<PAGE>
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of Earlier Event Reported): July 7, 2000
EARTHLINK, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware 001-15605 58-2511877
(State or other Jurisdiction (Commission File Number) (I.R.S. Employer
of Incorporation) Identification No.)
1430 West Peachtree Street, N.W.
Suite 400
Atlanta, Georgia 30309
(Address of Principal Executive Offices)
Registrant's telephone number including area code: (404) 815-0770
-------------------
================================================================================
<PAGE>
ITEM 5. OTHER ITEMS
On February 4, 2000, EarthLink Network, Inc. ("EarthLink Network") and
MindSpring Enterprises, Inc. ("MindSpring") merged to form a new
corporation named EarthLink, Inc. ("EarthLink") in a transaction accounted
for as a pooling of interests. Each outstanding share of EarthLink Network
securities was exchanged for 1.615 shares of the equivalent security of
EarthLink and each outstanding share of MindSpring common stock was exchanged
for one share of the common stock of EarthLink. Other outstanding securities
of the companies were converted on the same basis.
The consolidated financial statements of EarthLink as of December 31, 1999
and 1998 and for the three years then ended give retroactive effect to the
merger of EarthLink Network and MindSpring. These financial statements were
previously filed in EarthLink's 1999 Annual Report on Form 10-K as
supplementary combined financial statements. The financial statements filed
herewith are no longer supplementary as financial statements covering the
date of the consummation of the business combination have been filed in
EarthLink's Quarterly Report on Form 10-Q filed on May 15, 2000.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
II-1
<PAGE>
EARTHLINK, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Report of Independent Accountants........................... F-1
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheet as of December 31, 1998
and 1999.................................................. F-3
Consolidated Statement of Operations for the three
years ended December 31, 1999............................. F-4
Consolidated Statement of Stockholders' Equity for
the three years ended December 31, 1999................... F-5
Consolidated Statement of Cash Flows for the three
years ended December 31, 1999............................. F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of EarthLink, Inc.
In our opinion, based on our audits and the report of other auditors, the
accompanying consolidated balance sheet and the related consolidated
statement of operations, of stockholders' equity and of cash flows present
fairly, in all material respects, the financial position of EarthLink, Inc.
and its subsidiary at December 31, 1998 and 1999, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1999 in conformity with accounting principles generally
accepted in the United States. 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. These financial
statements give retroactive effect to the merger of EarthLink Network, Inc.
and MindSpring Enterprises, Inc., forming a new corporation named EarthLink,
Inc., on February 4, 2000 in a transaction accounted for as a pooling of
interests, as described in Note 1 to the consolidated financial statements.
We did not audit the financial statements of MindSpring Enterprises, Inc.,
which statements reflect total assets of $247.6 million and $714.9 million as
of December 31, 1998 and 1999, respectively, and total revenues of $52.6
million, $114.7 million and $328.1 million for each of the three years in the
period ended December 31, 1999. Those statements were audited by other
auditors whose report thereon has been furnished to us, and our opinion
expressed herein, insofar as it relates to the amounts included for
MindSpring Enterprises, Inc., is based solely on the report of the other
auditors. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States, 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 and the report
of other auditors provide reasonable basis for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
Century City, California
March 28, 2000
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To EarthLink, Inc.:
We have audited the balance sheets of MINDSPRING ENTERPRISES, INC. (a
Delaware corporation) as of December 31, 1998 and 1999 and the related
statements of operations, stockholders' equity, and cash flows for the three
years ended December 31, 1997, 1998 and 1999. These financial statements are
the responsibility of MindSpring's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards 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. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of MindSpring
Enterprises, Inc. as of December 31, 1998 and 1999 and the results of its
operations and its cash flows for the three years ended December 31, 1997,
1998 and 1999 in conformity with accounting principles generally accepted in
the United States.
ARTHUR ANDERSEN LLP
Atlanta, Georgia
February 7, 2000
F-2
<PAGE>
EARTHLINK, INC.
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1998 1999
--------- ----------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 308,607 $ 685,753
Accounts receivable, net of allowance of $1,629,000 and
$3,933,000 at December 31, 1998 and 1999,
respectively............................................ 8,057 16,367
Prepaid expenses.......................................... 5,082 19,596
Other assets.............................................. 598 13,672
--------- ----------
Total current assets.................................... 322,344 735,388
Investments in other companies (Note 3)..................... -- 4,000
Other long-term assets...................................... 1,863 12,936
Property and equipment, net (Notes 1 and 4)................. 71,047 151,435
Intangibles, net (Note 5)................................... 114,748 205,388
--------- ----------
$ 510,002 $1,109,147
========= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable.................................... $ 28,119 $ 47,074
Accrued payroll and related expenses...................... 11,484 15,850
Other accounts payable and accrued liabilities............ 32,477 58,947
Current portion of capital lease obligations (Note 12).... 11,036 11,724
Deferred revenue.......................................... 16,274 28,732
--------- ----------
Total current liabilities............................... 99,390 162,327
Long-term liabilities:
Convertible notes (Note 6)................................ -- 179,975
Long-term portion of capital lease obligations (Note
12)..................................................... 10,125 8,392
--------- ----------
Total liabilities....................................... 109,515 350,694
Commitments and contingencies (Note 12)
Stockholders' equity:
Preferred stock, $0.01 par value, 100,000,000 shares
authorized,
Series A convertible 6,626,250 shares issued and
outstanding December 31, 1998 and 1999 (Notes 8 and
9)...................................................... 66 66
Series B convertible nil and 978,940 shares issued and
outstanding December 31, 1998 and 1999, respectively
