<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
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 58-2389244
(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 28,367,928 shares of Common Stock outstanding as of June 30, 1998.
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<PAGE>
EARTHLINK NETWORK, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 1998
TABLE OF CONTENTS
PART I
Item 1. Financial Statements and Supplementary Data. . . . . . . . . . . . . 1
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . . . 7
Item 3. Quantitative and Qualitative Disclosures About Market Risk . . . . . 13
Item 4. Submission of Matters to a Vote of Security Holders. . . . . . . . . 14
PART II
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . 15
<PAGE>
PART I
ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
EARTHLINK NETWORK, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, 1997 JUNE 30, 1998
----------------- -------------
(AUDITED) (UNAUDITED)
(in thousands)
<S> <C> <C>
Current assets:
Cash and cash equivalents (Notes 4 and 5) $ 16,450 $137,713
Restricted short-term investment 1,250 1,250
Accounts receivable, net 2,520 5,498
Prepaid expenses 1,109 3,627
Other assets 753 379
-------- --------
Total current assets 22,082 148,467
Other long-term assets 449 564
Property and equipment, net 23,398 29,445
Intangibles, net (Note 6) 958 114,102
-------- --------
$ 46,887 $292,578
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 6,472 $ 16,656
Accrued payroll and related expenses 2,316 6,272
Other accounts payable and accrued liabilities 3,717 10,081
Current portion of capital lease obligations 7,112 8,375
Notes payable 9,387 200
Deferred revenue 3,590 6,518
-------- --------
Total current liabilities 32,594 48,102
Long-term portion of capital lease obligations 8,218 8,702
-------- --------
Total liabilities 40,812 56,804
-------- --------
Stockholders' equity:
Preferred stock (Note 4) -- 41
Common stock (Note 5) 225 284
Additional paid-in capital (Notes 4 and 5) 70,829 319,550
Warrants to purchase common stock 1,093 1,445
Accumulated deficit (66,072) (85,546)
-------- --------
Total stockholders' equity 6,075 235,774
-------- --------
$ 46,887 $292,578
-------- --------
-------- --------
</TABLE>
The accompanying notes are an integral part of these financial statements
1
<PAGE>
EARTHLINK NETWORK, INC
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
1997 1998 1997 1998
------- ------- ------- -------
(UNAUDITED)
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Revenues:
Recurring revenues $17,479 $ 34,871 $ 31,565 $ 62,141
Other revenues 1,367 1,620 2,999 3,198
Incremental revenues - 1,146 - 1,538
-------- --------- --------- ---------
Total revenues 18,846 37,637 34,564 66,877
Operating costs and expenses:
Cost of recurring revenues 9,187 18,114 17,142 32,620
Cost of other revenues 804 753 1,719 1,458
Sales and marketing 5,056 6,765 10,017 12,681
General and administrative 3,449 4,988 6,951 9,501
Operations and member support 7,791 11,630 14,213 21,170
Amortization and transaction costs (Note 7) - 7,208 - 7,208
-------- --------- --------- ---------
Total operating costs and expenses 26,287 49,458 50,042 84,638
-------- --------- --------- ---------
Loss from operations (7,441) (11,821) (15,478) (17,761)
Interest income 135 426 300 649
Interest expense (444) (621) (951) (1,308)
-------- --------- --------- ---------
Net loss (7,750) (12,016) (16,129) (18,420)
Deductions for dividends on convertible
preferred stock (Note 8) -- (1,054) -- (1,054)
-------- --------- --------- ---------
Net loss attributable to common stockholders $(7,750) $(13,070) $(16,129) $(19,474)
-------- --------- --------- ---------
-------- --------- --------- ---------
Basic and diluted net loss per share $ (0.40) $ (0.53) $(0.86) $(0.82)
-------- --------- --------- ---------
-------- --------- --------- ---------
Weighted average shares 19,476 24,586 18,842 23,674
-------- --------- --------- ---------
-------- --------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these financial statements
2
<PAGE>
EARTHLINK NETWORK, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
1997 1998 1997 1998
------- ------- ------- -------
(UNAUDITED)
(in thousands)
<S> <C> <C> <C> <C>
Net cash (used in) provided by operating activities $(4,103) $ 8,288 $(16,173) $ 11,936
-------- --------- --------- ---------
Cash flows from investing activities:
Purchases of property and equipment (4,182) (5,866) (8,968) (11,530)
Purchase of intangible assets (1,356) - (1,356) (9)
Transaction costs (7,142) (8,412)
Net cash acquired from acquisition - 23,750 - 23,750
Liquidation of restricted short-term investment 38 - 38 -
-------- --------- --------- ---------
Net cash (used in) provided by investing activities (5,500) 10,742 (10,286) 3,799
-------- --------- --------- ---------
Cash flows from financing activities:
Proceeds from issuance of notes payable 1,271 - 1,271 200
Repayment of notes payable - (5,385) (2,225) (4,387)
Proceeds from capital lease obligations 2,542 3,122 5,325 5,635
Principal payments under capital lease obligations (1,194) (1,994) (2,079) (3,888)
