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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
Commission File Number: 0-30162
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 of organization) Identification No.)
405 Lexington Avenue, New York, NY 10174
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(Address of principal executive office) (Zip Code)
(212) 931-8000
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(Registrant's telephone number including area code)
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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) Yes X No __, and (2) has been
subject to such filings for the past 90 days, Yes X No __.
Indicate by check mark whether the registrant is an "accelerated filer" as
defined in Exchange Act 12b-2. Yes [ ] No [X]
The registrant has only one class of common stock, issued at $.01 par value per
share with 37,344,039 shares outstanding as of May 15, 2003.
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FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
QUARTERLY REPORT
FOR THE THREE MONTHS ENDED MARCH 31, 2003
TABLE OF CONTENTS
INDEX PAGE
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PART I. FINANCIAL INFORMATION
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Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2003 (unaudited) and December
31, 2002.................................................................... 3
Consolidated Statements of Operations for the three months ended March 31,
2003 and 2002 (unaudited)................................................... 4
Consolidated Statements of Cash Flows for the three months ended March 31,
2003 and 2002 (unaudited)................................................... 5
Notes to the Consolidated Financial Statements (unaudited).................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations.................................................................. 30
Item 3. Quantitative and Qualitative Disclosures about Market Risk.................. 40
Item 4. Controls and Procedures..................................................... 41
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PART II. OTHER INFORMATION
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Item 1. Legal Proceedings........................................................... 41
Item 2. Changes in Securities and Use of Proceeds................................... 43
Item 3. Defaults Upon Senior Securities............................................. 43
Item 4. Submission of Matters to a Vote of Securities Holders....................... 43
Item 5. Other Information........................................................... 43
Item 6. Exhibits and Reports on Form 8-K............................................ 43
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SIGNATURES AND OFFICER CERTIFICATIONS 45
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2
PART 1 - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
MARCH 31, DECEMBER 31,
2003 2002
----------- ------------
ASSETS:
Current Assets:
Cash and cash equivalents .................................................... $ 6,698 $ 10,311
Restricted cash .............................................................. 1,050 1,044
Accounts receivable, net of allowance for doubtful accounts of
$1,953 at March 31, 2003 and $1,874 at December 31, 2002 ................... 5,155 4,007
Other current assets ......................................................... 14,379 14,370
----------- -----------
Total Current Assets ..................................................... 27,282 29,732
Ownership interests in and advances to unconsolidated companies ................... 12,322 12,322
Property and equipment, net ....................................................... 105,131 122,582
Deferred financing costs, net ..................................................... 6,889 7,616
Other assets, net ................................................................. 18,605 18,798
----------- -----------
Total Assets ............................................................. $ 170,229 $ 191,050
=========== ===========
LIABILITIES AND SHAREHOLDERS' DEFICIENCY:
Current Liabilities:
Liabilities subject to compromise:
Accounts payable and accrued expenses ........................................ $ 49,596 $ 50,073
Accrued restructuring costs .................................................. 80,501 62,818
Unsecured debt ............................................................... 125,000 125,000
Credit facilities with related parties ....................................... 189,464 189,464
Notes payable ................................................................ 25,000 25,000
Other liabilities ............................................................ 2,190 2,178
----------- -----------
Total liabilities subject to compromise .................................. 471,751 454,533
Liabilities not subject to compromise:
Accounts payable and accrued expenses ........................................ 52,460 46,096
Accrued restructuring costs .................................................. 1,324 1,029
Accrued reorganization costs ................................................. 3,518 3,440
Secured debt ................................................................. 227,633 227,433
Deferred rent payable ........................................................ 39,557 43,732
Other liabilities ............................................................ 31,297 31,724
----------- -----------
Total liabilities not subject to compromise .............................. 355,789 353,454
----------- -----------
Total current liabilities ................................................ 827,540 807,987
Other liabilities not subject to compromise ....................................... 5,051 5,051
----------- -----------
Total Liabilities ........................................................ 832,591 813,038
----------- -----------
Redeemable convertible preferred stock (aggregate liquidation preference
$25,000 at March 31, 2003 and December 31, 2002) ............................. 27,228 26,840
Shareholders' Deficiency:
8.875% convertible cumulative preferred stock, $.01 par value, 25,000,000
shares authorized, 26,000 issued and outstanding ......................... -- --
Common stock, $.01 par value, 100,000,000 shares authorized, 37,344,039 shares
issued and outstanding ................................................... 373 373
Additional paid-in capital ................................................... 398,210 398,598
Accumulated deficit .......................................................... (1,088,173) (1,047,799)
----------- -----------
Total Shareholders' Deficiency ........................................... (689,590) (648,828)
----------- -----------
Total Liabilities and Shareholders' Deficiency ........................... $ 170,229 $ 191,050
=========== ===========
See accompanying notes to consolidated financial statements
3
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-------------------------------
2003 2002
------------ ------------
HQ Operating Revenues:
Workstation revenue ................................................................ $ 47,015 $ 57,512
Support services ................................................................... 26,799 30,946
------------ ------------
Total HQ Operating Revenues ................................................... 73,814 88,458
------------ ------------
HQ Operating Expenses:
Rent ............................................................................... 40,390 49,155
Support services ................................................................... 7,648 10,686
Center general and administrative .................................................. 16,271 18,883
General and administrative ......................................................... 8,855 10,967
Depreciation and amortization ...................................................... 9,422 10,699
------------ ------------
Total HQ Operating Expenses ....................................................... 82,586 100,390
------------ ------------
HQ operating loss ................................................................. (8,772) (11,932)
HQ Other Expenses:
Impairment of assets ............................................................... (4,699) --
Reorganization costs ............................................................... (3,126) (9,852)
Restructuring costs ................................................................ (18,176) --
Interest expense, net .............................................................. (5,040) (8,836)
------------ ------------
HQ loss from continuing operations ................................................ (39,813) (30,620)
Parent Expenses:
General and administrative expenses ................................................ (568) (515)
Restructuring costs ................................................................ (66) (255)
Interest expense, net .............................................................. (25) (6,287)
------------ ------------
Loss from continuing operations before equity in earnings and net loss and impairment of
unconsolidated company ................................................................. (40,472) (37,677)
Equity in earnings and net loss and impairment of unconsolidated company ............... 125 (288)
------------ ------------
Loss before discontinued operations ............................................... (40,347) (37,965)
Income (loss) from discontinued operations ............................................. (27) 72
------------ ------------
Net loss .......................................................................... (40,374) (37,893)
Dividends on and accretion of preferred stock .......................................... (388) (699)
------------ ------------
Net loss applicable to common shareholders ........................................ $ (40,762) $ (38,592)
============ ============
Basic and diluted net loss per weighted average common share ........................... $ (1.09) $ (1.03)
============ ============
Basic and diluted weighted average common shares outstanding ........................... 37,344,039 37,344,039
============ ============
See accompanying notes to consolidated financial statements.
4
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-----------------------
2003 2002
-------- --------
Cash Flows from Operating Activities:
Loss from continuing operations .......................................... $(40,347) $(37,965)
Adjustments to reconcile loss from continuing operations to cash (used in)
and provided by operating activities:
Depreciation and amortization ........................................ 9,422 10,699
Impairment of assets ................................................. 4,699 --
Amortization of deferred financing costs ............................. 727 8,219
Equity in net loss and impairment of unconsolidated companies ........ -- 288
Stock and related compensation ....................................... 295 23
Non-cash restructuring costs ......................................... 17,977 66
Non-cash reorganization costs ........................................ 78 --
Changes in operating assets and liabilities:
Accounts receivable, net ........................................... (1,149) 2,240
Other assets ....................................................... (415) 155
Deferred rent payable .............................................. 80 1,517
Accounts payable and accrued expenses .............................. 5,886 35,057
Accrued restructuring costs ........................................ (295) (13,527)
Other liabilities .................................................. (977) 1,820
-------- --------
Net cash provided by (used in) continuing operating activities ... (4,019) 8,592
Net cash used in discontinued operations ......................... (27) (1,001)
-------- --------
Net cash provided by (used in) operating activities .............. (4,046) 7,591
-------- --------
Cash Flows from Investing Activities:
Purchases of equipment.................................................... (323) (443)
Restricted cash .......................................................... (6) (956)
Proceeds from sale of short-term investments ............................. -- 1,010
Acquisition of ownership interests and advances to unconsolidated
Companies .............................................................. -- (67)
-------- --------
Net cash used in continuing investing activities ................. (329) (456)
Net cash provided by discontinued operations ..................... -- 522
-------- --------
Net cash provided by (used in) investing activities .............. (329) 66
-------- --------
Cash Flows from Financing Activities:
Capital leases ........................................................... 562 (418)
Net draws of secured credit facility and notes payable ................... 200 100
-------- --------
Net cash provided by (used in) financing activities .............. 762 (318)
-------- --------
Cash and Cash Equivalents:
Net increase (decrease) .................................................. (3,613) 7,339
Beginning of period ...................................................... 10,311 18,139
-------- --------
End of period ............................................................ $ 6,698 $ 25,478
======== ========
See accompanying notes to consolidated financial statements.
5
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
1. DESCRIPTION OF THE COMPANY
FrontLine Capital Group ("FrontLine" or the "Company") is a holding company,
with two distinct operating segments: one holds FrontLine's interest in HQ
Global Holdings, Inc., a company in the officing solutions market (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 companies (the "Parent and Other
Interests Segment") that provide a range of services. In October 2000, FrontLine
announced that it would focus its resources and capital on the businesses within
its existing portfolio and cease pursuing new investment activities.
FRONTLINE BANKRUPTCY
On June 12, 2002, Frontline filed a voluntary petition for relief under Chapter
11 of the United States Bankruptcy Code in the United States Bankruptcy Court
for the Southern District of New York (the "Bankruptcy Court"). The Company
remains in possession of its assets and properties, and continues to operate its
business and manage its property as a debtor-in-possession under the
jurisdiction of the Bankruptcy Court and in accordance with the applicable
provisions of the United States Bankruptcy Code.
The deadline to file proofs of claims and interests expired on September 30,
2002. Frontline is currently in the process of reviewing and assessing the
claims and interests that have been filed, and intends to file objections, as
appropriate.
On November 14, 2002, the Bankruptcy Court issued an order, which, among other
things, extended the exclusive period during which only Frontline may file a
plan of reorganization through and including February 7, 2003. On March 24,
2003, the Bankruptcy Court issued an order which among other things, further
extended the exclusive period during which only Frontline may file a plan of
reorganization through and including June 6, 2003. The Company anticipates
proposing a plan of reorganization in accordance with the federal bankruptcy
laws as administered by the Bankruptcy Court prior to that date. Confirmation of
a Plan of reorganization could materially change the amounts currently recorded
in the financial statements. The financial statements do not give effect to any
adjustment to the carrying value of assets, or amounts and classifications of
liabilities that might be necessary as a consequence of this matter. The Company
has the exclusive right to propose a plan of reorganization through which period
may be extended further by the Bankruptcy Court.
