<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO _________
COMMISSION FILE NUMBER 0-27890
MINDSPRING ENTERPRISES, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 58-2113290
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
</TABLE>
<TABLE>
<S> <C>
1430 WEST PEACHTREE ST. NW, SUITE 400, ATLANTA, GA 30309
(Address of principal executive offices) (Zip Code)
</TABLE>
Registrant's telephone number, including area code: (404) 815-0770
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
OUTSTANDING AT AUGUST 13, 1998
------------------------------
Common Stock at $.01 par value 25,789,623 Shares
<PAGE> 2
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
MINDSPRING ENTERPRISES, INC.
BALANCE SHEETS
AS OF JUNE 30, 1998 AND DECEMBER 31, 1997
(IN 000'S)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents....................................................$ 60,257 $ 9,386
Trade receivables, net....................................................... 2,437 2,002
Prepaids and other current assets............................................ 638 1,043
--------------- -------------
Total current assets..................................................... 63,332 12,431
--------------- -------------
PROPERTY AND EQUIPMENT:
Computer and telecommunications equipment.................................... 24,325 18,050
Assets under capital lease................................................... 9,916 9,916
Other........................................................................ 3,138 1,805
--------------- -------------
37,379 29,771
Less: accumulated depreciation............................................... (9,660) (6,133)
--------------- -------------
Total property and equipment, net........................................ 27,719 23,638
--------------- -------------
OTHER ASSETS:
Acquired customer base, net.................................................. 6,278 7,477
Other........................................................................ 801 740
--------------- -------------
Total other assets....................................................... 7,079 8,217
--------------- -------------
$ 98,130 $ 44,286
=============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable.......................................................$ 4,750 $ 5,725
Other accrued expenses....................................................... 8,114 5,209
Current portion of capital lease obligations................................. 2,697 2,608
Current portion of notes payable............................................. 1,239 2,043
Deferred revenue............................................................. 3,351 2,198
--------------- -------------
Total current liabilities................................................ 20,151 17,783
--------------- -------------
LONG-TERM LIABILITIES:
Capital lease obligations.................................................... 3,753 5,090
--------------- -------------
Total liabilities........................................................ 23,904 22,873
--------------- -------------
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; 60,000,000 shares authorized
and 25,749,981 and 22,603,320 issued and outstanding at
June 30, 1998 and December 31, 1997, respectively.......................... 258 226
Additional paid-in-capital................................................... 84,817 34,916
Accumulated deficit.......................................................... (10,849) (13,729)
--------------- -------------
Total stockholders' equity................................................. 74,226 21,413
--------------- -------------
$ 98,130 $ 44,286
=============== =============
</TABLE>
The accompanying condensed notes to financial statements are an
integral part of these statements.
<PAGE> 3
MINDSPRING ENTERPRISES, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN 000'S)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
REVENUE:
Access $ 20,625 $ 9,053 $ 37,617 $ 16,409
Business services 3,393 1,741 6,566 3,164
Subscriber start-up fees 1,042 807 2,261 1,807
--------- --------- --------- ---------
Total revenue 25,060 11,601 46,444 21,380
--------- --------- --------- ---------
COSTS AND EXPENSES:
Costs of revenue-recurring 6,985 3,525 12,975 6,694
Costs of revenue-start-up fees 600 295 1,217 660
General and administrative 8,512 5,234 16,311 10,246
Selling 3,875 1,908 6,928 3,818
Depreciation and amortization 3,094 2,060 5,966 3,888
--------- --------- --------- ---------
Total cost and expenses 23,066 13,022 43,397 25,306
OPERATING INCOME (LOSS) 1,994 (1,421) 3,047 (3,926)
INTEREST INCOME (EXPENSE), NET 88 (9) (75) (29)
--------- --------- --------- ---------
PRETAX INCOME (LOSS) $ 2,082 $ (1,430) $ 2,972 $ (3,955)
INCOME TAXES (62) 0 (92) 0
--------- --------- --------- ---------
NET INCOME (LOSS) $ 2,020 $ (1,430) $ 2,880 $ (3,955)
========= ========= ========= =========
NET INCOME (LOSS) PER SHARE:
Basic $ 0.09 $ (0.06) $ 0.12 $ (0.18)
========= ========= ========= =========
Diluted $ 0.08 $ (0.06) $ 0.12 $ (0.18)
========= ========= ========= =========
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING:
Basic 23,673 22,551 23,157 22,493
========= ========= ========= =========
Diluted 25,140 22,551 24,588 22,493
========= ========= ========= =========
</TABLE>
The accompanying condensed notes to financial statements are an
integral part of these statements.
<PAGE> 4
Financial Statements - Continued
MINDSPRING ENTERPRISES, INC.
STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997
(UNAUDITED)
(IN 000'S)
<TABLE>
<CAPTION>
1998 1997
------------- ----------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)...............................................$ 2,880 $ (3,955)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization................................... 5,966 3,888
Changes in operating assets and liabilities:
Trade receivables........................................... (435) 9
Other current assets........................................ 405 (77)
Trade accounts payable...................................... (975) (2,138)
Other accrued expenses...................................... 2,905 2,346
Deferred revenue............................................ 1,153 829
------------- ----------------
Total adjustments......................................... 9,019 4,857
------------- ----------------
Net Cash Provided by Operating Activities................... 11,899 902
------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment............................. (7,608) (3,441)
Purchase of customer base....................................... (1,143) (351)
Other........................................................... (158) 128
-------------- ----------------
Net Cash Used in Investing Activities....................... (8,909) (3,664)
------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of notes payable....................................... (804) (154)
Payments of capital lease obligations........................... (1,248) (396)
Issuance of common stock........................................ 49,933 70
------------- ----------------
Net Cash Provided by (Used in) Financing Activities......... 47,881 (480)
------------- ----------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS..................................................... 50,871 (3,242)
CASH AND CASH EQUIVALENTS, beginning of period....................... 9,386 9,653
------------- ----------------
CASH AND CASH EQUIVALENTS, end of period.............................$ 60,257 $ 6,411
============= ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for interest..........................................$ 510 $ 236
============= ================
Cash paid for income taxes......................................$ 111 $ -
============= ================
SUPPLEMENTAL NON-CASH DISCLOSURES:
Assets acquired under capital leases............................$ - $ 3,793
============= ================
</TABLE>
THE ACCOMPANYING CONDENSED NOTES TO FINANCIAL STATEMENTS
ARE AN INTEGRAL PART OF THESE STATEMENTS.
<PAGE> 5
MINDSPRING ENTERPRISES, INC.
CONDENSED NOTES TO FINANCIAL STATEMENTS
JUNE 30, 1998 AND 1997
1. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to
Article 10 of Regulation S-X of the Securities and Exchange Commission.
The accompanying unaudited condensed financial statements reflect, in
the opinion of management, all adjustments necessary to achieve a fair
statement of the Company's financial position and results for the
interim periods presented. All such adjustments are of a normal and
recurring nature. It is suggested that these condensed financial
statements be read in conjunction with the financial statements and
notes thereto included in the Company's Annual Report on Form 10-K for
the year ended December 31, 1997 (File No. 0-27890).
On June 24, 1998, the Company declared a three-for-one stock split in
the form of a stock dividend which was paid on July 24, 1998 to
shareholders of record on July 9, 1998. Accordingly, the stock split
has been recognized in these financial statements by reclassifying
approximately $172,000, the par value of the additional shares issued
as a result of the split, from additional paid in capital to common
stock. For all periods presented, all shares outstanding and per share
amounts have been restated to reflect the stock split.
2. Certain amounts in the prior year financial statements have been
reclassified to conform to the current year presentation.
3. The Company adopted SFAS No. 128, "Earnings Per Share", effective
December 31, 1997. Basic earnings (loss) per common share ("EPS") was
computed by dividing net income (loss) by the weighted average number
of shares of common stock outstanding for the period then ended. The
effect of the Company's stock options (using the treasury stock method)
was included in the computation of diluted EPS for the three and six
months ended June 30, 1998. For the 1997 periods, the effect of the
options is excluded as it is antidilutive. Accordingly, no prior period
restatement for previously reported quarters is required. The following
table summarizes the shares used in the calculations:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1998 1997 1998 1997
------- -------- ------- --------
<S> <C> <C> <C> <C>
(in 000's except per share data)
Weighted average shares 23,673 22,551 23,157 22,493
outstanding-basic
Effect of dilutive stock options 1,467 0 1,431
------- -------- ------- --------
Shares used for diluted earnings per share 25,140 22,551 24,588 22,493
======= ======== ======= ========
Net income (loss) $ 2,020 $ (1,430) $ 2,880 $ (3,955)
Basic earnings (loss) per share $ 0.09 $ (0.06) $ 0.12 $ (0.18)
======= ======== ======= ========
Diluted earnings (loss) per share $ 0.08 $ (0.06) $ 0.12 $ (0.18)
======= ======== ======= ========
</TABLE>
4. For the quarter ended June 30, 1998, the Company recorded a provision
for income taxes equal to its liability in various states at the
enacted rates where it does not have any net operating loss
carryforwards available. The remaining portion of the current period
provision was offset by the reversal of previously recorded valuation
allowance amounts. For the quarter ended June 30, 1997, no income tax
benefit was recognized as the Company had a net taxable loss for the
period and anticipated being in a net taxable loss position for the
year ended December 31, 1997. The Company paid approximately $111,000
in cash payments for estimated income taxes in the quarter ended June
30, 1998. There were no cash payments for income taxes for the six
months ended June 30, 1997.
<PAGE> 6
The Company is continually assessing its income tax situation to
determine when it is "more likely than not" that its deferred tax
assets will be realized. Based on the Company's short history of
earnings and the uncertainty of near term earnings because of various
industry trends which may have a significant negative impact on near
term earnings, management does not believe it is "more likely than not"
that the deferred tax assets will be realized. When management believes
this situation has changed, the Company will reverse its valuation
allowance (approximately $4.2 million at June 30, 1998) through that
period's tax provision. Prior to that point, the Company will reverse
the valuation allowance against the current period's provision as
realized.
ITEM 2-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
MindSpring Enterprises, Inc. ("MindSpring" or the "Company") is a
leading national Internet access provider that focuses on serving individuals
and small businesses. The Company is also a leading provider of Web hosting
services, a complement to its Internet access business and one of the fastest
growing segments of the Internet marketplace. Through its network of
Company-owned and third-party POPs, the Company can offer its services in 45
U.S. states and the District of Columbia via a local telephone call. As of June
30, 1998, the Company served approximately 393,000 subscribers, including
approximately 15,000 Web hosting subscribers.
