<PAGE>
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UNITED STATES
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, 1997
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 000-20799
EARTHLINK NETWORK, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-4481766
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
3100 NEW YORK DRIVE, PASADENA, CALIFORNIA 91107
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(626) 296-2400
(REGISTRANT'S TELEPHONE, INCLUDING AREA CODE)
--------------------
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
$.01 par value
--------------------
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
--- ---
There were 9,753,622 shares of Common Stock outstanding as of June 30, 1997.
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<PAGE>
EARTHLINK NETWORK, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1997
TABLE OF CONTENTS
PART I
Item 1. Financial Statements and Supplementary Data . . . . . . . . . . 1
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . 6
Item 3. Quantitative and Qualitative Disclosures About Market Risk . . 11
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . 11
PART II
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . 11
<PAGE>
PART I
ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY Data
EARTHLINK NETWORK, INC.
BALANCE SHEET
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, 1996 JUNE 30, 1997
----------------- -------------
<S> <C> <C>
(AUDITED) (UNAUDITED)
(in thousands)
Current Assets:
Cash and Cash Equivalents $ 3,993 $ 6,165
Restricted Short-term Investment 1,087 1,050
Accounts Receivable, Net 1,725 2,500
Prepaid Expenses 885 1,121
Other Assets 1,383 1,077
-------- -------
Total Current Assets 9,073 11,913
Other Long-term Assets 329 408
Property and Equipment, Net 17,401 22,454
Intangibles, Net 316 1,612
-------- -------
$ 27,119 $ 36,387
-------- --------
-------- --------
LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Trade accounts payable $ 11,207 $ 5,404
Accrued payroll and related expenses 1,469 2,564
Other accounts payable and accrued liabilities 2,061 2,723
Current portion of capital lease obligations 3,582 5,194
Notes payable 7,950 5,000
Deferred revenue 2,010 2,745
-------- -------
Total current liabilities 28,279 23,630
Long-term debt - notes payable 1,271
Long-term debt of capital lease obligations 6,088 7,721
-------- -------
Total liabilities 34,367 32,622
-------- -------
Mandatorily redeemable convertible preferred stock 14,013 -
Stockholders' equity (deficit)
Common stock 60 98
Additional paid-in capital 14,236 55,276
Warrants to purchase common stock 599 675
Accumulated deficit (36,156) (52,284)
-------- -------
Total stockholders' equity (deficit) (21,261) 3,765
-------- -------
$ 27,119 $ 36,387
-------- -------
-------- -------
</TABLE>
The accompanying notes are an integral part of these financial statements
1
<PAGE>
EARTHLINK NETWORK, INC
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
1996 1997 1996 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
(UNAUDITED)
(in thousands)
Recurring revenues $ 5,014 $ 17,479 $ 7,642 $ 31,565
Other revenues 1,714 1,367 2,504 2,999
-------- -------- -------- --------
Total Revenues 6,728 18,846 10,146 34,564
Cost of recurring revenues 3,865 9,187 5,563 17,142
Cost of other revenues 758 804 1,327 1,719
Sales and marketing 3,263 5,056 5,472 10,017
General and administrative expenses 2,423 3,449 4,055 6,951
Operations and customer support 3,094 7,791 5,192 14,213
-------- -------- -------- --------
13,403 26,287 21,609 50,042
-------- -------- -------- --------
Loss from operations (6,675) (7,441) (11,463) (15,478)
Interest expense (161) (444) (261) (951)
Interest income 1 135 20 300
-------- -------- -------- --------
Net loss $ (6,835) $ (7,750) $(11,704) $(16,129)
-------- -------- -------- --------
-------- -------- -------- --------
-------- -------- -------- --------
Net loss per share $ (1.04) $ (0.80) $ (1.85) $ (1.71)
-------- -------- -------- --------
-------- -------- -------- --------
Weighted average shares 6,545 9,738 6,338 9,421
-------- -------- -------- --------
-------- -------- -------- --------
EBITDA (1) (5,916) (5,263) (10,254) (11,420)
</TABLE>
(1) Represents earnings (loss) before depreciation and amortization, interest
income and expense and income tax expense. EBITDA is not determined in
accordance with generally accepted accounting principals, is not indicative
of cash used by operating activities and should not be considered in
isolation or as an alternative to, or more meaningful than measures of
performance determined in accordance with generally accepted accounting
principles.
