, 2000 to recognize impairment charges to reduce the carrying
value of its investments in certain unconsolidated companies. Such charges are
included in "Equity in net loss and impairment of unconsolidated companies" in
the accompanying Consolidated Statements of Operations.
Long-Lived Assets
The Company reviews long-lived assets, including intangible assets, for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to projected future undiscounted cash flows expected to be generated by the
asset or business center. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the estimated fair value of the assets. Other than
the impairment charges reflected in "Restructuring Costs" (see Note 13), at
December 31, 2000, management believes that no impairment of long-lived assets
has occurred and that no reduction of the related estimated useful lives is
warranted. The assessment of the recoverability of long-lived assets will be
impacted if estimated future operating cash flows are not achieved. Assets to
be disposed of are reported at the lower of the carrying amount or estimated
fair value less costs to sell.
FOREIGN CURRENCY TRANSLATION
HQ's financial statements have been prepared using the local currency as
the functional currency. Foreign currency exchange gains and losses resulting
from the translation of financial statements denominated in local currencies
into U.S. dollars are included as a component of stockholders' equity.
REVENUE RECOGNITION
The Company's operating revenues for all periods presented were
attributable to HQ. Revenues from workstations and business services are
recognized as the related services are provided. Workstation revenues consist
of office and related furniture rental, parking and storage. Business services
consist of (1) technology services comprised of Internet, videoconferencing and
telecommunications services and (2) other business services which include
charges to clients that do not require offices on a full-time basis, conference
and training room usage, catering, copies, management and franchise fees.
IV-12
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
FRANCHISE FEES
As a result of the HQ Merger, HQ became a franchisor of 46 domestic and 30
international business centers operated by unrelated franchisees. The financial
results of franchised locations are not included in the consolidated results of
the Company. HQ charges a franchise fee for use of its brand name and marketing
support, which is recorded in the period earned. Franchise fees aggregated $1.8
million for the year ended December 31, 2000, and are included in business
service revenues.
RENT EXPENSE
Payments under operating leases are recognized as rent expense on a
straight-line basis over the term of the related lease. The difference between
the rent expense recognized for financial reporting purposes and the actual
payments made in accordance with the lease agreements is recognized as a
deferred rent liability. Rent expense charged to operations for the years ended
December 31, 2000 and 1999, exceeded actual rental payments by $9.2 million and
$6.0 million, respectively.
During the years ended December 31, 2000 and 1999, the Company recorded
deferred credits relating to tenant improvements which are reimbursed or paid
by landlords and amortized against rent expense over the life of the leases, of
$8.9 million and $11.8 million, respectively. As of December 31, 2000 and 1999,
the deferred rent liability includes approximately $21.3 million and $14.4
million, respectively, representing the unamortized balances of such deferred
credits.
The estimated fair value of favorable lease rates on business centers
acquired in the HQ Merger (see Note 3) is being amortized over the terms of the
respective leases acquired.
HQ DEPRECIATION AND AMORTIZATION
Depreciation and amortization of the HQ Segment consists of the following
(in thousands):
YEAR ENDED DECEMBER 31,
-----------------------
2000 1999
---------- ---------
Property and equipment ............................ $29,103 $ 8,738
Goodwill .......................................... 23,929 6,101
Favorable acquired business center leases ......... 1,400 --
Other intangible assets ........................... 330 165
------- -------
$54,762 $15,004
======= =======
STOCK-BASED COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" and related interpretations in
accounting for its employee stock options and grants because the alternative
fair value accounting provided for under Statement of Financial Accounting
Standard ("SFAS") No. 123 ("SFAS 123"), "Accounting for Stock-Based
Compensation," requires the use of option valuation models that were not
developed for use in valuing employee stock options.
INCOME TAXES
The Company accounts for income taxes under the liability method which
requires recognition of deferred tax assets and liabilities based upon the
expected future tax consequences of events included in the Company's financial
statements and tax returns. Under this method, deferred tax assets and
liabilities are determined based on the difference between the financial
statement and tax bases of assets and liabilities using enacted tax rates in
effect for the years in which the differences are expected to reverse.
IV-13
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
Additionally, deferred tax assets are recognized for temporary differences
that will result in deductible amounts in future years. A valuation allowance
is recognized if it is more likely than not that some portion of the deferred
asset will not be realized. As of December 31, 2000, the Company's deferred tax
assets have been fully reserved because of the uncertainty of the timing and
amount of future taxable income.
COMPREHENSIVE LOSS
Comprehensive income (loss) is defined as the change in equity of a
business enterprise during a period from transactions, events and circumstances
from non-owner sources. It includes all changes in equity during a period
except those resulting from investments by owners and distributions to owners.
During the year ended December 31, 2000, the difference between net loss
($232,778,000) and total comprehensive loss ($232,324,000) was due to
unrealized gains on "available-for-sale" marketable securities partially offset
by an unrealized loss arising from foreign currency translation.
SEGMENT REPORTING
The segment information required by SFAS No. 131, "Disclosure about
Segments of an Enterprise and Related Information," relating to the HQ Segment
and the Parent and Other Interests Segment is presented in Notes 3 and 4,
respectively.
Each of the segments has a FrontLine senior professional assigned for
purposes of monitoring performance and carrying out operating activity. These
professionals report directly to the Chief Executive Officer and Treasurer, who
along with the Board of Directors have been identified as the Chief Operating
Decision Makers ("CODM") because of their final authority over resource
allocation decisions and performance assessment.
FrontLine's governance and control rights are generally exercised through
Board of Directors seats and through representation on the executive committees
of the various segment entities.
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments"
requires the Company to disclose the estimated fair values of its financial
instrument assets and liabilities. The carrying amounts approximate fair value
for cash and cash equivalents, accounts receivable and accounts payable because
of the short maturity of those instruments. Other than as disclosed in Notes 9
and 15, the estimated fair values of the Company's long-term debt approximate
the recorded balances.
HQ NATURE OF OPERATIONS
The future results of operations and financial condition of HQ will be
impacted by the following factors, among others: the competition in the office
solutions business with respect to, among other things, price, service, and
location; dependence on leases and changes in lease costs; the availability of
capital for expansion; the ability to obtain and retain qualified employees;
and the level of difficulty experienced in the integration of acquired
businesses and the competition for future acquisitions.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENT
The Company adopted the provision of SFAS No. 133 ("SFAS 133") "Accounting
for Derivatives and Hedging Activities," as amended, effective January 1, 2001.
SFAS 133 will require the Company to recognize all derivatives on the balance
sheet at fair value. Derivatives that are not hedges must be
IV-14
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
adjusted to fair value through income. If the derivative is a hedge, depending
on the nature of the hedge, changes in the fair value of derivatives will
either be offset against the change in fair value of the hedged assets,
liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings.
HQ enters into contracts that establish a cap and a floor interest rate on
notional amounts to hedge the interest rate risk on its floating-rate debt. The
Company's policy is that it will not speculate in hedging activities. Had the
Company adopted SFAS 133 as of December 31, 2000, the effect would have been to
increase interest expense and current liabilities by $1.0 million.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. The most significant assumptions and
estimates relate to the lives and recoverability of long-lived assets. Actual
results could differ from those estimates.
RECLASSIFICATIONS
Certain prior period amounts and segment disclosures have been
reclassified to conform to the current year presentation.
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES
VANTAS AND PREDECESSOR ENTITIES
On January 8, 1999, InterOffice Superholdings Corporation ("InterOffice")
(36 executive office suite centers) and Reckson Executive Centers, Inc.
("Reckson Executive") (8 executive office suite centers) merged with Alliance
National Incorporated, a holding company which owned and operated approximately
90 nationally located executive office suite centers (the "VANTAS Merger"). To
effectuate the VANTAS Merger, the Company contributed approximately $21.4
million of assets represented by the assets of InterOffice and Reckson
Executive, which were acquired by FrontLine in 1998. The merged entity changed
its name to VANTAS. The stockholders of InterOffice and Reckson Executive
received 13,325,424 shares of convertible Series C Preferred Stock of VANTAS
valued at $63.3 million representing approximately 40% of the equity interest
in VANTAS of which approximately 23% was received by the Company.
In addition to the VANTAS Merger described above, VANTAS acquired 42
business centers, in 11 acquisitions, for an aggregate purchase price of $43.6
million in cash during the year ended December 31, 1999. The VANTAS Merger and
these acquisitions (collectively, the "1999 Mergers") were recorded using the
purchase method of accounting and are included in operations from the date of
acquisition. The aggregate cost of the 1999 Mergers consisted of the following
(in thousands):
Cash paid to former owners, net of cash received ......... $ 38,096
VANTAS Series C Preferred Stock .......................... 63,296
Transaction costs ........................................ 7,088
--------
$108,480
========
IV-15
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES - (CONTINUED)
The costs of the 1999 Mergers have been allocated to the respective assets
acquired and liabilities assumed, with the remainder recorded as goodwill as
follows (in thousands):
Working capital ........................................... $ 4,618
Goodwill .................................................. 115,968
Other assets .............................................. 2,984
Other non current liabilities ............................. (16,063)
Deferred income taxes ..................................... 973
---------
$ 108,480
=========
As of December 31, 1999, VANTAS operated 201 business centers in 27
states, the District of Columbia, France and Mexico and managed 5 other centers
for unrelated property owners. VANTAS provided fully furnished individual
offices and suites and a full range of telecommunication and business support
services to clients that generally required 2,000 square feet or less of
traditional office space. VANTAS did not own the real estate in which the
business centers were located.
