<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 MARCH 31, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 001-15605
EARTHLINK, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 58-2511877
(STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
1430 WEST PEACHTREE ST., SUITE 400, ATLANTA, GEORGIA 30309
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(404) 815-0770
(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 118,174,099 shares of Common Stock outstanding as of
March 31, 2000.
================================================================================
<PAGE>
EARTHLINK, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2000
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.......................................... 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk ......... 14
PART II
Item 4. Submission of Matters to a Vote of Security Holders................. 15
Item 6. Exhibits and Reports on Form 8-K.................................... 15
<PAGE>
PART I
ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
EARTHLINK, INC.
CONDENSED CONSOLIDATED BALANCE SHEET
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, 1999 MARCH 31, 2000
-------------------- -------------------
(AUDITED) (UNAUDITED)
(in thousands)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 685,753 $ 891,342
Accounts receivable, net 16,367 19,085
Prepaid expenses 19,596 11,699
Other assets 13,672 16,970
-------------------- -------------------
Total current assets 735,388 939,096
Investments in other companies 4,400 10,400
Other long-term assets 12,536 1,198
Property and equipment, net 151,435 166,080
Intangibles, net 205,388 181,858
-------------------- -------------------
$ 1,109,147 $ 1,298,632
==================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 47,074 $ 29,726
Accrued payroll and related expenses 15,850 11,189
Other accounts payable and accrued liabilities 58,947 101,227
Current portion of capital lease obligations 11,724 8,823
Convertible notes (Note 9) 179,975 179,975
Deferred revenue 28,732 31,171
-------------------- -------------------
Total current liabilities 342,302 362,111
Long-term debt
Long-term portion of capital lease obligations 8,392 8,203
-------------------- -------------------
Total liabilities 350,694 370,314
Stockholders' equity:
Preferred stock 76 167
Common stock 1,169 1,182
Additional paid-in capital 1,085,109 1,366,744
Warrants to purchase common stock 477 448
Accumulated deficit (328,378) (440,223)
-------------------- -------------------
Total stockholders' equity 758,453 928,318
-------------------- -------------------
$ 1,109,147 $ 1,298,632
==================== ===================
</TABLE>
The accompanying notes are an integral part of these financial statements
1
<PAGE>
EARTHLINK, INC.
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------------------------------
1999 2000
------------------ -------------------
(UNAUDITED)
(in thousands, except per share data)
<S> <C> <C>
Narrowband access $ 114,804 $ 185,455
Web hosting 9,217 16,300
Broadband access 3,493 8,974
Content, commerce and advertising 2,357 8,976
------------------ -------------------
Total revenues 129,871 219,705
Cost of revenues 50,992 77,548
Sales and marketing 31,122 118,967
Operations and member support 34,702 62,828
General and administrative 13,681 20,979
Merger and restructuring charges (Note 5) - 33,967
Acquisition-related costs (Note 6) 30,996 23,663
-------------------
------------------ -------------------
Total operating costs and expenses 161,493 337,952
------------------ -------------------
Loss from operations (31,622) (118,247)
Interest income 5,077 12,477
Interest expense (1,212) (2,744)
------------------ -------------------
Net loss (27,757) (108,514)
Deductions for accretion dividends (Note 7) $ (3,646) (3,331)
------------------ -------------------
Net loss attributable to common stockholders $ (31,403) $ (111,845)
================== ===================
Basic and diluted net loss per share (Note 4) $ (0.29) $ (0.95)
================== ===================
Weighted average common shares outstanding 107,902 117,426
================== ===================
</TABLE>
The accompanying notes are an integral part of these financial statements
2
<PAGE>
EARTHLINK, INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------------------------
1999 2000
------------------- -------------------
(UNAUDITED)
(in thousands)
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (27,757) $ (108,514)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities, net of effect from
acquisition:
Depreciation and amortization 39,148 29,822
Increase in accounts receivable, net (889) (2,718)
(Increase) decrease in prepaid expenses and other assets (4,726) 15,937
Increase in accounts payable and accrued liabilities 21,306 20,271
Increase in deferred revenue 5,742 (2,439)
------------------- -------------------
Net cash provided by (used in) operating activities $ 32,824 $ (42,763)
------------------- -------------------
Cash flows from investing activities:
Purchases of property and equipment (25,804) (20,936)
Purchases of member bases (225,409)
Investments in other companies (6,000)
------------------- -------------------
Net cash used in investing activities (251,213) (26,936)
------------------- -------------------
Cash flows from financing activities:
Proceeds from capital lease obligations 470 151
Principal payments under capital lease obligations (3,191) (3,241)
Proceeds from line of credit 78,064
Proceeds from public stock offerings 183,098
Proceeds from sale of common stock 19,252
Proceeds from issuance of redeemable preferred stock 42,622 257,097
Proceeds from liquidation of stock subscription receivable 1,041
Proceeds from stock options and warrants exercised 2,448 2,029
------------------- -------------------
Net cash provided by financing activities 304,552 275,288
------------------- -------------------
Net increase in cash and cash equivalents 86,163 205,589
Cash and cash equivalents, beginning of period 308,607 685,753
------------------- -------------------
Cash and cash equivalents, end of period $ 394,770 $ 891,342
=================== ===================
Supplemental Non-cash Disclosures:
Stock issued in conjunction with acquisition $ 30,000 $ -
=================== ===================
Non-cash adjustments related to accretion dividends $ 3,646 $ 3,331
=================== ===================
</TABLE>
The accompanying notes are an integral part of these financial statements
3
<PAGE>
EARTHLINK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
EarthLink, Inc., (collectively, "EarthLink" or the "Company"), is a
leading Internet service provider, or ISP, providing reliable nationwide
Internet access and related value-added services to our individual and
business members. EarthLink was formed in February 2000 as a result of the
merger of EarthLink Network, Inc ("EarthLink Network") and MindSpring
Enterprises, Inc., ("MindSpring") in a transaction accounted for as a
"pooling of interests". By combining the two companies, we formed the second
largest Internet service provider in the United States.
2. BASIS OF PRESENTATION
The condensed consolidated financial statements of EarthLink, Inc.,
which include the accounts of its wholly owned subsidiary, EarthLink
Operations Inc., for the three month periods ended March 31, 2000 and 1999
and the related footnote information are unaudited and have been prepared on
a basis substantially consistent with the Company's audited supplemental
financial statements as of December 31, 1999 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. The condensed consolidated financial statements have
been prepared to give retroactive effect to the merger, in February 2000, of
EarthLink Network and MindSpring in a transaction accounted for as a pooling
of interests. Separate results of the combined entities for the three months
ended March 31, 1999 were as follows:
THREE MONTHS ENDED
MARCH 31, 1999
--------------
(In thousands, unaudited)
Revenue:
EarthLink Network $ 68,243
MindSpring 61,628
==============
$ 129,871
==============
Net loss attributable to common shareholders:
EarthLink $ (25,889)
MindSpring (3,304)
Adjustment to reflect establishment of tax
valuation allowance (2,210)
==============
$ (31,403)
==============
These financial statements should be read in conjunction with the
audited supplemental 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 March
31, 2000 and the results of operations and of cash flows for the three month
period ended March 31, 2000. The results of operations for the three month
period ended March 31, 2000 are not necessarily indicative of the results
anticipated for the entire year ending December 31, 2000.
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.
4
<PAGE>
EARTHLINK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3. RECLASSIFICATIONS AND CONVERSIONS
Certain amounts in prior period financial statements have been
reclassified to conform to the current period presentation.
Each outstanding share of EarthLink Network securities was exchanged
for 1.615 shares of the equivalent security of the new Company and each
outstanding share of MindSpring securities was exchanged for one share of the
securities of the new Company. Other outstanding securities of the companies
were converted on the same basis. The accompanying financial statements have
also been retroactively adjusted to give effect to the two-for-one stock split
effected by MindSpring in June 1999. The effect of these conversions is
reflected in the earnings per share of EarthLink, Inc.
4. 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.
5. MERGER AND RESTRUCTURING CHARGES
During the three months ended March 31, 2000, the Company recorded a
charge of $34.0 million related to the merger of EarthLink Network and
MindSpring. The following table summarizes the activity in the accruals
during the three months ended March 31, 2000. The balance of the merger and
restructuring accrual at March 31, 2000 is included in accrued expenses on
the condensed consolidated balance sheet and is expected to be paid within 12
months.