(Note 8 and 9)........................................ -- 10
Common stock, $0.01 par value, 300,000,000 shares
authorized, 103,514,969 and 116,864,610 shares issued
and outstanding at December 31, 1998 and 1999,
respectively............................................ 1,035 1,169
Stock subscriptions receivable............................ (1,041) --
Additional paid-in capital................................ 540,408 1,085,109
Warrants to purchase common stock (Note 10)............... 597 477
Accumulated deficit....................................... (140,578) (328,378)
--------- ----------
Total stockholders' equity.............................. 400,487 758,453
--------- ----------
$ 510,002 $1,109,147
========= ==========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements
F-3
<PAGE>
EARTHLINK, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1997 1998 1999
---------- ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Revenues:
Narrowband access......................................... $119,030 $260,229 $ 582,883
Web hosting............................................... 12,557 22,007 47,435
Broadband access.......................................... 1,220 3,321 23,540
Content, commerce and advertising......................... 637 5,057 16,575
-------- -------- ---------
Total revenues.......................................... 133,444 290,614 670,433
-------- -------- ---------
Operating costs and expenses:
Cost of revenues.......................................... 57,183 115,529 248,487
Operations and member support............................. 44,801 80,244 182,134
Sales and marketing....................................... 36,281 65,037 219,349
General and administrative................................ 23,168 34,575 67,876
Acquisition-related costs (Note 5)........................ 4,208 49,684 148,267
-------- -------- ---------
Total operating costs and expenses...................... 165,641 345,069 866,113
-------- -------- ---------
Loss from operations........................................ (32,197) (54,455) (195,680)
Interest income (expense), net.............................. (1,800) 3,671 21,986
-------- -------- ---------
Net loss before income tax provision.................. (33,997) (50,784) (173,694)
Income tax provision........................................ (2,394)
-------- -------- ---------
Net loss.............................................. (33,997) (53,178) (173,694)
Deductions for accretion dividends (Note 9)................. (7,601) (14,106)
-------- -------- ---------
Net loss attributable to common stockholders................ $(33,997) $(60,779) $(187,800)
======== ======== =========
Basic and diluted net loss per share........................ $ (0.44) $ (0.66) $ (1.65)
======== ======== =========
Weighted average shares..................................... 77,387 91,466 113,637
======== ======== =========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements
F-4
<PAGE>
EARTHLINK, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK STOCK ADDITIONAL
------------------- ------------------- SUBSCRIPTIONS PAID-IN
SHARES AMOUNT SHARES AMOUNT RECEIVABLE CAPITAL WARRANTS
-------- -------- -------- -------- ------------- ---------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996....... 64,315 $ 644 $ 48,705 $ 599
Initial public offering, net of
expenses......................... 7,380 74 26,152
Conversion of redeemable preferred
stock into common stock.......... 4,404 44 13,969
Conversion of debt to common
stock............................ 181 2 723
Issuance of common stock in
connection with private
placement........................ 4,716 47 15,362
Issuance of common stock pursuant
to exercise of stock options..... 549 5 469
Warrants issued in exchange for
services (Note 10)............... 494
Net loss...........................
------ ---- ------- ------ ------- ---------- ------
Balance at December 31, 1997....... 81,545 816 105,380 1,093
Issuance of series A convertible
preferred stock (Note 8)......... 6,626 $ 66 134,934
Accretion of convertible preferred
stock............................ 7,601
Follow on offerings, net of
expenses (Note 7)................ 16,677 167 280,682
Conversion of debt to common
stock............................ 1,265 13 5,030
Issuance of common stock for
services......................... 32 130
Issuance of common stock pursuant
to exercise of stock options..... 2,739 27 4,216
Issuance of common stock pursuant
to exercise of warrants.......... 1,229 12 1,394 (647)
Warrants issued in conjunction with
marketing agreement.............. -- 91
Warrants issued in exchange for
services (Note 10)............... -- 60
Issuance of notes receivable from
stock sales...................... 28 $(1,041) 1,041
Net loss........................... --
------ ---- ------- ------ ------- ---------- ------
Balance at December 31, 1998....... 6,626 66 103,515 1,035 (1,041) 540,408 597
Issuance of series B convertible
preferred stock (Note 8)......... 979 $ 10 42,612
Accretion of convertible preferred
stock............................ 14,106
Follow on offering, net of expenses
(Note 7)......................... 9,744 98 446,540
Issuance of common stock pursuant
to customer base acquisition
(Note 2)......................... 752 7 29,993
Issuance of common stock pursuant
to exercise of stock options..... 2,307 23 10,929
Issuance of common stock pursuant
to exercise of warrants.......... 547 6 521 (120)
Collection of notes receivable from
stock sales...................... 1,041
Net loss...........................
------ ---- ------- ------ ------- ---------- ------
Balance at December 31, 1999....... 7,605 $ 76 116,865 $1,169 $ -- $1,085,109 $ 477
====== ==== ======= ====== ======= ========== ======
<CAPTION>
TOTAL
ACCUMULATED STOCKHOLDERS'
DEFICIT EQUITY
------------ -------------
(IN THOUSANDS)
<S> <C> <C>
Balance at December 31, 1996....... $ (45,802) $ 4,146
Initial public offering, net of
expenses......................... 26,226
Conversion of redeemable preferred
stock into common stock.......... 14,013
Conversion of debt to common
stock............................ 725
Issuance of common stock in
connection with private
placement........................ 15,409
Issuance of common stock pursuant
to exercise of stock options..... 474
Warrants issued in exchange for
services (Note 10)............... 494
Net loss........................... (33,997) (33,997)
--------- ---------
Balance at December 31, 1997....... (79,799) 27,490
Issuance of series A convertible
preferred stock (Note 8)......... 135,000
Accretion of convertible preferred
stock............................ (7,601)
Follow on offerings, net of
expenses (Note 7)................ 280,849
Conversion of debt to common
stock............................ 5,043
Issuance of common stock for
services......................... 130
Issuance of common stock pursuant
to exercise of stock options..... 4,243
Issuance of common stock pursuant
to exercise of warrants.......... 759
Warrants issued in conjunction with
marketing agreement.............. 91
Warrants issued in exchange for
services (Note 10)............... 60
Issuance of notes receivable from
stock sales......................
