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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
[X] AMENDMENT TO QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1997
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 000-20799
EARTHLINK NETWORK, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-4481766
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
3100 NEW YORK DRIVE, PASADENA, CALIFORNIA 91107
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(626) 296-2400
(REGISTRANT'S TELEPHONE, INCLUDING AREA CODE)
____________________
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
____________________
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No ___
There were 9,753,622 shares of Common Stock outstanding as of June 30, 1997.
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EARTHLINK NETWORK, INC.
AMENDMENT ON FORM 10-Q/A TO THE
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1997
TABLE OF CONTENTS
PART I
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................... 1
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This report contains certain forward-looking statements with respect to
the Company's operations, industry, financial condition and liquidity. These
statements, which are typically introduced by statements such as "the Company
believes", "anticipates", "estimates" or "expects" certain conditions to
exist, reflect management's best current assessment of a number of risks and
uncertainties. The Company's actual results could differ materially from the
results anticipated in these forward-looking financial statements as a result
of certain factors described in this report.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE UNAUDITED
CONDENSED FINANCIAL STATEMENTS AND RELATED NOTES THERETO AND THE AUDITED
FINANCIAL STATEMENTS AND THE NOTES THERETO ACCOMPANYING THE COMPANY'S
PREVIOUSLY FILED REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 1997.
OVERVIEW
EarthLink Network, Inc. ("EarthLink" or the "Company") is an Internet
service provider ("ISP") formed to help its members derive meaningful
benefits from the extensive resources of the Internet. The Company focuses on
providing access, information, assistance and services to its members to
encourage their introduction to the Internet and to help them have a
satisfying user experience.
The Company has experienced net losses in each quarter since it commenced
operations. The Company expects that it is likely to continue to incur net
losses at least through the end of 1997 as it continues to expend substantial
resources to build its infrastructure, develop new service and product
offerings and build its sales and marketing and administrative organizations.
The Company's operating results have fluctuated significantly in the past
and will likely continue to fluctuate significantly in the future as a result
of a variety of factors, many of which are beyond the Company's control.
EarthLink's principal strategy is to rapidly expand its member base and
increase its market share. To realize this strategy, the Company is
continuing to invest in sales and marketing, increasing its member support
capabilities, enhancing its network operations capacity to meet member demand
and adding administrative infrastructure. This strategy requires substantial
initial cash outlays.
The Company believes that its long-term success largely depends on
maintaining member satisfaction with its services. EarthLink continues to
devote significant resources to enhancing its network operations capability,
its World Wide Web site and its service offerings. In addition, the Company
continues to expand its technical support staff and enhance the staff's
effectiveness by providing software tools that can assist the staff in
identifying and solving member problems.
The Company provides Internet access service to a large number of
consumers and small businesses. The Company has recently expanded its
consumer service offerings, including a Personal Start Page-TM-, integrated
"plug-and-play" Web site software package, 56kbps modem access, and the Arena
which features pay-per-play multi-player Internet games. In addition, the
Company provides a variety of services for business customers, including
business Web sites, high-speed LAN ISDN communications capability, and frame
relay connections, each of which involve a monthly service charge plus set-up
fees.
In order to maintain its focus on member needs, the Company has leveraged
the infrastructure and software development efforts of others by leasing POP
capacity from UUNET Technologies, Inc. ("UUNET") and PSINet, Inc. ("PSINet")
and licensing software from developers such as Netscape Communications
Corporation and Microsoft Corporation. The Company believes that this
approach gives it flexibility to rapidly expand its service coverage without
the need for substantial capital expenditures. The Company will continue to
pursue this strategy so that, in addition to its sales and marketing efforts,
it can devote its principal resources to improving its members' experience
with the Internet.
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RESULTS OF OPERATIONS
REVENUES.
QUARTER QUARTER
ENDED PERCENT ENDED PERCENT
JUNE 30, OF TOTAL JUNE 30, OF TOTAL
1996 REVENUE 1997 REVENUE
---- ------- ---- -------
(in thousands except percentages)
Recurring revenues $ 5,014 75% $ 17,479 93%
Other revenues 1,714 25% 1,367 7%
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Total Revenues $ 6,728 100% $ 18,846 100%
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Recurring revenues consist of monthly fees charged to members for
Internet access and other ongoing services. Other revenues generally
represent one-time set-up fees. Recurring revenues are recognized over the
period in which the services are performed. As indicated in the above chart,
the Company experienced substantial growth in revenues for the quarter ended
June 30, 1997 as compared to the corresponding quarter of 1996. This growth
is primarily attributable to an increase in the number of members who use the
Company's services, from approximately 128,000 at June 30, 1996 to 328,000 at
June 30, 1997. The increase in revenues was partially offset by credits given
to members under the Company's member referral program. Under this program
the $19.95 service fee is waived for one month in consideration for each new
member referred by an existing member. Waived service fees resulted in a
reduction to revenues of approximately $564,000 during the quarter ended June
30, 1997.
As competition in the ISP market intensifies, the Company has found it
necessary to waive the one-time set-up fee to remain competitive.