Proceeds from issuance of common stock, net - 105,329 26,339 105,329
Proceeds from stock options and warrants exercised - 896 - 2,639
-------- --------- --------- ---------
Net cash provided by financing activities 2,619 101,968 28,631 105,528
-------- --------- --------- ---------
Net (decrease) increase in cash and cash equivalents (6,984) 120,998 2,172 121,263
Cash and cash equivalents, beginning of period 13,149 16,715 3,993 16,450
-------- --------- --------- ---------
Cash and cash equivalents, end of period $ 6,165 $137,713 $ 6,165 $137,713
-------- --------- --------- ---------
-------- --------- --------- ---------
Acquisition, net of cash acquired (Note 4):
Issuance of convertible preferred stock $135,000
Transaction costs 8,412
Intangible assets (119,662)
---------
Net cash acquired from acquisition $23,750
---------
---------
</TABLE>
The accompanying notes are an integral part of these financial statements
3
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The consolidated condensed financial statements of EarthLink Network,
Inc., which includes the accounts of its wholly owned subsidiary, EarthLink
Operations Inc., (collectively, "EarthLink" or the "Company") for the three
month and six month periods ended June 30, 1998 and the related footnote
information are unaudited and have been prepared on a basis substantially
consistent with the Company's audited financial statements as of December 31,
1997 contained in the Company's Annual Report on Form 10-K, as amended, as
filed with the Securities and Exchange Commission (the "Annual Report"). All
significant intercompany transactions have been eliminated. These financial
statements should be read in conjunction with the audited financial
statements and the related notes thereto contained in the Company's Annual
Report. In the opinion of management, the accompanying unaudited financial
statements contain all adjustments (consisting of normal recurring
adjustments) which management considers necessary to present fairly the
financial position of the Company at June 30, 1998 and the results of
operations and of cash flows for the three month and six month periods ended
June 30, 1997 and 1998. The results of operations for the three month and
six month periods ended June 30, 1998 are not necessarily indicative of the
results for the entire year ending December 31, 1998.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements.
Actual results may differ from those estimates.
2. STOCK SPLIT
In July 1998 the Company effected a two-for-one stock split. The
accompanying condensed consolidated financial statements and related notes
have been retroactively adjusted to give effect to the stock split.
3. NET LOSS PER SHARE
The Company has adopted Statement of Financial Accounting Standards
(SFAS) No. 128, "Earnings per Share" ("EPS"). SFAS No. 128 requires a dual
presentation of basic and diluted EPS. Basic EPS represents the weighted
average number of shares outstanding 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 as such inclusion would have
an anti-dilutive effect.
4. STRATEGIC ALLIANCE WITH SPRINT CORPORATION
On February 10, 1998, EarthLink entered into certain agreements to
establish a broad strategic relationship (the "Strategic Alliance") with
Sprint Corporation ("Sprint") in the area of consumer Internet access and
related services.
4
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In connection with the Strategic Alliance, on June 5, 1998, Sprint
consummated a tender offer for 2.5 million shares of the Company's Common
Stock at a price per share of $22.50 in cash to each tendering stockholder
(the "Offer"). Immediately following the closing of the Offer, Sprint
received approximately 4.1 million shares of the Company's Series A
Convertible Preferred Stock, par value $0.01 per share, in exchange for (i)
transfer to the Company of Sprint's approximately 130,000 Sprint Internet
Passport subscribers, (ii) aggregate cash consideration of approximately $24
million and (iii) the exclusive right to use certain ports within Sprint's
high-speed data network for four years. EarthLink and Sprint also entered
into a Marketing and Distribution Agreement which includes a commitment by
Sprint to deliver a minimum of 150,000 new subscribers per year for five
years through its own channels, EarthLink's right to be Sprint's exclusive
provider of consumer Internet access services for at least ten years and the
right to use Sprint's brand and distribution network for at least ten years.
Sprint has also provided EarthLink with a credit facility of up to $25
million (increasing to $100 million over three years) in the form of
convertible senior debt (collectively, the "Sprint Transaction").
In connection with the Sprint Transaction, a newly-formed subsidiary of
the Company was merged with and into the former EarthLink Network, Inc. (the
"Merger"), pursuant to which (i) the former EarthLink became a wholly-owned
subsidiary of the Company and (ii) each outstanding share of former EarthLink
common stock was converted into one share of common stock of the Company.