As a result of the step acquisition during 1999 of a controlling interest
in VANTAS, the Company changed the accounting method for its investment in
VANTAS from the equity method to the consolidation method during the fourth
quarter of 1999 and retroactively restated all 1999 quarters. During the third
quarter of 1999, the Company increased its ownership in VANTAS to approximately
35% on a basic basis and 29% on a diluted basis through the acquisition of an
additional $23.0 million equity ownership interest in VANTAS as a part of a
$30.0 million financing by VANTAS. Subsequently, the Company entered into stock
purchase agreements with other VANTAS stockholders to increase its ownership to
approximately 84% on a basic basis and 76% on a diluted basis. The terms to
acquire these VANTAS shares were generally to pay 70% of the purchase price in
cash and the remaining 30% in FrontLine stock, which at the time had a value of
$19.00 per share. The closings for these transactions took place periodically
from November 30, 1999 and were completed during the first quarter of 2000. As
of December 31, 1999, the Company had expended approximately $59.8 million in
cash and issued 1,828,099 shares of its common stock. In closings during the
first quarter of 2000, the Company paid approximately $43.3 million in cash and
issued 1,294,103 shares of its common stock.
MERGER WITH HQ
On June 1, 2000, VANTAS merged with HQ Global Workplaces, Inc. ("Old HQ"),
in a two-step merger, and HQ Global also acquired two other entities involved
in the executive office suites business outside the United States (the "HQ
Merger"). As a result of the HQ Merger, the combined company, under the name HQ
Global Workplaces, Inc., became a wholly-owned subsidiary of a newly-formed
parent corporation, HQ Global. The HQ Merger was financed through a combination
of debt and HQ Global preferred stock and warrants. As of December 31, 2000,
FrontLine's ownership interest was 56.5% on a basic basis. Although FrontLine's
percentage ownership may vary depending on the actual preferred stock
conversion price, on a fully-diluted basis, assuming the outstanding preferred
stock converted at the HQ Merger conversion price, and assuming that certain
warrants to purchase HQ Global stock become exercisable (which would occur if a
qualified initial offering of HQ is not consummated by March 1, 2002),
FrontLine would own approximately 37.1% of the common stock of HQ Global. To
effectuate the HQ Merger, FrontLine contributed approximately $17 million in
cash and its ownership interest in VANTAS. Additionally, FrontLine holds an
option it purchased in January 1999, to acquire another HQ Global shareholder's
3.1% basic interest for $4.3 million at any time between July 8, 2001 and
January 7, 2002.
IV-16
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES - (CONTINUED)
The costs of the HQ Merger have been allocated to the respective assets
acquired and liabilities assumed, with the remainder recorded as goodwill, based
on preliminary estimates of fair values as follows (in thousands):
Working capital ............................................. $ 7,840
Property and equipment ...................................... 107,047
Goodwill .................................................... 407,441
Favorable acquired business center operating leases ......... 25,690
Other assets ................................................ 32,504
Other liabilities ........................................... (45,080)
Notes payable ............................................... (138,693)
----------
Total .................................................... $ 396,749
==========
The estimates of fair value were determined by HQ's management based on
information provided by the management of the acquired entities. The above
purchase price allocation has been revised from the original allocation as
estimated amounts have been finalized.
HQ is the largest provider of flexible officing solutions in the world. As
of December 31, 2000, HQ owned, operated, or franchised 462 business centers in
19 countries. This included 26 business centers open for twelve months or less.
Also included are six business centers managed by HQ for unrelated third
parties and 9 international joint-venture business centers through its European
subsidiary. HQ's wholly-owned subsidiary is also the franchisor of 46 domestic
and 30 international business centers for unrelated franchisees. HQ also
provides a complete outsourced office solution through furnished and equipped
individual offices and multi-office suites available on short notice with
flexible contracts. HQ also provides business support and information services
including: telecommunications; broadband Internet access; mail room and
reception services; high-speed copying, faxing and printing services;
secretarial, desktop publishing and IT support services and various size
conference facilities, with multi-media presentation and, in certain cases,
video teleconferencing capabilities. HQ also provides similar services for
those businesses and individuals that do not require offices on a full-time
basis.
UNAUDITED PRO FORMA INFORMATION
The unaudited pro forma financial information set forth below is based
upon the historical statements of operations of FrontLine for the years ended
December 31, 2000 and 1999, adjusted to give effect to the HQ Merger as of the
beginning of each period presented. The pro forma financial information is
presented for informational purposes only and may not be indicative of what
actual results of operations would have been had the HQ Merger occurred as
presented, nor does it purport to represent the results of operations for
future periods (in millions, except per share amounts).
YEAR ENDED DECEMBER 31,
-----------------------
2000 1999
----------- -----------
Revenues ............................................ $ 612.3 $ 473.3
Net loss ............................................ (222.9) (100.8)
Net loss applicable to common shareholders .......... (225.0) (100.8)
Basic and diluted net loss per common share ......... (6.45) (2.91)
IV-17
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES - (CONTINUED)
GEOGRAPHIC INFORMATION
HQ's headquarters are located in Dallas, Texas. As of December 31, 2000,
HQ owned, operated or franchised 462 businesses in 19 countries, primarily in
the United States and the United Kingdom. Prior to 2000, substantially all of
HQ's revenues were derived from business centers located in the United States.
Revenues by geographical area for the year ended December 31, 2000 are
summarized below (in thousands):
United States .............................. $443,131
United Kingdom ............................. 25,836
Other ...................................... 14,995
--------
$483,962
========
The location of HQ's long-lived assets at December 31, 2000 are summarized
below (in thousands):
PROPERTY AND
EQUIPMENT INTANGIBLES TOTAL
------------- ------------- -----------
United States .......... $ 202,005 $581,980 $783,985
United Kingdom ......... 16,326 80,581 96,907
Other .................. 3,346 5,375 8,721
--------- -------- --------
$ 221,677 $667,936 $889,613
========= ======== ========
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The following represents the activity in HQ's allowance for doubtful
accounts for the years ended December 31, 1999 and 2000 (in thousands):
Balance at January 1, 1999 ....................................... $ 401
Charged to costs and expenses ................................... 1,291
Accounts written off ............................................ (831)
------
Balance at December 31, 1999 ..................................... 861
Charged to costs and expenses ................................... 3,110
Allowance acquired in the HQ Merger ............................. 1,335
Accounts written off ............................................ (1,913)
------
Balance at December 31, 2000 ..................................... $ 3,393
======
FINANCIAL STATEMENTS
The following statements present the portion of the Company's financial
position, results of operations and cash flows represented by HQ Global and
predecessor entities as of and for the periods indicated.
