<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended: March 31, 1996
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _________ to __________
Commission File Number 0-25216
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0317705
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3031 TISCH WAY
SAN JOSE, CALIFORNIA 95128
- --------------------------------------------------------------------------------
(Address of principal executive offices)
Registrant's telephone number, including area code: (408) 983-5950
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 the number of shares outstanding of each of the Issuer's classes of
common stock, as of the latest practicable date:
Title of Each Class Outstanding at May 8, 1996
- ------------------- --------------------------
Common stock, par value $.01 per share, 11,540,183
and Preferred Stock Purchase Rights
associated therewith
Transitional Small Business Disclosure Format (check one):
Yes No X
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NETCOM ON-LINE COMMUNICATION SERVICES, INC.
INDEX
<TABLE>
<CAPTION>
Page
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<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements 3
Consolidated Balance Sheets as of 3
December 31, 1995 and March 31, 1996
Consolidated Statements of Operations and Other 4
Operating Data for the Three Months Ended March 31, 1995
and March 31, 1996
Consolidated Statements of Cash Flows 5
for the Three Months Ended March 31, 1995
and March 31, 1996
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition 8
and Results of Operations
PART II. OTHER INFORMATION
Item 2. Changes in Securities 14
Item 4. Submission of Matters to a Vote of Security Holders 14
Item 6. Exhibits and Reports on Form 8-K 15
Signatures 16
</TABLE>
When used in this report, the words "estimate," "project," "intend" and
"expect" and similar expressions are intended to identify forward-looking
statements. Such statements are subject to risks and uncertainties that could
cause actual results to differ materially. For a discussion of such risks, see
"Investment Considerations" on page 12. Readers are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of the
date hereof. The Company undertakes no obligation to publicly release updates
or revisions to these statements.
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<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31, March 31,
1995 1996
------------ ----------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents . . . . . . . . . . . . . $146,001,200 $131,141,700
Accounts receivable, net of allowance for doubtful
accounts of $225,000 at December 31, 1995 and
$155,000 at March 31, 1996 . . . . . . . . . . . 1,452,600 2,161,200
Inventory . . . . . . . . . . . . . . . . . . . . . 205,800 267,700
Prepaid expenses . . . . . . . . . . . . . . . . . . 1,471,100 2,864,800
------------- -------------
Total current assets . . . . . . . . . . . . . . . 149,130,700 136,435,400
Property and equipment at cost, net . . . . . . . . . 46,724,200 54,613,000
Product development costs, net . . . . . . . . . . . 359,200 319,800
Deferred subscriber acquisition costs, net . . . . . 3,451,500 4,501,500
Deposits and other assets . . . . . . . . . . . . . . 3,014,400 2,985,300
------------- -------------
Total assets . . . . . . . . . . . . . . . . . . . $202,680,000 $198,855,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade accounts payable . . . . . . . . . . . . . . . $ 11,388,700 $ 11,139,600
Accrued payroll and related expenses . . . . . . . . 2,154,400 2,521,800
Other accrued expenses and liabilities . . . . . . . 2,420,500 3,249,600
Deferred revenue . . . . . . . . . . . . . . . . . . 1,250,500 2,158,500
------------- -------------
Total current liabilities . . . . . . . . . . . . 17,214,100 19,069,500
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; Authorized shares -
40,000,000; 11,096,100 shares issued and
outstanding at December 31, 1995; 11,493,500 shares
issued and outstanding at March 31,
1996 . . . . . . . . . . . . . . . . . . . . . . . 111,000 114,900
Additional paid-in capital . . . . . . . . . . . . . 203,159,800 204,046,100
Accumulated deficit . . . . . . . . . . . . . . . . . (17,777,000) (24,351,400)
Cumulative translation adjustment . . . . . . . . . . (27,900) (24,100)
------------ ------------
Total stockholders' equity . . . . . . . . . . . . 185,465,900 179,785,500
------------ ------------
Total liabilities and stockholders' equity . . . $202,680,000 $198,855,000
============ ============
</TABLE>
See accompanying notes
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NETCOM ON-LINE COMMUNICATION SERVICES, INC.