By order dated March 31, 2003, the Bankruptcy Court also authorized Frontline
to, among other things, in an attempt to resolve an ongoing dispute with the
preferred members (a) perform its duties as a debtor-in-possession in connection
with a wholly-owned subsidiary that is a managing member of a limited liability
company, by negotiating and executing definitive documents consistent with the
transactions detailed in the term sheets regarding the proposed restructuring of
Reckson Strategic Venture Partners, LLC ("RSVP") and with respect to New World
Realty, LLC annexed to such order (collectively, the "Transactions"), and (b) to
perform such actions and take all steps necessary to implement and consummate
such Transactions. Pursuant to such authorization, on or about April 29, 2003,
the Company and RSVP entered into agreements regarding the restructuring of
RSVP's capital structure. In addition, RSVP entered into an agreement regarding
the restructuring of its management arrangements.
In connection with the capital restructuring, RSVP agreed to redeem the
preferred equity holders' interests in RSVP for an aggregate amount of cash and
property of approximately $165.3 million (the "Restructuring Price"). Upon
execution of the restructuring agreement with the RSVP preferred equity holders,
6
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
RSVP distributed to such holders an initial cash payment of $41 million and the
assets that comprised its parking investments valued at approximately $28.5
million, as a payment against the Restructuring Price. The Restructuring is
subject to a financing contingency with respect to the $95.8 million balance of
the Restructuring Price. Upon closing, such balance is due and payable in cash.
In the event the financing does not close, the cash and assets distributed to
RSVP's preferred equity holders shall be treated as a distribution to the
preferred equity holders and RSVP shall continue to operate under the capital
structure in effect prior to the Transactions.
RSVP also agreed to restructure its relationship with its current managing
directors, conditioned upon the redemption of the preferred equity interests,
whereby a management company formed by the managing directors will serve as a
third party manager of RSVP. The management agreement will have a three-year
term, subject to early termination in the event of the disposition of all of the
assets of RSVP. The management agreement provides for an annual base management
fee of $2.0 million in year one, $1.75 million in year two and $1.0 million in
year three, an asset disposition fee equal to 2% of the aggregate consideration
received in connection with any sale or other disposition of RSVP Holdings LLC
or any RSVP investment (subject to a maximum amount over the term of the
agreement, together with the base management fee, of $7.5 million, and a minimum
amount of $3.5 million), and a subordinate one-third residual interest in RSVP's
assets after the return to the common equity holders of $75 million. Under the
restructured management arrangements, RSVP's former managing directors will have
a right of first offer in respect of any proposed sales of assets by RSVP.
There can be no assurance that any of the foregoing pending transactions will be
completed.
On May 12, 2003, the Bankruptcy Court approved an order which, among other
things, authorizes the Company to continue to indemnify Scott H. Rechler and
James Burnham as the persons expected to be the Debtor's only remaining director
(Mr. Rechler) and officers (Messrs. Rechler and Burnham) after its current
director and officer liability insurance policy expires on May 15, 2003, by
granting them a superpriority administrative expense for certain Coverage (as
defined in the motion) that would have been covered by the insurance policy had
it been extended.
HQ GLOBAL BANKRUPTCY
On March 13, 2002, HQ and certain of its affiliates (collectively, the
"Debtors") filed voluntary petitions for relief under Chapter 11 of the United
States Bankruptcy Code in the United States Bankruptcy Court for the District of
Delaware (the "Delaware Bankruptcy Court") and received a commitment for $30.0
million in debtor-in-possession financing. The Debtors continue to operate their
business and manage their properties as debtors-in-possession during the Chapter
11 proceeding. The Debtors had the exclusive right to propose a plan of
reorganization until July 12, 2003, which period may be extended further by the
Delaware Bankruptcy Court. The Debtors are obligated under their
debtor-in-possession financing facility to file with the Delaware Bankruptcy
Court, no later than May 31, 2003, a plan of reorganization in a form acceptable
to the "Requisite Lenders" under the facility.
The Debtors anticipate proposing a plan of reorganization in accordance with the
federal bankruptcy laws as administered by the Court. Confirmation of a plan of
reorganization could materially change the amounts currently recorded in the
financial statements. The financial statements do not give effect to any
adjustment to the carrying value of assets, or amounts and classifications of
liabilities that might be necessary as a consequence of this matter.
7
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
NOTES PAYABLE, CREDIT FACILITIES AND PREFERRED STOCK DEFAULTS
As of March 31, 2003, the Company has not paid certain principal and interest
due on the FrontLine Bank Credit Facility and both the FrontLine Bank Credit
Facility (Note 5) and the Credit Facilities with Reckson Operating Partnership,
L.P. ("Reckson") (Note 11) are in default. Additionally, the Company did not pay
the dividend that became payable on December 31, 2001 or any subsequent dividend
for the Redeemable Preferred Stock, and is in default under that agreement (Note
6).
The accompanying consolidated financial statements have been prepared on a going
concern basis of accounting and do not reflect any adjustments that might result
should the Company be unable to continue as a going concern. The Company's
inability to repay or refinance its indebtedness when due, and pay dividends on
its redeemable preferred stock, its recent losses from operations and the
related Chapter 11 proceedings of FrontLine and HQ raise concern about its
ability to continue as a going concern. The appropriateness of using the going
concern basis is dependent upon, among other things (i) confirmation of plans of
reorganization for FrontLine and HQ under the Bankruptcy Code, (ii) the ability
to achieve profitable operations after such confirmations and (iii) the ability
to generate sufficient cash from operations and through asset sales to meet its
obligations.
DELISTING BY NASDAQ
In March 2002, the Company's stock was delisted by Nasdaq as a direct result of
the HQ bankruptcy filing. The Company's common stock currently trades on the OTC
Bulletin Board under the symbol FLCGQOB.
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.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of
management, all adjustments (substantially consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three-month period ended March 31, 2003 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2003.
The balance sheet at December 31, 2002 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
8
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
For further information, refer to the consolidated financial statements and
notes thereto included in the Company's annual report on Form 10-K (the "Form
10-K") for the year ended December 31, 2002.
The accompanying unaudited financial statements have been presented in
accordance with statement of Position 90-7, Financial Reporting by Entities in
Reorganization under the Bankruptcy Code ("SOP 90-7"). In accordance with SOP
90-7, no interest has been accrued on unsecured debt, no dividends on preferred
stock have been accrued, unamortized premiums and debt issuance costs relating
to unsecured debt have been expensed, costs relating to the bankruptcy
proceeding and interest earned on accumulating cash resulting from the
bankruptcy proceeding and interest earned on accumulating cash resulting from
the bankruptcy proceeding have been reported as reorganization items in the
accompanying statement of operations, and liabilities subject to compromise have
been separately reported in the accompanying balance sheet.
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. 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. Participation of other (non-FrontLine)
shareholders in the earnings or losses of a consolidated entity 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 entity.
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. 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."
Cost Method. Investees not accounted for under either 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.
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.
9
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
MARKETABLE EQUITY SECURITIES
Available-for-sale marketable equity securities are reported at fair market
value, with the resulting net unrealized gain or loss reported within
shareholders' deficiency.
RECEIVABLES
HQ licenses 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's facilities included in continuing operations
are primarily located in the United States, which limits its exposure to certain
economic risks based upon local economic conditions. HQ generally requires
approximately two months' charges as a service retainer. HQ records an allowance
for doubtful accounts which reflects management's estimate of the risk of
uncollectible accounts receivable.
PROPERTY AND EQUIPMENT
Property and equipment consists of property and equipment owned by HQ, and is
stated at cost less accumulated depreciation and amortization. Depreciation is
calculated on the straight-line method over the estimated useful lives of the
assets which range from three to seven years. Leasehold improvements are
amortized over the lesser of the term of the related lease or the estimated
useful lives of the assets. As of March 31, 2003 and December 31, 2002, the
related accumulated depreciation and amortization was $106.5 million and $102.4
million, respectively.
DEFERRED FINANCING COSTS
The Company amortizes deferred financing costs over the term of the related
debt. Deferred financing costs totaled $6.9 million and $7.6 million at March
31, 2003 and December 31, 2002, respectively, net of accumulated amortization of
$12.5 million and $11.8 million, respectively. Amortization of deferred
financing costs is included as a component of interest expense in the
accompanying consolidated statements of operations.
IMPAIRMENTS OF 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. 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. In
recognition of continuing difficult capital market conditions and operating
performance of these ownership interests, the Company recorded an additional
impairment charge of $32.9 million during the year ended December 31, 2001. Of
the $32.9 million charge, $20.0 million related to Reckson Strategic Venture
Partners, LLC ("Reckson Strategic"). See Note 4 for further discussion. During
the three months ended March 31, 2003, the Company determined that no additional
impairment charge was necessary.
10
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
IMPAIRMENTS OF LONG-LIVED ASSETS
Impairment charges are recorded as a permanent reduction in the carrying amount
of the related asset. Effective January 1, 2002, the Company adopted Statements
of Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, ("FAS 142"). As a result, goodwill and
intangible assets deemed to have indefinite lives are no longer amortized, but
are subject to annual impairment tests. Other intangible assets continue to be
amortized over their useful lives.
As a result of impairment charges recorded in the third and fourth quarters of
2001, the Company did not have any goodwill or indefinite-lived intangible
assets recorded at December 31, 2001. Accordingly, adoption of FAS 142 did not
have an impact on the Company's financial condition or results of operations.
The Company does not have any goodwill or indefinite-lived assets recorded at
March 31, 2003.
Effective January 1, 2002, the Company also adopted FAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets ("FAS 144"). The FASB's new
rules on asset impairment supersede FAS No. 121, Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of ("FAS 121").
FAS 144 retains the requirements of FAS 121 to (a) recognize an impairment loss
only if the carrying amount of a long-lived asset is not recoverable from its
undiscounted cash flows, and (b) measure an impairment loss as the difference
between the carrying amount and fair value of the asset. FAS 144 primarily
impacts the accounting for intangible assets subject to amortization, property
and equipment, and certain other long-lived assets. The adoption of FAS 144 did
not have a significant impact on the Company's financial condition or results of
operations.
Assets to be disposed of are reported at the lower of the carrying amount or
estimated fair value less costs to sell. Accordingly, the Company recorded
impairment charges of $4.7 million related to the closure of centers
pursuant to restructurings during the three-month period ended March 31, 2003.
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.
INCOME TAXES
The Company uses the asset and liability method of accounting for income taxes.
Under the asset and liability method, deferred tax assets and liabilities are
recognized for the estimated future tax consequences attributable to differences
between financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. This method also requires the recognition of
future tax benefits such as net operating loss carry forwards, to the extent
that realization of such benefits is more likely than not. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
11
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in the period that includes the enactment
date. A valuation allowance is recognized if it is more likely than not that
some portion of the deferred asset will not be recognized. At March 31, 2003 and
December 31, 2002, all of HQ and FrontLine Parent's deferred tax assets have
been fully reserved due to the uncertainty as to whether these assets will
provide benefit in future years.