IV-18
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES - (CONTINUED)
BALANCE SHEETS (IN THOUSANDS)
DECEMBER 31, DECEMBER 31,
2000 1999
-------------- -------------
ASSETS:
Current Assets:
Cash and cash equivalents ................................................... $ 16,182 $ 3,807
Restricted cash ............................................................. 6,625 21,572
Accounts receivable, net of allowance for doubtful accounts of $3,393 and
$861 at December 31, 2000 and 1999, respectively .......................... 38,791 8,426
Other current assets ........................................................ 13,164 16,008
---------- --------
Total Current Assets ..................................................... 74,762 49,813
Intangible assets, net ....................................................... 667,936 239,412
Property and equipment, net .................................................. 221,677 80,064
Deferred financing costs, net ................................................ 48,246 5,426
Investments in joint ventures ................................................ 30,531 --
Other assets, net ............................................................ 10,347 10,039
---------- --------
Total Assets ............................................................. $1,053,499 $384,754
========== ========
LIABILITIES AND NET BUSINESS UNIT EQUITY:
Current Liabilities:
Accounts payable and accrued expenses ....................................... $ 58,166 $ 38,010
Current portion of senior secured debt ...................................... 32,999 12,500
Deferred rent payable ....................................................... 2,852 2,165
Other current liabilities ................................................... 2,558 1,139
---------- --------
Total Current Liabilities ................................................ 96,575 53,814
Senior secured debt .......................................................... 179,926 --
Subordinated notes payable ................................................... 125,000 108,125
Deferred rent payable ........................................................ 38,562 22,794
Other liabilities ............................................................ 68,406 28,176
---------- --------
Total Liabilities ........................................................ 508,469 212,909
Minority interest ............................................................ 305,577 35,338
Cumulative translation adjustment ............................................ (137) --
Net business unit equity ..................................................... 239,590 136,507
---------- --------
Total Liabilities and Net Business Unit Equity ........................... $1,053,499 $384,754
========== ========
IV-19
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES - (CONTINUED)
STATEMENT OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2000 1999 1998
------------- -------------- --------------
HQ Operating Revenues:
Workstation revenue ..................................... $ 296,136 $ 129,026 --
Support services ........................................ 187,826 85,419 --
---------- ----------- -----------
Total HQ Operating Revenues ........................... 483,962 214,445 --
---------- ----------- -----------
HQ Operating Expenses:
Rent .................................................... 178,981 87,775 --
Support services ........................................ 56,267 26,345 --
Center general and administrative ....................... 96,682 54,839 --
General and administrative .............................. 54,703 17,959 --
---------- ----------- -----------
Total HQ Operating Expenses ........................... 386,633 186,918 --
---------- ----------- -----------
HQ Operating Income ................................... 97,329 27,527 --
HQ Other Expenses:
Merger and integration costs ............................ (25,369) (26,730) --
Depreciation and amortization ........................... (54,762) (15,004) --
Interest expense, net ................................... (34,663) (10,199) --
---------- ----------- -----------
Loss before income taxes, minority interest and equity
losses ............................................... (17,465) (24,406) --
(Provision for) benefit from income taxes ................ (5,428) 2,841 --
Minority interest ........................................ (7,688) 18,790 --
Equity in net loss of unconsolidated companies ........... -- -- (95)
---------- ----------- -----------
Net loss attributable to HQ ........................... $ (30,581) $ (2,775) $ (95)
========== =========== ===========
Basic and diluted net loss attributable to HQ per weighted
average common share .................................... (0.88) $ (0.11) $ (0.01)
========== =========== ===========
Basic and diluted weighted average common shares of
FrontLine outstanding ................................... 34,880,709 25,600,985 14,522,513
========== =========== ===========
IV-20
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES - (CONTINUED)
STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31,
----------------------------------------
2000 1999 1998
------------- ------------ ---------
Cash Flows from Operating Activities:
Net loss attributable to HQ ................................ $ (30,581) $ (2,775) $ (95)
Adjustments to reconcile net loss attributable to HQ to cash
provided by operating activities:
Depreciation and amortization ........................... 54,762 15,004 --
Amortization of deferred financing costs ................ 4,920 719 --
Equity in net loss of unconsolidated companies .......... -- -- 95
Minority interest ....................................... 7,688 (18,790) --
Deferred income taxes ................................... -- (3,541) --
Amortization of deferred charges ........................ 858 12,493 --
Cumulative translation adjustment ....................... (247) -- --
Changes in operating assets and liabilities:
Accounts receivable, net ............................... (24,493) (1,328) --
Acquisition costs and other assets ..................... 11,141 (5,473) --
Deferred rent payable .................................. 16,455 6,024 --
Accounts payable and accrued expenses .................. (22,425) 19,755 --
Other liabilities ...................................... 9,700 2,527 --
---------- --------- -----
Net cash provided by operating activities ............ 27,778 24,615 --
---------- --------- -----
Cash Flows from Investing Activities:
Acquisitions of officing solutions centers ................ (251,051) (47,329) --
Equipment ................................................. (60,468) (41,541) --
Restricted cash ........................................... 22,866 (10,318) --
---------- --------- -----
Net cash used in investing activities ................ (288,653) (99,188) --
---------- --------- -----
Cash Flows from Financing Activities:
Net proceeds from Parent .................................. 18,424 23,817 --
Deferred financing costs .................................. (25,732) -- --
Net proceeds from notes payable ........................... 75,022 44,532 --
Capital leases ............................................ (2,657) (2,226) --
Net proceeds from minority interest ....................... 208,193 8,642 --
---------- --------- -----
Net cash provided by financing activities ............ 273,250 74,765 --
---------- --------- -----
Cash and Cash Equivalents:
Net increase ............................................. 12,375 192 --
Beginning of period ....................................... 3,807 3,615 --
---------- --------- -----
End of period ............................................. $ 16,182 $ 3,807 --
========== ========= =====
IV-21
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
4. OTHER OWNERSHIP INTERESTS
The Company's ownership interests in its investees are classified
according to the applicable accounting method utilized at December 31, 2000 and
1999. The carrying value of equity method investments represents the Company's
acquisition cost less any impairment charges and the Company's share of such
investees' losses. The carrying value of cost method investments represents the
Company's acquisition costs less any impairment charges in such investees. The
Company's ownership interests in and advances to investees as of December 31,
2000, are as follows (in thousands):
DECEMBER 31, 2000 DECEMBER 31, 1999
------------------------------ ------------------------------
CARRYING VALUE COST CARRYING VALUE COST
---------------- ----------- ---------------- -----------
Equity Method ......... $32,969 $156,104 $91,433 $107,245
Cost Method ........... 6,876 17,700 6,400 6,400
------- -------
$39,845 $97,833
======= =======
The following details the Company's equity in net loss and impairment of
unconsolidated companies (in thousands):
YEAR ENDED DECEMBER 31,
------------------------------------------
2000 1999 1998
------------- ------------ -----------
OnSite Access, Inc. and predecessor entity ............................. $ (39,017) $ (8,137) $ (30)
RealtyIQ Corp. ......................................................... (38,797) (11) --
EmployeeMatters, Inc. .................................................. (15,139) (2,230) --
Gain on sale of EmployeeMatters, Inc. (see below) ...................... 8,287 -- --
Reckson Strategic Venture Partners LLC.................................. (4,421) 638 (3,505)
Other unconsolidated companies ......................................... (11,101) (526) --
Aggregate impairment charges (see Note 13) ............................. (25,740) -- --
---------- --------- --------
Equity in net loss and impairment of unconsolidated companies ......... $ (125,928) $ (10,266) $ (3,535)
========== ========= ========
The following summarized financial information is presented for the two
most significant of the investments accounted for under the equity method prior
to December 31, 2000.
ONSITE ACCESS
OnSite Access, Inc. ("OnSite Access") provides advanced telecommunications
systems and services within commercial buildings and building complexes.
As of December 31, 2000, the Company had funded its remaining entire
capital commitment to OnSite Access. During the year ended December 31, 2000,
OnSite Access obtained $120.0 million from a combination of senior secured
financing and preferred stock.
IV-22
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
4. OTHER OWNERSHIP INTERESTS - (CONTINUED)
Summarized financial information, a summary of the Company's investment in
and advances to OnSite Access and FrontLine's share of its loss, is as follows
(in thousands):
BALANCE SHEET DATA:
DECEMBER 31,
-----------------------
2000 1999
---------- ----------
Current assets .......................................................... $ 27,156 $25,535
-------- -------
Total Assets ........................................................... $212,415 $74,774
======== =======
Current liabilities ..................................................... $ 53,335 $13,702
-------- -------
Total Liabilities (including minority interest) ........................ 145,922 15,615
Redeemable Preferred Stock and Stockholders' Equity (Deficit) (other than
FrontLine's interest) .................................................. 66,493 20,142
FrontLine's net investment in OnSite Access (after share of net losses) . -- 39,017
-------- -------
Total Liabilities and Stockholders' Equity (Deficit) .................... $212,415 $74,774
======== =======
STATEMENTS OF OPERATIONS DATA:
YEAR ENDED DECEMBER 31,
----------------------------
2000 1999
------------- ------------
Revenues ................................... $ 10,258 $ 3,646
---------- ---------
Total expenses ............................. 137,788 36,188
---------- ---------
Net loss ................................... (127,530) (32,542)
Other interests' share of net loss ......... (88,513) (24,405)
---------- ---------
FrontLine's share of net loss .............. $ (39,017) $ (8,137)
========== =========
REALTYIQ CORP.
Realty IQ Corp. ("RealtyIQ") created a comprehensive, proprietary,
national database of commercial real estate information for metropolitan areas
throughout the United States. RealtyIQ provides information to the commercial
real estate and related business community and operates within one reportable
business segment.
In December 2000, RealtyIQ determined to significantly reduce its staff
and consider ways to maximize shareholder value. Through December 31, 2000 and
December 31, 1999, FrontLine funded $36.2 million and $4.2 million,
respectively, in RealtyIQ.
IV-23
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
4. OTHER OWNERSHIP INTERESTS - (CONTINUED)
Summarized financial information, a summary of the Company's investment in
and advances to RealtyIQ and FrontLine's share of its loss, is as follows (in
thousands):
BALANCE SHEET DATA:
DECEMBER 31,
--------------------------
2000 1999
------------ -----------
Current assets .............................................................. $ 1,411 $ 1,722
--------- --------
Total Assets ............................................................... $ 10,190 $ 1,897
========= ========
Current liabilities ......................................................... $ 25,240 $ 1,223
--------- --------
Total Liabilities .......................................................... 25,240 1,276
Redeemable Preferred Stock and Stockholders' Equity (Deficit) (other than
FrontLine's interest) ...................................................... (15,050) (5,686)
FrontLine's net investment in RealtyIQ (after share of net losses) .......... -- 6,307
--------- --------
Total Liabilities and Stockholders' Equity (Deficit) ........................ $ 10,190 $ 1,897
========= ========
STATEMENTS OF OPERATIONS DATA:
YEAR ENDED
DECEMBER 31,
--------------------------
2000 1999
------------ -----------
Revenues ................................... $ 2,414 $ 1,970
--------- --------
Total expenses ............................. 50,931 3,218
--------- --------
Net loss ................................... (48,517) (1,248)
Other interests' share of net loss ......... (9,720) (1,237)
--------- --------
FrontLine's share of net loss .............. $ (38,797) $ (11)
========= ========
EMPLOYEEMATTERS
On August 11, 1999, FrontLine acquired a 53% noncontrolling interest on a
basic basis and 45% noncontrolling interest on a fully diluted basis in
EmployeeMatters, Inc. ("EmployeeMatters"), an Internet-based employee benefits
and human resource administration outsourcing company, for a purchase price of
$15.0 million. At the time, $5 million was paid in cash and $10 million was in
the form of a note.
