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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
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/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
.
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COMMISSION FILE NUMBER 001-15605
------------------------
EARTHLINK, INC.
(Exact name of Registrant as specified in its charter)
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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)
</TABLE>
(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 / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. /X/
The aggregate market value of the Registrant's outstanding Common Stock held
by non-affiliates of the Registrant on March 24, 2000 was $1.8 billion. There
were 118,191,356 shares of Common Stock outstanding as of March 24, 2000.
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<PAGE>
EARTHLINK, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
TABLE OF CONTENTS
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 6
Item 3. Legal Proceedings........................................... 6
Item 4. Submission of Matters to a Vote of Security Holders......... 6
PART II
Market for Registrant's Common Equity and Related
Item 5. Stockholder Matters......................................... 7
Item 6. Selected Financial Data..................................... 8
Item 6a. Selected Financial Data for EarthLink, Inc.................. 8
Item 6b. Selected Financial Data for EarthLink Network, Inc.......... 9
Item 6c. Selected Financial Data for MindSpring Enterprises, Inc..... 10
Management's Discussion and Analysis of Financial Condition
and Results of Operations for EarthLink, Inc................ 11
Item 7.
EarthLink, Inc.--Management's Discussion and Analysis of
Financial Condition
and Results of Operations................................... 11
Item 7a.
EarthLink Network, Inc.--Management's Discussion and
Analysis of Financial
Condition and Results of Operations......................... 19
Item 7b.
MindSpring Enterprises, Inc.--Management's Discussion and
Analysis of Financial Condition and Results of Operations... 24
Item 7c.
Item 8. Financial Statements and Supplementary Data................. 28
Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 28
Item 9.
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 29
Item 11. Executive Compensation...................................... 29
Security Ownership of Certain Beneficial Owners and
Item 12. Management.................................................. 29
Item 13. Certain Relationships and Related Transactions.............. 29
PART IV
Item 14. Exhibits, Financial Statements and Reports on Form 8-K...... 30
SIGNATURES.......................................................................... 37
MASTER INDEX TO FINANCIAL STATEMENTS................................................ F-1
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i
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THIS REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE
RISKS AND UNCERTAINTIES. ACTUAL EVENTS AND RESULTS COULD DIFFER MATERIALLY FROM
THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN
FACTORS. SEE ITEM 7, "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--SAFE HARBOR STATEMENT".
EXCEPT AS OTHERWISE NOTED, THE DISCUSSIONS, DESCRIPTIONS AND OTHER MATERIAL
PRESENTED IN THIS REPORT ARE PRESENTED ON A CONSOLIDATED BASIS ASSUMING THAT THE
MERGER OF MINDSPRING ENTERPRISES, INC. AND EARTHLINK NETWORK, INC. INTO
EARTHLINK, INC. HAD OCCURRED AS OF JANUARY 1, 1999. IN THE MERGER, EACH
MINDSPRING SHARE WAS EXCHANGED FOR ONE EARTHLINK, INC. SHARE AND EACH EARTHLINK
NETWORK, INC. SHARE WAS EXCHANGED OR 1.615 EARTHLINK, INC. SHARES.
PART I
ITEM 1. BUSINESS.
OVERVIEW
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 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. 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 to accelerate our
member growth rate.
Our combined member base grew from approximately 1.7 million paying members
on December 31, 1998 to approximately 3.1 million paying members on December 31,
1999. Our growth has resulted from strategic acquisitions as well as traditional
marketing channels and alliances. 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.
Our corporate offices are located at 1430 West Peachtree St., Suite 400,
Atlanta, Georgia 30309 and our telephone number at that address is (404)
815-0770.
STRATEGIC ALLIANCES AND ACQUISITIONS
In June 1998, we entered into a strategic alliance with Sprint Corporation
("Sprint"). As a part of this alliance, Sprint transferred approximately 130,000
members to us and is committed to generating at least 150,000 new members for us
during each of the succeeding 5 years through their channels. Additionally, we
are co-branded as Sprint's exclusive consumer Internet access provider, and we
have exclusive access to certain dial-up modem ports in Sprint's network. We
also have access to Sprint's marketing and distribution channels and the right
to use Sprint's widely recognized brand name. As a result of this relationship,
we recently announced our intention to offer wireless web access via Sprint PCS
wireless phones.
In October 1998, we purchased substantially all of Spry, Inc.'s ("Spry")
subscriber base of individual dial-up Internet access members in the United
States and Canada, including approximately 130,000 individual access accounts
and acquired various assets used in serving those members, including a leased
member support facility and a leased network operations facility in Seattle,
Washington and all rights to the "Sprynet" name. Spry was a wholly-owned
subsidiary of America Online, Inc ("AOL"). The purchase price for these assets
was approximately $32 million.
1
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In February 1999, we purchased substantially all of NETCOM On-Line
Communication Services, Inc.'s ("NETCOM") subscriber accounts in the U.S.,
including approximately 408,000 individual access accounts, approximately 25,000
web hosting accounts and approximately 3,000 dedicated Internet access accounts.
NETCOM, now known as ICG Netahead, Inc. ("ICG Netahead"), is a wholly owned
subsidiary of ICG Communications, Inc. We also acquired assets used in serving
those members, including leased operations facilities in San Jose, California
and Dallas, Texas and the rights to the "NETCOM" name, except in Canada, the
United Kingdom and Brazil. ICG Netahead retained all of its assets used in
connection with its network operations. Under a separate network services
agreement with ICG Netahead, we also acquired access to ICG Netahead's network.
We paid $245 million for the NETCOM assets, consisting of $215 million in cash
and $30 million in common stock.
In January 2000, we entered into a strategic alliance with Apple Computer
Corporation, which we expect to 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. Furthermore, Apple purchased $200 million of
our newly created Series C convertible preferred stock.
MARKETING CHANNELS
Our sales and marketing efforts consist of the following programs:
ADVERTISING. We advertise our services in print, billboards, electronic and
broadcast media. We maintain a presence at national trade shows such as Internet
World and MacWorld, as well as local and regional trade shows.
DIRECT MARKETING. EarthLink promotes its services directly to members in
the form of disk and coupon distribution through the mail, and through
promotional inserts in packages, periodicals and newspapers.
ORIGINAL EQUIPMENT MANUFACTURER CHANNELS. EarthLink has marketing
arrangements with a number of leading hardware and software manufacturers to
include our Internet access software pre-installed on or included with their
products.
AFFINITY MARKETING PROGRAM. Affinity marketing partners such as Discover
Card and AAA of Southern California typically bundle our Internet access
software with their own goods or services to create a package that promotes
EarthLink to potential members.
SPRINT ALLIANCE. Our alliance with Sprint includes a marketing and
distribution arrangement that provides us access to Sprint's branded marketing
and distribution channels in the United States, the right to use Sprint's brand
for a minimum of ten years and a five-year commitment from Sprint to deliver a
minimum of 150,000 new members annually through Sprint's channels. Additionally,
Sprint promotes EarthLink as Sprint's exclusive consumer Internet access
provider.
APPLE ALLIANCE. Although we have been the default ISP in Apple's setup
software on its Macintosh branded line of computers, our new January 5, 2000
Internet services agreement extends the time of our relationship through January
4, 2005. This new agreement also makes us the exclusive default ISP for dial-
up, ISDN and DSL services on Macintosh computers sold in the United States for a
minimum of two years.
MEMBER REFERRAL PROGRAM. We believe that our existing members are among our
most important marketing tools. We currently waive one month of standard access
service fees or grant credit for each member who refers a new member to our
service. These referrals generate a significant percentage of our new
membership.
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KEY BUSINESS AREAS
NARROWBAND ACCESS
Narrowband access revenues consist primarily of monthly fees charged to
members for dial-up Internet access. We have approximately three million
narrowband members. Narrowband revenues were $582.9 million in 1999 which
represented 87 percent of total revenues for the year.
WEB HOSTING
We lease server space and provide web services to companies and individuals
wishing to have a web or e-commerce presence. EarthLink's web hosting revenues
were $47.4 million in 1999, which represented seven percent of total revenues
for the year. As of December 31, 1999, we hosted approximately 109,000 Web sites
compared to 36,000 in 1998, a 203% increase.
BROADBAND ACCESS
Broadband access revenues consist of fees charged for high-speed,
high-capacity access services including cable, dedicated circuits and DSL
services. In 1999 our main broadband focus became DSL. In the fourth quarter of
1999, we began service to 12 major cities giving us access to 15 markets
nationwide including Los Angeles, Atlanta, New York and Chicago. As of December
31, 1999, we approximately had 25,000 broadband members.
CONTENT, COMMERCE AND ADVERTISING
We generate content, commerce and advertising revenues by leveraging the
value of our member base and user traffic. The principal component of our
strategy is our Premier Partnership Program, through which we offer and sell
promotional packages that provide advertisers with access to the multiple points
of contact we have with our members. The Premier Partnership Program focuses on
third parties having a natural affinity to and benefit for our member base. The
program generates revenues through (1) sales of banner and other online ads; (2)
fees generated through revenue sharing arrangements with online retailers who
are accessed through our properties; and, (3) payments for placing links from
our properties to third-party content. We also sell advertising and content
space on our various online properties, such as the Personal Start Page, the
Mall and our online magazine eLink, and through our news magazine, bLink.
SERVICES
We currently support the pre-merger products and services of both the former
EarthLink Network and MindSpring through approximately 5,000 dial-up points of
presence, or POPs as well as through our broadband access alternatives. Our
primary service offerings include:
- dial-up Internet access,
- high speed access via dedicated circuits, DSL or cable modem,
- Web hosting and Web page design, and
- Content, commerce and advertising.
These services are offered in various competitively priced plans designed to
meet the needs of our members. Our Internet access software incorporates a
telephone dialer and email program with several leading third-party Internet
access tools, including our own proprietary browser as well as the latest
browsers from Netscape and Microsoft. This software provides a functional,
easy-to-use Internet access solution for Windows and Macintosh platforms. The
software automatically installs these and other software applications on member
computers. The simple point-and-click functionality of our software, combined
with its easy-to-use multimedia registration and installation system, permits
online credit card registration, allowing both our novice and experienced
members to quickly set up access to the Internet.
3
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Our business services, which are provided by the company's EarthLink Biz
department, consist of:
- Web hosting, the business of maintaining a member's Internet Web site,
- Web page design,
- domain name registration, and
- e-commerce solutions.
In October 1999, we introduced our new access software and online interface,
EarthLink 5.0. EarthLink 5.0 is designed to provide members with an intuitive,
all-in-one Internet environment. It allows for customization and
personalization, letting EarthLink members take advantage of the power, speed
and scope of a direct Internet connection through one fully-integrated user
interface. Members need only click a button to access the Web, email, chat or
other Internet applications. In addition to a one-stop Internet environment,
EarthLink 5.0's feature set includes an intuitive multimedia-aided account setup
process, full management of user profiles and locations, seamless setup multiple
personalization and productivity options.
MEMBER AND TECHNICAL SUPPORT
We believe that reliable member and technical support are critical to
retaining existing members and attracting new members. We provide the following
member and technical support services:
- toll-free, live telephone assistance available seven days a week, 24 hours
a day,
- email-based assistance available seven days a week, 24 hours a day,
- help sites and Internet guide files on the EarthLink Web site,
- automated "fax back" and "fax on demand" assistance, and
- printed reference material.
We also provide dedicated support for business members. In addition, we
maintain newsgroups on the Internet where subscribers can post requests for help
and other subscribers, as well as our own support personnel, can respond.
We currently handle an average of over 60,000 member and technical support
calls a day through our call centers located in Pasadena, California; Atlanta,
Georgia; Harrisburg, Pennsylvania; Phoenix, Arizona; Seattle, Washington;
Sacramento, California; San Jose, California; and Dallas, Texas. We also
contract with call center services vendors whose EarthLink-trained employees
provide additional technical support assistance. We believe the call centers'
technology and systems are scaleable to accommodate call volume growth. We
actively evaluate our call center facilities in order to deliver more effective
and efficient services to our members.
TECHNICAL DEVELOPMENT AND SERVICE ENHANCEMENT
We place significant emphasis on expanding and refining our services to
enhance member Internet experience. Our technical staff is engaged in a variety
of technical development and service enhancement activities and continuously
reviews new third-party software products and technology for potential
incorporation into our systems and services. EarthLink 5.0 is a recent product
of these efforts. We also regularly update and expand the online services
provided through the EarthLink Web site, organize Web content and develop online
guides, help screens and other user services and resources.
POPS AND NETWORK INFRASTRUCTURE
We provide our members with Internet access primarily through both Company
managed network and third-party network POPs. Over 90% of the U.S. population
can access our Internet service through a local telephone call. We have access
to third-party provider POPs through network services agreements with
4
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UUNet, PSINet, Level 3, Sprint, Worldcom Advanced Networks (formerly Gridnet
International, L.L.C.), GTE Internetworking Incorporated (formerly BBN Planet
Corporation) and ICG Netahead.
We believe that using a combination of EarthLink-owned POPs and leased
third-party POPs enables us to provide Internet access services on a nationwide
basis while managing the timing and magnitude of our capital expenditures. We
employ a strategy of leasing POPs from third-party providers in locations where
it is more economical to do so. These are typically geographic areas where we
have lower market penetration than areas we serve through EarthLink-owned POPs.
We periodically reevaluate the economics of this strategy and, if warranted, may
install an EarthLink POP to replace or overlap with a third-party POP. Members
located in a geographic area not currently serviced by a local POP can access
the Internet through an 800 service.
We have invested in measures to minimize the effects of damage from fire,
earthquake, power loss, telecommunications failure, computer viruses, security
breaches and similar events or backup Internet services or backbone facilities
or other redundant computing or telecommunications facilities.
COMPETITION
We operate in the Internet services market, which is extremely competitive.
Our current and prospective competitors include many large companies that have
substantially greater market presence, financial, technical, marketing and other
resources than we have. We compete directly or indirectly with the following
categories of companies:
- established online services, such as America Online, the Microsoft Network
and Prodigy;
- local, regional and national ISPs, such as Rocky Mountain Internet and
Internet America Inc.;
- national telecommunications companies, such as AT&T and GTE;
- regional Bell operating companies, such as BellSouth and SBC
Communications Corp;
- online cable services, such as ExciteAt Home and Roadrunner;
- Free ISPs such as Netzero and Juno; and
- Broadband providers such as cable television, utility and local and long
distance telephone companies.
Our competition is likely to increase. We believe this will probably happen
as large diversified telecommunications and media companies acquire ISPs and
otherwise proved ISP services and as ISPs consolidate into larger, more
competitive companies. Diversified competitors may bundle other services and
products with Internet connectivity services, potentially placing us at a
significant competitive disadvantage. In addition, competitors may charge less
than we do for Internet services, causing us to reduce (or preventing us from
raising) our fees. As a result, our business may suffer.
PROPRIETARY RIGHTS
GENERAL. We rely on a combination of copyright, trademark, patent and trade
secret laws and contractual restrictions to establish and protect our technology
and proprietary rights and information. We require employees and consultants
and, when possible, suppliers and distributors, to sign confidentiality
agreements. However, we cannot assure you that our steps will be sufficient to
prevent misappropriation of our technology and proprietary rights and
information or that our competitors will not independently develop technologies
that are substantially equivalent or superior to ours. From time to time, third
parties have alleged that certain of our trademarks infringe their trademarks.
None of these claims has had an adverse effect on our ability to market and sell
its services. However, we cannot ensure that those claims will not have an
adverse effect in the future or that others will not assert infringement claims
against us in the future.
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LICENSES. We have licenses to distribute and/or use third-party software
incorporated in our software. Significant applications which we license for
distribution include Netscape Communicator (this license automatically renews
each December for additional one-year terms unless either party terminates the
license on 120 days notice), Microsoft Internet Explorer (this license expires
in August 2000 and thereafter automatically renews for additional one-year
terms, although either party may terminate the license at any time on 30 days
notice), and MacTCP software from Apple (this license renews each year). We
acquired some software, trademarks and other proprietary technology from Spry
and NETCOM which we may continue to use in support of the members we acquired
from those companies. We have an agreement with AOL, under which we distribute a
co-branded EarthLink version of AOL Instant Messenger. We intend to maintain or
negotiate renewals of existing software licenses and authorizations as
necessary. We may also want or need to license other applications in the future.
Our inability to renew existing software licenses or to license additional
applications could have a material adverse effect on us.
EMPLOYEES
As of December 31, 1999, we employed 4,828 full time equivalents, including
731 sales and marketing personnel, 3,232 member and technical support
representatives, 601 operations personnel, member and technical support
representatives and 264 administrative personnel. None of our employees are
represented by a labor union, and we have no collective bargaining agreement.
ITEM 2. PROPERTIES.
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 our corporate headquarters.
Our principal executive offices are in Atlanta, Georgia. We lease
approximately 51,900 square feet in our headquarters building at a current
monthly rent of $59,000. We also lease a 110,000 square foot facility in
Pasadena, California to house an equipment and technology center. Current
monthly rent on the facility is $147,000.
In addition, we maintain leased space for member support call centers and
office purposes in Atlanta Georgia, Harrisburg Pennsylvania, Pasadena
California, Phoenix Arizona, Sacramento California, San Jose California, and
Dallas Texas.
All of the above 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 the base rent payments, the Company generally pays a monthly allocation of
the buildings' operating expenses. We believe we have adequate facilities and
plan to acquire additional space to meet our future growth needs.
ITEM 3. LEGAL PROCEEDINGS.
We are not currently involved in any legal proceedings that we believe could
have, individually or in the aggregate, a material adverse effect on our
business or financial condition. There are proceedings pending before the FCC
and other governmental legislative and regulatory authorities that could
adversely affect the ISP industry and the means by which ISPs conduct business
and the cost structure for ISP services. We are not a party to these
proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Prior to the merger of the two companies, EarthLink Network common stock was
listed and traded on the Nasdaq national market under the symbol "ELNK," and
MindSpring common stock was listed and traded on the Nasdaq national market
under the symbol "MSPG". This table sets forth for the indicated periods, the
high and low sales prices per share as reported as composite transactions in The
Wall Street Journal. Neither EarthLink Network nor MindSpring has historically
paid dividends to its common stockholders. The data given for EarthLink Network
has been adjusted for the 2-for-1 stock split effected July 1998 and the 1.615
exchange ratio of its common stock in the merger with MindSpring. The data given
for MindSpring has been adjusted for the 3-for-1 stock split effected July 1998
and the 2-for-1 stock split effected June 1999.
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EARTHLINK MINDSPRING
NETWORK, INC. ENTERPRISES, INC.
COMMON STOCK COMMON STOCK
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HIGH LOW HIGH LOW
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YEAR ENDED DECEMBER 31, 1998
First Quarter............................... $17.47 $ 7.59 $11.50 $ 4.61
Second Quarter.............................. 23.76 15.48 17.38 8.08
Third Quarter............................... 27.32 16.41 26.19 12.66
Fourth Quarter.............................. 44.50 20.98 39.50 11.56
YEAR ENDED DECEMBER 31, 1999
First Quarter............................... 55.26 35.49 62.50 31.25
Second Quarter.............................. 56.04 23.07 66.50 27.94
Third Quarter............................... 43.65 22.95 54.88 23.00
Fourth Quarter.............................. 39.01 24.15 40.44 23.88
YEAR ENDING DECEMBER 31, 2000
First Quarter (through February 4, 2000).... 30.15 25.39 30.15 26.00
EARTHLINK, INC.
February 7 through March 17, 2000........... $31.44 $19.81
</TABLE>
The last reported sale price of the Company's common stock on the Nasdaq
National Market on March 17, 2000 was $21.50 per share. There were approximately
1,543 holders of the Company's Common Stock. Our common stock is listed and
traded on the Nasdaq national market under the symbol "ELNK".
DIVIDENDS
We have never paid or declared any cash dividends. We currently expect to
retain future earnings, if any, to finance the growth and development of our
business, including potential acquisitions. Therefore, we do not anticipate
paying cash dividends in the foreseeable future, except as required pursuant to
the terms of our convertible preferred stock owned by Sprint and Apple.
SALES OF UNREGISTERED SECURITIES
In connection with our January 1999 follow-on public offering, Sprint exercised
its "top-up" rights and purchased 979,000 shares of our newly created Series B
convertible preferred stock, convertible into 979,000 shares of common stock
(assuming the acceleration of certain paid in kind dividends rights).
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ITEM 6. SELECTED FINANCIAL DATA.
On February 4, 2000, EarthLink Network and MindSpring merged into EarthLink,
Inc. Following, in Items 6a, 6b and 6c, we present selected financial data for
(1) EarthLink, Inc., the combined company, (2) EarthLink Network prior to the
merger and (3) MindSpring prior to the merger, respectively. In all discussions,
share numbers for pre-merger EarthLink have been adjusted to reflect the effect
of the pooling of interests in which each outstanding share of then existing
EarthLink Network securities was exchanged for 1.615 shares of the equivalent
securities of the new company and each outstanding share of then existing
MindSpring securities was exchanged for one share of the equivalent security of
the new company.
ITEM 6A. EARTHLINK, INC.--SELECTED FINANCIAL DATA
The following supplemental selected financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations for EarthLink, Inc." and the Supplemental Combined
Financial Statements and Notes thereto included elsewhere in this Report
EARTHLINK, INC.--SELECTED PRO FORMA SUPPLEMENTAL COMBINED FINANCIAL INFORMATION
<TABLE>
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YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- -------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED COMBINED STATEMENT OF OPERATIONS DATA:
Revenues.................................................... $ 5,255 $ 51,362 $133,444 $290,614 $ 670,433
Operating costs and expenses................................ 12,507 89,142 165,641 345,069 866,113
Loss from operations........................................ (7,252) (37,780) (32,197) (54,455) (195,680)
Net loss.................................................... (8,079) (38,761) (33,997) (53,178) (173,694)
Deductions for accretion dividends (1)...................... -- -- -- (7,601) (14,106)
------- -------- -------- -------- ---------
Net loss attributable to common stockholders................ $(8,079) $(38,761) $(33,997) $(60,779) $(187,800)
======= ======== ======== ======== =========
Basic and diluted net loss per share (2).................... $ (0.25) $ (0.76) $ (0.44) $ (0.66) $ (1.65)
======= ======== ======== ======== =========
Weighted average shares (2)................................. 32,254 51,119 77,387 91,466 113,637
======= ======== ======== ======== =========
Other operating data:
EBITDA (3)................................................ $(6,682) $(30,342) $(14,127) $ 15,498 $ (6,157)
Cash flows from
Operating activities.................................... (3,713) (18,227) (9,936) 62,098 44,211
Investing activities.................................... (7,990) (39,697) (25,097) (56,886) (339,749)
Financing activities.................................... 11,833 70,855 47,223 277,559 672,684
</TABLE>
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DECEMBER 31,
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1995 1996 1997 1998 1999
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BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 715 $ 13,646 $ 25,836 $ 308,607 $ 685,753
Total assets................................................ 9,719 62,351 91,175 510,002 1,109,147
Long-term debt.............................................. 355 8,813 13,308 10,125 188,367
Total liabilities........................................... 8,947 44,192 63,685 109,515 350,694
Accumulated deficit......................................... (7,041) (45,802) (79,799) (140,578) (328,378)
Stockholders' equity........................................ 772 18,159 27,490 400,487 758,453
</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 then existing EarthLink Network common stock was
exchanged for 1.615 shares of the common stock of the new company and each
outstanding share of then existing MindSpring common stock was exchanged for
one share of the common stock of the new company. See Note 1 of Notes to
Supplemental Combined Financial Statements for an explanation of the
determination of the number of weighted average shares outstanding in the
net loss per share computation.