EarthLink Operations, Inc. ("EarthLink Operations"), the corporation
surviving the Merger, is now a wholly-owned subsidiary of the Company. All
references in these financial statements to EarthLink or the Company related,
collectively, to both EarthLink Network, Inc. and EarthLink Operations, Inc.
The Series A Convertible Preferred Stock will pay liquidation dividends
for the first five years in the form of increases in its Liquidation Value,
as defined, at a rate of 3% of the Liquidation Value. Thereafter, the Series
A Convertible Preferred Stock will pay a cash dividend of 3% for 15 years
increasing from 8% to 12% in years 21 through 23.
5. FOLLOW ON PUBLIC OFFERING
In June 1998 the Company completed a follow on public offering of 4.8
million shares of its Common Stock at $30 per share. The offering consisted
of 3.0 million shares and an underwriter's overallotment of 720,000 shares
offered by the Company and 1.8 million shares offered by certain
stockholders. The Company did not receive any proceeds from the sale of
shares by selling stockholders. Net proceeds to the Company were
approximately $105 million.
5
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
6. INTANGIBLE ASSETS
The value of intangible assets acquired in the Sprint Transaction,
aggregating $119.7 million, are being amortized on a straight-line basis over
the estimated useful lives as follows: member base amortized over 18 months,
the Marketing and Distribution Agreement amortized over 5 and 10 years, which
are the life of the portion of the contract related to Sprint's provision of
additional customers and the overall contract life relative to the
co-branding feature, respectively, and the excess of consideration over the
fair value of net asserts acquired (goodwill) over 18 months. 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 intangible assets. Intangible assets acquired in the
Sprint Transaction are valued as follows:
<TABLE>
<CAPTION>
June 30, 1998
--------------
(in thousands)
<S> <C>
Member base $ 65,000
Marketing and Distribution Agreement 20,000
Goodwill 34,662
--------
119,662
Less accumulated amortization (5,811)
--------
$113,851
--------
--------
</TABLE>
7. AMORTIZATION AND TRANSACTION COSTS
In June 1998 the Company incurred amortization expense of $5.8 million
on intangible assets acquired in the Sprint Transaction and a one-time cost
related to the Sprint Transaction of $1.4 million.
8. DEDUCTIONS FOR DIVIDENDS ON CONVERTIBLE PREFERRED STOCK
Dividends on Convertible Preferred Stock are reflected as an increase to
net loss attributable to common shareholders. This adjustment reflects the
liquidation dividend of $662,000 based on a 3% dividend and the accretion of
a $392,000 dividend related to the beneficial conversion feature of the
Series A Convertible Preferred Stock in accordance with EITF Topic No. D-60
based upon the rate at which the preferred stock becomes convertible.
6
<PAGE>
This Report contains certain forward-looking statements with respect to
the Company's operations, industry, financial condition and liquidity. These
statements, which are typically introduced by phrases 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. See "Safe Harbor Statement."
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE ACCOMPANYING
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES
THERETO AND THE AUDITED FINANCIAL STATEMENTS AND THE NOTES THERETO CONTAINED
IN THE ANNUAL REPORT.
IN JULY 1998 THE COMPANY EFFECTED A TWO-FOR-ONE STOCK SPLIT. THE FINANCIAL
INFORMATION DISCUSSED IN THIS ITEM 2 AND ELSEWHERE IN THIS REPORT HAS BEEN
RETROACTIVELY ADJUSTED TO GIVE EFFECT TO THE STOCK SPLIT.
OVERVIEW
EarthLink Network, Inc. (together with its wholly-owned operating
subsidiary, "EarthLink" or the "Company") is a leading Internet service
provider ("ISP") that provides reliable, nationwide Internet access and
related value-added services to its individual and business members, helping
them to derive meaningful benefits from the extensive resources of the
Internet. The Company has experienced rapid member growth and has become one
of the world's largest ISPs by enhancing its members' Internet experience
through simple, rapid and reliable access to the Internet, high quality
service and member support and enhanced services.
EarthLink provides its members with a core set of features through its
standard Internet service, which provides unlimited access to the Internet
and several related value-added services for a flat monthly fee of $19.95. In
addition, the Company offers a variety of premium services to both its
individual and business members. Recurring revenues, which are generally
paid for in advance with credit cards, consist of monthly fees charged to
members for Internet access and other ongoing services including Business Web
Site Hosting, National ISDN, LAN ISDN and Frame Relay Connections. Access
fees are recognized ratably over the period services are provided. Other
revenues generally represent one-time, non-refundable set up fees and are
recorded as earned. Incremental revenues are derived from leveraging the
Company's member base, including online advertising, commissions from
electronic commerce, and sales of certain products.