In December 1999, the Company issued warrants to purchase 200,000 shares
of the Company's common stock to the executive officers of EmployeeMatters in
exchange for options to purchase 789,474 shares of EmployeeMatters. The fair
market value of these warrants was approximately $2.2 million, as determined by
the Black-Scholes valuation pricing model. This value was included in the
Company's investment in EmployeeMatters at December 31, 1999.
During the year ended December 31, 2000, the Company invested an
additional $22.0 million in EmployeeMatters. On December 20, 2000 the Company
sold its interest in EmployeeMatters to Intuit, Inc. ("Intuit") for 556,027
shares of Intuit common stock. The fair value of such stock on the closing date
of the sale was $21.3 million. As a result of the sale, the Company recorded a
gain of $8.3 million, net of $0.7 million of expenses and other related
charges, in the fourth quarter of the year ended December 31, 2000. Included in
the above Intuit shares are 23,072 shares held in escrow in order to
collateralize certain indemnification obligations of the Company. Such shares
will be released to the Company in December 2001.
IV-24
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
4. OTHER OWNERSHIP INTERESTS - (CONTINUED)
RECKSON STRATEGIC
Reckson Strategic Venture Partners LLC ("Reckson Strategic") invests in
operating companies with experienced management teams in real estate and real
estate related market sectors which are in the early stages of their growth
cycle or offer unique circumstances for attractive investments, as well as
platforms for future growth.
Through RSVP Holdings, LLC ("Holdings"), the Company is a managing member
and 100% owner of the common equity of Reckson Strategic. New World Realty,
LLC, an entity owned by two individuals (the "RSVP Managing Directors")
retained by Holdings, acts as a managing member of Holdings, and have a carried
interest which provides for the RSVP Managing Directors to receive a share in
the profits of Reckson Strategic after the Company, Paine Webber Real Estate
Securities, Inc., ("Paine Webber") and Stratum Realty Fund, L.P. ("Stratum")
have received certain minimum returns and a return of capital. Paine Webber and
Stratum are non-managing members and preferred equity owners who have committed
$150 million and $50 million, respectively, in capital and share in profits and
losses of Reckson Strategic with the Company, subject to a maximum internal
rate of return of 16% of invested capital. The carrying values of the Company's
investment in Reckson Strategic were $29.0 million and $36.6 million as of
December 31, 2000 and 1999, respectively.
OTHER UNCONSOLIDATED COMPANIES AND INVESTMENTS
During the year ended December 31, 1999, the Company invested $15.5
million and issued approximately 53,000 shares of its common stock for
non-controlling interests in seven other unconsolidated companies. During the
year ended December 31, 2000, the Company invested $23.5 million to purchase
ownership interests in two new unconsolidated companies and funded $67.5
million to existing unconsolidated companies.
FINANCIAL STATEMENTS
The following statements present the portion of the Company's financial
position, results of operations and cash flows represented by FrontLine Parent
and other interests as of and for the periods indicated.
IV-25
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
4. OTHER OWNERSHIP INTERESTS - (CONTINUED)
FRONTLINE PARENT AND OTHER INTERESTS
BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31,
----------------------------
2000 1999
------------- ------------
ASSETS:
Current Assets:
Cash and cash equivalents .................................................. $ 6,923 $ 28,933
Other current assets ....................................................... 21,928 --
---------- ---------
Total Current Assets .................................................... 28,851 28,933
Ownership interests in and advances to unconsolidated companies ............. 39,845 97,833
Ownership interests in HQ Global and predecessor entities ................... 239,590 136,507
Other assets, net ........................................................... 10,165 30,463
---------- ---------
Total Assets ............................................................ $ 318,451 $ 293,736
========== =========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Current Liabilities:
Accounts payable and accrued expenses ...................................... $ 9,246 $ 7,842
Notes payable .............................................................. 25,000 --
---------- ---------
Total Current Liabilities ............................................... 34,246 7,842
Credit facilities with related parties ...................................... 135,523 121,848
Senior secured debt ......................................................... -- 44,407
Other liabilities ........................................................... 13,899 5,530
---------- ---------
Total Liabilities ....................................................... 183,668 179,627
---------- ---------
Redeemable convertible preferred stock ...................................... 13,940 --
SHAREHOLDERS' EQUITY:
8.875% convertible cumulative preferred stock, $.01 par value, 25,000,000
shares authorized, 26,000 and -0- issued and outstanding, at
December 31, 2000 and 1999, respectively ................................. -- --
Common stock, $.01 par value, 100,000,000 shares authorized, 36,625,847
and 30,672,794 shares issued and outstanding at December 31, 2000 and
1999, respectively ....................................................... 366 307
Additional paid-in capital ................................................. 400,916 162,054
Accumulated deficit ........................................................ (281,030) (48,252)
Unrealized gain on marketable equity securities ............................ 591 --
---------- ---------
Total Shareholders' Equity .............................................. 120,843 114,109
---------- ---------
Total Liabilities and Shareholders' Equity .............................. $ 318,451 $ 293,736
========== =========
IV-26
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
4. OTHER OWNERSHIP INTERESTS - (CONTINUED)
FRONTLINE PARENT AND OTHER INTERESTS
STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
-----------------------------------------------
2000 1999 1998
------------- -------------- --------------
Parent Expenses:
General and administrative expenses ......................... $ (16,478) $ (9,509) $ (2,613)
Depreciation and amortization ............................... (1,123) (676) (1,260)
Amortization of deferred charges ............................ (14,330) (8,455) --
Restructuring costs ......................................... (12,788) -- --
Interest expense, net ....................................... (18,903) (8,166) (644)
Development stage company costs ............................. (9,999) -- --
----------- ----------- -----------
Loss before equity in net loss and impairment of
unconsolidated companies ................................. (73,621) (26,806) (4,517)
Equity in net loss and impairment of unconsolidated
companies ................................................... (125,928) (10,266) (3,535)
----------- ----------- -----------
Loss before extraordinary item from early extinguishment
of debt .................................................. (199,549) (37,072) (8,052)
Extraordinary item from early extinguishment of debt ......... (2,648) -- --
----------- ----------- -----------
Net loss .................................................. (202,197) (37,072) (8,052)
Dividends on and accretion of preferred stock ................ (2,119) -- --
----------- ----------- -----------
Net loss applicable to common shareholders attributable
to Parent and Other Interests ............................ $ (204,316) $ (37,072) $ (8,052)
=========== =========== ===========
Basic and diluted net loss attributable to Parent and Other
Interests per weighted average common share ................. $ (5.86) $ (1.45) $ (.55)
=========== =========== ===========
Basic and diluted weighted average common shares of
FrontLine outstanding ....................................... 34,880,709 25,600,985 14,522,513
=========== =========== ===========
IV-27
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
4. OTHER OWNERSHIP INTERESTS - (CONTINUED)
FRONTLINE PARENT AND OTHER INTERESTS
STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-----------------------------------------
2000 1999 1998
-------------- ------------- ------------
Cash Flows from Operating Activities:
Net loss .................................................................. $ (202,197) $ (37,072) $ (8,052)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization ........................................... 1,123 676 1,260
Amortization of deferred financing costs ................................ 800 -- --
Extraordinary loss on early extinguishment of debt ...................... 2,648 -- --
Equity in net loss of unconsolidated companies .......................... 125,928 10,266 3,535
Amortization of deferred charges ........................................ 14,330 18,000 --
Non-cash restructuring costs ............................................ 8,875 -- --
Changes in operating assets and liabilities:
Acquisition costs and other assets ..................................... (1,735) (1,778) (795)
Accounts payable and accrued expenses .................................. (6,678) 79 1,774
Affiliate receivables .................................................. -- 7,759 (12,626)
Other liabilities ...................................................... 8,369 (2,439) --
---------- ---------- ---------
Net cash used in operating activities ................................ (48,537) (4,509) (14,904)
---------- ---------- ---------
Cash Flows from Investing Activities:
Acquisitions of officing solutions centers ................................ (91,026) -- --
Equipment ................................................................. (3,019) (341) (115)
Acquisition of ownership interests and advances to unconsolidated
companies ............................................................... (68,322) (132,332) (43,959)
---------- ---------- ---------
Net cash used in investing activities ................................ (162,367) (132,673) (44,074)
---------- ---------- ---------
Cash Flows from Financing Activities:
Issuance of common stock and warrants, net of costs ....................... 156,957 36,995 --
Issuance of preferred stock and redeemable preferred, net of costs ........ 38,510 -- --
Deferred financing costs .................................................. (1,429) (4,398) --
Exercise of options ....................................................... 1,165 3,125 --
Net proceeds from credit facilities with related parties .................. 13,675 128,492 40,982
Net proceeds from notes payable ........................................... (19,407) (125) --
Preferred dividends ....................................................... (577) -- --
Net proceeds from rights offering ......................................... -- -- 19,893
---------- ---------- ---------
Net cash provided by financing activities ............................ 188,894 164,089 60,875
---------- ---------- ---------
Cash and Cash Equivalents:
Net increase (decrease) ................................................... (22,010) 26,907 1,897
Beginning of period ....................................................... 28,933 2,026 129
---------- ---------- ---------
End of period ............................................................. $ 6,923 $ 28,933 $ 2,026
========== ========== =========
IV-28
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
5. PROPERTY AND EQUIPMENT
Property and equipment consists of (in thousands):
YEAR ENDED DECEMBER 31,
---------------------------
2000 1999
------------ ------------
Office equipment, furniture and fixtures ............... $ 182,417 $ 63,789
Enterprise resource system ............................. 11,229 5,510
Leasehold improvements ................................. 71,061 25,149
--------- ---------
264,707 94,448
Less accumulated depreciation and amortization ......... (43,030) (14,023)
--------- ---------
$ 221,677 $ 80,425
========= =========
Office equipment, furniture and fixtures include approximately $8.1
million and $5.6 million of office equipment under capital leases, net of
accumulated depreciation of $3.0 million and $1.2 million as of December 31,
2000 and 1999, respectively.
