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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
/ / 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
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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
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. /X/
The aggregate market value of the Registrant's outstanding Common Stock held
by non-affiliates of the Registrant on March 9, 1999 was $1.1 billion. There
were 31,813,504 shares of Common Stock outstanding as of March 9, 1999.
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EARTHLINK NETWORK, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
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PART I
Item 1. Business...................................................................... 1
Item 2. Properties.................................................................... 10
Item 3. Legal Proceedings............................................................. 10
Item 4. Submission of Matters to a vote of Security-Holders........................... 10
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters......... 11
Item 6. Selected Financial Data....................................................... 12
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................................... 13
Item 8. Financial Statements and Supplementary Data................................... 24
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure........................................................ 24
PART III
Item 10. Directors and Executive Officers of the Registrant........................... 25
Item 11. Executive Compensation....................................................... 25
Item 12. Security Ownership of Certain Beneficial Owners and Management............... 25
Item 13. Certain Relationships and Related Transactions............................... 25
PART IV
Item 14. Exhibits, Financial Statements and Reports on Form 8-K....................... 26
SIGNATURES............................................................................ 30
INDEX OF FINANCIAL STATEMENTS......................................................... F-1
EXHIBIT INDEX......................................................................... E-1
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THIS REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE
RISKS AND UNCERTAINTIES. ACTUAL EVENTS AND RESULTS COULD DIFFER MATERIALLY FROM
THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN
FACTORS. SEE ITEM 7, "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--SAFE HARBOR STATEMENT".
PART I
ITEM 1. BUSINESS.
OVERVIEW
EarthLink is a leading Internet service provider, or ISP, providing reliable
nationwide Internet access and related value-added services to our individual
and business members. Our member base grew from approximately 420,000 members on
December 31, 1997 to approximately 1,000,000 paying members on December 31,
1998, making us one of the world's leading ISPs. We believe our growth has
resulted from our efforts to enhance our members' Internet experience through
simple, rapid and reliable access to the Internet, high quality service, and
member education and support. As a result, we believe we have a high member
retention rate for our industry. We receive significant benefits from the size
of our member base, including bargaining power with Internet content providers,
online advertisers and retailers, and network providers.
We generate our members through a combination of innovative and
cost-conscious marketing programs. We market our services and products through
referrals, online advertising and magazine, radio and television advertisements.
Our affinity marketing and membership referral programs are also valuable
components of our marketing strategy. We have over 500 affinity marketing
partners, including prominent retailers, print publishers, and software and
hardware companies. Leading affinity marketing partners include CompUSA, Novus
Service's Discover Card, MacMillan Digital Publishing USA, SAM's Club, Sony
Entertainment and Warner Bros. In the fourth quarter of 1998 we added Apple and
Packard Bell to our family of distribution partners.
In June 1998, we entered into a strategic alliance with Sprint, which is
another important driver of our member growth. As a part of this alliance,
Sprint transferred approximately 130,000 members to us and is committed to
generating at least 150,000 new members for us during each of the next 5 years
through their channels. Additionally, we are now co-branded as Sprint's
exclusive consumer Internet access provider, and we have exclusive access to
certain dial-up modem ports in Sprint's network. We also have access to Sprint's
marketing and distribution channels and the right to use Sprint's widely
recognized brand name. As a result of this relationship, we recently added
Sprint PCS and Radio Shack as affinity partners.
EarthLink provides highly reliable Internet access through a nationwide
telecommunications network of leased, high-speed, dedicated data lines and over
1,700 dial-up access sites, or POPs. We own and operate POPs in Southern
California and lease POPs from UUNET, Sprint, and PSINet nationwide. Over 90% of
the U.S. population can access our Internet service through a local telephone
call. We also provide Internet connections by cable, ADSL, ISDN, frame relay and
other high-speed access technologies.
Our standard $19.95 per month dial-up Internet service provides our members
with unlimited access to the Internet, email, a Web browser, six megabytes for a
personal web site, a Personal Start Page, BLINK (our member news magazine),
toll-free 24-hour technical support and access to Internet newsgroups. We also
offer premium services to consumers and small businesses, including electronic
commerce solutions, Web hosting and high-speed Internet connections.
Our address is 3100 New York Drive, Pasadena, California 91107, and our
telephone number is (626) 296-2400.
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EARTHLINK'S STRATEGY
Our objectives are to be the leading nationwide ISP and to provide our
members with a high-quality Internet experience. Key elements of our strategy
include:
MAXIMIZE MEMBERS' OVERALL EXPERIENCE. We want to provide our members with a
superior online experience. The following points illustrate our efforts to do
so:
- Superior Member Service: We believe that an integral part of the EarthLink
experience is fast, polite, and helpful member service. Accordingly, we
invest significant resources in supporting our members. We view member
support as another opportunity to interface directly with our members to
educate them on how to get the most out of the Internet. We have scaled
our highly-trained member support staff in line with member growth to
minimize member hold times and solve each individual problem in the most
expeditious manner. Our member care center is available seven days a week,
24 hours a day via a toll free call.
- Reliable Access: We currently use UUNET, PSINet and Sprint, as well as our
own facilities, to provide nationwide dial-up access and network
telecommunications services. Our members can access our service through
over 1,700 POPs. As a result, our members are able to navigate the
Internet with few delays, timeouts and disruptions.
- Easy to Use Solution: Users may encounter numerous difficulties using the
Internet because of its size and complexity. Therefore, we focus
significant resources on retaining members by providing them with reliable
and easy to use Internet access. We designed our TotalAccess software
(which includes software and documentation for both Windows and Macintosh
users) to make it easy for members to register and configure their system
for Internet access. We constantly work to develop new services, content
and features to enhance that user experience.
- Personal Start Page: We provide a customizable personal start page user
interface that allows members to closely match their needs. Members may
select from a number of browsers, navigation engines and sources of news
headlines.
- Member sign-up: From marketing and promotional materials to registration
and access software, we have carefully crafted the sign-up process to be
easy-to-use and to engender loyalty.
- Broad Service Offering: Our members receive six megabytes of space on our
Web server and special tools to create their own Web page. We recently
introduced a "Click-N-Build" Web construction tool, an e-commerce solution
and cable access. Going forward, we will continue to offer our members
leading Internet and communication products and services.
RAPIDLY EXPAND OUR MEMBER BASE. We believe that a key to our success in the
competitive ISP market is to rapidly expand our member base. This will allow us
to amortize our assets over a larger revenue base and enhance our ability to
enter into favorable arrangements with network service providers, affinity
marketing partners, online advertisers and content providers. We have
accelerated efforts and financial commitments to attract new members, while
continuing to provide high-quality service to ensure member retention.
Historically, we have capitalized on our reputation for high-quality service and
have obtained a significant portion of our new members from existing member
referrals. We recently added Apple and Packard Bell to our family of over 500
affinity partners plus numerous other channel partners. We plan to continue to
expand our marketing program, to maintain a presence at national, regional and
local trade shows, and to offer economic incentives to members who refer new
members. Our access to Sprint's high-speed data network and marketing channels
further enhances our ability to add new members.
CAPITALIZE ON SPRINT ALLIANCE. We intend to maximize the opportunities
presented by our alliance with Sprint to attract new members nationwide and to
further enhance our position as a leading ISP. We believe that the substantial
increase in members and other financial and operational resources resulting from
the
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Sprint alliance will enable us to achieve our strategic objectives on a
cost-effective and accelerated basis. We also believe that new members will be
generated by the Sprint relationship at a lower cost than we would spend to add
these members on our own. Therefore, we intend to take full advantage of
Sprint's recognized brand image, extensive distribution channels (including
Radio Shack and Sprint PCS) and approximately 16 million long-distance and local
telephone customers. To that end, our brand is jointly marketed with Sprint's
widely-recognized brand in connection with consumer Internet services.
Additionally, we expect to further benefit from our exclusive access to certain
dial-up modem ports in Sprint's high-speed data network.
INCREASE MARKETING AND EXPAND DISTRIBUTION. We continue to expand our
targeted marketing programs and distribution efforts to increase our member
base, nationwide presence and brand recognition. To achieve these objectives, we
continue to increase our investments in a wide-ranging marketing and
distribution program, including expanded affinity partners, print publications,
radio, television, billboards and direct mail. We closely monitor the results of
these marketing programs as part of our ongoing effort to increase the
cost-effectiveness of our marketing efforts.
LEVERAGE THIRD PARTY SERVICE PROVIDERS. We leverage the infrastructure of
others by leasing POP capacity from UUNET, PSINet and Sprint. This allows us to
maintain focus on our members' needs while benefiting from the continuing
decrease in telecommunications services costs. Not only does this approach lower
our required capital expenditures, it also gives us flexibility to rapidly
expand service coverage. Moreover, access to multiple networks provides members
with increased service quality resulting from redundant network access. We will
continue pursuing this strategy so that we can devote our principal resources to
sales and marketing efforts and to improving members' Internet experience.
DERIVE INCREMENTAL REVENUES. We leverage our growing member base and user
traffic to increase revenues from sources other than those that are access
related such as advertising and electronic commerce. Our Premiere Partnership
Program is the principal component of this strategy. Through the Premiere
Partnership Program we sell promotional packages that provide advertisers,
retailers and content providers with access to the multiple points of contact we
have with our members. We also sell advertising space on our various online
properties like the Personal Start Page and our news magazine, BLINK. The
EarthLink Mall and branded Personal Start Pages are further sources of
incremental revenues.
MANAGE INFRASTRUCTURE TO MEET MEMBER GROWTH. Our membership has grown
rapidly since inception. To continue to effectively add new members and continue
to offer high-quality service, we have made significant capital investments,
including expansion of our network hub, accounting and billing systems and
customer care systems. We believe our current infrastructure is adequate to
manage a significant increase in our member base.
EARTHLINK'S SERVICES
We provide a wide variety of competitively priced Internet services. Our
TotalAccess software incorporates a telephone dialer and email program with
several leading third-party Internet access tools, including the latest browsers
from Netscape and Microsoft. This software provides a functional, easy-to-use
Internet access solution for Windows 3.1, Windows 95 and Macintosh platforms.
The TotalAccess software automatically installs these and other software
applications on member computers. The simple point-and-click functionality of
TotalAccess, combined with its easy-to-use multimedia registration system,
permits online credit card registration, allowing both our novice and
experienced members to quickly set up access to the Internet.
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Our service offerings include:
STANDARD INTERNET SERVICES
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EMAIL Publications
WEB BROWSER Member and Technical Support
6MB WEB SPACE FOR A PERSONAL WEB SITE EarthLink Web Site
PERSONAL START PAGE Newsgroups
Nationwide POPs The EarthLink Online Mall
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PREMIUM SERVICES
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BUSINESS WEB SITE HOSTING DOMAIN NAME SERVICE
NATIONAL ISDN STAR EMAIL ADDRESSING
NATIONAL LAN ISDN INTERNATIONAL ROAMING SERVICE
NATIONAL FRAME RELAY 800 SERVICE
TOTALACCESS GOLD INTERNET ROOMS
ADDITIONAL MAILBOXES ELECTRONIC COMMERCE SOLUTION
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EMERGING ACCESS SERVICES
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CABLE FIBER TO THE CURB
ADSL SATELLITE/WIRELESS ACCESS (IN DEVELOPMENT)
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EARTHLINK'S STANDARD INTERNET SERVICES. We provide our members with a core
set of features through our standard Internet service. This standard service
allows unlimited access to the Internet and the World Wide Web as well as other
features and services for a monthly fee of $19.95 and a one-time set up fee
(which is frequently waived). We include the following features in our standard
Internet service:
EMAIL. Each member receives an electronic mailbox which enables members
to exchange an unlimited number of multimedia, text, graphics, audio and
video messages with other online and Internet users.
WEB BROWSER. We provide members with a free Web browser. Currently, we
offer Netscape Communicator or Microsoft Internet Explorer. Members may
also use any other browser of their choice.
6MB WEB SPACE FOR A PERSONAL WEB SITE. We provide each member with six
free megabytes of space on our Web server to create a personal Web site.
We recently introduced our "Click-N-Build" web site creation tool which
enables members to build their sites without having to learn complex
programming languages. We also provide tutorials and tools to help
members develop their sites. This enables members to participate in the
Internet community by personally adding content to the World Wide Web.
PERSONAL START PAGE. Each member receives a Personal Start Page, an
enhanced default start page for members that first appears when they log
on to the EarthLink Network. Members can customize their start page. For
example, a member may select from a number of browsers, navigation
engines and sources of news headline. Members also have the option to
view stock quotes, and weather reports and are provided with a personal
reminder system, as well as a place to list their own personal Web links
and links to EarthLink member and technical support resources. Our
Premiere Partners on our member's Personal Start Page include
ABCNews.com, American Greetings, AccuWeather, CNN Interactive, Excite,
GoTo.com, Infoseek, Lycos, MiningCo.com, Snap, PC Quote, Travelscape.com
and Wired Digital.
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NATIONWIDE POPS. EarthLink members can access their accounts through a
nationwide network of over 1,700 POPs.
PUBLICATIONS. We mail our bi-monthly printed news magazine, BLINK, to
each member. BLINK provides useful information, such as tips on how to
search for certain categories of information on the Internet,
information regarding new EarthLink service offerings, pointers to new
Internet sites and other items of interest. BLINK is also available
online on the EarthLink home page. Additionally, we provide new members
with an orientation booklet called "Getting the Most Out of the
Internet," written by our founder, Sky Dayton.
MEMBER AND TECHNICAL SUPPORT. We currently provide the following member
and technical support services: (i) toll-free, live telephone assistance
available seven days a week, 24 hours a day; (ii) email-based assistance
available seven days a week, 24 hours a day; (iii) help sites and
Internet guide files on the EarthLink Web site; (iv) automated "fax
back" and "fax on demand" assistance; and (v) printed reference
material. Additionally, we provide dedicated support for business
members through dedicated member care support personnel who are
specially trained for business products and services such as business
Web sites and local area network ISDN.
EARTHLINK WEB SITE. We maintain a Web site at www.earthlink.net that
contains content and links to third-party content and services. Our
in-house staff actively seeks out interesting content from across the
World Wide Web and organizes it into areas of interest on our Web site
under topics such as "Arts & Entertainment," "Sports," "Travel," "News,"
"Finance," and "Games." Our Web site provides a road map to the abundant
information and services available on the Internet. The site also
contains Web pages dedicated to online member assistance including
technical support, account maintenance and service updates.
NEWSGROUPS. "Newsgroups," one of the most popular areas of the Internet,
facilitate ongoing online discussions of specific areas of interest.
EarthLink aggregates and provides access to thousands of these
newsgroups, enabling its members to participate in realtime public
discussions of a myriad of topics.
THE EARTHLINK ONLINE MALL. Our online electronic shopping mall provides
users with a one-stop gateway to some of the top retailers on the Web,
using a familiar mall map interface. Retailers such as The Disney Store,
BarnesandNoble.com and 1-800-FLOWERS "lease" space in the Mall.
EARTHLINK'S PREMIUM SERVICES. In addition to our standard service, we offer
a variety of premium services, including the following:
BUSINESS WEB SITE HOSTING. We provide a Web hosting service for business
members. Monthly fees for business Web sites range from $89 to $455,
plus one-time set up fees of $179 to $479, depending on the size of the
site and whether the site is a shared or unique address. A wide variety
of options is available for an extra fee. Additional charges may apply
for excess site traffic. We also offer an introductory service for small
businesses, STARTERSITE, which is a ten megabyte, unique-domain Web site
priced at $19.95 per month, plus a one-time set up fee of $25.
NATIONAL ISDN. Our nationwide high-speed ISDN access service provides
significantly higher access speeds than conventional analog modems. The
monthly charge for ISDN is $34.95 for the first 100 channel hours and
$0.99 for each additional channel hour, plus a one-time set up fee of
$50.
NATIONAL LAN ISDN. Small to medium-sized businesses can connect their
existing LAN to the Internet at ISDN speed with LAN ISDN. This
nationwide service costs $99.95 per month for 160 channel hours and four
email boxes. The set up fee of $149 is waived for current EarthLink
members, and additional channel hours cost $0.85 per hour.
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NATIONAL FRAME RELAY. Frame relay enables companies to connect their
LANs to the Internet via a direct, continuous connection at speeds
ranging from 56 Kbps to 1.5 Mbps. Frame relay connections, available
nationwide, range from $240 to $1,460 per month depending on access
speeds, data throughput, etc. One-time set up fees range from $495 to
$1,995.
TOTALACCESS GOLD. TotalAccess Gold is a value-added package, which
includes an additional email box, priority technical support with a
guaranteed 5-minute maximum wait time, and a quarterly CD-ROM containing
software tools and plug-ins. The package adds $9.95 to the monthly price
of a standard dialup or ISDN account.
ADDITIONAL MAILBOXES. Additional electronic mailboxes are available for
a per-mailbox fee of $4.95 per month and a $9.95 set up fee.
DOMAIN NAME SERVICE. We provide unique domain names for those members
who prefer an individualized address or plan to establish a business Web
site. These unique domain names allow consumers and businesses to
customize their email and Web site addresses. EarthLink charges a
one-time fee of $75 to set up domain name service and assist members in
establishing their unique domain names. Members then pay an annual
renewal fee to an Internet domain registration agency.
STAR EMAIL ADDRESSING. EarthLink members desiring an unlimited choice of
email addresses (for example "[email protected]" or
"[email protected]") can purchase star addressing. With star
addressing, all email goes into a central mailbox, for easy processing
to individual addresses at the same domain. There is a one-time set up
fee of $125, but no monthly fee for maintaining the service.
INTERNATIONAL ROAMING SERVICE. We offer international roaming services
so that members who travel outside the United States can access their
EarthLink accounts and the Internet. The fee for international roaming
is $0.15 per minute plus applicable fees, if any, charged by local and
long distance carriers.
800 SERVICE. EarthLink provides 800 number dial-up service for members
who do not have access to a local POP. EarthLink charges members $24.95
per month for five hours of 800 number service plus a one-time set up
fee of $25.00. Additional hours are $4.95 per hour.
ELECTRONIC COMMERCE SOLUTION. We recently introduced our electronic
commerce solution for businesses. The software components allow
businesses to build and operate an online "storefront" and process
online credit card transactions. In conjunction with our hosting
services, businesses can conveniently establish their electronic
commerce presence.
EARTHLINK'S EMERGING ACCESS SERVICES. In response to feedback from our
members, we are developing the next generation of Internet access services
targeted at consumers and small businesses. These services offer access speeds
several times faster than ISDN connections utilizing a variety of emerging
connectivity technologies.
CABLE. We currently offer high-speed cable connections to the Internet
for consumers and small businesses in selected service areas, through
partnerships with cable providers such as Charter Communications.
ADSL. We are testing Asymetric Digital Subscriber Line, or ADSL, service
that provides a continuous high-speed connection through existing
telephone lines. This service is in the pilot phase and has not yet been
priced.
FIBER TO THE CURB. We are conducting a technology trial utilizing "fiber
to the curb" technology, an emerging broadband-capable technology
alternative to both twisted pair copper lines and coaxial cable. This
service is in the pilot phase and has not yet been priced.
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SATELLITE/WIRELESS ACCESS. EarthLink is currently evaluating
opportunities to offer Internet access service delivery through both
satellite and ground-based wireless technologies.
MEMBER AND TECHNICAL SUPPORT
We believe that reliable member and technical support is critical to
retaining existing members and attracting new members. We currently provide the
following member and technical support services: (i) toll-free, live telephone
assistance available seven days a week, 24 hours a day; (ii) email-based
assistance available seven days a week, 24 hours a day; (iii) help sites and
Internet guide files on the EarthLink Web site; (iv) automated "fax back" and
"fax on demand" assistance; and (v) printed reference material. Additionally, we
provide dedicated support for business members.
Our call center currently handles an average of over 130,000 member and
technical support calls a week. We also contract with a vendor of call center
services whose EarthLink-trained employees provide additional technical support
assistance. We believe the center's technology and systems are scaleable to
accommodate call volume growth. We actively evaluate our call center facilities
in order to deliver more effective and efficient services to our members.
SALES AND MARKETING
Our sales and marketing efforts consist of the following programs:
ORIGINAL EQUIPMENT MANUFACTURER CHANNELS. EarthLink has marketing arrangements
with a number of leading hardware and software manufacturers to include our
TotalAccess software pre-installed on or included with their products. Our OEM
partners include, among numerous others, Apple, Packard Bell and Gateway.
AFFINITY MARKETING PROGRAM. Affinity marketing partners typically bundle our
TotalAccess software with their own goods or services to create a package that
promotes EarthLink to potential members. Our affinity marketing partners
include, among numerous others:
COMPUSA. CompUSA includes TotalAccess software pre-loaded on each of its
private-label computer systems, as well as offering TotalAccess software
to its customers through in-store displays.
DISCOVER CARD. EarthLink and NOVUS Services' Discover Card division
offer the Discover Connection, an Internet access package, with
exclusive features and awards for Discover Cardmembers.