The Company's services include dial-up Internet access, Web hosting and
other value-added services such as Web page design and Web-server co-location.
The Company's primary service offerings, dial-up Internet access and Web
hosting, are offered in various price and usage plans designed to meet the needs
of its customers. The Company offers local Internet access to subscribers either
through Company-owned POPs or through access to POPs owned and operated by third
parties with which the Company has network service agreements. Through these
service agreements, the Company has the flexibility to offer Internet access
through a Company-owned POP, a third-party network provider's POP or a
combination thereof.
STATEMENT OF OPERATIONS
The Company derives revenue primarily from monthly subscriptions and
start-up fees from individuals for dial-up access to the Internet. Monthly
subscription fees vary by billing plan. Under the Company's current pricing
plans, customers have a choice of two "flat rate" plans (The Works and Unlimited
Access) and two "usage-sensitive" plans (Standard and Light). For the three
months ended June 30, 1998 and 1997, the average monthly recurring revenue per
dial-up subscriber was approximately $20 (monthly recurring revenue plus usage
charges for non-"flat rate" subscribers, divided by total subscribers). Start-up
fees for new subscribers vary depending upon the promotional method by which the
subscriber is acquired, ranging up to a maximum of $25. Aggregate subscriber
start-up fees are sufficient to cover the aggregate costs of direct materials,
mailing expenses, and licensing fees associated with new subscribers. A majority
of the Company's individual subscribers pay their MindSpring fees automatically
by pre-authorized monthly charges to the subscriber's credit card.
During the second quarter of 1998 the Company instituted a prepayment
plan available to all dial-up subscribers. Under the plan, subscribers may
prepay their access fees for either one or two years at a discounted rate.
Subscribers prepaying for one year receive a monthly discount equivalent to
approximately ten percent of their monthly fee and subscribers prepaying for two
years receive a monthly discount equivalent to approximately fifteen percent of
their monthly fee.
In addition, the Company earns revenue by providing Web-hosting, domain
registration and Web page design services, Web-server co-location and full-time
dedicated access connections to the Internet. The Company's Web-hosting services
allow a business or individual to post information on the World Wide Web so that
the information is available to anyone who has access to the Internet. The
Company currently offers three price plans for Web hosting subscribers ranging
from $19.95 to $99.95 per month. MindSpring had approximately 15,000 Web hosting
subscribers as of June 30, 1998. Through its domain registration services, the
Company provides subscribers the ability to personalize electronic mail
addresses and URLs (Uniform Resource Locators). The services described in this
paragraph have been classified as business services in the statements of
operations and the "Results of Operations" table set forth below.
The Company's costs include (i) costs of revenue that are primarily
related to the number of subscribers; (ii) selling, general and administrative
expenses that are associated more generally with
2
<PAGE> 7
operations; and (iii) depreciation and amortization, which are related to the
size of the Company's network and the deferred costs associated with acquired
customer bases.
Costs of revenue that are primarily related to the number of
subscribers include both recurring costs and subscriber start-up expenses.
Recurring costs of revenue consist primarily of the costs of telecommunications
facilities necessary to provide service to subscribers and certain monthly
licensing fees per subscriber for the right to receive and make available
certain proprietary on-line services. Telecommunications facilities costs
include the costs of providing local telephone lines into each Company-owned
POP, costs related to the use of third-party networks pursuant to services
agreements and costs associated with leased lines connecting each Company-owned
POP and third-party network to the Company's hub and connecting the Company's
hub to the Internet backbone. Start-up expenses for each subscriber include
one-time license fees paid to third parties for the right to bundle other
capabilities into the Company's software, cost of diskettes and other product
media, manuals, and packaging and delivery costs associated with the materials
provided to new subscribers. The Company does not defer any such subscriber
start-up expenses.
Selling, general and administrative costs are incurred in the areas of
sales and marketing, customer support, network operations and maintenance,
engineering, accounting and administration. Selling, general and administrative
costs will increase over time as the Company's scope of operations increases.
However, the Company expects that such costs will be more than offset by
anticipated increases in revenue attributable to overall subscriber growth. In
addition, significant levels of marketing activity may be necessary in order for
the Company to build or increase its subscriber base in a given market to a size
large enough to generate sufficient revenue to offset such marketing expenses.
The Company may determine to significantly increase the level of marketing
activity in order to increase the rate of subscription growth. Any such increase
would have a short-term negative impact on earnings. The Company does not defer
any start-up expenses related to entering new markets.
As the Company expands into new markets, both costs of revenue and
selling, general and administrative expenses will increase. To the extent the
Company opens MindSpring POPs in new markets, such expenses may also increase as
a percentage of revenue in the short-term after a new MindSpring POP is opened
because many of the fixed costs of providing service in a new market are
incurred before significant revenue can be expected from that market. However,
to the extent that the Company expands into new markets by using third-party
POPs instead of opening its own POPs, the Company's incremental monthly
recurring costs will consist primarily of the fees to be paid to third parties
pursuant to network service agreements. The margins on such subscribers will
initially be higher than if the Company had developed its own POP in new
markets. Once a new market matures, costs of revenue as a percentage of revenue
will tend to be higher in markets served through utilization of purchased
network services rather than Company-owned POPs, since the full costs of
utilizing such network services is included in costs of revenue while a portion
of the costs of utilizing Company-owned POPs is included in depreciation and
amortization and because, subject to local area telecommunications charges, the
Company can provide services at a lower cost on its own POPs when certain
economies of scale are achieved.