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(3) Represents earnings (loss) before depreciation and amortization, interest
income and expense and income tax expense. EBITDA is not determined in
accordance with generally accepted accounting principles, is not indicative
of cash used by operating activities and should not be considered in
isolation from, as an alternative to, or more meaningful than measures of
performance determined in accordance with generally accepted accounting
principles.
(4) The financial data of the combined Company include adjustments of $3.9
million and $25.3 million for 1998 and 1999, respectively, to give effect to
the reestablishment of a valuation allowance on the MindSpring net deferred
tax assets. 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.
ITEM 6B. EARTHLINK NETWORK, INC.--SELECTED FINANCIAL DATA
The following consolidated selected financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations for EarthLink Network, Inc." and the Consolidated
Combined Financial Statements and Notes thereto included elsewhere in this
Report.
EARTHLINK NETWORK, INC.--SELECTED HISTORICAL FINANCIAL INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- -------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues.................................................... $ 3,028 $ 33,230 $ 80,888 $175,941 $ 342,288
Operating costs and expenses................................ 9,046 63,488 109,342 238,180 466,595
Loss from operations........................................ (6,018) (30,258) (28,454) (62,239) (124,307)
Net loss.................................................... (6,120) (31,149) (29,916) (59,782) (108,248)
Deductions for accretion dividends (1)...................... -- -- -- (7,601) (14,106)
------- -------- -------- -------- ---------
Net loss attributable to common stockholders................ $(6,120) $(31,149) $(29,916) $(67,383) $(122,354)
======= ======== ======== ======== =========
Basic and diluted net loss per share (2).................... $ (0.80) $ (2.57) $ (1.50) $ (2.58) $ (3.81)
======= ======== ======== ======== =========
Weighted average shares (2)................................. 7,674 12,138 20,002 26,157 32,133
======= ======== ======== ======== =========
Other operating data:
EBITDA (3)................................................ $(5,713) $(26,105) $(19,077) $ (7,513) $ (38,132)
Cash flows from
Operating activities.................................... (3,643) (16,222) (21,290) 26,597 (21,410)
Investing activities.................................... (4,266) (18,361) (16,095) (9,239) (49,899)
Financing activities.................................... 8,199 38,286 49,842 107,056 239,024
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- -------- --------- ----------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 290 $ 3,993 $ 16,450 $ 140,864 $ 308,579
Total assets................................................ 4,874 27,119 46,887 266,341 423,475
Long-term debt.............................................. 355 6,088 8,218 7,701 8,259
Total liabilities........................................... 4,584 34,367 40,812 68,997 96,937
Accumulated deficit......................................... (5,007) (36,156) (66,072) (133,454) (255,809)
Stockholders' equity (deficit).............................. 290 (21,261) 6,075 197,344 326,538
</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) See Note 1 of Notes to Consolidated Financial Statements of EarthLink
Network Inc., for an explanation of the determination of the number of
weighted average shares outstanding in the net loss per share computation.
9
<PAGE>
(3) Represents earnings (loss) before depreciation and amortization, interest
income and expense and income tax expense. EBITDA is not determined in
accordance with generally accepted accounting principles, is not indicative
of cash used by operating activities and should not be considered in
isolation from, as an alternative to, or more meaningful than measures of
performance determined in accordance with generally accepted accounting
principles.
ITEM 6C. MINDSPRING ENTERPRISES, INC.--SELECTED FINANCIAL DATA
The following consolidated selected financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations for MindSpring Enterprises, Inc." and the Financial
Statements of MindSpring and Notes thereto included elsewhere in this Report.
MINDSPRING ENTERPRISES, INC.--SELECTED HISTORICAL FINANCIAL INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- -------- -------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues.................................................... $ 2,227 $ 18,132 $52,556 $114,673 $ 328,145
Operating costs and expenses................................ 3,461 25,654 56,299 106,887 399,518
Profit (loss) from operations............................... (1,234) (7,522) (3,743) 7,786 (71,373)
------- -------- ------- -------- ---------
Net (loss) income........................................... $(1,959) $ (7,612) $(4,081) $ 10,544 $ (40,131)
======= ======== ======= ======== =========
Net (loss) income per share (1)
Basic..................................................... $ (0.10) $ (0.24) $ (0.09) $ 0.21 $ (0.65)
======= ======== ======= ======== =========
Diluted................................................... $ (0.10) $ (0.24) $ (0.09) $ 0.21 $ (0.65)
======= ======== ======= ======== =========
Weighted average shares (1)
Basic..................................................... 19,860 31,516 45,084 49,222 61,742
======= ======== ======= ======== =========
Diluted................................................... 19,860 31,516 45,084 50,862 61,742
======= ======== ======= ======== =========
Other operating data:
EBITDA (2)................................................ $ (969) $ (4,237) $ 4,950 $ 23,011 $ 31,975
Cash flows from
Operating activities.................................... (70) (2,005) 11,354 35,501 65,621
Investing activities.................................... (3,724) (21,336) (9,002) (47,647) (289,850)
Financing activities.................................... 3,634 32,569 (2,619) 170,503 433,660
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 425 $ 9,653 $ 9,386 $167,743 $377,174
Total assets................................................ 4,845 35,232 44,286 247,599 714,925
Long-term debt.............................................. -- 2,725 5,090 2,424 180,108
Total liabilities........................................... 4,363 9,825 22,873 40,518 253,755
Accumulated deficit......................................... (2,034) (9,646) (13,727) (3,183) (43,314)
Stockholders' equity........................................ 482 25,407 21,415 207,083 461,170
</TABLE>
- - ------------------------------
(1) See Note 1 of Notes to the Financial Statements MindSpring Enterprises for
an explanation of the determination of the number of weighted average shares
outstanding in the net income (loss) per share computation.
(2) Represents earnings (loss) before depreciation and amortization, interest
income and expense and income tax expense. EBITDA is not determined in
accordance with generally accepted accounting principles, is not indicative
of cash used by operating activities and should not be considered in
isolation from, as an alternative to, or more meaningful than measures of
performance determined in accordance with generally accepted accounting
principles.
10
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
On February 4, 2000, EarthLink Network and MindSpring merged into the
Company. Following, in Items 7a, 7b and 7c, we present Management's Discussion
and Analysis for (1) EarthLink, Inc., the combined company, (2) EarthLink
Network prior to the merger and (3) MindSpring prior to the merger,
respectively. In all discussions, share numbers for pre-merger EarthLink Network
have been adjusted to reflect the effect of the pooling of interests in which
each outstanding share of then existing EarthLink Network securities was
exchanged for 1.615 shares of the equivalent securities of the combined company
and each outstanding share of then existing MindSpring securities was exchanged
for one share of the equivalent security of the new company.
The following discusses the supplemental combined financial condition and
results of operations of the Company, EarthLink Network and MindSpring should be
read in conjunction with the financial statements and notes thereto included
elsewhere in this Report.
SAFE HARBOR STATEMENT
The Management's Discussion and Analyses 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's service offerings 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) customer attrition
rates 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 7A. EARTHLINK, INC.--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
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 by way
of the merger of EarthLink Network and MindSpring. By combining the two
companies we formed the second largest Internet service provider in the United
States. The combined company is expected 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. The
combined company 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 combined member base grew from approximately 1.7 million paying members
on December 31, 1998 to approximately 3.1 million paying members on December 31,
1999, making us one of the world's leading ISPs. Our growth has resulted from
strategic acquisitions as well as traditional marketing channels and alliances.
Our organic growth is a product of our efforts to enhance our members' Internet
experience
11
<PAGE>
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 derives revenue 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 by providing web services to companies
and individuals wishing to have a web or e-Commerce presence
- BROADBAND ACCESS REVENUES which consists of fees charged for high-speed,
high capacity access services including cable, dedicated circuits and DSL,
and
- CONTENT, COMMERCE AND ADVERTISING REVENUES which represent (1) sales of
banner and other online ads; (2) fees generated through revenue sharing
arrangements with online retailers who are accessed through our
properties; and (3) payments for placing links from our properties to
third-party content. We also sell advertising and content space on our
various online properties, such as the Personal Start Page, the Mall and
our online magazine eLink, and through our bi- monthly magazine, bLink.
In June 1998, we entered into a strategic alliance with Sprint. As a part of
this alliance, Sprint transferred approximately 130,000 members to us and is
committed to generating at least 150,000 new members for us during each of the
succeeding five years through their channels. Additionally, we are co-branded as
Sprint's exclusive consumer Internet access provider, and we have exclusive
access to certain dial-up modem ports in Sprint's network. We also have access
to Sprint's marketing and distribution channels and the right to use Sprint's
widely recognized brand name.
In October 1998, we purchased substantially all of Spry, Inc.'s subscriber
base of individual dial-up Internet access members in the United States and
Canada, including approximately 130,000 individual access accounts. We also
acquired various assets used in serving those members, including a leased member
support facility and a leased network operations facility in Seattle, Washington
and all rights to the "Sprynet" name. Spry was a wholly-owned subsidiary of
America Online, Inc. The purchase price for these assets was approximately $32
million.
In February 1999, we purchased substantially all of NETCOM On-Line
Communication Services, Inc.'s subscriber accounts in the U.S., including
approximately 408,000 individual access accounts, approximately 25,000 Web
hosting accounts and approximately 3,000 dedicated Internet access accounts.
NETCOM, now known as ICG Netahead, Inc., is a wholly owned subsidiary of ICG
Communications, Inc. We also acquired assets used in serving those members,
including leased operations facilities in San Jose, California and Dallas, Texas
and ICG Netahead's rights to the "NETCOM" name, except in Canada, the United
Kingdom and Brazil. ICG Netahead retained all of its assets used in connection
with its network operations. Under a separate network services agreement with
ICG Netahead, EarthLink Inc., purchases access to ICG Netahead's network. We
paid $245 million for the NETCOM assets, consisting of $215 million in cash and
$30 million in common stock.
In January 2000, we entered into a strategic alliance with Apple Computer,
which we expect to 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.
12
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth the percentage of total revenues represented
by certain items in our supplemental combined statements of operations for the
periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1998 DECEMBER 31, 1999
------------------- --------------------- ---------------------
% OF % OF % OF
(000'S) REVENUE (000'S) REVENUE (000'S) REVENUE
-------- -------- ---------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Narrowband access...................... $119,030 89 $ 260,229 90 $ 582,883 87
Web Hosting............................ 12,557 9 22,007 7 47,435 7
Broadband access....................... 1,220 1 3,321 1 23,540 4
Content, commerce and advertising...... 637 1 5,057 2 16,575 2
-------- --- ---------- --- ---------- ---
Total revenues....................... 133,444 100 290,614 100 670,433 100
Operating costs and expenses:
Cost of revenues....................... 57,183 43 115,529 40 248,487 37
Operations and member support.......... 44,801 34 80,244 28 182,134 27
Sales and marketing.................... 36,281 27 65,037 22 219,349 33
General and administrative............. 23,168 17 34,575 12 67,876 10
Acquisition-related costs(1)........... 4,208 3 49,684 17 148,267 22
-------- --- ---------- --- ---------- ---
Total operating costs and expenses... 165,641 124 345,069 119 866,113 129
-------- --- ---------- --- ---------- ---
Loss from operations..................... (32,197) (24) (54,455) (19) (195,680) (29)
Net interest income (expense)............ (1,800) 1 3,671 1 21,986 3
-------- ---------- ----------
Net loss before income tax
provision.......................... (33,997) (25) (50,784) (18) (173,694) (26)
Income tax provision(2).................. -- (2,394) (1) -- --
-------- --- ---------- --- ---------- ---
Net loss............................. (33,997) (25) (53,178) (19) (173,694) (26)
Deductions for accretion dividends....... -- -- (7,601) (2) (14,106) (2)
-------- --- ---------- --- ---------- ---
Net loss attributable to common
stockholders........................... $(33,997) (25) $ (60,779) (21) $ (187,800) (28)
======== === ========== === ========== ===
OPERATING DATA:
Number of members at year end............ 698,000 1,640,000 3,122,000
Number of employees at year end.......... 1,789 2,320 4,828
EBITDA................................... (14,127) (11) 15,498 5 (6,157) (1)
CASH FLOW DATA:
Cash flow (used in) from operations...... (9,936) 62,098 44,211
Cash flow (used in) from investing
activities............................. (25,097) (56,886) (339,749)
Cash flow (used in) from financing
activities............................. 47,223 277,559 672,684
</TABLE>
- - --------------------------
(1) Represents the amortization of intangible assets acquired and a one time
transaction cost, in June 1998, of $1,397,000 resulting from the strategic
alliance with Sprint.
(2) 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 data of the combined Company include adjustments of $3.9 million
and $25.3 million for 1998 and 1999, respectively, to give effect to the
reestablishment of a valuation allowance on the MindSpring net deferred tax
assets. See note 1 to the Supplemental Combined Financial Statements of
EarthLink, Inc. included herein.
13
<PAGE>
1999 COMPARED TO 1998
NARROWBAND ACCESS REVENUES
Narrowband access revenues consist primarily of monthly fees charged to
members for dial up Internet access. EarthLink's narrowband revenues increased
from $260.2 million in 1998 to $582.9 million in 1999, a 124 percent increase.
The substantial growth in narrowband revenues was primarily due to an increase
in the Company's member base from 1.6 million at December 31, 1998 to 3.1
million at December 31, 1999. Approximately 408,000 members were acquired from
NETCOM in February 1999, 130,000 were acquired from Spry in October 1998.
Approximately 130,000 members were acquired in June 1998 from Sprint.
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 $22.0 million in 1998
to $47.4 million in 1999, a 116 percent increase. As of December 31, 1999, the
combined company hosted 109,000 Web sites compared to 36,000 in 1998, a 203%
increase.
BROADBAND ACCESS REVENUES
Broadband access revenues represent fees charged for high-speed,
high-capacity access services including cable, ISDN and DSL services.
EarthLink's broadband revenues increased from $3.3 million in 1998 to $23.5
million in 1999, a 612 percent increase. In 1999 our main broadband focus became
DSL. In the fourth quarter of 1999, we began service to 12 major cities giving
us access to 15 markets nationwide. As of December 31, 1999, the combined
company had 25,000 broadband members.
CONTENT, COMMERCE AND ADVERTISING REVENUES
Content, commerce and advertising revenues are generated by leveraging the
value of the Company's member base and user traffic. Content, commerce and
advertising revenues increased from $5.1 million in 1998 to $16.6 million in
1999, a 225 percent increase. The principal component of our strategy is our
Premier Partnership Program, through which we offer and sell promotional
packages that provide advertisers with access to the multiple points of contact
we have with our members. We also sell advertising and content space on our
various online properties, such as the Personal Start Page and the Mall, and
through our news magazine, bLink.
COST OF REVENUES
Cost of revenues increased 115% during 1999 as compared 1998, primarily due
to the increase in our member base. However, cost of revenues as a percentage of
revenues decreased from 40% to 37%. This is attributable to: (a) more effective
management of our network, (b) the addition of lower cost POP providers such as
Sprint and Level 3, and (c) our increasing ability to negotiate more favorable
commercial arrangements with our telecommunications service providers as we
leverage our growing member base.
14
<PAGE>
OPERATIONS AND MEMBER SUPPORT
Operations and member support expenses consist primarily of costs associated
with technical support and member service, as well as customer information
systems. Operations and member support expenses increased from $80.2 million or
28% of revenue for the year ended December 31, 1998 to $182.1 million or 27% of
revenue for the year ended December 31, 1999. These increases reflect (1) the
increase in members from 1.6 million to 3.1 million, (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.
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 237% from $65.0 million to $219.3 million during
1999. The increase was primarily due to the costs of growing our member base
from 1.6 million members to 3.1 million members and is in accordance with
management's increased emphasis on organic growth through marketing strategies.
This increased emphasis includes the implementation of an ambitious advertising
program to create brand awareness, the development of new marketing channels,
the expansion of sales and marketing efforts, increased sales commissions and
increased marketing personnel headcount. Sales, marketing and other direct costs
associated with the acquisition of members are expensed as incurred.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist primarily of costs associated
with the accounting and human resources departments, professional expenses,
rent, and bad debt and credit card processing. General and administrative
expenses increased 96% from $34.6 million in 1998 to $67.9 million in 1999. The
increase was primarily due to increases in payroll, depreciation, credit card
processing fees and bad debt. The rise in payroll costs 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. As a percentage of total revenues, general and
administrative expenses decreased from 12% in 1998 to 10% in 1999.
INTEREST INCOME AND EXPENSE, NET
Net interest income increased from $3.7 million in 1998 to $22.0 million
1999. The increase was primarily due to an increase in average cash balances
available for investment as a result of our public follow on common stock
offerings completed in 1998 and 1999. Interest expense increased due to
borrowings of $80 million under the credit facility to finance the NETCOM
acquisition and $179.9 million in 5% convertible subordinated notes. This
increase in interest expense was partially offset by aging of lease obligations
and a general reduction in interest rates paid on capital leases entered into
during 1999.
1998 COMPARED TO 1997
REVENUES
EarthLink's narrowband access revenues increased from $118.9 million in 1997
to $260.2 million in 1998, a 119 percent increase. The substantial growth in
narrowband revenues was primarily due to an increase in the Company's member
base from 698,000 at December 31, 1997 to 1.6 million at December 31, 1998. In
June 1998 we gained access to Sprint's marketing and distribution channels as
part of our strategic relationship with Sprint. In addition to these channels,
we aggressively expanded into the OEM arena by securing relationships with
Apple, Packard Bell NEC and CompUSA. In October 1998 we obtained approximately
130,000 members in conjunction with our acquisition of Spry from AOL. Also
15
<PAGE>
contributing to our growth was the addition of several key Affinity marketing
partners, Sam's Club, Discover Card and AAA of Southern California. EarthLink's
Web hosting revenues increased from $12.6 million in 1997 to $22.0 million in
1998, a 75 percent increase. As of December 31, 1998, the combined company
hosted 36,000 Web sites compared to 14,000 in 1997, a 157 percent increase.
Revenues from broadband access and content, commerce and advertising were
minimal for 1997 and 1998.
COST OF REVENUES
Cost of revenues increased 102% from $57.2 million in 1997 to $115.5 million
in 1998 due to the increase in our member base. However, cost of revenues as a
percentage of revenues decreased from 43% to 40%. This is attributable to: (a)
more effective management of our network, (b) the addition of Sprint to our
family of POP providers, and (c) our increasing ability to negotiate more
favorable commercial arrangements with our telecommunications service providers
as we leverage our growing member base.
OPERATION AND MEMBER SUPPORT
Operations and member support expenses increased from $44.8 million or 34%
of revenue for the year ended December 31, 1997 to $80.2 million or 28% of
revenue for the year ended December 31, 1998. This increase in total
expenditures is attributable to the growth in our member base whereas the
decrease as a percentage of revenue is primarily due to an increase in staffing
in our technical support and member service call centers at a slower rate than
the growth of the overall member base. We focus on retaining existing members by
providing superior services and devoting significant resources to expanding
technical support staff and network operations capabilities but achieve
economies of scale as our member base grows.
SALES AND MARKETING
Sales and marketing expenses increased from $36.3 million in 1997 to $65.0
million in 1998. The increase was primarily due to an increase in direct
marketing and advertising costs associated with Company growth initiatives.
Sales and marketing expenses were approximately 27% of revenues for 1997 and 22%
of revenues in 1998. The decrease as a percentage of revenues resulted from
economies of scale with respect to costs such as payroll that do not increase in
direct proportion to increases in revenue and from cost control efforts
implemented by management. Sales, marketing and other direct costs associated
with the acquisition of members are generally expensed as incurred.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 49% from $23.2 million in 1997
to $34.6 million in 1998. The increase was primarily due to increases in
payroll, depreciation, credit card processing fees and bad debt. The rise in
payroll costs 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. As a percentage
of total revenues, general and administrative expenses decreased from 17% in
1997 to 12% in 1998.
INTEREST INCOME AND EXPENSE, NET
The Company incurred net interest expense of $1.8 million in 1997 and earned
net interest income of $3.7 million in 1998. The change was primarily due to an
increase in average cash balances available for investment as a result of our
public follow on common stock offerings completed in 1998. Interest expense
decreased due the aging of lease obligations and a general reduction in interest
rates paid on capital leases entered into during 1998.
16
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Our operating activities used cash of $9.9 million during the year ended
December 31, 1997, and provided $62.1 million and $44.2 million in cash during
the years ended December 31, 1998 and 1999, respectively. The Company's net
losses of $34.0 million, $53.2 million and $173.7 million were the primary
components of cash used in operating activities in the three years ended
December 31, 1999, respectively. The Company's net losses were offset by
significant non-cash depreciation and amortization expenses relating to the
Company's network and intangible assets of $18.1 million, $70.0 million and
$190.5 million during the three years ended December 31, 1999, respectively. In
1998 and the Company's net losses were further offset by significant increases
in deferred revenues and accounts payable and accrued expenses.
Our investing activities, used cash of approximately $25.1 million, $56.9
million and $339.7 million in 1997, 1998 and 1999, respectively. Capital
equipment purchases were $22.6 million, $44.5 million and $109.8 million during
the three years then ended. Net cash received in the Sprint transaction of $23.8
million was partially offset by Sprint transaction costs of $9.9 million for the
year ended December 31, 1998. We acquired the subscriber base of Spry, Inc.
effective October 1998 with an initial cash payment of $25 million followed by a
final payment of $7 million in the first quarter of 1999. In 1999 we acquired
the member base of NETCOM and approximately $13.2 million capital equipment for
consideration of $245 million, consisting of $215 in cash and common stock
valued at $30 million, (752,232 shares, at a price per share of $39.88). During
1999 we invested $4.0 million in a limited partnership and committed to make an
additional investment amounting to $6.0 million.
Financing activities provided approximately $47.2 million, $277.6 million
and $672.7 million in cash during 1997, 1998 and 1999, respectively. In January
1997, we sold 7.4 million shares of common stock in EarthLink Network's initial
public offering and generated approximately $26.2 million in net proceeds. In
September 1997 we raised $15.4 million in private sales of equity securities
during 1997. We completed a follow on public offering in June 1998 of 6.1
million shares of common stock. Our net proceeds were approximately $106.3
million. In January 1999, the Company completed a follow on public offering of
4.0 million shares of its common stock at $45.51 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 311,000 shares were common stock and 993,000 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.
We completed an additional offering of 6 million shares of common stock at $8.84
per share. Net proceeds from the offering were approximately $49.8 million. In
December 1998, the Company issued 4.6 million shares of common stock at $28.50
for net proceeds of approximately $124.8 million. In April 1999 the Company
completed a follow on public offering of 5.5 million shares of its common stock.
