<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
OR
/_/ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 000-20799
EARTHLINK NETWORK, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 58-2389244
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
3100 NEW YORK DRIVE, PASADENA, CALIFORNIA 91107
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(626) 296-2400
(REGISTRANT'S TELEPHONE, INCLUDING AREA CODE)
--------------------
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value
--------------------
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___
There were 32,597,732 shares of Common Stock outstanding as of
September 30, 1999.
<PAGE>
EARTHLINK NETWORK, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
TABLE OF CONTENTS
PART I
Item 1. Financial Statements and Supplementary Data......................... 1
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.......................................... 6
Item 3. Quantitative and Qualitative Disclosures About Market Risk ......... 12
PART II
Item 4. Submission of Matters to a Vote of Security Holders................. 12
Item 6. Exhibits and Reports on Form 8-K.................................... 13
<PAGE>
PART I
ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
EARTHLINK NETWORK, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, 1998 SEPTEMBER 30, 1999
----------------- ------------------
(AUDITED) (UNAUDITED)
(in thousands)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 140,864 $ 338,315
Accounts receivable, net 4,779 10,385
Prepaid expenses 4,147 5,785
Other assets 775 6,960
----------------- ------------------
Total current assets 150,565 361,445
Other long-term assets 564 2,995
Property and equipment, net 35,206 52,139
Intangibles, net (Note 4) 80,006 26,933
----------------- ------------------
$ 266,341 $ 443,512
----------------- ------------------
----------------- ------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 14,818 $ 22,299
Accrued payroll and related expenses 8,934 9,274
Other accounts payable and accrued liabilities 20,372 23,690
Current portion of capital lease obligations 8,341 9,337
Deferred revenue 8,831 13,826
----------------- ------------------
Total current liabilities 61,296 78,426
Long-term debt 7,701 9,201
----------------- ------------------
Total liabilities 68,997 87,627
Stockholders' equity:
Preferred stock 41 47
Common stock 291 326
Stock subscriptions receivable (1,041) -
Additional paid-in capital 330,911 577,202
Warrants to purchase common stock 597 597
Accumulated deficit (133,455) (222,287)
----------------- ------------------
Total stockholders' equity 197,344 355,885
----------------- ------------------
$ 266,341 $ 443,512
----------------- ------------------
----------------- ------------------
</TABLE>
The accompanying notes are an integral part of these financial statements
1
<PAGE>
EARTHLINK NETWORK, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
1998 1999 1998 1999
--------- --------- --------- ---------
(UNAUDITED)
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Recurring revenues $ 46,877 $ 84,627 $ 109,957 $ 224,055
Other revenues 1,699 1,931 4,897 4,490
Incremental revenues 1,248 3,016 2,786 7,273
--------- --------- --------- ---------
Total revenues 49,824 89,574 117,640 235,818
Cost of recurring revenues 20,619 33,398 52,261 95,494
Cost of other revenues 252 210 408 786
Sales and marketing 10,644 38,255 26,491 79,577
General and administrative 5,871 9,781 15,426 25,456
Operations and member support 15,078 25,748 36,248 71,282
Amortization and transaction costs (Note 4) 17,754 17,673 24,962 53,019
--------- --------- --------- ---------
Total operating costs and expenses 70,218 125,065 155,796 325,614
--------- --------- --------- ---------
Loss from operations (20,394) (35,491) (38,156) (89,796)
Interest income 1,919 4,434 2,568 12,681
Interest expense (353) (308) (1,661) (1,040)
--------- --------- --------- ---------
Net loss (18,828) (31,365) (37,249) (78,155)
Deductions for accretion dividends (Note 5) (3,276) (3,404) (4,330) (10,677)
--------- --------- --------- ---------
Net loss attributable to common stockholders $ (22,104) $ (34,769) $ (41,579) $ (88,832)
--------- --------- --------- ---------
--------- --------- --------- ---------
Basic and diluted net loss per share (Note 3) $ (0.78) $ (1.07) $ (1.64) $ (2.78)
--------- --------- --------- ---------
--------- --------- --------- ---------
Weighted average shares 28,458 32,383 25,292 31,925