MACMILLAN DIGITAL PUBLISHING USA. EarthLink is the exclusive national
Internet access provider included in the Internet Starter Kit CD-Rom
which MacMillan publishes.
SAM'S CLUB. SAM's Club co-brands and co-offers TotalAccess software
through direct mail and catalog promotions to SAM's Club members.
SONY ENTERTAINMENT. Sony bundles TotalAccess software on its enhanced
music CDs.
SPRINT ALLIANCE. Our alliance with Sprint includes a marketing agreement and
distribution arrangement that provides us access to Sprint's branded marketing
and distribution channels in the United States, the right to use Sprint's brand
for a minimum of ten years and a five-year commitment from Sprint to deliver a
minimum of 150,000 new members annually through Sprint's channels. Additionally,
Sprint promotes EarthLink as Sprint's exclusive consumer Internet access
provider.
MEMBER REFERRAL PROGRAM. We believe that our existing members are among our most
important marketing tools. We currently waive one month of standard access
service fees for each member who refers a new member to our service. These
referrals generate a significant percentage of our new membership.
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ADVERTISING. We advertise our services in print, electronic and broadcast media.
We also maintain a presence at national trade shows such as Internet World and
MacWorld, as well as numerous local and regional trade shows. Additionally, we
market through computer, Internet and related publications and bundle our
TotalAccess software with certain of these publications.
PREMIERE PARTNERSHIPS. As part of our strategy to generate incremental revenue
through third party electronic commerce, advertising and content, we leverage
our current properties (such as our Web site and Personal Start Page) through
our Premiere Partnership Program. The Premiere Partnership Program focuses on
third parties having a natural affinity to and benefit for our member base. The
program generates revenues through (1) sales of banner and other online ads; (2)
fees generated through revenue sharing arrangements with online retailers who
are accessed through our properties; and, (3) payments for placing links from
our properties to third-party content
TECHNICAL DEVELOPMENT AND SERVICE ENHANCEMENT
We place significant emphasis on expanding and refining our services to
enhance member Internet experience. Our technical staff is engaged in a variety
of technical development and service enhancement activities and continuously
reviews new third-party software products and technology for potential
incorporation into our systems and services. The redesigned and enhanced version
of TotalAccess, version 2.3, is a recent product of these efforts. The new
version places a premium on ease of use, and incorporates a variety of powerful
features that reduce the number and types of challenges faced by new members
using the Internet for the first time. We also regularly update and expand the
online services provided through the EarthLink Web site, organize Web content
and develop online guides, help screens and other user services and resources.
POPS AND NETWORK INFRASTRUCTURE
We provide our members with Internet access primarily through third-party
network POPs. Our use of third parties to provide Internet connectivity enables
us to increase port capacity without the significant capital requirements
necessary to build and maintain a network. It also gives us the flexibility
necessary to adapt to changing technology such as cables. Over 90% of the U.S.
population can access our Internet service through a local telephone call.
Members located in a geographic area not currently serviced by a local POP
can access the Internet through an 800 service. Our POP sites are connected to
the Internet primarily through our Pasadena network hub. That hub is in turn
connected directly to the Internet by redundant high-speed fiber optic data
lines obtained from various vendors. We have invested in measures to minimize
the effects of damage from fire, earthquake, power loss, telecommunications
failure, computer viruses, security breaches and similar events or backup
Internet services or backbone facilities or other redundant computing or
telecommunications facilities. We do not currently maintain redundant network
hub facilities.
COMPETITION
We operate in the Internet services market, which is extremely competitive.
Our current and prospective competitors include many large companies that have
substantially greater market presence, financial, technical, marketing and other
resources than we have. We compete directly or indirectly with the following
categories of companies:
- established online services, such as America Online, the Microsoft Network
and Prodigy;
- local, regional and national ISPs, such as MindSpring, Rocky Mountain
Internet and Internet America Inc.;
- national telecommunications companies, such as AT&T and GTE;
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- regional Bell operating companies, such as BellSouth and SBC
Communications Corp; and
- online cable services, such as At Home and Roadrunner.
Our competition is likely to increase. We believe this will probably happen
as large diversified telecommunications and media companies acquire ISPs and as
ISPs consolidate into larger, more competitive companies. Diversified
competitors may bundle other services and products with Internet connectivity
services, potentially placing us at a significant competitive disadvantage. In
addition, competitors may charge less than we do for Internet services, causing
us to reduce (or preventing us from raising) our fees. As a result, our business
may suffer.
PROPRIETARY RIGHTS
GENERAL. We rely on a combination of copyright, trademark, patent and trade
secret laws and contractual restrictions to establish and protect our technology
and proprietary rights and information. We require employees and consultants
and, when possible, suppliers and distributors, to sign confidentiality
agreements. However, we cannot assure you that our steps will be sufficient to
prevent misappropriation of our technology and proprietary rights and
information or that our competitors will not independently develop technologies
that are substantially equivalent or superior to ours.
From time to time, third parties have alleged that certain of our trademarks
infringe their trademarks. None of these claims has had an adverse effect on our
ability to market and sell its services. However, we cannot assure you that
those claims will not have an adverse effect in the future or that others will
not assert infringement claims against us in the future.
LICENSES. We have licenses to distribute third-party software incorporated
in our TotalAccess software. Applications which we license for distribution
include Netscape Communicator (this license automatically renews each December
for additional one-year terms unless either party terminates the license on 120
days notice), Microsoft Internet Explorer (this license expires in August 1999
and thereafter automatically renews for additional one-year terms, although
either party may terminate the license at any time on 30 days notice), and
MacTCP software from Apple (this license renews each December for additional
one-year terms unless either party terminates the license on twelve-month
notice). The only software in the TotalAccess package that we developed is the
front-end and installation/registration program. We intend to maintain or
negotiate renewals of existing software licenses and authorizations. We may also
want or need to license other applications in the future. Our inability to renew
existing software licenses or to license additional applications could have a
material adverse effect on us.
EMPLOYEES
As of December 31, 1998, we employed 1,343 people, including 217 sales and
marketing personnel, 998 operations and member and technical support
representatives and 128 administrative personnel. None of our employees are
represented by a labor union, and we have no collective bargaining agreement.
9
<PAGE>
ITEM 2. PROPERTIES.
Our corporate headquarters and call center are located in a 93,000
square-foot facility in Pasadena, California. Base rent is currently $73,000 per
month. We have an option to extend this lease for an additional five years at
the then-prevailing market rate following its expiration in September 2007. Our
data center and primary data hub are housed in a 110,000 square foot facility
adjacent to our headquarters with rent of $92,000 per month, subject to yearly
increases. The lease for this space expires February 2007, with an option to
extend for an additional ten year term.
ITEM 3. LEGAL PROCEEDINGS.
We are not currently involved in any legal proceedings that we believe could
have, either individually or in the aggregate, a materiel adverse effect on our
business or financial condition. There are proceedings pending before the FCC
that could adversely affect the ISP industry and the means by which ISPs conduct
business and the cost structure for ISP services. The Company is not a party to
these proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
10
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK
Our common stock has been traded on the Nasdaq National Market under the
symbol "ELNK" since our initial public offering on January 22, 1997. The
following table shows the high and low closing sales price as reported by the
Nasdaq National Market for each quarter since we have been public (as adjusted
for our 2-for-1 stock split effected on July 21, 1998).
<TABLE>
<CAPTION>
SALES PRICE
--------------------
HIGH LOW
--------- ---------
<S> <C> <C>
1997
First Quarter (from the date of the Company's initial public offering,
January 22, 1997)........................................................ $ 10.13 $ 5.06
Second Quarter............................................................. 6.75 4.31
Third Quarter.............................................................. 9.75 5.13
Fourth Quarter............................................................. 12.88 8.00
1998
First Quarter.............................................................. $ 28.22 $ 12.25
Second Quarter............................................................. 38.38 25.00
Third Quarter.............................................................. 44.13 26.50
Fourth Quarter............................................................. 71.88 33.88
</TABLE>
The last reported sale price of the Company's common stock on The Nasdaq
National Market on March 9, 1999 was $57.00 per share. There were approximately
310 holders of the Company's Common Stock.
DIVIDENDS
We have never paid or declared any cash dividends. We currently expect to
retain future earnings, if any, to finance the growth and development of our
business, including potential acquisitions. Therefore, we do not anticipate
paying cash dividends in the foreseeable future, except as required pursuant to
the terms of our convertible preferred stock owned by Sprint.
RECENT SALES OF UNREGISTERED SECURITIES
In connection with the consummation of our strategic relationship with
Sprint, we sold to Sprint 4.1 million shares of our newly created Series A
convertible preferred stock, convertible into 8.2 million shares of common stock
(assuming the acceleration of certain rights).
11
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA.
The following consolidated selected financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and Notes
thereto included elsewhere in this Report.
<TABLE>
<CAPTION>
INCEPTION
(MAY 26, 1994)
THROUGH YEAR ENDED DECEMBER 31,
DECEMBER 31, ------------------------------------------
1994 1995 1996 1997 1998
--------------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA
Revenues:
Recurring revenues............................................. $ 53 $ 2,422 $ 27,606 $ 74,657 $ 164,723
Other revenues................................................. 58 606 5,624 6,231 6,547
Incremental revenues........................................... -- -- -- -- 4,671
------ --------- --------- --------- ---------
Total revenues............................................... 111 3,028 33,230 80,888 175,941
------ --------- --------- --------- ---------
Operating costs and expenses:
Cost of recurring revenues..................................... 4 1,024 17,717 36,716 76,643
Cost of other revenues......................................... 12 328 2,066 1,349 685
Sales and marketing............................................ 37 3,763 17,363 25,971 42,732
General and administrative..................................... 168 2,062 10,534 14,406 21,042
Operations and member support.................................. 38 1,869 15,808 30,900 54,443
Amortization and transaction costs (1)......................... -- -- -- -- 42,635
------ --------- --------- --------- ---------
Total operating costs and expenses........................... 259 9,046 63,488 109,342 238,180
------ --------- --------- --------- ---------
Loss from operations........................................... (148) (6,018) (30,258) (28,454) (62,239)
Interest income................................................ -- 34 150 637 4,424
Interest expense............................................... -- (136) (1,041) (2,099) (1,967)
------ --------- --------- --------- ---------
Net loss..................................................... (148) (6,120) (31,149) (29,916) (59,782)
Deductions for accretion dividends (2)........................... -- -- -- -- (7,601)
------ --------- --------- --------- ---------
Net loss attributable to common stockholders..................... $ (148) $ (6,120) $ (31,149) $ (29,916) $ (67,383)
------ --------- --------- --------- ---------
------ --------- --------- --------- ---------
Basic and diluted net loss per share (3)......................... $ (0.05) $ (0.80) $ (2.57) $ (1.50) $ (2.58)
------ --------- --------- --------- ---------
------ --------- --------- --------- ---------
Weighted average shares (3)...................................... 3,100 7,674 12,138 20,002 26,157
------ --------- --------- --------- ---------
------ --------- --------- --------- ---------
Other operating data:
EBITDA (4)..................................................... $ (141) $ (5,713) $ (26,105) $ (19,077) $ (7,513)
Cash flows from
Operating activities......................................... (146) (3,643) (16,222) (21,290) 26,597
Investing activities......................................... (97) (4,266) (18,361) (16,095) (9,239)
Financing activities......................................... 243 8,199 38,286 49,842 107,056
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------------------------------
1994 1995 1996 1997 1998
--------------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents........................................ $ -- $ 290 $ 3,993 $ 16,450 $ 140,864
Total assets..................................................... 186 4,874 27,119 46,887 266,341
Long-term debt................................................... -- 355 6,088 8,218 7,701
Total liabilities................................................ 89 4,584 34,367 40,812 68,997
Accumulated deficit.............................................. (148) (5,007) (36,156) (66,072) (133,454)
Stockholders' equity (deficit)................................... 97 290 (21,261) 6,075 197,344
</TABLE>
- ------------------------
(1) Amortization and transaction costs represent $41,238,000 in amortization of
intangible assets acquired and a one time transaction cost, in June 1998, of
$1,397,000 resulting from our strategic alliance with Sprint.
(2) Reflects the accretion of liquidation dividends on Series A convertible
preferred stock at 3% compounded quarterly and the accretion of a dividend
related to the beneficial conversion feature in accordance with EITF D-60.
12
<PAGE>
(3) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the determination of the number of weighted average shares outstanding in
the net loss per share computation.
(4) 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, as an alternative to, or more meaningful than measures of
performance determined in accordance with generally accepted accounting
principles.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
THE FOLLOWING DISCUSSION OF THE FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF THE COMPANY SHOULD BE READ IN CONJUNCTION WITH THE FINANCIAL
STATEMENTS AND NOTES THERETO INCLUDED ELSEWHERE IN THIS REPORT.
OVERVIEW
We are a leading Internet service provider, or ISP, providing reliable
nationwide Internet access and related value-added services to our individual
and business members. Our member base has grown rapidly, making us one of the
world's leading ISPs. We believe this growth is the result of our efforts to
enhance our members' Internet experience through simple, rapid and reliable
access to the Internet, high quality service and member support and enhanced
services.
We provide our members with a core set of features through our standard
Internet service, which provides unlimited Internet access and several related
services for a $19.95 monthly fee. We also offer a variety of premium services
to both our 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 and, in
certain areas, cable access. We derive incremental revenues by leveraging the
value of our member base and user traffic through promotional and content
partnerships, online advertising, and electronic commerce. We recognize access
fees and certain incremental revenues ratably over the period services are
provided. Other revenues generally represent one-time, non-refundable set up
fees and are recorded as earned.
Cost of recurring revenues principally includes telecommunications costs and
depreciation expense on equipment used in network operations for ongoing member
services. Fees paid to UUNET, PSINet and Sprint for local dial-up access to
their respective nationwide systems of POPs are included in telecommunications
costs. Cost of other revenues principally includes expenses associated with new
member registration and cost of products sold. Cost of incremental revenues is
immaterial.
We have experienced net losses since we began operations. As of December 31,
1998, we had an accumulated deficit of $133.5 million (inclusive of $7.6 million
accretion representing dividends on Series A convertible preferred stock). We
expect we will continue to incur net losses as we continue to expend substantial
resources on sales and marketing to rapidly increase our member base.
We believe that a key to our success in the competitive ISP market is to
rapidly expand our member base. This will allow us to amortize our assets over a
larger revenue base and enhance our ability to enter into favorable arrangements
with network service providers, affinity marketing partners, online advertisers
and content providers. While we have experienced a trend of continuing
improvement in our net loss and earnings before interest, taxes, depreciation
and amortization ("EBITDA") we anticipate investing heavily in obtaining new
members and expect to have negative EBITDA for the foreseeable future.
EBITDA is not determined in accordance with generally accepted accounting
principles and is not indicative of cash used by operating activities. You
should not consider EBITDA in isolation from, as an alternative to, or more
meaningful than measures of performance determined in accordance with generally
accepted accounting principles.
13
<PAGE>
SPRINT TRANSACTION
On June 5, 1998, we entered into a very important strategic alliance with
Sprint in the area of consumer Internet access and related services. In
connection with the formation of that relationship, Sprint tendered for and
purchased 2.5 million shares of our common stock for $22.50 per share. At the
close of the tender offer, we issued Sprint approximately 4.1 million shares of
our newly created Series A convertible preferred stock, convertible into
approximately 8.2 million shares of our common stock (assuming the acceleration
of certain rights). In return, Sprint:
(1) transferred approximately 130,000 members to us;
(2) paid us approximately $24 million in cash; and
(3) granted us the exclusive right to use certain dial-up modem ports in
their high-speed data network for four years.
Additionally, we entered into a five-year marketing and distribution
agreement with Sprint. The following are highlights from that agreement:
(a) Sprint must deliver a minimum of 150,000 new members per year for five
years through its own marketing channels;
(b) we are Sprint's exclusive provider of consumer Internet access services
for at least ten years; and,
(c) we can use Sprint's brand and distribution network for at least ten
years.
Sprint also provided us with a $25 million line of credit (increasing to
$100 million over three years) in the form of convertible senior debt.
We also entered into a governance agreement with Sprint. This agreement
establishes certain terms and conditions concerning our corporate governance,
the acquisition and disposition of our equity securities by Sprint (including
certain preemptive rights in favor of Sprint), the rights of Sprint to make
offers to purchase all outstanding shares of our common stock and rights of our
Board of Directors to receive and entertain offers to effect certain business
combinations. EarthLink, and certain of our stockholders, have also entered into
an agreement with Sprint which obligates such stockholders, under certain terms
and conditions, to take action in support of our obligations to Sprint under the
governance agreement.
Sprint can appoint (1) one person to our Board of Directors so long as
Sprint owns at least 10% of our capital stock on a fully diluted basis, and (2)
an additional person to our Board of Directors so long as Sprint owns at least
20% of our capital stock on a fully diluted basis.
As a result of these transactions, Sprint now owns approximately 27% of our
capital stock on a fully diluted basis (this assumes the conversion of Sprint's
convertible preferred stock into common stock and assumes acceleration of
certain dividend rights and the exercise by Sprint of certain preemptive
rights), of which approximately 10% is voting stock. Sprint has the right to
maintain (but not exceed) these ownership levels by purchasing from us
additional common stock equivalent shares, with up to 75% of these common stock
equivalents being in the form of convertible preferred stock.
The Series A convertible preferred stock owned by Sprint accrues dividends
for the first five years by increasing its liquidation value at a rate of 3%
annually. Thereafter the convertible preferred stock will pay a cash dividend of
3% of the liquidation value during years six through 20. The cash dividend will
increase to 8% in year 21 and increase to 12% by year 23.
14
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth the percentage of total revenues represented
by certain items in our statements of operations for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Recuring revenues................................................................... 83% 92% 93%
Other revenues...................................................................... 17 8 4
Incremental revenues................................................................ -- -- 3
--- --- ---
Total revenues.................................................................... 100% 100% 100%
--- --- ---
Operating costs and expenses:
Cost of recurring revenues.......................................................... 53 46 44
Cost of other revenues.............................................................. 6 2 1
Sales and marketing................................................................. 52 32 23
General and administrative.......................................................... 32 18 13
Operations and member support....................................................... 48 38 31
Amortization and transaction costs (1).............................................. -- -- 23
--- --- ---
Total operating costs and expenses................................................ 191 136 135
Loss from operations................................................................ (91) (36) (35)
Interest income..................................................................... -- 1 2
--- --- ---
Interest expense.................................................................... (3) (3) (1)
--- --- ---
Net loss.......................................................................... (94%) (38%) (34%)
--- --- ---
--- --- ---
</TABLE>
- ------------------------
(1) Amortization and transaction costs represent $41,238,000 in amortization of
intangible assets acquired and a one time transaction cost, in June 1998, of
$1,397,000 resulting from the strategic alliance with Sprint.
1998 COMPARED TO 1997
RECURRING REVENUES
We experienced substantial growth in revenues during 1998. The increase in
recurring revenues of 120% from $74.7 million in 1997 to $164.7 million in 1998
was primarily due to an increase in our member base from approximately 420,000
at December 31, 1997 to approximately 1 million at December 31, 1998. In June
1998 we acquired approximately 130,000 members and gained access to Sprint's
marketing and distribution channels as part of our strategic relationship with
Sprint. In addition to those channels, we aggressively expanded into the OEM
arena by securing relationships with Apple, Packard Bell, NEC and Comp USA.
We also added several key affinity marketing partners, Sam's Club, Discover
Card and AAA of Southern California.
15
<PAGE>
OTHER REVENUES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
INCREASE
1997 1998 (DECREASE)
--------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Dial-up set up fees........................................... $ 3,478 $ 2,853 $ (625)
Non dial-up set up fees....................................... 2,753 3,694 941
--------- --------- -----
Total other revenues.......................................... $ 6,231 $ 6,547 $ 316
--------- --------- -----
--------- --------- -----
</TABLE>
The decrease in dial-up set up fees is primarily due to our increased
willingness to waive set up fees for dial-up members acquired through certain
marketing programs in response to competitive pressures. We expect this trend to
continue for dial-up set up fees. We have continued to expand our sales of
premium services such as business Web site hosting, national ISDN, LAN ISDN,
frame relay connections and cable connections. Set up fees for these services
are generally not waived, and, as such, one-time fees for the set up of
non-dial-up accounts has increased.
INCREMENTAL REVENUES
In the first quarter of 1998 EarthLink began reporting incremental revenues
derived from advertising, content and electronic commerce fees that leverage the
value of our growing member base and user traffic. The principal component of
our strategy is our Premiere Partnership Program, through which we offer and
sell promotional packages that provide advertisers with access to the multiple
points of contact we have with our members. We also sell advertising and content
space on our various online properties, such as the Personal Start Page and the
Mall, and through our news magazine, BLINK. We generally charge transaction fees
on electronic commerce activities we facilitate. Incremental revenues were $4.7
million in 1998.