Net loss........................... (53,178) (53,178)
--------- ---------
Balance at December 31, 1998....... (140,578) 400,487
Issuance of series B convertible
preferred stock (Note 8)......... 42,622
Accretion of convertible preferred
stock............................ (14,106)
Follow on offering, net of expenses
(Note 7)......................... 446,638
Issuance of common stock pursuant
to customer base acquisition
(Note 2)......................... 30,000
Issuance of common stock pursuant
to exercise of stock options..... 10,952
Issuance of common stock pursuant
to exercise of warrants.......... 407
Collection of notes receivable from
stock sales...................... 1,041
Net loss........................... (173,694) (173,694)
--------- ---------
Balance at December 31, 1999....... $(328,378) $ 758,453
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements
F-5
<PAGE>
EARTHLINK, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1998 1999
-------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(33,997) $(53,178) $(173,694)
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities, net of effect from
acquisition:
Depreciation and amortization........................... 18,070 69,953 190,504
Loss on sale of assets.................................. 31
Issuance of common stock in exchange for professional
services.............................................. 130
Issuance of warrants in exchange for professional
services.............................................. 494 60
Increase in net accounts receivable..................... (801) (3,536) (9,801)
Increase in prepaid expenses and other assets........... (362) (3,496) (32,077)
Increase in accounts payable and accrued liabilities.... 3,298 41,679 56,790
Increase in deferred revenue............................ 3,362 10,486 12,458
-------- -------- ---------
Net cash (used in) provided by operating activities......... (9,936) 62,098 44,211
-------- -------- ---------
Cash flows from investing activities:
Purchase of property and equipment........................ (22,570) (44,492) (109,819)
Sale of property and equipment............................ -- -- 1,416
Purchase of intangible assets............................. (2,364) (27,321) (227,494)
Transaction costs......................................... (9,914)
Cash acquired from acquisition............................ 23,750
Investments in other companies............................ (4,000)
Purchase of restricted short-term investment.............. (200)
Liquidation of restricted short-term investment........... 37 1,250
Other..................................................... (159) 148
-------- -------- ---------
Net cash used in investing activities................... (25,097) (56,886) (339,749)
-------- -------- ---------
Cash flows from financing activities:
Proceeds from issuance of notes payable................... 4,387 200 174,082
Repayment of notes payable................................ (2,849) (6,626)
Proceeds from line of credit.............................. 77,987
Repayment of line of credit............................... (80,000)
Proceeds from capital lease obligations................... 10,544 9,275 13,456
Principal payments under capital lease obligations........ (6,968) (11,141) (14,501)
Proceeds from private placement of common stock........... 15,409
Proceeds from public stock offerings...................... 26,226 280,849 489,260
Proceeds from warrants exercised.......................... 759 407
Proceeds from stock options exercised..................... 474 4,243 10,952
Proceeds from liquidation of stock subscription
receivable.............................................. 1,041
-------- -------- ---------
Net cash provided by financing activities............... 47,223 277,559 672,684
-------- -------- ---------
Net increase in cash and cash equivalents................... 12,190 282,771 377,146
Cash and cash equivalents, beginning of year................ 13,646 25,836 308,607
-------- -------- ---------
Cash and cash equivalents, end of year...................... $ 25,836 $308,607 $ 685,753
======== ======== =========
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, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
EarthLink, Inc. (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. The Company was formed in
February 2000 by way 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.
BASIS OF 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 common stock was exchanged for one share of the common stock
of the new Company. Other outstanding securities of the companies were converted
on the same basis. The effect of these conversions is reflected in the earnings
per share of the new Company.
The consolidated financial statements have been prepared to give
retroactive effect to the merger of EarthLink Network and MindSpring in a
transaction accounted for as a pooling of interests (see note 16). The
financial statements also include the accounts of EarthLink Operations, Inc.
a wholly-owned subsidiary the Consolidated Company. All intercompany
transactions and balances have been eliminated in the financial statements.
Separate results of EarthLink Network and MindSpring for the three years
ended December 31, 1999 were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1998 1999
-------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Revenue:
EarthLink Network.......................... $ 80,888 $175,941 $ 342,288
MindSpring................................. 52,556 114,673 328,145
-------- -------- ---------
$133,444 $290,614 $ 670,433
======== ======== =========
Net loss:
EarthLink Network.......................... $(29,916) $(59,782) $(108,248)
MindSpring................................. (4,081) 10,544 (40,131)
Adjustment to reflect establishment of tax
valuation allowance...................... (3,940) (25,315)
-------- -------- ---------
$(33,997) $(53,178) $(173,694)
======== ======== =========
</TABLE>
In 1998, MindSpring's management reviewed its net deferred tax asset,
consisting primarily of net operating loss carryforwards and based on the net
income generated in 1998 as well as the projections of future income
determined that it was more likely than not that the deferred tax assets
would be realized. Accordingly, the Company reversed its valuation allowance
in 1998 and did not record one in 1999. In the course of the reorganization
discussions, management of MindSpring and EarthLink Network reviewed the
combined net deferred tax assets and concluded that sufficient uncertainty
now exists regarding realizability of the net deferred tax asset. The
financial statements of the Company include adjustments of $3.9 million and
$25.3 million for 1998 and 1999, respectively, to give effect to the
F-7
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
reestablishment of a valuation allowance on the MindSpring net deferred tax
assets. There were no intercompany transactions between the two companies or
significant conforming accounting adjustments.
REVENUES
Narrowband access revenues consists primarily of monthly fees charged to
members for dial-up Internet access. Web hosting revenues consists of fees
earned by leasing server space and providing web services to companies and
individuals wishing to present a web or e-commerce presence. Broadband access
revenues consists of fees charged for high-speed, high-capacity access services
including cable, ISDN and DSL services. Content, commerce and advertising
revenues are generated by leveraging the value of the Company's member base and
user traffic. All 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
of 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 to five years. Leasehold improvements are depreciated 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 depreciated over the
lesser of their estimated useful lives of three to five years or the term of the
lease.
F-8
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INTANGIBLES
Intangible assets consist primarily of acquired member bases, 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 MEMBER ACQUISITION COSTS
Advertising and member acquisition costs are included in sales and
marketing. Such costs are expensed as incurred. Advertising expenses were $9.3
million, $18.9 million and $98.4 million in 1997, 1998 and 1999, 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 combined Company has retroactively adopted Statement of Financial
Accounting Standards (SFAS) No. 128, "Earnings per Share" (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 combined Company has not included
potential common stock in the calculation of EPS as such inclusion would have an
anti-dilutive effect.