<TABLE>
<CAPTION>
MERGER AND BALANCE AT
RESTRUCTURING NON CASH MARCH 31,
CHARGES ITEMS PAYMENTS 2000
------------- -------- -------- ----------
(in thousands)
<S> <C> <C> <C> <C>
Investment banking fees $ 16,411 $ (5,921) $10,490
Printing, filing, mailing and proxy solicitation, legal,
accounting and advisory fees 6,118 (5,477) 641
Acceleration of unamortized costs associated with:
line of credit and convertible debt 6,792 $(6,792)
Severance costs and accelerated compensation expense 2,716 (1,076) (300) 1,340
Other 1,930 (1,835) 95
------------- --------- --------- ----------
$ 33,967 $(7,868) $(13,533) $12,566
============= ========= ========= ==========
</TABLE>
6. ACQUISITION-RELATED COSTS
Acquisition related charges primarily represent amortization related to
the acquisition of the Sprint Internet Passport business in June 1998, the
acquisition of various assets used in connection with the consumer dial-up
Internet access business of Spry, Inc., ("Spry"), in October 1998 and the
acquisition of the United States Internet services business of NETCOM On-Line
Communication Services, Inc., ("NETCOM"), in February 1999. Intangible assets
acquired in connection with the Sprint Transaction are being amortized on a
straight-line basis over the estimated useful lives. The member base and
goodwill, which represents the excess of consideration over the fair value of
net assets acquired, were fully amortized as of December 31, 1999. The Marketing
and Distribution Agreement is being amortized over 5 and 10 years which
represents the life of the portion of the contract related to Sprint's provision
of additional members and the overall contract life relative to the co-branding
feature, respectively. The member bases acquired from Spry and NETCOM are being
amortized over three years.
5
<PAGE>
EARTHLINK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
7. DEDUCTIONS FOR DIVIDENDS ON CONVERTIBLE PREFERRED STOCK
Dividends on convertible preferred stock are reflected as an increase
to net loss attributable to common stockholders. The adjustment of $3.3 million
recorded during the three months ended March 31, 2000 represents a liquidation
dividend of $2.3 million based on a 3% dividend and the accretion of a $1.0
million dividend related to the beneficial conversion feature of the convertible
preferred stock.
8. COMMON AND CONVERTIBLE PREFERRED STOCK ISSUED
In January 2000, the Company entered into a multi-year partnership
to deliver services to customers of Apple Computer, Inc ("Apple") in the
U.S. Under the terms of the partnership, EarthLink will become the exclusive
default ISP in Apple's Internet Setup Software included with all Apple
Macintosh(R) computers sold in the U.S. Under this arrangement EarthLink will
pay Apple one time fees for new subscribers on the Apple platform. In
addition, Apple purchased 7,083,333 shares of Series C convertible preferred
stock for $200 million and appointed a member to the EarthLink Board of
Directors in accordance with Apple's rights under the agreement.
In February 2000, Sprint exercised its preemptive rights to maintain
its ownership in the Company after the aforementioned purchase of shares by
Apple. Accordingly, Sprint purchased 2.7 million shares of which 682,000 were
common stock and 2.0 million were series B convertible preferred stock.
Proceeds from the sale of common and preferred stock to Sprint were
approximately $77 million.
9. SUBSEQUENT EVENTS
As discussed in the Company's Annual Report, the merger of EarthLink
Network and MindSpring constituted a change in control as defined in the
Indenture Agreement of MindSpring's 5 percent Convertible Subordinated Notes.
Holders of the notes had the right to demand payment equal to 100% of the
principal amount of the notes, plus accrued interest. Accordingly, in
February 2000, the Company offered to purchase for cash all of its 5 percent
Convertible Subordinated Notes. On March 31, 2000 approximately $179.1
million of the $180.0 million aggregate principal amount of the notes
outstanding were tendered to the Company for repurchase. The total payment of
$183.4 million including interest was paid in April 2000 $183.4 million.
