<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
[X] AMENDMENT TO ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
[_] 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)
(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
--- ---
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 31, 1998 was $259,997,857.
There were 11,997,884 shares of Common Stock outstanding as of March 31, 1998.
<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, 1996 and 1997
Statement of Operations for the three years ended December 31, 1997
Statement of Stockholders' Equity (Deficit) for the three years ended
December 31, 1997
Statement of Cash Flows for the three years ended December 31, 1997
Notes to Financial Statements
-1-
<PAGE>
EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ------- -----------
<C> <S>
2.1 Investment Agreement dated as of February 10, 1998, among Sprint
Corporation, a Kansas corporation, Sprint Communications Company L.P.,
a Delaware limited partnership, Dolphin, Inc., a Delaware corporation,
Dolphin Sub, Inc., a Delaware corporation, and EarthLink Network,
Inc., a Delaware corporation (incorporated by reference to Exhibit 2.1
to the Company's Form 8-K filed on February 10, 1998).
3.1 Amended and Restated Certificate of Incorporation incorporated by
reference to (incorporated by reference to Exhibit 3.1 to the
Company's Registration Statement on Form S-1 - File No. 333-15781).
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to the Company's
Registration Statement on Form S-1 - File No. 333-15781).
4.1 See exhibits 3.1 and 3.2 for provisions of the Certificate of
Incorporation and Bylaws defining rights of holders of Common Stock.
4.2 Specimen Stock Certificate (incorporated by reference to Exhibit 4.2
to the Company's Registration Statement on Form S-1 - File No.
333-15781).
4.3 Form of Warrant Agreement (incorporated by reference to Exhibit 4.3 to
the Company's Registration Statement on Form S-1 - File No.
333-15781).
10.1 Governance Agreement, dated as of February 10, 1998, among Sprint
Corporation, a Kansas corporation, Sprint Communications Company L.P.,
a Delaware limited partnership, Dolphin, Inc., a Delaware corporation,
and EarthLink Network, Inc., a Delaware corporation (incorporated by
reference to Exhibit 10.1 to the Company's Form 8-K filed on February
10, 1998).
10.2 Proposed form of Certificate of Designation, Preferences and Rights of
Series A Convertible Preferred Stock of Dolphin, Inc. (incorporated by
reference to Exhibit 10.2 to the Company's Form 8-K filed on February
10, 1998).
10.3 Credit Agreement, dated as of February 10, 1998, between Dolphin,
Inc., a Delaware corporation, and EarthLink Network, Inc., a Delaware
corporation, as Borrowers, and Sprint Corporation, a Kansas
corporation, as Lender (incorporated by reference to Exhibit 10.3 to
the Company's Form 8-K filed on February 10, 1998).
10.4 Lease Line Agreement, dated January 30, 1996, between the Company and
Boston Financial & Equity Corporation (incorporated by reference to
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 (incorporated by reference to Exhibit
10.5 to the Company's Registration Statement on Form S-1 - File No.
333-15781).
-2-
<PAGE>
10.6 Netscape Communications Corporation Internet Service Provider
Navigator Distribution Agreement dated May 31, 1996, between the
Company and Netscape Communications Corporation (incorporated by
reference to 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 (incorporated by reference to 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 incorporated by reference to
(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. incorporated by reference to (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 (incorporated by
reference to 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. (incorporated by
reference to 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 (incorporated by reference to Exhibit 10.9 to the
Company's Registration Statement on Form S-1 - File No. 333-15781).
(a) Amendment to Employment Agreement - filed herewith
(b) First Amendment to Employment Agreement - filed herewith
(c) Second Amendment to Employment Agreement - filed herewith
10.10 Standard Industrial/Commercial Multi-Tenant Lease, dated December 1,
1995, between the Company and Becton, Dickinson (incorporated by
reference to Exhibit 10.12 to the Company's Registration Statement on
Form S-1 - File No. 333-15781).
10.11 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 (incorporated by reference to Exhibit 10.13 to
the Company's Registration Statement on Form S-1 - File No.
333-15781).
10.12 Production and Distribution Agreement, dated May 6, 1996, between the
Company and National Media Corporation (incorporated by reference to
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
(incorporated by reference to Exhibit 10.16(a) to the Company's
Registration Statement on Form S-1 - File No. 333-15781).
10.13 Internet Wizard Sign-Up Agreement between the Company and Microsoft
Corporation, dated August 16, 1996 (incorporated by reference to
Exhibit 10.19 to the Company's Registration
-3-
<PAGE>
Statement on Form S-1 - File No. 333-15781).
10.14 Network Access Agreement between the Company and PSINet, Inc., dated
July 22, 1996 and Amendment No. 1 to Network Access Agreement
(incorporated by reference to Exhibit 10.20 to the Company's
Registration Statement on Form S-1 - File No. 333-15781).