The Company has added, and may in the future continue to add,
MindSpring subscribers by purchasing customer bases from other Internet service
providers. The Company amortizes such purchased customer bases using the
straight-line method over a period of three years, commencing when the purchase
is completed. Customer base purchases and related amortization for the quarter
ended June 30, 1998 were not material to the Company's results of operations.
While the Company has experienced annual operating losses since its
inception as a result of efforts to build its network infrastructure and
internal staffing, develop its systems, and expand into new markets, it
generated positive cash flows from operations during 1997 and has been
profitable in each quarter since the fourth quarter of 1997. The Company expects
to continue to focus on increasing its subscriber base, which will cause its
costs of revenue, selling, general and administrative expenses and capital
expenditures to increase in addition to its revenues. There can be no assurance,
however, that growth in the Company's revenue or subscriber base will continue
or that the Company will be able to sustain profitability or positive cash
flows.
3
<PAGE> 8
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30, 1997
The following table sets forth certain unaudited financial data for the
three months ended June 30, 1998 and 1997. Operating results for any period are
not necessarily indicative of results for any future period. Dollar amounts are
shown in thousands (except per share data).
<TABLE>
<CAPTION>
QUARTER ENDED QUARTER ENDED
JUNE 30, 1998 JUNE 30, 1997
(000'S) % OF (000'S) % OF
REVENUE REVENUE
STATEMENTS OF OPERATIONS DATA:
<S> <C> <C> <C> <C>
Revenues:
Access $ 20,625 82% $ 9,053 78%
Business services 3,393 14% 1,741 15%
Subscriber start-up fees 1,042 4% 807 7%
--------- --- --------- ----
Total revenues 25,060 100% 11,601 100%
Costs and expenses:
Costs of revenue-recurring 6,985 28% 3,525 30%
Costs of revenue-start-up fees 600 2% 295 3%
Selling, general and administrative 12,387 50% 7,142 61%
Depreciation and amortization 3,094 12% 2,060 18%
--------- --- --------- ----
Total costs and expenses 23,066 92% 13,022 112%
--------- --- --------- ----
Operating income (loss) 1,994 8% (1,421) (12%)
Interest income (expense), net 88 0% (9) 0
--------- --- --------- ----
Income (loss) before taxes 2,082 8% (1,430) (12%)
Income tax provision (62) 0% 0 0
--------- --- --------- ----
Net income (loss) 2,020 8% (1,430) (12%)
========= === ========= ====
NET INCOME (LOSS) PER SHARE:
Basic $ 0.09 $ (0.06)
Diluted $ 0.08 $ (0.06)
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING (000's):
Basic 23,673 22,551
Diluted 25,140 22,551
OPERATING DATA:
Approximate number of subscribers at end of period 393,000 183,000
Number of Company employees at end of period 630 395
</TABLE>
Revenue: Revenue for the three months ended June 30, 1998 totaled
approximately $25,060,000, compared to approximately $11,601,000 for the three
months ended June 30, 1997. The approximately 116% increase in period revenue
resulted primarily from a 115% increase in subscribers. Revenues from dial-up
access to the Internet for the three months ended June 30, 1998 represented
approximately 82% of revenue, compared to approximately 78% of revenue for the
same three months in the prior year. Subscriber start-up fees accounted for
approximately 4% of revenue for the three months ended June 30, 1998, compared
to approximately 7% for the three months ended June 30, 1997. The Company
anticipates that as its customer base continues to expand, subscriber start-up
fees will progressively represent a smaller percentage of revenue. Business
services, consisting primarily of Web Hosting services, remained relatively
steady and represented approximately 14% and 15% of total revenue for the three
months ended June 30, 1998 and 1997, respectively.
4
<PAGE> 9
Costs of revenue-recurring: For the three months ended June 30, 1998,
costs of revenue-recurring decreased to approximately 28% of total revenue,
compared to approximately 30% of total revenue for the three months ended June
30, 1997. Costs of revenue-recurring also decreased as a percentage of dial-up
access revenue to approximately 34% in the second quarter of 1998 from
approximately 39% in the second quarter of 1997. Exclusive of $600,000 in
discounts received in the second quarter of 1998 and $450,000 in discounts
received in the second quarter of 1997 pursuant to the Company's network
services agreement with PSINet, Inc. ("PSINet") ("the PSINet Services
Agreement"), costs of revenue-recurring would have been approximately 37% and
44% of total dial-up revenue, respectively. This decrease of costs of
revenue-recurring as a percentage of total revenue and as a percentage of
dial-up access revenue resulted primarily from increased efficiency and reduced
network costs per subscriber in the Company's own network.
