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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE
FISCAL YEAR ENDED DECEMBER 31, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE
TRANSITION PERIOD FROM TO
Commission file number 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)
(818) 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
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. X
---
The aggregate market value of the Registrant's outstanding Common Stock held
by non-affiliates of the Registrant on March 14, 1997 was $43,765,357. There
were 9,675,510 shares of Common Stock outstanding as of March 14, 1997.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Stockholders to be held on May 22, 1997 are incorporated by reference in Part
III hereof.
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EARTHLINK NETWORK, INC.
Annual Report on Form 10-K
For the Fiscal Year Ended December 31, 1996
TABLE OF CONTENTS
PART I
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<S> <C> <C>
Item 1. Business.................................... 1
Item 2. Properties.................................. 8
Item 3. Legal Proceedings........................... 9
Item 4. Submission of Matters to a vote of
Security-Holders.......................... 9
Part II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters............... 10
Item 6. Selected Financial Data..................... 10
Item 7. Management's Discussion and Analysis of
Financial Condition and Result of
Operations................................ 11
Item 8. Financial Statements and Supplementary
Data...................................... 17
Item 9. Changes in and Disagreements with
Accountants on Accounting and Financial
Disclosure................................. 17
Part III
Item 10. Directors and Executive Officers of the
Registrant................................. 18
Item 11. Executive Compensation...................... 18
Item 12. Security Ownership of Certain Beneficial
Owners and Management..................... 18
Item 13. Certain Relationships and Related
Transactions.............................. 18
Part IV
Item 14. Exhibits, Financial Statements and Reports
on Form 8-K................................ 19
SIGNATURES............................................ 23
INDEX OF FINANCIAL STATEMENTS......................... F-1
EXHIBIT INDEX......................................... E-1
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This Report on Form 10-K contains forward-looking statements that involve
risks and uncertainties. Actual events and results could differ materially from
those anticipated in these forward-looking statements as a result of certain
factors.
PART I
ITEM 1. BUSINESS.
OVERVIEW
EarthLink Network, Inc. ("EarthLink" or the "Company") is an Internet
service provider ("ISP") that was formed to help users derive meaningful
benefits from the extensive resources of the Internet. The Company focuses on
providing access, information, assistance and services to its customers to
encourage their introduction to the Internet and to help them have a
satisfying user experience. The Company was incorporated in 1994 as a
California corporation and was reincorporated in 1996 under the laws of
Delaware.
The Company provides its services through its EarthLink Network TotalAccess
software package, which is designed to simplify access to the Internet through
an online registration feature and a "point and click" graphical user interface.
This software permits users to browse the Internet through use of Netscape
Navigator or Microsoft Explorer (one or the other of which is included in each
copy of TotalAccess), or any other third-party browser that a customer may wish
to use. The Company also provides useful information to its users through its
extensive World Wide Web site. On this site, a user can find technical
assistance information, an on-line newsletter, links to numerous popular
categories of information and entertainment and many other items and services
designed to enhance users' satisfaction with their Internet experience. In
addition, the Company provides a bi-monthly printed newsletter to its customers,
a booklet entitled "Getting the Most Out of EarthLink" and 24 hour customer and
technical support.
The Company markets its services through print advertisements, an affinity
marketing program, a customer referral program and other marketing activities.
Its affinity marketing programs include relationships with, among others,
prominent print publication, software and hardware companies. Customer referrals
have also been an important source of new customers, and the Company provides
economic incentives to its customers to encourage referrals.
EarthLink also offers business services, including business Web sites,
high-speed ISDN communications capability and frame relay connectivity. In
addition, the Company offers consumer services such as multiplayer Internet
games and the EarthLink online store.
STRATEGY
The principal components of EarthLink's growth strategy are as follows:
RAPIDLY EXPAND ITS CUSTOMER BASE. EarthLink believes that a key to success
in the competitive ISP market is to expand its customer base as rapidly as
possible to establish a significant revenue base, thereby enhancing its ability
to enter into favorable arrangements with affinity marketing partners and
providers of content, network access and software enhancements. The Company
plans to devote significant effort and financial resources on sales and
marketing. The Company also plans to continue print advertising in major
computer magazines, expand its radio advertising program, seek to expand its
affinity marketing program, maintain a presence at national, regional and local
trade shows and continue to offer economic incentives to customers who refer new
customers.
RETAIN THE COMPANY'S EXISTING CUSTOMERS. The sales, marketing and other
costs to the Company of acquiring new customers are substantial relative to the
monthly fee derived from such customers. Accordingly, the Company believes that
its long-term success largely depends on maintaining customer satisfaction with
its services. EarthLink plans to devote significant resources to enhancing its
network operations capability,
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its World Wide Web site and its service offerings. In addition, the Company
will continue to expand its technical support staff and enhance the staff's
effectiveness by implementing a new call center and providing software tools
that can assist the staff in identifying and solving customer problems.
DEVELOP ADDITIONAL SERVICE OFFERINGS. EarthLink recognizes that the
introduction of additional service offerings can serve not only to expand and
maintain its customer base, but also, in certain instances, to enhance revenues.
Accordingly, the Company has introduced a variety of services for business
consumers, including business Web sites, high-speed ISDN communications
capability and frame relay connections, each of which involve a monthly service
charge plus set-up fees. The Company also plans to expand its service offerings
for consumers, including personalized start pages, chat and multiplayer Internet
games.
FOCUS ON CUSTOMER NEEDS. EarthLink seeks to help its customers derive
meaningful benefits from the extensive resources of the Internet. In order to
maintain its focus on customer 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 software developers. 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 customers' experience with the
Internet.
EARTHLINK'S SERVICES
EarthLink provides a variety of competitively-priced Internet services to
consumer and business customers. The Company makes these services available
through its EarthLink Network TotalAccess software package. This software
incorporates a telephone dialer and email functionality with several leading
third-party Internet access tools, including either Netscape Navigator or
Microsoft Explorer, thereby providing a functional, easy-to-use Internet access
solution for Windows 3.1, Windows 95 and Macintosh platforms. EarthLink Network
TotalAccess installation software automatically installs these and other
software applications on the customer's computer. The simple point-and-click
functionality of EarthLink Network TotalAccess, combined with its easy-to-use
registration module, permits online credit card registration, allowing new
EarthLink customers to quickly access the Internet.
The prices quoted below are subject to change.
STANDARD EARTHLINK NETWORK INTERNET SERVICES. EarthLink provides its
customers with a core set of features through its standard Internet service,
which provides unlimited access to the Internet as well as the other features
and services for a flat monthly fee of $19.95 and a one-time setup fee of $25.
The following functionalities are included in the standard EarthLink service:
INTERNET ACCESS. EarthLink provides customers with direct high-speed access
to the Internet and the World Wide Web in a manner that is designed to be
reliable and easy to use.
EARTHLINK NETWORK WEB SITE. EarthLink has developed and maintains its own
Web site containing EarthLink content and links to third-party content.
EarthLink's in-house staff actively seeks out interesting content from across
the World Wide Web and categorizes it into subject areas of interest organized
on the EarthLink Web site under topics such as "What's Hot," "Hollywood,"
"News," "Finance" and "Games." The Company's Web site provides a road map to
volumes of information and services available on the Internet. A user can browse
the site and click on topics of interest in order to link to desired
information. In addition, through search engines and the embedded functionality
of Netscape Navigator or Microsoft Explorer, a user can conduct customized
searches for other topics.
EMAIL. Each customer is provided a mailbox, or address, from which to send
and receive email. Email functionality allows customers to exchange an unlimited
number of multimedia text, graphics, audio and video messages with other
EarthLink customers as well as with non-EarthLink Internet users.
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PERSONAL WEB SITES. Each EarthLink customer is provided two megabytes of
disk space on the Company's Web server to create his or her own Web home page.
This enables each customer to participate in the Internet community by
personally adding content to the World Wide Web.
PUBLICATIONS. EarthLink publishes bLink, a bi-monthly newsletter, which it
mails to each of its customers. Through this publication, the Company provides
its customers with useful information, such as tips on how to search for certain
categories of information on the Internet and information regarding new
EarthLink service offerings, new Internet sites and other items of interest.
This publication is also available as an online feature, updated daily, on the
EarthLink home page. Additionally, the Company's founder, Sky Dayton, has
authored and published a booklet entitled "Getting the Most Out of EarthLink,"
which the Company provides its new customers subscribing through dial-up sales
and provides to all other customers upon request.
CHAT. Chat enables customers to "talk" with one another in typed text in
real time, one-on-one or in groups known as chat rooms.
PREMIUM EARTHLINK NETWORK SERVICES. In addition to its standard service,
the Company offers a variety of premium services, including the following:
BUSINESS WEB SITES. The Company provides space on its Web server for
commercial customers to publish their own Web pages. Monthly fees for business
Web sites range from $89 to $439, plus one-time setup fees of $179 to $479,
depending on the size of the site and whether the site is a shared or unique
address. Each option is also available with an audio feature for an additional
charge. Additional charges, based on the volume of users accessing a site, may
apply.
ISDN CAPABILITY. EarthLink offers high-speed ISDN Internet access
communication lines on a nationwide basis. ISDN provides a faster, more
efficient method for communicating digital data over telephone lines. ISDN
speeds are significantly faster than conventional modem speeds (up to 128 Kbps
versus up to the current maximum of 33.6 Kbps). The monthly ISDN service charge
is $35 for the first 100 channel hours and $1 for each additional channel hour.
A one-time setup fee of $50 is also charged.
FRAME RELAY CAPABILITY. Frame relay enables direct, high-speed continuous
connection of an organization's internal local area network to the Internet
using dedicated circuits at speeds ranging from 56 Kbps to 1,536 Kbps. This
service enables businesses to connect an entire local area network or high-end
workstation to the Internet and provides the fastest data transfer rate
generally available. Frame relay service fees range from $335 to $1,675 per
month depending on access speeds, data throughput and other data transfer
metrics. One-time setup fees range from $495 to $1,995.
MULTIPLAYER INTERNET GAMES. The Company recently introduced The Arena, a
multiplayer Internet games service that allows EarthLink and non-EarthLink users
to play multimedia games through the EarthLink Network for an hourly fee. The
Company creates an incentive for non-EarthLink users to subscribe to EarthLink
by charging them a slightly higher fee to participate in The Arena.
SUPPLEMENTAL SERVICES. To augment its standard and premium services, the
Company provides its customers with the following supplemental services:
ADDITIONAL MAILBOXES. The Company provides additional mailboxes for a per
mailbox setup fee of $9.95 and a monthly service fee of $4.95 for those
customers who require more than one mailbox for colleagues, employees or family
members.
DOMAIN NAME REGISTRATION. EarthLink provides unique domain names for
those customers who prefer an individualized address. Instead of
"[email protected]," the user Joe Smith may prefer the name
"[email protected]." Or a business user may find greater marketing presence by
having a domain name in the name of his business, such as "[email protected]."
EarthLink charges $75 to assist in establishing unique
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domain names for customers. Customers then pay an annual renewal fee to an
Internet domain registration agency.
800 SERVICE. EarthLink provides 800 number dial-up service for customers
who do not have access to a local POP. EarthLink charges customers $24.95 per
month for five hours of 800 number service plus a one-time setup fee of
$25.00. Additional hours are $4.95 per hour.
TECHNICAL DEVELOPMENT AND SERVICE ENHANCEMENT
EarthLink places significant emphasis on expanding and refining its services
to enhance its customers' Internet experience. EarthLink's technical staff is
engaged in a variety of technical development and service enhancement
activities, including improvement of the functionality of the Company's
EarthLink Network TotalAccess software and reviewing new third-party software
products for potential incorporation into TotalAccess. EarthLink also regularly
updates and expands the online services provided through the EarthLink Web site.
These activities include organizing Web content and the development of online
guides, help screens and other user services.
The Company anticipates the near-term release of the following services:
PERSONALIZED START PAGE. When customers "sign on" to EarthLink, they
generally begin their Internet session at the EarthLink home page and proceed
from there to the other sites and services of their choice. A "personalized
start page," which the Company plans to introduce in early 1997, will allow
customers to customize the page that first appears when they log on to the
EarthLink Network. For example, a customer may include short-cuts to favorite
Web sites, find advertisements targeted to the customer's interests
automatically displayed, change the "look and feel" of the start page and
otherwise tailor the start page to accommodate his or her personal preferences.
PREMIUM SERVICE OFFERINGS. The Company is engaged in ongoing efforts to
provide its customers with access to premium services, such as the Wall Street
Journal online newspaper and the ESPN sports service. The Company intends to
bundle these third-party premium services in packages and offer them to its
customers at discounted rates. These services will be billed directly to the
user's EarthLink account rather than separately by the provider of the premium
services, and will not require EarthLink customers to establish separate user
names and passwords to access the premium services.
ONLINE COMMERCE. The Company recently opened the EarthLink online store,
which offers EarthLink branded merchandise that online shoppers may purchase by
placing an order through the EarthLink Network via an online credit card
transaction. The Company intends to further develop its systems for offering
electronic retail services by establishing an online mall through which it can
"lease space" to businesses to advertise and sell their products and services.
MARKETING
As of December 31, 1996, the Company marketed and sold its services through
its sales and marketing department comprised of 113 employees. EarthLink's sales
and marketing efforts consist of the following programs:
ADVERTISING. The Company advertises its services in print media and on
radio. Included in the advertisement is a toll-free 800 number to contact the
Company's internal sales staff. When a potential customer calls the Company's
sales staff, the customer is assigned a user name and password. Subsequently,
the new customer is sent a copy of EarthLink Network TotalAccess, which the
customer uses to log on to the Company's system.
AFFINITY MARKETING PROGRAM. EarthLink's affinity marketing program promotes
the Company through the distribution of the EarthLink Network TotalAccess
software package by its affinity marketing partners. These
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partners typically bundle EarthLink Network TotalAccess disks with their own
goods or services. Marketing partners include MacMillan Publishing USA,
Activision, Inc., Micro Warehouse Incorporated, Adobe Systems, Inc., United
Airlines, Inc., Iomega Corp., CompUSA, Inc. and Best Buy Co., Inc.
A significant number of EarthLink's customers have been generated through
its relationships with its affinity marketing partners, and the Company
believes that its affinity marketing relationships will continue to account
for a significant number of new customers. There can be no assurance,
however, that the Company's current affinity marketing partners will continue
to distribute the Company's software or will continue to generate new
customers for the Company's services. The Company's inability to maintain its
affinity marketing relationships or establish new affinity marketing
relationships could result in delays and increased costs in expanding its
customer base, which could, in turn, have a material adverse effect on the
Company.