10.15 Office Lease by and between The Mutual Life Insurance Company of New
York, as Landlord, and the Company, as Tenant, dated September 20,
1996 (incorporated by reference to Exhibit 10.21 to the Company's
Registration Statement on Form S-1 - File No. 333-15781).
10.16 Standard Office Lease by and between Glen Feliz Properties, as
Landlord, and the Company, as Tenant, dated July 2, 1996 (incorporated
by reference to Exhibit 10.22 to the Company's Registration Statement
on Form S-1 - File No. 333-15781).
10.17 Amended and Restated Note Purchase Agreement between the Company and
UUNET Technologies, Inc., dated October 31, 1996 (incorporated by
reference to Exhibit 10.23 to the Company's Registration Statement on
Form S-1 - File No. 333-15781).
(a) $5,000,000 Convertible Note (incorporated by reference to
Exhibit 10.23(a) to the Company's Registration Statement on Form S-1 -
File No. 333-15781).
(b) Addendum to Amended and Restated Registration Rights Agreement
(incorporated by reference to Exhibit 10.23(c) to the Company's
Registration Statement on Form S-1 - File No. 333-15781).
10.18 Amended and Restated Convertible Securities Vesting Plan
10.19 Key Employee Compensation Continuation Plan
(a) Amendment to Key Employee Compensation Continuation Plan
10.24 EarthLink Network, Inc. 1995 Stock Option Plan and Form of Stock
Option Agreement (incorporated by reference to Exhibit 10.1 to the
Registration Statement on Form S-1 of EarthLink Network, Inc. -
File No. 333-15781).
10.25 EarthLink Network, Inc. Amended and Restated Stock Option Plan for
Directors (incorporated by reference to Exhibit 10.2 to the
Registration Statement on Form S-1 of EarthLink Network, Inc. -
File No. 333-15781).
23.1 Consent of Price Waterhouse LLP, independent accountants - filed
herewith.
27.1 Financial Data Schedule.
99.1 Registration Rights Agreement, dated as of February 10, 1998, among
Dolphin, Inc., a Delaware corporation, Sprint Corporation, a Kansas
corporation, and Sprint Communications Company L.P., a Delaware
limited partnership (incorporated by reference to Exhibit 99.1 to the
Company's Form 8-K filed on February 10, 1998).
99.3 Agreement to Vote Stock, dated as of February 10, 1998, among the
Granting Stockholders named on Schedule A thereto, Sprint Corporation,
a Kansas corporation and Sprint Communications Company L.P., a
Delaware limited partnership (incorporated by reference to
Exhibit 99.3 to the Company's Form 8-K filed on February 10, 1998).
99.4 Agreement to Vote and Tender Stock, dated as of February 10, 1998,
among the Granting Stockholders named on Schedule A thereto, Sprint
Corporation, a Kansas corporation and Sprint Communications Company,
L.P., a Delaware limited partnership (incorporated by reference to
Exhibit 99.4 to the Company's Form 8-K filed on February 10, 1998).
</TABLE>
-4-
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
EARTHLINK NETWORK, INC.
Report of Independent Accountants.......................................................................... F-2
Balance Sheet as of December 31, 1996 and 1997............................................................. F-3
Statement of Operations for the three years ended December 31, 1997........................................ F-4
Statement of Stockholders' Equity (Deficit) for the three years ended December 31, 1997.................... F-5
Statement of Cash Flows for the three years ended December 31, 1997........................................ 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, 1996 and 1997, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1997, 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
January 29, 1998
F-2
<PAGE>
EARTHLINK NETWORK, INC.
BALANCE SHEET
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
<S> <C> <C>
1996 1997
---------- ----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C>
Current assets:
Cash and cash equivalents............................................................... $ 3,993 $ 16,450
Restricted short-term investment........................................................ 1,087 1,250
Accounts receivable, net of allowance of $781,000 and $165,000 at December 31, 1996 and
1997, respectively.................................................................... 1,725 2,520
Prepaid expenses........................................................................ 885 1,109
Other assets (Note 5)................................................................... 1,383 753
---------- ----------
Total current assets................................................................ 9,073 22,082
Other long-term assets (Note 5)........................................................... 329 449
Property and equipment, net (Notes 1 and 4) 17,401 23,398
Intangibles, net (Notes 3, 6 and 9)....................................................... 316 958
---------- ----------
$ 27,119 $ 46,887
---------- ----------
---------- ----------
LIABILITIES, MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Trade accounts payable.................................................................. $ 11,207 $ 6,472
Accrued payroll and related expenses.................................................... 1,469 2,316
Other accounts payable and accrued liabilities.......................................... 2,061 3,717
Current portion of capital lease obligations (Note 11).................................. 3,582 7,112
Notes payable (Note 7).................................................................. 7,950 9,387
Deferred revenue........................................................................ 2,010 3,590
---------- ----------
Total current liabilities 28,279 32,594
Long-term debt (Note 11).................................................................. 6,088 8,218
---------- ----------
Total liabilities................................................................... 34,367 40,812
Commitments and contingencies (Note 11)
Mandatorily redeemable convertible preferred stock (Note 8)............................... 14,013 --
Stockholders' equity (deficit)
Preferred stock, $0.01 par value, 10,000,000 shares authorized, 2,727,273 and nil shares
outstanding as redeemable preferred stock (Note 8).................................... -- --
Common stock, $0.01 par value, 50,000,000 shares authorized, 6,022,724 and 11,250,372
shares issued and outstanding (Note 8).................................................... 60 112