Costs of revenue-start-up fees: For the three months ended June 30,
1998, subscriber start-up expenses decreased to approximately 2% of total
revenue, compared to approximately 3% of total revenue for the three months
ended June 30, 1997. Costs of revenue-start-up fees increased as a percentage of
subscriber start-up revenue from approximately 37% for the three months ended
June 30, 1997 to approximately 58% in the three months ended June 30, 1998. This
increase of costs of revenue-start-up fees as a percentage of subscriber
start-up revenue resulted from the Company more aggressively waiving the
subscriber start-up fees during selected marketing campaigns in the second
quarter of 1998. The Company anticipates that start-up expenses will continue to
decrease as a percentage of total revenue to the extent that the number of new
subscribers decreases as a percentage of the entire subscriber base.
Selling, general and administrative expenses: Selling, general and
administrative expenses were approximately 50% of revenue for the three months
ended June 30, 1998, compared to approximately 61% of revenue for the three
months ended June 30, 1997. The decrease in selling, general and administrative
expenses as a percentage of revenue resulted from economies of scale with
respect to certain costs, such as employee compensation, that do not increase in
direct proportion to increases in revenue and to cost control efforts
implemented by management.
Depreciation and amortization: Depreciation and amortization expenses
decreased to approximately 12% of revenue for the three months ended June 30,
1998, compared to approximately 18% of revenue for the same period in the prior
year. Amortization expense for the three months ended June 30, 1998 was
approximately 5% of revenue compared to approximately 9% of revenue for the
three months ended June 30, 1997. Amortization expense resulted solely from
acquired customer bases which are being amortized over three years. Depreciation
expense was approximately 7% of total revenue for the three months ended June
30, 1998, compared to approximately 9% for the comparable period in the prior
year. The decrease in depreciation expense as a percentage of total revenue
resulted from efficiencies within the Company's owned POPs resulting from
reductions in the cost of new equipment and improved utilization within the
Company's network and the utilization of purchased network services as opposed
to increasing capacity by the construction of additional Company-owned POPs.
Interest income (expense), net: Interest income for the three months
ended June 30, 1998 consisted of approximately $328,000 of interest income
earned on the investment of excess cash balances offset by approximately
$240,000 related to capital leases of equipment and imputed interest related to
a note payable issued to PSINet. For the three months ended June 30, 1997, the
Company had interest expense related to capital leases of equipment and imputed
interest related to a note payable issued to PSINet of approximately $109,000
and interest income of approximately $100,000.
Income tax provision: For the three months ended June 30, 1998, the
Company recorded a provision for income taxes equal to its estimated liability
in various states at the enacted rates where it does not have any net operating
loss carryforwards available. The remaining portion of the current period
provision was offset by the reversal of previously recorded valuation allowance
amounts. For the three months ended June 30, 1997, no income tax benefit was
recognized as the Company had a net taxable loss for the period and anticipated
being in a net taxable loss position for the year ended December 31, 1997.
The Company is continually assessing its income tax situation to
determine when it is "more likely than not" that its deferred tax assets will be
realized. Based on the Company's short history of earnings and the uncertainty
of near term earnings due to various industry trends which may have a
significant negative impact on near term earnings, management does not believe
it is "more likely than not" that the deferred tax assets will be realized. When
management believes this situation has changed, the Company will reverse its
valuation allowance (approximately $4.2 million at June 30, 1998) through that
period's tax provision. Prior to that point, the Company will reverse the
valuation allowance against the current period's provision as realized.
Net income and income per share: As a result of the factors discussed
above, the Company's net income for the three months ended June 30, 1998 was
$2,020,000, or $0.09 basic and $0.08 diluted income
5
<PAGE> 10
per share, compared to a net loss of $1,430,000, or $0.06 basic and diluted loss
per share, for the three months ended June 30, 1997.
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997
The following table sets forth certain unaudited financial data for the
six months ended June 30, 1998 and 1997. Operating results for any period are
not necessarily indicative of results for any future period. Dollar amounts are
shown in thousands (except per share data).
<TABLE>
<CAPTION>
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 1998 JUNE 30, 1997
(000'S) % OF (000'S) % OF
REVENUE REVENUE
STATEMENTS OF OPERATIONS DATA:
<S> <C> <C> <C> <C>
Revenues:
Access $ 37,617 81% $ 16,409 77%
Business services 6,566 14% 3,164 15%
Subscriber start-up fees 2,261 5% 1,807 8%
--------- --- --------- ----
Total revenues 46,444 100% 21,380 100%
Costs and expenses:
Costs of revenue-recurring 12,975 28% 6,694 31%
Costs of revenue-start-up fees 1,217 2% 660 3%
Selling, general and administrative 23,239 50% 14,064 66%
Depreciation and amortization 5,966 13% 3,888 18%
--------- --- --------- ----
Total costs and expenses 43,397 93% 25,306 118%
--------- --- --------- ----
Operating income (loss) 3,047 7% (3,926) (18%)
Interest expense, net (75) 0% (29) 0
--------- --- --------- ----
Income (loss) before taxes 2,972 7% (3,955) (18%)
Income tax provision (92) 0% 0 0
--------- --- --------- ----
Net income (loss) 2,880 7% (3,955) (18%)
========= === ========= ====
NET INCOME (LOSS) PER SHARE:
Basic $ (0.12) $ (0.18)
Diluted $ (0.12) $ (0.18)
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING (000's):
Basic 23,157 22,493
Diluted 24,588 22,493
OPERATING DATA:
Approximate number of subscribers at end of period 393,000 183,000
Number of Company employees at end of period 630 395
</TABLE>
Revenue: Revenue for the six months ended June 30, 1998 totaled
approximately $46,444,000, compared to approximately $21,380,000 for the six
months ended June 30, 1997. The approximately 117% increase in period revenue
resulted primarily from a 115% increase in subscribers. Revenues from dial-up
access to the Internet for the six months ended June 30, 1998 represented
approximately 81% of revenue, compared to approximately 77% of revenue for the
same six months in the prior year. Subscriber start-up fees accounted for
approximately 5% of revenue for the six months ended June 30, 1998, compared to
approximately 8% for the six months ended June 30, 1997. The Company anticipates
that as its customer base continues to expand, subscriber start-up fees will
progressively represent a smaller percentage of revenue. Business services,
consisting primarily of Web Hosting services, remained relatively steady
6
<PAGE> 11
and represented approximately 14% and 15% of total revenue for the six months
ended June 30, 1998 and 1997, respectively.