Cost of recurring revenues principally includes telecommunications costs
and depreciation expense on equipment used in network operations for ongoing
member services. Included in telecommunications costs are fees paid to UUNET
Technologies, Inc. ("UUNET"), PSINet, Inc. ("PSINet") and Sprint Corporation
("Sprint") for local dial-up access to their respective nationwide systems of
points of presence ("POPs"). Cost of other revenues principally includes
expenses related to the registration of new members, such as bounties paid to
third parties for generating new members for the Company and licensing fees
for software.
The Company has experienced net losses since it commenced operations. As
of June 30, 1998, the Company had an accumulated deficit of $85.5 million
(exclusive of $1.3 million in losses incurred from inception through June 19,
1995 which have been reclassified from accumulated deficit to common stock as
a result of the Company's conversion from S Corporation to C Corporation
status and inclusive of $1.1 million representing dividends on Series A
Convertible Preferred Stock. The Company has noted a trend of continuing
improvement in net loss and earnings before interest, taxes, depreciation and
amortization ("EBITDA").
7
<PAGE>
EARTHLINK NETWORK, INC.
UNAUDITED CONSOLIDATED FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------------------ -----------------------------------------
PERCENT PERCENT PERCENT PERCENT
OF TOTAL OF TOTAL OF TOTAL OF TOTAL
1997 REVENUES 1998 REVENUES 1997 REVENUES 1998 REVENUES
-------- -------- -------- -------- ---- -------- ---- --------
(in thousands, except percentages)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
EBITDA $(5,263) -28% $(2,708) -7% $(11,420) -33% $(5,659) -8%
One-Time Sprint Transaction costs 1,397 4% 1,397 2%
-------- -------- -------- -------- -------- -------- ---- --------
EBITDA before Sprint Transaction Costs $(5,263) -28% $(1,311) -3% $(11,420) -33% $(4,262) -6%
-------- -------- -------- -------- -------- -------- ---- --------
-------- -------- -------- -------- -------- -------- ---- --------
</TABLE>
The improvement in EBITDA was primarily due to significant member growth and
the Company's ability to take advantage of economies of scale to control
costs and expenses. EBITDA is not determined in accordance with generally
accepted accounting principles, is not indicative of cash used by operating
activities and should not be considered in isolation from, an alternative to,
or more meaningful than measures of performance determined in accordance with
generally accepted accounting principles. The Company expects that it will
continue to incur net losses as it continues to expend substantial resources
on sales and marketing to rapidly increase its member base. There can be no
assurance that the Company will sustain profitability or positive cash flow
from its operating activities.
On February 10, 1998, the Company entered into certain agreements to
establish a broad strategic relationship (the "Strategic Alliance") with
Sprint in the area of consumer Internet access and related services. In
connection with the Strategic Alliance, on June 5, 1998, Sprint consummated a
tender offer for 2.5 million shares of the Company's Common Stock at a price
per share of $22.50 in cash to each tendering stockholder (the "Offer").
Immediately following the closing of the Offer, Sprint received approximately
4.1 million shares of the Company's Series A Convertible Preferred Stock, par
value $0.01 per share, in exchange for (i) transfer to the Company of
Sprint's approximately 130,000 Sprint Internet Passport subscribers, (ii)
aggregate cash consideration of approximately $24 million and (iii) the
exclusive right to use certain ports within Sprint's high-speed data network
for four years. EarthLink and Sprint also entered into a Marketing and
Distribution Agreement which includes a commitment by Sprint to deliver a
minimum of 150,000 new subscribers per year for five years through its own
channels, EarthLink's right to be Sprint's exclusive provider of consumer
Internet access services for at least ten years and the right to use Sprint's
brand and distribution network for at least ten years. Sprint has also
provided EarthLink with a credit facility of up to $25 million (increasing to
$100 million over three years) in the form of convertible senior debt
(collectively, the "Sprint Transaction"). Immediately following consummation
of the Sprint Transaction and the Company's recently completed follow on
public stock offering, Sprint owned Common Stock and Series A Convertible
Preferred Stock constituting approximately 27% of the Company's capital stock
on a fully diluted basis (assuming acceleration of certain dividend rights
and the exercise by Sprint of certain preemptive rights) and approximately 9%
of the Company's voting stock. Sprint also obtained two seats on the
Company's board of directors.
The Series A Convertible Preferred Stock will pay dividends for the
first five years in the form of increases in its Liquidation Value at a rate
of 3% of the Liquidation Value. Thereafter the Series A Convertible
Preferred Stock will pay a cash dividend of 3% for 15 years increasing from
8% to 12% in years 21 through 23.