COST OF RECURRING REVENUES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------
PERCENT OF PERCENT OF
RECURRING RECURRING
1997 REVENUES 1998 REVENUES
--------- ------------- ---------- -------------
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C>
Recurring revenues............................. $ 74,657 100% $ 164,723 100%
Cost of recurring revenues..................... 36,716 49 76,643 47
</TABLE>
Cost of recurring revenues increased 109% during 1998 as compared 1997,
primarily due to the increase in our member base. The decrease in the cost of
recurring revenues as a percentage of recurring revenues is attributable to: (a)
more effective management of our network, (b) the addition of Sprint to our
family of POP providers, and (c) our increasing ability to negotiate more
favorable commercial arrangements with our telecommunications service providers
as we leverage our growing member base.
16
<PAGE>
COST OF OTHER REVENUES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
PERCENT PERCENT
OF OTHER OF OTHER
1997 REVENUES 1998 REVENUES
--------- ------------- --------- -------------
(IN THOUSANDS, EXCEPT PERCENTAGES)
<S> <C> <C> <C> <C>
Royalties............................................ $ 930 15% $ 158 2%
Other................................................ 419 7 527 8
--------- --- --------- ---
Total cost of other revenues......................... $ 1,349 22% $ 685 10%
--------- --- --------- ---
--------- --- --------- ---
</TABLE>
Cost of other revenues decreased 49% in 1998 as compared to 1997. The
decrease was primarily due to a reduction in royalty expense. The increase in
the remaining components of cost of other revenues is primarily due to the
increase in the rate of member growth during 1998.
SALES AND MARKETING
Sales and marketing expenses consist primarily of third-party bounties,
advertising, sales commissions, salaries, referral credits, direct communication
costs associated with trial accounts and the cost of promotional material. Sales
and marketing expenses increased from $26.0 million in 1997 to $42.7 million in
1998. The increase was primarily due to increased third-party bounty payments,
increased emphasis on marketing, including expanded sales and marketing efforts
on a nationwide basis, increased sales commissions and increased marketing
personnel headcount. We do not defer sales, marketing or other direct costs
associated with the acquisition of members. We expense these costs 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
46% from $14.4 million in 1997 to $21.0 million in 1998. The increase was
primarily due to an increase in credit card processing fees and an increase in
bad debt expense. The increase in credit card processing fees was due to the
increase in our member base. As a percentage of total revenues, general and
administrative expenses decreased from 18% in 1997 to 13% in 1998.
OPERATIONS AND MEMBER SUPPORT
Operations and member support expenses consist primarily of costs associated
with technical support and member service, as well as customer information
systems. Operations and member support expenses increased 76% from $30.9 million
in 1997 to $54.4 million in 1998. However, as a percentage of total revenues
Operations and member support expenses decreased from 38% in 1997 to 31% in
1998. We focus on retaining existing members by providing superior services and
devoting significant resources to expanding technical support staff and network
operations capabilities. We had 565 employees engaged in operations and member
support activities on December 31, 1997 and 998 on December 31, 1998. We
continue to improve member service functions by investing in training programs,
hardware and software.
INTEREST EXPENSE
Interest expense decreased from $2.1 million in 1997 to $2.0 million during
1998 due to repayment of approximately $4 million in notes payable, the
conversion of $5 million in debt to equity and a reduction in interest rates
paid to lessors. The above was offset by the increase in capitalized lease
obligations.
17
<PAGE>
INTEREST INCOME
Interest income increased from $637,000 in 1997 to $4.4 million 1998. The
increase was primarily due to an increase in average cash balances available for
investment as a result of our public follow on common stock offering completed
in June 1998.
1997 COMPARED TO 1996
RECURRING REVENUES
Recurring revenues increased $47.1 million or 171% from $27.6 million in
1996 to $74.7 million in 1997 due to the significant increase in our member base
during 1997.
OTHER REVENUES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
INCREASE
1996 1997 (DECREASE)
--------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Dial-up set up fees........................................... $ 4,563 $ 3,478 $ (1,085)
Non dial-up set up fees....................................... 1,061 2,753 1,692
--------- --------- -----------
Total other revenues.......................................... $ 5,624 $ 6,231 $ 607
--------- --------- -----------
--------- --------- -----------
</TABLE>
Other revenues increased $607,000 or 11% from 1996 to 1997. Due to
competitive pricing and other pressures, we waived set up fees for dial-up
members acquired through certain marketing partnerships. This caused a decrease
in dial-up set up fees earned during 1997. We expect this trend to continue for
dial-up set up fees. During 1997, we began to aggressively promote Web hosting
and nationwide high speed access services. The decline in dial-up set up fees
was offset by increases in the other set up fees and revenues attributable to
our Web hosting, high speed access services and cost of products sold.
COST OF RECURRING REVENUES
Cost of recurring revenues increased from $17.7 million in 1996 to $36.7
million in 1997 because our member base increased, but decreased from 64% of
recurring revenues in 1996 to 49% of recurring revenues in 1997. The decrease
from 1996 to 1997 was primarily due to our ability to effectively manage
communications costs and economies of scale to reduce per member costs as the
total member base expanded. Until October 1996, we paid UUNET a fixed monthly
fee per member plus a variable amount based on member usage in excess of a
threshold number of hours per month. Our network services agreement with UUNET
was amended as of October 1996 to change the cost basis from per member to peak
port hours. In June 1997, UUNET agreed to waive monthly revenue minimums, excess
hours fees and peak service user targets for the remaining six months of 1997.
In return, EarthLink agreed not to invoke its early termination right prior to
September 1998. If usage becomes more concentrated during peak times, the fees
we pay to UUNET will increase, thereby adversely affecting our operating
margins. Under our agreement with PSINet, we pay PSINet a fixed monthly fee for
each member accessing our services through a PSINet POP.
18
<PAGE>
COST OF OTHER REVENUES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
INCREASE
1996 1997 (DECREASE)
------ ------ ----------
(IN THOUSANDS)
<S> <C> <C> <C>
Royalties................................................... $1,907 $ 930 $(977)
Other....................................................... 159 419 260
------ ------ -----
Total cost of other revenues................................ $2,066 $1,349 $(717)
------ ------ -----
------ ------ -----
</TABLE>
Cost of other revenues decreased $717,000 or 38% from $2.1 million in 1996
to $1.3 million in 1997. The decrease was due to the renewal of various
contracts under more favorable terms.
SALES AND MARKETING
Sales and marketing expenses increased $8.6 million or 49% from $17.4
million in 1996 to $26.0 million 1997. The increase was primarily due to our
emphasis on marketing services, expanding sales and marketing efforts
nationwide, increased sales commissions, marketing personnel headcount,
third-party bounties and referral credits. We do not defer sales, marketing or
other direct costs associated with the acquisition of members; rather, we
expense these costs as they are incurred.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased $3.9 million or 37% from $10.5
million in 1996 to $14.4 million in 1997 due to increases in bad debt, payroll,
rent, depreciation expenses and credit card fees. Bad debt expense was $2.5
million or 7.5% of total revenues in 1996 due to difficulties in billing and in
disconnecting late-paying members on a timely basis. Bad debt expense was $3.5
million or 4.3% of total revenues in 1997. Bad debt decreases were due to our
review and elimination of accounts with questionable payment history and the
compression of our collection cycle. The rise in payroll costs was primarily due
to growth in headcount. Personnel engaged in general and administrative
activities increased from 92 to 110 during 1997. Depreciation expense rose
because of the acquisition of office equipment and the build-out of leasehold
improvements. Credit card processing fees increased primarily because our member
base increased.
OPERATIONS AND MEMBER SUPPORT
Operations and member support expenses increased $15.1 million or 96% from
$15.8 million in 1996 to $30.9 million in 1997 reflecting our efforts to retain
existing members by devoting significant resources to expanding technical
support and network operations capabilities. Employees engaged in operations and
member support activities increased from 401 to 565 during 1997. During 1997, we
created a new call center and invested in training programs and hardware and
software to solve member problems.
INTEREST EXPENSE
Interest expense increased from $1.0 million in 1996 to $2.1 million in 1997
primarily due to our increased borrowings and capital lease obligations to
finance our expansion of network infrastructure and capital equipment
acquisitions.
INTEREST INCOME
Interest income increased from $150,000 in 1996 to $637,000 in 1997
primarily because of the increase in average cash balances available for
investment.
19
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Our operating activities used $16.2 million and $21.3 million in cash during
the years ended December 31, 1996 and 1997, respectively. In all three years,
the Company's net loss was the primary component of cash used in operating
activities. In 1998, however, the Company's net loss was offset by significant
non-cash depreciation and amortization expenses relating to the Company's
network and intangible assets. Our operating activities provided $26.6 million
of cash during the year ended December 31, 1998, primarily because of the
increase in accounts payable and accrued liabilities of $31.7 million.
Our investing activities, used cash of approximately $18.4 million, $16.1
million and $9.2 million in 1996, 1997 and 1998, respectively. Capital equipment
purchases were $18.8 million, $14.5 million and $24.3 million during the three
years then ended. During 1997, we purchased the rights to subscribers and
related assets of Internet in a Mall, Inc., a Tarzana, California based ISP, at
a cost of approximately $1.4 million. Net cash received in the Sprint
transaction of $23.8 million was partially offset by Sprint transaction costs of
$9.9 million for the year ended December 31, 1998.
Financing activities provided approximately $38.3 million, $49.8 million and
$107.1 million in cash during 1996, 1997 and 1998, respectively. We raised $8.7
million and $15.4 million in private sales of equity securities during 1996 and
1997, respectively. In the first quarter of 1997, we sold 4.6 million shares of
common stock in our initial public offering and generated approximately $26.2
million in net proceeds. We completed a follow on public offering in June 1998
of 3.8 million shares of common stock. Our net proceeds were approximately
$106.3 million. During 1996, 1997 and 1998, we financed the acquisition of data
processing and office equipment amounting to approximately $11.3 million, $10.5
million and $9.3 million, respectively, through equipment leases and sale
leaseback agreements. We record sale leaseback transactions at cost, which
approximates the fair market value of the property, and, therefore, no gains or
losses are recorded. We continue to depreciate the property and record a
financing obligation representing the proceeds based upon payments under the
lease agreement.
On December 31, 1998, we had approximately $140.9 million in cash and cash
equivalents. We believe our available cash is sufficient to meet our operating
expenses and capital requirements for the next 12 months. We also have a $25
million credit facility from Sprint in the form of convertible senior debt,
increasing to $100 million over a three-year period, at an interest rate of 6%
per annum. Our capital requirements depend on numerous factors, including the
rate of market acceptance of our services, our ability to maintain and expand
our member base, the rate of expansion of our network infrastructure, the size
and types of acquisitions in which we may engage and the level of resources
required to expand our marketing and sales programs. We cannot accurately
predict the timing and amount of capital requirements. We may require additional
financing sooner than anticipated if capital requirements vary materially from
those currently planned. We have no commitments for any additional financing
other than the line of credit from Sprint, and we cannot be sure that we can
obtain additional commitments on favorable terms, if at all. Additional equity
financing may dilute our stockholders, and debt financing, if available, may
restrict our ability to declare and pay dividends and raise future capital. If
we are unable to obtain additional needed financing, we may be required to
reduce the scope of operations or anticipated expansion, which could materially
and adversely affect us.
YEAR 2000 RISKS MAY ADVERSELY AFFECT US
Many existing computer programs use only two digits to identify a year.
These programs were designed and developed without addressing the impact of the
upcoming change in the century. If not corrected, many computer software
applications could fail or create erroneous results by, at or beyond the year
2000. We utilize software, computer technology and other services internally
developed and provided by third-party vendors that may fail due to the year 2000
phenomenon. For example, we are dependent on the institutions involved in
processing our members' credit card payments for Internet services. We are also
dependent on telecommunications vendors and leased POP vendors to maintain
network reliability.
20
<PAGE>
We are continuing to assess the year 2000 readiness of our third-party
supplied software, computer technology and other services. Based upon the
results of this assessment, we will develop and implement, if necessary, a
remediation plan with respect to third-party software, computer technology and
services which may fail to be year 2000 compliant. We have assessed our
proprietary software and internal systems and determined them to be year 2000
compliant. We anticipate that our systems, including components thereof provided
by third-party vendors, will be year 2000 compliant by 2000. The failure of our
software and computing systems and our third-party vendors to be year 2000
compliant could have a material adverse effect on us.
The most reasonably likely worst-case year 2000 scenario would be for one or
more of our network service providers to fail thereby making it difficult or
impossible for members to dial-up and access the Internet; however, we maintain
agreements with several nationwide network service providers including UUNET,
Sprint and PSINet, and have the ability to switch our members among the networks
of these providers. Therefore, should any of these providers be unable to
provide our members with Internet access as a result of year 2000 problems, we
believe our redundant network arrangements will adequately accommodate our dial
up access needs.
Total costs incurred in connection with our year 2000 compliance efforts are
expected to be minimal.
21
<PAGE>
QUARTERLY RESULTS
The following table sets forth certain unaudited quarterly consolidated
financial data for the eight quarters ended December 31, 1998. In the opinion of
the Company's management, this unaudited information has been prepared on the
same basis as the audited consolidated financial statements contained herein and
includes all adjustments (consisting of normal recurring adjustments) necessary
to present fairly the information set forth therein when read in conjunction
with the Consolidated Financial Statements and Notes thereto. The operating
results for any quarter are not necessarily indicative of results for any future
period.
<TABLE>
<CAPTION>
MAR. 31 JUN. 30 SEPT. 30 DEC. 31 MAR. 31 JUN. 30 SEPT. 30 DEC. 31
1997 1997 1997 1997 1998 1998 1998 1998
------- ------- -------- ------- ------- -------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS
DATA:
Revenues:
Recurring revenues.................... $14,540 $17,880 $19,450 $22,787 $27,856 $ 35,224 $ 46,877 $54,766
Other revenues........................ 1,632 1,367 1,559 1,673 1,578 1,620 1,699 1,650
Incremental revenues (1).............. -- -- -- -- 392 1,146 1,248 1,885
------- ------- -------- ------- ------- -------- -------- -------
Total revenues...................... 16,172 19,247 21,009 24,460 29,826 37,990 49,824 58,301
Operating costs and expenses:
Cost of recurring revenues............ 7,601 8,876 9,271 10,968 14,087 17,555 20,619 24,382
Cost of other revenues................ 406 429 281 233 36 120 252 277
Sales and marketing................... 6,261 6,125 6,756 6,829 7,566 8,281 10,644 16,241
General and administrative............ 3,519 3,467 3,529 3,891 4,537 5,018 5,871 5,616
Operations and member support......... 6,422 7,791 7,970 8,717 9,540 11,630 15,078 18,195
Amortization and transaction costs
(2)................................. -- -- -- -- -- 7,208 17,754 17,673
------- ------- -------- ------- ------- -------- -------- -------
Total operating costs and
expenses:......................... 24,209 26,688 27,807 30,638 35,766 49,812 70,218 82,384
Loss from operations.................... (8,037 ) (7,441) (6,798) (6,178) (5,940 ) (11,822) (20,394) (24,083)
Interest expense........................ (507 ) (444) (516) (632) (687 ) (621) (353) (306)
Interest income......................... 165 135 116 221 223 426 1,919 1,856
------- ------- -------- ------- ------- -------- -------- -------
Net loss.............................. (8,379 ) (7,750) (7,198) (6,589) (6,404 ) (12,017) (18,828) (22,533)
Deductions for accretion dividends
(3)................................... -- -- -- -- -- (1,054) (3,276) (3,271)
------- ------- -------- ------- ------- -------- -------- -------
Net loss attributable to common
stockholders.......................... $(8,379) $(7,750) $(7,198) $(6,589) $(6,404) $(13,071) $(22,104) $(25,804)
------- ------- -------- ------- ------- -------- -------- -------
------- ------- -------- ------- ------- -------- -------- -------
Basic and diluted net loss per share
(4)................................... $(0.46 ) $ (0.40) $ (0.36) $ (0.29) $(0.28 ) $ (0.53) $ (0.78) $ (0.89)
------- ------- -------- ------- ------- -------- -------- -------
------- ------- -------- ------- ------- -------- -------- -------
Weighted average shares (4)............. 18,188 19,476 19,864 22,482 22,746 24,586 28,458 28,838
------- ------- -------- ------- ------- -------- -------- -------
------- ------- -------- ------- ------- -------- -------- -------
</TABLE>
- ------------------------
(1) We began reporting incremental revenues in the first quarter of 1998.
(2) Amortization and transaction costs represent $41,238,000 in amortization of
intangible assets acquired and a one time transaction cost, in June 1998, of
$1,397,000 resulting from the strategic alliance with Sprint.
(3) Represents the accretion of liquidation dividends on Series A convertible
preferred stock at 3% compounded quarterly and the accretion of a dividend
related to the beneficial conversion feature in accordance with EITF D-60.
(4) SFAS No. 128, Earnings per Share ("EPS"), and Staff Accounting Bulletin No.
98 require companies, such as EarthLink, that incorporated the SAB 83
concept of "cheap stock" in determining pre-initial public offering EPS data
to restate EPS data to conform to SFAS No. 128. Basic EPS now represents the
weighted average number of shares divided into net income during a
22
<PAGE>
given period. Potential common stock items, options, warrants or convertible
instruments are not included in the calculation of EPS due to their
anti-dilutive effect.
<TABLE>
<CAPTION>
MAR. 31 JUN. 30 SEPT. 30 DEC. 31 MAR. 31 JUN. 30 SEPT. 30 DEC. 31
1997 1997 1997 1997 1998 1998 1998 1998
------- ------- -------- ------- ------- ------- -------- -------
(AS A PERCENTAGE OF TOTAL REVENUES)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT FO OPERATIONS
DATA
Revenues:
Recurring revenues.................... 90% 93% 93% 93% 94% 93% 94% 94%
Other revenues........................ 10 7 7 7 5 4 3 3
Incremental revenues (1).............. -- -- -- -- 1 3 3 3
------- ------- --- ------- ------- ------- --- -------
Total revenues...................... 100 100 100 100 100 100 100 100
Operating costs and expenses:
Cost of recurring revenues............ 47 46 44 45 47 46 41 42
Cost of other revenues................ 2 2 1 1 -- -- 1 --
Sales and marketing................... 39 32 32 28 26 22 21 28
General and administrative............ 22 18 17 16 15 13 12 10
Operations and member support......... 40 41 38 35 32 31 30 31
Amortization and transaction costs
(2)................................. -- -- -- -- -- 19 36 30
------- ------- --- ------- ------- ------- --- -------
Total operating costs and
expenses.......................... 150 139 132 125 120 131 141 141
Loss from operations.................... (50) (39) (32) (25) (20) (31) (41) (41)
Interest expense...................... (3) (2) (2) (3) (2) (2) (1) (1)
Interest income....................... 1 1 1 1 1 1 4 3
------- ------- --- ------- ------- ------- --- -------
Net loss............................ (52) (40) (33) (27) (21) (32) (38) (39)
Deductions for accretion dividends(3)... -- -- -- -- -- (2) (6) (5)
------- ------- --- ------- ------- ------- --- -------
Net loss attributable to common
stockholders.......................... (52)% (40)% (33)% (27)% (21)% (34)% (44)% (44)%
------- ------- --- ------- ------- ------- --- -------
------- ------- --- ------- ------- ------- --- -------
</TABLE>
- ------------------------
(1) We began reporting incremental revenues in the first quarter of 1998.
(2) Amortization and transaction costs represent $41,238,000 in amortization of
intangible assets acquired and a one time transaction cost, in June 1998, of
$1,397,000 resulting from the strategic alliance with Sprint.
(3) Represents the accretion of liquidation dividends on Series A convertible
preferred stock at 3% compounded quarterly and the accretion of a dividend
related to the beneficial conversion feature in accordance with EITF D-60.
SAFE HARBOR STATEMENT
The following "Safe Harbor Statement" is made pursuant to the Private
Securities Litigation Reform Act of 1995. Certain of the statements contained in
the body of this Report are forward-looking statements (rather than historical
facts) that are subject to risks and uncertainties that could cause actual
results to differ materially from those described in the forward-looking
statements. With respect to such forward-looking statements, the Company seeks
the protections afforded by the Private Securities Litigation Reform Act of
1995. These risks 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 Transactions will fail to
close, (4) that if the Sprint Transactions close, they will not be as beneficial
to the Company as management anticipates, (5) that the Company will not be able
to sustain its current growth, (6) that the Company will not adequately respond
to technological developments impacting the Internet, and (7) that needed
financing will not be available to the Company if and as needed. This list is
intended to identify certain of the principal factors that could cause actual
results to differ materially from those described in the forward-looking
statements included elsewhere herein. These factors are not intended to
represent a complete list of all risks and uncertainties inherent in the
Company's business, and should be read in conjunction with the more detailed
cautionary statements included elsewhere in recent SEC filings.