The accompanying notes are an integral part of these financial statements
2
<PAGE>
EARTHLINK NETWORK, INC
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
1996 1997 1996 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
(UNAUDITED)
(in thousands)
Net cash used in operating activities $ (4,303) $ (4,103) $ (7,132) $(16,173)
-------- -------- -------- --------
Cash flows from investing activities:
Purchases of property and equipment (5,342) (4,182) (9,589) (8,968)
Purchase of customer base - (1,356) - (1,356)
Liquidation of restricted short-term investment 46 38 1,046 38
-------- -------- -------- --------
Net cash used in investing activities (5,296) (5,500) (8,543) (10,286)
-------- -------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of notes payable 2,950 1,271 2,950 1,271
Repayment of notes payable - - - (2,225)
Repayment of line of credit - - (1,494) -
Proceeds from capital lease obligations 4,883 2,542 7,046 5,325
Principal payments under capital lease obligations (423) (1,194) (628) (2,079)
Proceeds from issuance of Common Stock, net 8,370 - 8,711 26,339
Conversion of Common Stock pending issuance, net (5,931) - - -
-------- -------- -------- --------
Net cash provided by financing activities 9,849 2,619 16,585 28,631
-------- -------- -------- --------
Net increase in cash and cash equivalents 250 (6,984) 910 2,172
Cash and cash equivalents, beginning of period 950 13,149 290 3,993
-------- -------- -------- --------
Cash and cash equivalents, end of period $ 1,200 $ 6,165 $ 1,200 $ 6,165
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
The accompanying notes are an integral part of these financial statements
3
<PAGE>
EARTHLINK NETWORK
NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The condensed financial statements of EarthLink Network, Inc. ("EarthLink"
or the "Company") for the three month and six month periods ended June 30, 1997
and the related footnote information are unaudited and have been prepared on a
basis substantially consistent with the Company's audited financial statements
as of December 31, 1996 contained in the Company's Annual Report on Form 10-K as
filed with the Securities and Exchange Commission (the "Annual Report"). These
financial statements should be read in conjunction with the audited financial
statements and the related notes thereto contained in the Company's Annual
Report. In the opinion of management, the accompanying unaudited financial
statements contain all adjustments (consisting of normal recurring adjustments)
which management considers necessary to present fairly the financial position of
the Company at June 30, 1997 and the results of operations and the cash flows
for the three month periods ended June 30, 1996 and 1997. The results of
operations for the three month and six month periods ended June 30, 1997 may not
be indicative of the results expected for any succeeding quarter or the entire
year ending December 31, 1997.
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.
Actual results may differ from those estimates.
2. RECLASSIFICATION
Certain amounts in the prior year financial statements have been
reclassified to conform to the current year presentation.
3. NET LOSS PER SHARE
For the three month and six month periods ended June 30, 1997, options to
purchase shares of Common Stock, warrants to purchase shares of Common Stock and
debt instruments convertible into shares of Common Stock are excluded from the
calculation as their effect is antidilutive. Pursuant to Securities and
Exchange Commission Staff Accounting Bulletins, Common Stock and Common Stock
equivalent shares issued by the Company at prices below the Company's initial
public offering price during the twelve month period prior to the Company's
initial public offering, which was effective on January 22, 1997, have been
included in the calculation for the three month and six month periods ended June
30, 1996 as if they were outstanding for all periods prior to the initial public
offering, regardless of whether they are dilutive (using the treasury stock
method and an initial public offering price of $13.00 per share). Accordingly,
all common stock equivalents are included in the earnings per share calculations
for the three month and six month periods ended June 30, 1996, even though the
effect on net loss is antidilutive. The Series A Convertible Preferred Stock
shares have been included for the respective weighted average periods for which
such shares were outstanding, even though their effect is antidilutive.
4. INCENTIVE STOCK OPTION GRANTS
On May 22, 1997 the Company granted incentive stock options to purchase
34,000 shares of Common Stock at $11.50 per share. The options were granted
pursuant to the Company's 1995 Stock Option Plan.
