UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-KSB
(Mark One)
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the fiscal year ended
December 31, 1996 TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
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)
2 N. Second Street, Plaza A
San Jose, California 95113
(Address of principal executive offices)
Issuer's telephone number: (408) 881-3516
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Securities registered pursuant to Section 12(b)
of the Exchange Act:
None
Securities registered pursuant to Section 12(g)
of the Exchange Act:
Common Stock, par value $0.01 per share
Preferred Stock Purchase Rights
(Title of Class)
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 .
--- ---
Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. .
---
The registrant's revenues for the fiscal year ended December 31, 1996 were
$120,540,000.
As of March 20, 1997, the aggregate market value of the registrant's voting
stock held by non-affiliates of the registrant, based on the closing price for
the registrant's Common Stock in the Nasdaq National Market on such date, was
approximately $99,830,000. This calculation does not reflect a determination
that certain persons are affiliates of the registrant for any other purposes.
The number of shares of Common Stock outstanding on March 20, 1997 was
11,683,286.
DOCUMENTS INCORPORATED BY REFERENCE
Items 9, 10, 11 and 12 of Part III incorporate information by reference
from the definitive proxy statement for the registrant's 1997 Annual Meeting of
Stockholders.
Transitional Small Business Disclosure Format: Yes No X .
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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, including competitive pressures, new
product introductions by the Company and its competitors and changes in the
rates of subscriber acquisition and retention. For a discussion of certain of
such risks, see "Risk Factors" on page 14. 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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TABLE OF CONTENTS
Page
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PART I....................................................................... 4
ITEM 1. DESCRIPTION OF BUSINESS.......................................... 4
ITEM 2. DESCRIPTION OF PROPERTY.......................................... 18
ITEM 3. LEGAL PROCEEDINGS................................................ 18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............. 19
EXECUTIVE OFFICERS OF THE REGISTRANT............................. 19
PART II...................................................................... 20
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS......... 20
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........................................ 21
ITEM 7. FINANCIAL STATEMENTS............................................. 25
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE......................................... 38
PART III..................................................................... 38
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT................ 38
ITEM 10. EXECUTIVE COMPENSATION........................................... 38
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT... 38
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................... 38
PART IV...................................................................... 39
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K................................. 39
SIGNATURES....................................................... 41
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
NETCOM On-Line Communication Services, Inc. ("NETCOM" or the "Company") is
a leading provider of high quality Internet solutions to businesses and
individuals. The Company was incorporated in California in August 1992 and
reincorporated in Delaware in October 1994. The Company offers customers
integrated Internet solutions aimed at enhancing customer productivity through
integration and application of technologies. The Company has experienced rapid
growth in its customer base, reaching 580,000 customers as of December 31, 1996,
compared to 308,000 customers as of December 31, 1995 and 73,000 customers as of
December 31, 1994. NETCOM provides packaged solutions to address the Internet
productivity needs of individuals, small and medium-sized businesses. The
Company believes the potential target market is large, with industry sources
estimating that the number of professionals working at home amounts to
approximately 30 million United States households. An estimated 18 million of
these households have personal computers and only 17% are currently on line.
Additionally, there are currently an estimated 7.1 million small businesses
(1-99 employees) in the United States. Approximately 23% of these small
businesses are currently on-line according to industry estimates.
In 1996, NETCOM developed and strengthened its relationships with leading
global technology companies. NETCOM is working in co-development relationships,
development alliances or commercial relationships with companies including
Microsoft Corporation (Microsoft Internet Explorer, Microsoft Internet News,
Microsoft NetMeeting), Netscape Communications Corporation (Netscape Navigator),
International Business Machines Corporation (Cryptolope secure purchasing
enabler), Lotus Development Corporation (Domino-based collaborative interactive
applications), Adobe Systems, Inc. (Acrobat Reader), Macromedia, Inc. (Shockwave
multimedia, graphics and audio capabilities), Qualcomm, Inc. (Eudora Pro and
Eudora Light E-mail applications), McAfee Associates, Inc. (Webscan virus
protection), Spyglass, Inc. (Surfwatch and NETCOM Surfwatch Service),
Quarterdeck Corporation (Global Chat) and Cisco Systems, Inc. (Cisco IOSO-TM-).