Consolidated Statements of Operations and Other Operating Data
<TABLE>
<CAPTION>
Three Months Ended
------------------------------
March 31, March 31,
1995 1996
------------------------------
(unaudited)
<S> <C> <C>
Revenues . . . . . . . . . . . . . . . . . . . . . $ 7,497,900 $ 24,101,300
Costs and expenses:
Cost of revenues . . . . . . . . . . . . . . . . 4,996,600 16,629,600
Product development . . . . . . . . . . . . . . 299,700 1,252,900
Sales and marketing . . . . . . . . . . . . . . 1,953,900 9,734,000
General and administrative . . . . . . . . . . . 1,760,200 4,454,300
Amortization of goodwill and intangible assets . - 334,000
------------- ------------
Total costs and expenses . . . . . . . . . . . 9,010,400 32,404,800
------------- ------------
Loss from operations . . . . . . . . . . . . . . . (1,512,500) (8,303,500)
Interest income . . . . . . . . . . . . . . . . . 221,300 1,732,800
------------- ------------
Loss before provision for income taxes . . . . . . (1,291,200) (6,570,700)
Provision (benefit) for income taxes . . . . . . . - 3,700
------------- ------------
Net loss . . . . . . . . . . . . . . . . . . . . . $ (1,291,200) $ (6,574,400)
============= =============
Net loss per share . . . . . . . . . . . . . . . . $ (0.19) $ (0.59)
Shares used in computing net loss per share . . . 6,731,000 11,223,700
OTHER OPERATING DATA:
Approximate number of subscribers at end of
period . . . . . . . . . . . . . . . . . . . . . . 114,200 391,000
Number of POPs at end of period . . . . . . . . . 89 230
</TABLE>
See accompanying notes
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<PAGE>
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------
March 31, March 31,
1995 1996
-----------------------------
(unaudited)
<S> <C>
OPERATING ACTIVITIES
Net income (loss) . . . . . . . . . . . . . . . . . . . . . $ (1,291,200) $ (6,574,400)
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization . . . . . . . . . . . . 1,112,100 5,253,400
Loss on disposal of assets . . . . . . . . . . . . . . 110,400 -
Changes in assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . (535,100) (708,600)
Inventory . . . . . . . . . . . . . . . . . . . . . 391,300 (61,900)
Prepaid expenses . . . . . . . . . . . . . . . . . . (158,600) (1,463,300)
Deposits and other assets . . . . . . . . . . . . . (47,100) (304,800)
Trade accounts payable . . . . . . . . . . . . . . . 2,922,800 (249,100)
Accrued payroll and related expenses . . . . . . . . 359,100 367,400
Other accrued expenses and liabilities . . . . . . . 296,100 829,100
Deferred subscriber costs . . . . . . . . . . . . . (308,500) (3,019,600)
Deferred revenue . . . . . . . . . . . . . . . . . . 681,600 908,000
------------ -------------
Total adjustments . . . . . . . . . . . . . . . . . . 4,824,100 1,550,600
------------ -------------
Net cash provided (used) by operating activities . . . . 3,532,900 (5,023,800)
INVESTING ACTIVITIES
Purchase of property and equipment . . . . . . . . . . . . . (10,286,600) (10,729,700)
------------ -------------
Net cash used in investing activities . . . . . . . . . . . (10,286,600) (10,729,700)
FINANCING ACTIVITIES
Proceeds from exercise of stock options and purchases
under employee stock purchase plan . . . . . . . . . . . . 22,100 890,200
------------ -------------
Net cash provided by financing activities . . . . . . . . . 22,100 890,200
------------ -------------
Net decrease in cash and cash equivalents . . . . . . . . . (6,731,600) (14,863,300)
Effects of exchange rates on cash . . . . . . . . . . . . . - 3,800
Cash and cash equivalents at beginning of period . . . . . . 20,938,200 146,001,200
------------ -------------
Cash and cash equivalents at end of period . . . . . . . . . $ 14,206,600 $ 131,141,700
============ =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid . . . . . . . . . . . . . . . . . . . . . . . $ - $ -
Income taxes paid . . . . . . . . . . . . . . . . . . . . . $ - $ 3,700
</TABLE>
See accompanying notes
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<PAGE>
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. INTERIM PERIODS
The unaudited interim information has been prepared on the same basis as the
annual financial statements and, in the opinion of the Company's management,
reflects normal recurring adjustments necessary for a fair presentation of the
information for the periods presented. Operating results for any quarter are
not necessarily indicative of results for any future periods.