4
<PAGE>
EARTHLINK NETWORK
NOTES TO FINANCIAL STATEMENTS
5. ACQUISITION OF INTERNET IN A MALL CUSTOMERS
Effective April 7, 1997 the Company purchased the subscribers and related
assets, including accounts receivable related to the consumer dial-up Internet
access service of Internet in a Mall, a Tarzana, CA based Internet access
provider. Under the terms of the agreement, as amended, the Company purchased
approximately 28,000 subscriber accounts as of April 7, 1997. The excess of
purchase price over assets acquired is being amortized over one year.
6. CREDIT FACILITY
In 1996, EarthLink obtained a $5 million credit facility for customer
access through an agreement with one of the Company's vendors. Customer access
service fees are applied against the payables related to those products and
services supplied by the vendor. Interest on the utilized portion of the credit
facility is calculated at a rate of prime plus 4% and the line is due upon the
termination of the agreement, or July 31, 1998, whichever occurs first. The
outstanding balance due under the credit facility at June 30, 1997 was
$1,271,000, leaving $3,729,000 unused and available.
7. RECENT PRONOUNCEMENTS
In February 1997 the Financial Accounting Standards Board issued statement
128, "Earnings per Share" ("SFAS No. 128"), which redefines how entities
compute earnings per share. Primary earnings per share will be replaced by
basic earnings per share which will be computed exclusively based on the
weighted average number of common shares outstanding. This statement is
effective for periods ending after December 15, 1997 and will require
restatement of all prior period earnings per share data presented. The adoption
of SFAS 128 is not expected to have a material impact on the Company's earnings
per share data.
8. AMENDMENT TO LEASE
Effective June 28, 1997, the Company amended the lease for its corporate
headquarters facility. Under the amended lease the lessor will provide
improvements costing up to $1.4 million and convert approximately 45,000 square
feet of the existing facility to office space. Base rent will continue to be
$48,185 until October 1, 1997. Effective October 1, 1997 rent commitments will
be as follows:
Monthly
Term Commitment
---------------------------------- ----------
October 1, 1997 - January 31, 2001 $ 73,000
February 1, 2001 - May 31, 2004 $ 82,000
June 1, 2004 - September 30, 2007 $ 91,000
Under the amended lease the deposit was increased to $82,000 from $55,000 and
the company delivered an irrevocable letter of credit in the amount of $450,000
to the Lessor.
5
<PAGE>
This report contains certain forward-looking statements with respect to the
Company's operations, industry, financial condition and liquidity. These
statements, which are typically introduced by statements such as "the Company
believes", "anticipates", "estimates" or "expects" certain conditions to exist,
reflect management's best current assessment of a number of risks and
uncertainties. The Company's actual results could differ materially from the
results anticipated in these forward-looking financial statements as a result of
certain factors described in this report.
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
UNAUDITED CONDENSED FINANCIAL STATEMENTS AND RELATED NOTES THERETO AND THE
AUDITED FINANCIAL STATEMENTS AND THE NOTES THERETO.
OVERVIEW
EarthLink Network, Inc. ("EarthLink" or the "Company") is an Internet
service provider ("ISP") formed to help its members derive meaningful benefits
from the extensive resources of the Internet. The Company focuses on providing
access, information, assistance and services to its members to encourage their
introduction to the Internet and to help them have a satisfying user experience.
The Company has experienced net losses in each quarter since it commenced
operations. The Company expects that it is likely to continue to incur net
losses at least through the end of 1997 as it continues to expend substantial
resources to build its infrastructure, develop new service and product offerings
and build its sales and marketing and administrative organizations. The
Company's operating results have fluctuated significantly in the past and will
likely continue to fluctuate significantly in the future as a result of a
variety of factors, many of which are beyond the Company's control.
EarthLink's principal strategy is to rapidly expand its member base and
increase its market share. To realize this strategy, the Company is continuing
to invest in sales and marketing, increasing its member support capabilities,
enhancing its network operations capacity to meet member demand and adding
administrative infrastructure. This strategy requires substantial initial cash
outlays.
The Company believes that its long-term success largely depends on
maintaining member satisfaction with its services. EarthLink continues to
devote significant resources to enhancing its network operations capability, its
World Wide Web site and its service offerings. In addition, the Company
continues to expand its technical support staff and enhance the staff's
effectiveness by providing software tools that can assist the staff in
identifying and solving member problems.