Net proceeds were approximately $263.5 million. We also sold $179,975,000
aggregate principal amount of our 5% Convertible Subordinated Notes due 2006,
raising net proceeds of approximately $174.1 million. During 1997, 1998 and
1999, we financed the acquisition of data processing and office equipment
amounting to approximately $10.5 million, $9.3 million and $10.4 million,
respectively, through equipment leases and sale leaseback agreements. We record
sale leaseback transactions at cost, which approximates the fair market value of
the property, and, therefore, no gains or losses are recorded. We continue to
depreciate the property and record a financing obligation representing the
proceeds based upon payments under the lease agreement.
On December 31, 1999, we had approximately $685.8 million in cash and cash
equivalents. We believe our available cash is sufficient to meet our operating
expenses and capital requirements for the next 12 months. We also have a $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.
In conjunction with the merger, each holder of our Convertible Subordinated
Notes has the option to require us to repurchase that holder's notes at a
repurchase price equal to 100% of the principal amount plus accrued interest to
the
17
<PAGE>
date of repurchase. The repurchase price will be paid in cash. If all holders
exercise this option the payment will be $184.3 million. Our capital
requirements depend on numerous factors, including the rate of market acceptance
of our services, our ability to maintain and expand our member base, the rate of
expansion of our network infrastructure, the size and types of acquisitions in
which we may engage and the level of resources required to expand our marketing
and sales programs. We cannot accurately predict the timing and amount of
capital requirements. We may require additional financing sooner than
anticipated if capital requirements vary materially from those currently
planned. We have no commitments for any additional financing other than the line
of credit from Sprint, and we cannot be sure that we can obtain additional
commitments on favorable terms, if at all. Additional equity financing may
dilute our stockholders, and debt financing, if available, may restrict our
ability to declare and pay dividends and raise future capital. If we are unable
to obtain additional needed financing, we may be required to reduce the scope of
operations or anticipated expansion, which could materially and adversely affect
us.
18
<PAGE>
ITEM 7B. EARTHLINK NETWORK, INC.--MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR.
RESULTS OF OPERATIONS
The following table sets forth the percentage of total revenues represented
by certain items in our statements of operations for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1998 DECEMBER 31, 1999
------------------- --------------------- ---------------------
% OF % OF % OF
(000'S) REVENUE (000'S) REVENUE (000'S) REVENUE
-------- -------- ---------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Narrowband access............... $ 74,228 92 $ 161,009 92 $ 310,868 91
Web hosting..................... 5,202 6 7,537 4 11,554 3
Broadband access................ 1,143 1 3,285 2 6,756 2
Content, commerce and
advertising................... 315 1 4,110 2 13,110 4
-------- --- ---------- --- ---------- ---
Total revenues................ 80,888 100 175,941 100 342,288 100
Operating costs and expenses:
Cost of revenues................ 38,065 47 77,223 44 132,679 39
Operations and member support... 30,607 38 53,765 31 104,842 31
Sales and marketing............. 25,971 32 42,837 24 125,992 37
General and administrative...... 14,699 18 21,720 12 38,010 11
Acquisition-related costs(1).... -- -- 42,635 24 65,072 19
-------- --- ---------- --- ---------- ---
Total operating costs and
expenses.................... 109,342 135 238,180 135 466,595 137
-------- --- ---------- --- ---------- ---
Loss from operations.............. (28,454) (35) (62,239) (35) (124,307) (37)
Net interest income, (expense).... (1,462) (2) 2,457 1 16,059 5
-------- --- ---------- --- ---------- ---
Net loss...................... (29,916) (37) (59,782) (34) (108,248) (32)
Deductions for accretion
dividends(2).................... -- -- (7,601) (4) (14,106) (4)
-------- --- ---------- --- ---------- ---
Net loss attributable to common
stockholders.................... $(29,916) (37) $ (67,383) (38) $ (122,354) (36)
======== === ========== === ========== ===
OPERATING DATA:
Number of customers at year end... 420,000 1,000,000 1,776,000
Number of employees at year end... 1,287 1,343 2,624
EBITDA(3)......................... (19,077) (24) (7,513) (4) (38,132) (11)
</TABLE>
- - ------------------------
(1) Represents acquisition and amortization related expenses for 1998 and 1999
and a one time transaction cost of $1,397,000 related to the June 1998
Sprint transaction.
(2) 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.
(3) Represents net loss before depreciation and amortization, interest income
and expense and income tax expense. EBITDA is not determined in accordance
with generally accepted accounting principles, is not indicative of cash
used by operating activities and should not be considered in or as an
alternative to, or more meaningful than measures of performance determined
in accordance with generally accepted accounting principles.
19
<PAGE>
1999 COMPARED TO 1998
NARROWBAND ACCESS REVENUES
Narrowband access revenues consist of monthly fees charged to members for
dial-up Internet access. EarthLink Network's narrowband access revenues
increased from $161.0 million in 1998 to $310.9 million in 1999, a 93 percent
increase. The substantial growth in narrowband access revenues was primarily due
to the increase in the company's member base from 1.0 million at December 31,
1998 to 1.8 million at December 31, 1999. The largest portion of our member
growth came through traditional marketing channels, direct marketing and
strategic relationship with Sprint.
WEB HOSTING REVENUES
Web hosting revenues are earned by leasing server space and providing web
services to companies and individuals wishing to have a web or e-commerce
presence. Web hosting revenues increased from $7.5 million in 1998 to $11.6
million in 1999, a 55 percent increase. As of December 31, 1999, the company
hosted 41,000 Web sites compared to 15,000 in 1998, a 173 percent increase.
BROADBAND ACCESS REVENUES
Broadband access revenues represent fees charged for high-speed,
high-capacity access services including cable, ISDN and DSL services. EarthLink
Network's broadband access revenues increased from $3.3 million in 1998 to $6.8
million in 1999, a 106 percent increase. As of December 31, 1999, the company
had 21,000 broadband members compared to 5,400 in December 1998.
CONTENT, COMMERCE AND ADVERTISING REVENUES
Content, commerce and advertising revenues are generated by leveraging the
value of the company's member base and user traffic. Content, commerce and
advertising revenues increased from $4.1 million in 1998 to $13.1 million in
1999, a 220% increase. The principal component of our strategy is our Premier
Partnership Program, through which we offer and sell promotional packages that
provide advertisers with access to the multiple points of contact we have with
our members. We also sell advertising and content space on our various online
properties, such as the Personal Start Page and the Mall, and through our bi-
monthly magazine, bLink.
COST OF REVENUES
Cost of revenues increased 72% from $77.2 million in 1998 to $132.7 million
in 1999 due to the increase in our member base. However, cost of revenues as a
percentage of revenues decreased from 44% to 39%. This is attributable to: (a)
more effective management of our network, (b) the addition of lower cost POP
providers such as Sprint and Level 3, and (c) our increasing ability to
negotiate more favorable commercial arrangements with our telecommunications
service providers as we leverage our growing member base.
OPERATIONS AND MEMBER SUPPORT
Operations and member support expenses consist primarily of costs associated
with technical support and member service, as well as customer information
systems. Operations and member support expenses increased from $53.8 million or
31% or revenue for the year ended December 31, 1998 to $104.8 million or 31% or
revenue for the year ended December 31, 1999. These increases reflect (1) the
increase in members from 1.0 million to 1.8 million, (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.
20
<PAGE>
SALES AND MARKETING
Sales and marketing expenses consist primarily of advertising, direct
response mailings, sales compensation, bounties, communications costs related to
trial members, salaries and the cost of promotional material. Sales and
marketing expenses increased 194% from $42.8 million in 1998 to $126.0 million
in 1999. The increase was primarily due to management's increased emphasis on
organic growth through marketing strategies including the implementation of an
ambitious advertising program to create brand awareness, the development of new
marketing channels, the expansion of sales and marketing efforts, the increase
of sales commissions and the increase of marketing personnel headcount. Sales,
marketing and other direct costs associated with the acquisition of members are
expensed as incurred.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist primarily of costs associated
with the accounting and human resources departments, professional expenses,
rent, and bad debt. General and administrative expenses increased 75% from $21.7
million in 1998 to $38.0 million in 1999. The increase was primarily due to
increases payroll, depreciation, credit card processing fees and bad debt. The
rise in payroll costs was primarily due to growth in headcount. The increases in
credit card processing fees and bad debt were due to the increase in our member
base. As a percentage of total revenues, general and administrative expenses
decreased from 12% in 1998 to 11% in 1999.
INTEREST INCOME (EXPENSE), NET
Interest income increased from $4.4 million in 1998 to $17.3 million 1999.
The increase was primarily due to an increase in average cash balances available
for investment as a result of our public follow on common stock offerings
completed in June 1998 and January 1999. Interest expense decreased from $2.0
million during 1998 to $1.3 million due to the aging of lease obligations and a
general reduction in effective interest rates paid on capital leases entered
into during 1999.
1998 COMPARED TO 1997
REVENUES
EarthLink Network's narrowband access revenues increased from $74.2 million
in 1997 to $161.0 million in 1998, a 117 percent increase. The substantial
growth in narrowband revenues was primarily due to an increase in the base of
narrowband members from 422,000 at December 31, 1997 to 1.0 million at December
31, 1998. In June 1998 we gained access to Sprint's marketing and distribution
channels as part of our strategic relationship with Sprint. EarthLink Network's
Web hosting revenues increased from $5.2 million in 1997 to $7.5 million in
1998, a 44 percent increase.
COST OF REVENUES
Cost of revenues increased 103% from $38.1 million in 1997 to $77.2 million
in 1998 due to the increase in our member base. However, cost of revenues as a
percentage of revenues decreased from 47% to 44%. This is attributable to: (a)
more effective management of our network, (b) the addition of Sprint to our
family of POP providers, and (c) our increasing ability to negotiate more
favorable commercial arrangements with our telecommunications service providers
as we leverage our growing member base.
OPERATIONS AND MEMBER SUPPORT
Operations and member support expenses increased from $30.6 million or 38%
of revenue for the year ended December 31, 1997 to $53.8 million or 31% or
revenue for the year ended December 31, 1998. This increase in total
expenditures is attributable to the growth in our member base whereas the
decrease as a percentage of revenue is primarily due to an increase in staffing
in our technical support and member
21
<PAGE>
service call centers at a slower rate than the growth of the overall member
base. We focus on retaining existing members by providing superior services and
devoting significant resources to expanding technical support staff and network
operations capabilities but achieve economies of scale as our member base grows.
SALES AND MARKETING
Sales and marketing expenses consist primarily of third-party, advertising,
sales commissions, salaries, referral credits, communication costs associated
with trial accounts and the cost of promotional material. Sales and marketing
expenses increased from $26.0 million in 1997 to $42.8 million in 1998. The
increase was primarily due to an increase in third-party bounty payments of $4
million, increased sales commissions of $1 million, increased marketing
personnel headcount leading to an increase in employee costs of $3.4 million and
increased emphasis on marketing including expanded sales and marketing efforts
on a nation wide basis leading to an increase in advertising expense of $3.2
million. Sales and marketing expenses were approximately 33% of revenues for
1997 and 25% of revenues in 1998. The decrease as a percentage of revenues
resulted from economies of scale with respect to costs such as payroll that do
not increase in direct proportion to increases in revenue and from cost control
efforts implemented by management. Sales, marketing and other direct costs
associated with the acquisition of members are expensed as incurred.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 48% from $14.7 million in 1997
to $21.7 million in 1998. The increase was primarily due to increases payroll,
depreciation, credit card processing fees and bad debt. The rise in payroll
costs 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. As a percentage of total
revenues, general and administrative expenses decreased from 18% in 1997 to 12%
in 1998.
INTEREST INCOME AND EXPENSE, NET
Interest income increased from $637,000 in 1997 to $4.4 million 1998. The
increase was primarily due to an increase in average cash balances available for
investment as a result of our public follow on common stock offering completed
in June 1998. Interest expense decreased from $2.1 million in 1997 to $2.0
million during 1998 due to repayment of approximately $4 million in notes
payable, the conversion of $5 million in debt to equity and a reduction in the
effective interest rates paid to lessors.
LIQUIDITY AND CAPITAL RESOURCES
Our operating activities used $21.3 million, provided $26.6 million and used
$21.4 million in cash during the years ended December 31, 1997, 1998 and 1999,
respectively. Net losses of $29.9 million, $59.8 million and $108.2 million were
the primary components of cash used in operating activities in the three years
ended December 31, 1999, respectively. Net losses were offset by significant
non-cash depreciation and amortization expenses relating to the EarthLink
Network's network and intangible assets of $9.3 million, $54.7 million and $86.2
million during the three years ended December 31, 1999, respectively. In 1998
EarthLink Network's net loss was further offset by significant increases in
accounts payable and accrued expenses.
Our investing activities, used cash of approximately $16.1 million, $9.2
million and $49.9 in 1997, 1998 and 1999, respectively. Capital equipment
purchases were $14.5 million, $24.3 million and $47.3 million during the three
years then ended. Net cash received in the Sprint transaction of $23.8 million
was partially offset by Sprint transaction costs of $9.9 million for the year
ended December 31, 1998. During 1999 we
22
<PAGE>
invested $4.0 million in a limited partnership. We are committed to invest an
additional $6.0 million in limited partnerships.
Financing activities provided approximately $49.8 million, $107.1 million
and $239.0 million in cash during 1997, 1998 and 1999, respectively. In January
1997, we sold 4.6 million shares of common stock in our initial public offering
and generated approximately $26.2 million in net proceeds. In September 1997 we
raised $15.4 million in private sales of equity securities during 1997. We
completed a follow on public offering in June 1998 of 3.8 million shares of
common stock. Our net proceeds were approximately $106.3 million. In January
1999, the company completed a follow on public offering of 2.4 million shares of
its common stock at $73.63 per share. In conjunction with the offering, Sprint
exercised its preemptive rights to maintain its existing ownership level in the
company. Accordingly, Sprint purchased 808,000 shares of which 201,000 shares
were common stock and 607,000 shares were Series B convertible preferred stock
(having the same rights and preferences as the Series A convertible preferred
stock already held by Sprint). Net proceeds from the sale of Common Stock were
$183.1 million. Net proceeds from the sale of Series B convertible preferred
stock to Sprint were approximately $42.6 million. During 1997, 1998 and 1999, we
financed the acquisition of data processing and office equipment amounting to
approximately $10.5 million, $9.3 million and $13.4 million, respectively,
through equipment leases and sale leaseback agreements. We record sale leaseback
transactions at cost, which approximates the fair market value of the property,
and, therefore, no gains or losses are recorded. We continue to depreciate the
property and record a financing obligation representing the proceeds based upon
payments under the lease agreement.
On December 31, 1999, we had approximately $308.6 million in cash and cash
equivalents. See Management's Discussion and Analysis for EarthLink, Inc. for
further discussion of cash requirements.
23
<PAGE>
ITEM 7C. MINDSPRING ENTERPRISES, INC.--MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS
The following table shows financial data for the years ended December 31,
1999, 1998 and 1997. Operating results for any period are not necessarily
indicative of results for any future period. Dollar amounts are shown in
thousands (except per share data)
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1998 DECEMBER 31, 1999
------------------- ------------------- ---------------------
% OF % OF % OF
(000'S) REVENUE (000'S) REVENUE (000'S) REVENUE
-------- -------- -------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues:
Narrowband access................................. $44,802 85% $ 99,220 86% $ 272,015 83%
Web hosting....................................... 7,355 14% 14,470 13% 35,881 11%
Broadband access.................................. 77 0% 36 0% 16,784 5%
Content, commerce, and advertising................ 322 1% 947 1% 3,465 1%
------- --- -------- --- ---------- ---
Total revenues.................................. 52,556 100% 114,673 100% 328,145 100%
Operating costs and expenses:
Cost of revenues.................................. 19,118 36% 38,306 33% 115,808 35%
Operations and Member Support..................... 14,194 27% 26,477 23% 77,292 24%
Sales and marketing............................... 10,310 20% 22,200 20% 93,357 29%
General and administrative........................ 8,469 16% 12,855 11% 29,866 9%
Acquisition-related costs......................... 4,208 8% 7,049 6% 83,195 25%
------- --- -------- --- ---------- ---
Total operating costs and expenses.............. 56,299 107% 106,887 93% 399,518 122%
Operating Loss (Income)............................. (3,743) (7)% 7,786 7% (71,373) (22)%
Interest (Expense) Income, net...................... (338) (1)% 1,214 1% 5,927 2%
------- --- -------- --- ---------- ---
(Loss) Income before taxes.......................... (4,081) (8)% 9,000 8% (65,446) (20)%
Income tax benefit.................................. -- 0% 1,544 1% 25,315 8%
------- --- -------- --- ---------- ---
Net (Loss) Income................................... $(4,081) (8)% $ 10,544 9% $ (40,131) (12)%
======= ======== ==========
Net (Loss) Income per share
Basic............................................. $ (0.09) $ 0.21 $ (0.65)
------- -------- ----------
Diluted........................................... $ (0.09) $ 0.21 $ (0.65)
------- -------- ----------
Weighted Average Common
Shares Outstanding
Basic............................................. 45,084 49,222 61,742
Diluted........................................... 45,084 50,862 61,742
Other Operating Data:
Approximate number of members at end of period.... 278,000 640,000 1,346,000
Number of employees at end of period.............. 502 977 2,204
</TABLE>
REVENUES. Revenues for the year ended December 31, 1999 totaled
approximately $328.1 million as compared to approximately $114.7 million for the
year ended December 31, 1998. The increase in revenues of 186% resulted
primarily from a 95% increase in total members. The increase in members is due
to the acquisition of the NETCOM members in February 1999, the acquisition of
Spry members in October 1998 and organic growth. Revenues from narrowband access
to the Internet, which includes start-up fees, represented approximately 83% of
total revenue for the year ended December 31, 1999 vs. 86% for the year ended
December 31, 1998. Web hosting revenue grew to $35.9 million, or 11% of total
revenue, for the year ended December 31, 1999 from $14.5 million, or 13% of
total revenue, for the year ended December 31, 1998. The decrease in both
narrowband access and Web Hosting revenue as a percentage of total revenue for
the year ended December 31, 1999 as compared to the year ended December 31, 1998
can be attributed to the greater contribution and relative growth in our
Broadband revenues. Broadband
24
<PAGE>
revenue grew to $16.8 million, or 5% of total revenues, for the year ended
December 31, 1999 from $36,000 million, or 0% of total revenue, for the year
ended December 31, 1998. This increase is attributed to the acquisition of 3,000
dedicated Internet access members from NETCOM in February 1999 as well as the
rollout of xDSL and cable services during the year.
COSTS OF REVENUES. For the year ended December 31, 1999, cost of revenues
increased to approximately 35% of total revenue, compared to approximately 33%
of total revenue for the year ended December 31, 1998. Cost of revenues
increased as a percentage of total revenues as a result of a greater percentage
of our members being served through the use of third party networks rather than
MindSpring POPs due to the Spry and NETCOM acquisitions. Cost of revenues for
members being serviced by MindSpring POP's includes depreciation for these POPs
and other related equipment.
OPERATIONS AND MEMBER SUPPORT. Operations and member support expenses
consist primarily of costs associated with technical support and member service,
as well as customer information systems. Operations and member support expenses
increased from $26.5 million or 23% of revenue for the year ended December 31,
1998 to $77.3 million or 24% of revenue for the year ended December 31, 1999.
This increase is primarily due to increased staffing in our technical support
and member service call centers necessary to support MindSpring's accelerated
growth program initiated in September 1999 as well the addition of several new
call centers in 1999.
SALES AND MARKETING EXPENSES. Sales and marketing expenses consist
primarily of advertising, direct response mailings, sales compensation,
bounties, communications costs related to trial members, salaries and cost of
promotional materials. Sales and marketing expenses increased to $93.4 million,
or approximately 29% of total revenue, for the year ended December 31, 1999,
compared to $22.2 million, or approximately 20% of total revenue, for the year
ended December 31, 1998. This increase is primarily due to higher advertising
expenditures related to MindSpring's accelerated growth program initiated in
September 1999.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of costs associated with the accounting and human resources
departments, professional expenses, bad debt, credit card processing and
executive compensation. General and administrative expenses increased to $29.9
million, or approximately 9% of total revenue, for the year ended December 31,
1999, compared to $12.9 million, or approximately 11% of total revenue, for the
year ended December 31, 1998. This decrease as a percentage of total revenue is
due to efficiencies gained primarily through economies of scale.
ACQUISITION-RELATED AMORTIZATION. Acquisition-related amortization expense
increased significantly to 25% of total revenues for the year ended December 31,
1999 from 6% of total revenues for the year ended December 31, 1998 due to the
acquisitions of the Spry and NETCOM member bases, which are being amortized over
three years.
INTEREST (EXPENSE) INCOME, NET. Interest (expense) income, net was
approximately $5.9 million, or 2% of total revenues, for the year ended December
31, 1999 compared to approximately $1.2 million, or 1% of total revenues, for
the year ended December 31, 1998. This increase in interest (expense) income,
net for the year ended December 31, 1999 compared to the year ended December 31,
1998 was primarily due to interest income increasing as a result of the increase
in cash available for investment purposes, resulting from equity and debt
offerings in December 1998 and April 1999, offset by interest expense increasing
which resulted from our convertible debt offering completed in April 1999. The
offerings raised net proceeds of approximately $562 million from which we repaid
$80 million outstanding under a secured credit facility. Interest expense
includes interest on our 5% Convertible Subordinated Notes due 2006 and fees
related to our unused credit facility as well as amortization of deferred
financing costs incurred in conjunction with both.
25
<PAGE>
INCOME TAX BENEFIT (PROVISION). For the year ended December 31, 1999,
MindSpring recorded an income tax benefit of $25.3 million, or 8% of total
revenues, for an effective tax rate of 39%, compared to an income tax benefit of
$1.5 million, or 1% of total revenues, for the year ended December 31, 1998. For
the year ended December 31, 1998 MindSpring recorded a benefit for income taxes
due to a one time benefit taken in the fourth quarter of the year as a result of
the removal of the valuation allowance associated with MindSpring's deferred tax
assets.
NET (LOSS) INCOME AND (LOSS) INCOME PER SHARE. As discussed above, and
primarily as a result of the increase in sales and marketing expenditures and in
acquired member base amortization, MindSpring had a net loss for the year ended
December 31, 1999 of ($40.1 million) or $(0.65) per basic and diluted share.
MindSpring's net income for the year ended December 31, 1998 was $10.5 million
or $0.21 per basic and diluted share.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1998
REVENUES. Revenues for the year ended December 31, 1998 totaled
approximately $114.7 million, as compared to approximately $52.6 million for the
year ended December 31, 1997. This approximately 118% increase in period
revenues resulted primarily from an approximately 130% increase in subscribers.
The greater proportional increase in subscribers compared to the percentage
increase in period revenues was principally due to the acquisition of Spry
subscribers from AOL during the fourth quarter of 1998. Revenues from access to
the Internet, which includes start-up fees, represented approximately 86% of
total revenue for the year ended December 31, 1998, compared to 85% of total
revenue for the year ended December 31, 1997. Web hosting revenue grew to $14.5
million, or 13% of total revenue, for the year ended December 31, 1998 from $7.4
million, or 14% of total revenue for the year ended December 31, 1997. Broadband
and content, commerce and advertising revenues were immaterial for both 1997 and
1998.