CUSTOMER REFERRAL PROGRAM. The Company believes that one of its most
important marketing tools is its existing customers. In order to encourage
customers to refer other users, the Company currently waives one month of
service fees per referred customer.
OTHER MARKETING ACTIVITIES. EarthLink maintains a presence at national
trade shows such as MacWorld and OnLine Expo, as well as local and regional
trade shows. Additionally, the Company markets through computer, Internet and
related publications, and bundles EarthLink Network TotalAccess with a few of
these publications, either as disks that contain only the EarthLink Network
TotalAccess software package or as CD-ROMs that may include numerous other
software applications.
CUSTOMERS, POPS AND NETWORK INFRASTRUCTURE
The Company presently provides its customers with Internet access primarily
through UUNET's nationwide system of POPs. Substantially all of the Company's
customers access the EarthLink Network and the Internet by dialing into local
POPs. Of these, as of March 14, 1997, the Company owned 18 POP sites in
California and offered additional access through 336 UUNET POPs and 225 PSINet
POPs. Access to the UUNET and PSINet POPs is on a non-exclusive basis.
For customers located in a geographic area not presently serviced by a local
POP, the EarthLink Network can be accessed by a toll-free number for which the
Company bills customers on an hourly usage basis. The Company's POP sites are
connected to the Internet primarily through its network hub in Los Angeles. The
Company's network hub is in turn connected directly to the Internet via leased
high-speed fiber optic data lines. The Company is in the process of relocating
its network hub from Los Angeles to Pasadena.
The Company does not presently maintain redundant or backup Internet
services or backbone facilities or other redundant computing and
telecommunication facilities. Any accident, incident or system failure that
causes interruptions in the Company's operations could have a material adverse
effect on the Company's ability to provide Internet services to its customers,
and, in turn, on the Company.
CUSTOMER AND TECHNICAL SUPPORT
The Company believes that reliable customer and technical support is
critical to retaining existing and attracting new customers. The Company
currently provides the following types of customer and technical support: (i)
toll-free, live telephone assistance available seven days a week, 24 hours a
day; (ii) email-based assistance available seven days a week, 24 hours a day;
(iii) help sites and Internet guide files on the EarthLink Web site; (iv)
automated "fax back" and "fax on demand" assistance; and (v) printed reference
material. Additionally, the Company provides dedicated support for its business
customers.
In order to continue to improve its support services and to deliver those
services in a more timely and cost-effective manner, the Company is currently
expanding its call center facilities and installing new call management database
software. The Company has also installed new call center hardware and software.
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The Company's growth has placed, and is expected to continue to place, a
significant strain on its managerial, operational, financial and information
system resources. Demand on the Company's network infrastructure, technical
staff and resources has grown rapidly with the Company's expanding customer
base, and the Company has experienced difficulties satisfying the demand for its
Internet services. There can be no assurance that the Company's infrastructure,
information systems, technical staff and resources will be adequate to
facilitate the Company's growth.
SUPPLIER RELATIONSHIPS
The Company is dependent on certain third-party suppliers of hardware
components. Certain components used by the Company in providing its network
services are currently acquired from limited sources. The Company also depends
on third-party software vendors to provide the Company with much of its Internet
software, including Netscape Navigator and Microsoft Explorer, the World Wide
Web browser software that the Company licenses from Netscape Communications
Corporation ("Netscape") and Microsoft Corporation ("Microsoft"), respectively.
Failure of the Company's suppliers to provide components and products in the
quantities, at the quality levels or at the times required by the Company, or an
inability by the Company to develop alternative sources of supply if required,
could materially adversely affect the Company's ability to effectively support
the growth of its customer base in a timely manner and result in delays in and
increase its costs of expansion. Moreover, because Netscape Navigator and
Microsoft Explorer are the two most widely used Web browsers, the failure of
Netscape or Microsoft to continue to provide World Wide Web browser software to
the Company could have a material adverse effect on the Company.
COMPETITION
The Internet services market in which the Company operates is extremely
competitive, and the Company expects competition in this market to intensify in
the future. The Company's current and prospective competitors include many large
companies that have substantially greater market presence and financial,
technical, marketing and other resources than the Company. The Company competes
(or in the future is expected to compete) directly or indirectly with the
following categories of companies: (i) national and regional ISPs, such as BBN,
IDT, MindSpring, NETCOM, PSINet and UUNET; (ii) established online services such
as America Online, CompuServe, Prodigy and the Microsoft Network; (iii) computer
software and technology companies such as Microsoft; (iv) national
telecommunications companies, such as AT&T, MCI and Sprint; (v) regional Bell
operating companies ("RBOCs"); (vi) cable operators, such as Comcast, TCI and
Time Warner; and (vii) nonprofit or educational ISPs.
The entry of new participants from these categories and the potential entry
of competitors from other categories (such as computer hardware manufacturers)
would result in substantially greater competition for the Company. The ability
of these competitors or others to bundle services and products with Internet
connectivity services could place the Company at a significant competitive
disadvantage. In addition, competitors in the telecommunications industry may be
able to provide customers with reduced communications costs in connection with
their Internet access services, reducing the overall cost of Internet access and
significantly increasing pricing pressures on the Company. Among other
competitors who have recently introduced or enhanced their Internet offerings,
AT&T has recently expanded its Internet services offerings. The Company believes
that AT&T's expansion has substantially increased pricing pressure in the
industry. In addition, certain of the Company's online competitors, including
America Online, the Microsoft Network and Prodigy, have recently introduced
unlimited access to the Internet and their proprietary content at flat rates
that are equal to the Company's monthly flat rate, and do not require a set-up
fee. Certain of the RBOCs have also introduced competitive flat-rate pricing for
unlimited access (without a set-up fee for at least some period of time). As a
result, competition for active users of Internet services has intensified. There
can be no assurance that the Company will be able to offset the adverse effect
on revenues of any necessary price reductions resulting from competitive pricing
pressures by increasing the number of its customers, by generating higher
revenue from enhanced services, by reducing costs or otherwise.
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The Company believes that its ability to compete successfully in the
Internet services market depends on a number of factors, including market
presence; the adequacy of the Company's customer and technical support
services; the capacity, reliability and security of its network
infrastructure; the ease of access to and navigation of the Internet provided
by the Company's services; the pricing policies of the Company, its
competitors and its suppliers; the timing of introductions of new services by
the Company and its competitors; the Company's ability to support existing
and emerging industry standards; and industry and general economic trends.
There can be no assurance that the Company will have the financial resources,
technical expertise or marketing and support capabilities to compete
successfully.
PROPRIETARY RIGHTS
GENERAL. The Company believes that its success is dependent in part on
its technology and its continuing right to use such technology. The Company
relies on a combination of copyright, trademark and trade secret laws and
contractual restrictions to establish and protect its technology. It is the
Company's policy to require employees and consultants and, when possible,
suppliers to execute confidentiality agreements upon the commencement of
their relationships with the Company. There can be no assurance that the
steps taken by the Company will be sufficient to prevent misappropriation of
its technology and other proprietary property or that the Company's
competitors will not independently develop technologies that are
substantially equivalent or superior to the Company's technology.
There can be no assurance that third parties will not assert that
EarthLink's services infringe their proprietary rights. From time to time, the
Company has received communications from third parties alleging that certain of
the names or marks for the Company's services infringe the trademarks of such
third parties. To date, no such claims have had an adverse effect on the
Company's ability to market and sell its services. However, there can be no
assurance that those claims will not have an adverse effect in the future or
that other parties will not assert infringement claims against the Company in
the future with respect to current or future services. Such claims could result
in substantial costs and diversion of resources even if ultimately decided in
favor of the Company and could have a material adverse effect on the Company,
particularly if judgments on such claims are adverse to the Company. In the
event a claim is asserted alleging that the Company has infringed the
intellectual property or information of a third party, the Company may be
required to seek licenses to continue to use such intellectual property. There
can be no assurance, however, that such licenses would be offered or obtained on
commercially reasonable terms, if at all, or that the terms of any offered
licenses will be acceptable to the Company. The failure to obtain the necessary
licenses or other rights could have a material adverse effect on the Company.
LICENSES. EarthLink has obtained authorization, typically in the form of a
license, to distribute third-party software incorporated in the EarthLink
Network TotalAccess software product for Windows 3.1, Windows 95 and Macintosh
platforms. Applications licensed by the Company include Netscape Navigator (the
initial term of the license for which expires in December 1997 and thereafter
automatically renews for additional one-year terms unless either party
terminates the license on 120 days notice), Microsoft Explorer (the initial term
of the license for which expires in August 1998 and thereafter automatically
renews for additional one-year terms, although either party may terminate the
license at any time on 30 days notice), and MacTCP software from Apple (the
current term of the license for which expires on December 31, 1997 thereafter
and automatically renews for additional one-year terms unless either party
terminates the license on twelve-month notice). The only software in the
EarthLink Network TotalAccess package that is developed by the Company is the
front-end program and the installation/registration program. The Company
currently intends to maintain or negotiate renewals of existing software
licenses and authorizations. The Company may want or need to license other
applications in the future. The failure to renew existing software licenses and
authorizations or license other applications could have a material adverse
effect on the Company.
TRADEMARKS. "EarthLink Network-Registered Trademark-," "EarthLink Network
TotalAccess ," "bLink ," "The Arena " and the EarthLink logo are trademarks of
the Company. This Prospectus includes trademarks of companies other than the
Company.
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GOVERNMENT REGULATION
The Company provides Internet services, in part, through data transmissions
over public telephone lines. These transmissions are governed by regulatory
policies establishing charges and terms for wire line communications. The
Company currently is not subject to direct regulation by the Federal
Communications Commission (the "FCC") or any other governmental agency, other
than regulations applicable to businesses generally. However, in the future the
Company could become subject to regulation by the FCC or another regulatory
agency as a provider of basic telecommunications services. For example, a number
of long distance telephone carriers recently filed a petition with the FCC
seeking a declaration that Internet telephone service is a "telecommunications
service" subject to common carrier regulation. Such a declaration, if enacted,
would create substantial barriers to the Company's entry into the Internet
telephone market. The FCC has requested comments on this petition, but has not
set a deadline for issuing a final decision. Also, a number of local telephone
companies have asked the FCC to levy access charges on "enhanced service
providers," which may be deemed to include ISPs. Although the Chairman of the
FCC has indicated his opposition to levying service charges against ISPs, local
interconnection charges could be levied in the future. Moreover, the public
service commissions of certain states are exploring the adoption of regulations
that might subject ISPs to state regulation.
The recently enacted Telecommunications Act of 1996 (the "Telecommunications
Act") contains certain provisions that lift, or establish procedures for
lifting, certain restrictions relating to the RBOCs' ability to engage directly
in the Internet access business. The Telecommunications Act also makes it easier
for national long distance carriers such as AT&T to offer local telephone
service. In addition, the Telecommunications Act allows the RBOCs to provide
electronic publishing of information and databases. Competition from these
companies could have an adverse effect on the Company's business. The
Telecommunications Act also imposes fines on any entity that knowingly (i) uses
any interactive computer service or telecommunications device to send obscene or
indecent material to minors; (ii) makes obscene or indecent material available
to minors via an interactive computer service; or (iii) permits any
telecommunications facility under such entity's control to be used for the
purposes detailed above. The standard for determining whether an entity acted
"knowingly" has not yet been established, although a federal district court
panel recently issued a preliminary injunction preventing enforcement of this
part of the Telecommunications Act. This decision has been appealed.
Due to the increasing use of the Internet, it is possible that additional
laws and regulations may be adopted with respect to the Internet, covering
issues such as content, user privacy, pricing, libel, intellectual property
protection and infringement and technology export and other controls. Changes in
the regulatory environment relating to the Internet access industry, including
regulatory changes that directly or indirectly affect telecommunications costs
or increase the likelihood or scope of competition from regional telephone
companies or others, could have a material adverse effect on the Company.
EMPLOYEES
As of December 31, 1996, the Company employed 593 people on a full-time
basis, including 107 sales and marketing personnel, 400 operations and customer
and technical support representatives and 86 administrative personnel. As of
that date, the Company also employed 28 people on a part-time basis, most of
whom serve as telephone customer and technical support representatives. None of
the Company's employees are represented by a labor union, and the Company is not
a party to any collective bargaining agreement.
ITEM 2. PROPERTIES.
EarthLink's corporate headquarters are located in an 85,500-square foot
facility in Pasadena, California. The lease for this space expires June 30, 2001
and currently provides for rental payments of approximately $46,000 per month.
The Company has an option to extend this lease for an additional five
years at the then prevailing market rate. In addition to the Company's corporate
headquarters, the Company also leases approximately 7,200 square feet of office
space in Los Angeles that presently houses the Company's data center.
8
<PAGE>
The lease for this space expires July 31, 1999 and currently provides for
rental payments of approximately $10,000 per month. EarthLink has signed a
lease for an additional 55,000 square feet in a facility located adjacent to
its corporate headquarters in which it plans to house its data center. The
Company commenced occupation of this new space in February 1997 for an
initial ten-year term at a rent of $66,000 per month for the first 60 months
and $77,000 per month for the remaining 60 months. The Company began
migrating its data center to this new facility in March 1997. The Company has an
option to extend this lease for an additional ten years at the then prevailing
market rate. The Company leases or is otherwise provided with the right to
utilize space in various geographic locations to co-locate the
telecommunications equipment for each of its POPs.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not currently involved in any legal proceedings that it
believes could have, either individually or in the aggregate, a materiel adverse
effect on its business or financial condition. There are proceedings pending
before the FCC that could affect the ISP industry and the means by which ISPs
such as the Company conduct their business. See "Business--Government
Regulation." The Company is not a party to these proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
In connection with its initial public offering, the Company called and
held a special meeting of its stockholders to (i) approve a one-for-two
combination of its issued and outstanding shares of Common Stock, and (ii)
amend certain provisions of its Statement of Designations, Rights and
Preferences of its Series A Convertible Preferred Stock to facilitate its
initial public offering. Voting both by proxy and by attendance at the
meeting, 11,270,157 shares of Common Stock were voted "for" the stock
combination and the amendment and 2,651,818 shares of Series A Convertible
Preferred Stock were voted "for" the stock combination and the amendment. No
shares of either class of stock were voted "against" either matter. 775,308
shares of Common Stock and 75,455 shares of Series A Convertible Preferred
Stock were not voted. Both proposals passed.