Consequently, revenues from the one-time set-up fee have decreased and are
expected to continue to decrease in future periods. The Company waived
set-up fees of approximately $466,000 during the quarter ended June 30, 1997.
Although the average set-up fee per customer decreased, the overall
reduction was partially offset, approximately $201,000, by the increase in
the number of members added during the quarter ended June 30, 1997.
COST OF REVENUES.
QUARTER QUARTER
ENDED PERCENT ENDED PERCENT
JUNE 30, OF RECURRING JUNE 30, OF RECURRING
1996 REVENUE 1997 REVENUE
---- ------- ---- -------
(in thousands except percentages)
Cost of recurring revenues $ 3,865 77% $ 9,187 53%
QUARTER QUARTER
ENDED PERCENT ENDED PERCENT
JUNE 30, OF TOTAL JUNE 30, OF TOTAL
1996 REVENUE 1997 REVENUE
---- ------- ---- -------
(in thousands except percentages)
Cost of other revenues $ 758 44% $ 804 59%
Cost of recurring revenues principally includes telecommunications
expenses and depreciation expense on equipment used in network operations for
ongoing member services. Included in telecommunications costs are fees paid
to UUNET and PSINet for local access to their respective nationwide systems
of POPs. Cost of other revenues principally includes expenses related to the
registration of new members. These costs include licensing
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fees for software, software duplication costs and commissions paid to third
parties for referring new members to the Company.
The increase in the cost of recurring revenues is primarily due to the
increase in the number of members. The decrease in cost of recurring
revenues as a percentage of recurring revenue is primarily due to the
Company's ability to exploit economies of scale to reduce per member costs as
the total member base expands.
As noted above, from time to time, the Company waives the one-time set-up
fee it charges new members. Therefore, the increase in cost of other revenue
as a percentage of other revenue is due to the waiving of the one-time set-up
fee for certain customers while the per set-up costs to the Company have
remained constant. Management expects revenues from the one-time set-up fee
to decrease in future periods.
Substantially all of the Company's customers access the EarthLink Network
and the Internet by dialing into local POPs. Access in the Company's
Southern California base is provided through POPs owned by the Company. The
Company provides nationwide service to members through POP access leased from
UUNET and PSINet. (Access to the UUNET and PSINet POPs is on a non-exclusive
basis.)
Under the Company's current agreement with UUNET, the Company pays UUNET
a monthly fee equal to the greater of a specified minimum or an amount that
varies based primarily on peak member usage. The Company also pays UUNET an
additional fee to the extent that hours of usage exceed a formula set forth
in the agreement. If the number of hours used by EarthLink members accessing
the Internet through UUNET increases beyond the amount provided for in the
agreement or the usage becomes more concentrated during peak times, the fees
paid by the Company to UUNET would increase, which would adversely affect the
Company's operating margins.
SALES AND MARKETING.
QUARTER QUARTER
ENDED PERCENT ENDED PERCENT
JUNE 30, OF TOTAL JUNE 30, OF TOTAL
1996 REVENUE 1997 REVENUE
---- ------- ---- -------
(in thousands except percentages)
Sales and marketing $ 3,263 48% $ 5,056 27%
Sales and marketing expenses consist primarily of sales commissions,
salaries, costs of promotional material, advertising, travel and trade shows.
The Company experienced an increase of 55% in sales and marketing expenses for
the quarter ended June 30, 1997 as compared to the corresponding quarter of the
previous year, primarily as a result of EarthLink's efforts to expand its member
base and increase brand awareness in the market place. However, as a percentage
of total revenue, sales and marketing expenses declined to 27% from 48%, as such
expenses grew at slower rate than the Company's revenues.
GENERAL AND ADMINISTRATIVE EXPENSES.
QUARTER QUARTER
ENDED PERCENT ENDED PERCENT
JUNE 30, OF TOTAL JUNE 30, OF TOTAL
1996 REVENUE 1997 REVENUE
---- ------- ---- -------
(in thousands except percentages)
General and administrative
expenses $ 2,423 36% $ 3,449 18%
General and administrative expenses consist primarily of costs associated
with the finance and human resources departments, professional expenses, rent
and other expenses, compensation earned by certain executive
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officers, depreciation associated with office equipment, and bad debts. The
Company experienced an increase of 42% percent in general and administrative
expenses for the quarter ended June 30, 1997 as compared to the corresponding
quarter of the previous year, due to an increase in payroll, rent,
depreciation expense, credit card fees and bad debt expense. The increase in
payroll costs is primarily due to an increase in headcount. Rent expense
increased as the Company occupied a new 55,000 square foot facility adjacent
to its corporate headquarters and a satellite office in Northern California
in February 1997. Monthly rents for the properties are $66,000 and $3,000
respectively. The increase in depreciation expense is due to the acquisition
of office equipment. The increases in credit card processing fees and bad
debt are primarily due to the increase in member count from approximately
128,000 at June 30, 1996 to 328,000 at June 30, 1997. As a percentage of
total revenue, general and administrative expenses declined to 18% from 36%,
as the expenses grew at a slower rate than the Company's revenues.