COSTS OF REVENUES. For the year ended December 31, 1998, cost of revenues
decreased to approximately 33% of total revenue, compared to approximately 36%
of total revenue for the year ended December 31, 1997. Not taking into account
approximately $2.0 million in discounts we received in 1998 under our network
services agreement with PSINet, Inc., cost of revenues would have been
approximately 35% of total revenue. Not taking into account approximately $2.1
million in discounts we received in 1997 under the network services agreement
with PSINet, Inc., cost of revenues would have been approximately 40% of total
revenue. The discounts earned under the network services agreement with PSINet
ended in October 1998. This decrease of cost of revenues as a percentage of
total revenue resulted primarily from increased efficiency and reduced network
costs associated with MindSpring-owned POPs.
OPERATIONS AND MEMBER SUPPORT. Operations and member support expenses
increased from $14.2 million or 27% of revenue for the year ended December 31,
1997 to $26.5 million or 23% of revenue for the year ended December 31, 1998.
This increase in total expenditures is attributable to the growth in our member
base whereas the decrease as a percentage of revenue is primarily due to an
increase in staffing in our technical support and member service call centers at
a slower rate than the growth of the overall member base. We focus on retaining
existing members by providing superior services and devoting significant
resources to expanding technical support staff and network operations
capabilities but achieve economies of scale as our member base grows.
SALES AND MARKETING EXPENSES. Sales and marketing expenses consist
primarily of advertising, direct response mailings, sales compensation,
bounties, communications costs related to trial members, salaries and cost of
promotional materials. Sales and marketing expenses increased to $22.2 million,
or approximately 20% of total revenue, for the year ended December 31, 1998,
compared to $10.3 million, or approximately 20% of total revenue, for the year
ended December 31, 1997.
26
<PAGE>
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
consist primarily of costs associated with the accounting and human resources
departments, professional expenses, bad debt, credit card processing and
executive compensation. General and administrative expenses increased to $12.9
million, or approximately 11% of total revenue, for the year ended December 31,
1998, compared to $8.5 million, or approximately 16% of total revenue, for the
year ended December 31, 1998. This decrease as a percentage of total revenue is
due to efficiencies gained primarily through economies of scale.
ACQUISITION-RELATED AMORTIZATION. Acquisition-related amortization expense
increased to $7.0 million, or 6% of total revenues, for the year ended December
31, 1998 from $4.2 million, or 8% of total revenues, for the year ended December
31, 1998. Amortization expense resulted solely from acquired subscriber bases,
which are being amortized over three years.
INTEREST (EXPENSE) INCOME. The following table details the increase in
interest income in 1997 compared to 1998:
<TABLE>
<CAPTION>
1997 1998
--------- ----------
<S> <C> <C>
Interest on capital leases.................................. $(473,000) $ (754,000)
Interest on PSINet notes.................................... (276,000) (136,000)
Interest income--other...................................... 411,000 2,104,000
--------- ----------
Interest (expense) income net............................... $(338,000) $1,214,000
========= ==========
</TABLE>
Interest on capital leases increased for the year ended December 31, 1998,
compared to the year ended December 31, 1997, because MindSpring entered into
several new capital leases for equipment at the end of 1997. Interest income
increased in 1998 due to the increase in outstanding cash balances available for
investment as a result of positive operating cash flows and two public equity
offerings completed during the year. See "--Liquidity and Capital Resources".
INCOME TAX PROVISION. For the year ended December 31, 1998 MindSpring
recorded a benefit for income taxes due to a one time benefit taken in the
fourth quarter of the year as a result of the removal of the valuation allowance
associated with MindSpring's deferred tax assets. MindSpring is continually
assessing its income tax situation and management believed that it was "more
likely than not" that the deferred tax assets would be realized in the future.
MindSpring expected to report taxable earnings, even though we expected to be
incurring net losses at the same time. This was principally due to the
requirement that, for tax purposes, subscriber acquisition costs must be
amortized over 15 years, compared to the three-year period applied for
accounting purposes. For the year ended December 31, 1997, no income tax benefit
was recognized as MindSpring had a net taxable loss for the year.
NET INCOME (LOSS) AND INCOME (LOSS) PER SHARE. As a result of the factors
discussed above, MindSpring's net income for the year ended December 31, 1998
was $10.5 million, or $0.21 income per basic and diluted share, compared to a
net loss of $4.1 million, or $0.09 basic and diluted loss per share, for the
year ended December 31, 1997.
27
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
For the year ended December 31, 1999, MindSpring generated net cash from
operations of approximately $65.6 million, compared to $35.5 million for the
year ended December 31, 1998, an increase of approximately 85%. During 1999, we
spent approximately $227.5 million to fund purchases of subscriber bases. $215
million of this amount was paid to ICG Communications in connection with the
closing of the NETCOM acquisition, approximately $80 million of which we
borrowed under our $100 million secured revolving credit facility, which we
repaid as discussed below, and the remainder from our available cash.
Additionally, in March 1999 we paid the remaining $7 million to complete the
payments related to the Spry acquisition. During the twelve months of 1999, we
spent a total of approximately $62.5 million primarily related to purchases of
telecommunications equipment necessary for the provision of service to
subscribers. We did not enter into any new capital lease agreements in 1999.
In March 1999, we 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, we completed
two public offerings of securities under this shelf registration statement. We
sold 5,520,000 shares of our common stock raising net proceeds of approximately
$263.5 million, from which we repaid approximately $80 million of principal and
interest outstanding under our secured credit facility. We also sold
$179,975,000 aggregate principal amount of our 5% Convertible Subordinated Notes
due 2006, raising net proceeds of approximately $174.1 million. Net of expenses
and repayment of debt, MindSpring raised an aggregate of approximately $357.6
million in these offerings.
On December 31, 1999, we had approximately $377.2 million in cash and cash
equivalents. See Management's Discussion and Analysis for EarthLink Inc. for
further discussion of cash requirements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this item appears in a subsequent section of
this Report. (See Item 14(a)(1) and (2)).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
28
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to management's nominees for directors of the Company
will be set forth under the captions "Proposal 1--Election of
Directors--Nominees" and "Proposal 1--Election of Directors--Information
Regarding Nominees for Director" in the Company's Proxy Statement for its 2000
Annual Meeting of Shareholders or in a subsequent amendment to this Report. Such
information is incorporated herein by reference. Information relating to the
executive officers of the Company will be set forth under the caption "Executive
Officers" in the above-referenced Proxy Statement or amendment. Such information
is incorporated herein by reference. Information regarding compliance by
directors and executive officers of the Company and owners of more than ten
percent of the Company's Common Stock with the reporting requirements of Section
16(a) of the Securities Exchange Act of 1934, as amended, will be set forth
under the caption "Compliance with Section 16(a) of the Securities Exchange Act
of 1934" in the above-referenced Proxy Statement or amendment.
ITEM 11. EXECUTIVE COMPENSATION
Information relating to management compensation will be set forth under the
captions "Proposal 1--Election of Directors--Director Compensation" and
"Executive Compensation" in the Company's Proxy Statement referred to in Item 10
above or in a subsequent amendment to this Report. Such information is
incorporated herein by reference, except for the information set forth under the
captions "Executive Compensation--Audit and Compensation Committee Report on
Executive Compensation" and "Stock Performance Graph," which specifically is not
so incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding ownership of the Company's securities by certain
persons is set forth under the captions "Beneficial Ownership of Common Stock"
in the Company's Proxy statement referred to in Item 10 above or in a subsequent
amendment to this Report. Such information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and transactions between the
Company and certain of its affiliates is set forth under the caption
"Compensation Committee Interlocks and Insider Participation" in the Company's
Proxy Statement referred to in Item 10 above or in a subsequent amendment to
this Report. Such information is incorporated herein by reference.
29
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(A) DOCUMENTS FILED AS PART OF THIS REPORT.
1. FINANCIAL STATEMENTS OF EARTHLINK, INC.
Report of Independent Accountants
Consolidated Combined Balance Sheet as of December 31, 1998 and 1999
Consolidated Combined Statement of Operations for the three years ended
December 31, 1999
Consolidated Combined Statement of Stockholders' Equity for the three years
ended
December 31, 1999
Consolidated Combined Statement of Cash Flows for the three years ended
December 31, 1999
Notes to Consolidated Combined Financial Statements
2. FINANCIAL STATEMENTS OF EARTHLINK NETWORK, INC.
Report of Independent Accountants
Consolidated Balance Sheet as of December 31, 1998 and 1999
Consolidated Statement of Operations for the three years ended December 31,
1999
Consolidated Statement of Stockholders' Equity for the three years ended
December 31, 1999
Consolidated Statement of Cash Flows for the three years ended December 31,
1999
Notes to Consolidated Financial Statements
3. FINANCIAL STATEMENTS OF MINDSPRING ENTERPRISES, INC.
Report of Independent Accountants
Consolidated Balance Sheet as of December 31, 1998 and 1999
Consolidated Statement of Operations for the three years ended December 31,
1999
Consolidated Statement of Stockholders' Equity for the three years ended
December 31, 1999
Consolidated Statement of Cash Flows for the three years ended December 31,
1999
Notes to Consolidated Financial Statements
(B) FINANCIAL STATEMENT SCHEDULE
The Financial Statement Schedule(s) described in Regulation S-X are omitted
from this Report because they are either not required or are immaterial.
(C) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- - --------------------- ------------------------------------------------------------
<S> <C> <C>
2.1 -- Agreement and Plan of Reorganization, dated September 22,
1999, by and among EarthLink Network, Inc., MindSpring
Enterprises, Inc. and Earthlink, Inc., as amended (included
as Annex A to the Proxy Statement/Prospectus contained in
Part I of this Registration Statement).
</TABLE>
30
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- - --------------------- ------------------------------------------------------------
<S> <C> <C>
2.2 -- Stock Option Agreement, dated September 22, 1999, between
MindSpring Enterprises, Inc. and EarthLink Network, Inc.
(incorporated by reference to Exhibit 2.2 of EarthLink
Network Inc.'s Form 8-K, dated September 22, 1999, File No.
0-20799).
2.3 -- Stock Option Agreement, dated September 22, 1999, between
EarthLink Network, Inc. and MindSpring Enterprises, Inc.
(incorporated by reference to Exhibit 2.3 of EarthLink
Network Inc.'s Form 8-K, dated September 22, 1999, File No.
0-20799).
2.4 -- Form of EarthLink Stockholder Agreement, dated September 22,
1999, between certain stockholders and EarthLink Network,
Inc. (incorporated by reference to Exhibit 2.4 of EarthLink
Network, Inc.'s Form 8-K, dated September 22, 1999, File No.
0-20799).
2.5 -- Form of MindSpring Stockholder Agreement, dated September
22, 1999, between certain stockholders and MindSpring
Enterprises, Inc. (incorporated by reference to Exhibit 2.5
of EarthLink Network, Inc.'s Form 8-K, dated September 22,
1999, File No. 0-20799).
2.6* -- Preferred Stock Purchase Agreement, dated January 4, 2000,
between EarthLink Network, Inc. and Apple Computer, Inc.
Limited.
2.7* -- Investor Rights Agreement dated January 4, 2000, between
EarthLink Network, Inc. and Apple Computer, Inc. Limited.
3.1* -- Certificate of Incorporation of EarthLink, Inc.
3.2* -- Form of Amended and Restated Certificate of Incorporation of
EarthLink, Inc.
3.3* -- By-laws of EarthLink, Inc.
3.4* -- Form of Certificate of Designation, Preferences and Rights
of Series A Convertible Preferred Stock.
3.5* -- Form of Certificate of Designation, Preferences and Rights
of Series B Convertible Preferred Stock and amendment
thereto.
3.6* -- Form of Certificate of Designation, Preferences and Rights
of Series C Convertible Preferred Stock.
10.1 -- 1995 Stock Option Plan and form of Stock Option Agreement
(incorporated by reference to Exhibit 10.1 to EarthLink
Network's Registration Statement on Form S-1--File No.
333-15781).
10.2 -- Amended and Restated Stock Option Plan for Directors
(incorporated by reference to Exhibit 10.2 to EarthLink
Network's Registration Statement on Form S-1--File No.
333-15781).
10.3 -- (a) Netscape Communications Corporation Internet Service
Provider Navigator Distribution Agreement, dated May 31,
1996, between EarthLink Network, Inc. and Netscape
Communications Corporation (incorporated by reference to
Exhibit 10.6 to EarthLink Network's Registration
Statement on Form S-1--File No. 333-15781).
(b) Amendment No. 1 to Netscape Communications Corporation
Internet Service Provider Agreement (incorporated by
reference to Exhibit 10.6(a) to EarthLink Network's
Registration Statement on Form S-1--File No. 333-15781).
(c) Amendment No. 2 to Netscape Communications Corporation
Internet Service Provider Agreement (incorporated by
reference to Exhibit 10.6(b) to EarthLink Network's
Registration Statement on Form S-1--File No. 333-15781).
</TABLE>
31
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- - --------------------- ------------------------------------------------------------
<S> <C> <C>
10.4 -- (a) Network Services Agreement, dated May 31, 1996, between
EarthLink Network, Inc. and UUNET Technologies, Inc.
(incorporated by reference to Exhibit 10.7 to EarthLink
Network's Registration Statement on Form S-1--File No.
333-15781).
(b) Addendum No. 1 to Network Services Agreement
(incorporated by reference to Exhibit 10.7 (a) to EarthLink
Network's Registration Statement on Form S-1--File No.
333-15781).
10.5 -- Software Distribution Agreement (MacTCP), dated October 2,
1995, between EarthLink Network, Inc. and Apple Computer,
Inc. (incorporated by reference to Exhibit 10.8 to EarthLink
Network's Registration Statement on Form S-1--File No.
333-15781).
10.6 -- Amended and Restated Employment Agreement (incorporated by
reference to Exhibit 10.8(d) to EarthLink Network's
Registration Statement on Form S-1--File No. 333-53063).
10.7 -- Standard Industrial/Commercial Multi-Tenant Lease, dated
December 1, 1995, between EarthLink Network, Inc. and Becton
Dickinson and Company (incorporated by reference to Exhibit
10.12 to EarthLink Network's Registration Statement on Form
S-1--File No. 333-15781).
10.8 -- Internet Wizard Sign-Up Agreement, between EarthLink
Network, Inc. and Microsoft Corporation, dated August 16,
1996 (incorporated by reference to Exhibit 10.19 to
EarthLink Network's Registration Statement on Form S-1--File
No. 333-15781).
10.9 -- Network Access Agreement, between EarthLink Network, Inc.
and PSINet, Inc., dated July 22, 1996 and Amendment No. 1 to
Network Access Agreement (incorporated by reference to
Exhibit 10.20 to EarthLink Network's Registration Statement
on Form S-1--File No. 333-15781).
10.10 -- (a) Office Lease by and between The Mutual Life Insurance
Company of New York, and EarthLink Network, Inc., dated
September 20, 1996 (incorporated by reference to Exhibit
10.21 to EarthLink Network's Registration Statement on
Form S-1--File No. 333-15781).
(b) Third Amendment to the lease agreement between WHMNY
Real Estate Limited Partnership and EarthLink Network, Inc.
(incorporated by reference to Exhibit 10.1 to EarthLink
Network's Form 10-Q filed on November 16, 1998--File No.
0-20799).
10.11 -- Amended and Restated Convertible Securities Vesting Plan
(incorporated by reference to Exhibit 10.18 to EarthLink
Network's Report on Form 10-K for the fiscal year ended
December 31, 1997--File No. 0-20799).
10.12 -- (a) Key Employee Compensation Continuation Plan
(incorporated by reference to Exhibit 10.19 to EarthLink
Network's Report on Form 10-K for the fiscal year ended
December 31, 1997--File No. 0-20799).
(b) Amendment to Key Employee Compensation Continuation Plan
(incorporated by reference to Exhibit 10.19(a) to EarthLink
Network's Report on Form 10-K for the fiscal year ended
December 31, 1997--File No. 0-20799).
10.13 -- Governance Agreement, dated as of February 10, 1998,
(incorporated by reference to Exhibit 10.1 to EarthLink
Network's Form 8-K filed on February 10, 1998--File No.
0-20799).
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- - --------------------- ------------------------------------------------------------
<S> <C> <C>
10.14 -- Credit Agreement, dated as of February 10, 1998, with Sprint
Corporation as the Lender (incorporated by reference to
Exhibit 10.3 to EarthLink Network's Form 8-K filed on
February 10, 1998--File No. 0-20799).
10.15 -- Registration Rights Agreement, dated as of February 10,
1998, with Sprint Corporation, and Sprint Communications
Company L.P. (incorporated by reference to Exhibit 99.1 to
EarthLink Network's Form 8-K filed on February 10,
1998--File No. 0-20799).
10.16 -- Stockholders Agreement, dated as of February 10, 1998, among
EarthLink Network, Inc., Sprint Corporation, Sprint
Communications Company L.P., and the persons identified on
Schedule 1 thereto (incorporated by reference to Exhibit
99.2 to EarthLink Network's Form 8-K filed on February 10,
1998--File No. 0-20799).
10.17 -- Agreement to Vote Stock, dated as of February 10, 1998,
among the Granting Stockholders named on Schedule A thereto,
Sprint Corporation and Sprint Communications Company L.P.
(incorporated by reference to Exhibit 99.3 to EarthLink
Network's Form 8-K filed on February 10, 1998--File No.
0-20799).
10.18 -- Agreement to Vote and Tender Stock, dated as of February 10,
1998, among the Granting Stockholders named on Schedule A
thereto, Sprint Corporation, and Sprint Communications
Company L.P. (incorporated by reference to Exhibit 99.4 to
EarthLink Network's Form 8-K filed on February 10,
1998--File No. 0-20799).
10.19 -- Marketing and Distribution Agreement, dated as of February
10, 1998, Sprint Corporation, and Sprint Communications
Company L.P. (incorporated by reference to Exhibit 10.26 of
EarthLink Network's Registration Statement on Form S-4 filed
May 13, 1998, File No. 333-52507).
10.20 -- Lease Agreement, between EarthLink Network Inc. and Prentiss
Properties Natomas, L.P. (incorporated by reference to
Exhibit 10.1 to EarthLink Network's Form 10-Q filed on
September 30, 1999--File No. 0-20799).
10.22 -- Lease Agreement, between Park West E-3 Associates and NETCOM
On-Line Communication Services, Inc., dated February 23,
1996 (incorporated by reference to Exhibit 10.2 to
MindSpring's Form 10-K for the fiscal year ended December
31, 1998--File No. 0-27890).
10.23 -- Credit Agreement, dated as of February 17, 1999 by and among
MindSpring Enterprises, Inc., as Borrower, the Lenders
referred to herein, First Union Capital Markets Corp., as
Arranger and First Union National Bank, as Administrative
Agent (incorporated by reference to Exhibit 10.1 to
MindSpring's Form 8-K dated February 25, 1999--File No.
0-27890).
10.24 -- Guaranty and Collateral Agreement made by MindSpring
Enterprises, Inc. and the other Grantors party hereto in
favor of First Union National Bank, as Administrative Agent
(incorporated by reference to Exhibit 10.2 to MindSpring's
Form 8-K dated February 25, 1999--File No. 0-27890).
10.25 -- First Amendment, Waiver and Consent Agreement, dated as of
April 7, 1999, by and among MindSpring Enterprises, Inc.,
certain Lenders identified therein, First Union Capital
Markets Corp., as Arranger, and First Union National Bank,
as Administrative Agent (incorporated by reference to
Exhibit 10.1 to MindSpring's Form 8-K dated April 7,
1999--File No. 0-27890).
</TABLE>
33
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- - --------------------- ------------------------------------------------------------
<S> <C> <C>
10.26 -- Lease Agreement, commencing on November 1, 1995, between
West Peachtree Point Partners, L.P. and MindSpring
Enterprises, Inc. (incorporated by reference to Exhibit
10(j) to MindSpring's Registration Statement on Form
S-1--File No. 333-108).
10.27 -- First Amendment dated February 6, 1996 to Lease Agreement
dated November 1, 1995 between John Marshall Law School,
Inc. (assignee of West Peachtree Point Partners, L.P.) and
MindSpring Enterprises, Inc. (incorporated by reference to
Exhibit 10(cc) to MindSpring's Registration Statement on
Form S-1--File No. 333-108).
10.28 -- MindSpring Enterprises, Inc. 1995 Stock Option Plan, as
amended (incorporated by reference to Exhibit 10.7 to
MindSpring's Form 10-K for the fiscal year ended December
31, 1998--File No. 0-27890).
10.29 -- Form of Stock Option Agreement (incorporated by reference to
Exhibit 10(v) to MindSpring's Registration Statement on Form
S-1--File No. 333-108).
10.30 -- MindSpring Enterprises, Inc. 1995 Directors Stock Option
Plan, as amended (incorporated by reference to Exhibit 10.9
to MindSpring's Form 10-K for the fiscal year ended December
31, 1998--File No. 0-27890).
10.31 -- Form of Director Stock Option Agreement, as amended
(incorporated by reference to Exhibit 10(x) to MindSpring's
Registration Statement on Form S-1--File No. 333-108).
10.32 -- Form of MindSpring Director or Officer Indemnity Agreement
(incorporated by reference to Exhibit 10(dd) to MindSpring's
Registration Statement on Form S-1--File No. 333-108).
10.33 -- Master Services Agreement, dated July 15, 1996, between
BellSouth Telecommunications, Inc. and MindSpring
Enterprises, Inc. (incorporated by reference to Exhibit
10(cc) to MindSpring's Form S-1--File No. 333-10779).
10.34 -- Office Building Lease Agreement, commencing December 15,
1997, between Pennsylvania Dental Service Corporation, a
Pennsylvania corporation d/b/a Delta Dental of Pennsylvania,
and MindSpring Enterprises, Inc. (incorporated by reference
to Exhibit 10.13 to MindSpring's Form 10-K for the fiscal
year ended December 31, 1998--File No. 0-27890).
10.35 -- Lease Agreement effective as of January 1, 1997 by and
between CMS Peachtree, L.P. and MindSpring Enterprises, Inc.
(incorporated by reference to Exhibit 10(hh) to MindSpring's
Form 10-K for the fiscal year ended December 31, 1996--File
No. 0-27890).
10.36 -- Amendment dated June 6, 1997 to Master Services Agreement,
dated July 15, 1996, between BellSouth Telecommunications,
Inc. and MindSpring Enterprises, Inc. (incorporated by
reference to Exhibit 10.1 to MindSpring's Form 10-Q for the
quarter ended June 30, 1997--File No. 0-27890).
10.37 -- Special Service Arrangement Agreement, dated June 1997,
between BellSouth Telecommunications, Inc. and MindSpring
Enterprises, Inc. (a substantially identical contract has
been executed for each of Alabama, Florida, Kentucky, North
Carolina, South Carolina and Tennessee) (incorporated by
reference to Exhibit 10.2 to MindSpring's Form 10-Q for the
quarter ended June 30, 1997--File No. 0-27890).
10.38* -- Lease Agreement dated November 16, 1999, between Kingston
Atlanta Partners, L.P. and MindSpring Enterprises, Inc.