In May 2000, Sprint exercised its preemptive rights to maintain its
ownership in the Company after the aforementioned merger of EarthLink Network
and MindSpring. Accordingly, Sprint agreed to purchase approximately 26.0
million shares consisting of approximately 6.0 million shares of common stock
and approximately 20.0 million shares of series B convertible preferred
stock. Proceeds from this sale of common and preferred stock to Sprint will
be approximately $431.5 million.
6
<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 events to occur,
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 "Forward Looking Statements."
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE ACCOMPANYING
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES THERETO
AND THE AUDITED SUPPLEMENTAL COMBINED FINANCIAL STATEMENTS AND THE NOTES THERETO
CONTAINED IN THE ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31,
1999.
OVERVIEW
EarthLink, Inc is a leading Internet service provider, or ISP, providing
reliable nationwide Internet access and related value-added services to our
individual and business members. The Company was formed in February 2000 as a
result of the merger of EarthLink Network Inc ("EarthLink Network") and
MindSpring Enterprises Inc., ("MindSpring"). By combining the two companies
we formed the second largest Internet service provider in the United States.
We expect to achieve significant revenue, expense and capital synergies
through economies of scale, the elimination of duplicative expenditures and
the combined skills of the two companies' management teams. We will also be
able to take advantage of the complimentary blend of assets and capabilities
contributed by the two companies to improve and expand service offerings and
accelerate its member growth rate.
Our member base grew from approximately 3.1 million paying members as of
December 31, 1999 to approximately 3.5 million paying members as of March 31,
2000. Our organic growth is a product of our efforts to enhance our members'
Internet experience through (1) simple, rapid and reliable access to the
Internet, (2) superior member service and technical support, and (3) member
education and support. As a result, we believe we have a high member
retention rate for our industry.
The Company continues to pursue revenue growth in four key business areas:
- NARROWBAND ACCESS REVENUES which consist of monthly fees charged to
members for dial up Internet access;
- WEB HOSTING REVENUES which we earn principally in the form of
monthly fees for providing web hosting services to companies and
individuals wishing to have a web or e-Commerce presence
- BROADBAND ACCESS REVENUES which consist of fees charged for
high-speed, high capacity access services including cable, dedicated
circuits and Digital Subscriber Lines, ("DSL"); and
- CONTENT, COMMERCE AND ADVERTISING REVENUES which primarily
represent revenues from Premier Partnerships. Premier Partnerships
are promotional arrangements with advertisers, retailers, service
providers, and content providers. Revenues are received in a
variety of forms, including: (i) fixed payments for placing links
from our properties to third party sites; (ii) variable payments
based on the volume of traffic delivered to our partners in the
form of customers, page views, or e-commerce revenues; and (iii)
payments for ads in our various on-line properties and our
bi-monthly magazine bLink.
In January 2000, we entered into a strategic alliance with Apple Computer,
Inc., ("Apple") which we expect to help accelerate our member growth. In
connection with this alliance, we expanded our existing commercial
relationship with Apple so that we will serve as the default ISP for Apple's
Macintosh line of computers for a minimum of two years and our overall
commercial relationship has been extended through January 4, 2005.
7
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth the percentage of total revenues represented by
certain items in our statement of operations for the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
March 31, 1999 March 31, 2000
--------------------- ---------------------
% of % of
(000's) Revenue (000's) Revenue
----------- --------- --------- --------
(Unaudited)
<S> <C> <C> <C> <C>
Statement of Operations Data:
Revenues:
Narrowband access $ 114,804 88 $ 185,455 85
Web Hosting 9,217 7 16,300 7
Broadband access 3,493 3 8,974 4
Content, commerce and advertising 2,357 2 8,976 4
----------- --------- --------- -----------
Total revenues 129,871 100 219,705 100
----------- --------- --------- -----------
Operating costs and expenses:
Cost of revenues 50,992 39 77,548 35
Sales and marketing 31,122 24 118,967 54
Operations and member support 34,702 27 62,828 29
General and administrative 13,681 10 20,979 10
Merger and restructuring charges (1) - - 33,967 15
Acquisition-related costs (2) 30,996 24 23,663 11
----------- --------- --------- -----------
Total operating costs and expenses 161,493 124 337,952 154
----------- --------- --------- -----------
Loss from operations (31,622) (24) (118,247) (54)
Interest income 5,077 4 12,477 6
Interest expense (1,212) (1) (2,744) (1)
----------- --------- --------- -----------
Net loss (27,757) (21) (108,514) (49)
Deductions for accretion dividends (3,646) (3) (3,331) (2)
----------- --------- --------- -----------
Net loss attributable to common stockholders $ (31,403) (24) $ (111,845) (51)
=========== ========= ========= ===========
</TABLE>
- -----------------
(1) These cost were primarily attribute to fees associated with investment
banking, legal and accounting services, the acceleration of unamortized
costs associated with a line of credit and convertible debt, severance
costs and noncash accelerated compensation expense resulting from the
merger.