6. INTANGIBLE ASSETS
Intangible assets consist of (in thousands):
YEAR ENDED DECEMBER 31,
---------------------------
2000 1999
------------- -----------
Goodwill .................................................... $ 676,775 $248,092
Favorable acquired business center operating leases ......... 25,690 --
Other intangible assets ..................................... 854 512
Less accumulated amortization ............................... (35,383) (9,192)
--------- --------
$ 667,936 $239,412
========= ========
7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued expenses consist of (in thousands):
YEAR ENDED DECEMBER 31,
------------------------
2000 1999
----------- ----------
Accounts payable ............................. $ 34,365 $22,305
Accrued compensation and benefits ............ 7,729 4,613
Accrued merger and integration costs ......... 1,992 10,900
Accrued stock grants ......................... -- 4,207
Other ........................................ 23,326 3,827
-------- -------
$ 67,412 $45,852
======== =======
IV-29
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
8. INCOME TAXES
The provision (benefit) for income taxes consists of the following (in
thousands):
YEAR ENDED DECEMBER 31,
-------------------------
2000 1999
--------- -------------
Current:
Foreign .............................................. $2,385 $ 100
State and local ...................................... 3,043 600
------ ---------
5,428 700
Deferred:
Federal .............................................. -- (3,291)
State and local ...................................... -- (250)
----- --------
-- (3,541)
----- --------
Total (benefit) provision ............................. $5,428 $ (2,841)
===== ========
The following is a reconciliation of the income tax expense (benefit)
computed using the U.S. federal statutory income tax rate to the provision
(benefit) for income taxes (in thousands):
YEAR ENDED DECEMBER 31,
----------------------------
2000 1999
------------ -------------
Income tax expense (benefit) at federal statutory rate .................. $ (5,037) $ (8,248)
Nondeductible goodwill .................................................. 4,170 928
State and local income taxes, net of federal income tax benefit ......... 3,043 (36)
Effect of foreign income taxes .......................................... 824 --
Benefit of net operating losses not recognized .......................... 2,220 4,515
Other, net .............................................................. 208 --
-------- ---------
Total provision (benefit) ............................................... $ 5,428 $ (2,841)
======== =========
The deferred tax effects of temporary differences as of December 31, 2000
and 1999 are as follows (in thousands):
YEAR ENDED DECEMBER 31,
---------------------------
2000 1999
------------ ------------
Deferred tax assets:
Net operating losses .................................... $ 83,848 $ 34,127
Accounts receivable allowance ........................... 1,293 332
AMT credit carryforward ................................. 252 252
Deferred rent payable ................................... 7,206 3,532
Other ................................................... 4,433 --
--------- ---------
97,032 38,243
Less valuation allowance ................................. (68,872) (28,340)
--------- ---------
28,160 9,903
--------- ---------
Deferred tax liabilities:
Fixed assets ............................................ (11,415) (4,665)
Intangibles ............................................. (9,206) (2,966)
Other ................................................... (7,539) (141)
--------- ---------
(28,160) (7,772)
--------- ---------
Net deferred tax asset after valuation allowance ......... $ -- $ 2,131
========= =========
IV-30
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
8. INCOME TAXES - (CONTINUED)
At December 31, 2000 and 1999, the Company had established valuation
allowances of $10.8 million and $4.5 million, respectively, to reduce certain
deferred tax assets to amounts that are more likely than not to be realized.
At December 31, 2000, Frontline has approximately $138 million of
available unused net operating loss carryforwards which expire beginning in
2017. At December 31, 2000 HQ has available unused net operating loss
carryforwards for U.S. federal income tax purposes of approximately $67
million, which expire beginning in 2019. A change in ownership, as defined for
purposes of the Internal Revenue Code, occurred in 2000 and will limit the
annual utilization of a portion of the U.S. Federal net operating loss
carryforward under the applicable Internal Revenue Service regulations. In
addition, HQ has available net operating loss carryforwards for income tax
purposes in the United Kingdom of approximately of $3.8 million. If realized,
the tax benefit related to approximately $19.0 million of the net operating
loss carryovers for U.S. tax purposes and all of the net operating loss
carryforwards in the United Kingdom will be recorded as a reduction of
goodwill, while the tax benefit of the remainder would be recorded as a
reduction of the provision for income taxes.
9. NOTES PAYABLE
HQ CREDIT FACILITY
HQ has a credit facility (the "HQ Credit Facility") with certain lending
institutions, which, as amended and restated as of May 31, 2000, provides for
borrowing of up to $219.4 million under four term loans (the "Term Loans") and
for borrowings or letters of credit of up to an additional $55.6 million under
two revolving loan commitments (the "Revolver Loans"). Availabilities under the
Revolver Loans are formula based. As of December 31, 2000, there was
$212.9 million in outstanding borrowings under the Term Loans and no borrowings
outstanding under the Revolver Loans. As of December 31, 2000, HQ had letters
of credit outstanding in the aggregate amount of $33.4 million for landlord
security deposits. Such letters of credit are collateralized by $5.6 million in
cash and $27.8 million of Revolver Loans, leaving $27.8 million available under
the Revolver Loans for additional borrowings.
The Term Loans are repayable in various quarterly installments through
November 2005. Additional annual principal payments of 75% of excess cash flow
as defined are required. Any outstanding borrowings under the two Revolver
Loans are due on November 6, 2003 and May 31, 2005, respectively. Borrowings
under the HQ Credit Facility bear interest ranging from LIBOR (one-month LIBOR
was approximately 6.8% at December 31, 2000) plus 3.25% to 4.0% for one, three
or nine-month periods at the election of HQ or prime (9.5% at December 31,
2000) plus 2.25% to 3.00%. The weighted average interest rate on borrowings
under the Term Loans at December 31, 2000 was approximately 10.7%. HQ pays a
commitment fee of 1/2 of 1.0% per annum on the unused portion of the HQ Credit
Facility.
As of December 31, 2000, HQ had hedged the interest rates on borrowings of
approximately $103.5 million under the HQ Credit Facility using various
instruments with various expiration dates through September 30, 2002. These
instruments lock in the maximum underlying three-month LIBOR at levels between
7.93% and 9.00%.
During 1999, interest on borrowings under the HQ Credit Facility ranged
from LIBOR plus 3.00% (9.5% at December 31, 1999) to LIBOR plus 3.75% (10.25%
at December 31, 1999) for one, three or six-month periods, at the election of
HQ.
IV-31
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
9. NOTES PAYABLE - (CONTINUED)
Maturities of borrowings outstanding under the HQ Credit Facility
subsequent to December 31, 2000 are as follows (in thousands):
AMOUNT
-----------
2001 ...................................... $ 32,999
2002 ...................................... 24,825
2003 ...................................... 28,500
2004 ...................................... 63,751
2005 ...................................... 62,850
--------
Total ..................................... $212,925
========
MEZZANINE LOAN
On May 31, 2000, HQ entered into a Senior Subordinated Credit Facility
(the "UBSW Loan") in the amount of $125.0 million with UBS Warburg LLC
("UBSW"). The UBSW Loan carried an interest rate of LIBOR plus 6.5% and was to
mature on May 31, 2007. On August 11, 2000, HQ replaced the UBSW Loan with a
$125.0 million Senior Subordinated Note Agreement (the "Mezzanine Loan") with a
group of lenders arranged by UBSW. The Mezzanine Loan bears interest at 13.5%
per annum and matures on May 31, 2007.
The Mezzanine Loan lenders received 503,545 Series A Warrants and 227,163
Series B Warrants. The fair value of the Series A Warrants to purchase Common
Stock issued to the lenders was recorded as debt issuance costs and is being
amortized over the terms of the related loan resulting in an effective interest
rate of 15.6%. No value will be assigned to the Series B Warrants until such
time as it becomes probable the Series B Warrants will become exercisable by
the holders.
The carrying values of HQ's notes payable approximated their fair values
as of December 31, 1999. As of December 31, 2000, the fair value of HQ's notes
payable exceeds the carrying value by approximately $20 million, assuming a 10%
discount rate.