Additional paid-in capital.............................................................. 14,236 70,942
Warrants to purchase common stock (Note 9).............................................. 599 1,093
Accumulated deficit..................................................................... (36,156) (66,072)
---------- ----------
Total stockholders' equity (deficit)................................................ (21,261) 6,075
---------- ----------
$ 27,119 $ 46,887
---------- ----------
---------- ----------
</TABLE>
The accompanying notes are an integral part of these financial statements
F-3
<PAGE>
EARTHLINK NETWORK, INC
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1995 1996 1997
--------- ---------- ----------
<S> <C> <C> <C>
(IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
Revenues:
Recurring revenues........................................................... $ 2,422 $ 26,879 $ 72,943
Other revenues............................................................... 606 5,624 6,231
--------- ---------- ----------
Total revenues............................................................. 3,028 32,503 79,174
Operating costs and expenses:
Cost of recurring revenues................................................... 1,055 18,462 37,974
Cost of other revenues....................................................... 349 2,699 3,401
Sales and marketing.......................................................... 3,711 15,258 21,020
General and administrative................................................... 2,062 10,534 14,333
Operations and member support................................................ 1,869 15,808 30,900
--------- ---------- ----------
9,046 62,761 107,628
--------- ---------- ----------
Loss from operations......................................................... (6,018) (30,258) (28,454)
Interest expense............................................................. (136) (1,041) (2,099)
Interest income.............................................................. 34 150 637
--------- ---------- ----------
Net loss................................................................... $ (6,120) $ (31,149) $ (29,916)
--------- ---------- ----------
--------- ---------- ----------
Basic and diluted net loss per share (Note 1).................................. $ (1.59) $ (5.13) $ (2.99)
--------- ---------- ----------
--------- ---------- ----------
Weighted average shares outstanding (Note 1)................................... 3,837 6,069 10,001
--------- ---------- ----------
--------- ---------- ----------
</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>
TOTAL
COMMON STOCK ADDITIONAL SHAREHOLDERS'
---------------------- PAID-IN WARRANTS ACCUMULATED EQUITY
SHARES AMOUNT CAPITAL ISSUED DEFICIT (DEFICIT)
--------- ----------- ----------- ----------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS)
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.......................................... -- -- (1,261) -- 1,261 --
Warrants issued for lease guarantee (Note 9)...... -- -- -- 50 -- 50
Warrants issued for non-competition agreement
(Note 9)......................................... -- -- -- 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 (Note 9)............. -- -- -- 475 -- 475
Net loss.......................................... -- -- -- -- (31,149) (31,149)
--------- ----- ----------- ----------- ------------ --------------
Balance at December 31, 1996...................... 6,023 60 14,236 599 (36,156) (21,261)
Initial Public Offering, net of expenses.......... 2,000 20 22,766 22,786
Conversion of redeemable preferred stock into
common stock..................................... 1,364 13 14,000 -- -- 14,013
Conversion of debt to common stock................ 56 -- 725 -- -- 725
Underwriters over-allotment....................... 285 3 3,437 -- -- 3,440
Issuance of common stock in connection with
Private Placement................................ 1,460 15 15,394 -- -- 15,409
Issuance of Common Stock pursuant to exercise of
stock options.................................... 62 1 384 -- -- 385
Warrants issued in exchange for services (Note
9)............................................... -- -- -- 494 -- 494
Net loss.......................................... -- -- -- -- (29,916) (29,916)
--------- ----- ----------- ----------- ------------ --------------
Balance at December 31, 1997...................... 11,250 $ 112 $ 70,942 $ 1,093 $ (66,072) $ 6,075
--------- ----- ----------- ----------- ------------ --------------
--------- ----- ----------- ----------- ------------ --------------
</TABLE>
The accompanying notes are an integral part of these financial statements
F-5
<PAGE>
EARTHLINK NETWORK, INC
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
<S> <C> <C> <C>
1995 1996 1997
--------- ---------- ----------
<CAPTION>
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss...................................................................... $ (6,120) $ (31,149) $ (29,916)
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:
Depreciation and amortization............................................... 305 4,153 9,377
Provision for doubtful accounts receivable.................................. -- 781 (615)
Issuance of Common Stock in exchange for professional services.............. -- 50 --
Issuance of Common Stock in exchange for termination of consulting
agreement................................................................. -- 413 --
Issuance of warrants in exchange for professional services.................. -- -- 494
Increase in accounts receivable............................................. (191) (2,288) (180)
(Increase) decrease in prepaid expenses and other assets.................... (141) (2,353) 202
Increase (decrease) in accounts payable and accrued liabilities............. 2,292 12,373 (2,232)
Increase in deferred revenue................................................ 212 1,798 1,580
--------- ---------- ----------
Net cash used in operating activities..................................... (3,643) (16,222) (21,290)
--------- ---------- ----------
Cash flows from investing activities:
Purchases of property and equipment........................................... (2,766) (18,774) (14,528)
Purchase of restricited short-term investment................................. (1,500) (1,087) (200)
Liquidation of restricted short-term investment............................... -- 1,500 37
Purchase of member base....................................................... -- -- (1,404)