The Company provides Internet access service to a large number of consumers
and small businesses. The Company has recently expanded its consumer service
offerings, including a Personal Start Page-TM-, integrated "plug-and-play" Web
site software package, 56kbps modem access, and the Arena which features
pay-per-play multi-player Internet games. In addition, the Company provides a
variety of services for business customers, including business Web sites,
high-speed LAN ISDN communications capability, and frame relay connections, each
of which involve a monthly service charge plus set-up fees.
In order to maintain its focus on member needs, the Company has leveraged the
infrastructure and software development efforts of others by leasing POP
capacity from UUNET Technologies, Inc. ("UUNET") and PSINet, Inc. ("PSINet") and
licensing software from developers such as Netscape Communications Corporation
and Microsoft Corporation. The Company believes that this approach gives it
flexibility to rapidly expand its service coverage without the need for
substantial capital expenditures. The Company will continue to pursue this
strategy so that, in addition to its sales and marketing efforts, it can devote
its principal resources to improving its members' experience with the Internet.
6
<PAGE>
RESULTS OF OPERATIONS
REVENUES.
<TABLE>
<CAPTION>
QUARTER QUARTER
ENDED PERCENT ENDED PERCENT
JUNE 30, OF TOTAL JUNE 30, OF TOTAL
1996 REVENUE 1997 REVENUE
-------- -------- -------- --------
<S> <C> <C> <C> <C>
(in thousands except percentages)
RECURRING REVENUES $ 5,014 75% $ 17,479 93%
OTHER REVENUES 1,714 25% 1,367 7%
-------- --------
TOTAL REVENUES $ 6,728 100% $ 18,846 100%
-------- --------
-------- --------
</TABLE>
Recurring revenues consist of monthly fees charged to members for Internet
access and other ongoing services. Other revenues generally represent one-time
set-up fees. Recurring revenues are recognized over the period in which the
services are performed. As indicated in the above chart, the Company
experienced substantial growth in revenues for the quarter ended June 30, 1997
as compared to the corresponding quarter of 1996. This growth is primarily
attributable to an increase in the number of members who use the Company s
services, from approximately 128,000 at June 30, 1996 to 328,000 at June 30,
1997. The increase in revenues was partially offset by credits given to members
under the Company s member referral program. Under this program the $19.95
service fee is waived for one month in consideration for each new member
referred by an existing member. Waived service fees resulted in a reduction to
revenues of approximately $564,000 during the quarter ended June 30, 1997.
As competition in the ISP market intensifies, the Company has found it
necessary to waive the one-time set-up fee to remain competitive. Consequently,
revenues from the one-time set-up fee have decreased and are expected to
continue to decrease in future periods. The Company waived set-up fees of
approximately $466,000 during the quarter ended June 30, 1997. Although the
average set-up fee per customer decreased, the overall reduction was partially
offset, approximately $201,000, by the increase in the number of members added
during the quarter ended June 30, 1997.
COST OF REVENUES.
<TABLE>
<CAPTION>
QUARTER QUARTER
ENDED PERCENT ENDED PERCENT
JUNE 30, OF RECURRING JUNE 30, OF RECURRING
1996 REVENUE 1997 REVENUE
--------- ------------ --------- ------------
<S> <C> <C> <C> <C>
(in thousands, except percentages)
Cost of recurring revenues $ 3,865 77% $ 9,187 53%
<CAPTION>
QUARTER QUARTER
ENDED PERCENT ENDED PERCENT
JUNE 30, OF OTHER JUNE 30, OF OTHER
1996 REVENUE 1997 REVENUE
--------- -------- --------- --------
<S> <C> <C> <C> <C>
(in thousands, except percentages)
Cost of other revenues $ 758 44% $ 804 59%
</TABLE>
Cost of recurring revenues principally includes telecommunications expenses
and depreciation expense on equipment used in network operations for ongoing
member services. Included in telecommunications costs are fees paid to UUNET and
PSINet for local access to their respective nationwide systems of POPs. Cost of
other revenues principally includes expenses related to the registration of new
members. These costs include
7
<PAGE>
licensing fees for software, software duplication costs and commissions paid to
third parties for referring new members to the Company.
The increase in the cost of recurring revenues is primarily due to the
increase in the number of members. The decrease in cost of recurring revenues
as a percentage of recurring revenue is primarily due to the Company's ability
to exploit economies of scale to reduce per member costs as the total member
base expands.