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
COMMON STOCK BASED COMPENSATION
Both EarthLink Network and MindSpring account for 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". The Company provides pro forma disclosures as if the
measurement provisions of SFAS No. 123 had been adopted.
F-9
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LONG LIVED ASSETS
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of," requires that long-lived assets and certain indentifiable intangible assets
to be held and used by an entity be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. The carrying value of long-lived assets is periodically reviewed
by management, and impairment losses, if any, are recognized when the expected
nondiscounted future operating cash flows derived from such assets are less than
their carrying value. Management believes that no such impairments have occurred
during the years ended December 31, 1998 and 1999.
RECENT ACCOUNTING PRONOUNCEMENTS
On December 3, 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements," which summarizes certain of the Staff's views in applying generally
accepted accounting principles to revenue recognition in financial statements.
The Staff is providing this guidance due, in part, to the large number of
revenue recognition issues that registrants encounter. The application of
SAB 101 to revenue recognition is not expected to have a material effect on
Earthlink, Inc.'s consolidated statement of operations.
2. STRATEGIC ALLIANCES AND ACQUISITIONS
On February 10, 1998, EarthLink Network 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 4.0 million shares of EarthLink Network's common
stock at a price per share of $13.94 in cash to each tendering stockholder (the
"Offer"). Immediately following the closing of the Offer, Sprint received
approximately 6.6 million shares of the EarthLink Network's Series A convertible
preferred stock which has been valued at $135 million, in exchange for
(i) transfer to the EarthLink Network 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 Network 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 Network'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 Network with a credit
facility currently totaling $50 million (increasing to $100 million by June
2001) 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 company,
"EarthLink Operations, Inc.," was formed and became a wholly-owned subsidiary of
the EarthLink Network, Inc. All references in these financial statements to
EarthLink Network relate, collectively, to both EarthLink Network and EarthLink
Operations, Inc.
In September 1998, MindSpring entered into an Asset Purchase Agreement with
America Online, Inc. ("AOL") and Spry, Inc. ("Spry"), a wholly-owned subsidiary
of AOL, to purchase certain assets used in connection with the consumer dial-up
Internet access business operated by Spry (the "Spry Agreement").
F-10
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. STRATEGIC ALLIANCES AND ACQUISITIONS (CONTINUED)
Pursuant to the Spry Agreement, MindSpring acquired Spry's subscriber base of
approximately 130,000 individual Internet access members in the United States
and Canada as well as various assets used in serving those members, including a
member support facility and a network operations facility in Seattle,
Washington. MindSpring also acquired all rights held by Spry to the "Spry" name.
The acquisition was closed in October 1998 and the total purchase price for
these assets was $32 million.
In February 1999, MindSpring completed its acquisition of certain assets
used in connection with the United States Internet access and Web hosting
business operated by NETCOM On-Line Communication Services Inc., which
subsequently changed its name to ICG Netahead, Inc. and is a wholly owned
subsidiary of ICG Communications, Inc. In this transaction, MindSpring acquired
NETCOM's subscriber base of approximately 408,000 individual Internet access
accounts, 25,000 Web hosting accounts, 3,000 dedicated Internet access accounts
in the United States and property and equipment valued at $13.2 million.
MindSpring paid NETCOM approximately $245 million, consisting of $215 million in
cash and $30 million in MindSpring common stock (752,232 shares, at a price per
share of $39.88). MindSpring incurred additional expenses of approximately $4.2
million in connection with this acquisition.
The following unaudited pro forma results of operations for the two years
ended December 31, 1999, assume the acquisitions of the Sprint Internet
Passport business and the Spry assets occurred on January 1, 1998 and the
acquisition of the NETCOM business occurred on January 1, 1998 and 1999,
respectively. 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,
-------------------------
1998 1999
----------- -----------
(IN THOUSANDS, EXCEPT PER
SHARE DATA UNAUDITED)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues........................................ $ 481,980 $ 689,290
Net loss.............................................. (223,024) (188,948)
Deductions for accretion dividends (Note 9)........... (13,126) (14,106)
Net loss attributable to common stockholders.......... (236,150) (203,054)
Basic and diluted net loss per share.................. $ (2.38) $ (1.71)
Weighted average shares............................... 99,016 118,472
</TABLE>
3. INVESTMENTS IN OTHER COMPANIES
In July 1999, EarthLink Network committed to invest in eCompanies Venture
Group, LP, ("EVG"), a limited partnership formed to invest in domestic emerging
growth companies. Mr. Sky Dayton is a member of the EarthLink, Inc. board of
directors and a founding partner in EVG. In 1999, EarthLink Network invested
$4.0 million in EVG and has committed to invest an additional $6.0 million. The
investment is accounted for under the cost method of accounting as the Company
does not have the ability to exercise significant influence over the
partnership's operating or financial policies. Any distributions of earnings
from the partnership, will be recorded as income when declared.
F-11
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. PROPERTY AND EQUIPMENT
Property and equipment consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Data center equipment................................... $ 72,411 $150,424
Office and other equipment.............................. 28,673 58,165
Leasehold improvements.................................. 8,771 12,488
Construction in progress................................ 541 4,526
-------- --------
110,396 225,603
Less accumulated depreciation and amortization.......... (39,349) (74,168)
-------- --------
$ 71,047 $151,435
======== ========
</TABLE>
Property under capital lease, primarily data communications equipment
included above, aggregated $41.2 million and $41.4 million at December 31, 1998
and 1999, respectively. Included in accumulated depreciation and amortization
are amounts related to property under capital lease of $19.6 million and
$25.3 million at December 31, 1998 and 1999, respectively. Depreciation expense
charged to operations was $13.0 million, $20.5 million and $41.0 million in
1997, 1998, and 1999, respectively.