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these financial statements
2
<PAGE>
EARTHLINK NETWORK, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
1998 1999 1998 1999
--------- --------- --------- ---------
(UNAUDITED)
(in thousands)
<S> <C> <C> <C> <C>
Net cash provided by (used in) operating activities $ 2,462 $ (8,746) $ 14,398 $ (8,034)
--------- --------- --------- ---------
Cash flows from investing activities:
Purchases of property and equipment (4,381) (11,422) (15,911) (33,625)
Proceeds from sale of property and equipment - 1,195 - 1,416
Purchase of investment - (1,500) - (1,500)
Purchase of intangible assets - - (9) -
Transaction costs (449) - (8,861) -
Net cash acquired from acquisition - - 23,750 -
--------- --------- --------- ---------
Net cash used in investing activities (4,830) (11,727) (1,031) (33,709)
--------- --------- --------- ---------
Cash flows from financing activities:
Proceeds from issuance of notes payable - - 200 -
Repayment of notes payable (120) - (4,507) -
Proceeds from capital lease obligations 576 3,990 6,212 11,752
Principal payments under capital lease obligations (2,380) (3,801) (6,269) (9,257)
Proceeds from issuance of common stock, net - - 105,329 183,099
Proceeds from stock options and warrants exercised 976 6,227 3,615 9,937
Proceeds from sale of redeemable preferred stock - - - 42,622
Proceeds from liquidation of subscription receivable - - - 1,041
--------- --------- --------- ---------
Net cash (used in) provided by financing activities (948) 6,416 104,580 239,194
--------- --------- --------- ---------
Net (decrease) increase in cash and cash equivalents (3,316) (14,057) 117,947 197,451
Cash and cash equivalents, beginning of period 137,713 352,372 16,450 140,864
--------- --------- --------- ---------
Cash and cash equivalents, end of period $ 134,397 $ 338,315 $ 134,397 $ 338,315
--------- --------- --------- ---------
--------- --------- --------- ---------
Acquisition, net of cash acquired (Note 4):
Issuance of convertible preferred stock $ 135,000
Transaction costs 9,914
Intangible assets (121,164)
---------
Net cash acquired from acquisition $ 23,750
---------
---------
</TABLE>
The accompanying notes are an integral part of these financial statements
3
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The condensed consolidated financial statements of EarthLink Network,
Inc., which include the accounts of its wholly owned subsidiary, EarthLink
Operations, Inc., (collectively, "EarthLink" or the "Company") for the three and
nine month periods ended September 30, 1999 and the related footnote information
are unaudited and have been prepared on a basis substantially consistent with
the Company's audited financial statements as of December 31, 1998 contained in
the Company's Annual Report on Form 10-K, as filed with the Securities and
Exchange Commission (the "Annual Report"). All significant intercompany
transactions have been eliminated. These financial statements should be read in
conjunction with the audited consolidated financial statements and the related
notes thereto contained in the Company's Annual Report. In the opinion of
management, the accompanying unaudited financial statements contain all
adjustments (consisting of normal recurring adjustments) which management
considers necessary to present fairly the financial position of the Company at
September 30, 1999 and the results of operations and of cash flows for the three
month and nine month periods ended September 30, 1999. The results of operations
for the three and nine month periods ended September 30, 1999 are not
necessarily indicative of the results for the entire year ending December 31,
1999.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements. Actual
results may differ from those estimates.
2. RECLASSIFICATIONS
Certain amounts in prior period financial statements have been
reclassified to conform to the current period presentation.
3. NET LOSS PER SHARE
The Company has adopted Statement of Financial Accounting Standards
(SFAS) No. 128, "Earnings per Share" ("EPS"). SFAS No. 128 requires a dual
presentation of basic and diluted EPS. Basic EPS represents the weighted average
number of shares outstanding divided into net income attributable to common
stockholders during a reported period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock. However, the Company has not
included potential common stock in the calculation of EPS as such inclusion
would have an anti-dilutive effect.