(2) Represents acquisition and amortization related expenses for the
periods ended March 31, 1999 and 2000 resulting from the following:
a. the acquisition of various assets used in connection with the
consumer dial-up Internet access business of Spry, Inc., ("Spry"),
in October 1998.
b. the acquisition of the United States Internet services
business of NETCOM On-Line Communication Services, Inc., ("NETCOM"),
in February 1999.
c. the acquisition of the Sprint Internet Passport business in June
1998.
8
<PAGE>
NARROWBAND ACCESS REVENUES
Narrowband access revenues consist of monthly fees charged to
members for dial up Internet access. EarthLink's narrowband revenues
increased from $114.8 million during the three months ended March 31, 1999 to
$185.5 million during the three months ended March 31, 2000, a 62 percent
increase. The substantial growth in narrowband revenues was primarily due to
an increase in the Company's narrowband member base from 2.2 million at March
31, 1999 to 3.3 million at March 31, 2000. The growth in our member base was
primarily due to our efforts in sales and marketing. Approximately 408,000
members were acquired from NETCOM in February 1999.
WEB HOSTING REVENUES
Web hosting revenues are earned by leasing server space and providing
web services to companies and individuals wishing to present a web or e-commerce
presence. EarthLink's Web hosting revenues increased from $9.2 million during
the three months ended March 31, 1999 to $16.3 million during the three months
ended March 31, 2000, a 77 percent increase. As of March 31, 2000, the Company
hosted 121,000 Web sites compared to 68,000 as of March 31, 1999, a 78 percent
increase.
BROADBAND ACCESS REVENUES
Broadband access revenues represent fees charged for high-speed,
high-capacity access services including cable, dedicated circuits and DSL
services. EarthLink's broadband revenues increased from $3.5 million during the
three months ended March 31, 1999 to $9.0 million during the three months ended
March 31, 2000, a 157 percent increase. The substantial growth in broadband
revenues was primarily due to an increase in the Company's broadband member base
from 9,400 at March 31, 1999 to 45,000 at March 31, 2000. We serviced 21
broadband markets nationwide as of March 31, 2000.
CONTENT, COMMERCE AND ADVERTISING REVENUES
Content, commerce and advertising revenues primarily represent
revenues from Premier Partnerships. Premier Partnerships are promotional
arrangements with advertisers, retailers, service providers, and content
providers. Revenues are received in a variety of forms, including: (i) fixed
payments for placing links from our properties to third party sites; (ii)
variable payments based on the volume of traffic delivered to our partners in
the form of customers, page views, or e-commerce revenues; and (iii) payments
for ads in our various on-line properties and our bi-monthly magazine bLink.
Content, commerce and advertising revenues increased from $2.4 million during
the three months ended March 31, 1999 to $9.0 million during the three months
ended March 31, 2000, a 275 percent increase. The principal component of our
strategy is our Premier Partnership Program, through which we offer and 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 and content space on our various online
properties.
COST OF REVENUES
Cost of revenues increased from $51.0 million during the three
months ended March 31, 1999 to $77.6 million during the three months ended
March 31, 2000, primarily due to the increase in our member base. However,
cost of revenues as a percentage of revenues decreased from 39% to 35%. This
percentage decrease is attributable to: (a) more effective management of our
network, (b) our increasing ability to negotiate more favorable commercial
arrangements with our telecommunications service providers as we leverage our
growing member base.