23
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this item appears in a subsequent section of
this Report. (See Item 14(a)(1) and (2)).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
24
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to management's nominees for directors of the Company
will be set forth under the captions "Proposal 1--Election of
Directors--Nominees" and "Proposal 1--Election of Directors-- Information
Regarding Nominees for Director" in the Company's Proxy Statement for its 1999
Annual Meeting of Shareholders or in a subsequent amendment to this Report. Such
information is incorporated herein by reference. Information relating to the
executive officers of the Company will be set forth under the caption "Executive
Officers" in the above-referenced Proxy Statement or amendment. Such information
is incorporated herein by reference. Information regarding compliance by
directors and executive officers of the Company and owners of more than ten
percent of the Company's Common Stock with the reporting requirements of Section
16(a) of the Securities Exchange Act of 1934, as amended, will be set forth
under the caption "Compliance with Section 16(a) of the Securities Exchange Act
of 1934" in the above-referenced Proxy Statement or amendment.
ITEM 11. EXECUTIVE COMPENSATION
Information relating to management compensation will be set forth under the
captions "Proposal 1-- Election of Directors--Director Compensation" and
"Executive Compensation" in the Company's Proxy Statement referred to in Item 10
above or in a subsequent amendment to this Report. Such information is
incorporated herein by reference, except for the information set forth under the
captions "Executive Compensation--Audit and Compensation Committee Report on
Executive Compensation" and "Stock Performance Graph," which specifically is not
so incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding ownership of the Company's $0.01 par value Common
Stock by certain persons is set forth under the captions "Beneficial Ownership
of Common Stock" in the Company's Proxy statement referred to in Item 10 above
or in a subsequent amendment to this Report. Such information is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and transactions between the
Company and certain of its affiliates is set forth under the caption
"Compensation Committee Interlocks and Insider Participation" in the Company's
Proxy Statement referred to in Item 10 above or in a subsequent amendment to
this Report. Such information is incorporated herein by reference.
25
<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
Consolidated Balance Sheet as of December 31, 1997 and 1998
Consolidated Statement of Operations for the three years ended December 31,
1998
Consolidated Statement of Stockholders' Equity (Deficit) for the three years
ended December 31, 1998
Consolidated Statement of Cash Flows for the three years ended December 31,
1998
Notes to Consolidated Financial Statements
2. FINANCIAL STATEMENT SCHEDULE
The Financial Statement Schedule(s) described in Regulation S-X are omitted
from this Report because they are either not required or are immaterial.
3. EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
2.1 Investment Agreement dated as of February 10, 1998, with Sprint Corporation and Sprint Communications
Company L.P. (incorporated by reference to Exhibit 2.1 to the Form 8-K filed by EarthLink Network, Inc.
on February 10, 1998).
3.1 Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Company's Registration
Statement on Form S-4--File No. 333-52507).
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to the Company's Registration Statement on Form
S-4--File No. 333-52507).
3.3 Form of Certificate of Designation, Preferences and Rights of the Company's Series A Convertible
Preferred Stock (incorporated by reference to Exhibit 10.2 to the Form 8-K filed by EarthLink Network,
Inc. on February 10, 1998).
3.4 Certificate of Designation, Preferences and Rights of the Company's Series B Convertible Preferred Stock
and amendment thereto.
4.1 See Exhibits 3.1, 3.2, 3.3 and 3.4 for provisions of the Certificate of Incorporation, Bylaws and
Certificates of Designation, Preference and Rights of Series A and B Convertible Preferred Stock.
4.2 Specimen Stock Certificate (incorporated by reference to Exhibit 4.2 to the Registration Statement on
Form S-1 of EarthLink Network, Inc.--File No. 333-15781).
4.3 Form of Warrant Agreement (incorporated by reference to Exhibit 4.3 to the Registration Statement on Form
S-1 of EarthLink Network, Inc.--File No. 333-15781).
4.4 Agreement and Plan of Merger between Newco, Inc. and EarthLink Network, Inc. dated as of February 10,
1998 and entered into in connection with the Sprint Transaction (incorporated by reference to Exhibit 4.4
to the Company's Registration Statement on Form S-4--File No. 333-52507).
</TABLE>
26
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
10.1 1995 Stock Option Plan and forms of Stock Option Agreement and Stock Purchase Agreement (incorporated by
reference to Exhibit 10.1 to Registration Statement of EarthLink Network, Inc. on form S-1--File No.
333-15781).
10.2 Amended and Restated Stock Option Plan for Directors (incorporated by reference to Exhibit 10.2 to the
Company's Registration Statement on Form S-1 of EarthLink Network, Inc.--File No. 333-15781).
10.3 Lease Line Agreement, dated January 30, 1996, between the Company and Boston Financial & Equity
Corporation (incorporated by reference to Exhibit 10.4 to the Registration Statement on Form S-1 of
EarthLink Network, Inc.--File No. 333-15781).
10.4 Master Lease Agreement, dated September 1, 1995, between the Company and LINC Capital Management
(incorporated by reference to Exhibit 10.5 to the Registration Statement on Form S-1 of EarthLink
Network, Inc.--File No. 333-15781).
10.5 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 Registration Statement on Form S-1 of EarthLink Network, Inc.--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 Registration Statement on Form S-1 of EarthLink
Network, Inc.--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 Registration Statement on Form S-1 of EarthLink
Network, Inc.--File No. 333-15781).
10.6 Network Services Agreement dated May 31, 1996, between the Company and UUNET Technologies, Inc.
incorporated by reference to (Exhibit 10.7 to the Registration Statement on Form S-1 of EarthLink
Network, Inc.--File No. 333-15781).
(a) Addendum No. 1 to Network Services Agreement (incorporated by reference to Exhibit 10.7 (a) to the
Registration Statement on Form S-1 of EarthLink Network, Inc.--File No. 333-15781).
10.7 Software Distribution Agreement (MacTCP), dated October 2, 1995, between the Company and Apple Computer,
Inc. (incorporated by reference to Exhibit 10.8 to the Registration Statement on Form S-1 of EarthLink
Network, Inc.--File No. 333-15781).
10.8 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 (incorporated by reference to Exhibit 10.9(a) to the Report on Form
10-K of EarthLink Network, Inc. for the fiscal year ended December 31, 1997)
(b) First Amendment to Employment Agreement (incorporated by reference to Exhibit 10.9 to the Company's
Report on Form 10-K of EarthLink Network, Inc. for the fiscal year ended December 31, 1997)
(c) Second Amendment to Employment Agreement (incorporated by reference to Exhibit 10.9(c) to the Report
on Form 10-K of EarthLink Network, Inc. for the fiscal year ended December 31, 1997)
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
(d) Amended and Restated Employment Agreement (incorporated by reference to Exhibit 10.8(d) to the
Company's Registration Statement on Form S-1--File No. 333-53063).
10.9 Standard Industrial/Commercial Multi-Tenant Lease, dated December 1, 1995, between the Company and Becton
Dickinson and Company (incorporated by reference to Exhibit 10.12 to the Registration Statement on Form
S-1 of EarthLink Network, Inc.--File No. 333-15781).
10.10 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 Registration Statement on Form S-1 of EarthLink Network, Inc.--File No. 333-15781).
10.11 Production and Distribution Agreement, dated May 6, 1996, between the Company and National Media
Corporation (incorporated by reference to Exhibit 10.16 to the Registration Statement on Form S-1 of
EarthLink Network, Inc.--File No. 333-15781). (a) Amendment No. 1 to Production and Distribution
Agreement (incorporated by reference to Exhibit 10.16(a) to the Registration Statement on Form S-1 of
EarthLink Network, Inc.--File No. 333-15781).
10.12 Internet Wizard Sign-Up Agreement between the Company and Microsoft Corporation, dated August 16, 1996
(incorporated by reference to Exhibit 10.19 to the Registration Statement on Form S-1 of EarthLink
Network, Inc.--File No. 333-15781).
10.13 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 Registration Statement on
Form S-1 of EarthLink Network, Inc.--File No. 333-15781).
10.14 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 Registration
Statement on Form S-1 of EarthLink Network, Inc.--File No. 333-15781).
10.15 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 Registration Statement on Form S-1
of EarthLink Network, Inc.--File No. 333-15781).
10.16 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 Registration Statement on Form S-1 of EarthLink Network, Inc.--File No. 333-15781). (b)
Addendum to Amended and Restated Registration Rights Agreement (incorporated by reference to Exhibit
10.23(c) to the Registration Statement on Form S-1 of EarthLink Network, Inc.--File No. 333-15781).
10.17 Amended and Restated Convertible Securities Vesting Plan (incorporated by reference to Exhibit 10.18 to
the Report on Form 10-K of EarthLink Network, Inc. for the fiscal year ended December 31, 1997).
10.18 Key Employee Compensation Continuation Plan (incorporated by reference to Exhibit 10.19 to the Report on
Form 10-K of EarthLink Network, Inc. for the fiscal year ended December 31, 1997). (a) Amendment to Key
Employee Compensation Continuation Plan (incorporated by reference to Exhibit 10.19(a) to the Report on
Form 10-K of EarthLink Network, Inc. for the fiscal year ended December 31, 1997).
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
10.19 Governance Agreement, dated as of February 10, 1998, (incorporated by reference to Exhibit 10.1 to the
Form 8-K filed by EarthLink Network, Inc. on February 10, 1998).
10.20 Credit Agreement, dated as of February 10, 1998, with Sprint Corporation as the Lender (incorporated by
reference to Exhibit 10.3 to the Form 8-K filed by EarthLink Network, Inc. on February 10, 1998).
10.21 Registration Rights Agreement, dated as of February 10, 1998, with Sprint Corporation, and Sprint
Communications Company L.P., (incorporated by reference to Exhibit 99.1 to the Form 8-K by EarthLink
Network, Inc. filed on February 10, 1998).
10.22 Stockholders Agreement, dated as of February 10, 1998, among EarthLink Network, Inc., Sprint Corporation,
Sprint Communications Company L.P., and the persons identified on Schedule 1 thereto (incorporated by
reference to Exhibit 99.2 to the Form 8-K of EarthLink Network, Inc. filed on February 10, 1998).
10.23 Agreement to Vote Stock, dated as of February 10, 1998, among the Granting Stockholders named on Schedule
A thereto, Sprint Corporation and Sprint Communications Company L.P. (incorporated by reference to
Exhibit 99.3 to the Form 8-K filed by EarthLink Network, Inc. on February 10, 1998).
10.24 Agreement to Vote and Tender Stock, dated as of February 10, 1998, among the Granting Stockholders named
on Schedule A thereto, Sprint Corporation, and Sprint Communications Company, L.P. (incorporated by
reference to Exhibit 99.4 to the Form 8-K filed by EarthLink Network, Inc. on February 10, 1998).
10.25 Marketing and Distribution Agreement, dated as of February 10, 1998, Sprint Corporation, and Sprint
Communications Company L.P. (incorporated by reference to Exhibit 10.26 of the Company's Registration
Statement on Form S-4, filed May 13, 1998, File No. 333-52507).
10.26 Third Amendment to the lease agreement between WHMNY Real Estate Limited Partnership, a Delaware limited
partnership ("Landlord"), and EarthLink Network, Inc. (incorporated by reference to Exhibit 10.1 to the
Company's Form 10-Q filed on November 16, 1998.
22.1 Significant Subsidiaries (incorporated by reference to Exhibit 22.1 to the Company's Registration
Statement on Form S-1, filed May 19, 1998, File No. 333-53063).
23.1 Consent of Independent Accountants.
24.1 Power of Attorney (set forth on the signature page to the Registration Statement).
27.1 Financial Data Schedule.
</TABLE>
(B) REPORTS ON FORM 8-K.
On February 10, 1998, the Company filed a Current Report on Form 8-K (the
"Form 8-K"). The Form 8-K reported that, on February 10, 1998 the Company
announced a long-term strategic alliance with Sprint Corporation as more
thoroughly described elsewhere in this report. See "Business--Sprint
Transaction".
On August 14, 1998 the Company filed a Current Report on Form 8-K describing
the Company's recently completed strategic alliance with Sprint Corporation and
related transactions.
29
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
EARTHLINK NETWORK, INC.
/s/ CHARLES G. BETTY
---------------------------------------------
Charles G. Betty
PRESIDENT, CEO
Date: March 30, 1999
Each person whose signature appears below hereby constitutes and appoints
Charles G. Betty and Grayson L. Hoberg the true and lawful attorneys-in-fact and
agents of the undersigned, with full power of substitution and resubstitution,
for and in the name, place and stead of the undersigned, in any and all
capacities, to sign any and all amendments to this Report, and to file the same,
with all exhibits thereto, and other documents in connection therewith, with the
Commission, and hereby grants to such attorneys-in-fact and agents full power
and authority to do and perform each and every act and thing requisite and
necessary to be done, as fully to all intents and purposes as the undersigned
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or their substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the Company
and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE
- -------------------------------------------------------- --------------------------------------------------------
<S> <C>
/s/ CHARLES G. BETTY
--------------------------------------------
Date: March 30, 1999 Charles G. Betty, President, Chief Executive Officer and
Director
/s/ GRAYSON L. HOBERG
--------------------------------------------
Date: March 30, 1999 Grayson L. Hoberg, Sr. Vice President--
Finance and Administration and Chief
Financial Officer
/s/ RICHARD A. QUIROGA
--------------------------------------------
Date: March 30, 1999 Richard A. Quiroga, Vice President--
Corporate Controller
/s/ SKY D. DAYTON
Date: March 30, 1999 --------------------------------------------
Sky D. Dayton, Chairman of the Board
/s/ SIDNEY AZEEZ
Date: March 30, 1999 --------------------------------------------
Sidney Azeez, Director
/s/ ROBERT M. KAVNER
Date: March 30, 1999 --------------------------------------------
Robert M. Kavner, Director
/s/ PAUL MCNULTY
Date: March 30, 1999 --------------------------------------------
Paul McNulty, Director
</TABLE>
30
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE
- -------------------------------------------------------- --------------------------------------------------------
<S> <C>
/s/ KEVIN M. O'DONNELL
Date: March 30, 1999 --------------------------------------------
Kevin M. O'Donnell, Director
/s/ REED E. SLATKIN
Date: March 30, 1999 --------------------------------------------
Reed E. Slatkin, Director
/s/ LINWOOD A. LACY
Date: March 30, 1999 --------------------------------------------
Linwood A. Lacy, Director
/s/ WILLIAM T. ESREY
Date: March 30, 1999 --------------------------------------------
William T. Esrey, Director
</TABLE>
31
<PAGE>
EARTHLINK NETWORK, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Independent Accountants.......................................................................... F-2
Consolidated Balance Sheet as of December 31, 1997 and 1998................................................ F-3
Consolidated Statement of Operations for the three years ended December 31, 1998........................... F-4
Consolidated Statement of Stockholders' Equity (Deficit) for the three years ended December 31, 1998....... F-5
Consolidated Statement of Cash Flows for the three years ended December 31, 1998........................... F-6
Notes to Consolidated 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 consolidated balance sheet and the related
consolidated statements of operations, of stockholders' equity (deficit) and of
cash flows present fairly, in all material respects, the financial position of
EarthLink Network, Inc. and its subsidiary (the "Company") at December 31, 1997
and 1998, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1998, 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.
PRICEWATERHOUSECOOPERS LLP
Century City, California
February 16, 1999, except as to Note 14, which is as of
February 24, 1999
F-2
<PAGE>
EARTHLINK NETWORK, INC.
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................................ $ 16,450 $ 140,864
Restricted short-term investment..................................... 1,250 --
Accounts receivable, net of allowance of $165,000 and $405,000 at
December 31, 1997 and 1998, respectively........................... 2,520 4,779
Prepaid expenses..................................................... 1,109 4,147
Other assets......................................................... 753 775
--------- ---------
Total current assets............................................... 22,082 150,565
Other long-term assets................................................. 449 564
Property and equipment, net (Notes 1 and 3)............................ 23,398 35,206
Intangibles, net (Note 4).............................................. 958 80,006
--------- ---------
$ 46,887 $ 266,341
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable............................................... $ 6,472 $ 14,818
Accrued payroll and related expenses................................. 2,316 8,934
Other accounts payable and accrued liabilities....................... 3,717 20,372
Current portion of capital lease obligations (Note 11)............... 7,112 8,341
Notes payable (Note 5)............................................... 9,387 --
Deferred revenue..................................................... 3,590 8,831
--------- ---------
Total current liabilities.......................................... 32,594 61,296
Long-term debt (Note 11)............................................... 8,218 7,701
--------- ---------
Total liabilities.................................................. 40,812 68,997
Commitments and contingencies (Note 11)
Stockholders' equity:
Preferred stock, $0.01 par value, 25,000,000 shares authorized, nil
and 4,102,941 shares issued and oustanding as Series A convertible
preferred stock at December 31, 1997 and 1998, respectively (Note
7)................................................................. -- 41
Common stock, $0.01 par value, 50,000,000 shares authorized,
22,500,744 and 29,069,827 shares issued and outstanding at December
31, 1997 and 1998, respectively.................................... 225 291
Stock subscriptions receivable....................................... -- (1,041)
Additional paid-in capital........................................... 70,829 330,911
Warrants to purchase common stock (Note 9)........................... 1,093 597
Accumulated deficit.................................................. (66,072) (133,455)
--------- ---------
Total stockholders' equity......................................... 6,075 197,344
--------- ---------
$ 46,887 $ 266,341
--------- ---------
--------- ---------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
F-3
<PAGE>
EARTHLINK NETWORK, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1997 1998
--------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C>
Revenues:
Recurring revenues.......................................... $ 27,606 $ 74,657 $ 164,723
Other revenues.............................................. 5,624 6,231 6,547
Incremental revenues........................................ -- -- 4,671
--------- --------- ---------
Total revenues............................................ 33,230 80,888 175,941
Operating costs and expenses:
Cost of recurring revenues.................................. 17,717 36,716 76,643
Cost of other revenues...................................... 2,066 1,349 685
Sales and marketing......................................... 17,363 25,971 42,732
General and administrative.................................. 10,534 14,406 21,042
Operations and member support............................... 15,808 30,900 54,443
Amortization and transaction expenses (Note 4).............. -- -- 42,635
--------- --------- ---------
Total operating costs and expenses........................ 63,488 109,342 238,180
--------- --------- ---------
Loss from operations.......................................... (30,258) (28,454) (62,239)
Interest income............................................... 150 637 4,424
Interest expense.............................................. (1,041) (2,099) (1,967)
--------- --------- ---------
Net loss................................................ (31,149) (29,916) (59,782)
Deductions for accretion dividends (Note 8)................... -- -- (7,601)
--------- --------- ---------
Net loss attributable to common stockholders.................. $ (31,149) $ (29,916) $ (67,383)
--------- --------- ---------
--------- --------- ---------
Basic and diluted net loss per share.......................... $ (2.57) $ (1.50) $ (2.58)
--------- --------- ---------
--------- --------- ---------
Weighted average shares....................................... 12,138 20,002 26,157
--------- --------- ---------
--------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
F-4
<PAGE>
EARTHLINK NETWORK, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
PREFERRED
STOCK COMMON STOCK STOCK ADDITIONAL TOTAL
-------------- ------------- SUBSCRIPTIONS PAID-IN WARRANTS ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT RECEIVABLE CAPITAL ISSUED DEFICIT EQUITY (DEFICIT)
------ ------ ------ ------ ------------- ---------- -------- ----------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
(IN THOUSANDS)
Balance at December 31,
1995........................ 10,114 $101 $ 5,072 $ 124 $ (5,007) $ 290
Issuance of common stock...... 1,846 18 8,642 -- -- 8,660
Issuance of common stock for
services.................... 85 1 462 -- -- 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........................ 12,045 120 14,176 599 (36,156) (21,261)
Initial public offering, net
of expenses................. 4,570 46 26,180 -- -- 26,226
Conversion of redeemable
preferred stock into common
stock....................... 2,727 27 13,986 -- -- 14,013
Conversion of debt to common
stock....................... 112 1 724 -- -- 725
Issuance of common stock in
connection with private
placement................... 2,920 30 15,379 -- -- 15,409
Issuance of common stock
pursuant to exercise of
stock options............... 127 1 384 -- -- 385
Warrants issued in exchange
for services (Note 9)....... -- -- -- 494 -- 494
Net loss...................... -- -- -- -- (29,916) (29,916)
------ ------ ------ ------ ------------- ---------- -------- ----------- --------
Balance at December 31,
1997........................ 22,501 225 70,829 1,093 (66,072) 6,075
Issuance of preferred stock... 4,103 $41 -- -- 134,959 -- -- 135,000
Accretion of convertible
preferred stock............. -- -- 7,601 -- (7,601) --
Follow on offering, net of
expenses (Note 6)........... -- -- 3,763 38 106,271 106,309
Conversion of debt to common
stock....................... -- -- 783 8 5,035 -- -- 5,043
Notes receivable from stock
sales....................... 18 $(1,041) 1,041 -- -- --
Issuance of common stock for
services.................... 20 -- 130 -- -- 130
Issuance of common stock
pursuant to exercise of
stock options............... -- -- 1,224 12 3,647 -- -- 3,659
Warrants issued in conjunction
with marketing agreement.... 91 91
Warrants issued in exchange
for services................ -- -- -- -- -- 60 -- 60
Issuance of common stock
pursuant to exercise of
warrants.................... 761 8 1,398 (647) 759
Net loss...................... -- -- -- -- -- -- (59,782) (59,782)
------ ------ ------ ------ ------------- ---------- -------- ----------- --------
Balance at December 31,
1998........................ 4,103 $41 29,070 $291 $(1,041) $330,911 $ 597 $(133,455) $197,344
------ ------ ------ ------ ------------- ---------- -------- ----------- --------
------ ------ ------ ------ ------------- ---------- -------- ----------- --------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
F-5
<PAGE>
EARTHLINK NETWORK, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1997 1998
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss..................................................... $ (31,149) $ (29,916) $ (59,782)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities, net of effect from
acquisition:
Depreciation and amortization.............................. 4,153 9,377 54,726
Issuance of common stock in exchange for professional
services................................................. 50 -- 130
Issuance of common stock in exchange for termination of
consulting agreement..................................... 413 -- --
Issuance of warrants in exchange for professional
services................................................. -- 494 60
Increase in net accounts receivable........................ (1,507) (180) (2,260)
Increase in prepaid expenses and other assets.............. (2,353) (413) (3,176)
Increase (decrease) in accounts payable and accrued
liabilities.............................................. 12,373 (2,232) 31,658
Increase in deferred revenue............................... 1,798 1,580 5,241
--------- --------- ---------
Net cash provided by (used in) operating activities............ (16,222) (21,290) 26,597
--------- --------- ---------
Cash flows from investing activities:
Purchases of property and equipment.......................... (18,774) (14,528) (24,316)
Purchases of intangible assets............................... -- (1,404) (9)
Transaction costs............................................ -- -- (9,914)
Cash acquired from acquisition............................... -- -- 23,750
Purchase of restricted short-term investment................. (1,087) (200) --
Liquidation of restricted short-term investment.............. 1,500 37 1,250
--------- --------- ---------
Net cash used in investing activities...................... (18,361) (16,095) (9,239)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from issuance of notes payable...................... 7,950 4,387 200
Repayment of notes payable................................... (1,494) (2,225) (4,583)
Proceeds from capital lease obligations...................... 11,348 10,544 9,275
Principal payments under capital lease obligations........... (2,191) (4,884) (8,563)
Proceeds from issuance of mandatorily redeemable preferred
stock (Note 6)............................................. 14,013 -- --
Proceeds from private placements of common stock............. 8,660 15,409 --
Proceeds from public stock offerings......................... -- 26,226 106,309
Proceeds from warrants exercised............................. -- 759
Proceeds from stock options exercised........................ -- 385 3,659
--------- --------- ---------
Net cash provided by financing activities.................. 38,286 49,842 107,056
--------- --------- ---------
Net increase in cash and cash equivalents...................... 3,703 12,457 124,414
Cash and cash equivalents, beginning of year................... 290 3,993 16,450
--------- --------- ---------
Cash and cash equivalents, end of year......................... $ 3,993 $ 16,450 $ 140,864
--------- --------- ---------
--------- --------- ---------
Acquisition, net of cash acquired (Note 2):
Issuance of convertible preferred stock...................... $ 135,000
Transaction costs............................................ 9,914
Intangible assets............................................ (121,164)
---------
Cash acquired from acquisition............................... $ 23,750
---------
---------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
F-6
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
EarthLink Network, Inc. ("EarthLink" or 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.
BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of EarthLink
Network, Inc. and its wholly-owned subsidiary EarthLink Operations, Inc. (Note
2). All intercompany transactions and balances have been eliminated in the
consolidated financial statements.
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. Incremental revenues are derived
from advertising, content and electronic commerce fees that leverage the value
of the Company's member base and user traffic. Such revenues are recorded as
earned.
CASH AND CASH EQUIVALENTS
All short-term, 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
The Company bills 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
F-7
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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 rights to customer lists, long-term
marketing agreements, goodwill, deferred financing and other items. 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 ten 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 $3.2
million, $5.1 million and $8.8 million in 1996, 1997 and 1998, respectively.
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 did not
include potential common stock in the calculation of EPS since inception as such
inclusion would have an anti-dilutive effect.
F-8
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
COMMON STOCK BASED COMPENSATION
The Company continues to account for its employee stock based compensation
using the intrinsic value method in accordance with the provisions of Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees," and provides pro forma disclosures in the notes to the consolidated
financial statements (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.
STOCK SPLIT
In July 1998 the Company effected a two-for-one stock split. The
accompanying consolidated financial statements and related notes have been
retroactively adjusted to give effect to the stock split.
2. 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. 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 which has been valued at $135 million, 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 above is referenced to as
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
F-9
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. STRATEGIC ALLIANCE WITH SPRINT CORPORATION (CONTINUED)
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 Company accounted for the acquisition of the Sprint Internet Passport
business ("SIP") as a purchase and, accordingly, the results of operations of
SIP for the period from June 5, 1998 are included in the accompanying
consolidated financial statements. Intangible assets acquired in the Sprint
Transaction are valued as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS)
--------------
<S> <C>
Member base................................................................... $ 65,000
Marketing and distribution agreement.......................................... 20,000
Goodwill...................................................................... 36,164
--------------
$ 121,164
--------------
--------------
</TABLE>
The assets 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. As such, the member base and goodwill will be fully
amortized by December 31, 1999.
The following unaudited pro forma consolidated results of operations for the
two years ended December 31 1998, assume the acquisition occurred on January 1,
1997 and 1998, respectivley. These pro forma results have been prepared for
comparative purposes only and do not purport to be indicative of the results of
operations that actually would have resulted had the acquisition occurred on the
date indicated, or which may result in the future.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1998
--------- ---------
(IN THOUSANDS,
EXCEPT PER SHARE
DATA)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues......................................... $ 95,377 $ 187,063
Net loss............................................... (153,935) (99,348)
Deductions for accretion dividends (Note 8)............ (13,099) (13,099)
Net loss attributable to common stockholders........... (167,034) (112,447)
Basic and diluted net loss per share................... $ (8.35) $ (4.30)
</TABLE>
F-10
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. PROPERTY AND EQUIPMENT
Property and equipment consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Data communications equipment........................... $ 17,056 $ 29,274
Office and other equipment.............................. 12,196 21,863
Leasehold improvements.................................. 5,013 8,771
Construction in progress................................ 1,901 541
--------- ---------
36,166 60,449
Less accumulated depreciation and amortization.......... (12,768) (25,243)
--------- ---------
$ 23,398 $ 35,206
--------- ---------
--------- ---------
</TABLE>
Property under capital lease, primarily data communications equipment
included above, aggregated $22.5 million and $31.7 million at December 31, 1997
and 1998, respectively. Included in accumulated depreciation and amortization
are amounts related to property under capital lease of $8.5 million and $15.7
million at December 31, 1997 and 1998, respectively. Depreciation expense
charged to operations was $3.9 million, $8.5 million and $12.5 million in 1996,
1997, and 1998, respectively, and included $2.8 million, $5.6 million and $7.1
million, respectively, pertaining to property under capital lease.
4. INTANGIBLE ASSETS
Intangible assets consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Member base............................................. $ -- $ 65,000
Marketing and distribution agreement.................... -- 20,000
Goodwill................................................ -- 36,164
Rights to client lists.................................. 1,414 10
Other................................................... 618 245
--------- ---------
2,032 121,419
Less accumulated amortization........................... (1,074) (41,413)
--------- ---------
$ 958 $ 80,006
--------- ---------
--------- ---------
</TABLE>
5. 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 111,534 shares of Common Stock. In January 1997, the Company
repaid the $2,225,000 balance remaining on the 10% Promissory Notes.
F-11
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. NOTES PAYABLE (CONTINUED)
On March 31, 1998, the Company's $5.0 million Convertible Note payable to
UUNET Technologies Inc., and related accrued interest, were converted into
783,030 shares of Common Stock at a conversion price of $6.44 per share. The
Company's note payable to PSINet, $4.4 million at December 31, 1997, was also
paid off during 1998.
6. CAPITAL STOCK AND MANDATORILY REDEEMABLE EQUITY SECURITIES
INITIAL PUBLIC OFFERING
On January 22, 1997 the Company commenced its initial public offering. The
offering consisted of 4,000,000 shares of common stock issued at $6.50 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
redeemable convertible preferred stock were converted to 2,727,248 shares of
common stock. In February 1997, the Underwriter exercised its over-allotment
option and purchased 569,500 shares at the initial public offering price of
$6.50. Net proceeds to the Company were approximately $3.4 million.
CONVERSION OF 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 million.
Stock issuance costs of $987,000 have been charged to redeemable convertible
preferred stock. Each two shares of the Series A redeemable 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.
COMMON STOCK
On September 19, 1997, the Company closed a private placement of 2,919,518
shares of its unregistered restricted common stock. Net proceeds from the
offering were approximately $15.4 million.
FOLLOW ON PUBLIC OFFERING
In June 1998 the Company completed a follow on public offering of 3.8
million shares of its common stock at $30 per share. The offering consisted of
3.0 million shares, including 490,000 shares sold to Sprint in accordance with
its preemptive rights under the Sprint Alliance, and an underwriter's
over-allotment of 720,000 shares. Net proceeds to the Company were approximately
$106.3 million.
COMMON STOCK ISSUANCES FOR OTHER THAN CASH
In May 1996, the Company issued 10,244 shares of common stock at $4.88 per
share, to a sub-contractor in lieu of cash for services provided to the Company.
In September 1996, the Company issued 75,000 shares of common stock at $5.50 per
share as consideration for the termination of a consulting agreement.
In January 1998, the Company issued 20,000 shares of its common stock to a
Consultant in lieu of cash for services provided pursuant to a consulting
agreement. The fair value of the shares was recorded as prepaid professional
services and amortized ratably over the term of the contract. Under this
agreement the Company issued 20,000 additional shares of its common stock in
January 1999.
F-12
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. CONVERTIBLE PREFERRED STOCK
All issued and outstanding shares of Series A convertible preferred stock
are held by Sprint (Note 2).
The Series A convertible preferred stockholders receive dividends at a rate
per annum of 3% of the Liquidation Value (as defined below), compounded
quarterly. For a period of five years from June 1998, such dividends are payable
"in kind" by way of an increase in the Liquidation Value of the shares.
Beginning in June 2003, holders of Series A convertible preferred stock will
receive cumulative quarterly cash dividends of 3% annually. Beginning in June
2018, holders of the Series A convertible preferred stock are entitled to
cumulative quarterly cash dividends of 8% of the Liquidation Value per share,
increasing annually to a maximum rate of 12%.
The holders of Series A convertible preferred stock will receive, prior to
any payment or distribution in respect of other shares of the Company's capital
stock, an amount per share equal to the average market value of the common stock
measured over the thirty day period ended June 5, 1998 (the "Average Stock
Price"), plus all accrued and unpaid dividends on such share, whether in cash or
in kind (such amount, the "Liquidation Value").
Beginning in June 1999, each share of Series A convertible preferred stock
is convertible into such number of shares of common stock as is determined by
dividing the Liquidation Value by the "Conversion Price" in effect at such time.
For the five year period following June 1998, the Conversion Price is equal to
the Average Stock Price multiplied by 116.118%. Thereafter, the Conversion Price
is increased annually by 6%, accruable quarterly. The Conversion Price is also
subject to adjustment based on changes in capitalization of the common stock.
Although conversion of the Series A convertible preferred stock is at the
holder's option, conversion is required in the event the Company consummates
certain business combination transactions.
Beginning in June 2001, the Company may elect to redeem the outstanding
shares of Series A convertible preferred stock at a redemption price per share
equal to the Liquidation Value of such shares, including the acceleration of
certain dividends, multiplied by a specified percentage. The specified
percentage is initially equal to 103%, and will be reduced by 1% annually in
each of the subsequent three years, and thereafter will be equal to 100%.
The Series A convertible preferred stockholders do not possess general
voting rights together with holders of common stock. However, the Series A
convertible preferred stockholders are separately entitled to elect two of the
Company's directors. This right terminates as to one of the directors if Sprint
fails to maintain at least a 20% equity interest in EarthLink (on a fully
diluted basis, subject to adjustment) for any three consecutive months, and will
terminate as to both of the directors if Sprint fails to maintain at least a 10%
equity interest over the same period. A separate vote of 66.67% of the
then-outstanding shares of Series A convertible preferred stock is required in
certain limited situations, including liquidation, dissolution or winding up of
the Company, or taking certain actions which would adversely affect the rights
of the holders of the Series A convertible preferred stock as a class.
8. DEDUCTIONS FOR DIVIDENDS ON CONVERTIBLE PREFERRED STOCK
Dividends on convertible preferred stock are reflected as an increase to net
loss attributable to common stockholders. This adjustment reflects the
liquidation dividend of $4.3 million based on a 3% dividend (Note 7) and the
accretion of a $3.3 million 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.
F-13
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCK OPTIONS AND WARRANTS
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 shares of common stock to employees of the Company and
non-qualified stock options to employees, officers, directors and consultants of
the Company. During 1998, the Plan was amended to increase the number of
available options from 2,500,000 to 5,700,000. The Plan is administered by a
committee appointed by the Board of Directors 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 have a maximum term of ten years and vest in equal
quarterly increments over a five year period. As of December 31, 1998, there
were 1,493,176 shares available for issuance under the 1995 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 an aggregate of
125,000 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
20,000 and 5,000 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 have a maximum term of ten years and vest in equal quarterly
increments over a five year period. As of December 31, 1998, there were no
outstanding options to purchase shares of common stock 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:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Annual dividends.................................... zero zero
Expected volatility................................. 69% 83%
Risk free interest rate............................. 6.49% 5.28%
Expected life....................................... 6.6 years 6.6 years
</TABLE>
F-14
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCK OPTIONS AND WARRANTS (CONTINUED)
For 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.
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,
-------------------------------
1996 1997 1998
--------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C>
Net loss attributable to common
stockholders
As reported.............................. $ 31,149 $ 29,916 $ 67,383
--------- --------- ---------
--------- --------- ---------
Pro forma................................ $ 31,477 $ 30,737 $ 104,577
--------- --------- ---------
--------- --------- ---------
Basic and diluted net loss per share
As reported.............................. $ 2.57 $ 1.50 $ 2.58
--------- --------- ---------
--------- --------- ---------
Pro forma................................ $ 2.60 $ 1.54 $ 4.00
--------- --------- ---------
--------- --------- ---------
</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 January 1996, certain stockholders guaranteed a $1.5 million lease for
networking equipment. The Company issued warrants to purchase 200,000 shares of
common stock at $2.42 per share. The fair value of the warrants has been
included in intangible assets. These warrants expire January 11, 2001.
In January 1996, the Company issued warrants to purchase 200,000 shares of
common stock at $2.42 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 No. 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 $1.5
million lease line for equipment. The Company issued warrants to LINC to
purchase 100,000 shares of common stock at $2.42 per share. The fair value of
the warrants has been included in intangible assets. 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 10,000 shares of common stock at $4.88 per share.
The fair value of the warrants has been included in intangible assets. These
warrants expire February 15, 2006.
In May 1996, the Company issued warrants to purchase 90,954 shares of common
stock at $4.88 per share to various lessors in return for lease lines and other
services to the Company. The fair value of the warrants has been included in
intangible assets. The warrants expire on May 10, 2006.
F-15
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCK OPTIONS AND WARRANTS (CONTINUED)
In May 1996, in connection with the amendment and restatement of the UUNET
Agreement, the Company agreed to issue warrants to purchase 20,000 shares of
common stock at an exercise price of $10.00 per share. The fair value of the
warrants has been included in intangible assets.
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 196,680 shares of common stock at an exercise price of $5.50 per share, as
adjusted. The fair value of the warrants has been included in intangible assets.
In connection with the execution of the PSINet, Inc. ("PSINet") agreement in
July 1996 (Note 11), the Company issued warrants to purchase 200,000 shares of
Common Stock at an exercise price of $10.00 per share. The fair value of the
warrants has been included in intangible assets.
In connection with the private placement of Series A redeemable convertible
preferred stock, described in Note 6, the Company granted to certain purchasers
of the convertible preferred stock warrants to purchase 200,000 shares of common
stock at $5.50 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 100,000 shares of common stock, having an exercise price of $4.88
per share. In September 1997, the parties orally agreed to rescind the
agreement. The rescission agreement included the return of the 100,000 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 value of the warrants, $76,000, has been recorded as
prepaid advertising and will be expensed upon airing of the infomercials.
In January 1997 and October 1997, the Company issued warrants to purchase
12,000 and 50,000 shares, respectively, of the Company's common stock to certain
consultants. The respective exercise prices of the warrants were $6.50 and
$8.88. 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 15,000 shares of
the Company's common stock at $5.50 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.
In March 1997 and October 1997, the Company issued warrants to purchase
15,000 shares of the Company's c common stock to each of two new members of the
Company's Technology Advisory Council. The warrants have an exercise price of
$5.25 per share and $8.88 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.
F-16
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCK OPTIONS AND WARRANTS (CONTINUED)
Following is a summary of stock option and warrant activity during the three
years ended December 31, 1998:
<TABLE>
<CAPTION>
NUMBER OF SHARES OF COMMON STOCK
------------------------------------- WEIGHTED
INCENTIVE NON-QUALIFIED AVERAGE
STOCK STOCK EXERCISE
OPTIONS OPTIONS WARRANTS PRICE
---------- ------------- ---------- -----------
<S> <C> <C> <C> <C>
Balance at December 31, 1995.............. 465,000 729,582 520,660 $ 1.50
Granted................................... 1,612,500 350,000 1,182,634 $ 4.58
Forfeited................................. (21,000) -- -- $ 4.88
---------- ------------- ---------- -----------
Balance at December 31, 1996.............. 2,056,500 1,079,582 1,703,294 $ 3.45
Granted................................... 691,250 100,000 92,000 $ 6.92
Exercised................................. (97,914) (29,582) -- $ 2.82
Forfeited................................. (422,614) -- -- $ 4.51
---------- ------------- ---------- -----------
Balance at December 31, 1997.............. 2,227,222 1,150,000 1,795,294 $ 4.01
Granted................................... 1,817,400 -- 7,306 $ 26.35
Exercised................................. (774,720) (494,034) (712,392) $ 2.82
Forfeited................................. (85,712) -- -- $ 14.79
Surrendered in cashless exercise.......... -- (7,966) (148,776) $ 8.77
---------- ------------- ---------- -----------
Balance at December 31, 1998.............. 3,184,190 648,000 941,432 $ 12.14
---------- ------------- ---------- -----------
---------- ------------- ---------- -----------
Exercisable at December 31, 1996.......... 168,312 194,584 1,538,294
---------- ------------- ----------
---------- ------------- ----------
Exercisable at December 31, 1997.......... 598,710 417,500 1,673,840
---------- ------------- ----------
---------- ------------- ----------
Exercisable at December 31, 1998.......... 583,497 145,500 874,257
---------- ------------- ----------
---------- ------------- ----------
</TABLE>
The weighted average fair values of the options granted during the three
years ended December 31, 1998, were $1.01, $4.98 and $20.47, respectively. The
weighted average fair values of warrants granted during the three years ended
December 31, 1998 were $0.86, $6.46 and $22.56, respectively.
Following is a summary of stock options and warrants outstanding as of
December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- ----------------------
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> <C>
$ 0.91 $ 0.91 615,000 6.23 $ 0.91 435,000 $ 0.91
$ 2.42 $ 2.42 964,910 6.97 $ 2.42 454,410 $ 2.42
$ 4.88 $ 5.75 1,004,128 7.67 $ 5.24 373,865 $ 5.23
$ 6.50 $ 16.06 1,080,734 8.85 $ 12.29 135,699 $ 11.99
$ 22.38 $ 39.19 1,108,850 9.56 $ 32.94 204,280 $ 23.84
----------- ---------
$ 0.91 $ 39.19 4,773,622 8.05 $ 12.14 1,603,254 $ 6.21
----------- ---------
----------- ---------
</TABLE>
F-17
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. INCOME TAXES
At December 31, 1997 and 1998, the Company had net operating loss
carryforwards for federal income tax purposes totaling approximately $61.0
million, and $106.8 million, respectively, which begin to expire in 2010. At
December 31, 1997 and 1998, the Company had net operating loss carryforwards for
California income tax purposes totaling approximately $48.0 million and $70.0
million, respectively, which begin to expire in 2001. 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. The net operating loss includes $24.0 million related to
the exercise of employee stock options. Any benefit resulting from the
utilization of this portion of the net operating loss will be credited directly
to equity.
Deferred tax assets and liabilities include the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Gross deferred tax liabilities:
Member base........................................... $ -- $ (17,414)
Other................................................. -- (819)
--------- ---------
-- (18,233)
--------- ---------
Gross deferred tax assets:
Net operating loss carryforwards...................... 24,584 42,625
Other................................................. 642 948
--------- ---------
25,226 43,573
--------- ---------
Valuation allowance..................................... (25,226) (25,340)
--------- ---------
$ -- $ --
--------- ---------
--------- ---------
</TABLE>
Because management believes sufficient uncertainty exists regarding
realizability, a full valuation allowance has been established.