4. INTANGIBLE ASSETS AND AMORTIZATION AND TRANSACTION COSTS
In June 1998, the Company consummated its strategic alliance with
Sprint Corporation (the "Sprint Transaction"). Intangible assets acquired in
the Sprint Transaction are valued as follows:
(IN THOUSANDS)
---------------
Member base $ 65,000
Marketing and distribution agreement 20,000
Goodwill 36,164
---------------
$121,164
===============
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
assets acquired (goodwill) over 18 months. As such, the member base and
goodwill will be fully amortized by December 31, 1999.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
1998 1999 1998 1999
------------ ------------ ------------ ------------
(in thousands)
<S> <C> <C> <C> <C>
Member base $10,833 $10,833 $14,444 $32,500
Marketing and distribution agreement 813 813 1,083 2,438
Goodwill 6,108 6,027 8,038 18,081
------------ ------------ ------------ ------------
Total $17,754 $17,673 $23,565 $53,019
============ ============ ============ ============
</TABLE>
In addition, a non-recurring Sprint Transaction cost of $1,397,000 was recorded
in June 1998.
4
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
5. DEDUCTIONS FOR ACCRETION DIVIDENDS ON CONVERTIBLE PREFERRED STOCK
The Convertible Preferred Stock issued to Sprint pays liquidation
dividends for the first five years in the form of increases in its
Liquidation Value. The adjustments of $3.4 million and $10.7 million recorded
during the three and nine month periods ended September 30, 1999,
respectively, represent liquidation dividends of $2.2 million and $6.5
million, based on a 3% dividend and accretion dividends of $1.2 million and
$4.2 million, respectively, related to the beneficial conversion feature of
the Convertible Preferred Stock.
6. AGREEMENT TO MERGE WITH MINDSPRING ENTERPRISES
In September 1999 EarthLink and MindSpring Enterprises Inc. agreed
to merge into a newly formed public company, in a transaction to be accounted
for as a pooling of interests, with MindSpring stockholders receiving one
share of the new company stock for each share of MindSpring stock, and
EarthLink stockholders receiving 1.615 shares of the new company stock in
exchange for each share of EarthLink stock. The combined company will be
known as EarthLink and will trade under the Nasdaq symbol "ELNK." Subject to
certain conditions, including regulatory approvals and approval by both
companies' stockholders, the transaction is expected to close in the first
quarter 2000.
7. INVESTMENTS
In July 1999, the Company committed to invest in eCompanies Venture
Group, LP, ("EVG"), a limited partnership formed to invest in domestic
emerging growth companies, and eCompanies LLC a partnership formed to create,
develop and invest in Internet related ventures. EarthLink Founder and
Chairman, Sky Dayton is a founding partner in both partnerships. In July 1999
EarthLink invested $1.5 million in EVG and has committed to invest an
additional $8.5 million and $2.0 million in EVG and eCompanies, respectively.
The investments are accounted for under the cost method of accounting as the
Company does not have the ability to exercise significant influence over the
partnerships' operating or financial policies. Any distributions of earnings
from the partnerships, will be recorded as income when declared.
8. SACRAMENTO CALL CENTER
In September 1999, the Company entered into a ten year lease for a
facility to house its permanent Sacramento Call Center. Rent commitments for
the 95,000 square feet of space are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31, IN THOUSANDS
----------------------------- ------------
<S> <C>
1999 (from September 1, 1999) $ 591
2000 1,773
2001 1,963
2002 2,059
2003 2,116
2004 2,135
Thereafter 10,426
------------
$ 21,063
------------
------------
</TABLE>
5
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
This Report contains certain forward-looking statements with respect
to the Company's operations, industry, financial condition and liquidity.
These statements, which are typically introduced by phrases such as "the
Company believes", "anticipates", "estimates" or "expects" certain conditions
to exist, reflect management's best current assessment of a number of risks
and uncertainties. The Company's actual results could differ materially from
the results anticipated in these forward-looking financial statements as a
result of certain factors described in this report. See "Safe Harbor
Statement."
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE ACCOMPANYING
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES
THERETO AND THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES
THERETO CONTAINED IN THE ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED
DECEMBER 31, 1998.
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. At September 30, 1999, our member base included
approximately 1,566,000 paying members and an additional 66,000 members
having trial accounts.
In September 1999 EarthLink and MindSpring Enterprises Inc. agreed
to merge into a newly formed public company, in a transaction to be accounted
for as a pooling of interests, with MindSpring stockholders receiving one
share of the new company stock for each share of MindSpring stock, and
EarthLink stockholders receiving 1.615 shares of the new company stock in
exchange for each share of EarthLink stock. The combined company will be
known as EarthLink and will trade under the Nasdaq symbol "ELNK." Subject to
several conditions, including regulatory approvals, approval by both
companies' shareholders, and certain third-party consents, the transaction is
expected to close in the first quarter 2000.