2. DEFERRED SUBSCRIBER ACQUISITION COSTS
The Company expenses the costs of advertising as incurred, except direct
response advertising which consists of subscriber acquisition costs. Subscriber
acquisition costs are deferred and amortized over a period determined by
calculating the ratio of current revenues related to the direct response
advertising versus the total expected revenues, or twelve months, whichever is
shorter. These costs relate directly to subscriber solicitations and
principally include the production, printing and shipping of starter packages,
trade show costs and the costs of obtaining qualified prospects by various
targeted direct marketing programs. No indirect costs are included in
subscriber acquisition costs. To date, all subscriber acquisition costs have
been incurred for the solicitation of specifically identified prospects.
Subscriber acquisition costs, which relate directly to potential
subscribers, are recorded separately from ordinary operating costs and do not
include indirect costs. The Company capitalized subscriber acquisition costs of
approximately $308,500 and $3,019,600 and amortized $282,100 and $1,969,600 for
the three months ended March 31, 1995 and 1996, respectively.
3. PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
December 31, 1995 March 31, 1996
----------------- --------------
(unaudited)
<S> <C> <C>
Property and equipment at cost $ 54,117,500 $ 64,847,200
Less accumulated depreciation
and amortization (7,393,300) (10,234,200)
------------ ------------
Net property and equipment $ 46,724,200 $ 54,613,000
============ ============
</TABLE>
4. NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of shares
of common stock and dilutive common stock equivalent shares from stock options
(using the treasury stock method).
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5. STOCKHOLDERS' EQUITY
The components of stockholders' equity are as follows:
<TABLE>
<CAPTION>
Common Total
Stock Additional Cumulative Stockholders'
------------------------ Paid-In Accumulated Translation Equity
Shares Amount Capital Deficit Adjustment (Deficit)
----------- ----------- ------------ ------------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 11,096,100 $111,000 $203,159,800 ($17,777,000) ($27,900) $185,465,900
Issuance under employee stock
purchase plan 16,900 200 437,400 - - 437,600
Exercise of stock options 380,500 3,700 448,900 - - 452,600
Cumulative translation adjustment - - - - 3,800 3,800
Net loss - - - (6,574,400) - (6,574,400)
----------- ----------- ------------ ------------- ---------- -------------
Balance at March 31, 1996 11,493,500 $ 114,900 $204,046,100 $(24,351,400) $ (24,100) $179,785,500
=========== =========== ============ ============= ========== =============
</TABLE>
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<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following information should be read in conjunction with the
consolidated financial statements and the notes thereto included in Item 1 of
this Quarterly Report, and the financial statements and the notes thereto and
Management's Discussion and Analysis of Financial Condition and Results of
Operations contained in the Company's Annual Report on Form 10-KSB for the year
ended December 31, 1995.
OVERVIEW
The Company's revenues are derived from providing Internet access services
primarily to individuals and to a lesser extent to business subscribers.
Revenues from monthly subscriptions have increased significantly since the
Company's inception as a result of increases in the Company's subscriber base.