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- - --------------------- ------------------------------------------------------------
<S> <C> <C>
10.39* -- First Amendment to Lease, dated October 1, 1999, between
Park West E-3 Associates and NETCOM On-line Communication
Services, Inc.
10.40* -- Lease Agreement, dated June 30, 1998, between Ryan Southbank
II, L.L.C. and MindSpring Enterprises, Inc.
10.41* -- Sublease, dated September 14, 1999, between International
Business Machines Corporation and MindSpring
Enterprises, Inc.
10.42* -- Fourth Amendment dated June 24, 1998, to Lease Agreement
dated August 11, 1995 by and among 1430 L.L.C. and
MindSpring Enterprises, Inc.
10.43* -- Fifth Amendment dated October 26, 1999 to Lease Agreement
dated August 11, 1995 by and among 1430 L.L.C. and
MindSpring Enterprises, Inc.
10.44* -- Amendment dated December 20, 1999, to Office Building Lease
Agreement dated December 15, 1997, between Pennsylvania
Dental Service Corporation and MindSpring Enterprises, Inc.
10.45* -- EarthLink Centre Standard Modified Gross Office Lease, dated
October 5, 1999, by and between Limar Realty Corp. #6 and
Earthlink Network, Inc.
27.1 -- Financial Data Schedule
</TABLE>
(D) REPORTS ON FORM 8-K.
MINDSPRING ENTERPRISES, INC.
On January 8, 1999, MindSpring filed a Current Report on Form 8-K reporting
that, on January 5, 1999, MindSpring entered into an Asset Purchase Agreement
with NETCOM On-Line Communication Services, Inc., a Delaware corporation and an
indirect wholly-owned subsidiary of ICG Communications, Inc., pursuant to which
MindSpring agreed to acquire certain assets used in connection with the Internet
services business operated in the United States by NETCOM (the "NETCOM
Acquisition").
On February 25, 1999, MindSpring filed a Current Report on Form 8-K
reporting that, on February 17, 1999, MindSpring completed the NETCOM
Acquisition. The Form 8-K contained, pursuant to Item 7 to Form 8-K, certain
financial information concerning the NETCOM Acquisition.
On February 25, 1999, MindSpring filed a Current Report on Form 8-K that
contained certain exhibits with respect to its business and financial condition,
including its Management's Discussion and Analysis of Financial Condition and
Results of Operations and audited financial statements of MindSpring
Enterprises, Inc. as of December 31, 1998 and 1997.
On April 12, 1999, MindSpring filed a Current Report on Form 8-K that
contained certain exhibits with respect to its debt offering completed in April
14, 1999.
On May 27, 1999, MindSpring filed a Current Report on Form 8-K to report
that on May 25, 1999, the Company's Board of Directors had declared a
two-for-one stock split to be effected in the form of a stock dividend.
On September 30, 1999, MindSpring filed a Current Report on Form 8-K to
report that, on September 22, 1999, the Company had entered into an Agreement
and Plan of Reorganization with EarthLink Network, Inc. (the "Merger
Agreement"). The Merger Agreement sets forth the terms and conditions of the
proposed merger of MindSpring and EarthLink into a new company (the "Merger").
35
<PAGE>
On October 12, 1999, MindSpring filed a Current Report on Form 8-K/A
amending its Current Report on Form 8-K dated September 30, 1999. The Form 8-K/A
included certain pro forma financial statements with respect to the Merger.
On December 12, 1999 MindSpring amended its Current Report on Form 8-K/A
describing the Company's acquisition of Spry, Inc.
EARTHLINK NETWORK, INC.
On September 30, 1999, EarthLink Network filed a Current Report on Form 8-K
to report that, on September 22, 1999, it had entered into an Agreement and Plan
of Reorganization with MindSpring Enterprises, Inc. (the "Merger Agreement").
The Merger Agreement sets forth the terms and conditions of the proposed merger
of MindSpring and EarthLink into a new company (the "Merger").
On October 14, 1999 EarthLink Network amended its Current Report on Form 8-K
describing its strategic alliance with Sprint Corporation and related
transactions.
36
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
EARTHLINK, INC.
/s/ CHARLES G. BETTY
---------------------------------------------
Charles G. Betty
CHIEF EXECUTIVE OFFICER
Date: March 30, 2000
</TABLE>
Each person whose signature appears below hereby constitutes and appoints
Charles G. Betty and Lee Adrean, the true and lawful attorneys-in-fact and
agents of the undersigned, with full power of substitution and resubstitution,
for and in the name, place and stead of the undersigned, in any and all
capacities, to sign any and all amendments to this Report, and to file the same,
with all exhibits thereto, and other documents in connection therewith, with the
Commission, and hereby grants to such attorneys-in-fact and agents full power
and authority to do and perform each and every act and thing requisite and
necessary to be done, as fully to all intents and purposes as the undersigned
might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or their substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the Company
and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
/s/ CHARLES G. BETTY
--------------------------------------------
Date: March 30, 2000 Charles G. Betty, Chief Executive
Officer and Director
/s/ LEE ADREAN
--------------------------------------------
Date: March 30, 2000 Lee Adrean, Executive Vice President--Finance
and Administration and Chief Financial
Officer
/s/ RICHARD A. QUIROGA
--------------------------------------------
Date: March 30, 2000 Richard A. Quiroga, Vice President--Corporate
Controller
/s/ CHARLES M. BREWER
Date: March 30, 2000 --------------------------------------------
Charles M. Brewer, Chairman of the Board
/s/ SKY D. DAYTON
Date: March 30, 2000 --------------------------------------------
Sky D. Dayton, Director
/s/ WILLIAM T. ESREY
Date: March 30, 2000 --------------------------------------------
William T. Esrey, Director
/s/ LINWOOD A. LACY
Date: March 30, 2000 --------------------------------------------
Linwood A. Lacy, Director
</TABLE>
37
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
/s/ CAMPBELL B. LANIER III
Date: March 30, 2000 --------------------------------------------
Campbell B. Lanier III, Director
/s/ LEN J. LAUER
Date: March 30, 2000 --------------------------------------------
Len J. Lauer, Director
/s/ MICHAEL S. MCQUARY
Date: March 30, 2000 --------------------------------------------
Michael S. McQuary, President, Director
/s/ WILLIAM H. SCOTT III
Date: March 30, 2000 --------------------------------------------
William H. Scott III, Director
/s/ REED E. SLATKIN
Date: March 30, 2000 --------------------------------------------
Reed E. Slatkin, Director
/s/ PHILIP SCHILLER
Date: March 30, 2000 --------------------------------------------
Philip Schiller, Director
</TABLE>
38
<PAGE>
MASTER INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Index to Financial Statements of EarthLink, Inc............. F-2
Index to Financial Statements of EarthLink Network, Inc..... F-26
Index to Financial Statements of MindSpring Enterprises,
Inc....................................................... F-48
</TABLE>
F-1
<PAGE>
EARTHLINK, INC.
INDEX TO SUPPLEMENTAL COMBINED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Report of Independent Accountants........................... F-3
Supplemental Combined Balance Sheet as of December 31, 1998
and 1999.................................................. F-4
Supplemental Combined Statement of Operations for the three
years ended December 31, 1999............................. F-5
Supplemental Combined Statement of Stockholders' Equity for
the three years ended December 31, 1999................... F-6
Supplemental Combined Statement of Cash Flows for the three
years ended December 31, 1999............................. F-7
Notes to Supplemental Combined Financial Statements......... F-8
</TABLE>
F-2
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of EarthLink, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of stockholders' equity (deficit) and of
cash flows present fairly, in all material respects, the financial position of
EarthLink Network, Inc. and its subsidiary 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. 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 provide a reasonable basis for the opinion expressed above.
As described in Note 1, on February 4, 2000, EarthLink Network, Inc. merged
with MindSpring Enterprises, Inc. and formed a new corporation named EarthLink,
Inc. in a transaction accounted for as a pooling of interests. The accompanying
supplementary combined financial statements give retroactive effect to the
merger of EarthLink Network, Inc. and MindSpring Enterprises, Inc. Generally
accepted accounting principles proscribe giving effect to a consummated business
combination accounted for by the pooling of interests method in financial
statements that do not extend through the date of consummation. These financial
statements do not extend through the date of the consummation; however, they
will become the historical consolidated financial statements of EarthLink, Inc.
and subsidiary after financial statements covering the date of consummation of
the business combination are issued.
In our opinion, based on our audits and the report of other auditors, the
accompanying supplementary combined balance sheet and the related supplementary
combined statements of operations, of stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of EarthLink,
Inc. at December 31, 1998 and 1999, and the results of its operations and its
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. 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 a reasonable
basis for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
Century City, California
March 28, 2000
F-3
<PAGE>
EARTHLINK, INC.
SUPPLEMENTAL COMBINED 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 supplemental combined
financial statements
F-4
<PAGE>
EARTHLINK, INC.
SUPPLEMENTAL COMBINED 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 supplemental combined
financial statements
F-5
<PAGE>
EARTHLINK, INC.
SUPPLEMENTAL COMBINED 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 supplemental combined
financial statements
F-6
<PAGE>
EARTHLINK, INC.
SUPPLEMENTAL COMBINED 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 supplemental combined
financial statements
F-7
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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 supplemental combined 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
supplemental financial statements also include the accounts of EarthLink
Operations, Inc. a wholly-owned subsidiary the Combined Company. All
intercompany transactions and balances have been eliminated in the supplemental
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
combined Company include adjustments of $3.9 million and $25.3 million for 1998
and 1999, respectively, to give effect to the
F-8
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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-9
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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-10
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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 supplemental combined 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 13.2 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-11
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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 supplemental 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-12
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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-13
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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-14
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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-15
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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
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-16
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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-17
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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-18
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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-19
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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
Net change to valuation allowance.............. 12,067 18,085 62,083
Other.......................................... -- 171 (245)
-------- -------- --------
$ -- $ 2,394 $ --
======== ======== ========
</TABLE>
F-20
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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-21
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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-22
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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 $389,000 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-23
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED FINANCIAL STATEMENTS (CONTINUED)
14. SUPPLEMENTAL 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-24
<PAGE>
EARTHLINK, INC.
NOTES TO SUPPLEMENTAL COMBINED 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 supplemental
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 Supplemental 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 supplemental 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 Supplemental Combined
Financial Statements for an explanation of the determination of the number
of weighted average shares outstanding in the net loss per share
computation.
F-25
<PAGE>
EARTHLINK NETWORK, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Report of Independent Accountants........................... F-27
Consolidated Balance Sheet as of December 31, 1998 and
1999...................................................... F-28
Consolidated Statement of Operations for the three years
ended December 31, 1999................................... F-29
Consolidated Statement of Stockholders' Equity (Deficit) for
the three years ended December 31, 1999................... F-30
Consolidated Statement of Cash Flows for the three years
ended December 31, 1999................................... F-31
Notes to Consolidated Financial Statements.................. F-32
</TABLE>
F-26
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of EarthLink, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of stockholders' equity (deficit) and of
cash flows present fairly, in all material respects, the financial position of
EarthLink Network, Inc. and its subsidiary 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. 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 provide a reasonable basis for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
Century City, California
March 15, 2000
F-27
<PAGE>
EARTHLINK NETWORK, INC.
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1998 1999
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 140,864 $ 308,579
Accounts receivable, net of allowance of $405,000 and
$925,000 at December 31, 1998 and 1999, respectively.... 4,779 10,750
Prepaid expenses.......................................... 4,324 15,105
Other assets.............................................. 598 8,916
--------- ---------
Total current assets.................................... 150,565 343,350
Investments in other companies.............................. -- 4,000
Other long-term assets...................................... 564 1,400
Property and equipment, net (Notes 1 and 5)................. 35,206 59,852
Intangibles, net (Note 6)................................... 80,006 14,873
--------- ---------
$ 266,341 $ 423,475
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable.................................... $ 14,818 $ 15,813
Accrued payroll and related expenses...................... 8,934 11,350
Other accounts payable and accrued liabilities............ 20,372 36,661
Current portion of capital lease obligations (Note 12).... 8,341 9,365
Deferred revenue.......................................... 8,831 15,489
--------- ---------
Total current liabilities............................... 61,296 88,678
Long-term debt (Note 12).................................... 7,701 8,259
--------- ---------
Total liabilities....................................... 68,997 96,937
Commitments and contingencies (Note 12)
Stockholders' equity:
Preferred stock, $0.01 par value, 25,000,000 shares
authorized, Series A convertible, 4,102,941 shares
issued and outstanding December 31, 1998 and 1999
(Notes 8 and 9)......................................... 41 41
Series B convertible, nil and 606,155 shares issued and
outstanding December 31, 1998 and 1999, respectively
(Notes 8 and 9)......................................... 6
Common stock, $0.01 par value, 50,000,000 shares
authorized, 29,069,827 and 32,951,017 shares issued and
outstanding at December 31, 1998 and 1999,
respectively............................................ 291 329
Stock subscriptions receivable............................ (1,041)
Additional paid-in capital................................ 330,911 581,494
Warrants to purchase common stock (Note 10)............... 597 477
Accumulated deficit....................................... (133,455) (255,809)
--------- ---------
Total stockholders' equity.............................. 197,344 326,538
--------- ---------
$ 266,341 $ 423,475
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
F-28
<PAGE>
EARTHLINK NETWORK, 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......................................... $ 74,228 $161,009 $ 310,868
Web Hosting............................................... 5,202 7,537 11,554
Broadband................................................. 1,143 3,285 6,756
Content, commerce and advertising......................... 315 4,110 13,110
-------- -------- ---------
Total revenues.......................................... 80,888 175,941 342,288
-------- -------- ---------
Operating costs and expenses:
Cost of revenues.......................................... 38,065 77,223 132,679
Sales and marketing....................................... 25,971 42,837 125,992
General and administrative................................ 14,699 21,720 38,010
Operations and member support............................. 30,607 53,765 104,842
Acquisition-related costs (Note 6)........................ -- 42,635 65,072
-------- -------- ---------
Total operating costs and expenses...................... 109,342 238,180 466,595
-------- -------- ---------
Loss from operations........................................ (28,454) (62,239) (124,307)
Interest income............................................. 637 4,424 17,334
Interest expense............................................ (2,099) (1,967) (1,275)
-------- -------- ---------
Net loss................................................ (29,916) (59,782) (108,248)
Deductions for accretion dividends (Note 9)................. -- (7,601) (14,106)
-------- -------- ---------
Net loss attributable to common stockholders................ $(29,916) $(67,383) $(122,354)
======== ======== =========
Basic and diluted net loss per share........................ $ (1.50) $ (2.58) $ (3.81)
======== ======== =========
Weighted average shares..................................... 20,002 26,157 32,133
======== ======== =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
F-29
<PAGE>
EARTHLINK NETWORK, 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....... 12,045 $120 $ 14,176 $ 599
Initial public offering, net of
expenses......................... 4,570 46 26,180
Conversion of redeemable preferred
stock into common stock.......... 2,727 27 13,986
Conversion of debt to common
stock............................ 112 1 724
Issuance of common stock in
connection with private
placement........................ 2,920 30 15,379
Issuance of common stock pursuant
to exercise of stock options..... 127 1 384
Warrants issued in exchange for
services (Note 10)............... 494
Net loss...........................
----- --- ------ ---- ------- -------- ------
Balance at December 31, 1997....... 22,501 225 70,829 1,093
Issuance of Series A convertible
preferred stock (Note 7)......... 4,103 $41 134,959
Accretion of convertible preferred
stock............................ 7,601
Follow on offering, net of expenses
(Note 7)......................... 3,763 38 106,271
Conversion of debt to common
stock............................ 783 8 5,035
Issuance of common stock for
services......................... 20 130
Issuance of common stock pursuant
to exercise of stock options..... 1,224 12 3,647
Issuance of common stock pursuant
to exercise of warrants.......... 761 8 1,398 (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...................... 18 $(1,041) 1,041
Net loss...........................
----- --- ------ ---- ------- -------- ------
Balance at December 31, 1998....... 4,103 41 29,070 291 (1,041) 330,911 597
Issuance of Series B convertible
preferred stock (Note 7)......... 606 6 42,616
Accretion of convertible preferred
stock............................ 14,106
Follow on offering, net of expenses
(Note 7)......................... 2,615 26 183,073
Issuance of common stock pursuant
to exercise of stock options..... 927 9 10,264
Issuance of common stock pursuant
to exercise of warrants.......... 339 3 524 (120)
Collection of notes receivable from
stock sales...................... 1,041
Net loss...........................
----- --- ------ ---- ------- -------- ------
Balance at December 31, 1999....... 4,709 $47 32,951 $329 $ -- $581,494 $ 477
===== === ====== ==== ======= ======== ======
<CAPTION>
TOTAL
ACCUMULATED STOCKHOLDERS'
DEFICIT EQUITY
------------ -------------
(IN THOUSANDS)
<S> <C> <C>
Balance at December 31, 1996....... $ (36,156) $ (21,261)
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..... 385
Warrants issued in exchange for
services (Note 10)............... 494
Net loss........................... (29,916) (29,916)
--------- ---------
Balance at December 31, 1997....... (66,072) 6,075
Issuance of Series A convertible
preferred stock (Note 7)......... 135,000
Accretion of convertible preferred
stock............................ (7,601)
Follow on offering, net of expenses
(Note 7)......................... 106,309
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..... 3,659
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........................... (59,782) (59,782)
--------- ---------
Balance at December 31, 1998....... (133,455) 197,344
Issuance of Series B convertible
preferred stock (Note 7)......... 42,622
Accretion of convertible preferred
stock............................ (14,106)
Follow on offering, net of expenses
(Note 7)......................... 183,099
Issuance of common stock pursuant
to exercise of stock options..... 10,273
Issuance of common stock pursuant
to exercise of warrants.......... 407
Collection of notes receivable from
stock sales...................... 1,041
Net loss........................... (108,248) (108,248)
--------- ---------
Balance at December 31, 1999....... $(255,809) $ 326,538
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
F-30
<PAGE>
EARTHLINK NETWORK, 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.................................................. $(29,916) $(59,782) $(108,248)
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities, net of effect from
acquisition:
Depreciation and amortization........................... 9,377 54,726 86,175
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..................... (796) (2,260) (5,791)
Increase in prepaid expenses and other assets........... 203 (3,176) (19,935)
(Decrease) increase in accounts payable and accrued
liabilities........................................... (2,232) 31,658 19,700
Increase in deferred revenue............................ 1,580 5,241 6,658
-------- -------- ---------
Net cash (used in) provided by operating activities......... (21,290) 26,597 (21,410)
-------- -------- ---------
Cash flows from investing activities:
Purchase of property and equipment........................ (14,528) (24,316) (47,315)
Sale of property and equipment............................ 1,416
Purchase of intangible assets............................. (1,404) (9)
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
-------- -------- ---------
Net cash used in investing activities................... (16,095) (9,239) (49,899)
-------- -------- ---------
Cash flows from financing activities:
Proceeds from issuance of notes payable................... 4,387 200
Repayment of notes payable................................ (2,225) (4,583)
Proceeds from capital lease obligations................... 10,544 9,275 13,456
Principal payments under capital lease obligations........ (4,884) (8,563) (11,874)
Proceeds from private placement of common stock........... 15,409
Proceeds from public stock offerings...................... 26,226 106,309 225,721
Proceeds from warrants exercised.......................... 759 407
Proceeds from stock options exercised..................... 385 3,659 10,273
Proceeds from liquidation of stock subscription
receivable.............................................. 1,041
-------- -------- ---------
Net cash provided by financing activities............... 49,842 107,056 239,024
-------- -------- ---------
Net increase in cash and cash equivalents................... 12,457 124,414 167,715
Cash and cash equivalents, beginning of year................ 3,993 16,450 140,864
-------- -------- ---------
Cash and cash equivalents, end of year...................... $ 16,450 $140,864 $ 308,579
======== ======== =========
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-31
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
EarthLink Network, Inc. ("EarthLink Network") is an Internet service
provider that was formed to help members derive meaningful benefits from the
extensive resources of the Internet.
EarthLink Network has experienced operating losses since inception as a
result of efforts to build its network infrastructure and internal staffing,
develop its systems, and expand into new markets. EarthLink Network expects that
it will continue to incur net losses as it continues to expend substantial
resources on sales and marketing as it attempts to rapidly increase its market
share. There can be no assurance that EarthLink Network will achieve or sustain
profitability or positive cash flow from its operations.
BASIS OF CONSOLIDATION
The consolidated financial statements include the accounts of EarthLink
Network, Inc. and its wholly-owned subsidiary EarthLink Operations, Inc. (Note
2). All intercompany transactions and balances have been eliminated in the
consolidated financial statements.
REVENUES
Narrowband access revenues consists 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, and DSL
services. Content, commerce and advertising revenues are derived from
advertising, content and electronic commerce fees that leverage the value of
EarthLink Network'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
EarthLink Network 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 EarthLink Network to
concentrations or credit risk consist principally of cash investments and trade
receivables. EarthLink Network'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 EarthLink Network's member base.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost and depreciated using the
straight-line method over the estimated useful life of the assets, which is
generally three years for computers and computer related
F-32
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
equipment and five years for other non-computer furniture and equipment.
Leasehold improvements are amortized using the straight-line method over the
shorter of their estimated lives or the term of the lease, ranging from one to
ten years.
EQUIPMENT UNDER CAPITAL LEASE
EarthLink Network 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.
INTANGIBLES
Intangible assets consist primarily of rights to member lists, long-term
marketing agreements, goodwill, deferred financing and other items. The costs
assigned to intangible assets are being amortized on a straight-line basis over
the estimated useful lives of the assets, which range from one to ten years.
EarthLink Network 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 $5.1
million, $8.8 million and $40.6 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
EarthLink Network adopted Statement of Financial Accounting Standards (SFAS)
No. 128, "Earnings per Share" (EPS) and Staff Accounting Bulletin (SAB) No. 98.
SAB No. 98 states that companies, such as EarthLink, that completed an initial
public offering ("IPO") within the past 5 years and incorporated the SAB No. 83
concept of "cheap stock" in determining pre-IPO EPS data must restate all EPS
data to conform to SFAS No. 128. Accordingly, all EPS data have been restated to
conform to SFAS No. 128. SFAS No. 128 requires a dual presentation of basic and
diluted EPS. Basic EPS represents the weighted average number of shares divided
into net income during a reported period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock. However, EarthLink Network did
not include potential common stock in the calculation of EPS since inception as
such inclusion would have an anti-dilutive effect.
F-33
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
COMMON STOCK BASED COMPENSATION
EarthLink Network continues to account for its employee stock based
compensation using the intrinsic value method in accordance with the provisions
of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock
Issued to Employees," and provides pro forma disclosures in the notes to the
consolidated financial statements (Note 9), as if the measurement provisions of
SFAS No. 123 had been adopted.
RECLASSIFICATION
Certain amounts in the prior year financial statements have been
reclassified to conform to current year presentation.
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 Network's consolidated statement of operations.