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
broadband and 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, DSL 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 cancellation fees attributable to certain term
marketing programs and one-time, non-refundable set up fees. Other revenues
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 third party providers for 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 and is included in cost of other
revenues.
6
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth the percentage of total revenues
represented by certain items on the Company's statements of operations for
the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1998 1999 1998 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Recurring revenues 94% 95% 94% 95%
Other revenues 3 2 4 2
Incremental revenues 3 3 2 3
---- ---- ---- ----
Total revenues 100% 100% 100% 100%
Operating costs and expenses:
Cost of recurring revenues 41 37 44 41
Cost of other revenues 1 - - -
Sales and marketing 21 43 23 34
General and administrative 12 11 13 11
Operations and member support 30 29 31 30
Amortization and transaction costs (1) 36 20 21 22
---- ---- ---- ----
141 140 132 138
---- ---- ---- ----
Loss from operations (41) (40) (32) (38)
Interest income 3 5 - 5
---- ---- ---- ----
Net loss (38%) (35%) (32%) (33%)
---- ---- ---- ----
---- ---- ---- ----
EBITDA (2) 2% (14%) (4%) (9%)
---- ---- ---- ----
---- ---- ---- ----
</TABLE>
- -------------------
(1) Represents amortization expense for the periods ended September 30,
1999 and 1998 and a one time transaction cost of $1,397,000
resulting from the June 1998 Sprint transaction.
(2) Represents earnings (loss) before depreciation and amortization,
interest income and expense and income tax expense. EBITDA is not
determined in accordance with generally accepted accounting
principles, is not indicative of cash used by operating activities
and should not be considered in isolation from an alternative to, or
more meaningful than measures of performance determined in
accordance with generally accepted accounting principles.
RECURRING REVENUES
The Company experienced substantial growth in revenues for the three
and nine month periods ended September 30, 1999 as compared to the
corresponding periods of 1998. The increase in recurring revenues of 80% from
$46.9 million in the quarter ended September 30, 1998 to $84.6 million in the
quarter ended September 30, 1999 was primarily due to an increase in the
Company's member base from 815,000 at September 30, 1998 to 1,566,000 at
September 30, 1999.
7
<PAGE>
OTHER REVENUES
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------ INCREASE -------------------- INCREASE
1998 1999 (DECREASE) 1998 1999 (DECREASE)
------- ------- ---------- ------- ------- ----------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Dial-up set up fees $ 771 $ 493 $ (278) $ 2,310 $ 990 $ (1,320)
Other fees 928 1,438 510 2,587 3,500 913
------- ------- ---------- ------- ------- ----------
Total other revenues $ 1,699 $ 1,931 $ 232 $ 4,897 $ 4,490 $ (407)
------- ------- ---------- ------- ------- ----------
------- ------- ---------- ------- ------- ----------
</TABLE>
The decrease in dial-up set up fees was primarily due to the
Company's willingness to waive set up fees for dial-up members acquired
through certain marketing programs. The Company expects this trend to
continue for dial-up set up fees. The increase in other fees was due to an
increase in the number of premium services sold such as web-site hosting,
broadband services and cancellation fees attributable to certain term
marketing programs.
INCREMENTAL REVENUES
The Company continued to focus on deriving additional revenue from
marketing activities targeted to its active member base. Incremental revenues
increased 131% from $1.3 million to $3.0 million and 161% from $2.8 million
to $7.3 million during the three and nine month periods ended September 30,
1999, respectively, as compared to the corresponding periods of 1998. The
principal component of the Company's incremental revenue strategy is its
Premier Partnership Program through which the Company offers and sells
promotional packages that provide advertisers with access to the multiple
points of contact EarthLink has with its members. The Company also sells
content space and advertising on its various online properties such as the
Personal Start Page and its bi-monthly print magazine, "bLink".