This subscriber growth, in turn, has resulted from the growth of the Internet
services market generally, the expansion of the Company's service offerings and
distribution channels and the increase in the number of the Company's
points-of-presence ("POPs") in metropolitan areas in the United States. The
introduction of new POPs in a geographic area allows NETCOM subscribers in that
area to access the Internet without incurring long distance telephone charges.
The introduction of a new POP is generally accompanied by promotional programs
in that geographic area. Subscriber growth accelerated after July 1994, when
the Company introduced NetCruiser, an Internet access service that features a
point-and-click graphical user interface providing subscribers with an
easy-to-use access to the Internet's applications and resources.
Revenues are comprised of both recurring revenues from the Company's
customer base and one-time registration fees. The Company's NetCruiser accounts
are billed monthly pursuant to a pre-authorized credit card account. The
Company recently adopted a new pricing strategy, offering unlimited access to
the Internet to individual subscribers for $19.95 per month. Also, new
individual customers will be charged $5.00 for their first subscription month
and receive unlimited access to the Internet. Currently, sales to individuals
represent a significant majority of the Company's revenues.
The Company's operating results have fluctuated in the past and may
fluctuate significantly in the future as a result of a variety of factors, some
of which are outside the Company's control. In response to the increasing
competition among Internet service providers, the Company has recently increased
its focus in the near term on increasing its subscriber base, which will require
it to significantly increase its expenses for personnel, new product
development, marketing and capital expenditures and will adversely impact
short-term operating results. As a result, the Company expects that it will
continue to incur substantial net losses for the foreseeable future. There can
be no assurance that revenue or subscriber growth will continue or that the
Company will be able to first achieve and then sustain profitability or positive
cash flow.
The Company may choose to adopt strategies designed to continue growth in
its subscriber base, such as aggressive promotional programs and the
implementation of new pricing programs. Such strategies may result in an
increase in costs as a percentage of revenues. Additionally, in order to
continue to realize subscriber growth, the Company must continue to replace
terminating subscribers and attract additional subscribers. However, the sales
and marketing expenses and subscriber acquisition costs associated with
attracting new subscribers are substantial. Accordingly, the Company's ability
to improve operating margins will depend in part on its ability to retain its
subscribers and there can be no assurances that the Company's investments in
telecommunications
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<PAGE>
infrastructure, customer support capabilities, new service offerings and
NetCruiser software releases will ensure subscriber retention.
Acceleration in the growth of the Company's subscriber base or changes in
usage patterns among subscribers may also increase costs as a percentage of
revenues. Acceleration in the growth of the subscriber base could further
increase the Company's need to hire additional personnel and increase the
Company's expenses related to product development, marketing, network
infrastructure and customer support. An increase in peak time usage or an
overall increase in usage by subscribers could adversely affect the Company's
ability to consistently meet the demand for its access services. As a result,
the Company may need to hire additional personnel and increase expenses related
to network infrastructure capacity with minimal corresponding increases in
revenue on a per subscriber basis.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1996
REVENUES
Revenues increased by $16,603,400, or 221.4%, from $7,497,900 for the three
months ended March 31, 1995 to $24,101,300 for the three months ended March 31,
1996. The increase in revenues was due to a significant increase in the number
of subscribers, which the Company attributes to the growth in the Internet
market generally, the increase in the number of the Company's POPs and the
Company's release of enhancements to its NetCruiser software, as well as
continued expansion of the Company's sales force and promotional activities.
The Company has begun international expansion in the United Kingdom and Canada.
There is no significant international revenue at this time due to the early
stages of such expansion. As a result, approximately 30% of the net loss for
the three months ended March 31, 1996 was incurred due to such expansion.
Total subscribers increased from approximately 114,200 accounts as of March 31,
1995 to approximately 391,000 accounts as of March 31, 1996.