9
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock trades under the symbol "ELNK" on the NASDAQ
National Market. During the first quarter of fiscal 1997 (beginning January 22,
1997, the date of the Company's initial public offering), the high sales price
of the Common Stock was 17 3/4 and the low sales price of the Common Stock was
13. On March 14, 1997, there were approximately 129 holders of record of the
Company's Common Stock.
The Company has not paid any dividends since its inception and does not
intend to pay any dividends in the foreseeable future. The payment of future
cash dividends, if any, will be at the sole discretion of the Board of
Directors.
ITEM 6. SELECTED FINANCIAL DATA.
The following selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Financial Statements and Notes thereto included elsewhere
in this Report.
<TABLE>
<CAPTION>
INCEPTION
(MAY 26, 1994)
THROUGH YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
STATEMENT OF OPERATIONS DATA: 1994 1995 1996
- --------------------------------------------------------------------- --------------- ------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA AND PERCENTAGES)
<S> <C> <C> <C>
Revenues:
Recurring revenues................................................. $ 53 $ 2,422 $ 26,879
Other revenues..................................................... 58 606 5,624
------ ------------ ------------
Total Revenues................................................... 111 3,028 32,503
Operating costs and expenses:
Cost of recurring revenues......................................... 4 1,055 18,462
Cost of other revenues............................................. 12 349 2,699
Sales and marketing................................................ 37 3,711 15,258
General and administrative......................................... 168 2,062 10,534
Operations and customer support.................................... 38 1,869 15,808
------ ------------ ------------
Total operating costs and expenses............................... 259 9,046 62,761
------ ------------ ------------
Loss from operations................................................ (148) (6,018) (30,258)
Interest expense.................................................... -- (136) (1,041)
Interest income..................................................... -- 34 150
------ ------------ ------------
Net loss......................................................... $ (148) $ (6,120) $ (31,149)
------ ------------ ------------
------ ------------ ------------
Net loss per share (1).............................................. $ (0.04) $ (1.25) $ (4.50)
------ ------------ ------------
------ ------------ ------------
Weighted average shares............................................. 3,653 4,903 6,920
</TABLE>
10
<PAGE>
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1994 1995 1996
--------------- ------------ ------------
<S> <C> <C> <C>
Balance Sheet Data:
Working capital (deficit)............................................ $ (62) $ (1,976) $ (19,206)
Total assets......................................................... 186 4,874 27,119
Long-term debt....................................................... -- 355 6,088
Total liabilities.................................................... 89 4,584 34,367
Accumulated deficit.................................................. (148) (5,007) (36,156)
Total stockholders' equity........................................... $ 97 $ 290 $ (21,261)
Other Data:
Fixed asset expenditures
% to sales.......................................................... 87% 91% 58%
Sales and Marketing
% to sales.......................................................... 33% 122% 47%
</TABLE>
- ------------------------
(1) See Note 1 of Notes to Financial Statements for an explanation of the
determination of the number of weighted average shares outstanding used in
the net loss per share computation.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
(Tabular data presented herein is in thousands, except for per share data
and percentages.)
<TABLE>
<CAPTION>
PERCENT PERCENT PERCENT
OF TOTAL OF TOTAL OF TOTAL
1994 REVENUE 1995 REVENUE 1996 REVENUE
--------- ----------- --------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Total Revenues........................... $ 111 100% 3,028 100% 32,503 100%
Total Cost of Revenue.................... 16 14% 1,404 46% 21,161 65%
Gross Margin............................. 95 86% 1,624 54% 11,342 35%
Net loss................................. $ (148) -133% $ (6,120) -202% $(31,149) -96%
</TABLE>
The Company was founded in May 1994 and began offering its services in July
1994. Accordingly, the Company has only a limited operating history upon which
an evaluation of its prospects can be made. Such prospects must be considered in
light of the substantial risks, expenses and difficulties encountered by new
entrants into the Internet services industry. The Company has experienced net
losses since it commenced operations and had net losses of approximately $6.3
million from inception through 1995 and of approximately $31.1 million for the
year ended December 31, 1996. As of December 31, 1996, the Company had an
accumulated deficit of approximately $36.1 million (exclusive of $1.3 million of
losses incurred while the Company was an S Corporation for tax purposes, which,
upon the Company's conversion to C Corporation status in June 1995, were charged
to the Company's capital accounts). The Company expects that it will continue to
incur net losses as it continues to expend substantial resources on sales,
marketing and administration, build its infrastructure, develop new service
offerings and improve its management information systems. There can be no
assurance that the Company will achieve or sustain profitability or positive
cash flow from its operations.
The Company's principal strategy is to expand rapidly and retain its
customer base. To realize this strategy, the Company continues to increase its
investment in sales and marketing. Also, the Company plans to add administrative
infrastructure, increase customer and technical support capability and build
network infrastructure to meet customer demand. The sales and marketing and
other costs to the Company of acquiring new customers are substantial relative
to the monthly fee derived from such customers. Accordingly, the
11
<PAGE>
Company's long-term success depends largely upon its ability to retain its
existing customers, while continuing to attract new customers.
The Company continues to invest significant resources in its
infrastructure and customer and technical support capabilities. However,
there can be no assurance that such investment will improve customer
retention. Because the Internet services market is new and the variety of
available services is not well understood by new and potential customers, it
is difficult, if not impossible, for the Company to predict future customer
retention rates. Moreover, intense competition from competitors, some of whom
offer many free hours of services for new customers, have most likely caused,
and may continue to cause, some of the Company's customers to switch to a
competitor's service. In addition, a certain number of new Internet users
experience the Internet only as a novelty and do not become consistent users
of Internet services. These factors adversely affect the Company's customer
retention rates. Any decline in customer retention rates would have a
material adverse effect on the Company.
The market for the Company's services has only recently begun to develop,
is rapidly evolving and is characterized by an increasing number of market
entrants who have introduced new services for access to the Internet. The
Company and its prospects must be considered in light of the risks, expenses
and difficulties frequently encountered by companies in the new and rapidly
evolving market for Internet services and products. To address these risks,
the Company must, among other things, continue to attract, retain and
motivate qualified persons, and continue to upgrade its infrastructure,
including its information systems, technologies and services. There can be no
assurance that the Company will be successful in addressing such risks.
RESULTS OF OPERATIONS
Revenues.
<TABLE>
<CAPTION>
INCEPTION
(MAY 26, 1994) PERCENT PERCENT PERCENT
THROUGH OF TOTAL OF TOTAL OF TOTAL
DECEMBER 31, 1994 REVENUE 1995 REVENUE 1996 REVENUE
------------------- ----------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Recurring revenues............. $ 53 48% $ 2,422 80% $ 26,879 83%
Other revenues................. 58 52% 606 20% 5,624 17%
--------- -------- ---------
Total Revenues................. $ 111 100% $ 3,028 100% $ 32,503 100%
--------- -------- ---------
--------- -------- ---------
</TABLE>
Recurring revenues consist of monthly fees charged to customers for Internet
access and other ongoing services. Other revenues generally represent one-time
setup fees. Recurring revenues are recognized over the period for which the
services are performed. The increase in recurring revenues in 1995 as compared
to the Inception Period is primarily attributable to the Company being
operational for the full year in 1995 and an increase in the number of customers
during that period. Revenues for the year ended December 31, 1996 increased over
revenues for the year ended December 31, 1995 as a result of an increase in the
number of customers. The increase in revenues was partially offset by credits
given to customers under the Company's customer referral program. Under this
program, the Company waives one month of service fee in consideration for each
new customer referred by an existing customer. This waived service fee results
in a reduction to revenue. The increase in other revenues for 1995 as compared
to the Inception Period is primarily attributable to an increase in the number
of customers added in 1995 and one-time set-up fees collected from customers.
Other revenues for the year ended December 31, 1996 increased over other
revenues in the year ended December 31, 1995 as a result of an increase in the
number of new customers during that period and one-time set-up fees collected
from customers. From time to time, the Company waives the one-time set-up fee it
charges new customers. As competition in the ISP market intensifies, the Company
may find it necessary to waive the
12
<PAGE>
one-time set-up fee to remain competitive. Therefore, revenues from the
one-time set-up fee are expected to decrease in future periods.
Cost of revenues.
<TABLE>
<CAPTION>
INCEPTION
(MAY 26, 1994) PERCENT PERCENT PERCENT
THROUGH OF RECURRING OF RECURRING OF RECURRING
DECEMBER 31, 1994 REVENUE 1995 REVENUE 1996 REVENUE
----------------------- ----------------- --------- ----------------- --------- ------------
<S> <C> <C> <C> <C> <C> <C>
Cost of recurring revenue.... $ 4 8% $ 1,055 44% $18,462 69%
</TABLE>
<TABLE>
<CAPTION>
INCEPTION
(MAY 26, 1994) PERCENT PERCENT PERCENT
THROUGH OF OTHER OF OTHER OF OTHER
DECEMBER 31, 1994 REVENUE 1995 REVENUE 1996 REVENUE
------------------------- ---------------- --------- ---------------- --------- ------------
<S> <C> <C> <C> <C> <C> <C>
Cost of other revenue........ $ 12 21% $ 349 58% $2,699 48%
</TABLE>
Cost of revenues consists of cost of recurring revenues and cost of other
revenues. Cost of recurring revenues principally includes telecommunications
expenses and depreciation expense on equipment used in network operations for
ongoing customer services. Included in telecommunications cost are fees paid to
UUNET for local access to its nationwide system of POPs. Cost of other revenues
principally includes expenses related to the registration of new customers.
These costs include licensing fees for software, software duplication costs and
commissions paid to third parties for referring new customers to the Company.
For the year ended December 31, 1995, cost of recurring revenues increased
to approximately 44% of recurring revenues, up from 8% of recurring revenues for
the Inception Period. This increase was due to increased hourly customer usage
and the Company's expansion of its POP sites. Cost of recurring revenues for the
year ended December 31, 1996 increased to approximately 69% of recurring due to
increased hourly customer usage and the Company's expansion to nationwide
service through its relationship with UUNET. During these periods, the Company
paid UUNET a fixed monthly fee per customer plus a variable amount based on
customer usage in excess of a threshold number of hours per month. The Company's
agreement with UUNET was amended as of October 1996 such that the key variable
component is peak usage rather than hourly usage. As the Company continues to
expand, the Company anticipates that it may build and use additional
Company-owned POPs in those geographical areas where there is a sufficient
concentration of customers to support the cost of such investment.
The Company's customers generally pay a fixed monthly fee for the Company's
Internet services. 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 customer usage. The Company also pays
UUNET an additional fee to the extent that hours of usage exceed a formula set
forth in the agreement. The Company has recently experienced increasing per
customer usage of its services. If the number of hours used by EarthLink
customers 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. The UUNET agreement also
provides that in the event of regulatory or legislative changes having a
structural impact on the ISP marketplace which materially increase UUNET's
costs, EarthLink will renegotiate the agreement in good faith at UUNET's
request. There can be no assurance that EarthLink and UUNET will be able to
renegotiate the UUNET agreement with terms acceptable to UUNET and EarthLink or
that any renegotiation would not result in additional costs to the Company. Any
such renegotiated agreement or the failure to renegotiate the agreement could
have a material adverse affect on the Company.
As noted above, 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
13
<PAGE>
customer usage. The specified minimum amount increases over the term of the
agreement. The Company's operating margins could be adversely affected if the
Company is unable to increase its customer base so as to avoid paying the
increasing minimum amount.
Sales and marketing.
<TABLE>
<CAPTION>
INCEPTION
(MAY 26, 1994) PERCENT PERCENT PERCENT
THROUGH OF TOTAL OF TOTAL OF TOTAL
DECEMBER 31, 1994 REVENUE 1995 REVENUE 1996 REVENUE
--------------------- ------------- --------- ----------- --------- -------------
<S> <C> <C> <C> <C> <C> <C>
Sales and marketing....... $ 37 33% $ 3,711 123% $15,258 47%
</TABLE>
Sales and marketing expenses consist primarily of sales commissions,
salaries, cost of promotional material, advertising, travel and third-party
sales commissions. EarthLink's principal strategy is to rapidly expand its
customer base and increase its market share of the under penetrated market
for Internet access services. To realize this strategy, the Company is
aggressively investing in sales and marketing. Customers increased from
approximately 27,000 at December 31, 1995 to approximately 227,000 at
December 31, 1996. This strategy requires substantial initial cash outlays
which currently outpace the resultant growth in revenues. The Company intends
to aggressively promote EarthLink's services and as a result expects further
significant increases in sales and marketing expenses in future periods. In
the latter part of 1996 EarthLink's marketing efforts emphasized the variety
of services available to business customers, including business Web sites,
high-speed ISDN communications capability, high-speed frame relay connections
and Internet access through corporate Intranets. The Company also recently
introduced the EarthLink Store, an online retailing service, and the Arena
and online multi-player gaming service
General and administrative expenses.
<TABLE>
<CAPTION>
INCEPTION
(MAY 26, 1994) PERCENT PERCENT PERCENT
THROUGH OF TOTAL OF TOTAL OF TOTAL
DECEMBER 31, 1994 REVENUE 1995 REVENUE 1996 REVENUE
------------------- ----------- --------- ------------- ------ -------------
<S> <C> <C> <C> <C> <C> <C>
General and administrative expenses... $ 168 151% $ 2,062 68% $10,534 32%
</TABLE>
General and administrative expenses consist primarily of costs associated
with the finance and accounting and human resources departments, professional
expenses, rent and expenses, principally compensation, related to certain
executive officers and bad debts. Since inception, general and administrative
expenses have increased as a result of increased employee headcount, rent and
other general and administrative expenses. During the year ended December 31,
1996, the Company hired a number of senior management personnel, moved into a
new headquarters building and engaged professional consultants to assist in the
development of an administrative infrastructure to accommodate anticipated
increases in the number of customers and employees, which resulted in a
significant increase in general and administrative expenses as compared to the
same period in 1995. General and administrative expenses for the year ended
December 31, 1996, included bad debt expense of $2.5 million resulting from
difficulties in billing customers and in disconnecting late-paying customers on
a timely basis. In addition, in September 1996, the Company issued 37,500 shares
of Common Stock as consideration for the termination of a consulting agreement.