5. INTANGIBLE ASSETS
Intangible assets consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1999
-------- ---------
(IN THOUSANDS)
<S> <C> <C>
Member base............................................ $ 90,000 $ 334,695
Marketing and distribution agreement................... 20,000 20,000
Goodwill............................................... 36,164 36,164
Other.................................................. 22,776 16,898
-------- ---------
168,940 407,757
Less accumulated amortization.......................... (54,192) (202,369)
-------- ---------
$114,748 $ 205,388
======== =========
</TABLE>
Intangible assets include (i) member bases acquired from Sprint, Spry and
NETCOM, (ii) marketing and distribution agreements and goodwill acquired in the
acquisition of the Sprint Internet Passport business and (iii) and various other
intangible assets of lesser value. Intangible assets acquired in the acquisition
of the Sprint Internet Passport business 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.
F-12
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. DEBT
CREDIT FACILITY
On February 17, 1999, in conjunction with the NETCOM transaction, MindSpring
entered into a credit agreement with First Union National Bank and several other
lenders. In February 1999, the Company borrowed approximately $80 million under
the credit facility to finance the NETCOM acquisition. The Company repaid all
amounts outstanding under the credit facility using a portion of its net
proceeds from the offering of common stock completed in April 1999. As a
consequence of MindSpring's merger with EarthLink Network, Inc. and the Company,
the credit facility was terminated.
CONVERTIBLE NOTES
In March 1999, MindSpring filed a universal shelf registration statement
with the Securities and Exchange Commission for the public offering from time to
time of up to $800 million of debt and equity securities. In April 1999,
MindSpring sold $180.0 million aggregate principal amount of 5% Convertible
Subordinated Notes due 2006, raising net proceeds of approximately $174.1
million. The notes were convertible into shares of the common stock of
MindSpring at any time prior to their maturity or their redemption by the
Company at a rate of 16 shares per each $1,000 principal amount of notes, or
$62.50 per share, subject to adjustment in certain circumstances. Interest is
payable semi-annually on April 15 and October 15 of each year beginning
October 15, 1999. The notes were subordinated in right of payment to all senior
debt of MindSpring. MindSpring had the option to redeem the notes before
April 15, 2002, in whole or in part, at a redemption price equal to principal
amount of the note plus accrued and unpaid interest, if any, to the redemption
date, if the closing price for MindSpring's common stock exceeded 150% of the
conversion price for at least 20 trading days within a period of 30 consecutive
trading days ending on the trading day prior to the date of the mailing of the
notice of redemption. MindSpring was required to make an additional payment of
cash with respect to notes called for redemption of $200 per $1,000 note, less
the amount of interest actually paid on such note prior to the call for
redemption. Further the notes could be redeemed on or after April 15, 2002 at
102.86% of the principal amount declining to 100% by April 15, 2006.
Upon completion of the merger, EarthLink adopted the indentures and the
notes became convertible into shares of EarthLink common stock. Completion of
the merger constituted a "change in control" of MindSpring under the indentures.
Thus each holder of notes has the option to require EarthLink to repurchase that
holder's notes at a repurchase price of 100% of the principal amount plus
accrued interest to the date of repurchase. The repurchase price will be paid in
cash. If all holders exercise this option the payment will be $184.3 million. A
holder that chooses not to have the notes repurchased will thereafter hold
convertible subordinated notes of EarthLink.
7. COMMON STOCK ISSUED
FOLLOW ON OFFERINGS
In May 1998, MindSpring completed a follow on public offering of
6.0 million shares of its common stock at $8.84 per share. Net proceeds from the
offering were approximately $49.8 million.
In June 1998 EarthLink Network completed a follow on public offering of 6.1
million shares of its common stock at $18.58 per share. The offering consisted
of 4.9 million shares, including 791,000 shares sold to Sprint in accordance
with its preemptive rights under the Sprint Alliance, and an underwriter's
over-allotment of 1.2 million shares. Net proceeds to the Company were
approximately $106.3 million.
F-13
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. COMMON STOCK ISSUED (CONTINUED)
In December 1998, MindSpring completed a follow on public offering of
4.6 million shares of its common stock at $28.50 per share. Net proceeds from
the offering were approximately $124.8 million.
In January 1999 EarthLink Network completed a follow on public offering of
3.9 million shares of its common stock at $45.59 per share. The offering
consisted of 3.7 million shares and an underwriter's over-allotment of 160,000
shares exercised in February 1999. Net proceeds to EarthLink Network were
approximately $170 million. In conjunction with the offering, Sprint exercised
its preemptive rights to maintain its existing ownership level in EarthLink
Network of approximately 27%, of which 10% is voting common stock. Accordingly,
Sprint purchased 1.2 million shares of which 310,000 were common stock and
932,000 were series B convertible preferred 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 EarthLink Network after the exercise of the underwriter's
over-allotment granted in connection with the aforementioned follow on public
offering. Accordingly, Sprint purchased 62,000 shares of which 15,000 were
common stock and 47,000 were series B convertible preferred stock. Series B
convertible preferred stock has the same rights and privileges as series A
convertible preferred stock shares, as described in Note 8, except that each
share is convertible into one share of EarthLink Network common stock. Proceeds
from the sale of stock to Sprint were $2.7 million.
In April 1999 MindSpring completed a follow on public offering of
5.5 million shares of its common stock. Net Proceeds were approximately
$263.5 million.
COMMON STOCK ISSUANCES FOR OTHER THAN CASH
In January 1998, EarthLink Network issued 32,000 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 EarthLink Network issued 32,000 additional shares of its common stock
in January 1999.
8. CONVERTIBLE PREFERRED STOCK
All issued and outstanding shares of Series A and B convertible preferred
stock are held by Sprint (Note 2).
The series A and B 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 at an 8% annual rate of the Liquidation
Value per share, increasing annually to a maximum rate of 12%.
Upon voluntary or involuntary liquidation or winding up of the Company the
holders of series A and B 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 on the June 5, 1998 (the "Average
Stock Price"), plus all
F-14
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. CONVERTIBLE PREFERRED STOCK (CONTINUED)
accrued and unpaid dividends on such shares, whether in cash or in kind (such
amount, the "Liquidation Value").
Each share of series A and B 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 and B 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 and B 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 and B convertible preferred stockholders do not possess general
voting rights together with holders of common stock. However, the series A and B
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 and B 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 and B convertible preferred stock as a class.