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 283% from $31.1 million during the three months
ended March 31, 1999 to $119.0 million during the three months ended March 31,
2000. The increase was primarily due to the costs of growing our member base
from 2.3 million at March 31, 1999 to 3.5 million at March 31, 2000
9
<PAGE>
and is in accordance with management's increased emphasis on organic growth and
increasing market share through marketing strategies. This increased emphasis
includes the implementation of an ambitious advertising program to create brand
awareness, expansion of direct mail marketing programs, the development of new
marketing channels, increased third party bounties 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 customer
information systems and network operations. Operations and member support
expenses increased from $34.7 million or 27% of revenues during the three months
ended March 31, 1999 to $62.8 million or 29% of revenues for the three months
ended March 31, 2000. These increases reflect (1) the increase in members from
2.3 million at March 31, 1999 to 3.5 million at March 31, 2000, (2) the opening
of additional call centers in 1999 and (3) management's focus on retaining
existing members by providing superior service and devoting significant
resources to expanding technical support capabilities.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist primarily of costs
associated with the finance, legal and human resources departments, outside
professional services, and payment processing, collections and bad debt
expenses. General and administrative expenses increased 53% from $13.7 million
during the three months ended March 31, 1999 to $21.0 million during the three
months ended March 31, 2000. The increase was primarily due to increases in
salaries and wages, depreciation, credit card processing fees, and bad debt. The
rise in salaries and wages was primarily due to growth in headcount. The
increase in depreciation expense was due to the acquisition of office equipment
and the build-out of leasehold improvements. The increases in credit card
processing fees and bad debt were due to the increase in our member base. The
Company incurred additional integration costs that have not been identified
as merger and restructuring charges because they have a future benefit to the
Company. Integration costs include travel and lodging, employee events, and
fees paid to consultants and attorneys.
MERGER AND RESTRUCTURING CHARGES
During the three months ended March 31, 2000, the Company recorded a
charge of $34.0 million related to the merger of EarthLink Network and
MindSpring. The following table summarizes the activity in the accruals
during the three months ended March 31, 2000. The balance of the merger and
restructuring accrual at March 31, 2000 is included in accrued expenses on
the condensed consolidated balance sheet and is expected to be paid within 12
months.
<TABLE>
<CAPTION>
MERGER AND BALANCE AT
RESTRUCTURING NON CASH MARCH 31,
CHARGES ITEMS PAYMENTS 2000
------------- -------- -------- ----------
(in thousands)
<S> <C> <C> <C> <C>
Investment banking fees $ 16,411 $ (5,921) $10,490
Printing, filing, mailing and proxy solicitation, legal,
accounting and advisory fees 6,118 (5,477) 641
Acceleration of unamortized costs associated with:
line of credit and convertible debt 6,792 $(6,792)
Severance costs and accelerated compensation expense 2,716 (1,076) (300) 1,340
Other 1,930 (1,835) 95
------------- --------- --------- ----------
$ 33,967 $(7,868) $(13,533) $12,566
============= ========= ========= ==========
</TABLE>
ACQUISITION RELATED COSTS
Intangible assets acquired in connection with the Sprint Transaction
are being amortized on a straight-line basis over their estimated useful lives.
The member base and goodwill, which represents the excess of consideration over
the fair value of net assets acquired, were fully amortized as of December 31,
1999. The Marketing and Distribution Agreement is being amortized over 5 and 10
years which represents the life of the portion of the contract related to
Sprint's provision of additional members and the overall contract life relative
to the co-branding feature, respectively. The member bases acquired from Spry
and NETCOM are being amortized over three years.
10
<PAGE>
The decrease in acquisition related costs from $31.0 million during the three
months ended March 31, 1999 to $23.7 million during the three months ended March
31, 2000 is primarily due to the fact that the customer base and the goodwill
acquired in connection with the sprint transaction were fully amortized by
December 31, 1999.