The value of the stock, $413,000, was included in general and administrative
expenses for the year ended December 31, 1996. Management intends to implement
new information systems and continue to expand staff in order to support
anticipated customer and operational growth. As a result, the Company expects
general and administrative expenses to increase in future periods.
14
<PAGE>
Operations and customer support.
<TABLE>
<CAPTION>
INCEPTION
(MAY 26, 1994) PERCENT PERCENT PERCENT
THROUGH OF TOTAL OF TOTAL OF TOTAL
DECEMBER 31, 1994 REVENUE 1995 REVENUE 1996 REVENUE
--------------------- ------------- --------- ------------- -------- -------------
<S> <C> <C> <C> <C> <C> <C>
Operations and customer support.... $ 38 34% $ 1,869 62% $15,808. 49%
</TABLE>
Operations and customer support expenses consist primarily of expenses
associated with technical support and customer service to register and maintain
customer 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 customer base and
anticipated customer growth. The Company intends to continue to increase
expenditures for operations and customer support.
INCOME TAXES. No provision for federal or state income taxes has been
recorded as the Company incurred net operating losses through December 31, 1996.
At December 31, 1996, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $33.7 million, which begin to
expire in 2010. The Internal Revenue Code of 1986, as amended, includes
provisions that limit the net operating loss carryforwards for use in a given
year if significant ownership changes have occurred. The Company's initial
public offering resulted in an ownership change limiting the Company's ability
to utilize net operating loss carryforwards to offset future income, if any. The
Company has provided a full valuation allowance on the deferred tax asset
because of the uncertainty regarding reliability. Prior to July 1995, the
Company was taxed as an S Corporation under the Internal Revenue Code. As a
result, losses totaling approximately $2.8 million flowed directly to the
stockholders during the period and are not included in the amount of net
operating loss carryforwards.
15
<PAGE>
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
customer acquisition, customer 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 sales of equity
securities (including its initial public offering in January 1997), borrowings
from third parties and capital leases of equipment. The Company's operating
activities used net cash of approximately $3.6 million and $17.9 million during
1995 and the year ended December 31, 1996, respectively. During 1995 and the
year ended December 31, 1996, net cash used in operations resulted primarily
from net losses, partially offset by increases in trade accounts payable.
Cash used by investing activities has consisted primarily of equipment
purchases for POP and network expansion. For the year ended December 31, 1995
and the year ended December 31, 1996, capital expenditures amounted to
approximately $2.8 million and $18.8 million, respectively. The Company
estimates that capital expenditures through the end of 1997 will be
approximately $20.2 million including network enhancements, data center
expansion, 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 from financing activities provided the Company with approximately $8.2
million and $38.3 million during 1995 and 1996, respectively. The Company's
financing activities have consisted of the sale of debt and equity securities
and capital lease transactions, primarily for equipment. From inception through
December 31, 1996, the Company raised $29.6 million through the private sale of
debt and equity securities and $11.9 million relating to capital lease
obligations, respectively. Capital lease obligations generally result from the
sale and leaseback of equipment. During the year ended December 31, 1995 and the
year ended December 31, 1996, the Company financed the acquisition of data
processing and office equipment amounting to approximately $556,000 and $11.3
million, respectively, by entering into a number of agreements for the sale and
leaseback of equipment. The sale leaseback transactions are recorded at cost,
which approximates the fair market value of the property and, therefore, no
gains or losses have been 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.
As of December 31, 1995 and December 31, 1996, the Company had cash and cash
equivalents of approximately $290,000 and $2.3 million, respectively, and
negative working capital of approximately $2.0 million and $18.9 million,
respectively. During the second quarter of 1996, the Company received short-term
debt financing (issued in the form of 10% Promissory Notes) of $2.95 million
from a limited number of investors, including certain directors and existing
stockholders. As additional consideration for this investment, EarthLink issued
warrants to purchase 98,340 shares of Common Stock having an exercise price of
$11.00 per share. The holders of $725,000 of such notes converted their notes
into 55,767 shares of Common Stock upon the consummation of the Company's
initial public offering on January 22,1997. Also during the third quarter of
1996, the Company sold 2,727,273 shares of Series A Convertible Preferred Stock
to a limited number of investors, including certain directors, existing
stockholders, the Underwriter and certain of its affiliates and associates for
approximately $15.0 million in the aggregate, or $5.50 per share. In connection
with this financing, the Company issued to certain of the investors warrants to
purchase up to 100,000 shares of
16
<PAGE>
Common Stock at an exercise price of $11.00 per share. The Series A
Convertible Preferred Stock was automatically converted into 1,363,624 shares
of Common Stock upon the consummation of the Company's initial public offering
on January 22, 1997.
In connection with an amendment of its strategic network services
relationship with UUNET, in October 1996, the Company issued a $5.0 million,
one-year promissory note to UUNET. This note bears interest at prime plus 2% per
annum (an effective rate of 10.25% per annum at December 1, 1996), and became
convertible upon consummation of the Company's initial public offering into up
to approximately 382,000 shares of Common Stock at a conversion price of between
$13.20 and $16.00 per share, depending upon the number of shares of Common
Stock, if any, purchased in the offering by certain investors referred to in the
preceding paragraph. This obligation matures in October 1997.
EarthLink completed its initial public offering in January 1997, which
(after partial exercise by the underwriter of its over-allotment option)
generated net proceeds, after expenses of the offering, of approximately $28
million. The Company believes that available cash will be sufficient to meet
the Company's operating expenses and capital requirements for at least the
next 12 months. However, 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 customer 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. If capital requirements vary materially from those currently
planned, the Company may require additional financing sooner than
anticipated. 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. 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
material adverse effect on the Company.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this item appears in a subsequent section of
this Report. (See Item 14(a)(1) and (2)).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
17
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to management's nominees for directors of the Company
will be set forth under the captions "Proposal 1--Election of Directors
- -Nominees" and "Proposal 1--Election of Directors-- Information Regarding
Nominees for Director" in the Company's Proxy Statement for its Annual Meeting
of Shareholders to be held on May 23, 1997. Such information is incorporated
herein by reference. Information relating to the executive officers of the
Company is set forth under the caption "Executive Officers" in the
above-referenced Proxy Statement. Such information is incorporated herein by
reference. Information regarding compliance by directors and executive officers
of the Company and owners of more than ten percent of the Company's Common Stock
with the reporting requirements of Section 16(a) of the Securities Exchange Act
of 1934, as amended, is set forth under the caption "Compliance with Section
16(a) of the Securities Exchange Act of 1934" in the above-referenced Proxy
Statement. Such information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information relating to management compensation is set forth under the
captions "Proposal 1-- Election of Directors--Director Compensation" and
"Executive Compensation" in the Company's Proxy Statement referred to in Item 10
above. Such information is incorporated herein by reference, except for the
information set forth under the captions "Executive Compensation--Audit and
Compensation Committee Report on Executive Compensation" and "Stock Performance
Graph," which specifically is not so incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding ownership of the Company's $0.01 par value Common
Stock by certain persons is set forth under the captions "Beneficial Ownership
of Common Stock" in the Company's Proxy statement referred to in Item 10 above.
Such information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and transactions between the
Company and certain of its affiliates is set forth under the caption "Certain
Transactions" in the Company's Proxy Statement referred to in Item 10 above.
Such information is incorporated herein by reference.
18
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this Report.
1. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT ACCOUNTANTS
Balance Sheet as of December 31, 1995 and 1996
Statement of Operations for the period from inception (May 26, 1994) through
December 31, 1994, and the two years ended December 31, 1996
Statement of Cash Flows for the period from inception (May 26, 1994) through
December 31, 1994, and the two years ended December 31, 1996
NOTES TO FINANCIAL STATEMENTS
2. FINANCIAL STATEMENT SCHEDULE
The Financial Statement Schedule(s) described in Regulation S-X are omitted
from this Report because they are either not required or are immaterial.
3. EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
3.1 Amended and Restated Certificate of Incorporation (Exhibit 3.1 to the Company's Registration Statement on
Form S-1--File No. 333-15781). (a) Certificate of Amendment of Amended and Restated Certificate of
Incorporation (Exhibit 3.1(a) to the Company's Registration Statement on Form S-1--File No. 333-15781).
3.2 Bylaws (Exhibit 3.2 to the Company's Registration Statement on Form S-1--File No. 333-15781).
3.3 Certificate of Designation Preferences and Rights of Series A Convertible Preferred Stock (Exhibit 3.3 to
the Company's Registration Statement on Form S-1--File No. 333-15781). (a) Certificate of Amendment of
EarthLink Network, Inc. Certificate of Designation, Preferences and Rights of Series A Convertible
Preferred Stock (Exhibit 3.3(a) to the Company's Registration Statement on Form S-1 -File No. 333-15781).
4.1 See exhibits 3.1, 3.2 and 3.3 for provisions of the Certificate of Incorporation and Bylaws defining
rights of holders of Common Stock.
4.2 Specimen Stock Certificate (Exhibit 4.2 to the Company's Registration Statement on Form S-1 -File No.
333-15781).
19
<PAGE>
4.3 Form of Warrant Agreement (Exhibit 4.3 to the Company's Registration Statement on Form S-1 -File No.
333-15781).
4.4 Registration Rights Agreement, Amendment No. 1 to Registration Rights Agreement and Amendment No. 2 to
Registration Rights Agreements (Exhibit 4.4 to the Company's Registration Statement on Form S-1--File No.
333-15781) (See also Exhibit 10.23(c)).
4.5 Buy-Sell Agreement, dated June 10, 1995, among the Company, Sky Dayton, Reed Slatkin and Kevin O'Donnell
(Exhibit 4.5 to the Company's Registration Statement on Form S-1--File No. 333-15781).
9.1 Voting Trust Agreement, dated June 10, 1995, among Sky Dayton, Reed Slatkin and Kevin O'Donnell (Exhibit
9.1 to the Company's Registration Statement on Form S-1--File No. 333-15781).
10.1 1995 Stock Option Plan and forms of Stock Option Agreement and Stock Purchase Agreement (Exhibit 10.1 to
the Company's Registration Statement on Form S-1--File No. 333-15781).
10.2 Amended and Restated Stock Option Plan for Directors (Exhibit 10.2 to the Company's Registration
Statement on Form S-1--File No. 333-15781).
10.3 Master Lease Agreement, dated February 8, 1996, between the Company and Boston Financial & Equity
Corporation (Exhibit 10.3 to the Company's Registration Statement on Form S-1 - File No. 333-15781).
10.4 Lease Line Agreement, dated January 30, 1996, between the Company and Boston Financial & Equity
Corporation (Exhibit 10.4 to the Company's Registration Statement on Form S-1 -File No. 333-15781).
10.5 Master Lease Agreement, dated September 1, 1995, between the Company and LINC Capital Management (Exhibit
10.5 to the Company's Registration Statement on Form S-1--File No. 333-15781).
10.6 Netscape Communications Corporation Internet Service Provider Navigator Distribution Agreement dated May
31, 1996, between the Company and Netscape Communications Corporation (Exhibit 10.6 to the Company's
Registration Statement on Form S-1--File No. 333-15781). (a) Amendment No. 1 to Netscape Communications
Corporation Internet Service Provider Agreement (Exhibit 10.6(a) to the Company's Registration Statement
on Form S-1-- File No. 333-15781). (b) Amendment No. 2 to Netscape Communications Corporation Internet
Service Provider Agreement (Exhibit 10.6(b) to the Company's Registration Statement on Form S-1--File No.
333-15781).
10.7 Network Services Agreement dated May 31, 1996, between the Company and UUNET Technologies, Inc. (Exhibit
10.7 to the Company's Registration Statement on Form S-1--File No. 333-15781). (a) Addendum No. 1 to
Network Services Agreement (Exhibit 10.7(a) to the Company's Registration Statement on Form S-1--File No.
333-15781).
10.8 Software Distribution Agreement (MacTCP), dated October 2, 1995, between the Company and Apple Computer,
Inc. (Exhibit 10.8 to the Company's Registration Statement on Form S-1 -File No. 333-15781).
20
<PAGE>
10.9 Employment Agreement, dated January 15, 1996, between the Company and Charles G. Betty (Exhibit 10.9 to
the Company's Registration Statement on Form S-1--File No. 333-15781).
10.10 Indemnification Agreement, dated August 31, 1995, among the Company and Kevin O'Donnell as Indemnitors
and Reed Slatkin as Indemnitee (Exhibit 10.10 to the Company's Registration Statement on Form S-1--File
No. 333-15781).
10.11 Indemnification and Participation Agreement, dated December 1, 1995, among the Company and Kevin
O'Donnell as Indemnitors and Reed Slatkin as Indemnitee (Exhibit 10.11 to the Company's Registration
Statement on Form S-1 -File No. 333-15781).
10.12 Standard Industrial/Commercial Multi-Tenant Lease, dated December 1, 1995, between the Company and
Becton, Dickinson (Exhibit 10.12 to the Company's Registration Statement on Form S-1--File No.
333-15781).
10.13 Business Loan Agreement, dated June 15, 1995, and Promissory Note in the original principal amount of
$250,000 between the Company and California United Bank (Exhibit 10.13 to the Company's Registration
Statement on Form S-1 -File No. 333-15781).
10.14 Line of Credit Note in the original principal amount of $250,000, dated June 23, 1995, and Security
Agreement, dated June 23, 1995, between the Company and the Bank of California, N.A. (Exhibit 10.14 to
the Company's Registration Statement on Form S-1 -File No. 333-15781).
10.15 Line of Credit Note in the original principal amount of $1,000,000, dated November 2, 1995, between the
Company and the Bank of California, N.A. (Exhibit 10.15 to the Company's Registration Statement on Form
S-1 -File No. 333-15781).
10.16 Production and Distribution Agreement, dated May 6, 1996, between the Company and National Media
Corporation (Exhibit 10.16 to the Company's Registration Statement on Form S-1 -File No. 333-15781). (a)
Amendment No. 1 to Production and Distribution Agreement (Exhibit 10.16(a) to the Company's Registration
Statement on Form S-1--File No. 333-15781).
10.17 Documents evidencing the Company's sale of $2,950,000 of its 10% Promissory Notes, dated June 18, 1996:
(a) Form of Subscription Agreement (Exhibit 10.17 to the Company's Registration Statement on Form
S-1--File No. 333-15781). (b) Form of Warrant (Exhibit 10.17(a) to the Company's Registration Statement
on Form S-1 -File No. 333-15781). (c) Form of 10% Promissory Note (Exhibit 10.7(b) to the Company's Registration
Statement on Form S-1--File No. 333-15781).