STOCK-BASED COMPENSATION
The Company follows Accounting Principles Board Opinion No. 25 (APB 25),
Accounting for Stock Issued to Employees, and related interpretations in
accounting for its employee stock options. The Company accounts for stock-based
compensation for non-employees under the fair value method prescribed by
Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based
Compensation ("FAS 123"). Through March 31, 2003, there have been no significant
grants to non-employees.
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 2003 and 2002, 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 for each period, and
a weighted-average expected life of the option of 7 years. The volatility
assumption 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.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. For the three months
ended March 31, 2003 and 2002 the Company's pro forma information follows (in
thousands, except per share data):
2003 2002
-------- --------
Net loss as reported ..................................... $(40,762) $(38,592)
Less: Stock option expense determined under the fair value
recognition methods for all awards ....................... (919) (1,014)
-------- --------
Pro forma net loss ....................................... $(41,681) $(39,606)
======== ========
Basic and diluted net loss per share as reported ......... $ (1.09) $ (1.03)
======== ========
Pro forma basic and diluted net loss per share ........... $ (1.12) $ (1.06)
======== ========
RECENT PRONOUNCEMENTS
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. This new rule requires companies to recognize costs
associated with exit or disposal activities when the liability is incurred
rather than at the date of commitment to exit from or dispose of an activity as
required by current generally accepted accounting principles. This statement is
to be applied prospectively to exit or disposal activities initiated after
December 31, 2002. Accordingly, the Company adopted this new rule on January 1,
2003 and did not have a material affect on the Company's financial statements.
However, the Company's accounting for exit and disposal activities, including
restructurings, after that date will be impacted.
12
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
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 its
investee 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 5 and 11, the
estimated fair values of the Company's long-term debt approximate the recorded
balances.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles 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 period presentation.
3. INTEREST IN HQ GLOBAL AND PREDECESSOR ENTITIES
OVERVIEW
HQ is a provider of flexible officing solutions. 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. As of March 31,
2003 HQ owned, operated, or franchised 284 business centers, which are included
in continuing operations and are primarily located in the United States. There
were 19 business centers operating at March 31, 2003 that were held for sale and
included in discontinued operations or in the process of being closed. HQ's
13
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
wholly-owned subsidiary is the franchisor of 15 domestic and 30 international
business centers for unrelated franchisees. Excluding franchised centers, HQ
owned and operated 239 business centers as of March 31, 2003.
OWNERSHIP BY FRONTLINE
As of March 31 2003, FrontLine's ownership interest in HQ was approximately 56%.
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
including certain warrants to purchase HQ Global stock, FrontLine would own
approximately 39.9% of the common stock of HQ Global.
An HQ Global shareholder has a put option ("Put Option") to require the Company
to purchase all of its interest any time until January 8, 2005, at the then
determined fair value of the interest.
DISCONTINUED OPERATIONS
In December 2001, HQ's Board of Directors approved a plan to dispose of HQ's
business in Europe. As a result of this transaction, the HQ consolidated balance
sheets at March 31, 2003 and December 31, 2002 and the statements of operations
and cash flows for the three-month periods ended March 31, 2003 and 2002 present
the European businesses as a discontinued operation. The results of operations
for the discontinued operations were not significant during the three months
ended March 31, 2003 and 2002.
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.
14
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
HQ GLOBAL AND PREDECESSOR ENTITIES
BALANCE SHEETS
(IN THOUSANDS)
MARCH 31, DECEMBER 31,
2003 2002
--------- ------------
ASSETS:
Current Assets:
Cash and cash equivalents .................................... $ 6,291 $ 10,011
Restricted cash .............................................. 1,050 1,044
Accounts receivable, net of allowance for doubtful accounts of
$1,953 at March 31, 2003 and $1,874 at December 31, 2002 ... 5,155 4,007
Other current assets ......................................... 14,037 13,516
--------- ---------
Total Current Assets ..................................... 26,533 28,578
Property and equipment, net ....................................... 105,131 122,582
Deferred financing costs, net ..................................... 6,868 7,570
Other assets, net ................................................. 18,003 18,161
--------- ---------
Total Assets ............................................. $ 156,535 $ 176,891
========= =========
LIABILITIES AND NET BUSINESS UNIT DEFICIENCY:
Current Liabilities
Liabilities subject to compromise:
Accounts payable and accrued expenses ........................ $ 43,913 $ 44,459
Accrued restructuring costs .................................. 80,501 62,818
Unsecured debt ............................................... 125,000 125,000
Other liabilities ............................................ 2,190 2,178
--------- ---------
Total liabilities subject to compromise .................. 251,604 234,455
Liabilities not subject to compromise:
Accounts payable and accrued expenses ........................ 52,460 46,096
Accrued restructuring costs .................................. 1,324 1,029
Accrued reorganization costs ................................. 3,518 3,440
Secured debt ................................................. 227,633 227,433
Deferred rent payable ........................................ 39,557 43,732
Other liabilities ............................................ 31,297 31,724
--------- ---------
Total liabilities not subject to compromise .............. 355,789 353,454
--------- ---------
Total Current Liabilities ................................ 607,393 587,909
Other liabilities not subject to compromise ....................... 5,051 5,051
--------- ---------
Total Liabilities ........................................ 612,444 592,960
Net business unit deficiency ...................................... (455,909) (416,069)
--------- ---------
Total Liabilities and Net Business Unit Deficiency ....... $ 156,535 $ 176,891
========= =========
15
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
HQ GLOBAL AND PREDECESSOR ENTITIES
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
THREE MONTHS ENDED
MARCH 31,
2003 2002
--------- ---------
HQ Operating Revenues:
Workstation revenue ........................ $ 47,015 $ 57,512
Support services ........................... 26,799 30,946
--------- ---------
Total HQ Operating Revenues .............. 73,814 88,458
--------- ---------
HQ Operating Expenses:
Rent ....................................... 40,390 49,155
Support services ........................... 7,648 10,686
Center general and administrative .......... 16,271 18,883
General and administrative ................. 8,855 10,967
Depreciation and amortization .............. 9,422 10,699
--------- ---------
Total HQ Operating Expenses .............. 82,586 100,390
--------- ---------
HQ operating loss ........................ (8,772) (11,932)
HQ Other Expenses:
Impairment of intangible assets ............ (4,699) --
Reorganization costs ....................... (3,126) (9,852)
Restructuring costs ........................ (18,176) --
Interest expense, net ...................... (5,040) (8,836)
--------- ---------
Loss before discontinued operations ........... (39,813) (30,620)
Income (loss) from discontinued operations..... (27) 72
--------- ---------
Net loss attributable to HQ .............. $ (39,840) $ (30,548)
========= =========
16
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
HQ GLOBAL AND PREDECESSOR
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
-----------------------
2003 2002
-------- --------
Cash Flows from Operating Activities:
Loss before discontinued operations attributable to HQ .................... $(39,813) $(30,620)
Adjustments to reconcile net loss before continuing operations attributable
to HQ to cash provided by (used in) operating activities:
Depreciation and amortization ......................................... 9,422 10,699
Impairment of assets .................................................. 4,699 --
Amortization of deferred financing costs .............................. 702 8,194
Stock and related compensation ........................................ 295 23
Non-cash restructuring ................................................ 17,977 --
Non-cash reorganization ............................................... 78 --
Changes in operating assets and liabilities:
Accounts receivable, net ............................................ (1,149) 2,240
Other assets ........................................................ (963) (81)
Deferred rent payable ............................................... 80 1,517
Accounts payable and accrued expenses ............................... 5,818 34,972
Accrued restructuring costs ......................................... (295) (13,527)
Other liabilities ................................................... (977) (4,228)
-------- --------
Net cash provided by (used in) operating activities from continuing
operations ............................................................ (4,126) 9,189
Net cash used in discontinued operations ............................ (27) (1,001)
-------- --------
Net cash provided by (used in) operating activities ................. (4,153) 8,188
-------- --------
Cash Flows from Investing Activities:
Purchases of equipment .................................................... (323) (433)
Restricted cash ........................................................... (6) (956)
-------- --------
Net cash used in continuing investing activities .................... (329) (1,399)
Net cash provided by discontinued operations ........................ -- 522
-------- --------
Net cash used in investing activities ............................... (329) (877)
-------- --------
Cash Flows from Financing Activities:
Net proceeds from notes payable ........................................... 200 100
Capital leases ............................................................ 562 (418)
-------- --------
Net cash provided by (used in) financing activities ................. 762 (318)
-------- --------
Cash and Cash Equivalents:
Net increase (decrease) ................................................... (3,720) 6,993
Beginning of period ....................................................... 10,011 16,151
-------- --------
End of period ............................................................. $ 6,291 $ 23,144
======== ========
17
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
4. OTHER OWNERSHIP INTERESTS
The Company's ownership interests in its investees are classified according to
the applicable accounting method utilized at March 31, 2003 and December 31,
2002. The carrying value of equity method investments represents the Company's
acquisition costs 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 March 31, 2003,
are as follows (in thousands):
MARCH 31, 2003 DECEMBER 31, 2002
---------------------------- -----------------------------
CARRYING VALUE COST BASIS CARRYING VALUE COST BASIS
-------------- ---------- -------------- ----------
Equity Method........ $ 12,322 $ 158,671 $ 12,322 $ 158,671
Cost Method.......... -- 18,075 -- 18,075
--------- ---------
$ 12,322 $ 12,322
========= =========
The following details the Company's equity in earnings and net loss and
impairment of unconsolidated companies (in thousands):
THREE MONTHS ENDED
MARCH 31,
------------------
2003 2002
----- -----
Reckson Strategic Venture Partners, LLC ............ $ 125 $(288)
----- -----
Equity in earnings and net loss and impairment of
unconsolidated companies ...................... $ 125 $(288)
===== =====
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 has a carried interest
which provides for the RSVP Managing Directors to receive a share in the profits
of Reckson Strategic after the Company, UBS Real Estate Securities, Inc. ("UBS
Real Estate"), formerly Paine Webber Real Estate Securities, Inc., and Stratum
Realty Fund, L.P. ("Stratum") have received certain minimum returns and a return
of capital. UBS Real Estate 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, which is
accounted for under the equity method, were $12.3 million as of March 31, 2003
and December 31, 2002. See Note 1 for current developments.
18
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
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.