2. STRATEGIC ALLIANCE WITH SPRINT CORPORATION
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 2.5 million shares of EarthLink Network's common
stock at a price per share of $22.50 in cash to each tendering stockholder (the
"Offer"). Immediately following the closing of the Offer, Sprint received
approximately 4.1 million shares of the 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
F-34
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. STRATEGIC ALLIANCE WITH SPRINT CORPORATION (CONTINUED)
convertible senior debt. Collectively, the above is referenced to as the "Sprint
Transaction". The series A convertible preferred stock received by Sprint is
convertible into 8.2 million shares of EarthLink Network common stock at
December 31, 1999 assuming acceleration of certain rights.
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, Inc., and
EarthLink Operations, Inc.
The following unaudited pro forma consolidated results of operations for the
year ended December 31 1998, assumes the acquisition of the Sprint Internet
Passport business on January 1, 1998. 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
-------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues................................... $ 187,063
Net loss......................................... (98,022)
Deductions for accretion dividends (Note 9)...... (13,126)
Net loss attributable to common stockholders..... (111,148)
Basic and diluted net loss per share............. $ (4.25)
</TABLE>
3. PREPAID EXPENSES
Prepaid expenses consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Prepaid advertising........................................ $ 16 $ 9,661
Deferred transaction costs................................. 177 1,631
Prepaid maintenance and support fees....................... 1,579 1,703
Prepaid communications costs............................... 1,285 593
Other...................................................... 1,267 1,517
------ -------
$4,324 $15,105
====== =======
</TABLE>
4. 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 Network 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 EarthLink
Network does not have the ability to
F-35
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INVESTMENTS IN OTHER COMPANIES (CONTINUED)
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.
5. PROPERTY AND EQUIPMENT
Property and equipment consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Data center equipment................................... $ 27,285 $ 41,538
Office and other equipment.............................. 23,852 41,403
Leasehold improvements.................................. 8,771 12,488
Construction in progress................................ 541 4,526
-------- --------
60,449 99,955
Less accumulated depreciation and amortization.......... (25,243) (40,103)
-------- --------
$ 35,206 $ 59,852
======== ========
</TABLE>
Property under capital lease, primarily data communications equipment
included above, aggregated $31.7 million and $33.3 million at December 31, 1998
and 1999, respectively. Included in accumulated depreciation and amortization
are amounts related to property under capital lease of $15.7 million and $20.0
million at December 31, 1998 and 1999, respectively. Depreciation expense
charged to operations was $8.5 million, $12.5 million and $21.0 million in 1997,
1998, and 1999, respectively.
6. INTANGIBLE ASSETS
Intangible assets consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1999
-------- ---------
(IN THOUSANDS)
<S> <C> <C>
Member base............................................ $ 65,000 $ 65,000
Marketing and distribution agreement................... 20,000 20,000
Goodwill............................................... 36,164 36,164
Other.................................................. 255 104
-------- ---------
121,419 121,268
Less accumulated amortization.......................... (41,413) (106,395)
-------- ---------
$ 80,006 $ 14,873
======== =========
</TABLE>
Intangible assets acquired in acquisition of the Sprint Internet Passport
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 asserts 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.
F-36
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. CAPITAL STOCK AND MANDATORILY REDEEMABLE EQUITY SECURITIES
FOLLOW ON PUBLIC OFFERINGS
In June 1998, EarthLink Network completed a follow on public offering of
3.8 million shares of its common stock at $30.00 per share. The offering
consisted of 3.0 million shares, including 490,000 shares sold to Sprint in
accordance with its preemptive rights under the Sprint Alliance, and an
underwriter's over-allotment of 720,000 shares. Net proceeds to EarthLink
Network were approximately $106.3 million.
In January 1999 EarthLink Network completed a follow on public offering of
2.4 million shares of its common stock at $73.63 per share. The offering
consisted of 2.3 million shares and an underwriter's over-allotment of 99,000
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 770,000 shares of EarthLink Network securities which 192,000
were common stock and 578,000 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 38,000 shares of which 9,000 were common
stock and 28,000 were series B convertible preferred stock. Series A convertible
preferred stock was issued prior to EarthLink Network's 2 for one stock split in
July 1999. Accordingly, each share of Series A convertible preferred stock is
convertible into two shares of EarthLink Network's common stock assuming
acceleration of certain rights. 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's common stock. Proceeds from the sale of stock to Sprint were
$2.7 million.
COMMON STOCK ISSUANCES FOR OTHER THAN CASH
In January 1998, EarthLink Network issued 20,000 shares of its common stock
to a Consultant in lieu of cash for services provided pursuant to a consulting
agreement. The fair value of the shares was recorded as prepaid professional
services and amortized ratably over the term of the contract. Under this
agreement EarthLink Network issued 20,000 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 EarthLink Network
the holders of series A and B convertible preferred stock will receive, prior to
any payment or distribution in respect of other
F-37
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. CONVERTIBLE PREFERRED STOCK (CONTINUED)
shares of EarthLink Network'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 accrued and
unpaid dividends on such share, 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 EarthLink Network
consummates certain business combination transactions.
Beginning in June 2001, EarthLink Network 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
EarthLink Network's directors. This right terminates as to one of the directors
if Sprint fails to maintain at least a 20% equity interest in EarthLink Network
(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 EarthLink Network, 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
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 and B 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
1995 STOCK OPTION PLAN
In September 1995, EarthLink Network established the EarthLink Network 1995
Stock Option Plan (the "1995 Plan"). The 1995 Plan provides for the grant of
incentive stock options to purchase shares of common stock to employees of
EarthLink Network and non-qualified stock options to employees, officers,
directors and consultants of EarthLink Network. During 1999, the Plan was
amended to increase the number of available options from 5,700,000 to 7,700,000.
The Plan is administered by a committee
F-38
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCK OPTIONS AND WARRANTS (CONTINUED)
appointed by the Board of Directors which determines the terms of the options
granted, including the exercise price, the number of shares subject to option,
and the option vesting period. The exercise price of all options granted under
the plan must be at least 100% of the fair market value on the date of grant.
Options generally have a maximum term of ten years and vest in equal quarterly
increments over a five-year period. As of December 31, 1999, there were
2,063,330 shares available for issuance under the 1995 Plan.
DIRECTORS STOCK OPTION PLAN
In September 1995, EarthLink Network established the EarthLink Directors
Stock Option Plan (the "Directors Plan"). The Directors Plan, as amended and
restated in December 1996, provides for the grant of options to purchase an
aggregate of 125,000 shares of common stock to directors who do not also serve
as employees of EarthLink Network and do not beneficially own, nor are
employees, directors or officers of any entity which owns 5% or more of the
outstanding shares of EarthLink Network's capital stock. Under the Directors
Plan, grants of options to purchase 20,000 and 5,000 shares of common stock are
automatically made to each non-management director at such time as the person
first becomes a member of the Board of Directors and at the beginning of each
fiscal year, respectively. Options generally have a maximum term of ten years
and vest in equal quarterly increments over a five year period. As of
December 31, 1999, there were no outstanding options to purchase shares of
common stock under the Directors Plan.
NON-QUALIFIED OPTION GRANTS
In addition to the options granted under the plans described above,
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.
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>
F-39
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCK OPTIONS AND WARRANTS (CONTINUED)
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................................ $(29,916) $ (67,383) $(122,354)
======== ========= =========
Pro forma.................................. $(30,737) $(104,577) $(205,005)
======== ========= =========
Basic and diluted net loss per share
As reported................................ $ (1.50) $ (2.58) $ (3.81)
======== ========= =========
Pro forma.................................. $ (1.54) $ (4.00) $ (6.38)
======== ========= =========
</TABLE>
WARRANTS
EarthLink Network has issued to certain Board members, consultants, lessors,
creditors and others warrants to purchase shares of EarthLink Network's common
stock.
WARRANTS ISSUED FOR SERVICES
In January 1997 and October 1997, EarthLink Network issued warrants to
purchase 12,000 and 50,000 shares, respectively, of EarthLink Network's common
stock to certain consultants. The respective exercise prices of the warrants
were $6.50 and $8.88. The fair value of the warrants is reflected as prepaid
consulting fees and amortized ratably over the life of the consulting agreement.
Consulting expense recorded with respect to warrants issued to consultants was
$23,340, $34,836 and $34,836 during 1997, 1998 and 1999, respectively.
In March 1997 and October 1997, EarthLink Network issued warrants to
purchase 15,000 shares of EarthLink Network's common stock to each of two new
members of EarthLink Network's Technology Advisory Council. The warrants have an
exercise price of $5.25 per share and $8.88 per share, respectively, and vest
quarterly over two years. The fair value of the warrants is reflected as
deferred professional services expense and amortized ratably over the member's
two year term of service in the Technology Advisory Council.
F-40
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCK OPTIONS AND WARRANTS (CONTINUED)
Following is a summary of stock option and warrant activity during the three
years ended December 31, 1999:
<TABLE>
<CAPTION>
NUMBER OF SHARES OF COMMON STOCK
------------------------------------- WEIGHTED
INCENTIVE NON-QUALIFIED AVERAGE
STOCK STOCK EXERCISE
OPTIONS OPTIONS WARRANTS PRICE
--------- ------------- --------- --------
<S> <C> <C> <C> <C>
Balance at December 31, 1996...... 2,056,500 1,079,582 1,703,294 $ 3.45
Granted........................... 691,250 100,000 92,000 $ 6.92
Exercised......................... (97,914) (29,582) -- $ 2.82
Forfeited......................... (422,614) -- -- $ 4.51
--------- --------- --------- ------
Balance at December 31, 1997...... 2,227,222 1,150,000 1,795,294 $ 4.01
Granted........................... 1,817,400 -- 7,306 $26.35
Exercised......................... (774,720) (494,034) (712,392) $ 2.82
Forfeited......................... (85,712) -- -- $14.79
Surrendered in cashless
exercise........................ -- (7,966) (148,776) $ 8.77
--------- --------- --------- ------
Balance at December 31, 1998...... 3,184,190 648,000 941,432 $12.14
Granted........................... 1,779,550 -- -- $58.02
Exercised......................... (785,306) (132,000) (333,304) $ 5.04
Forfeited......................... (349,704) -- -- $29.46
Surrendered in cashless
exercise........................ -- -- (1,111) $ 4.06
--------- --------- --------- ------
Balance at December 31, 1999...... 3,828,730 516,000 607,017 $16.81
========= ========= ========= ======
Exercisable at December 31,
1997............................ 598,710 417,500 1,673,840
========= ========= =========
Exercisable at December 31,
1998............................ 583,497 145,500 874,257
========= ========= =========
Exercisable at December 31,
1999............................ 531,410 243,500 565,617
========= ========= =========
</TABLE>
The weighted average fair values of the options granted during the three
years ended December 31, 1999, were $4.98, $20.47 and $28.76, respectively. The
weighted average fair values of warrants granted during the two years ended
December 31, 1998 were $6.46 and $22.56, respectively. There were no warrants
granted in 1999.
F-41
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCK OPTIONS AND WARRANTS (CONTINUED)
Following is a summary of stock options and warrants outstanding as of
December 31, 1999:
<TABLE>
<CAPTION>
OPTIONS AND WARRANTS
OPTIONS AND WARRANTS OUTSTANDING EXERCISABLE
------------------------------------ ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- - -------------------------------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
$ 0.91 $ 2.42 1,044,660 5.89 $ 2.11 698,160 $ 2.08
$ 4.88 $ 9.94 1,030,375 6.95 $ 6.08 388,575 $ 5.60
$12.63 $39.19 1,321,407 8.41 $27.47 253,792 $28.08
$40.25 $69.50 1,384,755 9.51 $54.88 -- $ --
$78.50 $78.50 170,550 9.27 $78.50 -- $ --
---------- ---------
$ 0.91 $78.50 4,951,747 7.91 $16.81 1,340,527 $ 8.02
========== =========
</TABLE>
11. INCOME TAXES
At December 31, 1998 and 1999, EarthLink Network 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, EarthLink Network 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 EarthLink
Network's initial public offering and other issuances of common stock and common
stock equivalents, utilization of EarthLink Network'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.
F-42
<PAGE>
EARTHLINK NETWORK, 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
Allowance for doubtful accounts....................... 178 405
Depreciation and amortization......................... 123 1,678
Deferred income....................................... -- 936
Accrued vacation...................................... 436 747
Other accrued liabilities............................. 211 811
Other................................................. -- 141
-------- --------
Gross deferred tax assets............................. 43,573 72,249
Valuation allowance..................................... (25,340) (65,737)
-------- --------
Total deferred tax assets............................. $(18,233) $ (6,512)
======== ========
Deferred tax liabilities:
Member base........................................... $(17,414) $ --
Co-branding........................................... -- (6,512)
Other................................................. (819) --
-------- --------
Total deferred tax liabilities........................ $(18,233) $ (6,512)
======== ========
</TABLE>
Because management believes sufficient uncertainty exists regarding
realizability, a full valuation allowance has been established.
The following table summarizes the significant differences between the U.S.
Federal statutory tax rate and EarthLink Network's effective tax rate for
financial statement purposes:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1997 1998 1999
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Federal income tax (benefit) at statutory
rate......................................... $(10,171) $(20,923) $(37,887)
State income taxes, net of federal benefit..... -- (3,435) (6,220)
Nondeductible expenses......................... -- 54 135
Nondeductible goodwill......................... -- 4,922 7,735
Net change to valuation allowance.............. 10,171 19,382 36,237
-------- -------- --------
$ -- $ -- $ --
======== ======== ========
</TABLE>
F-43
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. COMMITMENTS AND CONTINGENCIES
LEASES
EarthLink Network 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 $1.9
million, $2.4 million and $4.4 million respectively. EarthLink Network also
leases equipment, primarily data communications equipment, under non-cancelable
capital leases. Most of EarthLink Network's capital leases include purchase
options at the end of the lease term.
During the three years ended December 31, 1999, EarthLink Network 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 sale-leaseback transactions are recorded at cost, which
approximates the fair market value of the property and, therefore, no gains or
losses have been recorded. The property remains on the books and continues to be
depreciated. A financing obligation representing the proceeds is recorded and
reduced based upon payments under the lease agreement.
EarthLink Network 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, EarthLink Network pays a monthly allocation of the
buildings' operating expenses. EarthLink Network has recorded a deferred rent
liability to reflect the excess of rent expense over cash payments since
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..................................................... $10,579 $ 6,488
2001..................................................... 6,710 7,110
2002..................................................... 2,408 7,430
2003..................................................... 54 7,553
2004..................................................... -- 4,717
Thereafter............................................... -- 28,298
------- -------
Total minimum lease payments............................. 19,751 $61,596
=======
Less amount representing interest........................ (2,127)
-------
Present value of future lease payments................... 17,624
Less current portion..................................... (9,365)
-------
$ 8,259
=======
</TABLE>
SIGNIFICANT AGREEMENTS
EarthLink Network uses a combination of owned POPs and leased third-party
POPs enabling it to provide Internet access services on a nationwide basis while
managing the timing and magnitude of its
F-44
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. COMMITMENTS AND CONTINGENCIES (CONTINUED)
capital expenditures. EarthLink Network employs a strategy of leasing POPs from
third-party providers in locations where it is more economical to do so. As of
December 31, 1999, EarthLink Network has leased points of presence ("POP")
capacity leased from UUNET, PSINet, Level 3 and Sprint. EarthLink Network is, in
effect, buying this capacity in bulk at a discount, and providing access to
EarthLink Network's member base at EarthLink Network'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 accrued liabilities.
Minimum commitments under non-cancelable network service agreements from
UUNET and PSINet are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31, IN MILLIONS
- - ------------ -----------
<S> <C>
2000........................................................ $ 65.7
2001........................................................ 66.9
2002........................................................ 41.4
------
Total....................................................... $174.0
======
</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. EarthLink Network'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.
14. SUPPLEMENTAL 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............. $1,965 $2,101 $ 1,275
Cash paid during the year for income taxes......... 1 1 1
Non cash transactions related to the conversion of
notes payable to equity.......................... 725 5,043 --
Common stock subscription.......................... -- 1,041 --
Non cash adjustments related to accretion
dividends........................................ $ -- $7,601 $14,106
</TABLE>
15. SUBSEQUENT EVENTS
In January 2000, EarthLink Network entered into a multi-year partnership to
deliver services to member of Apple Computer corporation members in the U.S.
Under the terms of the partnership, EarthLink is 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
F-45
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. SUBSEQUENT EVENTS (CONTINUED)
convertible preferred stock for $200 million. Apple has the right to appoint a
member to EarthLink Network's Board of Directors. The new Company assumed this
alliance
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's 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 securities of the new company. Other outstanding
securities of the companies were converted on the same basis. 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% 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 EarthLink Network 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.
16. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth certain unaudited quarterly consolidated
financial data for the two years ended December 31, 1999. In the opinion of
EarthLink Network's management, this unaudited information has been prepared on
the same basis as the audited consolidated financial statements contained herein
and includes all adjustments (consisting of normal recurring adjustments)
necessary to present fairly the information set forth therein when read in
conjunction with the Consolidated Financial Statements and
F-46
<PAGE>
EARTHLINK NETWORK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)
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................................. 29,826 37,990 49,824 58,301 68,243 78,001 89,574 106,470
Operating costs and expenses............. 35,766 49,812 70,218 82,384 94,047 106,502 125,065 140,981
Loss from operations..................... (5,940) (11,822) (20,394) (24,083) (25,804) (28,501) (35,491) (34,511)
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........................... $(6,404) $(13,071) $(22,104) $(25,804) $(25,889) $(28,174) $(34,769) $(33,522)
======= ======== ======== ======== ======== ======== ======== ========
Basic and diluted net loss per
share(2)............................... $ (0.28) $ (0.53) $ (0.78) $ (0.89) $ (0.82) $ (0.88) $ (1.07) $ (1.02)
======= ======== ======== ======== ======== ======== ======== ========
</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 Combined
Financial Statements for an explanation of the determination of the number
of weighted average shares outstanding in the net loss per share
computation.
F-47
<PAGE>
INDEX TO FINANCIAL STATEMENTS
MINDSPRING ENTERPRISES, INC.
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Report of Independent Public Accountants.................... F-49
Balance Sheets as of December 31, 1998 and 1999............. F-50
Statements of Operations for the years ended December 31,
1997, 1998 and 1999....................................... F-51
Statements of Stockholders' Equity for the years ended
December 31, 1997, 1998 and 1999.......................... F-52
Statements of Cash Flows for the years ended December 31,
1997, 1998 and 1999....................................... F-53
Notes to Financial Statements............................... F-54
Report of Independent Public Accountants as to Schedules.... FS-1
Schedule II--Valuation of Qualifying Accounts............... FS-2
</TABLE>
F-48
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To EarthLink, Inc.:
We have audited the accompanying 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-49
<PAGE>
MINDSPRING ENTERPRISES, INC.
BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1999
<TABLE>
<CAPTION>
1998 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivelants................................. $167,743 $377,174
Trade receivables, net of allowance for doubtful accounts
of $1,224 and $3,008 at December 31, 1998 and 1999...... 3,278 5,617
Deferred income taxes (Note 8)............................ 3,421 7,061
Prepaids and other current assets......................... 758 9,247
-------- --------
Total current assets.................................... 175,200 399,099
PROPERTY AND EQUIPMENT
Computer and telecommunications equipment................. 35,580 100,788
Assets under capital lease................................ 9,546 8,098
Other..................................................... 4,821 16,762
-------- --------
49,947 125,648
Less: accumulated depreciation............................ (14,106) (34,065)
-------- --------
Property and equipment, net............................. 35,841 91,583
-------- --------
OTHER ASSETS
Acquired customer base, net (Notes 1 and 2)............... 34,742 190,514
Deferred income taxes (Note 8)............................ 1,123 26,452
Deferred Debt Costs....................................... 6,926
Other..................................................... 693 351
-------- --------
Total other assets...................................... 36,558 224,243
-------- --------
$247,599 $714,925
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Trade accounts payable.................................... $ 3,462 $ 10,774
Current portion of capital lease liability (Note 7)....... 2,695 2,359
Telecommunications cost payable........................... 2,831 10,629
Deferred revenue (Note 1)................................. 7,443 13,243
Other accrued expenses.................................... 12,105 20,424
Accrued compensation expense.............................. 2,550 4,500
Income tax payable........................................ 2,566 --
Accrued Interest.......................................... -- 1,860
Network service payable................................... 4,442 9,858
-------- --------
Total current liabilities............................... 38,094 73,647
-------- --------
LONG TERM LIABILITIES
Convertible Notes (Note 6)................................ 179,975
Capital lease liability (Note 7).......................... 2,424 133
-------- --------
Total long term liabilites.............................. 2,424 180,108
-------- --------
Total Liabilities....................................... 40,518 253,755
-------- --------
COMMITMENTS AND CONTINGENCIES (Note 7)
STOCKHOLDERS' EQUITY
Common Stock, $.01 par value; 60,000 and 400,000 shares
authorized at December 31, 1998 and 1999 and 56,568 and
63,649 issued and outstanding at December 31, 1998 and
1999, respectively...................................... 566 636
Additional paid-in capital................................ 209,698 503,848
Accumulated deficit....................................... (3,183) (43,314)
-------- --------
Total stockholders' equity.............................. 207,081 461,170
-------- --------
$247,599 $714,925
======== ========
</TABLE>
The accompanying Notes to the Financial Statements are an integral part of these
statements
F-50
<PAGE>
MINDSPRING ENTERPRISES, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998, AND 1999
<TABLE>
<CAPTION>
1997 1998 1999
-------- -------- --------
(IN THOUSANDS EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
REVENUES:
Access.................................................. $44,802 $ 99,220 $272,015
Web hosting............................................. 7,355 14,470 35,881
Broadband............................................... 77 36 16,784
Content, commerce, and advertising...................... 322 947 3,465
------- -------- --------
Total revenues........................................ 52,556 114,673 328,145
------- -------- --------
OPERATING COSTS AND EXPENSES
Cost of revenues........................................ 19,118 38,306 115,808
Sales and marketing..................................... 10,310 22,200 93,357
General and administrative.............................. 8,469 12,855 29,866
Operations and member support........................... 14,194 26,477 77,292
Acquisition-related amortization........................ 4,208 7,049 83,195
------- -------- --------
Total operating expenses.............................. 56,299 106,887 399,518
------- -------- --------
OPERATING INCOME (LOSS)................................... (3,743) 7,786 (71,373)
INTEREST INCOME (EXPENSE), NET............................ (338) 1,214 5,927
------- -------- --------
INCOME (LOSS) BEFORE TAXES................................ (4,081) 9,000 (65,446)
------- -------- --------
INCOME TAX BENEFIT...................................... -- 1,544 25,315
------- -------- --------
NET INCOME (LOSS)......................................... $(4,081) $ 10,544 $(40,131)
======= ======== ========
NET INCOME (LOSS) PER SHARE:
Basic................................................... $ (0.09) $ 0.21 $ (0.65)
======= ======== ========
Diluted................................................. $ (0.09) $ 0.21 $ (0.65)
======= ======== ========
SHARES USED FOR COMPUTING NET INCOME (LOSS) PER SHARE:
Basic................................................... 45,084 49,222 61,742
======= ======== ========
Diluted................................................. 45,084 50,862 61,742
======= ======== ========
</TABLE>
The accompanying Notes to the Financial Statements are an integral part of these
statements.