COST OF RECURRING REVENUES
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------- ---------------------------------------------
PERCENT OF PERCENT OF PERCENT OF PERCENT OF
RECURRING RECURRING RECURRING RECURRING
1998 REVENUES 1999 REVENUES 1998 REVENUES 1999 REVENUES
-------- ---------- -------- ---------- -------- ---------- -------- ----------
(in thousands, except percentages)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Recurring revenues $ 46,877 100% $ 84,627 100% $109,957 100% $224,055 100%
Cost of recurring revenues 20,619 44 33,398 39 52,261 48 95,494 43
</TABLE>
The decrease in the cost of recurring revenues as a percentage of
recurring revenues was primarily due to the Company's ability to negotiate
more favorable contracts with third party access providers and to effectively
manage communications costs per member.
COST OF OTHER REVENUES
Cost of other revenues decreased 17% during the three months ended
September 30, 1999 as compared to the corresponding period of 1998 due to a
reduction in ISDN equipment sold to members and the price of ISDN service.
Cost of other revenues increased 93% during the nine months ended September
30, 1999 as compared to the corresponding period of 1998 due to increases in
royalties paid to software vendors and the costs of providing a electronic
commerce.
8
<PAGE>
SALES AND MARKETING
Sales and marketing expenses consist primarily of advertising,
direct response mailings, sales compensation, bounties, communications costs
related to trial members, salaries and the cost of promotional material.
Sales and marketing expenses increased 260% from $10.6 million to $38.2
million during the three month periods ended September 30, 1998 and 1999,
respectively, and 200% from $26.5 million to $79.6 million in the nine months
ended September 30, 1999 as compared to the same period in 1998. The increase
was primarily due to management's increased emphasis on organic growth
through marketing strategies including expanding sales and marketing efforts,
increased sales commissions and increased marketing personnel headcount.
Sales, marketing and other direct costs associated with the acquisition of
members are generally expensed as incurred.
OPERATIONS AND MEMBER SUPPORT
Operations and member support expenses consist primarily of costs
associated with technical support and member service, as well as costs
associated with operating the data center and MIS functions to maintain
member accounts. Operations and member support expenses increased 70% from
$15.1 million to $25.7 million during the three month periods ended September
30, 1998 and 1999, respectively and 97% from $36.2 million to $71.3 million
during the nine months ended September 30, 1998 and 1999, respectively. These
increases reflect (1) the increase in members from 815,000 as of September
30, 1998 to 1,566,000 as of September 30, 1999, (2) the opening of the
Company's two Sacramento call centers in April 1999 and September 1999 and
(3) management's focus on retaining existing members by providing superior
service and devoting significant resources to expanding technical support
staff and network operations capabilities. The number of employees engaged in
operations and member support activities was 1,553 and 1,633 at September 30,
1998 and 1999, respectively.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist primarily of costs
associated with the accounting and human resources departments, professional
expenses, bad debt, credit card processing and executive compensation.
General and administrative expenses increased 66% from $5.9 million to $9.8
million during the three months ended September 30, 1998 and 1999, and 66%
from $15.4 million to $25.5 million in the nine months ended September 30,
1999 as compared to the same period in 1998. The increase was primarily due
to increases in payroll, depreciation expense and credit card processing
fees. The rise in payroll costs was primarily due to growth in headcount. In
October 1998, the Company occupied an additional 55,000 square feet of its
data center facility, and monthly rent increased from $66,000 to $92,000. The
increase in depreciation expense was due to the acquisition of office
equipment and the build-out of leasehold improvements. The increase in credit
card processing fees was due to the increase in the Company's member base and
increases in fees charged by credit card companies.
INTANGIBLE ASSETS AND AMORTIZATION AND TRANSACTION COSTS
In June 1998, the Company consummated its strategic alliance with
Sprint Corporation (the "Sprint Transaction"). Intangible assets acquired in
the Sprint Transaction are valued as follows:
(IN THOUSANDS)
---------------
Member base $ 65,000
Marketing and distribution agreement 20,000
Goodwill 36,164
---------------
$121,164
===============
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
assets acquired (goodwill) over 18 months. As such, the member base and
goodwill will be fully amortized by December 31, 1999.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
1998 1999 1998 1999
------------ ------------ ------------ ------------
(in thousands)
<S> <C> <C> <C> <C>
Member base $10,833 $10,833 $14,444 $32,500
Marketing and distribution agreement 813 813 1,083 2,438
Goodwill 6,108 6,027 8,038 18,081
------------ ------------ ------------ ------------
Total $17,754 $17,673 $23,565 $53,019
============ ============ ============ ============
</TABLE>
In addition, a non-recurring Sprint Transaction cost of $1,397,000 was recorded
in June 1998.