As noted above, from time to time, the Company waives the one-time set-up
fee it charges new members. Therefore, the increase in cost of other revenue as
a percentage of other revenue is due to the waiving of the one-time set-up fee
for certain customers while the per set-up costs to the Company have remained
constant. Management expects revenues from the one-time set-up fee to decrease
in future periods.
Substantially all of the Company's customers access the EarthLink Network
and the Internet by dialing into local POPs. Access in the Company's Southern
California base is provided through POPs owned by the Company. The Company
provides nationwide service to members through POP access leased from UUNET and
PSINet. (Access to the UUNET and PSINet POPs is on a non-exclusive basis.)
Under the Company's current agreement with UUNET, the Company pays UUNET a
monthly fee equal to the greater of a specified minimum or an amount that varies
based primarily on peak member usage. The Company also pays UUNET an additional
fee to the extent that hours of usage exceed a formula set forth in the
agreement. If the number of hours used by EarthLink members accessing the
Internet through UUNET increases beyond the amount provided for in the agreement
or the usage becomes more concentrated during peak times, the fees paid by the
Company to UUNET would increase, which would adversely affect the Company's
operating margins.
SALES AND MARKETING.
QUARTER QUARTER
ENDED PERCENT ENDED PERCENT
JUNE 30, OF TOTAL JUNE 30, OF TOTAL
1996 REVENUE 1997 REVENUE
-------- ------- -------- --------
(IN THOUSANDS, EXCEPT PERCENTAGES)
SALES AND MARKETING $3,263 48% $5,056 27%
Sales and marketing expenses consist primarily of sales commissions,
salaries, costs of promotional material, advertising, travel and trade shows.
The Company experienced an increase of 55% in sales and marketing expenses for
the quarter ended June 30, 1997 as compared to the corresponding quarter of the
previous year, primarily as a result of EarthLink s efforts to expand its member
base and increase brand awareness in the market place. However, as a percentage
of total revenue, sales and marketing expenses declined to 27% from 48%, as such
expenses grew at slower rate than the Company's revenues.
GENERAL AND ADMINISTRATIVE EXPENSES.
QUARTER QUARTER
ENDED PERCENT ENDED PERCENT
JUNE 30, OF TOTAL JUNE 30, OF TOTAL
1996 REVENUE 1997 REVENUE
-------- -------- -------- --------
(in thousands, except percentages)
GENERAL AND ADMINISTRATIVE EXPENSES $2,423 36% $3,449 18%
General and administrative expenses consist primarily of costs associated
with the finance and human resources departments, professional expenses, rent
and other expenses, compensation earned by certain
8
<PAGE>
executive officers, depreciation associated with office equipment, and bad
debts. The Company experienced an increase of 42% percent in general and
administrative expenses for the quarter ended June 30, 1997 as compared to the
corresponding quarter of the previous year, due to an increase in payroll, rent,
depreciation expense, credit card fees and bad debt expense. The increase in
payroll costs is primarily due to an increase in headcount. Rent expense
increased as the Company occupied a new 55,000 square foot facility adjacent to
its corporate headquarters and a satellite office in Northern California in
February 1997. Monthly rents for the properties are $66,000 and $3,000
respectively. The increase in depreciation expense is due to the acquisition of
office equipment. The increases in credit card processing fees and bad debt are
primarily due to the increase in member count from approximately 128,000 at June
30, 1996 to 328,000 at June 30, 1997. As a percentage of total revenue,
general and administrative expenses declined to 18% from 36%, as the expenses
grew at a slower rate than the Company s revenues.
OPERATIONS AND MEMBER SUPPORT.
QUARTER QUARTER
ENDED PERCENT ENDED PERCENT
JUNE 30, OF TOTAL JUNE 30, OF TOTAL
1996 REVENUE 1996 REVENUE
-------- -------- -------- --------
(in thousands, except percentages)
OPERATIONS AND CUSTOMER SUPPORT $3,094 46% $7,791 41%
Operations and member support expenses consist primarily of costs associated
with technical support and member services to register and maintain member
accounts. These expenses have increased significantly since the Company's
inception. This trend reflects the costs associated with building a customer
service organization to support the Company's member base and anticipated member
growth. Management has pledged to make significant investments in technical and
customer support capabilities and to reduce customer wait time for assistance.