The following table summarizes the significant differences between the U.S.
Federal statutory tax rate and the Company's effective tax rate for financial
statement purposes:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Federal income tax (benefit) at statutory rate.......... $ (10,171) $ (20,923)
Nondeductible goodwill.................................. -- 4,922
Nondeductible expenses.................................. -- 54
Net valuation allowance................................. 10,171 15,947
--------- ---------
$ -- $ --
--------- ---------
--------- ---------
</TABLE>
F-18
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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
1996, 1997 and 1998 for all operating leases amounted to $914,000, $1.9 million
and $2.4 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.
During the three years ended December 31, 1998, the Company financed the
acquisition of data processing and office equipment amounting to approximately
$11.3 million, $10.5 million and $9.3 million, respectively, by entering into a
number of leases and 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.
The Company's corporate headquarters and call center are located in a 93,000
square-foot facility in Pasadena, California. Base rent is currently $73,000 per
month. The Company has an option to extend this lease for an additional five
years at the then-prevailing market rate following its expiration in September
2007. The data center and primary data hub are housed in a 110,000 square foot
facility adjacent to the headquarters with rent of $92,000 per month, subject to
yearly increases. The lease for this space expires February 2007, with an option
to extend for an additional ten year term.
Minimum lease commitments under non-cancelable leases at December 31, 1998
are as follows:
<TABLE>
<CAPTION>
YEAR ENDING CAPITAL OPERATING
DECEMBER 31, LEASES LEASES
- ------------------------------------------------------------------------ --------- -----------
<S> <C> <C>
(IN THOUSANDS)
1999.................................................................... $ 10,048 $ 2,606
2000.................................................................... 7,109 2,967
2001.................................................................... 2,287 2,740
2002.................................................................... 183 2,865
2003.................................................................... 38 2,881
Thereafter.............................................................. 8 10,312
--------- -----------
Total minimum lease payments............................................ 19,673 $ 24,371
-----------
-----------
Less amount representing interest....................................... (3,631)
---------
Present value of future lease payments.................................. 16,042
Less current portion.................................................... (8,341)
---------
$ 7,701
---------
---------
</TABLE>
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. At December 31, 1998, $4.0 million and $4.1 million in amounts due
to UUNET were
F-19
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
recorded in accounts payable and other accrued liabilities, respectively, and
$4.7 million in amounts due PSINet were recorded in other accrued liabilities.
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>
1999.............................................................................. $ 36.0
2000.............................................................................. 40.8
2001.............................................................................. 43.0
2002.............................................................................. 47.0
-----------
Total............................................................................. $ 166.8
-----------
-----------
</TABLE>
EarthLink 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 this browser software under conditions acceptable to
EarthLink, is probable.
12. 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 and 1998 were $84,000
and $285,000, respectively.
13. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1997 1998
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash paid during the year for interest.............. $ 1,041 $ 1,965 $ 2,101
Cash paid during the year for income taxes.......... 1 1 1
Non cash transactions related to the conversion of
notes payable to equity........................... -- 725 5,043
Common stock subscription........................... -- -- 1,041
Non cash adjustments related to accretion dividends
of Series A convertible preferred stock........... -- -- 7,601
</TABLE>
14. SUBSEQUENT EVENTS
In January 1999 the Company completed a follow on public offering of 2.4
million shares of its common stock at $73.63 per share. The offering consisted
of 2.3 million shares and an underwriter's
F-20
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. SUBSEQUENT EVENTS (CONTINUED)
over-allotment of 99,000 shares exercised in February 1999. Net proceeds to the
Company were approximately $170 million. In conjunction with the offering,
Sprint exercised its preemptive rights to maintain its existing ownership level
in the Company. Accordingly, Sprint purchased 770,000 shares of which 192,000
were common stock and 578,000 were Series B convertible preferred stock. Series
B convertible preferred stock has the same rights and privileges as Series A
convertible preferred stock, as described in Note 7, except that each Series B
share is convertible into only one share of the Company's common stock. Proceeds
from the sale of shares to Sprint were $54.1 million.
In February 1999, Sprint exercised its preemptive rights to maintain its
ownership in the Company after the exercise of the underwriter's over-allotment
granted in connection with the aforementioned follow on public offering.
Accordingly, Sprint purchased 38,000 shares of which 9,000 were common stock and
29,000 were Series B convertible preferred stock. Proceeds from the sale of
stock to Sprint were $2.7 million.
F-21
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
2.1 Investment Agreement dated as of February 10, 1998, with Sprint Corporation and Sprint Communications
Company L.P. (incorporated by reference to Exhibit 2.1 to the Form 8-K filed by EarthLink Network, Inc.
on February 10, 1998).
3.1 Certificate of Incorporation (incorporated by reference to Exhibit 3.1 to the Company's Registration
Statement on Form S-4--File No. 333-52507).
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to the Company's Registration Statement on Form
S-4--File No. 333-52507).
3.3 Form of Certificate of Designation, Preferences and Rights of the Company's Series A Convertible
Preferred Stock. (incorporated by reference to Exhibit 10.2 to the Form 8-K filed by EarthLink Network,
Inc. on February 10, 1998).
3.4 Certificate of Designation, Preferences and Rights of the Company's Series B Convertible Preferred Stock
and amendment thereto.
4.1 See Exhibits 3.1, 3.2, 3.3 and 3.4 for provisions of the Certificate of Incorporation, Bylaws and
Certificates of Designation, Preference and Rights of Series A and B Convertible Preferred Stock.
4.2 Specimen Stock Certificate (incorporated by reference to Exhibit 4.2 to the Registration Statement on
Form S-1 of EarthLink Network, Inc.--File No. 333-15781).
4.3 Form of Warrant Agreement (incorporated by reference to Exhibit 4.3 to the Registration Statement on Form
S-1 of EarthLink Network, Inc.--File No. 333-15781).
4.4 Agreement and Plan of Merger between Newco, Inc. and EarthLink Network, Inc. dated as of February 10,
1998 and entered into in connection with the Sprint Transaction (incorporated by reference to Exhibit 4.4
to the Company's Registration Statement on Form S-4--File No. 333-52507).
10.1 1995 Stock Option Plan and forms of Stock Option Agreement and Stock Purchase Agreement (incorporated by
reference to Exhibit 10.1 to Registration Statement of EarthLink Network, Inc. on form S-1--File No.
333-15781).
10.2 Amended and Restated Stock Option Plan for Directors (incorporated by reference to Exhibit 10.2 to the
Company's Registration Statement on Form S-1 of EarthLink Network, Inc.--File No. 333-15781).
10.3 Lease Line Agreement, dated January 30, 1996, between the Company and Boston Financial & Equity
Corporation (incorporated by reference to Exhibit 10.4 to the Registration Statement on Form S-1 of
EarthLink Network, Inc.--File No. 333-15781).
10.4 Master Lease Agreement, dated September 1, 1995, between the Company and LINC Capital Management
(incorporated by reference to Exhibit 10.5 to the Registration Statement on Form S-1 of EarthLink
Network, Inc.--File No. 333-15781).
10.5 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 Registration Statement on Form S-1 of EarthLink Network, Inc.--File No. 333-15781).
</TABLE>
E-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
(c) Amendment No. 1 to Netscape Communications Corporation Internet Service Provider Agreement
(incorporated by reference to Exhibit 10.6(a) to the Registration Statement on Form S-1 of EarthLink
Network, Inc.--File No. 333-15781).
(d) Amendment No. 2 to Netscape Communications Corporation Internet Service Provider Agreement
incorporated by reference to (Exhibit 10.6(b) to the Registration Statement on Form S-1 of EarthLink
Network, Inc.--File No. 333-15781).
10.6 Network Services Agreement dated May 31, 1996, between the Company and UUNET Technologies, Inc.
incorporated by reference to (Exhibit 10.7 to the Registration Statement on Form S-1 of EarthLink
Network, Inc.--File No. 333-15781).
(a) Addendum No. 1 to Network Services Agreement (incorporated by reference to Exhibit 10.7 (a) to the
Registration Statement on Form S-1 of EarthLink Network, Inc.--File No. 333-15781).
10.7 Software Distribution Agreement (MacTCP), dated October 2, 1995, between the Company and Apple Computer,
Inc. (incorporated by reference to Exhibit 10.8 to the Registration Statement on Form S-1 of EarthLink
Network, Inc.--File No. 333-15781).
10.8 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).
(e) Amendment to Employment Agreement (incorporated by reference to Exhibit 10.9(a) to the Report on Form
10-K of EarthLink Network, Inc. for the fiscal year ended December 31, 1997)
(f) First Amendment to Employment Agreement (incorporated by reference to Exhibit 10.9 to the Company's
Report on Form 10-K of EarthLink Network, Inc. for the fiscal year ended December 31, 1997)
(g) Second Amendment to Employment Agreement (incorporated by reference to Exhibit 10.9(c) to the Report
on Form 10-K of EarthLink Network, Inc. for the fiscal year ended December 31, 1997)
(h) Amended and Restated Employment Agreement (incorporated by reference to Exhibit 10.8(d) to the
Company's Registration Statement on Form S-1--File No. 333-53063).
10.9 Standard Industrial/Commercial Multi-Tenant Lease, dated December 1, 1995, between the Company and Becton
Dickinson and Company (incorporated by reference to Exhibit 10.12 to the Registration Statement on Form
S-1 of EarthLink Network, Inc.--File No. 333-15781).
10.10 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 Registration Statement on Form S-1 of EarthLink Network, Inc.--File No. 333-15781).
10.11 Production and Distribution Agreement, dated May 6, 1996, between the Company and National Media
Corporation (incorporated by reference to Exhibit 10.16 to the Registration Statement on Form S-1 of
EarthLink Network, Inc.--File No. 333-15781). (a) Amendment No. 1 to Production and Distribution
Agreement (incorporated by reference to Exhibit 10.16(a) to the Registration Statement on Form S-1 of
EarthLink Network, Inc.--File No. 333-15781).
</TABLE>
E-2
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
10.12 Internet Wizard Sign-Up Agreement between the Company and Microsoft Corporation, dated August 16, 1996
(incorporated by reference to Exhibit 10.19 to the Registration Statement on Form S-1 of EarthLink
Network, Inc.--File No. 333-15781).
10.13 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 Registration Statement on
Form S-1 of EarthLink Network, Inc.--File No. 333-15781).
10.14 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 Registration
Statement on Form S-1 of EarthLink Network, Inc.--File No. 333-15781).
10.15 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 Registration Statement on Form S-1
of EarthLink Network, Inc.--File No. 333-15781).
10.16 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 Registration Statement on Form S-1 of EarthLink Network, Inc.--File No. 333-15781). (b)
Addendum to Amended and Restated Registration Rights Agreement (incorporated by reference to Exhibit
10.23(c) to the Registration Statement on Form S-1 of EarthLink Network, Inc.--File No. 333-15781).
10.17 Amended and Restated Convertible Securities Vesting Plan (incorporated by reference to Exhibit 10.18 to
the Report on Form 10-K of EarthLink Network, Inc. for the fiscal year ended December 31, 1997).
10.18 Key Employee Compensation Continuation Plan (incorporated by reference to Exhibit 10.19 to the Report on
Form 10-K of EarthLink Network, Inc. for the fiscal year ended December 31, 1997). (a) Amendment to Key
Employee Compensation Continuation Plan (incorporated by reference to Exhibit 10.19(a) to the Report on
Form 10-K of EarthLink Network, Inc. for the fiscal year ended December 31, 1997).
10.19 Governance Agreement, dated as of February 10, 1998, (incorporated by reference to Exhibit 10.1 to the
Form 8-K filed by EarthLink Network, Inc. on February 10, 1998).
10.20 Credit Agreement, dated as of February 10, 1998, with Sprint Corporation, a Kansas corporation, as Lender
(incorporated by reference to Exhibit 10.3 to the Form 8-K filed by EarthLink Network, Inc. on February
10, 1998).
10.21 Registration Rights Agreement, dated as of February 10, 1998, with Sprint Corporation, and Sprint
Communications Company L.P., (incorporated by reference to Exhibit 99.1 to the Form 8-K by EarthLink
Network, Inc. filed on February 10, 1998).
10.22 Stockholders Agreement, dated as of February 10, 1998, among EarthLink Network, Inc., Sprint Corporation,
Sprint Communications Company L.P., and the persons identified on Schedule 1 thereto (incorporated by
reference to Exhibit 99.2 to the Form 8-K of EarthLink Network, Inc. filed on February 10, 1998).
10.23 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 Form 8-K filed by EarthLink
Network, Inc. on February 10, 1998).
</TABLE>
E-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ----------- ---------------------------------------------------------------------------------------------------------
<C> <S>
10.24 Agreement to Vote and Tender Stock, dated as of February 10, 1998, among the Granting Stockholders named
on Schedule A thereto, Sprint Corporation, and Sprint Communications Company, L.P., (incorporated by
reference to Exhibit 99.4 to the Form 8-K filed by EarthLink Network, Inc. on February 10, 1998).
10.25 Marketing and Distribution Agreement, dated as of February 10, 1998, Sprint Corporation, and Sprint
Communications Company L.P., (incorporated by reference to Exhibit 10.26 of the Company's Registration
Statement on Form S-4, filed May 13, 1998, File No. 333-52507).
10.26 Third Amendment to the lease agreement between WHMNY Real Estate Limited Partnership, a Delaware limited
partnership ("Landlord"), and EarthLink Network, Inc. (incorporated by reference to Exhibit 10.1 to the
Company's Form 10-Q filed on November 16, 1998.
22.1 Significant Subsidiaries (incorporated by reference to Exhibit 22.1 to the Company's Registration
Statement on Form S-1, filed May 19, 1998, File No. 333-53063).
23.1 Consent of Independent Accountants.
24.1 Power of Attorney (set forth on the signature page to the Registration Statement).
27.1 Financial Data Schedule.
</TABLE>
E-4
<PAGE>
EARTHLINK NETWORK, INC.
CERTIFICATE OF DESIGNATION, PREFERENCES
AND RIGHTS OF SERIES B CONVERTIBLE PREFERRED STOCK
-----------------------------------------
PURSUANT TO SECTION 151 OF THE
GENERAL CORPORATION LAW OF THE STATE OF DELAWARE
------------------------------------------
EarthLink Network, Inc. (the "Corporation"), certifies that pursuant to
the authority contained in Article IV of its Certificate of Incorporation, and
in accordance with the provisions of Section 151 of the General Corporation Law
of the State of Delaware, its Board of Directors has adopted the following
resolution creating a series of the Preferred Stock, $.01 par value, designated
as Series B Convertible Preferred Stock:
RESOLVED, that a series of the class of Preferred Stock, $.01 par value,
of the Corporation be hereby created, and that the designation and amount
thereof and the voting powers, preferences, and relative, participating,
optional and other special rights of the shares of such series, and the
qualifications, limitations or restrictions thereof are set forth in this
Certificate of Designation, Preferences and Rights of Series B Convertible
Preferred Stock (the "Certificate of Designation") as follows:
1. DESIGNATION AND AMOUNT. Preferred Stock of the Corporation
created and authorized for issuance hereby shall be designated as "Series B
Convertible Preferred Stock" (herein referred to as "Series B Preferred Stock"),
having a par value per share equal to $.01, and the number of shares
constituting such series shall be 600,000. The Corporation shall only
originally issue shares of Series B Preferred Stock to Sprint Corporation, a
Kansas corporation ("Sprint"), and its successors and Affiliates.
2. RANK. The Series B Preferred Stock shall, with respect to any
and all rights and preferences set forth herein, including without limitation,
dividend rights and rights upon liquidation, winding up or dissolution, whether
voluntary or involuntary, rank immediately junior to that certain series of
preferred stock of the Corporation designated as Series A Convertible Preferred
Stock (the "Series A Stock") in the Certificate of Designation, Preferences and
Rights of the Series A Stock which was filed with the Secretary of State of the
State of Delaware on June 5, 1998. The Series B Preferred Stock will rank
junior only to the Series A Stock, and shall, with respect to dividend rights
and rights upon liquidation, winding up or dissolution, whether voluntary or
involuntary, rank prior to the Common Stock (as defined in Section 10 hereof)
and all classes or series of preferred stock, preference stock or any other
capital stock or equity securities of the Corporation, whether now issued or
hereafter created, other than the Series A Stock; PROVIDED, HOWEVER, that if the
Corporation hereafter issues a series of the equity securities of the
Corporation that rank immediately junior to the Series A Preferred Stock and
that are Alternative Securities issued pursuant to the Governance Agreement (as
defined in Section 7 herein), such issuance shall in no event be interpreted to
violate this Certificate of Designation, shall be interpreted in all respects to
be consistent with this Certificate of Designation, and such additional
Alternative Securities shall be designated as PARI PASSU with the Series B
Preferred Stock in all applicable rights, preferences and terms. All equity
securities of the Corporation to which the Series B Preferred Stock ranks prior,
including the Common Stock, are collectively referred to herein as the "Junior
<PAGE>
Securities."
3. DIVIDEND PROVISIONS.
(a) DIVIDENDS.
(i) LIQUIDATION ACCRETION DIVIDENDS. On and before
the fifth anniversary of the Purchase Date, the Corporation shall
pay, and the holders of outstanding shares of Series B Preferred
Stock ("Holders") shall be entitled to receive on each Dividend
Payment Date, a dividend on each share of Series B Preferred
Stock at a rate per annum equal to three percent (3.00%) of the
Liquidation Value (as then increased, as provided in Section
4(a)) per share of Series B Preferred Stock, accruable and
compounded quarterly on each of the Dividend Accrual Dates, which
dividend shall be in the form of an increase in the Liquidation
Value in such amount (each such increase is referred to as a
"Liquidation Accretion Dividend"). All dividends shall accrue
quarterly in arrears and shall compound on each Dividend Accrual
Date, commencing on the first Dividend Accrual Date after the
date of issuance of the applicable shares of Series B Preferred
Stock. The Board of Directors shall declare and pay such accrued
dividends on each Dividend Payment Date and the Corporation shall
take all further actions necessary to cause such dividend to be
paid to the Holders in the form and manner prescribed herein.
Notwithstanding the foregoing, upon the first date of the
consummation of a Business Combination, or an Optional Redemption
by the Corporation pursuant to Section 6(a), the Corporation
shall pay, and the Holders of outstanding shares of Series B
Preferred Stock shall be entitled to receive, a dividend on each
share of Series B Preferred Stock in the form of an aggregate
increase in the Liquidation Value in an amount equal to the
amount by which the Liquidation Value would have increased
pursuant to this Section 3(a)(i) if such Holder had held such
shares of Series B Preferred Stock, until the first Dividend
Payment Date on or following the fifth anniversary of the
Purchase Date.
(ii) CASH DIVIDENDS. After the fifth anniversary of
the Purchase Date, the Corporation shall pay, and the Holders of
outstanding shares of Series B Preferred Stock shall be entitled
to receive, when, as and if declared by the Board of Directors,
out of funds legally available therefor, cumulative dividends on
each share of Series B Preferred Stock at a rate per annum equal
to three percent (3.00%) of the Liquidation Value per share of
Series B Preferred Stock, accruable quarterly on each of the
Dividend Accrual Dates, payable only in cash; provided, however,
that after the twentieth anniversary of the Purchase Date, the
Corporation shall pay, and the Holders of outstanding shares of
Series B Preferred Stock shall be entitled to receive, when, as
and if declared by the Board of Directors, out of funds legally
available therefor, cumulative dividends on each share of Series
B Preferred Stock at a rate per annum equal to 8% of the
Liquidation Value per share of Series B Preferred Stock,
accruable quarterly on each of the Dividend Accrual Dates,
payable only in cash, which rate shall increase by 200 basis
points on each anniversary of the Purchase Date thereafter, but
not to exceed a maximum rate of 12%. All cash dividends shall be
cumulative, whether or not declared, on a daily basis from the
fifth anniversary of the Purchase Date or the date of issuance,
whichever is later, and shall accrue quarterly in arrears on each
Dividend Accrual Date, commencing on the first Dividend Accrual
Date after the fifth anniversary of the Purchase Date or the date
of issuance, whichever is later. The Board of Directors shall
2
<PAGE>
declare and pay such accrued dividends at such time and to the
extent permitted by law.
(iii) GENERAL PROVISIONS. Each distribution in the
form of a cash dividend shall be payable to Holders of record as
they appear on the stock books of the Corporation on such record
date, not less than 10 nor more than 60 days preceding the
relevant Dividend Payment Date, as shall be fixed by the Board of
Directors of the Corporation. For any period during which any
share of Series B Preferred Stock is outstanding less than a full
quarterly dividend period ending on a Dividend Accrual Date, the
dividends payable shall be computed on the basis of a 360 day
year consisting of twelve 30-day months and the actual number of
days elapsed in the period for which the dividends are payable.