COST OF REVENUES
The Company's cost of revenues was $4,996,600 for the three months ended
March 31, 1995 and $16,629,600 for the three months ended March 31, 1996,
increasing from 66.6% to 69.0% of revenues, respectively. The increase in the
cost of revenues was primarily attributable to increases in data communication
costs associated with the increase in the number of subscribers, increased
depreciation expense relating to capital expenditures for POP expansion and
network improvements and expansion of the Company's operations and customer
support staff to support growth. The Company expects that the cost of revenues
will continue to increase in absolute dollars as the Company plans to increase
its subscriber base and expand its infrastructure, including increased
depreciation expenses from capital expenditures associated with increases in the
number of POPs and network enhancements and increased customer support levels.
PRODUCT DEVELOPMENT
Total product development expenses were $299,700 for the three months ended
March 31, 1995 and $1,252,900 for the three months ended March 31, 1996,
representing 4.0% and 5.2% of revenues, respectively. In accordance with
Statement of Financial Accounting Standards No. 86, software
development costs are expensed as incurred until technological feasibility is
established, after which any additional costs are capitalized until the
software is commercially available. The Company did not capitalize any software
development costs in the first quarter of 1995 or 1996.
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<PAGE>
Amounts capitalized are amortized over the estimated useful life of
approximately three years. The Company plans to continue its expenditures on
product development as the Company develops new software products and upgrades
existing products. Accordingly, research and development expenses are
expected to increase in absolute dollars but remain relatively level as a
percentage of revenues in the near term.
SALES AND MARKETING
Sales and marketing expenses increased $7,780,100, or 398.2%, from
$1,953,900 for the three months ended March 31, 1995 to $9,734,000 for the three
months ended March 31, 1996, increasing from 26.1% to 40.4% of revenues,
respectively. The increase in sales and marketing expenses was due primarily to
increased costs associated with expansion of the Company's sales and marketing
department, the addition of management personnel, and marketing expenditures.
Sales and marketing expenses are expected to continue to increase in absolute
dollars, although they may vary as a percentage of revenues. Certain of the
subscriber acquisition costs are capitalized and amortized over a twelve-month
period using the straight-line method. The Company capitalized subscriber
acquisition costs of approximately $308,500 and $3,019,600 and amortized
subscriber acquisition costs of $282,100 and $1,969,600
for the three months ended March 31, 1995 and 1996, respectively.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased $2,694,100, or 153.1%, from
$1,760,200 for the three months ended March 31, 1995 to $4,454,300 for the three
months ended March 31, 1996, decreasing from 23.5% to 18.5% of revenues,
respectively. This increase was primarily attributable to hiring additional
administrative and accounting personnel and incurring additional corporate
facility expenses. Although no assurances can be given, the Company expects
general and administrative expenses to decrease as a percentage of revenues
over time as the Company seeks to increase its revenue base without commensurate
increases in general and administrative expenses.
GOODWILL AND INTANGIBLE ASSETS
On August 7, 1995, the Company completed the acquisition of Professional
Internet Consulting, Inc. The resulting consideration in excess of
assets acquired totaling $1,373,000 represents the valuation of the customer
base, other intangibles and goodwill acquired. These amounts were allocated to
intangible assets and are being amortized as an operating expense over a period
of up to eighteen months. Amortization of goodwill and intangible assets was
$334,000 in the three months ended March 31, 1996.
INTEREST INCOME
Net interest expense was $221,300 for the three months ended March 31, 1995
as compared to net interest income of $1,732,800 for the three months ended
March 31, 1996. This change is primarily the result of the investment of the
proceeds from the Company's public offerings in May 1995 and November 1995
primarily in United States treasury bills and high grade commercial paper.
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<PAGE>
NET LOSS
The higher cost of revenues and higher operating expenditures incurred in
the three months ended March 31, 1996 as described above, resulted in a net loss
of $6,574,400, as compared to a net loss of $1,291,200 for the three months
ended March 31, 1995, notwithstanding the period-to-period revenue growth. This
primarily reflected the Company's strategy to invest in the growth of its
subscriber base.