9
<PAGE>
INTEREST INCOME
Interest income increased from $1.9 million to $4.4 million and from
$2.6 million to $12.7 million during the three and nine months ended
September 30, 1998 and 1999, respectively. The increases were primarily due
to an increase in average cash balances available for investment.
INTEREST EXPENSE
Interest expense decreased from $353,000 to $308,000 and from $1.7
million to $1.0 million during the three months and nine months ended
September 30, 1998 and 1999, respectively. The decreases were primarily due
to the aging of capital lease obligations. As capital lease obligations have
aged, a greater portion of lease payments has been attributed to principal
payments rather than interest expense. Furthermore, management has been able
to obtain lower effective interest rates on new lease obligations.
LIQUIDITY AND CAPITAL RESOURCES
Cash used by operating activities was $8.7 million and $8.0 million
during the three and nine month periods ended September 30, 1999,
respectively. During the three months ended September 30, 1999, the effect of
the Company's net loss of $31.4 million was offset by non-cash expenses, such
as depreciation and amortization expenses, of $23.1 million. During the nine
months ended September 30, 1999, the Company's net loss of $78.2 million was
offset by non-cash expenses, such as depreciation and amortization expenses
of $68.1 million.
Cash used in investing activities was $11.7 million and $33.7
million during the three and nine month periods ended September 30, 1999,
respectively. Capital equipment purchases were $11.4 million and $33.6
million during the three and nine month periods ended September 30, 1999,
respectively. Cash proceeds from sales of capital equipment were $1.2 million
and $1.4 million during the three and nine month periods ended September 30,
1999, respectively. In September 1999 the Company made an initial investment
in a limited partnership of $1.5 million.
Cash provided by financing activities was approximately $6.4 million
and $239.2 million during the three and nine month periods ended September
30, 1999, respectively. Proceeds from the exercise of stock options and
warrants were $6.2 million during the three months ended September 30, 1999.
Proceeds and principal payments under capital leases were $4.0 million and
$3.8 million, respectively, during the three months ended September 30, 1999.
Sale leaseback transactions are recorded at cost, which approximates the fair
market value of the property and, therefore, no gains or losses are recorded.
The property continues to be depreciated by the Company. A financing
obligation representing the proceeds is recorded and reduced based upon
payments under the lease agreement. Proceeds from the exercise of stock
options and warrants were $9.9 million during the nine months ended
September 30, 1999. 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. In
conjunction with the offering, Sprint exercised its preemptive rights to
maintain its existing ownership level in the Company. Accordingly, Sprint
purchased 808,000 shares of which 201,000 shares were Common Stock and
607,000 shares were Series B Convertible Preferred Stock (having the same
rights and preferences as the Series A Convertible Preferred Stock already
held by Sprint). Net proceeds from the sale of Common Stock were $183.1
million. Net proceeds from the sale of Series B Convertible Preferred Stock
to Sprint were approximately $42.6 million. Proceeds and principal payments
under capital leases were $11.8 million and $9.3 million, respectively,
during the nine months ended September 30, 1999.
As of September 30, 1999, the Company had cash and cash equivalents
of approximately $338.3 million. The Company believes that available cash
will be sufficient to meet the Company's operating expenses and capital
requirements for the next 12 months. EarthLink has available a $50 million
credit facility from Sprint in the form of convertible senior debt,
increasing to $100 million by June 5, 2001, at an interest rate of 6% per
annum. The Company's capital requirements depend on numerous factors,
including the rate of market acceptance of the Company's services, the
Company's ability to maintain and expand its member base, the rate of
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expansion of the Company's network infrastructure, the level of resources
required to expand the Company's marketing and sales programs, information
systems and research and development activities, the availability of hardware
and software provided by third-party vendors and other factors.
YEAR 2000
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 dial
up access vendors to maintain network reliability.