8
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth the percentage of total revenues
represented by certain items on the Company's statements of operations for
the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -------------------
1997 1998 1997 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Recurring revenues 93% 93% 91% 93%
Other revenues 7 4 9 5
Incremental revenues - 3 - 2
----- ---- ----- ----
Total revenues 100% 100% 100% 100%
Operating costs and expenses:
Cost of recurring revenues 49 48 50 49
Cost of other revenues 4 2 5 2
Sales and marketing 27 18 29 19
General and administrative 18 13 20 14
Operations and member support 41 31 41 32
Amortization and transaction costs (1) - 19 - 11
----- ---- ----- ----
139 131 145 127
----- ---- ----- ----
Loss from operations (39) (31) (45) (27)
Interest income 1 1 1 1
Interest expense (2) (2) (3) (2)
----- ---- ----- ----
Net loss (40%) (32%) (47%) (28%)
----- ---- ----- ----
----- ---- ----- ----
EBITDA (2) (28%) (7%) (33%) (8%)
----- ---- ----- ----
----- ---- ----- ----
</TABLE>
___________________
(1) Represents $5.8 million in amortization of intangible assets acquired in
the Sprint Transaction and a one-time transaction related cost of $1.4
million.
(2) Represents earnings (loss) before depreciation and amortization, interest
income and expense and income tax expense. EBITDA is not determined in
accordance with generally accepted accounting principles, is not indicative
of cash used by operating activities and should not be considered in
isolation from an alternative to, or more meaningful than measures of
performance determined in accordance with generally accepted accounting
principles.
RECURRING REVENUES
The Company experienced substantial growth in revenues for the three and
six month periods ended June 30, 1998 as compared to the corresponding
periods of 1997. The increase in recurring revenues of 99% from $17.5
million in the quarter ended June 30, 1997 to $34.9 million in the quarter
ended June 30, 1998 was primarily due to an increase in the Company's member
base from 420,000 at December 31, 1997 to 710,000 at June 30, 1998.
OTHER REVENUES
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
--------------------- INCREASE --------------------- Increase
1997 1998 (DECREASE) 1997 1998 (Decrease)
------ ------ ---------- ------ ------ ----------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Dial-up set up fees $784 $ 711 $(73) $1,914 $1,539 $(375)
Non Dial-up set up fees 583 909 326 1,085 1,659 574
------ ------ ---- ------ ------ -----
Total other revenues $1,367 $1,620 $253 $2,999 $3,198 $ 199
------ ------ ---- ------ ------ -----
------ ------ ---- ------ ------ -----
</TABLE>
9
<PAGE>
The decrease in dial up set up fees is primarily due to the Company's
willingness to waive set up fees for dial-up members acquired through certain
affinity marketing partnerships in response to market pressures. The Company
expects this trend to continue for dial-up set up revenues. EarthLink has
aggressively expanded its sales of premium services such as Business Web Site
Hosting, National ISDN, LAN ISDN and Frame Relay Connections. As such,
one-time fees for the set up of non-dial-up accounts has increased
significantly.
INCREMENTAL REVENUES
In the first quarter of 1998 EarthLink began reporting incremental
revenues derived from programs such as advertising and electronic commerce
that leverage the Company's growing member base and user traffic. The Company
sells advertising space on its various online properties such as the Personal
Start Page and its bi-monthly newsletter, "bLink", and is developing other
sources of incremental revenue such as the EarthLink Mall, branded start
pages and Earthlink Internet Rooms. Incremental revenues were $392,000 and
$1.1 million during the three months ended March 31, 1998 and June 30, 1998,
respectively. The increase was primarily due to sales of content sponsorships
and increased sales of Premier Partnerships. Content sponsorships and
Premier Partnerships provide leading advertisers and merchandisers with
opportunities to gain visibility and placement throughout EarthLink's
properties.
COST OF RECURRING REVENUES
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------------------- --------------------------------------------
PERCENT OF PERCENT OF PERCENT OF PERCENT OF
RECURRING RECURRING RECURRING RECURRING
1997 REVENUES 1998 REVENUES 1997 REVENUES 1998 REVENUES
------- ---------- ------ ---------- ------ ---------- ------ ----------
(in thousands, except percentages)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Recurring revenues $17,479 100% $34,871 100% $31,565 100% $62,141 100%
Cost of recurring revenues 9,187 53 18,114 52 17,142 54 32,620 52
</TABLE>
Cost of recurring revenues increased 97% and 90% during the three and
six month periods ended June 30, 1998 as compared to the corresponding
periods of 1997, primarily due to the corresponding increase in the Company's
member base. The decrease in the cost of recurring revenues as a percentage
of recurring revenues was primarily due to the Company's ability to more
effectively manage and thereby reduce communications costs per member to
exploit economies of scale and to reduce per member costs as the total member
base expanded.