9. DEDUCTIONS FOR DIVIDENDS ON CONVERTIBLE PREFERRED STOCK
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS
Dividends on convertible preferred stock are reflected as an increase to net
loss attributable to common stockholders. This adjustment reflects the
liquidation dividend of $8.8 million based on a 3% dividend (Note 8) and the
accretion of a $5.3 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.
10. STOCK OPTIONS AND WARRANTS
Options and warrants granted by Earthlink Network and MindSpring will
(i) maintain their rights, (ii) continue to vest as originally scheduled and
(iii) be redeemable in the common stock of Earthlink, Inc.
1995 STOCK OPTION PLAN
EarthLink Network and MindSpring established their "1995 Stock Option Plans"
in September 1995 and February 1995, respectively. Each of the plans 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. Total options available under the
EarthLink Plan and the MindSpring Plan were 12,435,500 and 9,000,000,
respectively. Both Plans are administered by
F-15
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCK OPTIONS AND WARRANTS (CONTINUED)
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 over
terms of four to five years.
OPTIONS GRANTED UNDER EARTHLINK NETWORK DIRECTORS STOCK OPTION PLAN
In September 1995, EarthLink Network established the EarthLink Network
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 201,875 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 32,300 and 8,075 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, 1999, there were no outstanding options to purchase shares of
common stock under the Directors Plan.
MINDSPRING DIRECTORS STOCK OPTION PLAN
Under the MindSpring Directors' Stock Option Plan (the "Directors' Plan"),
adopted in December 1995, 420,000 shares of common stock are authorized for
issuance to nonemployee directors in the form of 60,000 options per director)
upon their initial election or appointment to the board or, in the case of
directors who joined the board prior to the creation of the Directors' Plan,
upon the adoption of the Directors' Plan by the board of directors. The
Directors' Plan, as amended by the board of directors on March 26, 1999 and
approved by the stockholders on April 22, 1999, provides for discretionary
option grants. Options become exercisable as follows: (i) 50% of the options
become exercisable two years after the date of grant, (ii) an additional 25% of
the options become exercisable three years after the date of grant, and (iii)
the remaining 25% of the options become exercisable four years after the date of
grant. All options were granted at an exercise price equal to the estimated fair
value of the common stock at the dates of grant as determined by the board of
directors based upon equity transactions and other analyses. The options expire
ten years from the date of grant.
NON-QUALIFIED OPTION GRANTS
In addition to the options granted under the plans described above,
EarthLink Network 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.
F-16
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. STOCK OPTIONS AND WARRANTS (CONTINUED)
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 1999
--------- --------- ---------
<S> <C> <C> <C>
Annual dividends.............................. zero zero zero
Expected volatility........................... 69% 83% 92%
Risk free interest rate....................... 6.49% 5.28% 5.44%
Expected life................................. 6.6 years 6.6 years 6.6 years
</TABLE>
The following weighted average assumptions were used for stock options
granted by MindSpring:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Annual dividends.............................. zero zero zero
Expected volatility........................... 58% 95% 84%
Risk free interest rate....................... 6.40% 5.30% 5.40%
Expected life................................. 3.5 years 3.5 years 3.5 years
</TABLE>
Had compensation cost been determined on the basis of fair value pursuant to
SFAS No. 123, net loss attributable to common stockholders and net loss
attributable to common shareholders per share would have been increased as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1997 1998 1999
-------- -------- --------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C> <C>
Net loss attributable to common stockholders
As reported.................................. $33,997 $ 60,779 $187,800
======= ======== ========
Pro forma.................................... $36,137 $110,808 $283,090
======= ======== ========
Basic and diluted net loss per share
As reported.................................. $ 0.44 $ 0.66 $ 1.65
======= ======== ========
Pro forma.................................... $ 0.47 $ 1.21 $ 2.49
======= ======== ========
</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.
F-17
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCK OPTIONS AND WARRANTS (CONTINUED)
WARRANTS ISSUED FOR SERVICES
In January 1997 and October 1997, EarthLink Network issued warrants to
purchase 19,000 and 81,000 shares, respectively, of EarthLink Network's common
stock to certain consultants. The respective exercise prices of the warrants
were $4.03 and $5.50. 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, $34,836 and $34,836 during 1997, 1998 and 1999, respectively.
In March 1997 and October 1997, EarthLink Network issued warrants to
purchase 24,225 shares of the Company's common stock to each of two new members
of the Company's Technology Advisory Council. The warrants have an exercise
price of $3.25 per share and $5.50 per share, respectively, and vest quarterly
over two years. The fair value of the warrants is reflected as deferred
professional services expense and amortized ratably over the member's two year
term of service in the Technology Advisory Council.
Following is a summary of combined stock option and warrant activity of both
EarthLink Network and MindSpring during the three years ended December 31, 1999:
<TABLE>
<CAPTION>
NUMBER OF SHARES
OF COMMON STOCK WEIGHTED
------------------- AVERAGE
STOCK EXERCISE
OPTIONS WARRANTS PRICE
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Balance at December 31, 1996...................... 8,533 2,751 $ 1.72
Granted........................................... 2,184 148 $ 3.44
Exercised......................................... (548) -- $ 0.75
Forfeited......................................... (1,031) -- $ 2.37
------ ------ ------
Balance at December 31, 1997...................... 9,138 2,899 $ 2.05
Granted........................................... 4,657 12 $17.22
Exercised......................................... (2,813) (1,151) $ 1.56
Forfeited......................................... (545) -- $ 5.29
Surrendered in cashless exercise.................. (13) (240) $ 5.43
------ ------ ------
Balance at December 31, 1998...................... 10,424 1,520 $ 7.71
Granted........................................... 5,801 -- $37.04
Exercised......................................... (2,290) (538) $ 2.47
Forfeited......................................... (1,450) -- $27.62
Surrendered in cashless exercise.................. -- (2) $ 2.51
------ ------ ------
Balance at December 31, 1999...................... 12,485 980 $14.72
====== ====== ======
Exercisable at December 31, 1997.................. 2,373 2,703
====== ======
Exercisable at December 31, 1998.................. 2,251 1,412
====== ======
Exercisable at December 31, 1999.................. 2,505 913
====== ======
</TABLE>
The weighted average fair values of the options granted by the Company,
during the three years ended December 31, 1999, were $6.93, $16.31 and $25.76,
respectively. The weighted average fair values of
F-18
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCK OPTIONS AND WARRANTS (CONTINUED)
warrants granted by during the two years ended December 31, 1998 were $4.00 and
$13.97, respectively. There were no warrants granted in 1999.