We have completed our assessment of the year 2000 readiness of our
third-party supplied software, computer technology and other services. Based
upon testing and vendor supplied documentation, we believe that all of our
material third party providers are year 2000 compliant and that all other
providers are substantially ready. We tested our own 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 operate properly when the year 2000 event occurs.
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, PSINet and Level 3, 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 readiness
efforts have been and are expected to continue to be minimal.
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"SAFE HARBOR" STATEMENT
The Management's Discussion and Analysis and other portions of this
Report include "forward looking" statements within the meaning of the federal
securities laws that are subject to future events, risks and uncertainties
that could cause actual results to differ materially from those expressed or
implied. Important factors that ether individually or in the aggregate could
cause actual results to differ materially from those expressed include,
without limitation, (1) that the Company will not retain or grow its member
base, (2) that the Company will fail to be competitive with existing and new
competitors, (3) that the Sprint alliance will not be as beneficial to the
Company as management anticipates, (4) that the Company will not be able to
sustain its current growth, (5) that the Company will not adequately respond
to technological developments impacting the Internet, (6) that needed
financing will not be available to the Company if and as needed, (7) that a
significant change in the growth rate of the overall U.S. economy will occur,
such that consumer and corporate spending are materially impacted, (8) that a
significant reversal in the trend toward increased usage of the Internet will
occur, and (9) that the Company or its vendors and suppliers may fail to
timely achieve Year 2000 readiness such that there is a material adverse
impact on the business, operations or financial results of the Company, (10)
that a drastic negative change in the market conditions may occur, or (11)
that some other unforeseen difficulties may occur. This list is intended to
identify only certain of the principal factors that could cause actual
results to differ materially from those describe in the forward-looking
statements included herein.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 6. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Exhibits. The following exhibits are filed as part of this report:
EXHIBIT NO. DESCRIPTION
----------- -----------
2.1 Agreement and Plan of Reorganization, dated September 22,
1999, among EarthLink Network, Inc., MindSpring Enterprises,
Inc. and WWW Holdings, Inc. (incorporated by reference to
Exhibit 2.1 of the Company's Report on Form 8-K, File No.
333-52507).
2.2 Stock Option Agreement, dated September 22, 1999, between
MindSpring Enterprises, Inc. and EarthLink Network, Inc.
(incorporated by reference to Exhibit 2.2 of the Company's
Report on Form 8-K, File No. 333-52507).
2.3 Stock Option Agreement, dated September 22, 1999, between
EarthLink Network, Inc. and MindSpring Enterprises, Inc.
(incorporated by reference to Exhibit 2.3 of the Company's
Report on Form 8-K, File No. 333-52507).
2.4 Form of EarthLink Stockholder Agreements, dated September 22,
1999, between certain stockholders and EarthLink Network, Inc.
(incorporated by reference to Exhibit 2.4 of the Company's
Report on Form 8-K, File No. 333-52507).
2.5 Form of MindSpring Stockholder Agreement, dated September 22,
1999, between certain stockholders and MindSpring Enterprises,
Inc. (incorporated by reference to Exhibit 2.5 of the
Company's Report on Form 8-K, File No. 333-52507).
2.6 Press Release, dated September 23, 1999, announcing execution
of a definitive agreement to merge with MindSpring
Enterprises, Inc. (incorporated by reference to Exhibit 2.6 of
the Company's Report on Form 8-K, File No. 333-52507).
10.1 Lease agreement between EarthLink Network Inc. and Prentiss
Properties Natomas, L.P. a Delaware limited partnership.
27.1 Financial Data Schedule.
(b) Reports on Form 8-K.
See the Company's Report on Form 8-K, File No. 333-52507 filed
September 30, 1999.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EARTHLINK NETWORK, INC.
Date: November 15, 1999 /s/ CHARLES G. BETTY
--------------------- --------------------------------------------
Charles G. Betty, President, Chief Executive
Officer and Director
Date: November 15, 1999 /s/ GRAYSON L. HOBERG
--------------------- --------------------------------------------
Grayson L. Hoberg, Senior Vice President -
Finance and Administration and Chief
Financial Officer
Date: November 15, 1999 /s/ RICHARD A. QUIROGA
--------------------- --------------------------------------------
Richard A. Quiroga, Vice President, Corporate
Controller
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