--------- ---------- ----------
Net cash used in investing activities..................................... (4,266) (18,361) (16,095)
--------- ---------- ----------
Cash flows from financing activities:
Proceeds from (payment of) line of credit 1,494 (1,494) 4,387
(Payment of) proceeds from notes payable...................................... (67) 7,950 (2,225)
Proceeds from capital lease obligations....................................... 556 11,348 10,544
Principal payments under capital lease obligations............................ (42) (2,191) (4,884)
Proceeds from issuance of mandatorily redeemable convertible preferred
stock....................................................................... -- 14,013 --
Proceeds from initial public offering......................................... -- -- 26,226
Proceeds from stock options exercised......................................... -- -- 385
Proceeds from private placements of Common Stock.............................. 6,258 8,660 15,409
--------- ---------- ----------
Net cash provided by financing activities................................. 8,199 38,286 49,842
--------- ---------- ----------
Net increase in cash and cash equivalents....................................... 290 3,703 12,457
Cash and cash equivalents, beginning of year.................................... -- 290 3,993
--------- ---------- ----------
Cash and cash equivalents, end of period........................................ $ 290 $ 3,993 $ 16,450
--------- ---------- ----------
--------- ---------- ----------
</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 as a California corporation and reincorporated in 1996 as a Delaware
corporation. The Company is an Internet service provider that was formed to help
members derive meaningful benefits from the extensive resources of the Internet.
The Company has experienced operating losses since 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 that it will continue
to incur net losses as it continues to expend substantial resources on sales and
marketing as it attempts to rapidly increase its market share. There can be no
assurance that the Company will achieve or sustain profitability or positive
cash flow from its operations.
REVENUES
Recurring revenues consists of monthly fees charged to members for Internet
access and other ongoing services from monthly Internet service and are
recognized over the period services are provided. Other revenues generally
represent one-time non-refundable set up fees. Such revenues are recorded as
earned.
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 members comprising the
Company's member base.
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 for computers and computer related equipment and five
years for other non-computer furniture and equipment. 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 ten years.
F-7
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 to five 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 one 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. Advertising expenses were
$937,000, $3.2 million and $5.1 million, respectively, for the three years ended
December 31, 1997.
INCOME TAXES
Income taxes are accounted for under the liability method. 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
The Company adopted Statement of Financial Accounting Standards (SFAS) No.
128, "Earnings per Share" (EPS) and Staff Accounting Bulletin (SAB) No. 98. SAB
No. 98 states that companies, such as EarthLink, that completed an initial
public offering ("IPO") within the past 5 years and incorporated the SAB No. 83
concept of "cheap stock" in determining pre-IPO EPS data must restate all EPS
data to conform to SFAS No. 128. Accordingly, all EPS data have been restated to
conform to SFAS No. 128. SFAS No. 128 requires a dual presentation of basic and
diluted EPS. Basic EPS represents the weighted average number of shares divided
into net income during a reported period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock. However, the Company has not
included potential common stock in the calculation of EPS since inception as
such inclusion would have an anti-dilutive effect.
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
F-8
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
COMMON STOCK BASED COMPENSATION
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 9), as if the measurement
provisions of SFAS No. 123 had been adopted.
RECLASSIFICATION
Certain amounts in the prior year financial statements have been
reclassified to conform to current year presentation.
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. PURCHASE OF CERTAIN ASSETS FROM INTERNET IN A MALL
In April 1997, the Company purchased the subscribers and related assets,
including accounts receivable related to the consumer dial-up Internet access
service of Internet in a Mall, a Tarzana, California based Internet access
provider. Under the terms of the agreement, as amended, the Company purchased
rights to approximately 28,000 subscriber accounts as of April 1997.
4. PROPERTY AND EQUIPMENT
Property and equipment consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1996 1997
--------- ----------
<S> <C> <C>
(IN THOUSANDS)
Data communications equipment.......................................... $ 11,464 $ 17,056
Office and other equipment............................................. 6,686 12,196
Leasehold improvements................................................. 646 5,013
Construction in progress............................................... 2,841 1,901
--------- ----------
21,637 36,166
Less accumulated depreciation and amortization......................... (4,236) (12,768)
--------- ----------
$ 17,401 $ 23,398
--------- ----------
--------- ----------
</TABLE>
F-9
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
4. PROPERTY AND EQUIPMENT (CONTINUED)
Property under capital lease, primarily data communications equipment
included above, aggregated $11,904,000, and $22,448,000 at December 31, 1996 and
1997, respectively. Included in accumulated depreciation and amortization are
amounts related to property under capital lease of $2,896,000 and $8,528,000 at
December 31, 1996 and 1997, respectively. Depreciation expense charged to
operations was $305,000, $3,924,000 and $8,531,000 in 1995, 1996, and 1997,
respectively, and included $56,000, $2,840,000 and $5,632,000, respectively,
pertaining to property under capital lease.