Following is a summary of stock options and warrants outstanding as of
December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS AND WARRANTS OUTSTANDING OPTIONS AND WARRANTS
------------------------------------ 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>
0.1067 0.5950 986,625 5.61 $ 0.42 889,725 0.42
1.0634 1.4985 1,929,827 5.48 $ 1.41 1,194,531 1.39
1.5209 42.8019 9,075,250 8.33 $16.74 1,333,658 7.67
43.0341 46.2190 1,185,710 9.10 $44.42 -- --
48.6068 51.4375 287,938 9.26 $48.73 -- --
---------- ---------
0.1067 51.4375 13,465,350 7.95 $18.54 3,417,914 3.78
========== =========
</TABLE>
11. INCOME TAXES
The provision for income taxes is comprised of the following:
<TABLE>
<CAPTION>
1997 1998 1999
---------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Current............................................... $ -- $3,000 $ 3,654
Deferred.............................................. -- (606) (3,654)
---------- ------ -------
Income tax provision (benefit)........................ $ -- $2,394 $ --
========== ====== =======
</TABLE>
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 1999
-------- -------- --------
<S> <C> <C> <C>
Federal income tax (benefit) at statutory
rate......................................... $(11,899) $(17,774) $(60,793)
State income taxes, net of federal benefit..... (168) (3,064) (8,915)
Nondeductible expenses......................... -- 54 135
Nondeductible goodwill......................... -- 4,922 7,735
Valuation allowance............................ 12,067 18,085 62,083
Other.......................................... -- 171 (245)
-------- -------- --------
$ -- $ 2,394 $ --
======== ======== ========
</TABLE>
F-19
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. INCOME TAXES (CONTINUED)
Deferred tax assets and liabilities include the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1998 1999
-------- ------------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards................... $ 42,625 $ 67,531
Member base........................................ -- 31,315
Allowance for doubtful accounts.................... 657 1,600
Deferred income.................................... 2,912 6,177
Accrued vacation................................... 818 1,580
Other accrued liabilities.......................... 211 811
-------- ------------
Gross deferred tax assets.......................... 47,223 109,014
Valuation allowance.................................. (29,412) (95,977)
-------- ------------
TOTAL DEFERRED TAX ASSETS.......................... 17,811 13,037
Deferred tax liabilities:
Member base........................................ (13,397) --
Depreciation and amortization...................... (3,557) (2,025)
Co-branding........................................ -- (6,512)
Other.............................................. (251) (240)
-------- ------------
TOTAL DEFERRED TAX LIABILITIES..................... (17,205) (8,777)
-------- ------------
NET DEFERRED TAXES................................. $ 606 $ 4,260
======== ============
</TABLE>
At December 31, 1998 and 1999, the Company had net operating loss
carryforwards for federal income tax purposes totaling approximately
$106.8 million, and $177.7 million, respectively, which begin to expire in 2010.
At December 31, 1998 and 1999, the Company had net operating loss carryforwards
for state income tax purposes totaling approximately $70.0 million and
$90.4 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 merger 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. At December 31, 1998 and 1999, the net operating loss includes
approximately $24.0 million and $64.0 million, respectively, related to the
exercise of employee stock options and warrants. Any benefit resulting from the
utilization of this portion of the net operating loss will be credited directly
to equity.
The Company has recorded a net deferred tax asset to the extent that its
current deferred tax assets will reverse within the two year federal net
operating loss carryback period.
F-20
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. 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
1997, 1998 and 1999 for all operating leases amounted to $3.3 million, $4.4
million and $12.8 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, 1999, the Company financed the
acquisition of data processing and office equipment amounting to approximately
$10.5 million, $9.3 million and $13.5 million, respectively, by entering into a
number of leases and agreements for the sale and leaseback of equipment. The
saleleaseback 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 maintains facilities and offices at various locations throughout
the United States for general corporate purposes, including technology centers,
member call centers, office space and headquarters.
All operating leases include scheduled base rent increases over the
respective lease terms. The total amount of base rent payments is being charged
to expense on the straight-line method over the terms of the leases. In addition
to base rent payments, the Company pays a monthly allocation of the buildings'
operating expenses. The Company has recorded a deferred rent liability to
reflect the excess of rent expense over cash payments since the inception of the
leases.
Minimum lease commitments under non-cancelable leases at December 31, 1999
are as follows:
<TABLE>
<CAPTION>
YEAR ENDING CAPITAL OPERATING
DECEMBER 31, LEASES LEASES
------------ -------- ---------
(IN THOUSANDS)
<S> <C> <C>
2000.................................................... $ 13,096 $ 14,656
2001.................................................... 6,844 16,705
2002.................................................... 2,408 17,748
2003.................................................... 54 17,180
2004.................................................... -- 14,043
Thereafter.............................................. -- 38,783
-------- --------
Total minimum lease payments............................ 22,402 $119,115
========
Less amount representing interest....................... (2,286)
--------
Present value of future lease payments.................. 20,116
Less current portion.................................... (11,724)
--------
$ 8,392
========
</TABLE>
F-21
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. COMMITMENTS AND CONTINGENCIES (CONTINUED)
SIGNIFICANT AGREEMENTS
Access to the Internet for members outside of areas served by the Company's
owned network is provided through points of presence ("POP") capacity leased
from third party providers. 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, 1999, $1 million and $3.9 million in
amounts due to Level 3 and Sprint, respectively, were recorded in accounts
payable and $7.2 million and $7.5 million in amounts due to UUNET and PSINet,
respectively, were recorded in other accounts payable and accrued liabilities.