COST OF OTHER REVENUES
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------------------- --------------------------------------------
PERCENT PERCENT PERCENT PERCENT OF
OF OTHER OF OTHER OF OTHER RECURRING
1997 REVENUES 1998 REVENUES 1997 REVENUES 1998 REVENUES
------- ---------- ------ ---------- ------ ---------- ------ ----------
(in thousands, except percentages)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Royalties $336 24% $ 32 2% $ 682 23% $ 47 2%
Bounties 309 23 532 33 745 25 1,122 35
Other 159 12 189 12 292 9 289 9
------ ---- ------ ----- -------- ---- -------- -----
Total cost of other revenues $804 59% $753 47% $1,719 57% $1,458 46%
------ ---- ------ ----- -------- ---- -------- -----
------ ---- ------ ----- -------- ---- -------- -----
</TABLE>
Cost of other revenues decreased 6% and 15% during the three and six
months ended June 30, 1998 as compared to the corresponding periods of 1997.
The decrease was primarily due to a reduction in royalty expense occasioned
by the renewal of various contracts for licensed software under more
favorable terms. The increase in the other components of cost of other
revenue is primarily due to the increase in the rate of member growth during
the three and six month periods ended June 30, 1998 as compared to the
corresponding periods of 1997.
10
<PAGE>
SALES AND MARKETING
Sales and marketing expenses consist primarily of advertising, sales
commissions, salaries and the cost of promotional material. Sales and
marketing expenses increased 33% from $5.1 million to $6.8 million during the
three month periods ended June 30, 1997 and 1998, respectively, and 27% from
$10.0 million to $12.7 million during the six months ended June 30, 1997 and
1998, respectively. The increases were primarily due to increased emphasis
on marketing the Company's services, expanding sales and marketing efforts on
a nationwide basis, increased sales commissions and increased marketing
personnel headcount. The Company does not defer sales, marketing or other
direct costs associated with the acquisition of members. These costs are
expensed as incurred.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist primarily of costs
associated with the accounting and human resources departments, professional
expenses, rent, bad debt and compensation. General and administrative
expenses increased 43% from $3.5 million to $5.0 million during the three
months ended June 30, 1997 and 1998, respectively and 36% from $7.0 million
to $9.5 million during the six months ended June 30, 1997 and 1998,
respectively. The increase was primarily due to increases in payroll, rent,
depreciation expenses and credit card fees. The rise in payroll costs was
primarily due to growth in headcount. In October 1997, the Company occupied
an additional 45,000 square feet of its corporate headquarters facility, and
monthly rent increased from $46,000 to $73,000. The increase in depreciation
expense was due to the acquisition of office equipment and the build-out of
leasehold improvements. The increase in credit card processing fees was due
to the increase in the Company's member base.
OPERATIONS AND MEMBER SUPPORT
Operations and member support expenses consist primarily of costs
associated with technical support and member service, as well as costs to
register and maintain member accounts. Operations and member support expenses
increased 49% from $7.8 million to $11.6 million during the three month
periods ended June 30, 1997 and 1998, respectively, and 49% from $14.2
million to $21.2 million during the six months ended June 30, 1997 and 1998,
respectively. The increases reflect management's focus on retaining existing
members by providing superior services and devoting significant resources to
expanding technical support and network operations capabilities. The number
of employees engaged in operations and member support activities was 500 and
775 at June 30, 1997 and 1998, respectively. The Company also continues to
improve member service functions by investing in training programs, hardware
and software.
INTEREST EXPENSE
Interest expense increased from $444,000 to $621,000 and from $951,000
to $1.3 million during the three and six months ended June 30, 1998,
respectively, as compared to the corresponding periods of 1997. The
increases in interest expense were primarily due to increased borrowings and
capital lease obligations incurred to finance the Company's network
infrastructure and capital improvements.
INTEREST INCOME
Interest income increased from $135,000 to $426,000 and from $300,000 to
$649,000 during the three and six months ended June 30, 1998, respectively,
as compared to the corresponding periods of 1997. The increases were
primarily due to an increase in average cash balances available for
investment.
11
<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 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), 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 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
Cash provided by operating activities was $8.2 million and $11.9 million
during the three and six month periods ended June 30, 1998, respectively.
This was primarily due to an increase in accounts payable and accrued
liabilities of $13.3 million and $20.5 million during the three and six month
periods ended June 30, 1998, respectively, due to investment banking fees and
network service costs.
Cash provided by investing activities was $10.7 million and $3.8 million
for the three and six month periods ended June 30, 1998, respectively. Net
cash acquired in the Sprint Transaction of $23.8 million was partially offset
by Sprint Transaction costs of $7.1 million and $8.4 million for the three
and six month periods ended June 30, 1998, respectively, and capital
equipment purchases of $5.8 million and $11.5 million for the three and six
month periods ended June 30, 1998, respectively.