INCOME TAXES
There was a $3,700 provision for minimum state income taxes for the three
months ended March 31, 1996. No provision for income taxes is expected for
1996, other than minimum state income taxes, as the Company expects to incur a
net loss for the year and does not expect earnings for the foreseeable future.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations primarily through cash generated from
operations, private and public sales of equity securities and bank indebtedness.
The Company's operating activities provided cash of approximately $3,532,900 for
the three months ended March 31, 1995, and used cash of approximately $5,023,800
for the three months ended March 31, 1996. During the three months ended March
31, 1995, cash from operations was primarily generated by increases in accounts
payable and deferred revenue and partially offset by increases in accounts
receivable. During the three months ended March 31, 1996, cash from operations
was primarily used by increases in accounts receivable and prepaid expenses and
decreases in accounts payable and partially offset by increases in other accrued
expenses and liabilities and deferred revenue.
The Company's investing activities have consisted primarily of equipment
purchases for POPs and network expansion, and amounted to $10,286,600 and
$10,729,700 for the three months ended March 31, 1995 and 1996, respectively.
The Company's financing activities provided $22,100 and $890,200 for the
three months ended March 31, 1995 and March 31, 1996, respectively. For the
three months ended March 31, 1996, financing activities consisted primarily of
proceeds from the exercise of stock options and purchases under the employee
stock purchase plan. Although the Company has no material capital commitments
(other than for its POP expansion and operating infrastructure program), a
substantial portion of the proceeds of its May 1995 and November 1995 public
offerings have been used, and are expected to continue to be used for additional
equipment purchases and for subscriber acquisition.
As of March 31, 1996, the Company had cash and cash equivalents of
$131,141,700 and working capital of $117,365,900. The Company used $6,731,600
and $14,863,300 of cash in the three months ended March 31, 1995 and March 31,
1996, respectively. In addition, the Company has $15,000,000 available under its
bank credit facility. Borrowings may not exceed 90% of the Company's prior
three-month subscriber revenue, subject to certain adjustments. This credit
facility bears interest at a rate of prime plus 1.0%. The line matures in May
1996. The Company may extend this bank line of credit or evaluate other lines
of credit in the future. The Company believes that existing cash and cash
equivalents, together with existing sources of liquidity, will be sufficient to
fund its operations, capital expenditures, working capital and other cash
requirements. There were no outstanding borrowings under this credit facility as
of March 31, 1996.
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<PAGE>
INVESTMENT CONSIDERATIONS
The following factors, in addition to the factors discussed in the
Company's Report on Form 10-KSB for the fiscal year ended December 31, 1995, and
other information contained elsewhere herein, should be considered carefully in
evaluating the Company and its business.
LIMITED OPERATING HISTORY; OPERATING LOSSES; FLUCTUATIONS IN OPERATING
RESULTS. The Company was incorporated in August 1992, and accordingly has had a
limited operating history. Although the Company has experienced revenue growth
in each of its fiscal quarters since incorporation, it experienced net losses of
$100,000 in 1994, $14,063,600 in 1995 and $6,574,400 in the first quarter of
1996, and had an accumulated deficit of $24,351,400 as of March 31, 1996.
These losses are also reflected in the Company's declining operating
margins, which decreased from a loss of .9% for 1994 to a loss of 31% for 1995
and a loss of 35% for the first quarter of 1996. The Company's current focus is
on increasing its subscriber base, and the Company continues to hire additional
personnel and to increase its expenses related to product development,
marketing, network, infrastructure and customer support. In addition, the
Company is seeking to expand its operations to international markets. The costs
associated with the penetration of new markets, particularly new
international markets in which Internet services are less well established, are
likely to further impact cash flow and operating performance. As a result, the
Company expects that it will continue to incur substantial losses for the
foreseeable future. There can be no assurance that revenue growth will continue
or that the Company will in the future achieve or sustain profitability or
positive cash flow from operations. In view of the competitive nature of its
market, the Company has adopted strategies designed to continue growth in its
subscriber base. Such strategies, and any promotional measures the Company
could adopt in the future in pursuit of these strategies, may result in an
increase in costs as a percentage of revenues. In addition, an acceleration in
the growth of the subscriber base or changes in usage patterns among subscribers
may also increase costs as a percentage of revenues. The acceleration of the
introduction of new technologies may also increase the costs and complexities of
providing acceptable customer services. There can be no assurance that the
Company's operating margins will not be materially adversely affected in the
future by the adoption of these strategies.