Costs of revenue-recurring: For the six months ended June 30, 1998,
costs of revenue-recurring decreased to approximately 28% of total revenue,
compared to approximately 31% of total revenue for the six months ended June 30,
1997. Costs of revenue-recurring also decreased as a percentage of dial-up
access revenue to approximately 35% in the first six months of 1998 from
approximately 41% in the first six months of 1997. Exclusive of $1,200,000 in
discounts received in the first six months of 1998 and $900,000 in discounts
received in the first six months of 1997 pursuant to the PSINet Services
Agreement, costs of revenue-recurring would have been approximately 38% and 46%
of total dial-up revenue, respectively. This decrease of costs of
revenue-recurring as a percentage of total revenue and as a percentage of
dial-up access revenue resulted primarily from increased efficiency and reduced
network costs per subscriber in the Company's own network.
Costs of revenue-start-up fees: For the six months ended June 30, 1998,
subscriber start-up expenses decreased to approximately 2% of total revenue,
compared to approximately 3% of total revenue for the six months ended June 30,
1997. Costs of revenue-start-up fees increased as a percentage of subscriber
start-up revenue from approximately 37% for the six months ended June 30, 1997
to approximately 54% in the six months ended June 30, 1998. This increase of
costs of revenue-start-up fees as a percentage of subscriber start-up revenue
resulted from the Company more aggressively waiving the subscriber start-up fees
during selected marketing campaigns in the first six months of 1998. The Company
anticipates that start-up expenses will continue to decrease as a percentage of
total revenue to the extent that the number of new subscribers decreases as a
percentage of the entire subscriber base.
Selling, general and administrative expenses: Selling, general and
administrative expenses were approximately 50% of revenue for the six months
ended June 30, 1998, compared to approximately 66% of revenue for the six months
ended June 30, 1997. The decrease in selling, general and administrative
expenses as a percentage of revenue resulted from economies of scale with
respect to certain costs, such as employee compensation, that do not increase in
direct proportion to increases in revenue and to cost control efforts
implemented by management.
Depreciation and amortization: Depreciation and amortization expenses
decreased to approximately 13% of revenue for the six months ended June 30,
1998, compared to approximately 18% of revenue for the same period in the prior
year. Amortization expense for the six months ended June 30, 1998 was
approximately 5% of revenue compared to approximately 10% of revenue for the six
months ended June 30, 1997. Amortization expense resulted solely from acquired
customer bases which are being amortized over three years. Depreciation expense
was approximately 8% of total revenue for the six months ended June 30, 1998,
compared to approximately 8% for the comparable period in the prior year. The
decrease in depreciation expense as a percentage of total revenue resulted from
efficiencies within the Company's owned POPs resulting from reductions in the
cost of new equipment and improved utilization within the Company's network and
the utilization of purchased network services as opposed to increasing capacity
by the construction of additional Company-owned POPs.
Interest expense, net: Interest expense for the six months ended June
30, 1998 consisted of approximately $510,000 related to capital leases of
equipment and imputed interest related to a note payable issued to PSINet,
offset by approximately $435,000 of interest income. For the six months ended
June 30, 1997, the Company had interest expense related to capital leases of
equipment and imputed interest related to a note payable issued to PSINet of
approximately $236,000 and interest income of approximately $207,000.
Income tax provision: For the six months ended June 30, 1998, the
Company recorded a provision for income taxes equal to its estimated liability
in various states at the enacted rates where it does not have any net operating
loss carryforwards available. The remaining portion of the current period
provision was offset by the reversal of previously recorded valuation allowance
amounts. For the six months ended June 30, 1997, no income tax benefit was
recognized as the Company had a net taxable loss for the period and anticipated
being in a net taxable loss position for the year ended December 31, 1997.
The Company is continually assessing its income tax situation to
determine when it is "more likely than not" that its deferred tax assets will be
realized. Based on the Company's short history of earnings and the uncertainty
of near term earnings due to various industry trends which may have a
significant negative impact on near term earnings, management does not believe
it is "more likely than not" that the deferred tax assets will be realized. When
management believes this situation has changed, the Company will reverse its
valuation allowance (approximately $4.2 million at June 30, 1998) through that
period's tax provision. Prior to that point, the Company will reverse the
valuation allowance against the current period's provision as realized.