10.18 Amended and Restated Stock Purchase Agreement Relating to 2,727,273 Shares of Series A Convertible
Preferred Stock between the Company and the Investors named therein, dated September 10, 1996 (Exhibit
10.18 to the Company's Registration Statement on Form S-1 -File No. 333-15781). (a) Form of Stock
Purchase Warrant (Exhibit 10.18(a) to the Company's Registration Statement on Form S-1--File No.
333-15781).
21
<PAGE>
10.19 Internet Wizard Sign-Up Agreement between the Company and Microsoft Corporation, dated August 16, 1996
(Exhibit 10.19 to the Company's Registration Statement on Form S-1 -File No. 333-15781).
10.20 Network Access Agreement between the Company and PSINet, Inc., dated July 22, 1996 and Amendment No. 1 to
Network Access Agreement (Exhibit 10.20 to the Company's Registration Statement on Form S-1--File No.
333-15781).
10.21 Office Lease by and between The Mutual Life Insurance Company of New York, as Landlord, and the Company,
as Tenant, dated September 20, 1996 (Exhibit 10.21 to the Company's Registration Statement on Form
S-1--File No. 333-15781).
10.22 Standard Office Lease by and between Glen Feliz Properties, as Landlord, and the Company, as Tenant,
dated July 2, 1996 (Exhibit 10.22 to the Company's Registration Statement on Form S-1--File No.
333-15781).
10.23 Amended and Restated Note Purchase Agreement between the Company and UUNET Technologies, Inc., dated
October 31, 1996 (Exhibit 10.23 to the Company's Registration Statement on Form S-1--File No. 333-15781).
(a) $5,000,000 Convertible Note (Exhibit 10.23(a) to the Company's Registration Statement on Form
S-1--File No. 333-15781). (b) Stockholders Agreement (Exhibit 10.23(b) to the Company's Registration
Statement on Form S-1--File No. 333-15781). (c) Addendum to Amended and Restated Registration Rights
Agreement (Exhibit 10.23(c) to the Company's Registration Statement on Form S-1--File No. 333-15781).
11.1 Statement of computation of per share earnings - filed herewith.
23.1 Consent of Price Waterhouse LLP, independent public accountants--filed herewith.
27. Financial Data Schedule--filed herewith.
</TABLE>
(b) Reports on Form 8-K.
None.
22
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
EARTHLINK NETWORK, INC.
/S/ C. GARRY BETTY C.
-------------------------------
GARRY BETTY, PRESIDENT, CEO
DATE: MARCH 28, 1997
-------
Each person whose signature appears below hereby constitutes and appoints
C. Garry Betty and Barry W. Hall the true and lawful attorneys-in- fact and
agents of the undersigned, with full power of substitution and
resubstitution, for and in the name, place and stead of the undersigned, in
any and all capacities, to sign any and all amendments to this Report, and to
file the same, with all exhibits thereto, and other documents in connection
therewith, with the Commission, and hereby grants to such attorneys-in- fact
and agents full power and authority to do and perform each and every act and
thing requisite and necessary to be done, as fully to all intents and
purposes as the undersigned might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents, or their substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Company and in the capacities and on the dates indicated.
Date: March 28 , 1997 /s/ C. Garry Betty
----------------------------------
C. Garry Betty, President,
Chief Executive Officer and Director
Date: March 28 , 1997 /s/ Barry W. Hall
----------------------------------
Barry W. Hall, Vice President--
Finance and Administration and Chief
Financial Officer
Date: March 28 , 1997 /s/ Sky D. Dayton
----------------------------------
Sky D. Dayton, Chairman of the Board
Date: March 28 , 1997 /s/ Sidney Azeez
----------------------------------
Sidney Azeez, Director
Date: March 28 , 1997 /s/ Robert M. Kavner
----------------------------------
Robert M. Kavner, Director
23
<PAGE>
Date: March 28 , 1997 /s/ Paul McNulty.
----------------------------------
Paul McNulty, Director
Date: March 28 , 1997 /s/ Kevin M. O'Donnell.
----------------------------------
Kevin M. O'Donnell, Director
Date: March 28 , 1997 /s/ John W. Sidgmore
----------------------------------
John W. Sidgmore, Director
Date: March 28 , 1997 /s/ Reed E. Slatkin
----------------------------------
Reed E. Slatkin, Director
24
<PAGE>
EARTHLINK NETWORK, INC.
INDEX TO FINANCIAL STATEMENTS
December 31, 1996
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Independent Accountants.................................... F-2
Balance Sheet as of December 31, 1995 and 1996....................... F-3
Statement of Operations for the period from inception (May 26, 1994)
through December 31, 1994, and the two years ended December 31,
1996............................................................... F-4
Statement of Stockholders' Equity (Deficit) for the period from
inception (May 26, 1994) through December 31, 1994, and the two
years ended December 31, 1996...................................... F-5
Statement of Cash Flows for the period from inception (May 26, 1994)
through December 31, 1994, and the two years ended December 31,
1996............................................................... F-6
Notes to Financial Statements........................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of EarthLink Network, Inc.
In our opinion, the accompanying balance sheet and the related statements
of operations, of changes in stockholders' equity (deficit) and of cash flows
present fairly, in all material respects, the financial position of EarthLink
Network, Inc. at December 31, 1995 and 1996, and the results of its
operations and its cash flows for the period from inception (May 26, 1994)
through December 31, 1994, and the two years ended December 31, 1996 in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Costa Mesa, California
March 14, 1997
F-2
<PAGE>
EARTHLINK NETWORK, INC.
BALANCE SHEET
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
------ -------
(IN THOUSANDS)
<S> <C> <C>
Current assets:
Cash and cash equivalents.......................... $ 290 $ 2,313
Restricted short-term investment (Note 6).......... 1,500 1,087
Marketable securities.............................. 1,680
Accounts receivable, net of allowance of $781,000
at December 31, 1996............................. 218 1,725
Prepaid expenses................................... 123 885
Other assets (Note 4).............................. 122 1,383
-------- --------
Total current assets............................. 2,253 9,073
Other long-term assets (Note 4)...................... 329
Property and equipment, net (Notes 1 and 3).......... 2,551 17,401
Intangibles, net (Notes 2, 5 and 8)................. 70 316
-------- ---------
$ 4,874 $ 27,119
-------- ---------
-------- ---------
</TABLE>
LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS EQUITY (DEFICIT)
<TABLE>
<S> <C> <C>
Current liabilities:
Trade accounts payable............................. $ 1,766 $ 11,207
Accrued payroll and related expenses............... 193 1,469
Other accounts payable and accrued liabilities..... 405 2,061
Lines of credit (Note 6)........................... 1,494 --
Current portion of capital lease obligations
(Note 10)........................................ 159 3,582
Notes payable (Note 6)............................. -- 7,950
Deferred revenue................................... 212 2,010
-------- --------
Total current liabilities........................ 4,229 28,279
Long-term debt (Note 10)........................... 355 6,088
-------- --------
Total liabilities................................ 4,584 34,367
-------- --------
Commitments and contingencies (Note 10)
Mandatorily redeemable convertable preferred stock
(Note 7)........................................... -- 14,013
Stockholders' equity (deficit)
Preferred stock, $0.01 par value, 10,000,000 shares
authorized, nil and 2,727,273 shares
outstanding as redeemable preferred stock........ -- --
Common stock, $0.01 par value, 50,000,000 shares
authorized, 5,057,165 and 6,022,724
issued and outstanding basis (Note 7)............ 51 60
Additional paid-in capital......................... 5,122 14,236
Warrants to purchase common stock (Note 8)......... 124 599
Accumulated deficit................................ (5,007) (36,156)
-------- --------
Total stockholders' equity (deficit)................. 290 (21,261)
-------- ---------
$ 4,874 $ 27,119
-------- ---------
-------- ---------
</TABLE>
The accompanying notes are an integral part of these financial statements
F-3
<PAGE>
EARTHLINK NETWORK, INC
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
INCEPTION
(MAY 26, 1994) YEAR ENDED DECEMBER 31,
THROUGH -----------------------
DECEMBER 31, 1994 1995 1996
----------------- --------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
Revenues:
Recurring revenues................. $ 53 $ 2,422 $ 26,879
Other revenues..................... 58 606 5,624
------- -------- ---------
Total Revenues................... 111 3,028 32,503
Operating costs and expenses:
Cost of recurring revenue.......... 4 1,055 18,462
Cost of other revenue.............. 12 349 2,699
Sales and marketing................ 37 3,711 15,258
General and administrative
expenses......................... 168 2,062 10,534
Operations and customer support.... 38 1,869 15,808
------- -------- ---------
259 9,046 62,761
------- -------- ---------
Loss from operations............... (148) (6,018) (30,258)
Interest expense................... -- (136) (1,041)
Interest income.................... -- 34 150
------- -------- ---------
Net loss......................... $ (148) $ (6,120) $ (31,149)
------- -------- ---------
------- -------- ---------
Net loss per share (Note 1)........ $ (0.04) $ (1.25) $ (4.50)
------- -------- ---------
------- -------- ---------
Weighted average shares outstanding
(Note 1)......................... 3,653 4,903 6,920
</TABLE>
The accompanying notes are an integral part of these financial statements
F-4
<PAGE>
EARTHLINK NETWORK, INC
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
ADDITIONAL TOTAL
COMMON STOCK PAID-IN WARRANTS ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT CAPITAL ISSUED DEFICIT EQUITY (DEFICIT)
----------------- ----------- -------- ----------- ----------------
<S> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Issuance of Common Stock........... 2,941 $ 29 $ 147 $ -- $ -- $ 176
Warrants issued in connection
with line of credit (Note 8)..... -- -- -- 69 -- 69
Net loss........................... -- -- -- -- (148) (148)
----- ---- -------- ----- -------- ---------
Balance at December 31, 1994....... 2,941 29 147 69 (148) 97
Issuance of Common Stock........... 2,116 22 6,236 -- -- 6,258
Reclassification of S Corporation
accumulated deficit (Note 8)..... -- -- (1,261) -- 1,261 --
Warrants issued for lease guarantee
(Note 8)......................... -- -- -- 50 -- 50
Warrants issued for non-competition
agreement (Notes 2 and 8)........ -- -- -- 5 -- 5
Net loss........................... -- -- -- -- (6,120) (6,120)
----- ---- -------- ----- -------- ---------
Balance at December 31, 1995....... 5,057 51 5,122 124 (5,007) 290
Issuance of Common Stock........... 923 9 8,651 -- -- 8,660
Issuance of Common Stock for
services......................... 43 -- 463 -- -- 463
Warrants issued in connection with
equipment leases and other
financings....................... -- -- -- 475 -- 475
Net loss........................... -- -- -- -- (31,149) (31,149)
----- ---- -------- ----- --------- ---------
Balance December 31, 1996.......... 6,023 $ 60 $ 14,236 $ 599 $ (36,156) $ (21,261)
----- ---- -------- ----- --------- ---------
----- ---- -------- ----- --------- ---------
</TABLE>
The accompanying notes are an integral part of these financial statements
F-5
<PAGE>
EARTHLINK NETWORK, INC
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
INCEPTION YEAR ENDED
(MAY 26, 1994) DECEMBER 31,
THROUGH ------------------
DECEMBER 31, 1994 1995 1996
------------------- ----- ------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss........................... $ (148) $ (6,120) $ (31,149)
Adjustments to reconcile net loss
to net cash provided by (used in)
operating activities:
Depreciation and amortization.... 7 305 4,153
Provision for doubtful accounts
receivable..................... -- -- 781
Issuance of common stock in
exchange for professional
services....................... -- -- 50
Issuance of common stock in
exchange for termination of
consulting agreement........... -- -- 413
Increase in marketable
securities..................... -- -- (1,681)
Increase in accounts receivable.. (27) (191) (2,288)
Increase in prepaid expenses
and other assets............... -- (141) (2,352)
Increase in accounts payable and
accrued liabilities............ 22 2,292 12,373
Increase in deferred revenue..... -- 212 1,798
----- -------- ---------
Net cash used in operating
activities................... (146) (3,643) (17,902)
----- -------- ---------
Cash flows from investing activities:
Purchases of property and equipment. (97) (2,766) (18,774)
Purchase of restricited short-term
investment........................ -- (1,500) (1,087)
Liquidation of restricited short-term
investment........................ -- -- 1,500
----- -------- ---------
Net cash used in investing
activities.................... (97) (4,266) (18,361)
----- -------- ---------
Cash flows from financing activities:
Proceeds from (payment of) line of
credit............................ -- 1,494 (1,494)
Increase (Decrease) in notes
payable........................... 67 (67) 7,950
Proceeds from capital lease
obligations....................... -- 556 11,348
Principal payments under capital
lease obligations................. -- (42) (2,191)
Proceeds from issuance of Mandatorily
Redeemable Preferred Stock........ -- -- 14,013
Proceeds from issuance of
Common Stock...................... 176 6,258 8,660
----- -------- ---------
Net cash provided by financing
activities.................... 243 8,199 38,286
----- -------- ---------
Net increase in cash and cash
equivalents......................... -- 290 2,023
Cash and cash equivalents,
beginning of year................... -- -- 290
----- -------- ---------
Cash and cash equivalents,
end of period....................... $ -- $ 290 $ 2,313
----- -------- ---------
----- -------- ---------
</TABLE>
The accompanying notes are an integral part of these financial statements
F-6
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
EarthLink Network, Inc. ("EarthLink" or the "Company") was organized on
May 26, 1994 and is an Internet service provider that was formed to help
users derive meaningful benefits from the extensive resources of the Internet.
The Company has experienced 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. The Company expects to
continue to focus on increasing its customer base and to expend substantial
resources on sales, marketing and administration, building its network
systems, developing new service offerings and improving its management
information systems. Accordingly, the Company expects its cost of revenues,
selling, general, and administrative expenses and capital expenditures will
continue to increase significantly, all of which will have a negative impact
on short-term operating results. In addition, the Company may change its
pricing policies to respond to a changing competitive environment. There can
be no assurance that growth in the Company's revenues or customer base will
continue or that the Company will be able to achieve or sustain profitability
or positive cash flow. The failure of the Company to achieve or sustain
profitability or positive cash flow may require the Company to reduce the
scope of its operations or its anticipated expansion, which could adversely
affect the Company's business and results of operations.