5. OTHER ASSETS
Other assets consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1997
--------- ---------
<S> <C> <C>
(IN THOUSANDS)
Deposits................................................................... $ 409 $ 789
Deferred offering costs.................................................... 804 --
Inventory.................................................................. 499 413
--------- ---------
$ 1,712 $ 1,202
--------- ---------
--------- ---------
</TABLE>
6. INTANGIBLE ASSETS
Intangible assets consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1997
--------- ---------
<S> <C> <C>
(IN THOUSANDS)
Deferred financing costs................................................... $ 347 $ 430
Rights to client lists..................................................... 10 1,414
Other...................................................................... 188 188
--------- ---------
545 2,032
Less accumulated amortization.............................................. (229) (1,074)
--------- ---------
$ 316 $ 958
--------- ---------
--------- ---------
</TABLE>
7. NOTES PAYABLE
In June 1996, the Company issued to 17 investors, 10% Promissory Notes
aggregating $2,950,000. Certain of the investors were directors and stockholders
of the Company. As described in Note 9, the Company issued warrants valued at
$116,000 to the note holders. The fair value of the warrants was recorded as
deferred financing costs and amortized as interest expense over the life of the
notes. Upon consummation of the Company's initial public offering on January 22,
1997, the holders of $725,000 of the 10% Promissory Notes converted their
indebtedness into 55,767 shares of Common Stock. In January 1997, the Company
repaid the $2,225,000 balance remaining on the 10% Promissory Notes.
The Company has a convertible note payable to UUNET Technologies, Inc.
("UUNET"). The $5 million Convertible Note was extended one year, and as such
the entire amount is due October 31, 1998, if not converted. The convertible
note will become due and payable immediately if the monthly amounts payable
under Company's Network Service Agreement with UUNET are less than $1.5 million
during any
F-10
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
7. NOTES PAYABLE (CONTINUED)
consecutive three months. The convertible note bears interest at 10.25% and is
convertible into a maximum of 391,515 shares of Common Stock at a conversion
price of $12.88 per share.
8. CAPITAL STOCK AND MANDATORILY REDEEMABLE EQUITY SECURITIES
COMMON STOCK
The Company issued 367,155 shares of Common Stock at $0.82 per share,
827,085 shares of Common Stock at $1.81 per share and 921,745 at $4.84 per share
on March 10, 1995, June 19, 1995 and October 31, 1995, respectively. As a result
of these placements, the Company raised, in the aggregate $6,258,000 during
1995. 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 during 1996. On
September 19, 1997, the Company closed a private placement of 1,459,759 shares
of its unregistered restricted Common Stock. Net proceeds from the offering were
approximately $15.4 million.
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 into one share of Common Stock upon consummation of the
initial public offering of the Company's common stock on January 22, 1997.
INITIAL PUBLIC OFFERING
On January 22, 1997 the Company commenced 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 $22.8 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. In February 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.
COMMON STOCK ISSUANCES FOR OTHER THAN CASH
In May 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.
F-11
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. 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. As of
December 31, 1997, 87,432 options remain available for issuance under the 1995
Incentive Stock Option Plan.
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, 1997, there
were no outstanding options to purchase shares of Common Stock outstanding under
the Directors Plan.
NON-QUALIFIED OPTION GRANTS
In addition to the options granted under the plans described above, the
Company granted non-qualified stock options to certain employees, officers and
directors. Non-qualified options generally have a maximum term of ten years and
generally vest in equal quarterly increments over a five-year period.
VALUE OF OPTIONS GRANTED TO EMPLOYEES
For disclosure purposes the fair value of all stock options granted is
estimated using the Black-Scholes option-pricing model with the following
weighted average assumptions used for stock options granted in 1997: no annual
dividends, expected volatility of 69%, risk-free interest rate of 6.49%, and
expected life of 6.6 years. For 1995 and 1996, 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.
F-12
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. STOCK OPTIONS AND WARRANTS (CONTINUED)
Had compensation cost been determined on the basis of fair value pursuant to
SFAS No. 123, net loss and net loss per share would have been increased as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
--------- --------- ---------
<S> <C> <C> <C>
(IN THOUSANDS)
Net loss
As reported..................................................................... $ 6,120 $ 31,149 $ 29,916
--------- --------- ---------
--------- --------- ---------
Pro forma....................................................................... $ 6,145 $ 31,477 $ 30,737
--------- --------- ---------
--------- --------- ---------
Basic and diluted net loss per share
As reported..................................................................... $ 1.59 $ 5.13 $ 2.99
--------- --------- ---------
--------- --------- ---------
Pro forma....................................................................... $ 1.60 $ 5.19 $ 3.07
--------- --------- ---------
--------- --------- ---------
</TABLE>
WARRANTS
The Company has issued to certain Board members, consultants, lessors,
creditors and others, warrants to purchase shares of the Company's Common Stock.