7
<PAGE> 12
Net income and income per share: As a result of the factors discussed
above, the Company's net income for the six months ended June 30, 1998 was
$2,880,000, or $0.12 basic and diluted income per share, compared to a net loss
of $3,955,000, or $0.18 basic and diluted loss per share, for the six months
ended June 30, 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company generated net cash from operations in the amount of
$11,899,000 for the six months ended June 30, 1998 versus approximately $902,000
during the six months ended June 30, 1997. The Company has primarily financed
its operations to date through cash flows generated from operations, public and
private sales of equity securities, loans from third parties and capital leases
of equipment. The company completed a secondary public offering in June 1998
(the "June 1998 Offering"), issuing 3,000,000 shares at a price of $17.67 per
share (offering information has been adjusted to reflect the Company's
three-for-one stock split). The proceeds of the public offering were
approximately $49,747,000, net of underwriting discounts and expenses. The
Company's investing activities of approximately $8,909,000 for the six months
ended June 30, 1998 primarily related to purchases of telecommunications
equipment necessary for the provision of service to subscribers. In addition to
the net proceeds of the June 1998 Offering, the Company's primary financing
activities of approximately $1,866,000 for the six months ended June 30, 1998
consisted of cash paid for capital lease obligations and cash paid to PSINet in
connection with a transaction between the Company and PSINet in 1996 in which
the Company purchased certain individual subscriber accounts of PSINet and
related assets (the "PSINet Transaction"), offset by proceeds from the exercise
of employee incentive stock options of $186,000. Total cash used in financing
activities for the six months ended June 30, 1997 was approximately $480,000,
consisting of cash paid for capital lease obligations cash and paid to PSINet in
connection with the PSINet Transaction.
As of June 30, 1998, the Company had cash on hand of approximately
$60,257,000. The Company anticipates that it will continue to generate cash
flows from operations in 1998. The Company estimates that its cash and financing
needs for the next 12 months, assuming reasonable internal growth, can be met by
cash on hand and cash flow from operations. The Company's future capital
requirements depend on several factors, including the rate of market acceptance
of the Company's services, the Company's ability to maintain and expand its
subscriber base, the rate of expansion of the Company's network infrastructure,
the level of resources required to expand the Company's marketing and sales
efforts, the availability of hardware and software provided by third-party
vendors and other factors. If capital requirements vary materially from those
currently planned, the Company may require additional financing. The Company has
no commitments for any additional financing, and there can be no assurance that
any such commitments can be obtained on favorable terms, if at all. Any
additional equity financing may be dilutive to the Company's stockholders, and
debt financing, if available, may involve restrictive covenants with respect to
dividends, raising future capital and other financial and operational matters
and may otherwise limit the Company's ability to raise additional equity
capital.
The Company frequently engages in discussions involving potential
business acquisitions. Depending on the circumstances, the Company may not
disclose material acquisitions until completion of a definitive agreement. The
Company may determine to raise additional debt or equity capital to finance
potential acquisitions and/or to fund accelerated growth. Any significant
acquisitions or increases in the Company's growth rate could materially affect
the Company's operating and financial expectations and results, liquidity and
capital resources.
RECENT ACCOUNTING PRONOUNCEMENTS
Effective with the first quarter of 1998, the Company was subject to
the provisions of Statement of Financial Accounting Standards No. 130 ("SFAS
130"), "Reporting Comprehensive Income" and Statement of Financial Accounting
Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and
Related Information". Neither statement had any impact on the Company's
financial statements as the Company does not have any "comprehensive income"
type earnings (losses) and its financial statements reflect how the "key
operating decision maker" views the business. The Company will continue to
review these statements over time, in particular, SFAS 131, to determine if any
additional disclosures are necessary based on evolving circumstances.
OTHER
The Year 2000 issue is the result of computer programs using two digits
rather than four to define the applicable year. Date-sensitive software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in system failures or miscalculations, causing disruptions of
operations, including, among others, a temporary inability to process
transactions, send invoices, or engage in similar normal business activities.
The Company does not believe that the Year 2000 issue will have a material
effect on its programs and computer systems, but will continue to assess the
potential impact of the Year 2000 issue on its reporting and operating systems.
Due to the proprietary nature of many of the Company's
8
<PAGE> 13
operating platforms, including its billing and accounts receivable systems, the
Company has limited reliance on external vendors that might be vulnerable to
Year 2000 problems. To the extent that the Company does rely on external vendors
with Year 2000 exposure, however, any failure by such vendors to resolve any
Year 2000 issues on a timely basis or in a manner that is compatible with the
Company's systems could have a material adverse effect on the Company. The
Company has begun to ask its third-party network providers about their progress
in identifying and addressing problems that their computer systems may face in
correctly processing data information related to the Year 2000. Preliminary
indications are that the Company's third-party network providers are, or will
be, Year 2000 compliant, although the Company has not undertaken an in-depth
evaluation of such providers in relation to the Year 2000 issue. Any failure on
the part of such third-party network providers to become Year 2000 compliant on
a timely basis or in a manner that is compatible with the Company's systems
could have a material adverse effect on the Company.