19
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
FRONTLINE PARENT AND OTHER INTERESTS
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
MARCH 31, DECEMBER 31,
----------- ------------
2003 2002
----------- -----------
ASSETS:
Current Assets:
Cash and cash equivalents ..................................... $ 407 $ 300
Other current assets .......................................... 342 854
----------- -----------
Total Current Assets ...................................... 749 1,154
Ownership interests in and advances to unconsolidated companies .... 12,322 12,322
Deferred financing costs, net ...................................... 21 46
Other assets, net .................................................. 602 637
----------- -----------
Total Assets .............................................. $ 13,694 $ 14,159
=========== ===========
LIABILITIES AND SHAREHOLDERS' DEFICIENCY:
Liabilities subject to compromise:
Accounts payable and accrued expenses ......................... $ 5,683 $ 5,614
Credit facilities with related parties ........................ 189,464 189,464
Notes payable ................................................. 25,000 25,000
----------- -----------
Total Liabilities subject to compromise ................... 220,147 220,078
Negative ownership interest in HQ Global and predecessor entities .. 455,909 416,069
Redeemable convertible preferred stock ............................. 27,228 26,840
Shareholders' Deficiency:
8.875% convertible cumulative preferred stock, $.01 par value,
25,000,000 shares authorized, 26,000 issued and outstanding . -- --
Common stock, $.01 par value, 100,000,000 shares authorized,
37,344,039 shares issued and outstanding .................... 373 373
Additional paid-in capital .................................... 398,210 398,598
Accumulated deficit ........................................... (1,088,173) (1,047,799)
----------- -----------
Total Shareholders' Deficiency ............................ (689,590) (648,828)
----------- -----------
Total Liabilities and Shareholders' Deficiency ............ $ 13,694 $ 14,159
=========== ===========
20
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
FRONTLINE PARENT AND OTHER INTERESTS
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
THREE MONTHS ENDED
MARCH 31,
----------------------
2003 2002
Parent Expenses:
General and administrative expenses ................ $ (568) $ (515)
Restructuring costs ................................ (66) (255)
Interest expense, net .............................. (25) (6,287)
------- -------
Loss before equity in net loss and impairment of
unconsolidated companies ....................... (659) (7,057)
Equity in net loss and impairment of unconsolidated
companies .......................................... 125 (288)
------- -------
Net loss ......................................... (534) (7,345)
Dividends on and accretion of preferred stock ......... (388) (699)
------- -------
Net loss applicable to common shareholders
attributable to Parent and Other Interests . $ (922) $(8,044)
======= =======
21
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
FRONTLINE PARENT AND OTHER INTERESTS
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
---------------------
2003 2002
------- -------
Cash Flows from Operating Activities:
Net loss ................................................................ $ (534) $(7,345)
Adjustments to reconcile net loss to cash provided by (used in) operating
activities
Amortization of deferred financing costs ............................ 25 25
Equity in earnings and net loss of unconsolidated companies ......... (125) 288
Non-cash restructuring costs ........................................ -- 66
Changes in operating assets and liabilities:
Other assets ...................................................... 675 236
Accounts payable and accrued expenses ............................. 66 85
Other liabilities ................................................. -- 6,048
------- -------
Net cash provided by (used in) operating activities ............. 107 (597)
------- -------
Cash Flows from Investing Activities:
Proceeds from sale of short-term investments ............................ -- 1,010
Acquisition of ownership interests and advances to unconsolidated
companies ............................................................. -- (67)
------- -------
Net cash provided by investing activities ....................... -- 943
------- -------
Cash and Cash Equivalents:
Net increase ............................................................ 107 346
Beginning of period ..................................................... 300 1,988
------- -------
End of period ........................................................... $ 407 $ 2,334
======= =======
22
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
5. NOTES PAYABLE
HQ DEBTOR-IN-POSSESSION FACILITY
In connection with HQ's bankruptcy filing (See Note 1), HQ received a commitment
for a $30.0 million facility, with borrowings permitted through December 31,
2002 in accordance with certain operating and liquidity covenants. Any
borrowings, of which there have been none, will incur interest at prime plus 3%.
HQ and its lenders have agreed to extend this facility through and including
July 31, 2003.
HQ CREDIT FACILITY
HQ has a pre-petition credit facility (the "HQ Credit Facility") with certain
lending institutions, which, as amended and restated as of June 29, 2001,
provides for borrowings 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 March 31, 2003,
there was $188.7 million in outstanding borrowings under the Term Loans and
$39.0 million in borrowings outstanding under the Revolver Loans. As of March
31, 2003, HQ had letters of credit outstanding in the aggregate amount of $16.0
million for landlord security deposits. Such letters of credit are
collateralized by $0.2 million in cash and $15.8 million of Revolver Loans.
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. Pursuant to such requirement, HQ made an accelerated principal
payment of $15.1 million during the twelve-month period ended December 31, 2001,
based on cash flows for the year ended December 31, 2000. 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 4.04% at March 31, 2003)
plus 3.25% to 4.0% for one, three or nine-month periods at the election of HQ or
prime (4.25% at March 31, 2003) plus 2.25% to 3.00%. The weighted average
interest rate on borrowings under the Term Loans and the Revolver Loans at March
31, 2003, were approximately 5.9% and 6.0%, respectively. A commitment fee of
1/2 of 1.0% per annum is payable on the unused portion of the HQ Credit
Facility.
HQ's lending institutions have an assignment of leases and rents associated with
HQ's business centers and certain preferred security interests to collateralize
the borrowings under the HQ Credit Facility.
The stated maturities of borrowings outstanding under the HQ Credit Facility
subsequent to December 31, 2002 are as follows (in thousands):
TWELVE MONTHS ENDED
MARCH 31, AMOUNT
----------------------------------------------
2003 and arrears........... $ 68,645
2004....................... 58,976
2005....................... 100,012
--------
Total...................... $227,633
========
23
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
MEZZANINE LOAN/UNSECURED DEBT
On May 31, 2000, HQ entered into a Senior Subordinated Credit Facility (the
"Bridge Loan") in the amount of $125.0 million. The Bridge 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 Bridge Loan with a $125.0 million Note and Warrant
Purchase Agreement (the "Mezzanine Loan"). The Mezzanine Loan bears interest at
13.5% per annum and matures on May 31, 2007. The entire balance was outstanding
at March 31, 2003 and December 31, 2002.
EVENTS OF DEFAULT AND COMPLIANCE WITH 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.
In addition to not complying with certain financial covenants, in September
2001, HQ defaulted on its principle payments due under the HQ Credit Facility
and, in February 2002, commenced defaulting on interest payments. As a result of
entering into forbearance agreements, additional borrowings under the HQ Credit
Facility were permitted from September 30, 2001 to February 14, 2002. Due to
these defaults, outstanding borrowings are reflected as a current liability as
of March 31, 2003 and December 31, 2002.
HQ also has defaulted on the interest payments on the Mezzanine Loan beginning
September 30, 2001. As a result of these defaults and non-compliance with
financial covenants, the Mezzanine Loan has been classified as a current
liability as of March 31, 2003 and December 31, 2002.
HQ was not in compliance with certain financial covenants set forth in the
Debtor-in-Possession facility as of December 31, 2002. However, HQ received a
waiver for these financial covenants from its lenders through March 31, 2003
that was also approved by the Bankruptcy court. HQ is in compliance with its
financial covenants for 2003 as set forth in the subsequent amendments to the
Debtor-in-Possession facility.
FRONTLINE BANK CREDIT FACILITY
On September 11, 2000, FrontLine entered into a $25.0 million line of credit
agreement (the "FrontLine Bank Credit Facility"). Borrowings under the FrontLine
Bank Credit Facility are secured by a 20.51% common ownership interest in shares
of HQ Global and bear interest, at the election of FrontLine, at the Prime rate
plus 5%. 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 maturity date until June 11, 2001. In May 2001, the Company
further extended the maturity date to September 11, 2001. In September 2001, the
Company further extended the maturity date to October 25, 2001. Since the entire
outstanding balance of $25.0 million and accrued interest was not repaid at this
time, FrontLine became in default. 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 7.66%.
The restructuring of the Company's indebtedness may result in significant
dilution to holders of the Company's common stock or the elimination of their
interest.
24
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
6. 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 during the three months ended March 31, 2001, for net proceeds of
$10.0 million.
The Preferred Equity Facility is comprised of a series of redeemable convertible
preferred securities (the "Series B Preferred Stock"). The holders have consent
rights for certain significant transactions, including the incurrence of
additional debt by the Company or HQ, the issuance of equity securities senior
to, or on a parity with, the Series B Preferred Stock or the issuance by HQ of
preferred stock. These securities also contain certain covenants relating to HQ.
In addition, the securities include a redemption premium of 27.5%. Since the
securities were not redeemed prior to December 13, 2001, the securities
(including the amount of the redemption premium) have become convertible at the
holder's option into FrontLine common stock at the initial rate of $13.3875 per
share, the preferred stock has become a voting security on an "as-converted"
basis, and quarterly dividends have become payable from the date of initial
issuance at the annual rate of 9.25%. Securities have a mandatory redemption
requirement at a 27.5% premium, which has been triggered as a result of uncured
events of default. Accordingly, the securities are classified as "Redeemable
convertible preferred stock" in the accompanying consolidated balance sheet at
March 31, 2003.
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.
At March 31, 2003, the Company did not pay the dividend that was payable at that
time and accordingly is in default. The Company is in arrears with regard to the
payment of dividends on its Series A and Series B Preferred Stock.
7. SHAREHOLDERS' DEFICIENCY
During the three months ended March 31, 2000, the Company completed preferred
stock offerings of 26,000 shares of 8.875% Convertible Cumulative Preferred
Stock (the "Series A Preferred Stock") at a price of $1,000 per share with net
proceeds of $24.6 million. These shares are convertible into the Company's
common stock at a price of $70.48. The Company did not declare or pay the
quarterly dividend due on these shares commencing with the payment that was due
on November 6, 2001. Accordingly, future dividends will accrue at a higher rate
of 10.875%. Since dividend distributions are in arrears for more than two
quarterly periods, then the holders of such shares are entitled to elect two
additional members to the Company's Board of Directors.
In connection with the HQ Merger, the Company entered into a stockholders
agreement (the "HQ Stockholders Agreement") with certain of the stockholders of
HQ Global which provide them with rights 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 did not complete an initial public
offering of its shares. On February 25, 2002, such stockholders irrevocably
waived their Put Rights.
25
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
8. LONG-TERM INCENTIVE PLAN
In March 2000, the Compensation Committee of the Board of Directors adopted a
long-term incentive plan (the "LTIP"). The terms of the LTIP are described in
the Company's Annual Report on Form 10-K for the year ended December 31, 2001.
In April 2000, FrontLine paid advances aggregating $2.8 million on future
payments under the long-term incentive plan to its four executive officers at
that date. During the three months ended September 30, 2001, $1.8 million of
these advances were forgiven as a result of the termination of three of these
executives. Including related income tax accruals, the resulting expenses
relating to the forgiveness of the advances to these three executives was $2.8
million in the twelve months ended December 31, 2001.
The Company is continuing to amortize the remaining $1.0 million and related tax
payments through April 2007, the end of the required service period, for the
remaining executive officer who is still employed with the Company. During the
three months ended March 31 2003 and 2002, $0.1 million, of amortization related
to the LTIP was recorded.