NETCOM's telecommunications network is comprised of regional hubs, ATM
switches and network control centers connecting a backbone of leased high-speed
dedicated data lines and 331 local access numbers in the United States, United
Kingdom and Canada. These local access numbers allow customers in these areas to
access the Internet through a local telephone call or dedicated connection. The
Company has engaged in a rapid expansion of its local access numbers throughout
the United States, United Kingdom and Canada, and intends to continue its
expansion of local access numbers internationally in 1997.
In September 1996, the Company signed a joint-venture agreement in Brazil
with Grupo Itamarati, a large Brazilian conglomerate. Together they agreed to
form a company, INTERNETCOM do Brasil, S.A., to offer access and web-based
solutions tailored to meet business customers' demand for high quality, complete
Internet services.
The Company operates in one principal industry segment and markets and
delivers its services internationally through foreign subsidiaries and
affiliates. For a detailed breakdown of the Company's international operations,
see Note 6 to Notes to Consolidated Financial Statements.
Internet Growth
Use of the Internet has grown rapidly since the commercialization of the
Internet in the early 1990's. Industry sources predict that the on-line spending
by small businesses (1-99 employees) will reach $1.3 billion by the year 2000.
The rapid growth of the Internet is due in a large part to:
- Growth of the commercial, informational and entertainment
applications of the Internet and growing awareness of these
applications: An increasing number of host computers are being
connected to the Internet, making available text, graphics, audio and
video information and public domain software. Through an Internet
connection, users can access commercial, educational and governmental
databases, software, graphics, newspapers, magazines, library
catalogs, industry newsletters, and other information. Traditional and
emerging Internet applications are also continuing to increase in
popularity, including E-mail and the World Wide Web.
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- Availability of navigational and utility tools enabling easier access
to the Internet's resources: Internet use is being promoted by the
development of software tools that simplify access to the Internet's
applications and resources. For example, the Company's NETCOMplete
software provides easy to use point-and-click access to Internet
resources. Navigational tools such as Netscape Navigator and Microsoft
Internet Explorer and search tools from such companies as Excite, Inc.
and InfoSeek, Inc. also help users access information from
the Internet.
- Continuing penetration of computers and modems: An increasing
percentage of computer owners also own modems, which are now
pre-installed in most new computers. In addition, it is estimated that
approximately 83% of individual professionals working at home, and 77%
of small businesses are not currently on-line.
The NETCOM Solution
Currently, a significant portion of the Company's revenues are from
Internet access. The Company's Internet access is provided primarily through two
types of services (dial-up and dedicated connections).
Dial-Up Accounts: The Company's NETCOMplete customers receive an integrated
solution comprised of front-end software, high quality access service and 24
hour seven days a week automated customer support. NETCOMplete software is
preconfigured with TCP/IP communications software that is customized for
NETCOM's service, thus eliminating the need for complex setup procedures.
NETCOMplete, uses a Windows and Macintosh based graphical user interface making
it an easy-to-use, point-and-click tool. NETCOMplete provides a direct
connection to the Internet through CSlip or PPP connection and
Winsock-compatibility combined with either Netscape Navigator or Microsoft
Internet Explorer. By following a sequence of simple on-screen steps after
installing a NETCOMplete CD or diskette, customers can quickly register with
NETCOM, obtain an Internet E-mail address, and establish automatic billing to
the customer's credit card. NETCOMplete allows access to the Internet's
resources, including E-mail, the World Wide Web and USENET news groups. In
addition to providing phone support, the Company has invested in technology
solutions such as an on-line technical knowledge base and fax-on-demand in order
to provide prompt customer assistance. NETCOMplete is currently available to
customers for $19.95 a month.