Cash provided by financing activities was approximately $102.0 million
and $105.5 million during the three and six month periods ended June 30,
1998, respectively. In June 1998 the Company completed a follow on public
offering of 4.8 million shares of its Common Stock at $30 per share. The
offering consisted of 3.0 million shares and an underwriter's overallotment
of 720,000 shares offered by the Company and 1.8 million shares offered by
certain stockholders. The Company did not receive any proceeds from the sale
of shares by selling stockholders. Net proceeds to the Company were
approximately $105 million. Proceeds from capital lease transactions for the
three and six month periods ended June 30, 1998 were $3.1 million and $5.6
million, respectively. The sale leaseback transactions are recorded at cost,
which approximates the fair market value of the property and, therefore, no
gains or losses are recorded. The property continues to be depreciated by the
Company. A financing obligation representing the proceeds is recorded and
reduced based upon payments under the lease agreement.
In connection with an amendment of its agreement with UUNET in October
1996, the Company issued a $5.0 million, one-year convertible promissory note
to UUNET. This note, along with accrued interest, was converted into 783,030
shares of Common Stock at $6.44 per share in March 1998 per the terms of the
note.
In June 1998 the Company repaid its $5 million dollar line of credit to
PSINet per the terms of the agreement. Amounts due under the line of credit
agreement were previously reflected as current notes payable.
As of June 30, 1998, the Company had cash and cash equivalents of
approximately $137.7 million. The Company believes that available cash will
be sufficient to meet the Company's operating expenses and capital
requirements for the next 12 months. In addition, as a result of the Sprint
Transaction, EarthLink will have available a $25 million credit facility in
the form of convertible senior debt financing, increasing to $100 million
over a three-year period, at an interest rate of 6% per annum. 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 programs, information systems and research
12
<PAGE>
and development activities, the availability of hardware and software
provided by third-party vendors and other factors.
YEAR 2000
Many existing computer programs and systems use only two digits to
identify a year. These programs and systems were designed and developed
without considering the impact of the upcoming change in the century. If not
corrected, many computer programs and systems fail or create erroneous
results by, at or beyond the Year 2000. The Company is currently assessing
the Year 2000 readiness of its third-party supplied software, computer
technology, telecommunications and other services. Any failure by third
party vendors to resolve any Year 2000 issues on a timely basis or in a
manner that is compatible with the Company's systems could have a material
adverse effect on the Company. Preliminary indications are, however, that the
Company's third-party providers are, or will be, Year 2000 compliant. Based
upon the results of the Company' assessment, the Company will develop and
implement, if necessary, a remediation plan with respect to third-party
software, computer technology telecommunications and other services which may
fail to be Year 2000 ready. The Company has assessed its proprietary
software and other systems and has determined them to be Year 2000 ready. At
this time, the expenses associated with this assessment and potential
remediation plan cannot be determined.
"SAFE HARBOR" STATEMENT
The Management's Discussion and Analysis and other portions of this
Report include "forward looking" statements within the meaning of the federal
securities laws, that are subject to future events, risks and uncertainties
that could cause actual results to differ materially from those expressed or
implied. Important factors that ether individually or in the aggregate could
cause actual results to differ materially from those expressed include,
without limitation, (1) that the Company will not retain or grow its member
base, (2) that the Company will fail to be competitive with existing and new
competitors, (3) that the Sprint alliance will not be as beneficial to the
Company as management anticipates, (4) that the Company will not be able to
sustain its current growth, (5) that the Company will not adequately respond
to technological developments impacting the Internet, (6) that needed
financing will not be available to the Company if and as needed, (7) that a
significant change in the growth rate of the overall U.S. economy will occur,
such that consumer and corporate spending are materially impacted, (8) that a
significant reversal in the trend toward increased usage of the Internet will
occur, and (9) that the Company or its vendors and suppliers may fail to
timely achieve Year 2000 readiness such that there is a material adverse
impact on the business, operations or financial results of the Company, (10)
that a drastic negative change in the market conditions may occur, or (11)
that some other unforeseen difficulties may occur. This list is intended to
identify only certain of the principal factors that could cause actual
results to differ materially from those describe in the forward-looking
statements included herein.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable
13
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 5, 1998 the Company held a special meeting of its stockholders to
approve the following proposals necessary for the Company to consummate the
Sprint Transaction. Each proposal was approved.