If any Dividend Payment Date for a dividend payable in cash
occurs on a day that is not a Business Day, any accrued dividends
otherwise payable on such Dividend Payment Date shall be paid on
the next succeeding Business Day.
(b) CERTAIN OTHER NON-CASH DISTRIBUTIONS. If the Corporation
shall at any time, or from time to time, after the Purchase Date,
declare, order, pay or make a dividend or other distribution (including,
without limitation, any distribution or issuance of stock or other
securities or property or rights or warrants to subscribe for securities
of the Corporation or any of its Subsidiaries by way of dividend or
spinoff or rights to purchase Common Stock or other Junior Securities)
on its Common Stock, other than (i) dividends payable in cash in an
aggregate amount in any fiscal year which, when declared, are not
expected to exceed the net income of the Corporation during such year
from continuing operations before extraordinary items, as determined in
accordance with generally accepted accounting principles consistently
applied in accordance with past practice, or (ii) any dividend or
distribution described in Section 5(c)(i), Section 5(c)(ii) or
Section 5(c)(iii), then, and in each such case (a "Triggering
Distribution"), each Holder of shares of Series B Preferred Stock shall
be entitled to receive from the Corporation, with respect to the shares
of Series B Preferred Stock held by such Holder, the same dividend or
distribution that such Holder would have received if immediately prior
to the earlier of such Triggering Distribution or any record date
therefor (i) a Business Combination had occurred causing the last
sentence of Section 3(a)(i) to be effected, and (ii) such Holder
converted all of such Holder's shares of Series B Preferred Stock into
shares of Common Stock. Any such dividend, distribution or issuance
shall be declared, ordered, paid or made on the Series B Preferred Stock
at the same time such dividend, distribution or issuance is declared,
ordered, paid or made on the Common Stock.
(c) LIMITATION ON DIVIDENDS AND OTHER DISTRIBUTIONS. Unless
full cumulative dividends, if any, accrued on all outstanding shares of
the Series B Preferred Stock have been or contemporaneously are declared
and paid for all periods prior to and ending on the most recent Dividend
Accrual Date, no dividend shall be declared or paid or set aside for
payment or other distribution declared or made upon the Junior
Securities (other than a dividend or distribution paid solely in shares
of, or warrants, rights or options solely exercisable for or convertible
into, Junior Securities), nor shall any Junior Securities be redeemed,
purchased or otherwise acquired for any consideration, nor may any
moneys be paid to or made available for a sinking fund for the
redemption of any shares of any such securities, by the Corporation
(other than redemptions and purchases pursuant to or in accordance with
agreements between the Corporation and its or its subsidiaries'
directors, officers and key employees), except by conversion into or
exchange for
3
<PAGE>
Junior Securities.
4. LIQUIDATION PREFERENCE.
(a) In the event of any voluntary or involuntary liquidation,
dissolution or winding up of the Corporation ("Liquidation Event"), the
Holders of Series B Preferred Stock then outstanding shall be entitled
to receive, prior and in preference to any distribution of any of the
assets of the Corporation to the holders of Common Stock and other
Junior Securities by reason of their ownership thereof, an amount per
share equal to the sum of (i) the average of the Closing Price per share
of Common Stock for the 30 Trading Days immediately preceding the
Purchase Date (the "Average Stock Price") for each outstanding share of
Series B Preferred Stock, (ii) the amount of all Liquidation Accretion
Dividends that have been paid pursuant to Section 3(a)(i) (including an
amount equal to a prorated dividend pursuant to Section 3(a)(i) for the
period from the Dividend Accrual Date immediately preceding the date of
the Liquidation Event through the date of the Liquidation Event), and
(iii) all accumulations of accrued but unpaid dividends payable in cash
pursuant to Section 3(a)(ii) on each share of Series B Preferred Stock
(including an amount equal to a prorated dividend pursuant to
Section 3(a)(ii) for the period from the Dividend Accrual Date
immediately prior to the receipt of such sum to the date of receipt of
such sum), with the sum of the amounts referred to in clauses (i), (ii)
and (iii) referred to herein as the "Liquidation Value". The schedule
of (i) the amount of the applicable Liquidation Accretion Dividend for
each Share of Series B Preferred Stock for each Dividend Payment Date
therefor, and (ii) the cumulative amount of the Liquidation Value for
each Share of Series B Preferred Stock, as of each Dividend Payment
Date, is as follows:
<TABLE>
<CAPTION>
Amount of Applicable Quarterly
Dividend Payment Liquidation Cumulative Liquidation Value for
Date for Accretion Dividend for Each Share of Each Share of Series B Preferred
Quarter Series B Preferred Stock Stock
- ------------------ -------------------------------------- ----------------------------------
<S> <C> <C>
1 $0.50 $67.31
2 0.50 67.82
3 0.51 68.32
4 0.51 68.84
5 0.52 69.35
6 0.52 69.87
7 0.52 70.40
8 0.53 70.93
9 0.53 71.46
10 0.54 71.99
11 0.54 72.53
12 0.54 73.08
13 0.55 73.63
14 0.55 74.18
15 0.56 74.73
16 0.56 75.29
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
Amount of Applicable Quarterly
Dividend Payment Liquidation Cumulative Liquidation Value for
Date for Accretion Dividend for Each Share of Each Share of Series B Preferred
Quarter Series B Preferred Stock Stock
- ------------------ -------------------------------------- ----------------------------------
<S> <C> <C>
17 0.56 75.86
18 0.57 76.43
19 0.57 77.00
20 0.58 77.58
</TABLE>
If upon the occurrence of such Liquidation Event, the assets and
funds are not sufficient to pay in full the liquidation payments payable
to the Holders of the Series B Preferred Stock, then the Holders of
outstanding shares of Series B Preferred Stock shall share ratably in
such distribution of assets. Except as provided in this Section 4(a),
Holders of Series B Preferred Stock shall not be entitled to any
additional distribution upon the occurrence of a Liquidation Event.
(b) After the distribution described in Section 4(a) has been
paid, the remaining assets of the Corporation available for distribution
to shareholders shall be distributed among the holders of Junior
Securities in accordance with their respective rights thereto.
(c) Neither the consolidation, merger, Business Combination
or any other form of business combination of the Corporation with or
into any other person or entity, nor the sale, lease, exchange,
conveyance or disposition of all or substantially all of the assets of
the Corporation to persons or entities other than the holders of Junior
Securities shall be deemed to be a Liquidation Event for purposes of
this Section 4.
5. CONVERSION. The Holders of the Series B Preferred Stock shall
have conversion rights as follows (the "Conversion Rights"):
(a) OPTIONAL CONVERSION RIGHTS AND AUTOMATIC CONVERSION.
(i) Each share of Series B Preferred Stock shall be
convertible, at the option of the Holder thereof, at any time
after June 5, 1999, at the office of the Corporation or any
transfer agent for the Series B Preferred Stock, into such number
of validly issued, fully paid and nonassessable shares of Common
Stock, free and clear of all pledges, claims, liens, charges,
encumbrances and security interests of any kind or nature
whatsoever, as is determined by dividing the Liquidation Value by
the Conversion Price at the time in effect for such share;
provided, however, that, notwithstanding any other provision
hereof to the contrary, conversion of all outstanding shares of
Series B Preferred Stock shall be required in the event of
consummation of a Business Combination. The Conversion Price per
share for shares of Series B Preferred Stock shall be (i) for the
period from the Purchase Date through the Dividend Accrual Date
immediately after the fifth anniversary of the Purchase Date, the
product of (A) the Average Stock Price, times (B) 116.118%, and
(ii) thereafter, the Conversion Price then
5
<PAGE>
in effect shall be increased at a rate per annum equal to six
percent (6%) thereof, accruable quarterly, and in each case the
Conversion Price shall be subject to adjustment, from time to
time as set forth in Section 5(c).
(ii) Upon conversion of any Series B Preferred Stock,
payment shall be made for (A) dividends under Section 3(a)(i) on
each converted share of Series B Preferred Stock in an amount
equal to a prorated Liquidation Accretion Dividend for the period
from the Dividend Accrual Date immediately prior to the date of
conversion to such conversion date, and (B) unpaid dividends
under Section 3(b) resulting from events described therein and
occurring prior to the date of conversion.
(b) MECHANICS OF CONVERSION. If the Holder of shares of
Series B Preferred Stock desires to exercise such right of conversion,
such Holder shall give written notice to the Corporation (the
"Conversion Notice") of that Holder's election to convert a stated whole
number of shares of Series B Preferred Stock (the "Conversion Shares")
into shares of Common Stock, and surrender to the Corporation, at its
principal office or at such other office or agency maintained by the
Corporation for such purpose, such Holder's certificate or certificates
evidencing such Conversion Shares. The Conversion Notice shall also
contain a statement of the name or names (with addresses) in which the
certificate or certificates for Common Stock shall be issued.
Notwithstanding the foregoing, the Corporation shall not be required to
issue any certificates to any person other than the Holder thereof
unless the Corporation has obtained reasonable assurance that such
transaction is exempt from the registration requirements of, or is
covered by an effective registration statement under, the Securities Act
of 1933, as amended (the "Act"), and all applicable state securities
laws, including, if necessary in the reasonable judgment of the
Corporation or its legal counsel, receipt of an opinion to such effect
from counsel reasonably satisfactory to the Corporation. In no event
would such opinion be required if the shares of Common Stock could, upon
conversion, be resold pursuant to Rule 144 or Rule 144A under the Act.
As promptly as practicable, and in any event within five business days,
after the receipt of the Conversion Notice and the surrender of the
certificate or certificates representing the Conversion Shares, the
Corporation shall issue and deliver, or cause to be delivered, to the
Holder of the Conversion Shares or his nominee or nominees, (i) a
certificate or certificates for the number of shares of Common Stock
issuable upon the conversion of such Conversion Shares and (ii) if less
than the full number of shares of Series B Preferred Stock evidenced by
the surrendered certificate or certificates are being converted, a new
certificate or certificates, of like tenor, evidencing the number of
shares evidenced by such surrendered certificate or certificates less
the number of Conversion Shares. Such conversion shall be deemed to have
been effected as of the close of business on the date the Corporation
received the Conversion Notice and the certificate or certificates
representing the Conversion Shares, and the person or persons entitled
to receive the shares of Common Stock issuable upon conversion shall be
treated for all purposes as the holder or holders of record of such
shares of Common Stock as of the close of business on such date,
provided, however, that if such conversion by a Holder of Series B
Preferred Stock would give rise to the waiting period of the HSR Act,
such conversion shall not be effective and shall be contingent upon (i)
the expiration or termination of such waiting period, and (ii) the
absence of any action taken or instituted by the Department of Justice,
the Federal Trade Commission or any other governmental entity by the
expiration or termination of such waiting period to delay, enjoin or
place conditions on such conversion.
6
<PAGE>
(c) CONVERSION PRICE ADJUSTMENTS OF PREFERRED STOCK.
(i) If the Corporation should at any time or from
time to time after the Purchase Date fix a record date for the
effectuation of a split or subdivision of the outstanding shares
of Common Stock or the determination of holders of Common Stock
entitled to receive a dividend or other distribution payable in
additional shares of Common Stock, then, as of such record date
(or, if no record date is fixed, as of the close of business on
the date on which the Board of Directors adopts the resolution
relating to such dividend, distribution, split or subdivision),
the Conversion Price shall be decreased to equal the product of
the Conversion Price in effect immediately prior to such date
multiplied by a fraction, the numerator of which shall be the
number of shares of Common Stock outstanding immediately prior
thereto and the denominator of which shall be the number of
shares of Common Stock outstanding immediately thereafter.
(ii) If the number of shares of Common Stock
outstanding at any time or from time to time after the Purchase
Date is decreased by a combination of the outstanding shares of
Common Stock, then following such combination, the Conversion
Price shall be increased to equal the product of the Conversion
Price in effect immediately prior thereto multiplied by a
fraction, the numerator of which shall be the number of shares of
Common Stock outstanding immediately prior thereto and the
denominator of which shall be the number of shares of Common
Stock outstanding immediately thereafter. So long as any shares
of Series B Preferred Stock are outstanding, the Corporation
shall not combine any shares of Common Stock unless it likewise
combines all shares of Common Stock.
(iii) If the Corporation shall at any time and from
time to time after the Purchase Date issue rights or warrants to
all holders of the Common Stock entitling such holders to
subscribe for or purchase Common Stock at a price per share less
than the Current Market Price per share of the Common Stock on
the record date for the determination of stockholders entitled to
receive such rights or warrants, then, and in each such case, the
number of shares of Common Stock into which each share of Series
B Preferred Stock is convertible shall be adjusted so that the
holder of each share thereof shall be entitled to receive, upon
the conversion thereof, the number of shares of Common Stock
determined by multiplying the number of shares of Common Stock
into which such share was convertible on the day immediately
prior to such record date by a fraction, (A) the numerator of
which is the sum of (1) the number of shares of Common Stock
outstanding on such record date and (2) the number of additional
shares of Common Stock which such rights or warrants entitle
holders of Common Stock to subscribe for or purchase ("Offered
Shares"), and (B) the denominator of which is the sum of (1) the
number of shares of Common Stock outstanding on the record date
and (2) a fraction, (x) the numerator of which is the product of
the number of Offered Shares multiplied by the subscription or
purchase price of the Offered Shares and (y) the denominator of
which is the Current Market Price per share of Common Stock on
such record date. Such adjustment shall become effective
immediately after such record date.
(iv) If the Corporation shall be a party to any
transaction, including any capital reorganization,
reclassification or recapitalization involving the Common Stock
of
7
<PAGE>
the Corporation (other than (A) a transaction described in
clauses (i) and (ii) of this Section 5(c) or in Section 3(b) or
(B) a consummated Business Combination), or some other form of
transaction (other than a consummated Business Combination) in
which the previously outstanding shares of Common Stock shall be
changed into or, pursuant to the operation of law or the terms of
the transaction to which the Corporation is a party, exchanged,
or would have been changed or exchanged as required by the
Certificate of Incorporation if such Common Stock were
outstanding, for different securities of the Corporation or
common stock or other securities of another corporation or
interests in a non-corporate entity (such other corporation or
non-corporate entity is referred to herein as the "Surviving
Entity") or other property (including cash) or any combination of
the foregoing, then, as a condition to the consummation of such
transaction, lawful and adequate provision shall be made whereby
the Holders of the Series B Preferred Stock shall thereafter have
the right to receive, in lieu of the shares of Common Stock of
the Corporation immediately theretofore receivable with respect
to the conversion of such shares of Series B Preferred Stock,
such shares of stock or securities (such stock and securities are
referred to herein as the "Surviving Entity Securities") or
assets as would have been issued or payable with respect to or in
exchange for the shares of Common Stock which such holders would
have held had the shares of Series B Preferred Stock been
converted immediately prior to such transaction. In any such
case, appropriate provisions shall be made with respect to the
rights and interests of the Holders of the Series B Preferred
Stock to the end that such conversion rights (including, without
limitation, provisions for adjustment of the Conversion Price)
shall thereafter be applicable, as nearly as may be practicable
in relation to any shares of Surviving Entity Securities or
assets thereafter deliverable upon the exercise thereof.
(d) STOCK TRANSFER TAXES. The issuance of stock
certificates upon the conversion of the Series B Preferred Stock shall
be made without charge to the converting Holder for any tax in respect
of such issuance. The Corporation shall not, however, be required to
pay any tax which may be payable in respect of any transfer involved in
the issuance and delivery of shares in any name other than that of the
Holder of such shares of Series B Preferred Stock converted, and the
Corporation shall not be required to issue or deliver any such stock
certificate unless and until the person or persons requesting the
issuance thereof shall have paid to the Corporation the amount of such
tax, if any.
(e) NO FRACTIONAL SHARES: CERTIFICATE AS TO ADJUSTMENTS.
(i) No fractional shares shall be issued upon
conversion of the Series B Preferred Stock, and the number of
shares of Common Stock to be issued shall be rounded to the
nearest whole share.
(ii) Upon the occurrence of each adjustment or
readjustment of the Conversion Price of Series B Preferred Stock
pursuant to this Section 5, the Corporation, at its expense,
shall promptly compute such adjustment or readjustment in
accordance with the terms hereof and prepare and furnish to each
Holder of Series B Preferred Stock a certificate setting forth
such adjustment or readjustment and showing in detail the facts
upon which such adjustment or readjustment is based. The
Corporation shall, upon the written request at any time of any
Holder of Series B Preferred Stock, furnish or cause to
8
<PAGE>
be furnished to such Holder a like certificate setting forth (A)
such adjustment and readjustment, (B) the Conversion Price at the
time in effect, and (C) the number of shares of Common Stock and
the amount, if any, of other property which at the time would be
received upon the conversion of a share of Series B Preferred
Stock.
(f) NOTICES OF RECORD DATE. In the event of any taking by
the Corporation of a record of the Holders of any class of securities
for the purpose of determining the Holders thereof who are entitled to
receive any dividend (other than a cash dividend or a Liquidation
Accretion Dividend) or other distribution, any right or warrant to
subscribe for, purchase or otherwise acquire any shares of stock or any
class of any other securities or property, or to receive any other right
(including, without limitation, making a dividend or other distribution
of any rights under a stockholder rights plan (sometimes known as a
"poison pill" plan), whether now existing or hereafter created), the
Corporation shall mail to each Holder of Series B Preferred Stock, at
least 20 days prior to the date specified therein, a notice specifying
the date on which any such record is to be taken for the purpose of such
dividend, distribution, right or warrant, and the amount and character
of such dividend, distribution, right or warrant. The Corporation shall
not issue such dividend, distribution, right or warrant described herein
or in Section 5(c)(iii), or consummate any Business Combination, or any
reorganization, reclassification or recapitalization described in
Section 5(c)(iv), unless it provides the Holders of the Series B
Preferred Stock at least 20 days advance written notice thereof.
(g) RESERVATION OF SECURITIES ISSUABLE UPON CONVERSION. The
Corporation shall at all times reserve and keep available out of its
authorized but unissued shares of Common Stock, solely for the purpose
of effecting the conversion of the shares of the Series B Preferred
Stock, free from any preemptive right or other obligation, such number
of its shares of Common Stock as shall from time to time be sufficient
to effect the conversion of all outstanding shares of the Series B
Preferred Stock; and if at any time the number of authorized but
unissued shares of Common Stock shall not be sufficient to effect the
conversion of all then outstanding shares of the Series B Preferred
Stock, in addition to such other remedies as shall be available to the
Holder of such Series B Preferred Stock, the Corporation will take such
corporate action as may be necessary to increase its authorized but
unissued shares of Common Stock to such number of shares as shall be
sufficient for such purposes. The Corporation shall prepare and shall
use commercially reasonable efforts to obtain and keep in force such
governmental or regulatory permits or other authorizations as may be
required by law, and shall comply with all requirements as to
registration, qualification or listing of the Common Stock in order to
enable the Corporation to lawfully issue and deliver to each Holder of
record of Series B Preferred Stock such number of shares of its Common
Stock as shall from time to time be sufficient to effect the conversion
of all Series B Preferred Stock then outstanding and convertible into
shares of Common Stock, including, without limitation, compliance with
the filing and waiting period requirements of the HSR Act.
(h) NOTICES. Any notice required by the provisions of this
Section 5 to be given to the Holders of shares of Series B Preferred
Stock shall only be effective upon receipt and may be given by personal
delivery, U.S. certified mail, return receipt requested, or by a
nationally recognized overnight delivery service (e.g., United Parcel
Service or Federal Express), delivery or postage prepaid and addressed
to each Holder of record at his address appearing on the books of this
Corporation (and, in the case of any Holder that is a corporation ore
other entity, to the
9
<PAGE>
attention of the President).
6. REDEMPTION.
(a) OPTIONAL REDEMPTION. The Series B Preferred Stock may be
redeemed (subject to (i) the right of any or all shares of Series B
Preferred Stock to be converted into Common Stock at any time prior to
the Redemption Date (as defined in Section 6(b)), and (ii) subject to
the restrictions described in this Section 6(a) and the legal
availability of funds therefor) at any time after June 5, 2001, at the
Corporation's option, in whole or in part, in the manner provided in
Section 6(b), at a redemption price per share of Series B Preferred
Stock (expressed as a percentage of the Liquidation Value, which
includes the full accelerated amount of the Liquidation Accretion
Dividends as prescribed by Section 3(a)(i)) set forth above), if
redeemed during the 12-month period beginning on the anniversary date of
the Purchase Date of each of the years set forth below:
<TABLE>
<CAPTION>
Year Percentage
----------
<S> <C>
2001 103%
2002 102%
2003 101%
Thereafter 100%
</TABLE>
In the event a redemption of less than all of the outstanding shares of
Series B Preferred Stock pursuant to this Section 6(a), the Corporation
shall effect such redemption either pro rata according to the number of
shares held by each Holder of shares of Series B Preferred Stock, or by
lot, in each case, as may be determined by the Corporation in its sole
discretion.