COVENANTS
The HQ Credit Facility and Mezzanine Loan contain certain covenants,
including a defined maximum ratio of consolidated indebtedness to consolidated
earnings before interest, income taxes, depreciation and amortization. In
addition, there are other covenants pertaining to financial ratios and
limitations on capital expenditures. Also, the HQ Credit Facility and Mezzanine
Loan prohibit the declaration or payment of dividends by HQ Global or any of
its subsidiaries, except for the payment of dividends in kind on its preferred
stock. At December 31, 2000, HQ was in compliance with the covenants under
these facilities as amended.
HQ's lending institutions have an assignment of leases and rents
associated with HQ's business centers to collateralize the borrowing under the
HQ Credit Facility.
FRONTLINE BANK CREDIT FACILITY
On September 11, 2000, FrontLine amended its $25.0 million credit agreement
(the "FrontLine Bank Credit Facility"). Borrowings under the FrontLine Bank
Credit Facility are secured by shares of HQ Global and bear interest at LIBOR
plus 5% for one, two, three or six-month interest periods, as selected by
FrontLine. Any outstanding borrowings under the FrontLine Bank Credit Facility
were originally due on March 11, 2001. In January 2001, FrontLine exercised its
option to extend the
IV-32
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
9. NOTES PAYABLE - (CONTINUED)
maturity date until June 11, 2001. FrontLine has the ability to further extend
the maturity date to September 11, 2001. At December 31, 2000, FrontLine had
borrowed $25.0 million under the FrontLine Bank Credit Facility. Such amount is
classified as current in the accompanying Consolidated Balance Sheet. The
weighted average interest rate of the outstanding borrowings at such date was
11.67%. The carrying value of FrontLine's borrowings under the FrontLine Bank
Credit Facility approximates its fair value as of December 31, 2000.
10. REDEEMABLE PREFERRED STOCK
On December 13, 2000, FrontLine obtained a $25.0 million preferred equity
facility (the "Preferred Equity Facility") with a major financial institution.
At the inception of the Preferred Equity Facility, the Company drew $15.0
million, for net proceeds of $13.9 million; the remaining amount was drawn by
FrontLine subsequent to December 31, 2000, for net proceeds of $10.0 million.
The Preferred Equity Facility is comprised of a new series of redeemable
convertible preferred securities. At the Company's option, the Preferred Equity
Facility may be redeemed within the twelve months following its inception.
Quarterly dividends accrue during this period at the annual rate of 9.25%, but
are not payable if the securities are redeemed within such twelve-month period.
While these securities are outstanding, the holders have consent rights for
certain significant transactions, including the incurrence of additional debt
or the issuance of equity securities senior to, or on a parity with, the Series
B Preferred Stock. In addition, the securities include a redemption premium
that gradually increases from an initial rate of 6.0% for the first three
months to a maximum of 27.5% after eleven months. If the securities are not
redeemed prior to December 13, 2001, the securities (including the amount of
the redemption premium) become convertible at the holder's option into
FrontLine common stock at the initial rate of $13.3875 per share, the preferred
stock becomes a voting security on an "as-converted" basis, and quarterly
dividends become payable from the date of initial issuance at the annual rate
of 9.25%. The securities have a mandatory redemption requirement after five
years at a 27.5% premium, although certain capital events or uncured events of
default would accelerate this period. Accordingly, the securities are
classified as "Redeemable preferred stock" in the accompanying consolidated
balance sheet at December 31, 2000.
The initial net proceeds of the securities are being accreted to the
mandatory redemption price of 127.5% of face value over the five-year period
through the mandatory redemption date.
11. SHAREHOLDERS' EQUITY
The Company has established the 1998 stock option plan, the 1998 employee
stock option plan, the 1999 stock option plan and the 2000 employee stock
option plan (the "Plans") for the purpose of attracting and retaining
directors, executive officers, other key employees and advisory board members.
As of December 31, 2000, 3,700,376, 100,000, 1,750,000 and 2,500,000 of the
Company's authorized shares have been reserved for issuance under the 1998
stock option plan, the 1998 employee stock option plan, the 1999 stock option
plan and the 2000 employee stock option plan, respectively.
IV-33
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
11. SHAREHOLDERS' EQUITY - (CONTINUED)
The following table sets forth the outstanding options by plan and their
corresponding exercise price ranges:
EXERCISE PRICE RANGE
OUTSTANDING -----------------------
OPTIONS FROM TO
------------ ---------- ----------
1998 Stock Option Plan .................. 3,395,376 $ 1.04 $ 2.00
1998 Employee Stock Option Plan ......... 61,721 $ 2.00 $ 2.00
1999 Stock Option Plan .................. 766,833 $ 4.63 $ 29.25
2000 Employee Stock Option Plan ......... 1,515,624 $ 10.63 $ 58.00
Other Options ........................... 160,777 $ 2.00 $ 28.69
---------
Total ................................... 5,900,331
=========
A summary of the Company's stock option activity and related information
is as follows:
WEIGHTED
AVERAGE
OPTION
OPTIONS OPTION PRICE PRICE
-------------------- --------------------- ---------
Granted during the year ended December 31, 1998 ......... 3,831,541 (a) $ 1.04 -- $ 2.00 $ 1.19
---------
Outstanding - December 31, 1998 ........................ 3,831,541 $ 1.04 -- $ 2.00 $ 1.19
Granted ................................................. 1,218,500 (a) $ 4.63 -- $29.25 $ 15.10
Exercised ............................................... (210,000) $ 1.04 -- $ 2.00 $ 1.31
-------------
Outstanding - December 31, 1999 ........................ 4,840,041 $ 1.04 -- $29.25 $ 4.69
Granted ................................................. 2,159,792 (a) $ 10.63 -- $58.00 $ 21.88
Exercised ............................................... (260,333) $ 1.04 -- $13.31 $ 4.48
Forfeited ............................................... (839,169) $ 4.63 -- $29.25 $ 17.32
-------------
Outstanding - December 31, 2000 ........................ 5,900,331 $ 1.04 -- $58.00 $ 9.19
=============
(a) The weighted average grant date fair value per option (see discussion of
valuation below) was $1.15, $13.23 and $13.15 for the years ended December
31, 1998, 1999 and 2000, respectively.
The following table sets forth information relating to stock options
outstanding and exercisable at December 31, 2000:
STOCK OPTIONS OUTSTANDING STOCK OPTIONS EXERCISABLE
---------------------------------------- -------------------------
OUTSTANDING WEIGHTED WEIGHTED OUTSTANDING WEIGHTED
AS OF AVERAGE AVERAGE AS OF AVERAGE
DECEMBER YEARS OPTION DECEMBER OPTION
OPTION PRICE 31, 2000 REMAINING PRICE 31, 2000 PRICE
- --------------------- ------------- ----------- ---------- ------------- ---------
$ 1.04 2,567,085 7.24 $ 1.04 2,567,085 $ 1.04
$ 1.10 -- $ 4.63 1,096,788 6.62 $ 2.07 883,880 $ 1.94
$ 10.63 -- $21.19 852,291 8.96 $ 15.87 631,169 $ 14.98
$ 24.88 1,182,500 9.28 $ 24.88 324,833 $ 24.88
$ 26.72 -- $29.25 181,667 8.91 $ 28.48 71,670 $ 28.60
$ 58.00 20,000 9.05 $ 58.00 -- --
--------- ---------
5,900,331 7.84 $ 9.19 4,478,637 $ 5.35
========= =========
Options granted to officers under the 1998 stock option plan were fully
vested on January 1, 1999. Options granted to new employees generally vest in
three equal installments on the first, second and third anniversaries of the
date of the grant. Options granted under the Plans are generally exercisable at
the
IV-34
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
11. SHAREHOLDERS' EQUITY - (CONTINUED)
market price on the date of the grant and, subject to termination of
employment, expire ten years from date of the grant, are not transferable other
than on death.
In December 1999, the Company formed an advisory board to provide
strategic guidance and be actively involved in the development of the Company's
investee companies. As of December 31, 2000, the advisory board consists of
seven members. These members were granted a total of 140,000 options under the
1999 stock option plan with exercise prices ranging from $26.72 to $58.00
(weighted average $32.58),
These options vest in three equal installments on the first, second and
third anniversaries of the date of the grant. In accordance with FAS 123, the
Company was amortizing to compensation expense over three years the fair values
of these options determined by the Black-Scholes option valuation model. As a
result of the Company's new strategic objectives in connection with the
Restructuring, the Company will not require substantial assistance from the
advisory board subsequent to 2000. Accordingly, the remaining value of the
related options was recognized in the fourth quarter of 2000.