F-51
<PAGE>
MINDSPRING ENTERPRISES, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998, AND 1999
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
------------------- PAID-IN ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT EQUITY
-------- -------- ---------- ----------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1996................. 44,862 $449 $ 34,604 $ (9,646) $ 25,407
Issuance of common stock pursuant to
exercise of options.................... 344 3 86 -- 89
Net Loss............................... -- -- -- (4,081) (4,081)
------ ---- -------- -------- --------
Balance, December 31, 1997................. 45,206 452 34,690 (13,727) 21,415
Issuance of common stock, net of related
offering expenses...................... 6,000 60 49,696 -- 49,756
Issuance of common stock, net of related
offering expenses...................... 4,600 46 124,738 -- 124,784
Issuance of common stock pursuant to
exercise of options.................... 762 8 576 -- 584
Net Income............................. -- -- -- 10,544 10,544
------ ---- -------- -------- --------
Balance, December 31, 1998................. 56,568 566 209,700 (3,183) 207,083
Issuance of common stock, net of related
offering expenses...................... 5,520 55 263,484 -- 263,539
Issuance of common stock, pursuant
customer base acquisition.............. 752 7 29,993 -- 30,000
Issuance of common stock pursuant to
exercise of options.................... 809 8 671 -- 679
Net Loss............................... -- -- -- (40,131) (40,131)
------ ---- -------- -------- --------
Balance, December 31, 1999................. 63,649 $636 $503,848 $(43,314) $461,170
====== ==== ======== ======== ========
</TABLE>
The accompanying Notes to Financial Statements are an integral part of these
statements.
F-52
<PAGE>
MINDSPRING ENTERPRISES, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998, AND 1999
<TABLE>
<CAPTION>
1997 1998 1999
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES:
Net (loss) income......................................... $(4,081) $ 10,544 $(40,131)
------- -------- --------
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization............................. 8,693 15,227 104,329
Deferred income taxes..................................... -- (4,544) (28,969)
Changes in operating assets and liabilities:
Trade receivables....................................... (5) (1,276) (4,010)
Other current assets.................................... (565) 284 (8,489)
Trade accounts payable.................................. 2,352 (844) 7,312
Telecommunications cost payable......................... 1,332 598 7,798
Deferred revenue........................................ 1,782 5,245 5,800
Other accrued expenses.................................. 1,166 3,329 15,321
Accrued interest........................................ -- -- 1,860
Accrued compensations expense........................... 769 1,146 1,950
Income taxes payable.................................... -- 2,566 (2,566)
Network services payable................................ (89) 3,226 5,416
------- -------- --------
Total adjustments..................................... 15,435 24,957 105,752
------- -------- --------
Net Cash Provided By Operating Activities........... 11,354 35,501 65,621
------- -------- --------
CASH FLOW FROM INVESTING ACTIVITIES:
Purchases of property and equipment....................... (8,042) (20,176) (62,504)
Purchase of customer base................................. (960) (27,312) (227,494)
Other..................................................... -- (159) 148
------- -------- --------
Net Cash Used in Investing Activities............... (9,002) (47,647) (289,850)
------- -------- --------
CASH FLOW FROM FINANCING ACTIVITIES
Payments of notes payable................................. (624) (2,043)
Cash provided by credit line.............................. -- -- 77,987
Repayment of credit line.................................. -- -- (80,000)
Proceeds from issuance of convertible debt................ -- -- 174,082
Payments of capital lease obligations..................... (2,084) (2,578) (2,627)
Issuance of common stock.................................. 89 175,124 264,218
------- -------- --------
Net Cash (Used in) Provided By Financing
Activities........................................ (2,619) 170,503 433,660
------- -------- --------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS........ (267) 158,357 209,431
CASH AND CASH EQUIVALENTS, beginning of year................ 9,653 9,386 167,743
------- -------- --------
CASH AND CASH EQUIVALENTS, end of year...................... $ 9,386 $167,743 $377,174
======= ======== ========
SUPPLEMENTAL DISCLOSURE FOR CASH FLOW INFORMATION:
Interest paid............................................. $ 749 $ 890 $ 6,501
======= ======== ========
Income taxes paid......................................... $ -- $ 434 $ 6,580
======= ======== ========
SUPPLEMENTAL NONCASH DISCLOSURES:
Stock issued in conjunction with acquisition.............. $ -- $ -- $ 30,000
======= ======== ========
Assets acquired under capital lease....................... $ 8,443 $ -- $ --
======= ======== ========
Noncash accrual for acquired subscriber base.............. $ -- $ 7,000 $ --
======= ======== ========
</TABLE>
The accompanying Notes to the Financial Statements are an integral part of these
statements.
F-53
<PAGE>
MINDSPRING ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1998, AND 1999
1. ORGANIZATION AND NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
MindSpring Enterprises, Inc. ("MindSpring") is a national provider of
Internet access. MindSpring was incorporated in Georgia on February 24, 1994 and
began marketing its services in June 1994. MindSpring reincorporated in Delaware
and effected a recapitalization in December 1995.
On February 4, 2000 EarthLink Network, Inc. ("EarthLink Network") and
MindSpring merged ("the Merger") into a new company named EarthLink, Inc, ("the
newly formed Company" ). The merger was accounted for as a 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 common stock
of the newly formed company and each outstanding share of MindSpring securities
was exchanged for one share of the securities of the newly formed company. The
newly formed company has also assumed MindSpring's outstanding 5% convertible
subordinated notes due 2006 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 the repurchase. Under the Merger Agreement, any
notes presented for repurchase will only be repurchased for cash. See Note 6.
ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the period. Actual results could differ from those estimates.
PRESENTATION
Certain amounts in the prior year financial statements have been
reclassified to conform to the current year presentation.
SOURCES OF SUPPLIES
MindSpring relies on third-party networks, local telephone companies, and
other companies to provide data communications capacity. Although management
feels alternative telecommunications facilities could be found in a timely
manner, any disruption of these services could have an adverse effect on
operating results.
CASH AND CASH EQUIVALENTS
MindSpring considers all short-term, highly liquid investments with an
original maturity date of three months or less to be cash equivalents. Cash and
cash equivalents are stated at cost, which approximates fair value.
CREDIT RISK
MindSpring's accounts receivable potentially subject MindSpring to credit
risk, as collateral is generally not required. MindSpring's risk of loss is
limited due to advance billings to members for services,
F-54
<PAGE>
MINDSPRING ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
1. ORGANIZATION AND NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
the use of preapproved charges to member credit cards, and the ability to
terminate access on delinquent accounts. In addition, the concentration of
credit risk is mitigated by the large number of members comprising the member
base. The carrying amount of MindSpring's receivables approximates their fair
value.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization are
provided for using the straight-line method over the estimated useful lives of
the assets, commencing when assets are installed or placed in service. The
estimated useful life for all assets is five years or, for leasehold
improvements, the life of the lease, if shorter.
EQUIPMENT UNDER CAPITAL LEASE
MindSpring leases certain of its data communication and other equipment
under lease agreements accounted for as capital. The assets and liabilities
under capital leases 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 their estimated useful lives of five years, which are
longer than the terms of the leases.
ACQUIRED MEMBER BASE
MindSpring capitalizes specific costs incurred for the purchase of member
bases from other Internet Service Providers ("ISPs"). The member acquisition
costs include the actual fee paid to the selling ISP, as well as legal and other
expenses specifically related to the transactions. Subscriber acquisition costs
capitalized at December 31, 1998 and 1999 were $47,521,000, and $286,488,000,
respectively. Amortization is provided using the straight-line method over three
years commencing when the member base is received. Amortization expense for the
years ended December 31, 1997, 1998, and 1999 was $4,208,000, $7,049,000, and
$83,195,000, respectively. See Note 2 for further discussion.
LONG-LIVED ASSETS
MindSpring periodically reviews the values assigned to long-lived assets,
such as property and equipment and acquired member bases, to determine whether
any impairments are other than temporary. Management reviews the undiscounted
projected cash flows related to such assets and compares them to the carrying
values of the assets to determine if an impairment has occurred. If an asset is
deemed to be impaired, MindSpring records the difference between the projected
cash flows on a discounted basis or the fair market value (whichever is more
appropriate) and the carrying value as an asset impairment charge in the period
incurred. There were no such impairments in the periods presented. Management
believes that the long-lived assets in the accompanying balance sheets are
appropriately valued.
F-55
<PAGE>
MINDSPRING ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
1. ORGANIZATION AND NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
INCOME TAXES
Deferred income taxes are recorded using enacted tax laws and rates for the
years in which the taxes are expected to be paid. Deferred income taxes are
provided for items when there is a temporary difference in recording such items
for financial reporting and income tax reporting.
STOCK-BASED COMPENSATION PLANS
MindSpring accounts for its stock-based compensation plans under Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees." The disclosure option of Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation" requires that
companies which do not choose to account for stock-based compensation as
prescribed by this statement shall disclose the pro forma effects on earnings
and earnings per share as if SFAS No. 123 had been adopted.
REVENUE RECOGNITION
MindSpring recognizes revenue when services are provided. Services are
generally billed one month in advance. During 1998, MindSpring began offering
prepaid services. Advance billings including prepaid services and collections
relating to future access services are recorded as deferred revenue and
recognized as revenue when earned.
BARTER TRANSACTIONS
MindSpring engages in certain exchanges of services for advertising and
promotional services. MindSpring records these transactions at the market value
of the services provided. Such transactions are not material for the periods
presented.
ADVERTISING COSTS
MindSpring expenses all advertising costs as incurred.
NET INCOME (LOSS) PER SHARE
MindSpring calculates net income (loss) per share as required by SFAS No.
128, "Earnings Per Share." Basic earnings (loss) per common share ("EPS") was
computed by dividing net income (loss) by the weighted average number of shares
of common stock outstanding for the year ended. The effect of MindSpring's stock
options (using the treasury stock method) was included in the computation of
diluted EPS for the year ended December 31, 1998. For the years ended
December 31, 1997 and 1999, the effect of
F-56
<PAGE>
MINDSPRING ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
1. ORGANIZATION AND NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
the options is excluded as their effect is anti-dilutive. The following table
summarizes the shares used in the calculations:
<TABLE>
<CAPTION>
TWELVE MONTHS ENDED
DECEMBER 31,
------------------------------
1997 1998 1999
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Weighted average shares
Outstanding--basic................................ 45,084 49,222 61,742
Effect of dilutive stock options.................... 1,640
------ ------ ------
Shares used for diluted earnings per share.......... 45,084 50,862 61,742
====== ====== ======
</TABLE>
RECENT ACCOUNTING PRONOUNCEMENTS
In 1998, MindSpring was subject to the provisions of Statement of Financial
Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income" and
Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures
about Segments of an Enterprise and Related Information." Neither statement had
any impact on MindSpring's financial statements as MindSpring does not have any
"comprehensive income" type earnings (losses) and its financial statements
reflect how the "key operating decisions maker" views the business. MindSpring
will continue to review these statements over time, in particular SFAS 131, to
determine if any additional disclosures are necessary based on evolving
circumstances.
2. MEMBER BASE ACQUISITIONS
On September 10, 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"). Pursuant to the Spry Agreement, MindSpring acquired Spry's
subscriber base of 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 on October 15, 1998 and in accordance with the
agreement MindSpring paid the initial payment of $25 million in cash to AOL. The
ultimate purchase price for these assets was $32 million.
On February 17, 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 and 3,000 dedicated Internet access
accounts in the United States. MindSpring paid NETCOM approximately
$245 million, consisting of $215 million in cash and $30 million in MindSpring
common stock (752,232
F-57
<PAGE>
MINDSPRING ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
2. MEMBER BASE ACQUISITIONS (CONTINUED)
shares, at a price per share of $39.88). MindSpring also incurred expenses of
approximately $4.2 million in connection with this acquisition.
In conjunction with the NETCOM acquisition, MindSpring obtained a $100
million secured revolving credit facility from First Union National Bank and
certain other lenders. For more discussion of this credit facility see
footnote 6.
The following table summarizes the net assets purchased in connection with
Spry and Netcom acquisitions and the amount attributable to intangibles (in
thousands):
<TABLE>
<CAPTION>
NETCOM SPRY
-------- --------
<S> <C> <C>
Working Capital.......................................... $ (1,672) $ --
Property and Equipment................................... $ 13,200 $ --
Acquired subscriber base................................. $237,695 $32,450
</TABLE>
The preliminary estimate of net assets acquired represents management's best
estimate based on currently available information; however, such estimate may be
revised up to one year from the acquisition date. MindSpring is amortizing the
acquired member base over three years.
The following unaudited pro forma condensed statements of operations (in
millions) assumes the NETCOM and Spry acquisitions occurred on January 1, 1998.
In the opinion of management, all adjustments necessary to present fairly such
unaudited pro forma condensed statements of operations have been made.
<TABLE>
<CAPTION>
1998 1999
--------- ---------
(IN MILLIONS, EXCEPT PER
SHARE DATA)
<S> <C> <C>
Revenue.................................................. $ 294.9 $347.0
Net loss................................................. $(121.1) $(55.4)
Net loss per share....................................... $ (2.13) $(0.84)
</TABLE>
3. STOCKHOLDERS' EQUITY
At the annual meeting of stockholders in May 1999 MindSpring voted to
approve and adopt an amendment to Article 4 of MindSpring's Amended and Restated
Certificate of Incorporation to increase the number of authorized shares of $.01
par value common stock from 60,000,000 to 400,000,000.
STOCK SPLIT
On June 25, 1999 MindSpring effected a two-for-one stock split of the
outstanding shares of common stock in the form of a stock dividend. Accordingly,
all data shown in the accompanying financial statements and notes has been
retroactively adjusted to reflect the stock split.
F-58
<PAGE>
MINDSPRING ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
3. STOCKHOLDERS' EQUITY (CONTINUED)
COMMON STOCK
In April 1999, MindSpring issued 5,520,000 shares at a public offering price
of $50 per share. The total prcoeeds of the offering, net of underwriting
discounts and offering expenses, were approximately $263,500,000.
4. STOCK-BASED COMPENSATION PLANS
EMPLOYEE STOCK OPTION PLAN
Under MindSpring's 1995 Stock Option Plan, as amended (the "Stock Option
Plan"), 9,000,000 shares of common stock are reserved and authorized for
issuance upon the exercise of options. All employees of MindSpring are eligible
to receive options under the Stock Option Plan. The compensation committee of
the board of directors administers the Stock Option Plan. Options granted under
the Stock Option Plan are intended to qualify as incentive stock options under
Section 422 of the Internal Revenue Code of 1986, as amended. Options generally
become exercisable as follows: (i) 50% of the options become exercisable two
years after the date of grant or, in certain cases, the commencement date of the
holder's employment; (ii) an additional 25% of the options become exercisable
three years after the date of grant or, in certain cases, the commencement date
of the holder's employment; and (iii) the remaining 25% of the options become
exercisable four years after the date of grant or, in certain cases, the
commencement date of the holder's employment. Except as noted in the next
sentence, all options were granted at an exercise price equal to the estimated
fair value of the common stock on the dates of grant as determined by the board
of directors based on equity transactions and other analyses. Options granted to
holders of 10% or more of the outstanding common stock were granted at an
exercise price equal to 110% of the estimated fair value of the common stock on
the dates of grant as determined by the board of directors based on equity
transactions and other analyses. The options expire ten years from the date of
grant or, in certain circumstances, the commencement date of the option holder's
employment.
DIRECTORS' STOCK OPTION PLAN
Under MindSpring's 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.
F-59
<PAGE>
MINDSPRING ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
4. STOCK-BASED COMPENSATION PLANS (CONTINUED)
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123
During 1995, the Financial Accounting Standards Board issued SFAS No. 123,
which defines a fair value-based method of accounting for an employee stock
option or similar equity instrument and encourages all entities to adopt that
method of accounting for all of their employee stock-based compensation plans.
However, it also allows an entity to continue to measure compensation cost for
those plans using the method of accounting prescribed by APB No. 25. Entities
electing to remain with the accounting in APB No. 25 must make pro forma
disclosures of net income and, if presented, earnings per share as if the fair
value-based method of accounting defined in this statement had been applied.
MindSpring has elected to account for its stock-based compensation plans
under APB No. 25; however, MindSpring has computed for pro forma disclosure
purposes the value of all options granted during 1997, 1998, and 1999 using the
Black-Scholes option-pricing model as prescribed by SFAS No. 123 using the
following weighted average assumptions used for grants in 1997, 1998, and 1999:
<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>
The total value of options granted during 1997, 1998, and 1999 was computed
as approximately $3,735,000, $38,679,000, and $66,399,000, respectively, which
would be amortized on a pro forma basis over the four-year vesting period of the
options. If MindSpring had accounted for these plans in accordance with SFAS No.
123, MindSpring's net income (loss) and pro forma net income (loss) per share
for the years ended December 31, 1997, 1998 and 1999 would have been as follows:
<TABLE>
<CAPTION>
AS REPORTED PRO FORMA
------------ ----------
(IN THOUSANDS EXCEPT PER
SHARE DATA)
<S> <C> <C>
1997
Net loss............................................... $ (4,081) $ (5,402)
Net loss per share..................................... $ (0.09) $ (0.12)
1998
Net income............................................. $ 10,544 $ 2,291
Net income per share................................... $ 0.21 $ 0.05
1999
Net loss............................................... $(40,131) $(52,770)
Net loss per share..................................... $ (0.65) $ (0.85)
</TABLE>
F-60
<PAGE>
MINDSPRING ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
4. STOCK-BASED COMPENSATION PLANS (CONTINUED)
A summary of the status of MindSpring's two stock options plans at
December 31, 1997, 1998 and 1999 and changes during the years then ended are
presented in the following table:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
STOCK OPTIONS PRICE
-------------- --------
(IN THOUSANDS)
<S> <C> <C>
Balance at December 31, 1996.......................... 3,468 $ 0.77
Granted............................................... 906 $ 2.11
Exercised............................................. (342) $ 0.15
Forfeited............................................. (348) $ 1.56
----- ------
Balance at December 31, 1997.......................... 3,684 $ 1.08
Granted............................................... 1,722 $18.77
Exercised............................................. (764) $ 0.77
Forfeited............................................. (407) $ 3.98
----- ------
Balance at December 31, 1998.......................... 4,235 $ 8.05
Granted............................................... 2,927 $38.13
Exercised............................................. (809) $ 0.84
Forfeited............................................. (885) $33.60
----- ------
Balance at December 31, 1999.......................... 5,468 $21.03
===== ======
Exercisable at December 31, 1997 732
=====
Exercisable at December 31, 1998 1,074
=====
Exercisable at December 31, 1999 1,254
=====
</TABLE>
The weighted average fair value of the options granted during the three
years ended December 31, 1997, 1998, and 1999 were $12.36, $22.50, and $22.81,
respectively.
F-61
<PAGE>
MINDSPRING ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
4. STOCK-BASED COMPENSATION PLANS (CONTINUED)
The following is a summary of stock options outstanding as of December 31,
1999
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------ ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING LIFE PRICE EXERCISABLE PRICE
- - -------------------------------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
$ 0.11 $ 0.60 639 5.56 $ 0.34 639 $ 0.34
$ 1.06 $ 1.40 590 6.56 $ 1.21 317 $ 1.16
$ 1.52 $ 4.85 547 7.15 $ 2.37 260 $ 2.30
$ 5.47 $11.46 649 8.25 $10.19 -- $ --
$13.43 $28.63 560 9.24 $23.23 -- $ --
$30.13 $30.34 695 9.19 $30.27 37 $30.34
$34.50 $36.81 617 9.56 $35.28 -- $ --
$39.75 $41.94 640 9.36 $40.23 -- $ --
$46.13 $46.22 518 9.16 $46.21 -- $ --
$51.44 $51.44 13 9.07 $51.44 -- $ --
---------- ---------
5,468 1,254
========== =========
</TABLE>
EMPLOYEE BENEFIT PLAN
MindSpring has a savings plan (the "Savings Plan") that qualifies 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.
Annually, MindSpring determines whether to make a discretionary matching
contribution equal to a percentage, determined by MindSpring, of the employee's
deferred compensation contribution. MindSpring has not made any matching
contributions to the Savings Plan.
5. RELATED-PARTY TRANSACTIONS
MindSpring 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.
MindSpring 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.
F-62
<PAGE>
MINDSPRING ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
6. DEBT
CREDIT FACILITY
On February 17, 1999, in conjunction with the NETCOM acquisition, MindSpring
entered into a credit agreement with First Union National Bank ("First Union")
and several other lenders. On February 17, 1999, MindSpring borrowed
approximately $80 million under the credit facility to finance the NETCOM
acquisition. MindSpring repaid all amounts outstanding under the credit facility
with a portion of the net proceeds from offering completed in April of 5,520,000
shares of common stock, and MindSpring amended the credit facility to permit the
issuance of notes, the payment of interest thereon, and certain redemptions
thereof. Subsequent to year end, in conjunction with MindSpring's merger with
Earthlink Network, Inc., MindSpring terminated this credit facility.
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. MindSpring sold
$179,975,000 aggregate principal amount of 5% Convertible Subordinated Notes due
2006, raising net proceeds of approximately $174.1 million.
The notes may be converted into shares of common stock of MindSpring at any
time before their maturity or their redemption by MindSpring at a rate of 16
shares per each $1,000 principal amount of notes, or $62.50 per share, subject
to adjustment in circumstances. Interest is payable semi-annually on April 15
and October 15 of each year beginning October 15, 1999. The notes are
subordinated in right of payment to all senior debt of MindSpring.
MindSpring may 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 has exceeded 150% of the conversion price for at least
20 trading days within a period of 30 consecutive trading days ending on the
trading prior to the date of the mailing of the notice of redemption. MindSpring
will make an additional payment of cash with respect to the 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 MindSpring may redeem the
notes on or after April 15, 2002 at 102.86% of the principal amount declining to
100% by April 15, 2006.
As discussed in Note 1, the merger with EarthLink Network constituted a
change in control as defined in the Indenture Agreement. Holders of the notes
have the right to demand payment equal to 100% of the principal amount of the
notes, plus accrued interest to the date of repurchase. Accordingly, MindSpring
extended an offer to purchase the notes for cash as of April 7, 2000. If all
holders exercise this option the payment will be $184,274,000, including
interest.
7. COMMITMENTS AND CONTINGENCIES
LEASES
MindSpring leases certain equipment under agreements, which are classified
as capital leases. These leases have original terms of three years or less and
contain bargain purchase options at the end of the original lease terms.
MindSpring also has operating leases, which relate to the lease of office and
F-63
<PAGE>
MINDSPRING ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
7. COMMITMENTS AND CONTINGENCIES (CONTINUED)
equipment space. Rental expense attributable to these operating leases was
approximately $1,420,000, $1,953,000 and $8,383,000 for the years ended December
31, 1997, 1998 and 1999, respectively.