9. REORGANIZATION COSTS
HQ
In the first quarter of 2002, HQ recorded $3.7 million of professional costs
associated with the Chapter 11 proceeding and a $6.2 million non-cash charge
associated with the write-off of deferred financing costs associated with the
Mezzanine Loan.
In each of the second and third quarters of 2002, HQ accrued $4.4 million of
professional costs associated with the Chapter 11 proceeding.
The following table summarizes the accrued charges related to reorganization (in
thousands):
Write off of
Deferred
Professional Financing Costs
Costs non-cash Total
------------ ---------------- --------
2002 charges $ 8,464 $ 24,722 $ 33,186
Non-cash reduction -- (24,722) (24,722)
Cash expenditures (5,024) -- (5,024)
-------- -------- --------
Balance at December 31, 2002 3,440 -- 3,440
2003 charges 3,126 -- 3,126
Cash expenditures (3,048) -- (3,048)
-------- -------- --------
Balance at March 31, 2003 $ 3,518 $ -- $ 3,518
======== ======== ========
FRONTLINE
FrontLine has incurred approximately $0.1 million of reorganization costs, all
of which were paid prior to the three months ended March 31, 2003.
26
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
10. RESTRUCTURING
HQ
In 2002, HQ recorded a restructuring charge of $29.4 million related to
additional planned center closures and employee severance. During the twelve
months ended December 31, 2002, various landlords drew down $10.9 million of
letters of credit, which reduced the estimated liability related to center
closures.
In 2003, HQ recorded $0.3 million in severances costs and an additional $17.9
million related to additional center closures.
The following table summarizes the accrued charges related to restructuring (in
thousands):
Professional
Severance Lease Costs Services Costs Total
--------- ----------- --------------- --------
Balance at January 1, 2002 $ 2,695 $ 46,979 $ 1,893 $ 51,567
2002 charges 1,105 28,267 -- 29,372
Cash expenditures (957) (14,241) (1,893) (17,091)
-------- -------- -------- --------
Balance at December 31, 2002 2,843 61,005 -- 63,848
2003 charges 295 17,881 -- 18,176
Cash expenditures -- (199) -- (199)
-------- -------- -------- --------
Balance at March 31, 2003 $ 3,138 $ 76,687 $ -- $ 81,825
======== ======== ======== ========
FRONTLINE
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 terminated
approximately 90% of its headquarters personnel, which has occurred during a
transition period through the fourth quarter of 2001. As a result of this
Restructuring, FrontLine has recognized cash and non-cash restructuring charges
of $0.1 million and $0.3 million during the three months ended March 31, 2003
and 2002, respectively.
The restructuring costs recognized during the first quarter of 2003 consist
entirely of LTIP amortization for the remaining officer.
The restructuring costs recognized during the first quarter of 2002 consist
principally of professional fees and other expenses.
11. TRANSACTIONS WITH RELATED PARTIES
HQ believes that the terms and pricing of each of the following transactions
with related parties are similar to those negotiated at arms length. Certain
officers and members of HQ's Board of Directors are also officers and/or on the
board of directors of FrontLine, Reckson Associates Realty Corp. ("Reckson
Associates"), Equity Office Properties ("EOP") or CarrAmerica.
HQ is a tenant under several leases with Reckson Associates and affiliates. For
the three months ended March 31, 2003, HQ made payments of $1.2 million for
rent, construction and other charges under such leases.
27
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
HQ is a tenant under several leases with EOP and affiliates of EOP, which are
affiliated with EOP Operating Limited Partnership, a purchaser of HQ's Series A
Preferred Stock in conjunction with the HQ Merger. For the three months ended
March 31, 2003, HQ made payments of $5.1 million for rent and other charges
under such leases.
HQ is a tenant under several leases with CarrAmerica and affiliates of
CarrAmerica, who received shares of HQ's Voting Common Stock and Nonvoting
Common Stock in conjunction with the HQ Merger. For the three months ended March
31, 2003, HQ made payments of $0.4 million for rent and other charges under such
leases.
FRONTLINE
The Company has a credit facility with Reckson Operating Partnership, L.P.
("Reckson") in the amount of $100 million (the "FrontLine Facility"). Reckson
has advanced the Company $93.4 million at March 31, 2003 under the FrontLine
Facility.
Additionally, Reckson Strategic has a $100 million commitment from Reckson to
fund its investment activities (the "Reckson Strategic Facility"). Draws on the
Reckson Strategic Facility occur either in the form of loans 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
March 31, 2003, Reckson has advanced FrontLine $49.3 million under the Reckson
Strategic Facility. The aggregate principal amount outstanding and due Reckson
at March 31, 2003 under both credit facilities was $142.7 million. Interest
accrued on these facilities at March 31, 2003, was $46.7 million. Both of the
FrontLine and Reckson Strategic Facilities expire in June 2003. Currently, the
Company has an outstanding letter of credit in the amount of $0.2 million.
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. Reckson has advanced approximately $59.8 million under the Reckson
Strategic Facility to fund additional Reckson Strategic-controlled joint
ventures through March 31, 2003. There is no remaining availability under the
Credit Facilities. At March 31, 2003, as a result of the Company's failure to
pay the principal and interest due upon maturity on the FrontLine Bank Credit
Facility, an event of default has occurred upon the Credit Facilities with
Reckson. As a result of the default under the Credit Facilities, interest
borrowings currently bear interest at 14.62% per annum.
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 UBS Real
Estate receiving an annual minimum rate of return of 16% and a return of its
capital. The non-subordinated portion of the fee for each of the three months
ended March 31, 2003 and 2002 was $0.1 million.
12. CONTINGENCIES
Reference is made to the lawsuit captioned OmniOffices, Inc. et al. v. Joseph
Kaidanow et al. set forth in the Company's Annual Report on Form 10-K for the
year ended December 31, 2001. In connection with such litigation, on September
12, 2001, without holding oral argument, the Court denied Plaintiffs' motion for
28
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
summary judgment, but granted the Defendants' cross-motion for summary judgment.
Plaintiffs and the directors of old HQ filed a Notice of Appeal in October 2001.
On February 15, 2002, the D.C. Circuit announced that oral argument was
scheduled for January 16, 2003. In March 2002, the D.C. Circuit referred the
appeal to its Appellate Mediation Program. On April 24, 2002, HQ filed a notice
of bankruptcy stay in respect of its March 13, 2002 Chapter 11 filing. HQ
informed the D.C. Circuit that the appeal was stayed as to HQ pursuant to the
automatic stay provisions of the U.S. Bankruptcy Code. The D.C. Circuit reversed
the District Court in an opinion dated March 7, 2003.
Reference is made to the lawsuit captioned 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 set
forth in the Company's Annual Report on Form 10-K for the year ended December
31, 2001. In connection with such litigation, on March 8, 2002, Plaintiffs filed
a motion for leave to amend their complaint to add, inter alia, a breach of
warrant agreements claim against HQ and other claims against FrontLine. On March
15, 2002, HQ filed a notice of bankruptcy stay, stemming from its March 13, 2002
voluntary petition for Chapter 11 bankruptcy protection in the United States
Bankruptcy Court for the District of Delaware (the "Delaware Bankruptcy Court").
HQ informed the Court that the consolidated action was stayed as to HQ pursuant
to the automatic stay provisions of the Bankruptcy Code. Co-defendant
CarrAmerica Realty Corporation filed a motion requesting that, in light of HQ's
bankruptcy, the consolidated litigation be stayed as to all defendants. At a
status conference held on March 25, 2002, the Vice Chancellor ordered the
parties to work out a scheduling order for the briefing of the motion regarding
the stay of the proceedings. At a hearing on this motion on September 9, 2002,
the Vice Chancellor stayed the proceedings until November 13, 2002. The former
director co-defendants in the consolidated action separately filed an adversary
proceeding in the Delaware Bankruptcy Court seeking to stay the consolidated
action as to the former directors. After a hearing on June 25, 2002, the
Delaware Bankruptcy Court denied the requested relief.
On September 9, 2002, HQ Global Workplaces, Inc. filed an adversary proceeding
in the Delaware Bankruptcy Court seeking to subordinate, pursuant to Section
510(b) of the Bankruptcy Code, the claims of Messrs. Kaidanow and Arcoro on the
basis that the claims arose from the purchase or sale of an equity security.
On or about October 3, 2001, Burgess Services, LLC ("Burgess Services"),
Dominion Venture Group, LLC ("Dominion Venture Group") and certain affiliated
parties commenced an action in Oklahoma State Court against Reckson Strategic
Venture Partners, LLP ("RSVP"), Reckson Associates Realty Corp. ("Reckson"), and
RAP-Dominion LLC ("RAP-Dominion"), a joint venture through which RSVP and
Reckson invested in a venture with certain of the plaintiffs. On April 10, 2002,
the litigation was settled without liability on the part of the Company or the
defendant. In connection with the settlement, the joint venture will be
terminated. As a result of this settlement, the Company determined that no
further impairment was necessary on its carrying value in its investment in
Reckson Strategic.
In April 2000, the Company entered into an office lease which expires in
December 2010. In January 2001, the Company assigned the lease to HQ. The lease
assignment did not relieve the Company of any of its obligations under the terms
of this lease. At March 31, 2003, HQ was past due on $0.9 million of rent. The
landlord has drawn the full letter on credit of $2.8 million. Of the $57.6
million HQ restructuring charge recorded in 2001, a $4.8 million accrual
applicable to this lease was recorded as an estimate for the cost of terminating
this lease. If the ultimate cost of terminating this lease exceeds the
outstanding letter of credit, then additional cash may need to be paid by either
HQ or the Company. Since HQ is currently in bankruptcy, the landlord is likely
to seek to recover any further damages from FrontLine. As of March 31, 2003, the
remaining lease commitment was $23.4 million.
29
FRONTLINE CAPITAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(UNAUDITED)
The Company also has potential liability under its indemnification of
CarrAmerica for liabilities of Carr America under its guarantees relating to
four HQ leases. In conjunction with the HQ Merger, FrontLine agreed to indemnify
CarrAmerica for its guarantees of certain HQ leases. As of March 31, 2003, the
remaining lease commitments in excess of the existing letter of credit was $26.9
million.
The Equal Employment Opportunity Commission has filed a suit (N.D. 111., Cause
No. 02 C 6623, on September 1, 2002), on behalf of a former employee alleging
discrimination under the Americans with Disability Act and Title 1 of the Civil
Rights Act of 1991. HQ is currently evaluating the information and has not yet
filed a response.
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 2. 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 Quarterly Report Form
10-Q 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 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, an inability to extend and/or amend the terms of the
Company's outstanding indebtedness and HQ Global Holdings Inc. ("HQ" or the "HQ
Global Segment") indebtedness on terms that are favorable to the Company and its
common stockholders, results of any recapitalization of HQ and its bankruptcy,
negative changes in the officing solutions industry or the Internet-related
businesses in which the unconsolidated companies in which we invest operate, a
continued downturn in general economic conditions, increases in interest rates,
a lack of capital availability, ability to satisfy financial covenants,
competition, reduced demand or decreases in rental rates for executive office
suites and other real estate-related risks such as the timely completion of
projects under development, our inability to complete future strategic
transactions, costs incurred in connection with strategic transactions and our
dependence upon our key personnel and the key personnel of HQ and other risks
detailed in FrontLine'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.