REVENUES
Recurring revenues from monthly Internet service are recognized over the
period services are provided. Other revenues, consisting primarily of sign-up
fees, are recognized as revenue when the registration process is completed.
CASH AND CASH EQUIVALENTS
All highly liquid investments with an original maturity of three months
or less at the date of acquisition are classified as cash equivalents.
ACCOUNTS RECEIVABLE AND DEFERRED REVENUES
Commencing in 1995, the Company began to bill for Internet service
generally one month in advance. Accordingly, these non-cancelable advanced
billings are included in both accounts receivable and deferred revenue.
CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to
concentrations or credit risk consist principally of cash investments and
trade receivables. The Company's cash investment policies limit investments
to short-term, investment grade instruments. Concentrations of credit risk
with respect to trade receivables are limited due to the large number of
customers comprising the Company's customer base.
F-7
<PAGE>
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost and depreciated using the
straight-line method over the estimated useful life of the assets, which is
generally three years. Leasehold improvements are amortized using the
straight-line method over the shorter of their estimated lives or the term of
the lease, ranging from one to five years.
EQUIPMENT UNDER CAPITAL LEASE
The Company leases certain of its data communications and other equipment
under capital lease agreements. The assets and liabilities under capital
lease are recorded at the lesser of the present value of aggregate future
minimum lease payments, including estimated bargain purchase options, or the
fair value of the assets under lease. Assets under capital lease are
amortized over the lesser of their estimated useful lives of three years or
the term of the lease.
INTANGIBLES
Intangible assets consist primarily of deferred financing and
professional service costs, prepaid lease guarantee costs, goodwill, rights
to client lists and a covenant not to compete. The costs assigned to
intangible assets are being amortized on a straight-line basis over the
estimated useful lives of the assets, which range from two to three years.
The Company regularly reviews the recoverability of intangible assets based
on estimated undiscounted future cash flows from operating activities
compared with the carrying values of the intangibles.
ADVERTISING AND CUSTOMER ACQUISITION COSTS
Advertising and customer acquisition costs are included in sales and
marketing. Such costs are expensed as incurred.
INCOME TAXES
Income taxes are accounted for under Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes." Under this method, deferred
tax assets and liabilities are determined based on differences between the
financial reporting basis and tax basis of assets and liabilities and are
measured using the enacted tax rates and laws that will be in effect when the
differences are expected to reverse.
NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of
common shares outstanding. In addition, pursuant to Securities and Exchange
Commission Staff Accounting Bulletin No. 83, Common Stock and other
potentially dilutive instruments issued by the Company at prices below the
public offering price during the twelve-month period prior to the offering
date (using the treasury stock method and an initial public offering price of
$13.00 per share) including Common Stock pending issuance have been included
in the calculation as if they were outstanding for all periods regardless of
whether they are dilutive. Common Stock equivalent shares issued by the
Company more than twelve months prior to the initial public offering date
have been excluded from the net loss per share calculation because the impact
is anti-dilutive.
F-8
<PAGE>
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
RECENT PRONOUNCEMENTS
The Company has adopted, as of January 1, 1996, SFAS No. 121 "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of" and SFAS 123 and "Accounting for Stock-Based Compensation". The
adoption of SFAS No. 121 has not had any effect on the Company's financial
position or results of operations. The Company continues to account for its
employee stock based compensation in accordance with the provisions of APB 25
and provides pro forma disclosures in the notes to the financial statements
(see note 8), as if the measurement provisions of SFAS No. 123 had been
adopted. As such SFAS 123 has not had a material effect on the Company's
financial position or results of operations.
2. PURCHASE OF CERTAIN ASSETS FROM BECKEMEYER DEVELOPMENT TECHNOLOGIES
In order to recruit the principal shareholder of Beckemeyer Development
Technologies ("BDT") to serve as the Company's Vice President of Engineering,
on November 7, 1995, the Company agreed to purchase all fixtures, equipment,
and the client list of BDT for cash of $64,000. In addition to the above, the
principal shareholder was issued warrants to purchase 10,330 shares of the
Company's Common Stock at $4.84 per share as consideration for an agreement
not to compete for a two-year period. The value assigned to the warrants was
$5,000 based upon an appraisal obtained by the Company. The warrants expire
October 10, 2005. This purchase price was allocated to the assets acquired
with the remainder reflected as an intangible asset. At the time of purchase,
BDT was not material to the results of operations, financial position or
customer base of EarthLink.
3. PROPERTY AND EQUIPMENT
PROPERTY AND EQUIPMENT CONSIST OF:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1995 1996
------ ------
(IN THOUSANDS)
<S> <C> <C>
Data communications equipment............................................ $2,167 $11,464
Office and other equipment............................................... 661 6,686
Leasehold improvements................................................... 35 646
Construction in progress................................................. -- 2,841
------ --------
2,863 21,637
Less accumulated depreciation and amortization........................... (312) (4,236)
------ --------
$2,551 $17,401
------ ---------
------ ---------
</TABLE>
F-9
<PAGE>
Property under capital lease, primarily data communications equipment
included above, aggregated $556,000 and $11,904,000 at December 31, 1995 and
1996, respectively. Included in accumulated depreciation and amortization are
amounts related to property under capital lease of $56,000 and $2,896,000 at
December 31, 1995 and 1996, respectively. Depreciation expense charged to
operations was $7,000, $305,000 and $3,924,000 in 1994, 1995 and 1996,
respectively, and included nil, $56,000, and $2,840,000, respectively,
pertaining to property under capital lease.
4. OTHER ASSETS
Other Assets Consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Deposits..................................................................... $ 122 $ 409
Deferred Offering Costs...................................................... -- 804
Inventory.................................................................... -- 499
----- --------
$ 122 $ 1,712
---------------
---------------
</TABLE>
5. INTANGIBLE ASSETS
Intangible Assets Consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
(IN THOUSANDS)
----------------------
1995 1996
----- ---------
<S> <C> <C>
Deferred Financing Costs....................................................... $ -- $ 347
Lease Guarantee................................................................ 50 110
Rights to client lists......................................................... 10 10
Professional Services.......................................................... -- 56
Other.......................................................................... 10 22
----- ---------
70 545
Less accumulated amortization.................................................. -- (229)
----- ----------
$ 70 316
----- ---------
----- ---------
</TABLE>
6. NOTES PAYABLE
In 1995 the Company had three secured revolving credit agreements with
its banks. The outstanding principal balances under these lines of credit
were $1,000,000, $248,000 and $246,000 at December 31, 1995. The effective
interest rates at December 31, 1995 were 6.48%, 7.62% and 7.65%,
respectively. The Company repaid amounts outstanding on such lines of credit
on April 6, 1996, March 14, 1996 and June 8, 1996 respectively. The lines of
credit subsequently expired.
In June 1996, the Company issued to 17 investors, promissory notes
aggregating $2,950,000. Certain of the investors are directors and
stockholders of the Company. The 10% promissory notes expire on June 6, 1997.
As described in Note 7, the Company issued warrants valued at $116,000 to
note holders. The fair value of the warrants is included in deferred
financing costs and is being amortized as interest expense over the life of
the notes resulting in a 13.4% effective interest rate. Interest expense,
which is paid in advance, on these notes was approximately $198,000 for the
year ended December 31, 1996.
F-10
<PAGE>
CONVERTIBLE DEBT
In October 1996, the Company issued a $5 million, one year promissory
note at prime plus 2% to UUNET Technologies, Inc. ("UUNET"). Upon closing of
the initial public offering, the note became convertible into a maximum of
382,000 shares of Common Stock at a conversion price between $13.20 per share
and $16.00 per share depending upon the number of shares of Common Stock
purchased in the initial offering by certain investors in Series A
Convertible Preferred Stock. UUNET is a provider of services to the Company
and has a designate on the Company's board of directors.
7. CAPITAL STOCK AND MANDATORILY REDEEMABLE EQUITY SECURITIES
BUY-SELL AGREEMENT
The Company and certain stockholders entered into a Buy-Sell Agreement
pursuant to which the Company has the first right of refusal upon sale or
transfer of shares of Common Stock by these stockholders. The right expired
upon consummation of the Company's initial public offering.
COMMON STOCK
The Company issued 45,485 shares of Common Stock at $4.84 per share and
25,000 shares of Common Stock at $4.84 per share on January 18, 1996 and
March 20, 1996, respectively. On May 6, 1996, the Company issued 852,460
shares of common stock at $9.76 per share in a private placement. As a result
of these placements, EarthLink raised, in the aggregate, $8,660,000.
COMMON STOCK ISSUANCES FOR OTHER THAN CASH
On May 5, 1996, the Company issued 5,122 shares of Common Stock at $9.76
per share, to a sub-contractor in lieu of cash for services provided to the
Company. In September 1996, the Company issued 37,500 shares of Common Stock
at $11.00 per share as consideration for the termination of a consulting
agreement.
MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
On September 10, 1996, the Company issued 2,727,273 shares of its Series
A Redeemable Convertible Preferred Stock to investors including among others,
certain directors, stockholders and the Underwriter associated with the
Company's initial public offering and certain of its associates for
$15,000,000. Stock issuance costs of $987,000 have been charged to redeemable
convertible preferred stock. Each two shares of the Series A Convertible
Preferred Stock was automatically converted upon consummation of the initial
public offering of the Company's common stock on January 22, 1997. Assuming
conversion of the Series A Redeemable Convertible Preferred Stock into shares
of common stock on December 31, 1996, the pro forma number and par value of
common stock shares outstanding would be 7,386,348 and $74,000, respectively.
Holders of Series A Convertible Preferred Stock are entitled to voting
rights and participation in dividends equivalent to the number of common shares
issuable if converted. The Series A Convertible Preferred Stockholders have the
exclusive right to elect one director and participate in the election of other
directors along with holders of Common Stock. In the event of a change in
ownership, as defined, the holders of the Company's Series A Convertible
Preferred Stock have the right to demand complete redemption. The holders of the
Company's Series A Convertible Preferred Stock have a liquidation preference
equal to their initial investment. Any assets remaining after the preferred
liquidation preference plus declared and unpaid dividends will be distributed to
the holders of Common Stock. The Series A Convertible Preferred Stock was
automatically converted into shares of Common Stock upon consummation of the
Company's initial public offering. (See Note 13.)
F-11
<PAGE>
8. STOCK OPTIONS AND WARRANTS
STOCK OPTIONS
1995 Stock Option Plan
In September 1995, the Company established the EarthLink Network 1995
Stock Option Plan (the "1995 Plan"). The 1995 Plan provides for the grant of
incentive stock options to purchase up to 1,250,000 shares of common stock to
employees of the Company and non-qualified stock options to employees,
officers, directors and consultants of the Company. The 1995 Plan is
administered by a committee appointed by the Board which determines the terms
of the options granted, including the exercise price, the number of shares
subject to option, and the option vesting period. The exercise price of all
options granted under the plan must be at least 100% of the fair market value
on the date of grant. Options generally vest in equal quarterly increments
over a five year period.
DIRECTORS STOCK OPTION PLAN
In September 1995, the Company established the EarthLink Directors Stock
Option Plan (the "Directors Plan"). The Directors Plan as amended and
restated in December 1996, provides for the grant of options to purchase
62,500 shares of Common Stock to directors who do not also serve as employees
of the Company and do not beneficially own, nor are employees, directors or
officers of any entity which owns 5% or more of the outstanding shares of the
Company's capital stock. Under the Directors Plan, grants of options to
purchase 10,000 and 2,500 shares of Common Stock are automatically made to
each non-management director at such time as the person first becomes a
member of the Board of Directors and at the beginning of each fiscal year,
respectively. Options generally vest in equal quarterly increments over a
five year period. As of December 31, 1996, there were no options to purchase
shares of Common Stock outstanding under the Directors Plan.
NON-QUALIFIED OPTION GRANTS
In addition to the options granted under the plan described above, the
Company granted non-qualified stock options to certain employees, officers
and directors. Non-qualified options have a maximum term of ten years and
generally vest in equal quarterly increments over a five-year period.
F-12
<PAGE>
Following is a summary of the status of the incentive stock and
non-qualified options during the two years ended December 31, 1996.
<TABLE>
<CAPTION>
INCENTIVE STOCK OPTIONS
-----------------------
OPTIONS OUTSTANDING
-------------------
WEIGHTED
AVERAGE
NUMBER OF OPTION PRICE EXERCISE
SHARES PER SHARE PRICE
---------- ------------- -----------
<S> <C> <C> <C>
Plan Creation 1995
Granted.................................................................... 232,500 $ 4.84 $ 4.84
---------- ---------- ----------
Balance at December 31, 1995............................................... 232,500 $ 4.84 $ 4.84
Granted.................................................................... 806,250 $ 4.84-11.00 $ 8.25
Forfeited.................................................................. (10,500) $ 9.76 $ 9.76
---------- ----------- ------------
Balance at December 31, 1996............................................... 1,028,250 $ 4.84-11.00 $ 7.48
---------- ------------ ------------
---------- ------------ ------------
</TABLE>
<TABLE>
<CAPTION>
OPTIONS EXERCISABLE
--------------------------
<S> <C> <C> <C>
WEIGHTED
AVERAGE
NUMBER OF OPTION PRICE EXERCISE
SHARES PER SHARE PRICE
----------- ------------- -----------
Plan Creation 1995
Granted..................................................................... 36,125 $ 4.84 4.84
---------- ----------- ----------
Balance at December 31, 1995................................................ 36,125 $ 4.84 $ 4.84
Granted..................................................................... 48,031 $ 4.84-11.00 $ 6.94
----------- ------------ -----------
Balance at December 31, 1996................................................ 84,156 $ 4.84-11.00 $ 6.04
----------- ------------ -----------
----------- ------------ -----------
</TABLE>
<TABLE>
<CAPTION>
NON-QUALIFIED STOCK OPTIONS
---------------------------------------
OPTIONS OUTSTANDING
--------------------------
WEIGHTED
AVERAGE
NUMBER OF OPTION PRICE EXERCISE
SHARES PER SHARE PRICE
----------- ------------- -----------
<S> <C> <C> <C>
Granted in 1995.......................................... 425,000 $ 0.60-1.81 $ 1.60
Forfeited (60,209) $ 0.60 $ 0.60
--------- --------------- ----------
Balance at December 31, 1995............................. 364,791 $ 0.60-1.81 $ 1.76
Granted.................................................. 175,000 $ 4.84-11.00 $ 7.48
--------- --------------- -----------
Balance at December 31, 1996............................. 539,791 $ 0.60-1.81 $ 3.62
--------- --------------- -----------
--------- --------------- -----------
</TABLE>
<TABLE>
<CAPTION>
OPTIONS EXCERCISABLE
-------------------------
<S> <C> <C> <C>
WEIGHTED
AVERAGE
NUMBER OF OPTION PRICE EXERCISE
SHARES PER SHARE PRICE
----------- ------------ -----------
Granted in 1995.............................................................. 97,292 $0.60-1.81 $ 1.63
----------- ---------- -----------
Balance at December 31, 1995................................................. 97,292 $0.60-1.81 $ 1.63
Granted...................................................................... -- -- --
Balance at December 31, 1996................................................. 97,292 $0.60-1.81 $ 1.63
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
F-13
<PAGE>
The summary of non-qualified options includes warrants to purchase
100,000 shares of Common Stock at $4.84. These warrants were issued for
service on the Board of Directors and as such are accounted for under APB 25.