INTEREST INCOME AND EXPENSE
Interest income increased from $5.1 million during the three months
ended March 31, 1999 to $12.5 million during the three months ended March 31,
2000. The increase was primarily due to an increase in average cash balances
available for investment as a result of our public stock offerings completed
in 1999 as well as investments in the company made by Apple and Sprint during
the first quarter of 2000. Interest expense increased from $1.2 million
during the three months ended March 31, 1999 to $2.7 million during the three
months ended March 31, 2000 due to borrowings of $179.9 million in 5%
convertible subordinated notes that were issued in the second quarter of 1999
and outstanding during the first quarter of 2000. This increase in interest
expense was partially offset by the aging of capital lease obligations and a
general reduction in interest rates paid on capital leases entered into
during 1999.
LIQUIDITY AND CAPITAL RESOURCES
Our operating activities provided approximately $32.8 million and
used approximately $42.8 million during the three months ended March 31, 1999
and March 31, 2000, respectively. The Company's net losses of $27.8 million
and $108.5 million were the primary components of cash used in operating
activities during the three months ended March 31, 1999 and March 31, 2000,
respectively. During the three months ended March 31, 1999 the Company's net
losses were offset by (i) non-cash depreciation and amortization expenses,
relating to the Company's network and intangible assets, of $39.1 million and
(ii) an increase accounts payable and accrued expenses of $21.3 million
particularly related to merger costs. During the three months ended March 31,
2000 the Company's net losses were partially offset by (i) non-cash
depreciation and amortization expenses, relating to the Company's network and
intangible assets, of $29.8 million (ii) an increase accounts payable and
accrued expenses of $20.3 million, and (iii) a decrease in accounts
receivable and other assets of $13.2 million.
Our investing activities, used cash of approximately $251.2 million,
and $26.9 million during the three months ended March 31, 1999 and March 31,
2000, respectively. In February 1999 we acquired the member base of NETCOM and
approximately $13.2 million capital equipment for consideration of $245 million,
consisting of $215 million in cash and $30 million in common stock, (752,232
shares, at a price per share of $39.88). Capital equipment purchases were $25.8
million and $20.9 million during the three month periods ended March 31, 1999
and March 31, 2000, respectively. During the three months ended March 31, 2000
the Company invested $6.0 million in eCompanies Venture Group, LP.
Our financing activities provided approximately $304.6 million and
$275.3 million in cash during the three months ended March 31, 1999 and March
31, 2000, respectively. In January 1999, the Company completed a follow-on
public offering of 3.9 million shares of its common stock at $45.59 per share.
In conjunction with the offering, Sprint exercised its preemptive rights to
maintain its existing ownership level in the Company. Accordingly, Sprint
purchased 1.2 million shares of which 310,000 shares were common stock and
932,000 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. In February 1999 the Company borrowed approximately
$80 million under a secured revolving credit facility for the purpose of funding
the acquisition of the NETCOM member base. In January 2000, the Company
entered into a multi-year partnership to deliver services to customers of
Apple in the U.S. Under the terms of the partnership, Apple purchased
7.1 million shares of EarthLink's series C convertible preferred stock for $200
million. In February 2000, Sprint exercised its preemptive rights to maintain
its ownership in the Company after the aforementioned purchase of shares by
Apple Computer Corporation. Accordingly, Sprint purchased 2.7 million shares
of which 682,000 were common stock and 2.0 million were series B convertible
preferred stock. Proceeds from the sale of common and preferred stock to
Sprint were approximately $77 million.
On March 31, 2000, we had approximately $891.3 million in cash and cash
equivalents. On March 31, 2000 approximately $179.1 million of the $180.0
million aggregate principal amount of notes outstanding were tendered to the
Company for repurchase. In April 2000, the Company paid $183.4 million
including interest on this repurchase. In May 2000, Sprint exercised its
preemptive rights to maintain its ownership in the Company after the
aforementioned merger of EarthLink Network and MindSpring. Accordingly,
Sprint agreed to purchase approximately 26.0 million shares consisting of
approximately 6.0 million shares of common stock and approximately 20.0
million shares of Series B convertible preferred stock. Proceeds from the
sale of common and preferred stock to Sprint will be approximately $431.5
million. We believe our available cash is sufficient to meet our operating
expenses and capital requirements for more than the next 12 months. We also
have 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. We have not borrowed any funds under this credit arrangement
with Sprint and do not anticipate any such borrowings. Our capital
requirements depend
11
<PAGE>
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.