Minimum commitments under non-cancelable network service agreements from
UUNET, GTE Internetworking Incorporated and PSINet are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31, IN MILLIONS
------------ -----------
<S> <C>
2000........................................................ $ 68.0
2001........................................................ 66.9
2002........................................................ 41.4
------
Total....................................................... $176.3
======
</TABLE>
13. PROFIT SHARING PLAN
Effective January 1997, EarthLink Network 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. EarthLink Network 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, 1998 and 1999
were $84,000, $285,000, and $375,000 respectively.
Prior to the merger with EarthLink Network, MindSpring had a savings plan
(the "Savings Plan") that qualified as a deferred salary arrangement under
Section 401(k) of the Internal Revenue Code. Under the Savings Plan,
participating employees may defer a portion of their pretax earnings, up to the
Internal Revenue Service annual contribution limit. The Company did not make any
matching contributions to the Savings Plan.
F-22
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. DISCLOSURE OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1997 1998 1999
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash paid during the year for interest............. $2,714 $2,991 $ 7,776
Cash paid during the year for income taxes......... 1 435 6,581
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........................................ -- 7,601 14,106
Common stock issued in conjunction with
acquisition...................................... -- -- 30,000
Assets acquired under capital lease................ 8,443 -- --
Noncash accrual for acquired subscriber base....... $ -- $7,000 $ --
</TABLE>
15. RELATED PARTY TRANSACTIONS
Mr. Cambell Lanier is a stockholder and member of the Board of Directors of
both EarthLink Inc. and ITC Holding. ITC Holdings holds 10.7 million shares of
EarthLink Inc. common stock as of December 31, 1999. The Company has entered
into certain business relationships with several subsidiaries and affiliates of
ITC Holding Company, Inc. ("ITC Holding"). Except as noted below, none of these
transactions were material for the periods presented.
The Company purchases long-distance telephone services and wide area network
transport service from ITC DeltaCom, Inc. (ITC DeltaCom"), a related party
through relationships with ITC Holding. Long-distance charges from ITC DeltaCom
totaled approximately $1,942,000, $3,672,000 and $9,540,000 for the years ended
December 31, 1997, 1998 and 1999, respectively.
16. SUBSEQUENT EVENTS
In January 2000, the Company entered into a multi-year partnership to
deliver services to customers of Apple Computer Corporation 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-Registered
Trademark-computers sold in the U.S. In addition, Apple purchased 7,083,333
shares of Series C convertible preferred stock for $200 million. Apple has the
right to appoint a member to EarthLink's Board of Directors.
On February 4, 2000, EarthLink Network and MindSpring merged into EarthLink,
Inc. in a transaction accounted for as tax-free reorganization under Section 368
of the Internal Revenue Code of 1986, as amended, and as a
"pooling-of-interests" transaction. Each outstanding share of EarthLink Network
securities was exchanged for 1.615 shares of the equivalent securities of the
new company and each outstanding share of MindSpring securities was exchanged
for one share of the equivalent securities of the new Company. In connection
with the merger, the new company assumed EarthLink Network's alliance agreements
with Sprint. As a result, Sprint has the right, among others, to appoint up to
two (2) representatives to the new company's board of directors provided Sprint
holds 20% or more of EarthLink's fully diluted outstanding stock, to appoint one
representative to the new company's board of directors provided Sprint holds 10%
or more of EarthLink's fully diluted outstanding stock and to purchase
additional shares of equity securities in the new company in order to maintain,
but not exceed, a 27.8%
F-23
<PAGE>
EARTHLINK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. SUBSEQUENT EVENTS (CONTINUED)
ownership level. The new Company has also assumed MindSpring's outstanding 5%
convertible subordinated notes and the indentures pursuant to which the notes
were issued. The merger has given rise to the MindSpring noteholders' right to
have the new company repurchase the notes at 100% of the principal amount plus
accrued interest to the date of repurchase. Under the Agreement and Plan of
Reorganization, any notes presented for repurchase will only be repurchased for
cash. Accordingly, the Company extended an offer to purchase the notes for cash
as of April 7, 2000. If all holders exercise this option, the payment will be
$184.3 million plus interest.
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.
17. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth certain unaudited quarterly financial data
for the eight quarters ended December 31, 1999. In the opinion of the
Company's management, this unaudited information has been prepared on the
same basis as the audited 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 combined 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
1998 1998 1998 1998 1999 1999 1999 1999
-------- -------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:................................. $51,210 $ 63,050 $ 78,519 $ 97,835 $129,871 $163,664 $177,753 $199,145
Operating costs and expenses:............. 56,097 72,879 95,473 120,620 161,493 204,859 232,980 266,781
Loss from operations...................... (4,887) (9,829) (16,954) (22,785) (31,622) (41,195) (55,227) (67,636)
Deductions for accretion dividends (1).... -- (1,054) (3,276) (3,271) (3,646) (3,627) (3,404) (3,429)
------- -------- -------- -------- -------- -------- -------- --------
Net loss attributable to common
stockholders............................ $(5,919) $(11,464) $(18,542) $(24,854) $(31,403) $(39,685) $(52,529) $(64,183)
======= ======== ======== ======== ======== ======== ======== ========
Basic and diluted net loss per share
(2)..................................... $ (0.07) $ (0.13) $ (0.19) $ (0.25) $ (0.29) $ (0.35) $ (0.45) $ (0.55)
======= ======== ======== ======== ======== ======== ======== ========
</TABLE>
------------------------------
(1) Reflects the accretion of Liquidation Dividends on Series A and B
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.
(2) Each outstanding share of EarthLink Network common stock was exchanged for
1.615 shares of the common stock of the new company and each outstanding
share of MindSpring common stock was exchanged for one share of the common
stock of the new company. 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.
F-24
<PAGE>
(c) Exhibits.
23.1 Consent of PricewaterhouseCoopers LLP
23.2 Consent of Arthur Andersen LLP
II-2
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
EARTHLINK, INC.
Date: July 7, 2000 By: /s/ Michael S. McQuary
------------------------
Michael S. McQuary
President
<PAGE>
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
-------- -----------
23.1 Consent of Pricewaterhouse Coopers LLP
23.2 Consent of Arthur Andersen LLP