Had compensation cost been determined on the basis of fair value pursuant
to SFAS 123, net loss and net loss per share would have been increased as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
<S> <C> <C>
1995 1996
------------ -------------
Net Loss
As reported...................................................... $ 6,120,000 $ 31,149,000
------------ --------------
------------ --------------
Pro forma........................................................ $ 6,405,000 $ 32,448,000
------------ --------------
------------ --------------
Net loss per share
As reported...................................................... $ 1.25 $ 4.50
------------ --------------
------------- -------------
Pro forma........................................................ $ 1.31 $ 4.69
------------- -------------
------------- -------------
</TABLE>
The fair value of each option grant is estimated on the date of grant
using the minimum value method with the following assumptions used for grants
during both periods: dividend yield of 0.0%, risk free interest rate of 5.83%
and expected option term of 10 years.
WARRANTS
The Company has issued to certain Board members, consultants, lease
providers, creditors and others warrants to purchase shares of the Company's
Common Stock.
On December 15, 1994, certain stockholders provided the Company a
revolving line of credit of $400,000 bearing interest at a rate of 8.1%. As
of December 31, 1994, the outstanding balance was $67,000. The loan balance,
including interest expense of $15,000, was repaid during the year ended
December 31, 1995. The Company issued warrants to the stockholders to
purchase 150,000 shares of Common Stock at $1.81 per share valued at $69,000,
based upon an appraisal obtained by the Company, as additional consideration
for this line of credit. These warrants expire June 19, 2000.
On September 1, 1995, certain stockholders guaranteed a $500,000 lease for
networking equipment. The Company issued warrants to purchase 50,000 shares of
Common Stock at $1.81 per share, valued at $25,000, based upon an appraisal
obtained by the Company, as consideration for this guarantee. These warrants
expire August 31, 2000.
On December 13, 1995, certain stockholders provided the Company with a
$250,000 Irrevocable Standby Letter of Credit as a performance guarantee for
a real estate lease. In conjunction with this transaction the Company issued
warrants to purchase 50,000 shares at $4.84 per share, valued at $25,000,
based upon an appraisal obtained by the Company. These warrants expire
December 1, 2000.
On January 11, 1996, certain stockholders guaranteed a $1,500,000 lease
for networking equipment. The Company issued warrants to purchase 100,000
shares of Common Stock at $4.84 per share. The value of the warrants has been
reflected in intangible assets. These warrants expire January 11, 2001.
F-14
<PAGE>
On January 12, 1996 the Company issued warrants to purchase 100,000
shares of Common Stock at $4.84 to Board members. The warrants vest quarterly
over five years. As these warrants were issued for
service on the Board of Directors they are accounted for under APB 25 and as
such are included in the summary of nonqualified options and are not included in
the summary of warrant grants below.
On January 18, 1996, LINC Capital Partners, Inc. ("LINC") provided a
$1,500,000 lease line for equipment. The Company issued warrants to LINC to
purchase 50,000 shares of Common Stock at $4.84 per share. The value of the
warrants has been reflected as deferred financing costs. These warrants
expire January 18, 2006.
On February 15, 1996, Boston Financial & Equity Corporation ("Boston
Financial") provided a $700,000 lease line for equipment. The Company issued
warrants to Boston Financial to purchase 5,000 shares of Common Stock at
$9.76 per share. The value of the warrants has been reflected as deferred
financing costs. These warrants expire February 15, 2006.
On May 6, 1996, the Company agreed to issue warrants to a producer of
infomercials and commercials to purchase 50,000 shares of Common Stock at an
exercise price of $9.76 per share upon completion, subject to the Company's
approval, of 15-second and 60-second commercials for the Company's services.
In addition, the Company agreed to issue additional warrants to purchase a
maximum of 300,000 shares of Common Stock based upon the number of customers
obtained through the commercials. Through December 31, 1997, the exercise
price will be $9.76; per share thereafter, the exercise price will be set at
the then fair value of the Common Stock. The value of the warrants will be
reflected as consideration upon issuance.
On May 10, 1996, the Company issued warrants to purchase 45,477 shares of
Common Stock at $9.76 per share to various lessors in return for lease lines
and other services to the Company. The value of the warrants has been
reflected as deferred financing costs. The warrants expire on May 10, 2006.
On May 31,1996, in connection with the amendment and restatement of the
UUNET Agreement, the Company agreed to issue warrants to purchase 10,000
shares of Common Stock at an exercise price of $20.00 per share.
In connection with the issuance of promissory notes aggregating
$2,950,000, the Company issued to the lenders warrants to purchase an
aggregate of 98,340 shares of Common Stock at an exercise price of $11.00 per
share, as adjusted. The value of the warrants has been reflected as deferred
financing costs.
In connection with the execution of the PSINet, Inc. ("PSINet") agreement
on July 22, 1996 (Note 10) the Company issued warrants to purchase 100,000
shares of Common Stock at an exercise price of $20.00 per share. The value of
the warrants has been reflected as deferred financing costs.
In connection with the private placement of Series A Convertible
Preferred Stock, described above, the Company granted to certain purchasers
of the Series A Convertible Preferred Stock warrants to purchase 100,000
shares of common stock at $11.00 per share.
On September 24, 1996 the Company issued warrants to purchase 7,500
shares of the Company's common stock at $11.00 per share to each of the three
members of the Company's Technology Advisory Council. The warrants vest
quarterly over two years. The value of the warrants is reflected as deferred
professional services expense and amortized ratably over the vesting period.
F-15
<PAGE>
A summary of these warrant grants is as follows:
<TABLE>
<CAPTION>
WARRANTS OUTSTANDING
---------------------------------------
WEIGHTED
AVERAGE
NUMBER OF WARRANT PRICE EXERCISE
SHARES PER SHARE PRICE
----------- ------------- -----------
<S> <C> <C> <C>
Granted..................................................................... 150,000 $ 1.81 $ 1.81
----------- ------------- -----------
Balance at December 31,1994................................................. 150,000 $ 1.81 $ 1.81
Granted..................................................................... 110,330 $ 1.81-4.84 $ 3.47
----------- ------------- -----------
Balance at December 31,1995................................................. 260,330 $1.81-11.00 $ 2.51
Granted..................................................................... 531,317 $4.84-20.00 $ 11.01
----------- ------------- -----------
Balance at December 31,1996................................................. 791,647 $1.81-20.00 $ 8.21
----------- ------------- -----------
----------- ------------- -----------
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
WARRANTS EXCERCISABLE
---------------------------------------
NUMBER OF WARRANT PRICE EXERCISE
SHARES PER SHARE PRICE
----------- ------------- -----------
Granted..................................................................... 150,000 $ 1.81 $ 1.81
----------- ------------- -----------
Balance at December 31,1994................................................. 150,000 $ 1.81 $ 1.81
Granted..................................................................... 110,330 $ 1.81-4.84 $ 3.47
----------- ------------ ------------
Balance at December 31,1995................................................. 260,330 $1.81-11.00 $ 2.51
Granted..................................................................... 508,817 $4.84-20.00 $ 11.01
------------ ------------- ------------
Balance at December 31,1996................................................. 769,147 $1.81-20.00 $ 8.13
------------ ------------- ------------
------------ ------------- ------------
</TABLE>
9. INCOME TAXES
The stockholders, upon incorporating the Company, elected to treat the
Company as an S Corporation under the Internal Revenue Code. On June 19,
1995, this election was revoked as certain ineligible entities (i.e
partnerships and zcorporations) became stockholders. Losses of $1,261,000
incurred from inception through June 19, 1995 have been reclassified from
accumulated deficit to Common Stock as a result of the change to C
Corporation status. The Company is now subject to income taxes on income
earned after June 19, 1995. At December 31, 1995 and December 31, 1996, the
Company had net operating loss carryforwards for federal income tax purposes
totaling approximately $3,328,000 and $33,751,000 respectively, which begin
to expire in 2010. The Internal Revenue Code of 1986, as amended, includes
provisions which may limit the net operating loss carryforwards available for
use in any given year if certain events occur, including significant changes
in ownership. Due to the Company's initial public offering, utilization of
the Company's net operating loss carryforwards to offset future income may be
limited.
F-16
<PAGE>
DEFERRED TAX ASSETS INCLUDE THE FOLLOWING:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1995 1996
------------ -------------
<S> <C> <C>
Net operating loss carryforwards................................. $ 1,304,000 $ 13,578,000
Deferred financing costs......................................... -- 88,000
Depreciation..................................................... -- 50,000
Vacation accrual................................................. 27,000 103,000
-------------- ------------
Gross deferred tax assets........................................ 1,331,000 13,819,000
Deferred tax asset valuation allowance........................... (1,331,000) (13,819,000)
-------------- ------------
$ -- $ --
-------------- ------------
-------------- ------------
</TABLE>
The Company recorded a full valuation allowance for net deferred tax
assets due to the uncertainty of future taxable income.
10. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases its facilities and certain equipment under
non-cancelable operating leases expiring in various years through 2000. Total
rent expense in 1994 , 1995 and 1996 for all operating leases amounted to
$24,000, $145,000 and $914,000, respectively. The Company also leases
equipment, primarily data communications equipment, under non-cancelable
capital leases. Most of the Company's capital leases include purchase options
at the end of the lease term.
During the years ended December 31, 1995 and 1996, the Company financed
the acquisition of data processing and office equipment amounting to
approximately $556,000 and $11.3 million, respectively, by entering into a
number of agreements for the sale and leaseback of equipment. The sale
leaseback transactions are recorded at cost, which approximates the fair
market value of the property and, therefore, no gains or losses have been
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.
Minimum lease commitments under non-cancelable leases at December 31, 1996
are as follows:
<TABLE>
<CAPTION>
YEAR ENDING CAPITAL OPERATING
DECEMBER 31, LEASES LEASES
-------- -----------
<S> <C> <C>
(IN THOUSANDS)
1997 ......................................................................... $ 4,462 $ 1,449
1998 ......................................................................... 4,420 1,501
1999 ......................................................................... 2,936 1,445
2000 ......................................................................... 311 1,442
2001 ......................................................................... 76 1,124
Thereafter.................................................................... -- 4,620
--------- ---------
Total minimum lease payments.................................................. 12,205 $ 11,581
---------
---------
Less amount representing interest............................................. (2,535)
----------
Present value of future lease payments........................................ 9,670
Less current portion.......................................................... (3,582)
----------
$ 6,088
----------
----------
</TABLE>
F-17
<PAGE>
GUARANTEED USAGE LEVELS
At December 31, 1996, the Company has committed to guaranteed usage
levels of data and voice communication with certain telecommunication vendors
in the aggregate amount of $3,135,000.
SIGNIFICANT AGREEMENTS
Access to the Internet for customers outside of the Company's California
regional base is provided through points of presence ("POP") capacity leased
from UUNET. EarthLink is in effect a reseller of UUNET's services, buying in
bulk at a discount, and providing access to EarthLink's customer base at
EarthLink's normal rates. Payment to UUNET is generally concurrent with
EarthLink's receipt of funds from customers. UUNET was recently acquired by
MFS Communications, Inc. ("MFS"), a supplier of local and long distance
telephone service. In August 1996, MFS and WorldCom, Inc. ("WorldCom")
announced that MFS and WorldCom had executed a definitive agreement for the
merger of MFS into WorldCom. At December 31, 1996, $35,000 and $1.4 million
in amounts due to UUNET were recorded in accounts payable and other accrued
liabilities, respectively.
In October 1996, the Company's agreement with UUNET was amended. Under
the amended agreement, the Company pays UUNET a monthly fee equal to the
greater of a specified minimum or an amount that varies based primarily on
peak customer usage. The Company also pays UUNET an additional fee to the
extent that hours of usage exceed a formula set forth in the agreement. This
agreement has a term that expires in March 1999 (subject to earlier
cancellation after March 1998 with one year's prior notice, but provided that
if this notice is given, the Company is required to begin to reduce its usage
of UUNET's POPs in accordance with a schedule set forth in the agreement). If
the agreement expires at the end of its term, it is automatically renewed for
consecutive one-year terms unless prior notice of termination is given.
Minimum fees under the agreement are:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31, IN MILLIONS
- -----------
<S> <C>
1997 ............................................................. $ 16.2
1998 ............................................................. 22.8
1999 ............................................................. 6.0
-----------
Total.............................................................. $ 45.0
-----------
-----------
</TABLE>
EarthLink has licensed Netscape Navigator software ("Netscape
Navigator"), the World Wide Web client software, from Netscape Communications
Corporation. This license permits the Company to distribute Netscape
Navigator as part of its EarthLink Network TotalAccess software package.
Management believes that contract renewal, under conditions acceptable to
EarthLink, is probable.
On July 22, 1996 the Company entered into an agreement with PSINet, Inc.
("PSINet") pursuant to which the Company intends to lease POP access from
PSINet, becoming in effect a reseller of PSINet services in a similar fashion
to the Company's UUNET arrangement, as amended.
11. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
----------------------
1995 1996
-------- ---------
(IN THOUSANDS)
<S> <C> <C>
Cash paid for:
Interest............................................... $ 60 $ 1,041
Income taxes........................................... $ 1 $ 1
</TABLE>
F-18
<PAGE>
NON-CASH INVESTING AND FINANCING ACTIVITIES:
As discussed in Note 2, the Company obtained a covenant not to compete
agreement in exchange for warrants valued at $5,000.