"SAFE HARBOR" STATEMENT
The following "Safe Harbor" Statement is made pursuant to the Private
Securities Litigation Reform Act of 1995. Certain of the Statements contained in
the body of this Report are forward-looking statements (rather than historical
facts) that are subject to risks and uncertainties that could cause actual
results to differ materially from those described in the forward-looking
statements. With respect to such forward-looking statements, the Company seeks
the protections afforded by the Private Securities Litigation Reform Act of
1995. These risks include, without limitation, (1) that the Company will not
retain or grow its subscriber base, (2) that the Company will fail to be
competitive with existing and new competitors, (3) that the Company will not be
able to sustain its current growth, (4) that the Company will not adequately
respond to technological developments impacting the Internet, and (5) that
needed financing will not be available to the Company if and as needed. This
list is intended to identify certain of the principal factors that could cause
actual results to differ materially from those described in the forward-looking
statements included elsewhere herein. These factors are not intended to
represent a complete list of all risks and uncertainties inherent in the
Company's business, and should be read in conjunction with the more detailed
cautionary statements included in the Company's Report on Form 10-K, as amended,
for fiscal 1997 as well as the Company's other publicly filed reports and
documents.
9
<PAGE> 14
PART II
OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The following matters were submitted to a vote of security holders at the 1998
Annual Meeting of Stockholders held on June 17, 1998:
1. Election of two Class III Directors to the Board of Directors of the Company.
The following votes were cast in the election of directors:
<TABLE>
<CAPTION>
Class III Directors For Withhold Authority
<S> <C> <C>
Charles M. Brewer 22,019,166 72,063
Campbell B. Lanier, III 22,019,286 71,943
</TABLE>
The term of two Class I Directors, Michael G. Misikoff and O. Gene Gabbard, and
two Class II Directors, Michael S. McQuary and William H. Scott, III, did not
expire at this Annual Meeting and each of them continue to serve as directors of
the Company.
2. Proposed Amendment to Article 4 of the Company's Amended and Restated
Certificate of Incorporation to increase the number of authorized shares of the
Company's Common Stock, described in the proxy statement dated May 20, 1998.
There were 20,282,781 votes cast for approval of the amendment, 1,785,015 votes
cast against approval of the amendment and 23,433 abstentions.
3. Proposed Amendment to Article 4 of the Company's Amended and Restated
Certificate of Incorporation to eliminate the Company's Class C Preferred Stock
described in the proxy statement dated May 20, 1998. There were 14,198,208 votes
cast for approval of the amendment, 66,570 votes cast against approval of the
amendment and 50,841 abstentions. There were 7,775,610 broker non-votes
recorded.
4. Proposed Amendment to 1995 Stock Option Plan described in the proxy statement
dated May 20, 1998. There were 21,749,280 votes cast for approval of the
amendment, 294,696 votes cast against approval of the amendment and 47,253
abstentions.
5. Proposed Amendment to Company's Directors Stock Option Plan described in the
proxy statement dated May 20, 1998. There were 21,509,427 votes cast for
approval of the amendment, 506,070 votes cast against approval of the amendment
and 75,732 abstentions.
6. Proposed ratification of the appointment of Arthur Andersen LLP as the
independent auditors of the Company for the fiscal year ending December 31,
1997. There were 22,021,293 votes cast for ratification, 53,076 votes cast
against ratification and 16,860 abstentions.
10
<PAGE> 15
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27. Financial Data Schedule (for SEC use only).
(b) Report on Form 8-K
On June 25, 1998, the Company filed a Current Report on Form
8-K to report that, on June 24, 1998, the Company's Board of Directors had
declared a three-for-one stock split to be effected in the form of a stock
dividend.
11
<PAGE> 16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MINDSPRING ENTERPRISES, INC.
----------------------------
(Registrant)
Date: August 13, 1998 By: /s/ Michael S. McQuary
------------------------
Michael S. McQuary
President and Chief Operating Officer
Date: August 13, 1998 By: /s/ Michael G. Misikoff
------------------------
Michael G. Misikoff
Executive Vice President and Chief Financial
Officer
12
<PAGE> 17
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Exhibit Description Page
- -------- ------------
<S> <C> <C>
27. Financial Data Schedule (for SEC use only)
</TABLE>
13
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF MINDSPRING ENTERPRISES, INC. FOR THE SIX MONTHS ENDED
JUNE 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 60,257
<SECURITIES> 0
<RECEIVABLES> 4,020
<ALLOWANCES> 1,583
<INVENTORY> 151
<CURRENT-ASSETS> 63,332
<PP&E> 37,379
<DEPRECIATION> 9,660
<TOTAL-ASSETS> 98,130
<CURRENT-LIABILITIES> 20,151
<BONDS> 0
0
0
<COMMON> 258
<OTHER-SE> 73,968
<TOTAL-LIABILITY-AND-EQUITY> 98,130
<SALES> 0
<TOTAL-REVENUES> 46,444
<CGS> 14,192
<TOTAL-COSTS> 43,397
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,169
<INTEREST-EXPENSE> 75
<INCOME-PRETAX> 2,972
<INCOME-TAX> 92
<INCOME-CONTINUING> 2,880
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,880
<EPS-PRIMARY> 0.12
<EPS-DILUTED> 0.12
</TABLE>