OPERATIONS AND MEMBER SUPPORT.
QUARTER QUARTER
ENDED PERCENT ENDED PERCENT
JUNE 30, OF TOTAL JUNE 30, OF TOTAL
1996 REVENUE 1997 REVENUE
---- ------- ---- -------
(in thousands except percentages)
Operations and customer
support $ 3,094 46% $ 7,791 41%
Operations and member support expenses consist primarily of costs
associated with technical support and member services to register and
maintain member accounts. These expenses have increased significantly since
the Company's inception. This trend reflects the costs associated with
building a customer service organization to support the Company's member base
and anticipated member growth. Management has pledged to make significant
investments in technical and customer support capabilities and to reduce
customer wait time for assistance. Consequently, operations and customer
support expenses have not significantly decreased as a percentage of revenue.
POTENTIAL FLUCTUATIONS IN QUARTERLY RESULTS
The Company's operating results may fluctuate significantly in the future
as a result of a variety of factors, many of which are beyond the Company's
control. These factors include the rates of, and costs associated with, new
member acquisition, member retention, capital expenditures and other costs
relating to the expansion of operations, including upgrading the Company's
systems and infrastructure, the timing and market acceptance of new and
upgraded service introductions, changes in the pricing policies of the
Company and its competitors, changes in operating expenses (including
telecommunications costs), personnel changes, the introduction of alternative
technologies, the effect of potential acquisitions, increased competition in
the Company's markets and other general economic factors. In addition, a
significant portion of the Company's expenses are fixed; therefore, the
Company's operating margins are particularly sensitive to fluctuations in
revenues.
LIQUIDITY AND CAPITAL RESOURCES
The Company has not generated net cash from operations since its
inception. The Company has funded its operations primarily through public and
private sales of equity securities, borrowings from third parties and capital
leases of equipment. The Company's operating activities used net cash of
approximately $4.3 million and $4.1 million during the quarters ended June
30, 1996 and 1997, respectively. During the quarter ended June 30, 1996, net
cash used in operations resulted primarily from net losses, partially offset
by increases in trade accounts payable. During the quarter ended June 30,
1997, net cash used in operations resulted from net losses, partially offset
by increases in trade accounts payable and accrued payroll related
liabilities.
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Cash used in investing activities has consisted primarily of equipment
purchases for POP and network expansion. For the quarters ended June 30, 1996
and 1997, capital expenditures amounted to approximately $5.3 million and
$4.2 million, respectively. The Company estimates that remaining capital
expenditures for 1997 will be approximately $4.9 million including network
enhancements, data center expansion, leasehold improvements, and procurement
of telecommunication and office equipment and furniture and fixtures. Where
feasible, the Company will seek to finance certain of these expenditures
through capital leases.
Cash provided by financing activities was $9.8 million and $2.6 million
for the quarters ended June 30, 1996 and, 1997, respectively. During the
second quarter of 1996, the Company's financing activities consisted of the
private sale of debt and equity securities and capital lease transactions,
primarily for equipment. The Company raised $4.9 million and $2.5 million
from the sale and leaseback of equipment during the quarters ended June 30,
1996 and 1997, respectively. The sale leaseback transactions were recorded
at cost, which approximates the fair market value of the property and,
therefore, no gains or losses were recorded. The property remains on the
books and continues to be depreciated. A financing obligation representing
the proceeds is recorded and reduced based upon payments under the lease
agreement. Under an agreement with one of its vendors, EarthLink obtained a
$5 million credit facility for customer access. EarthLink accumulates
customer access charges, applies them against the credit facility and is
charged interest at a rate of prime plus 4% on the balance. The outstanding
balance due under the credit facility at June 30, 1997 was $1,271,000 leaving
$3,729,000 unused and available. The line of credit is due on the earlier of
termination or July 31, 1998
As of June 30, 1996 and 1997, the Company had cash and cash equivalents
of approximately $1.2 million and $6.2 million, respectively, and negative
working capital of approximately $9.2 million and $11.7 million,
respectively.
The Company believes that available cash will be sufficient to meet the
Company's operating expenses and capital requirements through the end of this
fiscal year. 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 member base, the rate of
expansion of the Company's network infrastructure, the level of resources
required to expand the Company's marketing and sales organization,
information systems and research and development activities, the availability
of hardware and software provided by third-party vendors and other factors.
The timing and amount of all of these capital requirements cannot accurately
be predicted; however, many of these factors are within the control of
management, and to that extent management has control over the Company's
liquidity position. If capital requirements vary materially from those
currently planned, the Company may require additional financing sooner than
anticipated. However, the Company believes that financing alternatives are
available to address the Company's current liquidity requirements should the
need arise.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EARTHLINK NETWORK, INC.
Date: August 14, 1997 /s/ C. Garry Betty
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C. Garry Betty, President, Chief
Executive Officer and Director
Date: August 14, 1997 /s/ Barry W. Hall
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Barry W. Hall, Vice President - Finance
and Administration and Chief Financial
Officer
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