30
CRITICAL ACCOUNTING POLICIES
The consolidated financial statements of the Company include accounts of the
Company and its majority-owned subsidiary. The preparation of financial
statements in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions in certain
circumstances that affect amounts reported in the Company's consolidated
financial statements and related notes. In preparing these financial statements,
management has utilized information available including its past history,
industry standards and the current economic environment among other factors in
forming its estimates and judgments of certain amounts included in the
consolidated financial statements, giving due consideration to materiality. It
is possible that the ultimate outcome as anticipated by management in
formulating its estimates inherent in these financial statements may not
materialize. However, application of the critical accounting policies below
involves the exercise of judgment and use of assumptions as to future
uncertainties and, as a result, actual results could differ from these
estimates. In addition, other companies may utilize different estimates, which
may impact comparability of the Company's results of operations to those of
companies in similar businesses.
PROPERTY AND EQUIPMENT
Property and equipment consists of property and equipment owned by HQ, and is
stated at cost less accumulated depreciation and amortization. Depreciation is
calculated on the straight-line method over the estimated useful lives of the
assets which range from three to seven years. Leasehold improvements are
amortized over the lesser of the term of the related lease or the estimated
useful lives of the assets.
IMPAIRMENTS OF 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. 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. In
recognition of continuing difficult capital market conditions and operating
performance of these ownership interests, the Company recorded an additional
impairment charge of $32.9 million during the year ended December 31, 2001. Of
the $32.9 million charge, $20.0 million related to Reckson Strategic Venture
Partners, LLC ("Reckson Strategic"). See Note 4 for further discussion. During
the three months ended March 31, 2003, the Company determined that no additional
impairment charge was necessary.
IMPAIRMENTS OF LONG-LIVED ASSETS
Impairment charges are recorded as a permanent reduction in the carrying amount
of the related asset. Effective January 1, 2002, the Company adopted Statements
of Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, ("FAS 142"). As a result, goodwill and
intangible assets deemed to have indefinite lives are no longer amortized, but
are subject to annual impairment tests. Other intangible assets continue to be
amortized over their useful lives.
As a result of impairment charges recorded in the third and fourth quarters of
2001, discussed below, the Company does not have any goodwill or
indefinite-lived intangible assets recorded at March 31, 2003 or December 31,
31
2002. Accordingly, adoption of FAS 142 did not have an impact on the Company's
financial condition or results of operations.
Effective January 1, 2002, the Company also adopted FAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets ("FAS 144"). The FASB's new
rules on asset impairment supersede FAS No. 121, Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of ("FAS 121").
FAS 144 retains the requirements of FAS 121 to (a) recognize an impairment loss
only if the carrying amount of a long-lived asset is not recoverable from its
undiscounted cash flows, and (b) measure an impairment loss as the difference
between the carrying amount and fair value of the asset, but removes goodwill
from its scope. FAS 144 will primarily impact the accounting for intangible
assets subject to amortization, property and equipment, and certain other
long-lived assets. The adoption of FAS 144 did not have a significant impact on
the Company's financial condition or results of operations.
Assets to be disposed of are reported at the lower of the carrying amount or
estimated fair value less costs to sell. Accordingly, the Company recorded
impairment charges of $4.7 million and zero related to the closure of centers
pursuant to restructurings during the three-month periods ended March 31, 2003
and 2002, respectively.
RISK AND UNCERTAINTIES
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; the level of
difficulty experienced in the integration of acquired businesses; the
competition for future acquisitions; and the ability of HQ to secure adequate
capital.
OVERVIEW AND BACKGROUND
FrontLine is a holding company, with two distinct operating segments: one holds
FrontLine's interest in HQ Global Workplaces, Inc., a company in the officing
solutions market, and its predecessor companies ("HQ" or the "HQ Global
Segment"), the other consists of FrontLine (parent company) ("FrontLine Parent")
and its interests in a group of companies (the "Parent and Other Interests
Segment") that provided a range of services. In October 2000, FrontLine
announced that, as a result of changing capital 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.
32
In conjunction with the Restructuring, FrontLine re-evaluated the carrying
values of its investments and recorded aggregate impairment charges of $57.7
million through the years ended December 31, 2002 and 2001 and $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.
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 "HQ Merger") of VANTAS with HQ
Global Workplaces, Inc. ("Old HQ"), HQ Global. 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.
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.
33
HQ
All of FrontLine's operating revenues and operating expenses for the three
months ended March 31, 2003 and 2002 were attributable to HQ. The following is a
discussion of HQ's results of operations for such periods.
RESULTS OF CONTINUING OPERATIONS
THREE MONTHS ENDED MARCH 31, 2003 AND 2002
Revenues. Total business center revenues for the three-month period ended March
31, 2003 were $73.8 million, representing a decrease in 2003 of $14.6 million,
or 16.6%, as compared to 2002.
Business centers with three months of activity for both periods under comparison
("Same Centers") had revenues for the three-month period ended March 31, 2003
and 2002 of $71.4 million and $75.0 million, respectively, representing a
decrease in 2003 of $3.6 million, or 4.8%, compared with 2002. The decrease in
revenues in 2003 is attributable to the continued economic decline in business
performance that has been reflected in the overall US economy.
Business centers that were closed subsequent to January 1, 2002 ("Closed
Centers") had revenues for the three-month period ended March 31, 2003 and 2002
of $2.1 million and $13.4 million, respectively. Subsequent to January 1, 2002,
the Company has ceased operations in approximately 119 business centers.
Business centers opened subsequent to April 1, 2002 ("Development Centers") had
revenues for the three months ended March 31, 2003 of $0.3 million.
Expenses. Total business center expenses for the three-month period ended March
31, 2003 were $64.3 million, representing a decrease of $14.4 million, or 18.3%,
from the three-month period ended March 31, 2002.
Business centers with three months of activity for both periods under comparison
("Same Centers") had expenses for the three-month period ended March 31, 2003
and 2002 of $61.4 million and $64.0 million, respectively, representing a
decrease in 2003 of $2.6 million, or 4.1%, compared with 2002. The decrease is
attributable to reduced bad debt expense, center general and administrative
costs, as well as lower technology and business service expenses associated with
the decline in related revenue, offset by certain normal lease increases.
Business centers that were closed subsequent to January 1, 2002 ("Closed
Centers") had expenses for the three-month period ended March 31, 2003 and 2002
of $2.5 million and $14.7 million, respectively.
Business centers opened subsequent to January 1, 2002 ("Development Centers")
had expenses for the three months ended March 31, 2003 and 2002 of $0.4 million
and zero, respectively.
Business Center Operating Income ("BCOI"). For the three-month period ended
March 31, 2003, BCOI was $9.5 million as compared with $9.7 million for
three-month period ended March 31, 2002. The BCOI as a percentage of total
revenues ("BCOI Margin") was 12.9% for the period ended March 31, 2003 as
compared to 11.0% for 2002. The increase in BCOI Margin is primarily
attributable to closure of unprofitable centers.
34
Same Center BCOI was $10.0 million and $11.0 million for the three-month periods
ended March 31, 2003 and 2002, respectively, representing a decrease in 2003 of
$1.0 million from 2002. The BCOI Margin from Same Centers for the three-month
period ended March 31, 2003 was 14.1% as compared with 14.7% in the
corresponding period in 2002.
Closed Center BCOI was negative $0.4 million and negative $1.3 million for the
three-month periods ended March 31, 2003 and 2002, respectively.
Corporate General and Administrative Expenses. For the three-month periods ended
March 31, 2003 and 2002, corporate general and administrative expenses were $8.9
million and $11.0 million, respectively. For the three-month periods ended March
31, 2003 and 2002, corporate general and administrative expenses were 12.0% and
12.4% of total revenue, respectively.
Reorganization Charges. For the three-month periods ended March 31, 2003 and
2002, reorganization charges associated with HQ's bankruptcy filing were $3.1
million and $9.8, respectively. For the period ended March 31, 2003,
reorganization charges consisted of professional fees. Reorganization charges
for the period ended March 31, 2002 consisted of professional fees of $3.7
million and a write-off of $6.1 million of deferred financing costs associated
with the HQ Mezzanine Loan.
Restructuring Charges. For the three months ended March 31, 2003 and 2002,
restructuring charges were $18.2 million and zero, respectively. For the period
ended March 31, 2003, restructuring charges consist of center closure costs and
severance costs.
Depreciation and Amortization. For the three-month periods ended March 31, 2003
and 2002, depreciation and amortization expenses were $9.4 million and $10.7
million, respectively. The decrease in depreciation and amortization is
attributable to the reduced carrying value of intangible and fixed assets due to
impairment charges recorded.
Interest Expense. For the three-month periods ended March 31, 2003 and 2002, net
interest expense was $5.0 million and $8.8 million, respectively. The decrease
in interest expense is due to ceasing to accrue interest on the Mezzanine Loan
after March 13, 2002, the date of HQ's bankruptcy filing, and lower interest
rates.
Minority Interest. Minority interest was eliminated subsequent to 2001 due to
the losses HQ incurred.
DISCONTINUED OPERATIONS
Income From Discontinued Operations. For the three-month period ended March 31,
2003, loss from discontinued operations was $27 thousand, as compared to income
of $72 thousand for the three-month period ended March 31, 2002.
PARENT AND OTHER INTERESTS
THREE MONTHS ENDED MARCH 31, 2003 AND 2002
As a result of the Restructuring discussed in Note 10 of the Consolidated
Financial Statements, FrontLine has changed from a company which invested in
early stage companies which leveraged the Internet into one which is focused on
highlighting the value of HQ.
35
The restructuring costs recognized in the three month periods ended March 31,
2003 and 2002 were $66,000 and $0.3 million, and consisted of LTIP amortization
and professional fees and other expenses, respectively.
FrontLine's general and administrative expenses were $0.6 million and $0.5
million during the three month periods ended March 31, 2003 and 2002,
respectively.
The equity in earning of unconsolidated companies of $0.1 million represents the
quarterly management fee from RSVP. The equity in net loss and impairment of
unconsolidated companies in the corresponding 2002 quarter consisted of $0.2
million of equity in net loss of unconsolidated companies.
Dividends on, and accretion of, preferred stock of $0.4 million in the three
month period ended March 31, 2003 represents accretion of FrontLine's Series B
Convertible Cumulative Preferred Stock which was issued in the fourth quarter of
2000. Such amount in the three month period ended March 31, 2002 of $0.7 million
represents dividends on the Series A Stock and accretion of the Series B Stock.