In September 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.
In December 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.
F-13
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. STOCK OPTIONS AND WARRANTS (CONTINUED)
In January 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 fair value of the warrants has been
reflected in intangible assets. These warrants expire January 11, 2001.
In January 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
non-qualified options and are not included in the summary of warrant grants.
In January 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 fair value of the warrants has
been reflected as deferred financing costs. These warrants expire January 18,
2006.
In February 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 fair value of the warrants has been reflected as deferred financing costs.
These warrants expire February 15, 2006.
In May 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 fair value of the warrants has been reflected as
deferred financing costs. The warrants expire on May 10, 2006.
In May 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. The fair value of the
warrants has been reflected as deferred financing costs.
In connection with the issuance of 10% 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 fair value of the warrants has been reflected as deferred
financing costs.
In connection with the execution of the PSINet, Inc. ("PSINet") agreement in
July 1996, (Note 11) the Company issued warrants to purchase 100,000 shares of
Common Stock at an exercise price of $20.00 per share. The fair 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.
WARRANTS ISSUED FOR SERVICES
In May 1996, the Company entered into an agreement with NMC, a producer of
infomercials and commercials, pursuant to which NMC agreed to produce and
broadcast commercials for EarthLink's services in exchange for Warrants. Upon
completion of the infomercial in April 1997 the Company issued warrants to NMC
to purchase 50,000 shares of Common Stock, having an exercise price of $9.76 per
share. In September 1997, the parties verbally agreed to rescind the agreement.
The rescission agreement included the return of the 50,000 warrants and the
cancellation of any future obligations of either party. However, the rescission
agreement was never executed and thus may be considered non-operative. The fair
F-14
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. STOCK OPTIONS AND WARRANTS (CONTINUED)
value of the warrants, $76,000, has been recorded as prepaid advertising and
will be expensed upon airing of the infomericals.
In January 1997 and October 1997, the Company issued warrants to purchase
6,000 and 25,000 shares, respectively, of the Company's Common Stock to certain
consultants. The respective exercise prices of the warrants were $13.00 and
$17.75. The fair value of the warrants is reflected as prepaid consulting fees
and amortized ratably over the life of the consulting agreement. Consulting
expense recorded with respect to warrants issued to consultants was $23,340
during 1997.
In September 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 fair value of the warrants is reflected as deferred professional
services expense and amortized ratably over the member's two year term of
service in the Technology Advisory Council.
On March 1997 and October 1997, the Company issued warrants to purchase
7,500 shares of the Company's common stock to each of two new members of the
Company's Technology Advisory Council. The warrants have an exercise price of
$10.50 per share and $17.75 per share, respectively, and vest quarterly over two
years. The fair value of the warrants is reflected as deferred professional
services expense and amortized ratably over the member's two year term of
service in the Technology Advisory Council.
Following is a summary of stock option and warrant activity during the three
years ended December 31, 1997:
<TABLE>
<CAPTION>
NUMBER OF SHARES OF COMMON STOCK
------------------------------------ WEIGHTED
INCENTIVE AVERAGE
STOCK NON-QUALIFIED PRICE PER EXERCISE
OPTIONS STOCK OPTIONS WARRANTS SHARE PRICE
---------- ------------- --------- ------------- -----------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1994..................... -- -- 150,000 $ 1.81 $ 1.81
Granted.......................................... 232,500 425,000 110,330 $ 0.60- 4.84 $ 3.04
Forfeited........................................ -- (60,209) -- $ 0.60 $ 0.60
---------- ------------- --------- ------------- -----------
Balance at December 31, 1995..................... 232,500 364,791 260,330 $ 1.81- 4.84 $ 3.00
Granted.......................................... 806,250 175,000 531,317 $ 1.81-20.00 $ 9.14
Forfeited........................................ (10,500) -- -- $ 9.76 $ 9.76
---------- ------------- --------- ------------- -----------
Balance at December 31, 1996..................... 1,028,250 539,791 791,647 $ 1.81-11.00 $ 6.91
Granted.......................................... 345,625 50,000 96,000 $ 1.81-20.00 $ 13.42
Forfeited........................................ (211,307) -- -- $ 4.84-13.00 $ 9.02
Exercised........................................ (48,957) (14,791) -- $ 0.60-13.00 $ 5.64
---------- ------------- --------- ------------- -----------
Balance at December 31, 1997..................... 1,113,611 575,000 887,647 $ 1.81-20.00 $ 8.01
---------- ------------- --------- ------------- -----------
---------- ------------- --------- ------------- -----------
Exercisable at December 31, 1997................. 299,355 208,750 836,920 $ 1.81-20.00 $ 7.32
---------- ------------- --------- ------------- -----------
---------- ------------- --------- ------------- -----------
</TABLE>
The weighted average fair values of the options granted during the three
years ended December 31, 1997, were $0.69, $2.01 and $9.95, respectively. The
weighted average fair values of warrants granted during the three years ended
December 31, 1997, were $0.09, $1.71 and $6.98, respectively.