The Company's operating results have fluctuated in the past and may
fluctuate significantly in the future as a result of a variety of factors, some
of which are outside of the Company's control, including capital expenditures
and other costs relating to the expansion of operations, the timing of new
product announcements by the Company or its competitors, changes in pricing
strategies by the Company and competitors, market acceptance of new and enhanced
versions of the Company's software products and services and the rates of new
subscriber acquisition and retention. Operating results could also be adversely
affected by increased competition in the Company's markets, including price
competition.
COMPETITION. The market for Internet access services is extremely
competitive. There are no substantial barriers to entry and the Company expects
that competition will intensify in the future. The Company believes that its
ability to compete successfully depends upon a number of factors, including
market presence; the capacity, reliability and security of its network
infrastructure; ease of access to and navigation of the Internet; the pricing
policies of its competitors and suppliers; the timing of introductions of new
products and services by the Company and its competitors; the Company's ability
to support existing and emerging industry standards; and industry and general
economic trends.
-12-
<PAGE>
The Company's current and prospective competitors include many large
companies that have substantially greater market presence and financial,
technical, marketing and other resources than the Company. The Company competes
or expects to compete directly or indirectly with the following categories of
companies: (1) other national and regional commercial Internet services
providers, such as Performance Systems International, Inc., Bolt, Bernanek &
Newman, Inc., and UUNET Technologies, Inc., (2) established on-line services
companies which currently offer or are expected to offer Internet connectivity,
such as America Online, Inc., CompuServe Incorporated and Prodigy
Services Company, (3) computer hardware and software and other technology
companies, such as International Business Machines Corporation and Microsoft
Corporation, (4) national long distance carriers such as American Telephone and
Telegraph Company ("AT&T"), MCI Communications Corporation and Sprint
Corporation, (5) regional telephone companies, such as Pacific Bell and Bell
Atlantic, (6) cable operators, such as Tele-Communications, Inc., and (7)
nonprofit or educational Internet service providers.
Most of the established on-line services companies and telecommunications
companies currently offer Internet access. In addition, the Company believes
that new competitors, including large computer hardware and software, media and
telecommunications companies, such as additional regional telephone companies,
will enter the Internet access market, resulting in even greater competition for
the Company. For example, in the first quarter of 1996, AT&T began to offer its
telephone customers Internet access with an aggressive pricing structure.
Increased competition could result in significant price competition, which
in turn could result in significant reductions in the average selling price of
the Company's services. In addition, increased competition for new subscribers
could result in increased sales and marketing expenses and related subscriber
acquisition costs, which could materially adversely affect the Company's
profitability. There can be no assurance that the Company will be able to
offset the effects of any such competition or resulting price reductions through
an increase in the number of its subscribers, higher revenue from enhanced
services, cost reductions or otherwise. Increased competition, price or
otherwise, could result in erosion of the Company's market share and adversely
affect the Company's operating results. There can be no assurance that the
Company will have the financial resources, technical resources, technical
expertise or marketing and support capabilities to continue to compete
successfully.
NEW AND UNCERTAIN MARKET. The market for Internet connectivity services
and related software products is in an early stage of growth. Since this market
is relatively new and because current and future competitors are likely to
introduce competing Internet connectivity and/or on-line services and products,
it is difficult to predict the rate at which the market will grow or at which
new or increased competition will result in market saturation. The novelty of
the market for Internet access services may also adversely affect the Company's
ability to retain new customers as they may be unfamiliar with the Internet and
more likely to discontinue the Company's services after an initial trial period.