LIQUIDITY AND CAPITAL RESOURCES
HQ
On March 13, 2002, HQ filed voluntary petitions for relief under Chapter 11 of
the United States Bankruptcy Code in the United States Bankruptcy Court for the
District of Delaware (the "Court"). HQ will continue to operate and manage
properties in the ordinary course of business during the Chapter 11 proceeding.
HQ anticipates proposing a plan of reorganization in accordance with the federal
bankruptcy laws as administered by the Court.
In connection with HQ's bankruptcy proceeding, HQ received a commitment for a
$30.0 million credit facility ("Debtor-in-Possession Facility"), with borrowings
permitted through December 31, 2002 in accordance with certain operating and
liquidity covenants. HQ and its lenders have agreed to extend the
Debtor-in-Possession Facility through and including July 31, 2003. Any
borrowings, of which there have been none, will incur interest at Prime plus
3.0%.
There can be no assurance as to HQ's ability to execute its business plan and
meet its obligations with respect to its Debtor-in-Possession Facility. The
ability of HQ to obtain confirmation of a plan of reorganization and emerge from
bankruptcy protection is subject to numerous factors, including some that are
beyond HQ's control. In the event HQ is unable to secure a confirmed plan of
reorganization, no assurance can be given that HQ will be able to meet its
future cash requirements.
FRONTLINE
On June 12, 2002, FrontLine filed a voluntary petition for relief under Chapter
11 of the Untied states Bankruptcy Code in the United States Bankruptcy Court
for the Southern District of New York (the "Bankruptcy Court"). The Company
remains in possession of its assets and properties, and continues to operate its
business and manage its property as a debtor-in-possession under the
jurisdiction of the Bankruptcy Court and in accordance with the applicable
provisions of the United States Bankruptcy Code.
The deadline to file proofs of claims and interests expired on September 30,
2002. Frontline is currently in the process of reviewing and assessing the
claims and interests that have been filed, and intends to file objections, as
appropriate.
36
On November 14, 2002, the Bankruptcy Court issued an order, which, among other
things, extended the exclusive period during which only Frontline may file a
plan of reorganization through and including February 7, 2003. On March 24,
2003, the Bankruptcy Court issued an order which among other things, further
extended the exclusive period during which only Frontline may file a plan of
reorganization through and including June 6, 2003. The Company anticipates
proposing a plan of reorganization in accordance with the federal bankruptcy
laws as administered by the Bankruptcy Court prior to that date. Confirmation of
a Plan of reorganization could materially change the amounts currently recorded
in the financial statements. The financial statements do not give effect to any
adjustment to the carrying value of assets, or amounts and classifications of
liabilities that might be necessary as a consequence of this matter. The Company
has the exclusive right to propose a plan of reorganization through which period
may be extended further by the Bankruptcy Court.
By order dated March 31, 2003, the Bankruptcy Court also authorized Frontline
to, among other things, in an attempt to resolve an ongoing dispute with the
preferred members (a) perform its duties as a debtor-in-possession in connection
with a wholly-owned subsidiary that is a managing member of a limited liability
company, by negotiating and executing definitive documents consistent with the
transactions detailed in the term sheets regarding the proposed restructuring of
Reckson Strategic Venture Partners, LLC ("RSVP") and with respect to New World
Realty, LLC annexed to such order (collectively, the "Transactions"), and (b) to
perform such actions and take all steps necessary to implement and consummate
such Transactions. Pursuant to such authorization, on or about April 29, 2003,
the Company and RSVP entered into agreements regarding the restructuring of
RSVP's capital structure. In addition, RSVP entered into an agreement regarding
the restructuring of its management arrangements.
In connection with the capital restructuring, RSVP agreed to redeem the
preferred equity holders' interests in RSVP for an aggregate amount of cash and
property of approximately $165.3 million (the "Restructuring Price"). Upon
execution of the restructuring agreement with the RSVP preferred equity holders,
RSVP distributed to such holders an initial cash payment of $41 million and the
assets that comprised its parking investments valued at approximately $28.5
million, as a payment against the Restructuring Price. The Restructuring is
subject to a financing contingency with respect to the $95.8 million balance of
the Restructuring Price. Upon closing, such balance is due and payable in cash.
In the event the financing does not close, the cash and assets distributed to
RSVP's preferred equity holders shall be treated as a distribution to the
preferred equity holders and RSVP shall continue to operate under the capital
structure in effect prior to the Transactions.
RSVP also agreed to restructure its relationship with its current managing
directors, conditioned upon the redemption of the preferred equity interests,
whereby a management company formed by the managing directors will serve as a
third party manager of RSVP. The management agreement will have a three-year
term, subject to early termination in the event of the disposition of all of the
assets of RSVP. The management agreement provides for an annual base management
fee of $2.0 million in year one, $1.75 million in year two and $1.0 million in
year three, an asset disposition fee equal to 2% of the aggregate consideration
received in connection with any sale or other disposition of RSVP Holdings LLC
or any RSVP investment (subject to a maximum amount over the term of the
agreement, together with the base management fee, of $7.5 million, and a minimum
amount of $3.5 million), and a subordinate one-third residual interest in RSVP's
assets after the return to the common equity holders of $75 million. Under the
restructured management arrangements, RSVP's former managing directors will have
a right of first offer in respect of any proposed sales of assets by RSVP.
There can be no assurance that any of the foregoing pending transactions will be
completed.
On May 12, 2003, the Bankruptcy Court approved an order which, among other
things, authorizes the company to continue to indemnify Scott H. Rechler and
James Burnham as the persons expected to be the Debtor's only remaining director
37
(Mr. Rechler) and officers (Messrs. Rechler and Burnham) after its current
director and officer liability insurance policy expires on May 15, 2003, by
granting them a superpriority administrative expense for certain Coverage (as
defined in the motion)that would have been covered by the insurance policy had
it been extended.
Historically, 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. Since the Restructuring,
FrontLine's cash requirements have been substantially reduced. As of March 31,
2003, there is no remaining availability under any FrontLine credit facility.
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 March 31, 2003, and due to
outstanding letters of credit and accrued interest, has no remaining
availability. The Company had $49.3 million outstanding under the Reckson
Strategic Facility at March 31, 2003. These borrowings were utilized to fund
Reckson Strategic investments and its general operations. 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. The
Credit Facilities also provide for defaults thereunder in the event debt is
accelerated under another of FrontLine's financing agreements. 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 (from $100 million).
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 a 20.51% common ownership interest in HQ and bear
interest at the Prime rate plus 2%. Any outstanding borrowings under the
FrontLine Bank Credit Facility were due on October 25, 2001, as a result of
various extensions exercised by FrontLine in May 2001. At September 30, 2001,
FrontLine had fully borrowed the FrontLine Bank Credit Facility. The FrontLine
Bank Credit Facility provides for a default thereunder in the event debt is
accelerated under another of FrontLine's financing agreements or if there is a
default under certain HQ financing agreements. The FrontLine Bank Credit
Facility contains, among others, covenants relating to the financial ratios of
HQ and 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 of the
Company or HQ 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. Subsequent to December 31, 2002, the Company has not repaid the
principal or paid any interest applicable to this period and accordingly is at
the forbearance of the bank. There is no remaining availability under the Credit
Facilities. As a result of the Company's failure to pay the principal and
38
interest upon maturity on the FrontLine Bank Credit Facility, an event of
default has occurred under the credit facilities with Reckson.
During the three months ended March 31, 2000, the Company completed preferred
stock offerings of 26,000 shares of Series A Preferred Stock at a price of
$1,000 per share with net proceeds of $24.6 million. These shares are
convertible into the Company's common stock at a price of $70.48. The Company
did not declare or pay the quarterly dividend due on these shares commencing
with the payment that was due on November 6, 2001. Accordingly, future dividends
will accrue at a higher rate of 10.875%. Since dividend distributions are in
arrears for more than two quarterly periods, then the holders of such shares are
entitled to elect two additional members to the Company's Board of Directors.
While the Company's $25 million of Series B Preferred Stock is outstanding, the
holders have consent rights for certain significant transactions, including the
incurrence of additional debt by the Company or HQ, the issuance of equity
securities senior to, or on a parity with, the Series B Preferred Stock or the
issuance by HQ of preferred stock. These securities also contain certain
covenants relating to HQ. In addition, the securities include a redemption
premium of 27.5%. Since securities were not redeemed prior to December 13, 2001,
the securities (including the amount of the redemption premium) have become
convertible at the holder's option into FrontLine common stock at the initial
rate of $13.3875 per share, the preferred stock has become a voting security on
an "as-converted" basis, and quarterly dividends have become payable from the
date of initial issuance at the annual rate of 9.25%. In addition, since the
Company did not pay the dividend on the Series B Preferred Stock in December
2001, the holders of such stock have the right to vote on an "as converted"
basis on any matters that holders of common stock are permitted to vote upon and
to elect two members to the Company's Board of Directors. Securities have a
mandatory redemption requirement at a 27.5% premium, which has been triggered as
a result of uncured events of default. 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. The Company is in arrears with regard to the payment of
dividends on its Series A and Series B Preferred Stock.
Currently, the Company has a short-term letter of credit in the amount of $0.2
million, which is being utilized as a security deposit.
The Company has entered into a stockholders agreement (the "HQ Stockholders
Agreement") with certain of the stockholders of HQ Global which provides them
with rights 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. On February
25, 2002, such stockholders irrevocably waived their Put Rights.
FrontLine's operations do not require significant capital expenditures. There
were no significant capital expenditure commitments as of March 31, 2003.
There can be no assurance as to the Company's ability to execute its business
plan and to meet its obligations with respect to its credit facilities. If
additional funds are raised through the issuance of equity securities, existing
shareholders may experience significant dilution. The availability of additional
capital is subject to numerous factors including some that are beyond the
Company's control. In the event the company is unable to access additional
capital, no assurance can be given that it will be able to meet its future cash
requirements.
39
The Company has formed a committee of its Board of Directors, comprised solely
of the independent directors of the Board, in order to address conflicts that
may arise in connection with the Company's credit facilities with Reckson
Operating Partnership. The committee has retained legal counsel in connection
with its responsibilities.
In March 2002, the Company's stock was delisted by Nasdaq as a direct result of
the HQ bankruptcy filing. The Company's common stock currently trades on the OTC
Bulletin Board under the symbol FLCGQOB.
INFLATION
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 clients
generally range from six to twelve months in duration. Accordingly, HQ may have
the ability to pass on any inflation related increased costs at the time of
renewal of such contracts.
FRONTLINE
Management believes that inflation did not have a significant effect on its
results of operations during any of the periods presented.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
HQ
Historically, the primary market risk facing HQ was interest rate risk on the HQ
Credit Facility. The HQ Credit Facility bears interest ranging from 2.25% to
3.00% over prime.
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 its foreign currency risk.
HQ has not, and does not plan to, enter into any derivative financial
instruments for trading or speculative purposes. As of March 31, 2003, 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.