F-15
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. STOCK OPTIONS AND WARRANTS (CONTINUED)
Following is a summary of stock options and warrants outstanding as of December
31, 1997:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- ----------------- ----------- --------------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C>
$ 1.81 - $ 1.81 500,000 7.32 $ 1.81 350,000 $ 1.81
$ 4.84 - $ 4.84 787,630 7.98 $ 4.84 409,380 $ 4.84
$ 9.76 - $11.00 879,378 8.17 $ 10.40 454,508 $ 10.48
$11.50 - $19.88 299,250 9.49 $ 15.21 21,137 $ 12.77
$20.00 - $20.00 110,000 8.54 $ 20.00 110,000 $ 20.00
----------- ----------
$ 1.81 - $20.00 2,576,258 8.12 $ 8.00 1,345,025 $ 7.32
----------- ----------
----------- ----------
</TABLE>
F-16
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
10. 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
corporations) 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,
1996 and 1997, the Company had net operating loss carryforwards for federal
income tax purposes totaling approximately $33,751,000, and $61,004,000,
respectively, which begin to expire in 2011. 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 and other issuances of Common Stock and Common Stock equivalents,
utilization of the Company's net operating loss carryforwards to offset future
income may be limited.
Deferred tax assets include the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1997
---------- ----------
(IN THOUSANDS)
<S> <C> <C>
Net operating loss carryforwards...................................... $ 13,578 $ 24,584
Deferred financing costs.............................................. 88 118
Depreciation.......................................................... 50 323
Accrued Liabilities................................................... 103 201
---------- ----------
Gross deferred tax assets............................................. 13,819 25,226
Deferred tax asset valuation allowance................................ (13,819) (25,226)
---------- ----------
$ -- $ --
---------- ----------
---------- ----------
</TABLE>
The Company recorded a full valuation allowance for net deferred tax assets
due to the uncertainty of future taxable income.
PROFIT SHARING PLAN
Effective January 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 Company makes a discretionary matching
contribution of 25% up to a maximum of 6% of the participant's total eligible
compensation. The Company's matching contributions vest over four years from the
participant's date of hire. Total contributions for 1997 were $84,000.
11. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases its facilities and certain equipment under non-cancelable
operating leases expiring in various years through 2008. Total rent expense in
1995, 1996 and 1997, respectively, for all operating leases amounted to
$145,000, $914,000 and $1.9 million, 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.
In February 1997, EarthLink commenced occupation of a 55,000 square feet in
a facility located adjacent to its corporate headquarters to house the Company's
data center. In June 1997, the Company amended the lease for its corporate
headquarters facility. Under the amended lease the Company will
F-17
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
occupy an additional 45,000 square feet of the existing facility and deliver an
irrevocable letter of credit in the amount of $450,000 to the Lessor.
During the three years ended December 31, 1997, the Company financed the
acquisition of data processing and office equipment amounting to approximately
$556,000, $11.3 million and $10.5 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, 1997
are as follows:
<TABLE>
<CAPTION>
YEAR ENDING CAPITAL OPERATING
DECEMBER 31, LEASES LEASES
--------- -----------
(IN THOUSANDS)
<S> <C> <C>
1998........................................................................................ $ 8,576 $ 1,898
1999........................................................................................ 6,516 2,126
2000........................................................................................ 3,258 1,994
2001........................................................................................ 657 1,767
2002........................................................................................ 91 1,897
Thereafter.................................................................................. 8 8,807
--------- -----------
Total minimum lease payments................................................................ 19,106 $ 18,489
-----------
-----------
Less amount representing interest........................................................... (3,776)
---------
---------
Present value of future lease payments...................................................... 15,330
Less current portion........................................................................ 7,112
---------
---------
$ 8,218
---------
---------
</TABLE>
GUARANTEED USAGE LEVELS
At December 31, 1997, the Company has committed to guaranteed usage levels
of data and voice communication with certain telecommunication vendors in the
aggregate amount of $3 million in 1998.
SIGNIFICANT AGREEMENTS
Access to the Internet for members outside of the Company's California
regional base is provided through points of presence ("POP") capacity leased
from UUNET and PSINet. EarthLink is, in effect, buying this capacity in bulk at
a discount, and providing access to EarthLink's member base at EarthLink's
normal rates. Payment to UUNET and PSINet is generally concurrent with
EarthLink's receipt of funds from members. At December 31, 1997, $2.0 million
and $2.1 million in amounts due to UUNET were recorded in accounts payable and
other accrued liabilities, respectively, and $540,000 and $4.4 million in
amounts due PSINet were recorded in other accrued liabilities and notes payable,
respectively.