As discussed in Note 7, certain stockholders guaranteed a $500,000
equipment lease in exchange for warrants valued at $25,000 and provided a
standby letter of credit as a performance guarantee for a real estate lease
in exchange for warrants valued at $25,000 during the year ended December 31,
1995. The Company obtained a revolving line of credit of $400,000 in exchange
for warrants valued at $69,000 during 1994.
12. REINCORPORATION
On June 27, 1996, the Company effected a reincorporation in Delaware. As
a result of the reincorporation, the Company's authorized shares of Common
Stock were increased to 25,000,000 shares with a par value of $0.01 per
share. In addition, the Company authorized 10,000,000 shares of preferred
stock with a par value of $0.01 per share. In March 1995 and January 1996 the
Company effected splits of the Company's Common Stock of 100-for-1 and
10-for-1, respectively. In December 1996, the Company effected a 1-for-2
reverse stock split. The accompanying financial statements have been
retroactively adjusted to give effect to the reincorporation, the stock
splits and the reverse stock split.
13. SUBSEQUENT EVENTS
INITIAL PUBLIC OFFERING
On January 22, 1997 the Company executed its initial public offering. The
offering consisted of 2,000,000 shares of common stock issued at $13 per
share. Net proceeds to the Company were approximately $23.5 million. Upon
consummation of the offering 2,727,273 shares of the Company's Series A
Convertible Preferred Stock were converted to 1,363,624 shares of Common
stock. The holders of $725,000 of the 10% Promissory Notes converted their
indebtedness into 55,767 shares of Common Stock upon consummation of the
initial public offering. On January 29, 1997 the Company repaid the
$2,225,000 balance remaining of the 10% Promissory Notes. At the completion
of this offering, 9,442,115 shares of Common Stock were outstanding.
On February 13, 1997 the Underwriter exercised its over-allotment option
and purchased 284,750 shares at the initial public offering price of $13.00.
Net proceeds to the Company were approximately $3.4 million.
PROFIT SHARING PLAN
Effective January 1, 1997, the Company implemented a profit sharing plan
(the Plan) pursuant to Section 401(k) of the internal revenue code, whereby
participants may contribute a percentage of compensation, but not in excess
of the maximum allowed under the code. The Plan provides for a matching
contribution from the Company which vests over four years from the
participants date of hire.
LEASES
EarthLink has signed a lease for an additional 55,000 square feet in a
facility located adjacent to its corporate headquarters in which it plans to
house its data center. The lease term commenced and the Company began
occupation of this new space in February 1997 for an initial ten-year term.
Monthly rental will be $66,000 for the first 60 months increasing to $77,000
for the remaining 60 months.
F-19
<PAGE>
EXHIBIT INDEX
EXHIBIT DESCRIPTION PAGE
- ------- -------------------------------------------------------------- ----
3.1 Amended and Restated Certificate of Incorporation (Exhibit 3.1
to the Company's Registration Statement on Form S-1--File No.
333-15781). (a) Certificate of Amendment of Amended and
Restated Certificate of Incorporation (Exhibit 3.1(a) to the
Company's Registration Statement on Form S-1--File No.
333-15781).
3.2 Bylaws (Exhibit 3.2 to the Company's Registration Statement on
Form S-1--File No. 333-15781).
3.3 Certificate of Designation Preferences and Rights of Series A
Convertible Preferred Stock (Exhibit 3.3 to the Company's
Registration Statement on Form S-1 -File No. 333-15781). (a)
Certificate of Amendment of EarthLink Network, Inc.
Certificate of Designation, Preferences and Rights of Series A
Convertible Preferred Stock (Exhibit 3.3(a) to the Company's
Registration Statement on Form S-1--File No. 333-15781).
4.1 See exhibits 3.1, 3.2 and 3.3 for provisions of the
Certificate of Incorporation and Bylaws defining rights of
holders of Common Stock.
4.2 Specimen Stock Certificate (Exhibit 4.2 to the Company's
Registration Statement on Form S-1--File No. 333-15781).
4.3 Form of Warrant Agreement (Exhibit 4.3 to the Company's
Registration Statement on Form S-1--File No. 333-15781).
4.4 Registration Rights Agreement, Amendment No. 1 to Registration
Rights Agreement and Amendment No. 2 to Registration Rights
Agreements (Exhibit 4.4 to the Company's Registration
Statement on Form S-1--File No. 333-15781) (See also Exhibit
10.23(c)).
4.5 Buy-Sell Agreement, dated June 10, 1995, among the Company, Sky
Dayton, Reed Slatkin and Kevin O'Donnell (Exhibit 4.5 to the
Company's Registration Statement on Form S-1--File No.
333-15781).
9.1 Voting Trust Agreement, dated June 10, 1995, among Sky Dayton,
Reed Slatkin and Kevin O'Donnell (Exhibit 9.1 to the Company's
Registration Statement on Form S-1--File No. 333-15781).
10.1 1995 Stock Option Plan and forms of Stock Option Agreement and
Stock Purchase Agreement (Exhibit 10.1 to the Company's
Registration Statement on Form S-1 - File No. 333-15781).
10.2 Amended and Restated Stock Option Plan for Directors (Exhibit
10.2 to the Company's Registration Statement on Form S-1--File
No. 333-15781).
10.3 Master Lease Agreement, dated February 8, 1996, between the
Company and Boston Financial & Equity Corporation (Exhibit
10.3 to the Company's Registration Statement on Form S-1--
File No. 333-15781).
10.4 Lease Line Agreement, dated January 30, 1996, between the
Company and Boston Financial & Equity Corporation (Exhibit
10.4 to the Company's Registration Statement on Form S-1--File
No. 333-15781).
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<PAGE>
10.5 Master Lease Agreement, dated September 1, 1995, between the
Company and LINC Capital Management (Exhibit 10.5 to the
Company's Registration Statement on Form S-1--File No.
333-15781).
10.6 Netscape Communications Corporation Internet Service Provider
Navigator Distribution Agreement dated May 31, 1996, between
the Company and Netscape Communications Corporation (Exhibit
10.6 to the Company's Registration Statement on Form S-1--File
No. 333-15781). (a) Amendment No. 1 to Netscape Communications
Corporation Internet Service Provider Agreement (Exhibit
10.6(a) to the Company's Registration Statement on Form S-1--
File No. 333-15781). (b) Amendment No. 2 to Netscape
Communications Corporation Internet Service Provider Agreement
(Exhibit 10.6(b) to the Company's Registration Statement on
Form S-1--File No. 333-15781).
10.7 Network Services Agreement dated May 31, 1996, between the
Company and UUNET Technologies, Inc. (Exhibit 10.7 to the
Company's Registration Statement on Form S-1--File No.
333-15781). (a) Addendum No. 1 to Network Services Agreement
(Exhibit 10.7(a) to the Company's Registration Statement on
Form S-1--File No. 333-15781).
10.8 Software Distribution Agreement (MacTCP), dated October 2,
1995, between the Company and Apple Computer, Inc. (Exhibit
10.8 to the Company's Registration Statement on Form S-1--File
No. 333-15781).
10.9 Employment Agreement, dated January 15, 1996, between the
Company and Charles G. Betty (Exhibit 10.9 to the Company's
Registration Statement on Form S-1--File No. 333-15781).
10.10 Indemnification Agreement, dated August 31, 1995, among the
Company and Kevin O'Donnell as Indemnitors and Reed Slatkin as
Indemnitee (Exhibit 10.10 to the Company's Registration
Statement on Form S-1 -File No. 333-15781).
10.11 Indemnification and Participation Agreement, dated December 1,
1995, among the Company and Kevin O'Donnell as Indemnitors and
Reed Slatkin as Indemnitee (Exhibit 10.11 to the Company's
Registration Statement on Form S-1--File No. 333-15781).
10.12 Standard Industrial/Commercial Multi-Tenant Lease, dated
December 1, 1995, between the Company and Becton, Dickinson
(Exhibit 10.12 to the Company's Registration Statement on Form
S-1--File No. 333-15781).
10.13 Business Loan Agreement, dated June 15, 1995, and Promissory
Note in the original principal amount of $250,000 between the
Company and California United Bank (Exhibit 10.13 to the
Company's Registration Statement on Form S-1--File No.
333-15781).
10.14 Line of Credit Note in the original principal amount of
$250,000, dated June 23, 1995, and Security Agreement, dated
June 23, 1995, between the Company and the Bank of California,
N.A. (Exhibit 10.14 to the Company's Registration Statement on
Form S-1 -File No. 333-15781).
10.15 Line of Credit Note in the original principal amount of
$1,000,000, dated November 2, 1995, between the Company and
the Bank of California, N.A. (Exhibit 10.15 to the Company's
Registration Statement on Form S-1--File No. 333-15781).
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<PAGE>
10.16 Production and Distribution Agreement, dated May 6, 1996,
between the Company and National Media Corporation (Exhibit
10.16 to the Company's Registration Statement on Form
S-1--File No. 333-15781). (a) Amendment No. 1 to Production
and Distribution Agreement (Exhibit 10.16(a) to the Company's
Registration Statement on Form S-1--File No. 333-15781).
10.17 Documents evidencing the Company's sale of $2,950,000 of its
10% Promissory Notes, dated June 18, 1996: (a) Form of
Subscription Agreement (Exhibit 10.17 to the Company's
Registration Statement on Form S-1-File No. 333-15781). (b)
Form of Warrant (Exhibit 10.17(a) to the Company's
Registration Statement on Form S-1--File No. 333-15781). (c)
Form of 10% Promissory Note (Exhibit 10.7(b) to the Company's
Registration Statement on Form S-1 -File No. 333-15781).
10.18 Amended and Restated Stock Purchase Agreement Relating to
2,727,273 Shares of Series A Convertible Preferred Stock
between the Company and the Investors named therein, dated
September 10, 1996 (Exhibit 10.18 to the Company's
Registration Statement on Form S-1-- File No. 333-15781). (a)
Form of Stock Purchase Warrant (Exhibit 10.18(a) to the
Company's Registration Statement on Form S-1 - File No.
333-15781).
10.19 Internet Wizard Sign-Up Agreement between the Company and
Microsoft Corporation, dated August 16, 1996 (Exhibit 10.19 to
the Company's Registration Statement on Form S-1--File No.
333-15781).
10.20 Network Access Agreement between the Company and PSINet, Inc.,
dated July 22, 1996 and Amendment No. 1 to Network Access
Agreement (Exhibit 10.20 to the Company's Registration
Statement on Form S-1--File No. 333-15781).
10.21 Office Lease by and between The Mutual Life Insurance Company
of New York, as Landlord, and the Company, as Tenant, dated
September 20, 1996 (Exhibit 10.21 to the Company's
Registration Statement on Form S-1--File No. 333-15781).
10.22 Standard Office Lease by and between Glen Feliz Properties, as
Landlord, and the Company, as Tenant, dated July 2, 1996
(Exhibit 10.22 to the Company's Registration Statement on Form
S-1--File No. 333-15781).
10.23 Amended and Restated Note Purchase Agreement between the
Company and UUNET Technologies, Inc., dated October 31, 1996
(Exhibit 10.23 to the Company's Registration Statement on Form
S-1--File No. 333-15781). (a) $5,000,000 Convertible Note
(Exhibit 10.23(a) to the Company's Registration Statement on
Form S-1-File No. 333-15781). (b) Stockholders Agreement
(Exhibit 10.23(b) to the Company's Registration Statement on
Form S-1--File No. 333-15781). (c) Addendum to Amended and
Restated Registration Rights Agreement (Exhibit 10.23(c) to
the Company's Registration Statement on Form S-1--File No.
333-15781).
11.1 Statement of computation of per share earnings -filed herewith.
23.1 Consent of Price Waterhouse LLP, independent public accountants
--filed herewith.
27. Financial Data Schedule--filed herewith.
E-3
<PAGE>
E-4
<PAGE>
EXHIBIT 11
EARTHLINK NETWORK, INC
COMPUTATION OF EARNINGS PER COMMON SHARE
(In thousands, except per share data)
<TABLE>
<CAPTION>
INCEPTION
(MAY 26,
1994)
THROUGH YEAR ENDED DECEMBER 31,
DECEMBER 31, -----------------------
1994 1995 1996
------------- --------- ----------
<S> <C> <C> <C>
Net loss..................................................................... $ (148) $ (6,120) $ (31,149)
------ --------- ----------
Average shares oustanding.................................................... 2,587 3,837 6,097
Common equivalent shares:
Purchase of shares of Common Stock below the expected IPO price during fiscal
1996....................................................................... 468 468 225
Assumed exchange of warrants for Common Stock................................ 235 235 235
Assumed exchange of options for Common Stock................................. 363 363 363
------ --------- ----------
Weighted average shares outstanding.......................................... 3,653 4,903 6,920
------ --------- ----------
------ --------- ----------
Net loss per share........................................................... $ (0.04) $ (1.25) $ (4.50)
------ --------- ----------
------ --------- ----------
</TABLE>
- ------------------------
* All shares in these tables are weighted on the basis of the number of days
the shares were outstanding or assumed to be outstanding during each period.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-22317) of EarthLink Network, Inc. of our report
dated March 14, 1997 appearing on page F-2 of this Form 10-K.
PRICE WATERHOUSE LLP
Costa Mesa, California
March 28, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 2,313
<SECURITIES> 1,680
<RECEIVABLES> 2,506
<ALLOWANCES> (781)
<INVENTORY> 499
<CURRENT-ASSETS> 9,073
<PP&E> 21,637
<DEPRECIATION> 4,236
<TOTAL-ASSETS> 27,119
<CURRENT-LIABILITIES> 28,279
<BONDS> 0
14,013
0
<COMMON> 60
<OTHER-SE> 14,236
<TOTAL-LIABILITY-AND-EQUITY> 27,119
<SALES> 0
<TOTAL-REVENUES> 32,503
<CGS> 0
<TOTAL-COSTS> 21,161
<OTHER-EXPENSES> 21,161
<LOSS-PROVISION> 781
<INTEREST-EXPENSE> 1,041
<INCOME-PRETAX> (31,149)
<INCOME-TAX> 0
<INCOME-CONTINUING> (30,258)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 31,149
<EPS-PRIMARY> 4.50
<EPS-DILUTED> 4.50
</TABLE>