Consequently, operations and customer support expenses have not significantly
decreased as a percentage of revenue.
POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS
The Company's operating results may fluctuate significantly in the future
as a result of a variety of factors, many of which are beyond the Company's
control. These factors include the rates of, and costs associated with, new
member acquisition, member retention, capital expenditures and other costs
relating to the expansion of operations, including upgrading the Company's
systems and infrastructure, the timing and market acceptance of new and upgraded
service introductions, changes in the pricing policies of the Company and its
competitors, changes in operating expenses (including telecommunications costs),
personnel changes, the introduction of alternative technologies, the effect of
potential acquisitions, increased competition in the Company's markets and other
general economic factors. In addition, a significant portion of the Company's
expenses are fixed; therefore, the Company's operating margins are particularly
sensitive to fluctuations in revenues.
LIQUIDITY AND CAPITAL RESOURCES
The Company has not generated net cash from operations since its inception.
The Company has funded its operations primarily through public and private sales
of equity securities, borrowings from third parties and capital leases of
equipment. The Company's operating activities used net cash of approximately
$4.3 million and $4.1 million during the quarters ended June 30, 1996 and 1997,
respectively. During the quarter ended June 30, 1996, net cash used in
operations resulted primarily from net losses, partially offset by increases in
trade
9
<PAGE>
accounts payable. During the quarter ended June 30, 1997, net cash used in
operations resulted from net losses, partially offset by increases in trade
accounts payable and accrued payroll related liabilities.
Cash used in investing activities has consisted primarily of equipment
purchases for POP and network expansion. For the quarters ended June 30, 1996
and 1997, capital expenditures amounted to approximately $5.3 million and
$4.2 million, respectively. The Company estimates that remaining capital
expenditures for 1997 will be approximately $4.9 million including network
enhancements, data center expansion, leasehold improvements, and procurement of
telecommunication and office equipment and furniture and fixtures. Where
feasible, the Company will seek to finance certain of these expenditures through
capital leases.
Cash provided by financing activities was $9.8 million and $2.6 million for
the quarters ended June 30, 1996 and, 1997, respectively. During the second
quarter of 1996, the Company's financing activities consisted of the private
sale of debt and equity securities and capital lease transactions, primarily for
equipment. The Company raised $4.9 million and $2.5 million from the sale and
leaseback of equipment during the quarters ended June 30, 1996 and 1997,
respectively. The sale leaseback transactions were recorded at cost, which
approximates the fair market value of the property and, therefore, no gains or
losses were recorded. The property remains on the books and continues to be
depreciated. A financing obligation representing the proceeds is recorded and
reduced based upon payments under the lease agreement. Under an agreement with
one of its vendors, EarthLink obtained a $5 million credit facility for customer
access. EarthLink accumulates customer access charges, applies them against the
credit facility and is charged interest at a rate of prime plus 4% on the
balance. The outstanding balance due under the credit facility at June 30, 1997
was $1,271,000 leaving $3,729,000 unused and available. The line of credit is
due on the earlier of termination or July 31, 1998
As of June 30, 1996 and 1997, the Company had cash and cash equivalents of
approximately $1.2 million and $6.2 million, respectively, and negative working
capital of approximately $9.2 million and $11.7 million, respectively.
Management does not believe available cash will be sufficient to meet the
Company's operating expenses and capital requirements through the end of this
fiscal year, at the current burn rate. As in the past, the Company plans to
raise additional cash from potential sources such as debt, leases, existing
investors, large institutional investors or strategic partners. At present, the
Company has no formal commitments for 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. If the Company is unable to obtain additional
financing as needed, the Company may be required to reduce the scope of its
operations or its anticipated expansion, which could have a materially adverse
effect on the Company. If capital requirements vary materially from those
currently planned, the Company may require additional financing sooner than
anticipated. The Company's capital requirements depend on numerous factors,
including the rate of market acceptance of the Company's services, the Company's
ability to maintain and expand its member base, the rate of expansion of the
Company's network infrastructure, the level of resources required to expand the
Company's marketing and sales organization, information systems and research and
development activities, the availability of hardware and software provided by
third-party vendors and other factors. The timing and amount of such capital
requirements cannot accurately be predicted
10
<PAGE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its 1997 annual meeting of Stockholders (the "Annual
Meeting") on May 22, 1997 for the purpose of electing Messrs. Sky D. Dayton,
Charles G. Betty, Sidney Azeez, Robert M. Kavner, Paul McNulty, Kevin M.