(b) PROCEDURES FOR REDEMPTION.
(i) At least 30 days and not more than 60 days prior
to the date fixed for any redemption of the Series B Preferred
Stock, written notice (the "Redemption Notice") shall be given by
first-class mail, postage prepaid, to each Holder of record on
the record date fixed for such redemption (the "Redemption Date")
of the Series B Preferred Stock at such Holder's address as the
same appears on the stock register of the Corporation, provided
that no failure to give such notice nor any deficiency therein
shall affect the validity of the procedure for the redemption of
any shares of Series B Preferred Stock to be redeemed except as
to the Holder or Holders to whom the Corporation has failed to
give said notice or except as to the Holder or Holders whose
notice was defective; provided, further, that the Corporation may
withdraw such Redemption Notice and thereby have no obligation to
consummate the redemption described therein at any time prior to
the third day prior to the Redemption Date set forth therein by
providing written notice of such withdrawal to each Holder who
received such Redemption Notice. The Redemption Notice shall
state:
(1) the redemption price;
(2) whether all or less than all the
outstanding shares of the Series B
10
<PAGE>
Preferred Stock are to be redeemed and the total number
of shares of the Series B Preferred Stock being redeemed;
(3) the number of shares of Series B Preferred
stock held, as of the appropriate record date, by the
Holder that the Corporation intends to redeem;
(4) the Redemption Date;
(5) that the Holder is to surrender to the
Corporation, at the place or places where certificates
for shares of Series B Preferred Stock are to be
surrendered for redemption, in the manner and at the
price designated, Holder's certificate or certificates
representing the shares of Series B Preferred Stock to be
redeemed; and
(6) that cash dividends on the shares of the
Series B Preferred Stock to be redeemed shall cease to
accrue on such Redemption Date unless the Corporation
defaults in the payment of the redemption price.
(ii) Each Holder of Series B Preferred Stock shall
surrender the certificate or certificates representing such
shares of Series B Preferred Stock to the Corporation, duly
endorsed, in the manner and at the place designated in the
Redemption Notice and on the Redemption Date. The full
redemption price for such shares of Series B Preferred Stock
shall be payable in cash to the person whose name appears on such
certificate or certificates as the owner thereof, and each
surrendered certificate shall be canceled and retired. In the
event that less than all of the shares represented by any such
certificate are redeemed, a new certificate shall be issued
representing the unredeemed shares.
(iii) Unless the Corporation defaults in the payment
in full of the applicable redemption price, cash dividends on the
shares of Series B Preferred Stock called for redemption shall
cease to accrue and accumulate on the Redemption Date, and the
Holders of such redeemed shares shall cease to have any further
rights with respect thereto from and after the Redemption Date,
other than the right to receive the redemption price on the
Redemption Date, without interest.
7. VOTING RIGHTS. The Holders of shares of Series B Preferred Stock
shall not be entitled to any voting rights, except as hereinafter provided in
Section 7(b) and Section 8 or as otherwise provided by law or by that certain
Governance Agreement between the Corporation, Sprint, Sprint L.P. and the
Corporation (formerly, Dolphin, Inc.), dated the Purchase Date (the "Governance
Agreement"). Notwithstanding any other provision of this Section 7 or
Section 8, the Holders of shares of Series B Preferred Stock shall not be
entitled to any voting rights hereunder with respect to a Business Combination
which is not a Discriminatory Transaction.
8. PROTECTIVE PROVISIONS.
(a) CLASS VOTING. So long as shares of Series B Preferred
Stock are outstanding, this Corporation shall not, without first
obtaining the approval (by vote or written consent) of the Holders of
sixty-six and two-thirds percent (66 2/3%) of the then outstanding
shares of Series B
11
<PAGE>
Preferred Stock (voting as a class):
(i) alter or change the rights, preferences or
privileges of the shares of Series B Preferred Stock so as to
affect adversely the shares;
(ii) increase the number of authorized shares of
Series B Preferred Stock, or create any new series of stock or
any other securities convertible into equity securities of the
Corporation having a preference over, or being on a parity with,
the Series B Preferred Stock (other than Alternative Securities)
with respect to, dividends, distribution of assets upon
liquidation, dissolution, winding up or otherwise or conversion
rights;
(iii) amend the Certificate of Incorporation, Bylaws
or other organizational documents of the Corporation or take any
action or enter into any other agreements which, prohibit or
materially conflict with the Corporation's obligations hereunder
with respect to the Holders of Series B Preferred Stock; or
(iv) engage in a Liquidation Event.
(b) NO IMPAIRMENT. The Corporation will not, by amendment
of its Certificate of Incorporation, Bylaws or other organizational
documents or through any reorganization, reclassification,
recapitalization, Liquidation Event, issue or sale of securities or any
other voluntary action by the Corporation, avoid or seek to avoid the
observance or performance of any of the terms to be observed or
performed hereunder by the Corporation but will at all times in good
faith assist in the carrying out of all the provisions of this
Certificate of Designation, and in the taking of all such action as may
be necessary or appropriate in order to protect the conversion and other
rights of the Holders of the Series B Preferred Stock against
impairment; provided, however, that the protection provided by this
Section 8(b) shall not apply to a Business Combination in which
(i) neither the Liquidation Value nor the Conversion Price of the Series
B Preferred Stock is changed, and (ii) the Holders of Series B Preferred
Stock shall be entitled to receive consideration at the same time, and
in the same amount and in the same form per share, as if each share of
Series B Preferred Stock had been converted into Common Stock
immediately prior to such Business Combination, after giving effect to
the acceleration of the full amount of all of the Liquidation Accretion
Dividends as contemplated by the last sentence of Section 3(a)(i).
Without limiting the foregoing, but subject to the proviso in the
immediately preceding sentence, the Corporation will not effect any
transaction described in this Section 8(b), the result of which is to
adversely affect any of the rights of holders of Common Stock relative
to the rights of holders of any other securities other than the Series B
Preferred Stock.
(c) TOLLING OF AUTOMATIC CONVERSION AND OTHER TIME PERIODS
FOR HSR COMPLIANCE. Notwithstanding any other provision of this
Certificate of Designation, until such time as the filing and waiting
period requirements of the HSR Act relating to the conversion of any of
the shares of Series B Preferred Stock pursuant to Section 5 shall have
been complied with, if any, and there shall be no action taken or
instituted by the United States Department of Justice or the United
States Federal Trade Commission to delay, enjoin or impose conditions on
such conversion, and such waiting period applicable under the HSR Act
shall have expired or received early termination: (i) there shall be no
automatic conversion of the Series B Preferred Stock into Common Stock,
(ii) the Redemption Date shall be automatically extended for a period of
five
12
<PAGE>
Business Days beyond the latest date contemplated by the first sentence
of Section 6(b)(i) (as so extended, the "Extended Redemption Date") and
each Holder of shares of Series B Preferred Stock shall be entitled to
convert any or all of such shares into Common Stock prior to the
Extended Redemption Date, and (iii) each other date or event that would
otherwise impair any right to convert the Series B Preferred Stock into
Common Stock or otherwise impair the rights of the Series B Preferred
Stock shall be tolled until 10 days after the expiration or early
termination of all waiting periods under the HSR Act; provided, however,
that no cash dividends shall accrue during the period after the date
originally set for redemption pursuant to Section 6. Any Holder who is
required to comply with the filing and waiting period requirements of
the HSR Act with respect to the conversion of any shares of Series B
Preferred Stock shall use commercially reasonable efforts to cause such
filing to be made as soon as practicable after such Holder has provided
notice of its intention to convert such shares of Series B Preferred
Stock and to diligently and in good faith pursue expiration or
termination of the waiting period of the HRS Act.
9. STOCKHOLDER RIGHTS PLAN. Notwithstanding any other provision of
this Certificate of Designation to the contrary, if the Corporation shall adopt
a stockholders rights plan (sometimes known as a "poison pill" plan), and shall
declare, order, pay or make a dividend or other distribution of rights
thereunder with respect to the Common Stock (whether or not separate from the
Common Stock), each Holder of shares of Series B Preferred Stock shall be
entitled to receive from the Corporation, upon conversion of such shares of
Series B Preferred Stock into Common Stock pursuant to Section 5, all of the
rights distributed under such plan (but without any limitation or restriction or
the exercise of such rights that are not also applicable to holders of Common
Stock) fully and to the same extent as if immediately prior to the earlier of
such distribution or any record date therefor (i) the Liquidation Value of such
shares of Series B Preferred Stock had then increased by the full amount of all
Liquidation Accretion Dividends payable as if such shares of Series B Preferred
Stock had been held through and including the first Dividend Payment Date on or
following the fifth anniversary of the Purchase Date, and (ii) such Holder had
then converted all of such Holder's shares of Series B Preferred Stock into
shares of Common Stock. The preceding sentence shall provide the exclusive
protection under this Certificate of Designation to the Holders of the Series B
Preferred Stock (including any adjustments that would otherwise be required by
Section 5(c)) with respect to the subject matter of the immediately preceding
sentence.
10. STATUS OF CONVERTED STOCK. In the event any shares of Series B
Preferred Stock shall be converted pursuant to Section 5 hereof, the shares so
converted shall be canceled and thereupon restored to the status of authorized
but unissued Preferred Stock undesignated as to class or series.
11. CERTAIN DEFINITIONS. For purposes of this Certificate of
Designation, Preferences and Rights of Series B Preferred Stock, unless the
context otherwise requires:
(i) "Acquisition Proposal" shall have the meaning
set forth in the Governance Agreement.
(ii) "Affiliate" and "Associate" shall have the
respective meanings ascribed to such terms in Rule 12b-2 under
the Exchange Act as such Rule is in effect on the Purchase Date.
13
<PAGE>
(iii) "Alternative Securities" shall have the meaning
set forth in the Governance Agreement.
(iv) A Person shall be deemed to "beneficially own,"
any securities:
(A) which such Person or any of such Person's
Affiliates or Associates, directly or indirectly, has the
right to acquire (whether such right is exercisable
immediately or only after the passage of time) pursuant
to any agreement, arrangement or understanding (whether
or not in writing) or upon the exercise of conversion
rights, exchange rights, rights, warrants or options, or
otherwise;
(B) which such Person or any of such Person's
Affiliates or Associates, directly or indirectly, has the
right to vote or dispose of or has "beneficial ownership"
of (as determined pursuant to Rule 13d-3 under the
Exchange Act as such Rule is in effect on the date of
this Agreement), including pursuant to any agreement,
arrangement or understanding, whether or not in writing;
PROVIDED, HOWEVER, that a Person shall not be deemed the
"Beneficial Owner" of, or to "beneficially own," any
security under this subparagraph (B) as a result of an
agreement, arrangement or understanding to vote such
security if such agreement, arrangement or understanding
arises solely from a revocable proxy given in response to
a public proxy or consent solicitation made by the
Corporation pursuant to, and in accordance with, the
applicable provisions of the General Rules and
Regulations under the Exchange Act; or
(C) which are beneficially owned, directly or
indirectly, by any other Person (or any Affiliate or
Associate thereof) with which such Person (or any of such
Person's Affiliates or Associates) has any agreement,
arrangement or understanding (whether or not in writing),
for the purpose of acquiring, holding, voting (except
pursuant to a revocable proxy as described in the proviso
to subparagraph (B)) or disposing of any voting
securities of the Corporation; PROVIDED, HOWEVER, that
nothing in this subparagraph (C) shall cause a person
engaged in business as an underwriter of securities to be
the "Beneficial Owner" of, or to "beneficially own," any
securities acquired through such person's participation
in good faith in a firm commitment underwriting under the
Act until the expiration of 40 days after the date of
such acquisition.
(v) "Business Combination" shall have the meaning
set forth in the Governance Agreement.
(vi) "Business Day" means any day other than a
Saturday, Sunday or a day on which banking institutions in the
State of New York are authorized or obligated by law or executive
order to close.
(vii) "Closing Price" per share of Common Stock on any
date shall be the last sale price, regular way, or, in case no
such sale takes place on such day, the average of the closing bid
and asked prices, regular way, in either case as reported in the
principal
14
<PAGE>
consolidated transaction reporting system with respect to
securities listed or admitted to trading on the New York Stock
Exchange or, if the Common Stock is not listed or admitted to
trading on the New York Stock Exchange, as reported in the
principal consolidated transaction reporting system with respect
to securities listed on the principal national securities
exchange on which the Common Stock is listed or admitted to
trading or, if the Common Stock is not listed or admitted to
trading on any national securities exchange, if such shares of
Common Stock are not listed or admitted to trading on such
exchange, as reported on the Nasdaq National Market, or if not
quoted on the Nasdaq National Market, the last quoted sale price
or, if not so quoted, the average of the high bid and low asked
prices in the over-the-counter market, as reported by Nasdaq or
such other system then in use, or, if on any such date the Common
Stock is not quoted by any such organization, the average of the
closing bid and asked prices as furnished by a professional
market maker making a market in the Common Stock selected by the
Board of Directors. If the Common Stock is not publicly held or
so listed or publicly traded, "Closing Price" shall mean the Fair
Market Value per share as determined in good faith by the Board
of Directors of the Corporation.
(viii) "Common Stock" shall mean the Corporation's
authorized Common Stock, $.01 par value, as constituted on the
Purchase Date, and any stock into which such Common Stock may
thereafter be changed or reclassified, including, without
limitation, any Surviving Entity Securities; provided, however,
that if Common Stock is changed or reclassified into more than
one class or series of equity securities, the term "Common Stock"
shall refer to the class or series of such equity securities
having the greatest general voting power in the election of
directors of the Corporation as compared to the other classes or
series of equity securities.
(ix) "Corporation" means EarthLink Network, Inc., a
Delaware corporation, together with any successors of the
Corporation, whether by merger, consolidation or otherwise,
including without limitation a Surviving Entity.
(x) "Current Market Price" per share of Common Stock
on any date shall be deemed to be the Closing Price per share of
Common Stock on the Trading Day immediately prior to such date.
(xi) "Discriminatory Transaction" shall have the
meaning set forth in the Governance Agreement.
(xii) "Dividend Accrual Date" shall mean each
anniversary date of the Purchase Date and the dates three months,
six months and nine months of each year thereafter, beginning
with the date three months after the Purchase Date, or at such
additional times and for such interim periods, if any, as
determined by the Board of Directors.
(xiii) "Dividend Payment Date" shall mean with respect
to dividends under Section 3(a)(i), the Dividend Accrual Date,
and with respect to dividends under Section 3(a)(ii), the date
established by the Board of Directors for the payment of all or
part of the accrued dividends on the Series B Preferred Stock.
15
<PAGE>
(xiv) "Equity Security" means (i) any Common Stock,
(ii) any debt or equity securities of the Corporation convertible
into or exchangeable for Common Stock or other Equity Securities
of the Corporation that grant the right to vote generally in the
election of directors ("Voting Equity Securities"), (iii) any
options, rights or warrants (or any other similar securities)
issued by the Corporation to acquire Common Stock or other Voting
Equity Securities or (iv) any security issuable in connection
with any stock split, stock dividend, recapitalization or other
similar transaction in which securities are issued on a
proportionate basis to all holders of a class of Equity
Securities.
(xv) "Exchange Act" shall mean the Securities
Exchange Act of 1934, as amended and in effect on the Purchase
Date.
(xvi) "Fair Market Value" means the amount which a
willing buyer would pay a willing seller in an arm's-length
transaction.
(xvii) "Higher Threshold" shall have the meaning set
forth in the Governance Agreement.
(xviii) "HSR Act" means the Hart-Scott-Rodino Antitrust
Improvements Act of 1976, as amended, and the regulations
promulgated thereunder.
(xix) "Lower Threshold" shall have the meaning set
forth in the Governance Agreement.
(xx) "Person" means any individual, firm,
corporation, partnership, limited liability company or other
entity, and shall include any successor (by merger or otherwise)
of such entity.
(xxi) "Purchase Date" means January 20, 1999.
(xxii) "Qualified Offer" shall have the meaning set
forth in the Governance Agreement.
(xxiii) "Significant Subsidiary" shall have the meaning
set forth in the Governance Agreement.
(xxiv) "Sprint Offer" shall have the meaning set forth
in the Governance Agreement.
(xxv) "Sprint's Percentage Interest" shall have the
meaning set forth in the Governance Agreement.
(xxvi) "Subsidiary" of any person means any corporation
or other entity of which a majority of the voting power of the
voting equity securities or equity interest is owned, directly or
indirectly, by such person.
16
<PAGE>
(xxvii) "Trading Day" means a day on which the principal
national securities exchange, Nasdaq or other securities market
on which the Common Stock is listed or admitted to trading is
open for the transaction of business or, if the Common Stock is
not listed or admitted to trading on any national securities
exchange, any day other than a Saturday, Sunday, or a day on
which banking institutions in the State of New York are
authorized or obligated by law or executive order to close.
IN WITNESS WHEREOF, the Corporation has caused the foregoing certificate
to be signed on January 20, 1999.
EARTHLINK NETWORK, INC.
By:/s/ Charles G. Betty
--------------------
Name: Charles G. Betty
----------------
Title: President and Chief Executive Officer
-------------------------------------
17
<PAGE>
EARTHLINK NETWORK, INC.
CERTIFICATE OF AMENDMENT
TO CERTIFICATE OF DESIGNATION, PREFERENCES
AND RIGHTS OF SERIES B CONVERTIBLE PREFERRED STOCK
EARTHLINK NETWORK, INC., a corporation organized and existing under and
by virtue of the General Corporation Law of the State of Delaware, DOES HEREBY
CERTIFY:
FIRST: That the resolutions of the Board of Directors of EarthLink
Network, Inc. (the "Company") were duly adopted February 16, 1999 setting forth
a proposed amendment to the Certificate of Designation, Preferences and Rights
of Series B Convertible Preferred Stock ("Certificate of Designation") of the
Company, declaring said amendment to be advisable and recommending such change
to the sole stockholder of the Series B Convertible Preferred Stock ("Series B
Preferred Stock"). The resolution setting forth the proposed amendment is as
follows:
That the Certificate of Designation of EarthLink Network, Inc.,
filed January 20, 1999, be amended by changing the authorized
number of shares of Series B Preferred Stock from 600,000 to
625,000.
SECOND: That in lieu of a meeting and vote of the sole stockholder of
the Series B Preferred Stock, such stockholder gave its unanimous written
consent to said amendment to the Certificate of Designation in accordance with
the provisions of Section 228 of the General Corporation Law of the State of
Delaware.
THIRD: That said amendment was duly adopted in accordance with the
provisions of Section 242 of the General Corporation Law of the State of
Delaware.
IN WITNESS WHEREOF, said the Company has caused the foregoing
certificate of amendment to be signed this 16th day of February, 1999.
EARTHLINK NETWORK, INC.
By:/s/ Charles G. Betty
--------------------
Name: Charles G. Betty
Title: President and Chief Executive Officer
18
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (Nos. 333-22317, 333-48909, 333-66435 and 333-66437)
of EarthLink Network, Inc. of our report dated February 16, 1999, except as
to Note 14, which is as of February 24, 1999, appearing on page F-2 of
EarthLink Network, Inc.'s Annual Report on Form 10-K for the year ended
December 31, 1998.
PRICEWATERHOUSECOOPERS LLP
Century City, California
March 30, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> YEAR YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1998 JAN-01-1997 JAN-01-1996
<PERIOD-END> DEC-31-1998 DEC-31-1997 DEC-31-1996
<CASH> 140,864 16,450 0
<SECURITIES> 0 0 0
<RECEIVABLES> 5,184 2,085 0
<ALLOWANCES> 405 165 0
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 150,565 22,082 0
<PP&E> 60,449 36,166 0
<DEPRECIATION> 25,243 12,768 0
<TOTAL-ASSETS> 266,341 46,887 0
<CURRENT-LIABILITIES> 61,296 32,504 0
<BONDS> 0 0 0
0 0 0
41 0 0
<COMMON> 291 225 0
<OTHER-SE> 197,012 5,850 0
<TOTAL-LIABILITY-AND-EQUITY> 266,341 46,887 0
<SALES> 0 0 0
<TOTAL-REVENUES> 175,941 80,888<F1> 33,230<F1>
<CGS> 0 0 0
<TOTAL-COSTS> 77,328 38,065<F1> 19,783<F1>
<OTHER-EXPENSES> 160,852 71,277<F1> 43,705<F1>
<LOSS-PROVISION> 3,725 3,526 2,526
<INTEREST-EXPENSE> 1,967 2,099 1,041
<INCOME-PRETAX> (59,782) (29,916) (31,149)
<INCOME-TAX> 0 0 0
<INCOME-CONTINUING> (62,239) (28,454) (30,258)
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> (67,383) (29,916) (31,149)
<EPS-PRIMARY> (2.58) (1.50) (2.57)
<EPS-DILUTED> (2.58) (1.50) (2.57)
<FN>
<F1>Certain amounts in prior years are reclassified to conform to current year presentation.
</FN>
</TABLE>