Pro forma information regarding net income and earnings per share has been
determined as if the Company had accounted for its employee stock options under
the fair value method prescribed by FAS 123. The fair value for these options
was estimated at the date of grant using a Black-Scholes option pricing model
with the following weighted-average assumptions for 2000, 1999 and 1998,
risk-free interest rate of 5%, no expected dividend yield, a volatility factor
of the expected market price of the Company's common stock of .600, 1.367 and
1.723, respectively, and a weighted-average expected life of the option of 7
years. The lower volatility assumption used for 2000 reflects the estimated
volatility that has occurred and is expected to continue to occur as a result of
FrontLine's revised business plan following the Restructuring.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value estimate,
in management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. For the years
ended December 31, 2000, 1999 and 1998 the Company's pro forma information
follows (in thousands, except per share data):
2000 1999 1998
-------------- ------------- -------------
Pro forma net loss ............................ $ (251,543) $ (43,474) $ (11,495)
Basic and diluted net loss per share .......... $ (7.21) $ (1.70) $ (.79)
A summary of grants of FrontLine common stock to employees under the 1999
and 2000 stock option plans is as follows:
Granted during the year ended December 31, 1999 ......... 550,000
-------
Grants through December 31, 1999 ....................... 550,000
Granted ................................................. 283,233
Forfeited ............................................... (48,332)
-------
Net grants through December 31, 2000 ................... 784,901
=======
IV-35
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
11. SHAREHOLDERS' EQUITY - (CONTINUED)
In connection with the 1999 stock grants the Company made loans to
employees to cover the associated tax liabilities. Such loans were forgiven
over the one-year period following the date of grant. In connection with
200,000 of the shares granted in 2000, the Company made payments on behalf
employees to cover the associated tax liabilities.
On December 16, 1999, the Company issued 1,437,500 shares of its common
stock in a public offering at $47.25 per share for an aggregate consideration
of $63.9 million.
From January 26, 2000 through February 28, 2000, the Company completed
preferred stock offerings of 26,000 shares of 8.875% Cumulative Convertible
Preferred Stock at a price of $1,000 per share with net proceeds of $24.5
million. These shares are convertible into the Company's common stock at a
price of $70.48.
On March 7, 2000, an investment partnership invested $30 million to
purchase 1.5 million warrants to acquire FrontLine's common stock at an
exercise price of $70 per share. The warrants have a term of 3.25 years. On
June 29, 2000, the investment partnership invested an additional $3.0 million
to obtain a reduction in the warrant exercise price to $47.25 per share and to
extend the expiration of the warrant to March 2005. Simultaneously with this
transaction, the Company issued 1,075,000 shares of its common stock for an
additional 2.5% ownership interest in HQ Global in connection with an agreement
with the investment partnership, which had originally owned preferred stock of
VANTAS.
On March 31, 2000, the Company sold approximately 2.6 million shares of
its common stock at a price of $47.25 per share for an aggregate consideration
of $122.6 million. Proceeds from the sale were utilized to repay the remaining
portion of a then-existing $60.0 million credit facility. As a result, certain
deferred financing costs of $2.6 million incurred in connection with the
establishment of such credit facility were expensed as an extraordinary loss in
the accompanying Consolidated Statements of Operations. As a part of this
transaction, the Company issued 128,750 warrants to purchase the Company's
common stock with an exercise price of $47.25 per share for three years.
The Company has entered into a stockholders agreement (the "HQ Stockholders
Agreement") with certain of the stockholders of HQ Global which provides them
with a right to put up to approximately 3.1 million shares of HQ Global (the "HQ
Shares") to the Company during the two years subsequent to the HQ Merger if HQ
Global has not completed an initial public offering of its shares. The put right
provides that up to 50% of the HQ Shares may be put to the Company in December
2001 and any remaining HQ Shares may be put to the Company in July 2002. The put
is payable in cash or FrontLine common stock (valued at the time of closing
under the put) at the Company's option.
On September 20, 2000, the Company issued 331,400 shares of its common
stock at a price of $15.0875 per share for gross proceeds of $5.0 million.
On October 17, 2000, the Company's Board of Directors announced that it
adopted a Shareholder Rights Plan (the "Rights Plan") designed to protect
shareholders from various abusive takeover tactics, including attempts to
acquire control of the Company at an inadequate price, depriving shareholders
of the full value of their investment. The Rights Plan is designed to allow the
Board of Directors to secure the best available transaction for all the
Company's shareholders. The Rights Plan was not adopted in response to any
known effort to acquire control of the Company.
Under the Rights Plan, each shareholder received a dividend of one Right
for each share of the Company's outstanding common stock owned. The Rights are
exercisable only if a person or group acquires, or announces their intent to
acquire, 15% or more of the Company's common stock, or announces a tender offer
the consummation of which would result in beneficial ownership by a person or
group of 15% or more of the common stock. Each Right entitles the holder to
purchase one one-hundreth of a share of a new series
IV-36
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
11. SHAREHOLDERS' EQUITY - (CONTINUED)
of junior participating preferred stock of the Company at an initial exercise
price of $60.00. If any person acquires beneficial ownership of 15% or more of
the outstanding shares of common stock, then all Rights holders except the
acquiring person will be entitled to purchase the Company's common stock at a
price discounted from the then market price. If the Company is acquired in a
merger after such an acquisition, all Rights holders except the acquiring
person will also be entitled to purchase stock in the buyer at a discount in
accordance with the Rights Plan. The distribution of Rights was made to all
common stockholders of record at the close of business on November 3, 2000 and
shares of common stock that are newly-issued after that date will also carry
Rights until the Rights become detached from the common stock. The Rights
expire at the close of business on October 15, 2010, unless earlier redeemed by
the Company. The Rights distribution was not taxable to stockholders.
12. MERGER AND INTEGRATION COSTS
Merger and integration costs related to the HQ Merger incurred and charged
to expense during the year ended December 31, 2000 were comprised of the
following (in thousands):
Payments to cancel options to purchase VANTAS common stock held by officers and
employees .................................................................... $ 11,382
Severance, retention incentives and other benefits ............................ 10,080
Professional fees and other expenses .......................................... 3,907
--------
$ 25,369
========
Of the total merger and integration costs incurred through December 31,
2000 of $25.4 million, approximately $23.4 million required cash outlays. At
December 31, 2000, the remaining balance to be paid totaled approximately $2.0
million, relating to employee severance, retention incentives and other
benefits, and relocation costs.
In connection with the HQ Merger, HQ consolidated and relocated the former
headquarters of VANTAS and Old HQ in New York, New York and Atlanta, Georgia,
respectively, into a new corporate headquarters in Dallas, Texas. Due to the HQ
Merger and relocations, VANTAS and Old HQ entered into incentive bonus
agreements with certain key executives and employees, which bonuses will be
earned as long as such executives and employees remain with HQ through a
specified date. Relocation costs and retention incentives are being charged to
expense as incurred.
HQ incurred merger and integration charges of approximately $26.7 million
during the year ended December 31, 1999, in connection with its merger
transactions in 1999 and certain transactions with FrontLine. Such charges
consisted primarily of compensation expense pursuant to the transactions with
FrontLine of $23.7 million and professional fees, business process
reengineering and other integration costs, which aggregated approximately
$3.0 million.
13. RESTRUCTURING
On October 18, 2000, FrontLine announced a restructuring of its strategic
plan, the steps under which are collectively referred to herein as the
Restructuring (see Note 1). In connection with the Restructuring, FrontLine
announced the termination of approximately 75% of its headquarters personnel
which will occur during a transition period through the first quarter of 2001.
As a result of the Restructuring, FrontLine recognized cash and non-cash
restructuring charges of $12.8 million.
The aggregate charges incurred during 2000 were comprised of (1) $4.6
million of accelerated amortization of deferred stock compensation and related
awards that resulted from the termination of certain employees in connection
with the Restructuring, (2) $3.4 million of severance and related
IV-37
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
13. RESTRUCTURING - (CONTINUED)
payments made to employees terminated during 2000 in connection with the
Restructuring, and (3) $4.8 million representing assets determined to be
impaired as a result of Restructuring. As a result, as of December 31, 2000, all
but $0.6 million of the aggregate cash portion of the restructuring charges had
been paid. In connection with the Restructuring, FrontLine has adopted a
severance plan for its remaining employees.
In conjunction with the Restructuring, FrontLine recorded aggregate
impairment charges of $25.7 million during the year ended December 31, 2000 in
order to reduce the carrying value of its investments to estimated fair value.
Such writedowns were determined in recognition of both the lack of continuing
financial support FrontLine planned to provide to certain investees following
the Restructuring and the difficult market conditions experienced in mid-2000.
Such charges are included in "Equity in net loss and impairment of
unconsolidated companies" in the accompanying Consolidated Statements of
Operations.
14. LONG-TERM INCENTIVE PLAN
In March 2000, the Compensation Committee of the Board of Directors
adopted a long-term incentive plan. Under the long-term incentive plan,
participants may purchase or be granted interests in limited partnerships
established by the Company to hold a profit participation interest in the
investments made by the Company. The plan contemplates the allocation to such
partnerships of up to a 12.5% profits interest in each investment made by the
Company. FrontLine, through a wholly-owned subsidiary, will act as the general
partner of each partnership and will retain an 87.5% or greater interest in
each partnership depending upon the vesting and type of interest participants
receive. FrontLine generally must receive a minimum return on its holdings in a
particular partnership, typically 100% of the cost of its investment, before
participants receive distributions from such partnership. A partnership will
generally distribute the securities or cash it holds to its partners after five
to ten years, but may distribute securities or cash earlier if the company has
completed an initial public offering or been sold. The plan also permits the
award of equivalent grants without the use of a limited partnership. In April
2000, FrontLine paid advances aggregating $2.8 million on future payments under
the long-term incentive plan to its four executive officers.