If demand for Internet services fails to grow, grows more slowly than
anticipated, or becomes saturated with competitors, the Company's business,
operating results and financial condition will be materially adversely affected.
Although the Company intends to support emerging standards in the market for
Internet connectivity, there can be no assurance that industry standards will
emerge or, if they become established, that the Company will be able to conform
to these new standards in a timely fashion and maintain a competitive position
in the market.
In order to continue to realize subscriber growth, the Company must
continue to replace terminating subscribers and attract additional subscribers.
However, the sales and marketing expenses and subscriber acquisition costs
associated with attracting new subscribers are substantial.
-13-
<PAGE>
Accordingly, the Company's ability to improve operating margins will depend in
part on the Company's ability to retain its subscribers. The Company continues
to invest significant resources in its telecommunications infrastructure and
customer support resources. There can be no assurances that the Company's
investments in its telecommunications infrastructure, customer support
capabilities and NetCruiser software releases will improve subscriber retention.
Since the Internet market is new and the utility of available services is not
well understood by new and potential subscribers, the Company is unable to
predict future subscriber retention rates.
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
Reference is hereby made to "Exhibit C--Summary of Rights," from the
Company's Report on Form 8-K, filed with the Commission on March 18, 1996,
relating to the adoption by the Company of a Stockholder Rights Plan.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At a Special Meeting of Stockholders on February 15, 1996, the holders of
7,385,756 shares of common stock, representing 66.5% of the total votes eligible
to be cast, approved a proposal to amend and restate the Company's 1993 Stock
Option Plan by the margin indicated below.
Vote For Voted Against Abstained No Vote
-------- ------------- --------- -------
5,838,424 1,370,494 10,368 166,470
-14-
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description of Document
------ -----------------------
10.1 Form 8-K, filed with the Commission on March 18, 1996, relating
to the adoption by the Company of a Stockholder Rights Plan and
incorporated herein by reference.
(b) Reports on Form 8-K
On March 18, 1996, the Company filed a report on Form 8-K relating to the
adoption by the Company of a Stockholder Rights Plan.
ITEMS 1, 3 AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.
-15-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
Date: May 13, 1996 By /s/ David W. Garrison
-------------------------------------------
David W. Garrison
Chairman of the Board, President and
Chief Executive Officer
By /s/ Clifton T. Weatherford
-------------------------------------------
Clifton T. Weatherford
Senior Vice President,
Chief Financial Officer and Secretary
-16-
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND> This schedule contains summary information extracted from
NETCOM On-Line Communication Services, Inc.'s Consolidated
Statements of Operations and Other Operating Data and Consolidated
Balance Sheets and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<CASH> 131,141,700
<SECURITIES> 0
<RECEIVABLES> 2,316,200
<ALLOWANCES> 155,000
<INVENTORY> 267,700
<CURRENT-ASSETS> 136,435,400
<PP&E> 64,847,200
<DEPRECIATION> 10,234,200
<TOTAL-ASSETS> 198,855,000
<CURRENT-LIABILITIES> 19,069,500
<BONDS> 0
<COMMON> 114,900
0
0
<OTHER-SE> 179,670,600
<TOTAL-LIABILITY-AND-EQUITY> 179,785,500
<SALES> 0
<TOTAL-REVENUES> 24,101,300
<CGS> 0
<TOTAL-COSTS> 16,629,600
<OTHER-EXPENSES> 15,775,200
<LOSS-PROVISION> (70,000)
<INTEREST-EXPENSE> 1,732,800
<INCOME-PRETAX> (6,570,700)
<INCOME-TAX> 3,700
<INCOME-CONTINUING> (6,574,400)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,574,400)
<EPS-PRIMARY> (0.59)
<EPS-DILUTED> (0.59)
</TABLE>