At December 31, 1999, MindSpring's capital lease obligations and minimum
rental commitments under non-cancelable operating leases with initial or
remaining terms of more than one year were as follows:
<TABLE>
<CAPTION>
YEAR ENDING CAPITAL OPERATING
DECEMBER 31, LEASES LEASES
- - ------------ -------- ---------
(IN THOUSANDS)
<S> <C> <C>
2000...................................................... $ 2,517 $ 8,168
2001...................................................... 134 9,595
2002...................................................... -- 10,318
2003...................................................... -- 9,627
2004...................................................... -- 9,326
Thereafter................................................ -- 10,485
------- -------
Total minimum lease payments.............................. 2,651 $57,519
=======
Less amount representing interest......................... (159)
-------
Present value of future lease payments.................... 2,492
Less current portion...................................... (2,359)
-------
$ 133
=======
</TABLE>
LEGAL PROCEEDINGS
MindSpring is subject to legal proceedings and claims that arise in the
ordinary course of business. As of December 31, 1999, management is not aware of
any asserted or pending litigation or claims against MindSpring that would have
a material adverse effect on MindSpring's financial condition, results of
operations or liquidity.
8. INCOME TAXES
The provision for income taxes is attributable to:
<TABLE>
<CAPTION>
1997 1998 1999
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Current.......................................... $ $ 3,000 $ 3,654
Deferred......................................... (1,574) 654 (28,969)
Increase in (reversal of) valuation allowance.... 1,574 (5,198) --
------- ------- --------
Income tax provision (benefit)................. $ -- $(1,544) $(25,315)
======= ======= ========
</TABLE>
F-64
<PAGE>
MINDSPRING ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
8. INCOME TAXES (CONTINUED)
A reconciliation of the income tax provision (benefit) computed at statutory
tax rates to the income tax benefit for the year ended December 31, 1997, 1998
and 1999 is as follows:
<TABLE>
<CAPTION>
1997 1998 1999
-------- -------- --------
(PERCENT OF TAXABLE
INCOME)
<S> <C> <C> <C>
Income tax benefit at statutory rate....................... (34) 34 (34)
State income taxes, net of federal benefit................. (4) 4 (4)
Other...................................................... -- 2 (1)
Valuation allowance........................................ (38) (57) --
Total income tax provision (benefit)..................... -- 17 (39)
</TABLE>
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The significant
components of MindSpring's deferred tax assets and liabilities as of
December 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
1998 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Acquired customer base.................................. $ 3,902 $30,420
Deferred revenue........................................ 2,829 5,091
Allowance for doubtful accounts......................... 465 1,161
Accrued vacation........................................ 371 809
------- -------
Total deferred tax assets............................. 7,567 37,481
------- -------
Deferred tax liabilities:
Depreciation............................................ (2,779) (3,597)
Other................................................... (244) (371)
------- -------
Total deferred tax liabilities........................ (3,023) (3,968)
------- -------
Net deferred tax asset.................................... 4,544 33,513
Less current portion...................................... 3,421 7,061
------- -------
Net deferred taxes-long term.............................. $ 1,123 $26,452
======= =======
</TABLE>
Due to the fact that prior to 1998 MindSpring incurred losses since
inception, MindSpring did not recognize the income tax benefit of the net
operating loss carryforwards. Management provided a 100% valuation reserve
against its net deferred tax asset, consisting primarily of net operating loss
carryforwards. Management reviewed this position based on the net income
generated in 1998 as well as the projections of future income and determined
that it was more likely than not that the deferred tax assets would be realized.
Accordingly, MindSpring reversed its entire valuation allowance in 1998.
F-65
<PAGE>
MINDSPRING ENTERPRISES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997, 1998, AND 1999
9. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of the unaudited quarterly results for 1997,
1998, and 1999:
<TABLE>
<CAPTION>
NET INCOME
(LOSS) PER
SHARE
OPERATING NET INCOME -------------------
QUARTER ENDED REVENUE INCOME (LOSS) (LOSS) BASIC DILUTED
- - ------------- -------- ------------- ----------- -------- --------
(IN THOUSANDS EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
December 31, 1997........................... $17,209 $ 646 $ 498 $ (01 $ 0.1
September 30, 1997.......................... 13,967 (465) (626) (.02) (.02)
June 30, 1997............................... 11,600 (1,421) (1,430) (.03) (.03)
March 31, 1997.............................. 9,780 (2,505) (2,525) (.06) (.06)
December 31, 1998........................... $39,534 $ 1,299 $ 3,679 $ .07 $ .07
September 30, 1998.......................... 28,695 3,440 3,985 .08 .08
June 30, 1998............................... 25,060 1,994 2,020 .05 .04
March 31, 1998.............................. 21,384 1,053 860 .02 .02
December 31, 1999........................... $92,674 $(33,125) $(18,912) $(.30) $(.30)
September 30, 1999.......................... 88,179 (19,736) (10,834) (.17) (.17)
June 30, 1999............................... 85,664 (12,694) (7,081) (.06) (.06)
March 31, 1999.............................. 61,628 (5,818) (3,304) (.06) (.06)
</TABLE>
See Note 1 for a discussion of earnings per share.
F-66
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS AS TO SCHEDULES
We have audited, in accordance with generally accepted auditing standards,
the financial statements of MINDSPRING ENTERPRISES, INC. included in this Form
10-K and have issued our report thereon dated February 7, 2000. Our audits were
made for the purpose of forming an opinion on the basic financial statements
taken as a whole. The schedule listed in the index is the responsibility of
MindSpring's management and is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in the audits of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
ARTHUR ANDERSEN LLP
Atlanta, Georgia
February 7, 2000
FS-1
<PAGE>
SCHEDULE II--VALUATION OF QUALIFYING ACCOUNTS
MINDSPRING ENTERPRISES, INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEAR ENDED DECEMBER 31, 1999
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- - -------------------------------------------- ---------- ----------------------- ------------- ----------
ADDITIONS
-----------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS(A) PERIOD
- - ----------- ---------- ---------- ---------- ------------- ----------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
DEDUCTION IN THE BALANCE SHEET FROM THE
ASSET TO WHICH IT APPLIES:
Allowance for uncollectible accounts
Receivable................................ $1,224 $5,976 $0 $(4,192) $3,008
</TABLE>
(a) Represents specific accounts written-off considered to be uncollectible.
MINDSPRING ENTERPRISES, INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- - -------------------------------------------- ---------- ----------------------- ------------- ----------
ADDITIONS
-----------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS(A) PERIOD
- - ----------- ---------- ---------- ---------- ------------- ----------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
DEDUCTION IN THE BALANCE SHEET FROM THE
ASSET TO WHICH IT APPLIES:
Allowance for uncollectible accounts
Receivable................................ $751 $3,123 $0 $(2,650) $1,224
</TABLE>
(a) Represents specific accounts written-off considered to be uncollectible.
MINDSPRING ENTERPRISES, INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- - -------------------------------------------- ---------- ----------------------- ------------- ----------
ADDITIONS
-----------------------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING COSTS AND OTHER END OF
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS(A) PERIOD
- - ----------- ---------- ---------- ---------- ------------- ----------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
DEDUCTION IN THE BALANCE SHEET FROM THE
ASSET TO WHICH IT APPLIES:
Allowance for uncollectible accounts
Receivable................................ $386 $1,459 $0 $(1,094) $751
</TABLE>
(a) Represents specific accounts written-off considered to be uncollectible.
FS-2
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- - ------- ------------------------------------------------------------
<C> <C> <S>
2.1 -- Agreement and Plan of Reorganization, dated September 22,
1999, by and among EarthLink Network, Inc., MindSpring
Enterprises, Inc. and Earthlink, Inc., as amended.
2.2 -- Stock Option Agreement, dated September 22, 1999, between
MindSpring Enterprises, Inc. and EarthLink Network, Inc.
(incorporated by reference to Exhibit 2.2 of EarthLink
Network Inc.'s Form 8-K, dated September 22, 1999, File No.
0-20799).
2.3 -- Stock Option Agreement, dated September 22, 1999, between
EarthLink Network, Inc. and MindSpring Enterprises, Inc.
(incorporated by reference to Exhibit 2.3 of EarthLink
Network Inc.'s Form 8-K, dated September 22, 1999, File No.
0-20799).
2.4 -- Form of EarthLink Stockholder Agreement, dated September 22,
1999, between certain stockholders and EarthLink Network,
Inc. (incorporated by reference to Exhibit 2.4 of EarthLink
Network, Inc.'s Form 8-K, dated September 22, 1999, File No.
0-20799).
2.5 -- Form of MindSpring Stockholder Agreement, dated September
22, 1999, between certain stockholders and MindSpring
Enterprises, Inc. (incorporated by reference to Exhibit 2.5
of EarthLink Network, Inc.'s Form 8-K, dated September 22,
1999, File No. 0-20799).
2.6* -- Preferred Stock Purchase Agreement, dated January 4, 2000,
between EarthLink Network, Inc. and Apple Computer, Inc.
Limited.
2.7* -- Investor Rights Agreement dated January 4, 2000, between
EarthLink Network, Inc. and Apple Computer, Inc. Limited.
3.1* -- Certificate of Incorporation of EarthLink, Inc.
3.2* -- Form of Amended and Restated Certificate of Incorporation of
EarthLink, Inc.
3.3* -- By-laws of EarthLink, Inc.
3.4* -- Form of Certificate of Designation, Preferences and Rights
of Series A Convertible Preferred Stock.
3.5* -- Form of Certificate of Designation, Preferences and Rights
of Series B Convertible Preferred Stock and amendment
thereto.
3.6* -- Form of Certificate of Designation, Preferences and Rights
of Series C Convertible Preferred Stock.
10.1 -- 1995 Stock Option Plan and form of Stock Option Agreement
(incorporated by reference to Exhibit 10.1 to EarthLink
Network's Registration Statement on Form S-1--File No.
333-15781).
10.2 -- Amended and Restated Stock Option Plan for Directors
(incorporated by reference to Exhibit 10.2 to EarthLink
Network's Registration Statement on Form S-1--File No.
333-15781).
10.3 -- (a) Netscape Communications Corporation Internet Service
Provider Navigator Distribution Agreement, dated May 31,
1996, between EarthLink Network, Inc. and Netscape
Communications Corporation (incorporated by reference to
Exhibit 10.6 to EarthLink Network's Registration
Statement on Form S-1--File No. 333-15781).
(b) Amendment No. 1 to Netscape Communications Corporation
Internet Service Provider Agreement (incorporated by
reference to Exhibit 10.6(a) to EarthLink Network's
Registration Statement on Form S-1--File No. 333-15781).
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- - ------- ------------------------------------------------------------
<C> <C> <S>
(c) Amendment No. 2 to Netscape Communications Corporation
Internet Service Provider Agreement (incorporated by
reference to Exhibit 10.6(b) to EarthLink Network's
Registration Statement on Form S-1--File No. 333-15781).
10.4 -- (a) Network Services Agreement, dated May 31, 1996, between
EarthLink Network, Inc. and UUNET Technologies, Inc.
(incorporated by reference to Exhibit 10.7 to EarthLink
Network's Registration Statement on Form S-1--File No.
333-15781).
(b) Addendum No. 1 to Network Services Agreement
(incorporated by reference to Exhibit 10.7 (a) to EarthLink
Network's Registration Statement on Form S-1--File No.
333-15781).
10.5 -- Software Distribution Agreement (MacTCP), dated October 2,
1995, between EarthLink Network, Inc. and Apple Computer,
Inc. (incorporated by reference to Exhibit 10.8 to EarthLink
Network's Registration Statement on Form S-1--File No.
333-15781).
10.6 -- Amended and Restated Employment Agreement (incorporated by
reference to Exhibit 10.8(d) to EarthLink Network's
Registration Statement on Form S-1--File No. 333-53063).
10.7 -- Standard Industrial/Commercial Multi-Tenant Lease, dated
December 1, 1995, between EarthLink Network, Inc. and Becton
Dickinson and Company (incorporated by reference to Exhibit
10.12 to EarthLink Network's Registration Statement on Form
S-1--File No. 333-15781).
10.8 -- Internet Wizard Sign-Up Agreement, between EarthLink
Network, Inc. and Microsoft Corporation, dated August 16,
1996 (incorporated by reference to Exhibit 10.19 to
EarthLink Network's Registration Statement on Form S-1--File
No. 333-15781).
10.9 -- Network Access Agreement, between EarthLink Network, Inc.
and PSINet, Inc., dated July 22, 1996 and Amendment No. 1 to
Network Access Agreement (incorporated by reference to
Exhibit 10.20 to EarthLink Network's Registration Statement
on Form S-1--File No. 333-15781).
10.10 -- (a) Office Lease by and between The Mutual Life Insurance
Company of New York, and EarthLink Network, Inc., dated
September 20, 1996 (incorporated by reference to Exhibit
10.21 to EarthLink Network's Registration Statement on
Form S-1--File No. 333-15781).
(b) Third Amendment to the lease agreement between WHMNY
Real Estate Limited Partnership and EarthLink Network, Inc.
(incorporated by reference to Exhibit 10.1 to EarthLink
Network's Form 10-Q filed on November 16, 1998--File No.
0-20799).
10.11 -- Amended and Restated Convertible Securities Vesting Plan
(incorporated by reference to Exhibit 10.18 to EarthLink
Network's Report on Form 10-K for the fiscal year ended
December 31, 1997--File No. 0-20799).
10.12 -- (a) Key Employee Compensation Continuation Plan
(incorporated by reference to Exhibit 10.19 to EarthLink
Network's Report on Form 10-K for the fiscal year ended
December 31, 1997--File No. 0-20799).
(b) Amendment to Key Employee Compensation Continuation Plan
(incorporated by reference to Exhibit 10.19(a) to EarthLink
Network's Report on Form 10-K for the fiscal year ended
December 31, 1997--File No. 0-20799).
10.13 -- Governance Agreement, dated as of February 10, 1998,
(incorporated by reference to Exhibit 10.1 to EarthLink
Network's Form 8-K filed on February 10, 1998--File No.
0-20799).
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- - ------- ------------------------------------------------------------
<C> <C> <S>
10.14 -- Credit Agreement, dated as of February 10, 1998, with Sprint
Corporation as the Lender (incorporated by reference to
Exhibit 10.3 to EarthLink Network's Form 8-K filed on
February 10, 1998--File No. 0-20799).
10.15 -- Registration Rights Agreement, dated as of February 10,
1998, with Sprint Corporation, and Sprint Communications
Company L.P. (incorporated by reference to Exhibit 99.1 to
EarthLink Network's Form 8-K filed on February 10,
1998--File No. 0-20799).
10.16 -- Stockholders Agreement, dated as of February 10, 1998, among
EarthLink Network, Inc., Sprint Corporation, Sprint
Communications Company L.P., and the persons identified on
Schedule 1 thereto (incorporated by reference to Exhibit
99.2 to EarthLink Network's Form 8-K filed on February 10,
1998--File No. 0-20799).
10.17 -- Agreement to Vote Stock, dated as of February 10, 1998,
among the Granting Stockholders named on Schedule A thereto,
Sprint Corporation and Sprint Communications Company L.P.
(incorporated by reference to Exhibit 99.3 to EarthLink
Network's Form 8-K filed on February 10, 1998--File No.
0-20799).
10.18 -- Agreement to Vote and Tender Stock, dated as of February 10,
1998, among the Granting Stockholders named on Schedule A
thereto, Sprint Corporation, and Sprint Communications
Company L.P. (incorporated by reference to Exhibit 99.4 to
EarthLink Network's Form 8-K filed on February 10,
1998--File No. 0-20799).
10.19 -- Marketing and Distribution Agreement, dated as of February
10, 1998, Sprint Corporation, and Sprint Communications
Company L.P. (incorporated by reference to Exhibit 10.26 of
EarthLink Network's Registration Statement on Form S-4 filed
May 13, 1998, File No. 333-52507).
10.20 -- Lease Agreement, between EarthLink Network Inc. and Prentiss
Properties Natomas, L.P. (incorporated by reference to
Exhibit 10.1 to EarthLink Network's Form 10-Q filed on
September 30, 1999--File No. 0-20799).
10.22 -- Lease Agreement, between Park West E-3 Associates and NETCOM
On-Line Communication Services, Inc., dated February 23,
1996 (incorporated by reference to Exhibit 10.2 to
MindSpring's Form 10-K for the fiscal year ended December
31, 1998--File No. 0-27890).
10.23 -- Credit Agreement, dated as of February 17, 1999 by and among
MindSpring Enterprises, Inc., as Borrower, the Lenders
referred to herein, First Union Capital Markets Corp., as
Arranger and First Union National Bank, as Administrative
Agent (incorporated by reference to Exhibit 10.1 to
MindSpring's Form 8-K dated February 25, 1999--File No.
0-27890).
10.24 -- Guaranty and Collateral Agreement made by MindSpring
Enterprises, Inc. and the other Grantors party hereto in
favor of First Union National Bank, as Administrative Agent
(incorporated by reference to Exhibit 10.2 to MindSpring's
Form 8-K dated February 25, 1999--File No. 0-27890).
10.25 -- First Amendment, Waiver and Consent Agreement, dated as of
April 7, 1999, by and among MindSpring Enterprises, Inc.,
certain Lenders identified therein, First Union Capital
Markets Corp., as Arranger, and First Union National Bank,
as Administrative Agent (incorporated by reference to
Exhibit 10.1 to MindSpring's Form 8-K dated April 7,
1999--File No. 0-27890).
10.26 -- Lease Agreement, commencing on November 1, 1995, between
West Peachtree Point Partners, L.P. and MindSpring
Enterprises, Inc. (incorporated by reference to Exhibit
10(j) to MindSpring's Registration Statement on Form
S-1--File No. 333-108).
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- - ------- ------------------------------------------------------------
<C> <C> <S>
10.27 -- First Amendment dated February 6, 1996 to Lease Agreement
dated November 1, 1995 between John Marshall Law School,
Inc. (assignee of West Peachtree Point Partners, L.P.) and
MindSpring Enterprises, Inc. (incorporated by reference to
Exhibit 10(cc) to MindSpring's Registration Statement on
Form S-1--File No. 333-108).
10.28 -- MindSpring Enterprises, Inc. 1995 Stock Option Plan, as
amended (incorporated by reference to Exhibit 10.7 to
MindSpring's Form 10-K for the fiscal year ended December
31, 1998--File No. 0-27890).
10.29 -- Form of Stock Option Agreement (incorporated by reference to
Exhibit 10(v) to MindSpring's Registration Statement on Form
S-1--File No. 333-108).
10.30 -- MindSpring Enterprises, Inc. 1995 Directors Stock Option
Plan, as amended (incorporated by reference to Exhibit 10.9
to MindSpring's Form 10-K for the fiscal year ended December
31, 1998--File No. 0-27890).
10.31 -- Form of Director Stock Option Agreement, as amended
(incorporated by reference to Exhibit 10(x) to MindSpring's
Registration Statement on Form S-1--File No. 333-108).
10.32 -- Form of MindSpring Director or Officer Indemnity Agreement
(incorporated by reference to Exhibit 10(dd) to MindSpring's
Registration Statement on Form S-1--File No. 333-108).
10.33 -- Master Services Agreement, dated July 15, 1996, between
BellSouth Telecommunications, Inc. and MindSpring
Enterprises, Inc. (incorporated by reference to Exhibit
10(cc) to MindSpring's Form S-1--File No. 333-10779).
10.34 -- Office Building Lease Agreement, commencing December 15,
1997, between Pennsylvania Dental Service Corporation, a
Pennsylvania corporation d/b/a Delta Dental of Pennsylvania,
and MindSpring Enterprises, Inc. (incorporated by reference
to Exhibit 10.13 to MindSpring's Form 10-K for the fiscal
year ended December 31, 1998--File No. 0-27890).
10.35 -- Lease Agreement effective as of January 1, 1997 by and
between CMS Peachtree, L.P. and MindSpring Enterprises, Inc.
(incorporated by reference to Exhibit 10(hh) to MindSpring's
Form 10-K for the fiscal year ended December 31, 1996--File
No. 0-27890).
10.36 -- Amendment dated June 6, 1997 to Master Services Agreement,
dated July 15, 1996, between BellSouth Telecommunications,
Inc. and MindSpring Enterprises, Inc. (incorporated by
reference to Exhibit 10.1 to MindSpring's Form 10-Q for the
quarter ended June 30, 1997--File No. 0-27890).
10.37 -- Special Service Arrangement Agreement, dated June 1997,
between BellSouth Telecommunications, Inc. and MindSpring
Enterprises, Inc. (a substantially identical contract has
been executed for each of Alabama, Florida, Kentucky, North
Carolina, South Carolina and Tennessee) (incorporated by
reference to Exhibit 10.2 to MindSpring's Form 10-Q for the
quarter ended June 30, 1997--File No. 0-27890).
10.38* -- Lease Agreement dated November 16, 1999, between Kingston
Atlanta Partners, L.P. and MindSpring Enterprises, Inc.
10.39* -- First Amendment to Lease, dated October 1, 1999, between
Park West E-3 Associates and NETCOM On-line Communication
Services, Inc.
10.40* -- Lease Agreement, dated June 30, 1998, between Ryan Southbank
II, L.L.C. and MindSpring Enterprises, Inc.
10.41* -- Sublease, dated September 14, 1999, between International
Business Machines Corporation and MindSpring
Enterprises, Inc.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- - ------- ------------------------------------------------------------
<C> <C> <S>
10.42* -- Fourth Amendment dated June 24, 1998, to Lease Agreement
dated August 11, 1995 by and among 1430 L.L.C. and
MindSpring Enterprises, Inc.
10.43* -- Fifth Amendment dated October 26, 1999 to Lease Agreement
dated August 11, 1995 by and among 1430 L.L.C. and
MindSpring Enterprises, Inc.
10.44* -- Amendment dated December 20, 1999, to Office Building Lease
Agreement dated December 15, 1997, between Pennsylvania
Dental Service Corporation and MindSpring Enterprises, Inc.
10.45* -- EarthLink Centre Standard Modified Gross Office Lease, dated
October 5, 1999, by and between Limar Realty Corp. #6 and
Earthlink Network, Inc.
27.1 -- Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> YEAR YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1999 DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1999 JAN-01-1998 JAN-01-1997
<PERIOD-END> DEC-31-1999 DEC-31-1998 DEC-31-1997
<CASH> 685,753 308,607 0
<SECURITIES> 0 0 0
<RECEIVABLES> 20,300 9,886 0
<ALLOWANCES> 3,933 1,629 0
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 735,388 322,344 0
<PP&E> 225,603 110,396 0
<DEPRECIATION> 74,168 39,349 0
<TOTAL-ASSETS> 1,109,147 510,002 0
<CURRENT-LIABILITIES> 162,327 99,390 0
<BONDS> 0 0 0
0 0 0
142 132 0
<COMMON> 1,169 1,035 0
<OTHER-SE> 757,142 400,355 0
<TOTAL-LIABILITY-AND-EQUITY> 1,109,147 510,002 0
<SALES> 0 0 0
<TOTAL-REVENUES> 670,433 290,614 133,444
<CGS> 0 0 0
<TOTAL-COSTS> 866,113 345,069 165,641
<OTHER-EXPENSES> 0 0 0
<LOSS-PROVISION> 9,866 0 0
<INTEREST-EXPENSE> (21,986) (3,671) 1,800
<INCOME-PRETAX> (173,694) (53,178) (33,997)
<INCOME-TAX> 0 0 0
<INCOME-CONTINUING> (187,800) (60,779) (33,997)
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> (187,800) (60,779) (33,997)
<EPS-BASIC> (1.65) (0.66) (0.44)
<EPS-DILUTED> (1.65) (0.66) (0.44)
</TABLE>