Network and other Business Accounts: NETCOM offers network accounts to
provide Internet services including Web site creation and hosting, high-speed
dedicated connections, and Intranet programs to businesses. The Internet
services offered to businesses are at various speeds, including 14.4 Kbps, 28.8
Kbps, 56 Kbps, T1, and T3 levels, depending on the customer's needs. There are
currently no usage charges for any of NETCOM's dedicated accounts, and E-mail
service and USENET news feed are provided at no additional charge. Network
connections for the 56 Kbps and above services require the customer to obtain a
leased line from a local telephone company. In addition, NETCOM also offers a
FrameConnect service, which provides an Internet connection based on frame relay
technology provided by local telephone carriers. The Company's high-speed
digital network provides subscribers with direct access to the full range of
Internet applications. Employing the protocol of the Internet, TCP/IP, the
network is made up of regional hubs, ATM switches and network control centers
connecting fiber-optic T3 and T1 lines. As of December 31, 1996, the Company had
approximately 5,000 network, hosting and other business accounts.
NETCOM provides its customers with access to the full range of available
Internet applications, including:
Electronic Mail: E-mail is an Internet application by which an Internet
user can exchange messages with any other user who has an E-mail address.
Messages can be sent almost instantly to designated individuals or groups on a
mailing list. Additionally, NETCOMplete allows users to attach application files
such as spreadsheets or word processing documents to E-mail messages and
provides an address book that stores E-mail addresses.
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World Wide Web: The World Wide Web is a browsing and searching system
comprised of thousands of computer servers, referred to as web sites, each
linked by a special communications protocol called hypertext transfer protocol
(http) and hypertext Markup Language. This open protocol allows Internet users
to view and access text, graphics, digital video and audio resident on a web
page or to connect instantaneously to related and linked information on the same
server or other web pages on other servers. Since the Internet is an open
system, any company can create a home page on the World Wide Web in order to
provide users with product or service information. Users can then solicit more
information and, in some cases, make purchases electronically. Browsers such as
Netscape Navigator and Microsoft Internet Explorer have contributed to the rapid
growth of the World Wide Web. The Company expects the World Wide Web to continue
to grow rapidly as more businesses and consumers become aware of the advantages
of communications on the Internet.
Databases and Public Domain Software: An increasing number of host
computers are being connected to the Internet, which make available growing
amounts of text, graphics, audio and video information and public domain
software. For example, with an Internet connection, a user can access
commercial, educational and government databases, newspapers, magazines, library
catalogs, industry newsletters, weather updates and other information.
File Transfer: The Internet can be used to move electronic files (including
data, programs or text) easily from one computer to another. This can be very
useful for parties in separate locations that collaborate on data files. Data
transferred over the Internet remains in digital format and does not need to be
re-entered by a receiving party; it can be manipulated and then re-transmitted
to other Internet users.
USENET News Groups: USENET is a network of thousands of computers attached
to the Internet that provide forums, or news groups, that allow users to
exchange information on a variety of topics of shared interest. Internet users
can seek or provide information on diverse topics ranging from sports, to job
opportunities, to restaurant and travel suggestions.
In 1997, NETCOM intends to address the needs of business and individual
customers through three product categories:
Personal Productivity Solutions: Personal Productivity Solutions include
both stand alone and packaged solutions that address customer needs in the areas
of office and business services. These solutions include both third party
products and NETCOM bundled products. In 1997, the Company intends to launch
application solutions designed to provide customers with a set of solutions to
help them communicate more efficiently and to make their computer more
effective. Beginning in April 1997, NETCOMplete Advantage will be available to
new customers for $24.95 per month with a $25.00 set-up fee. Current customers
can choose to upgrade to the new services or keep their current plan.
NETCOMplete Advantage features access at 28.8 Kbps and the NETCOMplete
Connection Kit, which installs and configures all the software needed to connect
and communicate on the Internet, including either Netscape Navigator or
Microsoft Internet Explorer, as the standard browser. NETCOMplete Advantage
includes tools such as one additional mailbox, a PersonalPage with 1MB of
storage, customizable PersonalNews, PersonalFinance and SurfWatch blocking
software. Additional features includes protection from viruses with McAfee
WebScan, support for point-to-point and broadcast faxes with NetCentric,
worldwide on-line access with Global Roaming for an additional fee and mail
forwarding functionality. The Company believes there is significant market
interest in higher levels of access and customer service combined with enhanced
capabilities and services. The Company plans to offer additional services geared
at providing premium support levels, protection from computer crashes and
viruses and support for research over the Internet.
Web Hosting Solutions: Web Hosting Solutions include client domain name
registration, hosting and site maintenance. Business Web Hosting service is
available beginning at $125 per month with a one-time set-up fee of $150.