15. TRANSACTIONS WITH RELATED PARTIES
On June 15, 1998, the Company established a credit facility with Reckson
Operating Partnership, L.P. ("Reckson"), a subsidiary of Reckson Associates, in
the amount of $100 million (the "FrontLine Facility") for their service sector
operations and other general corporate purposes. Reckson has advanced the
Company $93.4 million at December 31, 2000. These advances bear interest at 12%
per annum with such rate increasing by 4% of the prior year's rate on
outstanding borrowings.
Additionally, Reckson Strategic has a $100 million commitment from Reckson
to fund its investment activities (the "Reckson Strategic Commitment"). Draws on
the Reckson Strategic Commitment occur either in the form of advances to
FrontLine (the "Reckson Strategic Facility" and, collectively with the FrontLine
Facility, the "Credit Facilities") under terms similar to the FrontLine Facility
or whereby Reckson makes direct investments with Reckson Strategic in joint
ventures. As of December 31, 2000, Reckson has advanced FrontLine $42.1 million
under the Reckson Strategic Commitment. The aggregate principal amount
outstanding and due Reckson at December 31, 2000 under the Credit Facilities was
$135.5 million. The estimated fair value of the Credit Facilities was
approximately $3.0 million lower than the carrying value at December 31, 2000.
Interest accrued on these facilities at December 31, 2000, was $13.8 million.
Both of the FrontLine and Reckson Strategic Facilities expire in June 2003.
Currently, the Company has two short-term open letters of credit totaling $3.2
million. These letters of credit decrease the availability under the FrontLine
Facility.
In November 1999, the Boards of Directors of FrontLine and Reckson
approved amendments to the FrontLine Facility and Reckson Strategic Credit
Facility necessary in order for FrontLine to proceed with certain short-term
financings for proposed acquisitions. As consideration for such approvals,
FrontLine
IV-38
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
15. TRANSACTIONS WITH RELATED PARTIES - (CONTINUED)
paid a fee to Reckson in the form of 176,186 shares of FrontLine common stock
which were valued at $20.31 per share. The fee of approximately $3.6 million
was included in deferred financing costs and was amortized over the estimated
nine-month benefit period.
On March 28, 2001, the Company's Board of Directors approved amendments to
the Credit Facilities pursuant to which (i) interest is payable only at maturity
and (ii) Reckson may transfer all or any portion of its rights or obligations
under the Credit Facilities to its affiliates. In addition, the Reckson
Strategic Facility was amended to increase the amount available thereunder to up
to $110 million. Further, in March 2001, Reckson advanced approximately $24
million under the Reckson Strategic Commitment to fund additional Reckson
Strategic-controlled joint ventures (unaudited).
The Company is entitled to a cumulative annual management fee of $2
million with respect to Reckson Strategic, of which $1.5 million is subordinate
to Paine Webber receiving an annual minimum rate of return of 16% and a return
of its capital. The non-subordinated portion of the fee for the years ended
December 31, 2000, 1999 and 1998 were $0.5 million, $0.5 million and $0.4
million, respectively.
The Company reimburses Reckson with respect to general and administrative
expenses (including payroll expenses) incurred by Reckson for the benefit of
the Company. These services include payroll, human resources, accounting and
other advisory services. During 2000, 1999 and 1998, the Company incurred $1.3
million, $0.5 million and $0.4 million, respectively, for such activities.
16. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
HQ and its subsidiaries lease certain business center facilities and their
corporate offices under non-cancelable operating leases expiring at various
dates through 2011, with the exception of ten business centers in the United
Kingdom which expire at various dates from 2012 to 2023. Certain of these
operating leases provide for renewal options. HQ is also generally obligated to
reimburse the lessor for its proportionate share of operating expenses, which
are not included in the minimum lease commitments below. HQ also leases
equipment under operating and capital leases which expire at various dates
through 2002.
Minimum future rental payments under theses non-cancelable operating
leases as of December 31, 2000 for each of the next five years and in the
aggregate are approximately (in thousands):
CAPITAL OPERATING
LEASES LEASES
--------- -------------
2001 ................................................ $ 2,844 $ 185,249
2002 ................................................ 969 175,309
2003 ................................................ -- 166,310
2004 ................................................ -- 154,462
2005 ................................................ -- 142,952
Thereafter .......................................... -- 508,833
------- ----------
Total minimum lease payments ....................... 3,813 $1,333,115
==========
Less amount representing interest ................... 384
-------
Present value of minimum lease commitments ......... $ 3,429
=======
Total rent expense for the years ended December 31, 2000 and 1999 was
$182.1 million and $89.9 million, respectively. Future rental payments for
office rent expense are typically subject to adjustments for operating expenses
and inflation increases as measure by the Consumer Price Index.
IV-39
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
16. COMMITMENTS AND CONTINGENCIES - (CONTINUED)
LITIGATION
On February 4, 1999, a lawsuit captioned OmniOffices, Inc. et al. v.
Joseph Kaidanow, et al., (Civil Action No. 99-0260) was filed in the United
States District Court for the District of Columbia. This litigation (the "D.C.
Action"), is with two stockholders of Old HQ (f/k/a OmniOffices, Inc.) and
involves the conversion of approximately $111 million of debt previously loaned
to Old HQ by CarrAmerica, into HQ's non-voting common stock. CarrAmerica and
Old HQ initiated the action by filing a complaint seeking declaratory judgment
that the conversion price was fair, following threats by Messrs. Kaidanow and
Arcoro to challenge the conversion price. Messrs. Kaidanow and Arcoro filed
counterclaims against CarrAmerica, Old HQ and the then current directors of Old
HQ, seeking a judgment declaring the conversion void or voidable, or in the
alternative, compensatory and punitive damages. The stockholders' counterclaim
makes no allegations against HQ. Discovery in this action was completed in late
1999. A motion for summary judgment is currently pending. The case has been
reassigned several times causing delays. It is unclear when this motion will be
acted upon or when the case would be set for trial.
Joseph Kaidanow and Robert Arcoro v. CarrAmerica Realty Corporation, HQ
Global Workplaces, Inc., Thomas A. Carr, Philip L. Hawkins, C. Ronald
Blankenship, Oliver T. Carr, and Gary Kusin. This action (the "Fiduciary
Action"), originally brought in Delaware state Chancery Court on April 17,
2000, was removed to the Federal District Court for the District of Delaware
and then remanded on plaintiffs motion back to Delaware Chancery Court. The
action alleges a breach of fiduciary duty by CarrAmerica Realty Corporation and
Old HQ's directors in approving the HQ Merger transaction. The complaint
alleges among other things that allocation of purchase price between the UK and
U.S. companies failed to meet the standard of entire fairness. The complaint
also states that CarrAmerica breached its obligations under the Tag a Long and
Sharing Agreement between plaintiffs and CarrAmerica. HQ is named as a party
because the request for injunctive and/or recissory damages would affect its
interests in the assets acquired in the HQ Merger. The plaintiffs in the
Fiduciary Action have also brought an appraisal action in the Chancery Court
requesting appraisal of the value of shares sold in the HQ Merger.
In addition to the cases set forth above, the Company and its investee
entities are party to claims and administrative proceedings arising in the
ordinary course of business or which are otherwise subject to indemnification,
some of which are expected to be covered by liability insurance (subject to
policy deductibles and limitations of liability) and all of which, including
the cases discussed above, collectively are not expected to have a material
adverse effect on the Company's financial position or results of operations.
IV-40
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 2000 - (CONTINUED)
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following summary represents the Company's results of operations for
each quarter during 2000 and 1999 (in thousands, except share amounts):
FIRST SECOND THIRD FOURTH
2000 QUARTER QUARTER QUARTER QUARTER
- ---- -------------- -------------- -------------- --------------
Total revenues ..................................... $ 62,490 $ 98,697 $ 160,266 $ 162,509
Total expenses ..................................... 82,225 130,410 176,575 185,838
Equity in net loss and impairment of
unconsolidated companies .......................... (18,295) (34,452) (31,106) (42,075)
Minority interest .................................. 902 196 (4,416) (4,370)
Net loss ........................................... (39,966) (66,249) (53,814) (72,749)
Net loss applicable to common shareholders ......... (40,311) (66,826) (54,390) (73,370)
Basic and diluted net loss per weighted
average common share .............................. $ (1.27) $ (1.92) $ (1.49) $ (2.00)
Basic and diluted weighted average common
shares outstanding ................................ 31,717,891 34,889,374 36,574,462 36,664,644
FIRST SECOND THIRD FOURTH
1999 QUARTER QUARTER QUARTER QUARTER
- ---- -------------- -------------- -------------- --------------
Revenues reported by HQ .................. $ 46,050 $ 53,574 $ 56,898 $ 57,923
Expenses reported by the Company ......... 1,668 8,754 6,847 9,537
Expenses reported by HQ .................. 44,490 52,359 56,413 85,589
Total expenses ........................... 46,158 61,113 63,260 95,126
Equity in net loss and impairment of
unconsolidated companies ................ (547) (1,309) (4,828) (3,582)
Minority interest ........................ (550) (407) 314 19,433
Net loss ................................. (1,956) (9,835) (11,740) (16,316)
Basic and diluted net loss per weighted
average common share .................... $ (0.08) $ (0.40) $ (0.47) $ (0.59)
Basic and diluted weighted average common
shares outstanding ...................... 24,686,042 24,712,383 25,163,301 27,812,667
IV-41