O'Donnell, John W. Sidgmore and Reed E. Slatkin (the "Nominees") to the
Company's Board of Directors for the ensuing year. Voting both by proxy and by
attendance at the Annual Meeting, with respect to Mr. Dayton, 6,871,092 shares
were voted "for" his election and Stockholders withheld the authority to vote
3,100 shares, and with respect to each of the other Nominees, 6,871,192 shares
were voted "for" the election of each such Nominee and Stockholders withheld the
authority to vote 3,000 shares. 2,858,397 shares of Common Stock were not
voted. The proposal to elect the Nominees to the Company's Board of Directors
passed.
PART II
ITEM 6. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Exhibits. The following exhibits are filed as part of this report:
EXHIBIT NO. DESCRIPTION
----------- ----------------------------------------------
11.1 Statement of computation of earnings per share
27 Financial Data Schedule
(b) No reports on Form 8-K were filed during the quarter ended June 30, 1997.
11
<PAGE>
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.
EARTHLINK NETWORK, INC.
Date: /s/ C. Garry Betty
-------------------- -------------------------------
C. Garry Betty, President, Chief
Executive Officer and Director
Date: /s/ Barry W. Hall
-------------------- -------------------------------
Barry W. Hall, Vice President - Finance
and Administration and Chief Financial
Officer
12
<PAGE>
EXHIBIT 11.1
EARTHLINK NETWORK, INC
COMPUTATION OF EARNINGS PER COMMON SHARE
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------ ------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
1996 1997 1996 1997
---------- ---------- ---------- ----------
Net loss . . . . . . . . . . . . . . . . . . . . . . $ (6,835) $ (7,751) $ (11,704) $ (16,129)
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Weighted average shares oustanding pursuant to SAB 83 5,865 - 5,581 -
Weighted average shares oustanding pursuant to APB 15 9,738 9,421
Purchase of shares of Common
Stock below the expected IPO
price during fiscal 1996 . . . . . . . . . . 82 - 159 -
Assumed exchange of warrants
for Common Stock . . . . . . . . . . . . . . 235 - 235 -
Assumed exchange of options
for Common Stock . . . . . . . . . . . . . . 363 - 363 -
---------- ---------- ---------- ----------
Weighted average
shares outstanding. . . . . . . . . . . . . . . . . . 6,545 9,738 6,338 9,421
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net loss per share. . . . . . . . . . . . . . . . . . $ (1.04) $ (0.80) $ (1.85) $ (1.71)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) THE SECURITIES EXCHANGE ACT OF 1934 FOR
QUARTERLY PERIOD ENDED JUNE 30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997
<PERIOD-START> MAR-31-1997 JAN-01-1997
<PERIOD-END> JUN-30-1997 JUN-30-1997
<CASH> 6,165 6,165
<SECURITIES> 0 0
<RECEIVABLES> 2,693 2,693
<ALLOWANCES> 194 194
<INVENTORY> 422 422
<CURRENT-ASSETS> 11,913 11,913
<PP&E> 30,606 30,606
<DEPRECIATION> 8,152 8,152
<TOTAL-ASSETS> 36,387 36,387
<CURRENT-LIABILITIES> 23,630 23,630
<BONDS> 0 0
0 0
0 0
<COMMON> 98 98
<OTHER-SE> 55,276 55,276
<TOTAL-LIABILITY-AND-EQUITY> 36,387 36,387
<SALES> 0 0
<TOTAL-REVENUES> 18,846 34,564
<CGS> 0 0
<TOTAL-COSTS> 9,991 18,861
<OTHER-EXPENSES> 16,296 47,477
<LOSS-PROVISION> 837 1,974
<INTEREST-EXPENSE> 444 951
<INCOME-PRETAX> (7,750) (16,129)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (7,441) (15,478)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (7,750) (16,129)
<EPS-PRIMARY> (0.80) (1.71)
<EPS-DILUTED> (0.80) (1.71)
</TABLE>