40
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
valued at March 31, 2003 (in thousands, except rates).
FOR THE YEARENDED DECEMBER 31,
-------------------------------------------------
2003 2004 2005 2006 2007 THEREAFTER TOTAL FAIR VALUE
-------- ------- ------- ------- ------- ---------- -------- ----------
Variable rate.......... $214,464 -- -- -- -- -- $214,464 $214,464
Average interest
rate................... 11.95% -- -- -- -- -- 11.95% --
Equity Market Risk
FrontLine faces equity market risk in its ownership interests in its
unconsolidated companies. During the year ended December 31, 2001, 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 March 31, 2003 was $12.3 million, approximately
7.2% of total assets, thereby mitigating FrontLine's future equity market risk
related to these interests.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing of this report, an evaluation was
carried out under the supervision and with the participation of the Registrant's
management, including its Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of the Registrant's disclosure
controls and procedures (as defined in Rule 13a-14 and 15d-14 under the
Securities Exchange Act of 1934). Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that those disclosure
controls and procedures were adequate to ensure that information required to be
disclosed by the Registrant in the reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the Commission's rules and forms. There were no significant
changes in the Registrant's internal controls or in other factors that could
significantly affect these controls subsequent to the date of their evaluation.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Reference is made to the lawsuit captioned OmniOffices, Inc. et al. v. Joseph
Kaidanow et al. set forth in the Company's Annual Report on Form 10-K for the
year ended December 31, 2001. In connection with such litigation, on September
12, 2001, without holding oral argument, the Court denied Plaintiffs' motion for
summary judgment, but granted the Defendants' cross-motion for summary judgment.
Plaintiffs and the directors of old HQ filed a Notice of Appeal in October 2001.
On February 15, 2002, the D.C. Circuit announced that oral argument was
scheduled for January 16, 2003. In March 2002, the D.C. Circuit referred the
appeal to its Appellate Mediation Program. On April 24, 2002, HQ filed a notice
of bankruptcy stay in respect of its March 13, 2002 Chapter 11 filing. HQ
informed the D.C. Circuit that the appeal was stayed as to HQ pursuant to the
automatic stay provisions of the U.S. Bankruptcy Code. The D.C. Circuit reversed
the District Court in an opinion dated March 7, 2003.
41
Reference is made to the lawsuit captioned 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 set
forth in the Company's Annual Report on Form 10-K for the year ended December
31, 2001. In connection with such litigation, on March 8, 2002, Plaintiffs filed
a motion for leave to amend their complaint to add, inter alia, a breach of
warrant agreements claim against HQ and other claims against FrontLine. On March
15, 2002, HQ filed a notice of bankruptcy stay, stemming from its March 13, 2002
voluntary petition for Chapter 11 bankruptcy protection in the United States
Bankruptcy Court for the District of Delaware (the "Delaware Bankruptcy Court").
HQ informed the Court that the consolidated action was stayed as to HQ pursuant
to the automatic stay provisions of the Bankruptcy Code. Co-defendant
CarrAmerica Realty Corporation filed a motion requesting that, in light of HQ's
bankruptcy, the consolidated litigation be stayed as to all defendants. At a
status conference held on March 25, 2002, the Vice Chancellor ordered the
parties to work out a scheduling order for the briefing of the motion regarding
the stay of the proceedings. At a hearing on this motion on September 9, 2002,
the Vice Chancellor stayed the proceedings until November 13, 2002. The former
director co-defendants in the consolidated action separately filed an adversary
proceeding in the Delaware Bankruptcy Court seeking to stay the consolidated
action as to the former directors. After a hearing on June 25, 2002, the
Delaware Bankruptcy Court denied the requested relief.
On September 9, 2002, HQ Global Workplaces, Inc. filed an adversary proceeding
in the Delaware Bankruptcy Court seeking to subordinate, pursuant to Section
510(b) of the Bankruptcy Code, the claims of Messrs. Kaidanow and Arcoro on the
basis that the claims arose from the purchase or sale of an equity security.
On or about October 3, 2001, Burgess Services, LLC ("Burgess Services"),
Dominion Venture Group, LLC ("Dominion Venture Group") and certain affiliated
parties commenced an action in Oklahoma State Court against Reckson Strategic
Venture Partners, LLP ("RSVP"), Reckson Associates Realty Corp. ("Reckson"), and
RAP-Dominion LLC ("RAP-Dominion"), a joint venture through which RSVP and
Reckson invested in a venture with certain of the plaintiffs. On April 10, 2002,
the litigation was settled without liability on the part of the Company or the
defendant. In connection with the settlement, the joint venture will be
terminated. As a result of this settlement, the Company determined that no
further impairment was necessary on its carrying value in its investment in
Reckson Strategic.
In April 2000, the Company entered into an office lease which expires in
December 2010. In January 2001, the Company assigned the lease to HQ. The lease
assignment did not relieve the Company of any of its obligations under the terms
of this lease. At December 31, 2002, HQ was past due on $0.9 million of rent.
The landlord has drawn the full letter on credit of $2.8 million. Of the $57.6
million HQ restructuring charge recorded in 2001, a $4.8 million accrual
applicable to this lease was recorded as an estimate for the cost of terminating
this lease. If the ultimate cost of terminating this lease exceeds the
outstanding letter of credit, then additional cash may need to be paid by either
HQ or the Company. Since HQ is currently in bankruptcy, the landlord is likely
to seek to recover any further damages from FrontLine. As of December 31, 2002,
the remaining lease commitment was $23.4 million.
The Company also has potential liability under its indemnification of
CarrAmerica for liabilities of Carr America under its guarantees relating to
four HQ leases. In conjunction with the HQ Merger pursuant to the terms of a
stockholders agreement, FrontLine agreed to indemnify CarrAmerica for its
guarantees of certain HQ leases. As of December 31, 2002, the remaining lease
commitments in excess of the existing letter of credit was $27.4 million.
The Equal Employment Opportunity Commission has filed a suit (N.D. 111., Cause
No. 02 C 6623, on September 1, 2002), on behalf of a former employee alleging
discrimination under the Americans with Disability Act and Title 1 of the Civil
42
Rights Act of 1991. HQ is currently evaluating the information and has not yet
filed a response.
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
(i) HQ. HQ has received notice from the lenders under its senior credit
agreement (the "Credit Agreement") that it is in default with respect to certain
of its covenant and payment obligations under such agreement. On September 30,
2001, HQ elected not to make the principal amortization payment of $4.1 million
due and payable under the Credit Agreement. On November 1, 2001, HQ entered into
a forbearance agreement (the "Agreement"), effective as of October 1, 2001, with
the lenders party to the Credit Agreement, wherein the lenders have agreed for a
certain period of time to forbear from the enforcement of their remedies under
the Credit Agreement with respect to HQ's default. For additional information
regarding this matter, see "Note 5 -Notes Payable" to the Company's financial
statements included elsewhere in this report, which note is incorporated by
reference into this item.
On September 30, 2001, HQ elected not to make the interest payment due and
payable with respect to its $125 million senior subordinated credit facility
(the "Mezzanine Loan") in the amount of $4.2 million. For additional information
regarding this matter, see "Note 5 - Notes Payable" to the Company's financial
statements included elsewhere in this report, which note is incorporated by
reference into this item.
(ii) FrontLine. The Company failed to repay the $25 million of principal and
$0.2 million of interest due under the Company's $25 million secured credit
facility, which matured on October 25, 2001. The Company is currently in
negotiations to further extend the maturity of this facility. For additional
information regarding this matter see "Note 5 - Notes Payable" to the Company's
financial statements included elsewhere in this report, which note is
incorporated by reference into this item. As a result of the Company's failure
to pay the principal and interest under the senior facility when due, an event
of default has occurred under the Company's credit facilities with Reckson
Operating Partnership, L.P. For additional information regarding this matter,
see "Note 11 - Transactions with Related Parties" to the Company's financial
statements included elsewhere in this report, which note is incorporated by
reference into this item.
On February 6, 2002, the Company elected not to make the dividend payment due on
the Company's Series A convertible cumulative preferred stock in the aggregate
amount of $0.6 million. As a result of the failure to make the dividend payment,
dividends on the Series A preferred stock will accrue quarterly at the rate of
10.875%. If dividends are in arrears for more than two quarterly periods, the
holders of the Series A preferred stock will be entitled to elect two additional
members to the Company's Board of Directors. Dividends on the Company's Series A
preferred stock are cumulative, and therefore, all accrued and unpaid dividends
on the Company's Series A preferred stock must be paid in full prior to
commencing the payment of cash dividends on the Company's common stock.
Item 4. Submission of Matters to a Vote of Securities Holders--None
Item 5. Other Information--None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
43
10.1 Restructuring Agreement, dated as of April 29, 2003, by and among RSVP
Holdings, LLC, RSI Fund Management LLC, New World Realty, LLC, New World
Realty Management, LLC, Reckson Asset Partners, LLC, Reckson Strategic
Venture Partners LLC and FrontLine Capital Group.
10.2 Restructuring Agreement, dated as of April 29, 2003, by and among
Reckson Strategic Venture Partners LLC, RSVP Holdings, LLC, Reckson
Asset Partners, LLC, UBS Warburg Real Estate Securities Inc. and Stratum
Realty Fund, L.P.
10.3 Management Agreement, dated as of April 29, 2003, by and among New World
Realty Management, LLC, Reckson Strategic Venture Partners LLC, RSVP
Holdings, LLC and Reckson Asset Partners, LLC.
10.4 Amended and Restated Limited Liability Company Agreement, dated as of
April 29, 2003, by and among RSVP Holdings, LLC, RSI Fund Management
LLC, New World Realty, LLC and RSVP Management Partners, LLC.
99.1 Certification of Scott H. Rechler, President and Chief Executive
Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification of James D. Burnham, Chief Financial Officer and
Treasurer, pursuant to 18 U.S.C. section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
(b) During the three months ended March 31, 2003, the Registrant filed the
following reports:
On April 14, 2003, the Registrant submitted an Annual Report on Form 10-K to
report financial results for the year ended December 31, 2002.
44
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FRONTLINE CAPITAL GROUP
By: \s\ Scott H. Rechler
-------------------------------------------------------
Scott H. Rechler, President and Chief Executive Officer
(Principal Executive Officer)
By: \s\ James D. Burnham
-------------------------------------------------------
James D. Burnham, Chief Financial Officer and Treasurer
(Chief Accounting Officer)
Date: May 20, 2003
45
CERTIFICATIONS
I, Scott H. Rechler, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Frontline Capital
Group;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) All significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 20, 2003. /S/ SCOTT H. RECHLER
-------------------------------------
Scott H. Rechler
President and Chief Executive Officer
(Principal Executive Officer)
46
I, James D. Burnham, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Frontline Capital
Group;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) All significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 20, 2003.
/s/ JAMES D. BURNHAM
-------------------------------------
James D. Burnham
Chief Financial Officer and Treasurer
(Chief Accounting Officer)
47