FORWARD LOOKING STATEMENTS
As the second largest Internet service provider in the United
States, the Company intends to grow its business aggressively in order to
widen its lead over other Internet service providers and to narrow the gap
between itself and the number one ISP. Consistent with this intent, the
Company expects to end the year 2000 with approximately 4.5 million paying
subscribers and approximately $1 billion in revenues, although there can be
no assurances that we will achieve either or both of such levels this year.
Consistent with these aggressive growth objectives, the Company will invest
significantly in sales and marketing. Accordingly, the Company expects to
continue operating at a loss during 2000, with a net loss before transaction
costs (acquisition-related costs and merger and restructuring charges) in the
range of a negative $170 million to $215 million.
The preceding paragraph, 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 either individually or in the
aggregate could cause actual results to differ materially from those expressed
include, without limitation, (1) that the Company may fail to be competitive
with existing and new competitors, (2) that the Company may not retain or grow
its member base, (3) that the Sprint and/or the Apple alliance may not be as
beneficial to the Company as management anticipates, (4) churn may not improve
to expected levels, (5) the expected rate of growth in advertising, content and
commerce may not be achieved, (6) the Company may not adequately respond to
technological developments impacting the Internet, (7) that needed financing may
not be available to the Company if and as needed, (8) that a significant change
in the growth rate of the overall U.S. economy may occur, such that consumer and
corporate spending are materially impacted, (9) that a significant reversal in
the trend toward increased usage of the Internet may occur, (10) that a drastic
negative change in the market conditions may occur, and (11) that some other
unforeseen difficulties may occur. 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
12
<PAGE>
PART II
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
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
----------- ------------
27.1 Financial Data Schedule
(b) Reports on Form 8-K.
On February 16, 2000 the Company filed a Current Report on form 8-K to
report the consummation of the Merger of EarthLink Network, Inc.
("EarthLink Network") and MindSpring Enterprises ("MindSpring") into a
newly created company, (the "Merger"). On September 22, 1999, EarthLink
Network and MindSpring. entered into an Agreement and Plan of
Reorganization (the "Merger Agreement"), as previously reported in the
Current Report on Form 8-K filed by EarthLink on September 30, 1999. The
Merger Agreement and the transactions contemplated thereby were approved by
EarthLink Network and MindSpring stockholders at their respective
stockholder meetings on February 4, 2000, and the merger of EarthLink
Network and MindSpring into the newly created company was consummated on
such date pursuant to the Merger Agreement. Upon the closing of the Merger,
the new company was renamed "EarthLink, Inc." As a result of the Merger,
EarthLink, Inc. is the successor registrant to EarthLink Network, Inc. and
MindSpring Enterprises, Inc., and shall for all purposes be considered the
successor registrant to such companies under the Securities Act of 1933, as
amended, and the Securities Exchange Act of 1934, as amended, including
without limitation for use of Form S-3 Registration Statements.
13
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
EARTHLINK, INC.
Date: MAY 15, 2000 /s/ CHARLES G. BETTY
----------------------- -----------------------------------
Charles G. Betty, Chief Executive
Officer
Date: MAY 15, 2000 /s/ LEE ADREAN
----------------------- -----------------------------------
Lee Adrean, Executive Vice
President - Finance and
Administration and
Chief Financial Officer
(principal financial officer)
Date: MAY 15, 2000 /s/ D. CARY SMITH
---------------------- -----------------------------------
D. Cary Smith, Corporate Controller
(chief accounting officer)
14
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<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM (INDENTIFY
SPECIFIC FINANCIAL STATEMENTS HERE) QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
MARCH 31, 2000 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
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<FISCAL-YEAR-END> DEC-31-2000 DEC-31-1999
<PERIOD-START> JAN-01-2000 JAN-01-1999
<PERIOD-END> MAR-31-2000 MAR-31-1999
<CASH> 891,392 0
<SECURITIES> 0 0
<RECEIVABLES> 22,383 0
<ALLOWANCES> 3,298 0
<INVENTORY> 4,308 0
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<OTHER-SE> 926,969 0
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<INTEREST-EXPENSE> 2,744 0
<INCOME-PRETAX> (118,247) (31,622)
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