Effective June 30, 1997 the Company's agreement with UUNET was amended.
UUNET agreed to waive monthly revenue minimums, excess hours fees, and peak
service user targets during the six months ended December 31, 1997. In return,
EarthLink agreed not to invoke its early termination right prior to
F-18
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
September 1998. 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.
EarthLink has licensed Netscape Communicator software ("Netscape
Communicator") from Netscape Communications Corporation, and Microsoft Internet
Explorer software ("Internet Explorer") from Microsoft Corporation. These
licenses permit the Company to distribute Netscape Communicator and Internet
Explorer in the EarthLink Network TotalAccess software package. Management
believes that contract renewal for both of the browsers, under conditions
acceptable to EarthLink, is probable.
Minimum commitments under non-cancelable network service agreements from
UUNET and PSINet are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31, IN MILLIONS
-----------
<S> <C>
1998.............................................................................. $ 22.8
1999.............................................................................. 6.0
-----
Total............................................................................. $ 28.8
-----
-----
</TABLE>
12. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash paid for:
Interest $ 60 $ 1,041 $ 1,965
--------- --------- ---------
--------- --------- ---------
Income Taxes $ 1 $ 1 $ 1
--------- --------- ---------
--------- --------- ---------
</TABLE>
13. SUBSEQUENT EVENTS
STRATEGIC ALLIANCE WITH SPRINT CORPORATION
On February 11, 1998, the Company announced a long-term strategic alliance
with Sprint Corporation. In connection with this alliance, Sprint has tendered
to purchase approximately 1.25 million shares of EarthLink's Common Stock at $45
per share. Upon closing of this tender offer, Sprint will purchase
approximately, 4.1 million shares of convertible preferred stock from Dolphin,
Inc. ("Newco") a new corporation formed by EarthLink for the purpose of
consummating the Sprint transactions. In exchange for the convertible preferred
stock Sprint will transfer its Sprint Internet Passport customer base of
approximately 130,000 members, pay approximately $24 million in cash, and
provide access to $100 million in convertible debt financing. Sprint and
EarthLink will also enter into a marketing and distribution arrangement and
EarthLink will obtain access to Sprint's data network. Concurrently with the
closing of these transactions, a wholly-owned subsidiary of Newco will merge
with and into EarthLink and each share of EarthLink Common Stock outstanding
will convert into one share of Newco common stock. Sprint will also secure two
seats on Newco's board of directors.
CONVERSION OF NOTE PAYABLE (UNAUDITED)
On March 31, 1998, UUNET converted the $5 million Convertible Note and
related accrued interest into 391,515 shares of the Company's common stock at a
conversion price of $12.88 per share.
F-19
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act, the Registrant has
duly caused this Amendment to Form 10-K to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Pasadena, State of
California, on the 13th day of May, 1998.
EARTHLINK NETWORK, INC.
By: /s/ GRAYSON L. HOBERG
---------------------------
Grayson L. Hoberg
Chief Financial Officer, Vice
President Finance and
Administration
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Amendment to Form 10-K has been signed by the following persons in the
capacities indicated below on the 13th day of May, 1998.
SIGNATURE TITLE
--------- -----
/s/ SKY D. DAYTON* Chairman of the Board of Directors
- ------------------
Sky D. Dayton
/s/ CHARLES G. BETTY* President, Chief Executive Officer and Director
- --------------------- (Principal Executive Officer)
Charles G. Betty
/s/ GRAYSON L. HOBERG Chief Financial Officer (Principal Financial
- --------------------- and Accounting Officer)
Grayson L. Hoberg
/s/ SIDNEY AZEEZ* Director
- -----------------
Sidney Azeez
/s/ ROBERT M. KAVNER* Director
- ---------------------
Robert M. Kavner
/s/ LINWOOD A. LACY, JR*. Director
- -------------------------
Linwood A. Lacy, Jr.
/s/ KEVIN M. O'DONNELL* Director
- -----------------------
Kevin M. O'Donnell
/s/ JOHN W. SIDGMORE* Director
- ---------------------
John W. Sidgmore
/s/ REED E. SLATKIN* Director
- --------------------
Reed E. Slatkin
<PAGE>
/s/ PAUL MCNULTY* Director
- -----------------
Paul McNulty
* By:/s/ GRAYSON L. HOBERG
---------------------
Grayson L. Hoberg
Attorney-in-Fact
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (No. 333-22317, No. 333-48909 and No. 333-50963) of
EarthLink Network, Inc. of our report dated January 29, 1998 appearing on
page F-2 of EarthLink Network, Inc.'s Annual Report on Form 10-K/A for the
year ended December 31, 1997.
Price Waterhouse LLP
Costa Mesa, California
May 11, 1998