<TABLE>
<CAPTION>
BROKER
PROPOSAL VOTES FOR VOTES AGAINST ABSTENTIONS NON-VOTES
- -------- --------- ------------- ----------- ---------
<S> <C> <C> <C> <C>
To approve and adopt an Agreement 7,578,415 8,757 6,745 0
and Plan of Merger, dated as of
February 10, 1998, by and among the
Company, Newco and Newco Sub,
pursuant to which (a) Newco Sub
will merge with and into the Company
with the Company as the surviving
company, and (b) each outstanding
share of Company Common Stock
outstanding at the effective time of
the Merger will be converted into the
right to receive one share of Newco
Common Stock.
To approve the issuance by Newco of 7,576,927 9,995 6,995 0
4,102,941 shares of Convertible
Preferred Stock to Sprint L.P. and the
issuance of Newco Common Stock upon
conversion thereof pursuant to the
Investment Agreement, dated as of
February 10, 1998, by and between the
Company, Newco, Sprint Corporation
and Sprint L.P.
To approve the issuance by Newco of 7,575,906 10,258 7,753 0
Convertible Notes to Sprint and the
issuance of Newco Common Stock upon
conversion thereof pursuant to the Credit
Agreement, dated as of February 10, 1998,
by and between Newco, the Company and
Sprint.
To approve and adopt amendments to the 7,548,517 10,398 35,002 0
agreements governing outstanding options,
warrants and other rights to acquire Company
Common Stock which thereafter will only
permit the issuance of Newco Common
Stock rather than Company Common Stock
upon exercise thereof.
</TABLE>
14
<PAGE>
PART II
ITEM 6. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Exhibits. The following exhibits are filed as part of this report:
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<S> <C>
10.1 Marketing and Distribution Agreement, dated as of February 10,
1998 among Dolphin, Inc., EarthLink Network, Inc., Sprint
Corporation and Sprint Communications Company L.P. (incorporated
by reference to Exhibit 10.26 of the Registration Statement on
Form S-4 of Dolphin, Inc., File No. 333-52507)
10.2 Amended and Restated Employment agreement between the Company and
Charles G. Betty (incorporated by reference to Exhibit 10.8 of the
Company's Registration Statement on Form S-1, File No. 333-53063)
27.1 Financial Data Schedule
</TABLE>
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
<TABLE>
<CAPTION>
EARTHLINK NETWORK, INC.
<S> <C>
Date: AUGUST 14, 1998 /s/ Charles G. Betty
----------------------------------
Charles G. Betty, President, Chief
Executive Officer and Director
Date: August 14, 1998 /s/ Grayson L. Hoberg
----------------------------------
Grayson L. Hoberg, Senior Vice President -
Finance and Administration and Chief
Financial Officer
Date: August 14, 1998 /s/ Richard A. Quiroga
---------------------------------
Richard A. Quiroga, Vice President,
Corporate Controller
</TABLE>
16
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF
1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 6-MOS 3-MOS 6-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1998 DEC-31-1997 DEC-31-1997
<PERIOD-START> APR-01-1998 JAN-01-1998 APR-01-1997 JAN-01-1997
<PERIOD-END> JUN-30-1998 JUN-30-1998 JUN-30-1997 JUN-30-1997
<CASH> 137,713 0 0 0
<SECURITIES> 0 0 0 0
<RECEIVABLES> 5,798 0 0 0
<ALLOWANCES> 300 0 0 0
<INVENTORY> 260 0 0 0
<CURRENT-ASSETS> 148,467 0 0 0
<PP&E> 47,696 0 0 0
<DEPRECIATION> 18,215 0 0 0
<TOTAL-ASSETS> 292,578 0 0 0
<CURRENT-LIABILITIES> 48,102 0 0 0
<BONDS> 0 0 0 0
0 0 0 0
41 0 0 0
<COMMON> 284 0 0 0
<OTHER-SE> 235,449 0 0 0
<TOTAL-LIABILITY-AND-EQUITY> 292,578 0 0 0
<SALES> 0 0 0 0
<TOTAL-REVENUES> 37,637 66,877 18,846 34,564
<CGS> 0 0 0 0
<TOTAL-COSTS> 18,867 34,078 9,991 18,861
<OTHER-EXPENSES> 30,591 50,560 16,296 31,181
<LOSS-PROVISION> 591 1,687 837 1,974
<INTEREST-EXPENSE> 621 1,308 444 951
<INCOME-PRETAX> (12,016) (18,420) (7,750) (16,129)
<INCOME-TAX> 0 0 0 0
<INCOME-CONTINUING> (11,821) (17,761) (7,441) (15,478)
<DISCONTINUED> 0 0 0 0
<EXTRAORDINARY> (1,054) (1,054) 0 0
<CHANGES> 0 0 0 0
<NET-INCOME> (13,070) (19,474) (7,750) (16,129)
<EPS-PRIMARY> (0.53) (0.82) (0.40) (0.86)
<EPS-DILUTED> (0.53) (0.82) (0.40) (0.86)
</TABLE>