Services received includes domain name service, 10 E-mail addresses, access to
NETCOM's on-line Business Center, CGI scripting, weekly back-up service, 50 MB
of data storage, 1000 Mb/month of data transfers, traffic logs and web site
statistics and premium support. Additional NETCOM hosting services will be
rolled out during 1997 which in addition to web site hosting, the new services
will include the Company's enhanced on-line service, NETCOMplete Advantage, and
enable customers to register domain names and web sites on-line.
Business Connectivity Solutions: Business Connectivity Solutions include
Desktop software, speed (from 28.8 Kbps dial-up to dedicated T3 connections),
redundancy, reliability, security products and customer support. The Company
believes that high speed access solutions will command premium pricing and
should increase the Company's average revenue per customer. Additionally, the
Company plans to bundle additional services with connectivity products and to
enhance hardware product offerings through relationships with companies such as
iPlanet, Inc. and Whistle Communications Corporation. The Company plans to offer
three Internet connectivity services geared towards small and mid-size
businesses: (1) NETCOM DirectConnect enables the customer to fortify their
connection and ensure optimal network performance. The NETCOM DirectConnect
service solution is built upon NETCOM's dedicated access services and features
Automatic Reconnect which automatically reroutes a customers' traffic to an
alternate ISDN line so customers remain connected. It also features a
password-protected web site with on-line usage statistics so customers can
proactively evaluate network utilization, and Newsserver access. As customers'
business grow, NETCOM will help re-evaluate their needs and provide scaleable
options such as increased line speed or high-performance
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routing. NETCOM DirectConnect is available for $400 a month. It includes
toll-fee, 24 hours a day, 7 days a week support; (2) NETCOM SecureConnect is
built on NETCOM's dedicated access services, includes needs assessments,
maintenance, configuration and monitoring. NETCOM SecureConnect allows secure
communication between branch offices and off-site employees while keeping
internal networks protected. To determine businesses' security requirements,
NETCOM performs a security assessment and then implements a flexible and secure
solution. As part of the package, the Company monitors and troubleshoots
NETCOM SecureConnect. NETCOM SecureConnect features toll-free, 24 hours a day, 7
days a week support. NETCOM SecureConnect is available for a monthly fee between
$400 - $800 depending on the level of security required; (3) NETCOM SiteConnect
connects an internally-managed web site to the Internet using NETCOM's
high-speed, reliable access, from fractional T1 lines to full T3 lines. The
speed of access to the site is determined by the number of expected visits and
is flexible and scaleable to grow as web site traffic increases. The
NETCOM SiteConnect service, built on NETCOM's dedicated access service includes
additional domain name registration, additional IP addresses and Automatic
Reconnect service that automatically reroutes a customers' disabled line to
another networking path so customers' web sites are connected and available at
all times.
NETCOM's emphasis is on developing products and services that differentiate
it from competitors, provide sustainable, profitable recurring revenue, are easy
to use and are desired by sufficiently large market segments.
Software and Services Development
NETCOM has placed significant emphasis on developing its products and
services, both internally and through third party partnerships. NETCOM's newest
software package, NETCOMplete features NETCOM's versions of leading products
including Microsoft Internet Explorer or Netscape Navigator 3.0, Qualcomm Eudora
Pro and Eudora Light, McAfee Webscan, SurfWatch Software and Service, VocalTec
Internet Phone and Internet Phone Lite, NETCOM Unplugged by WebEx, NETCOM
Unplugged Lite, Storm EasyPhoto, Macromedia Shockwave, Adobe Acrobat Reader,
OnBase DragNet and DragNet Lite, NCSA Telnet. Quarterdeck Global Chat, IBM
Cryptolope, Microsoft NetMeeting, Internet Mail, Internet News and Comic Chat.
In 1994, NetCruiser 1.6 was developed which introduced Winsock compliance,
automatic modem detection and support for audio, E-mail attachments and
printing. NetCruiser 2.0, which the Company released in August 1995, introduced
an improved easy-to-use interface, including an index of and direct links to
World Wide Web sites. The Company intends to design additional features into
future versions of NETCOMplete and additional products. Additionally, the
Company will continue to enhance the ease of installation and automatic
configuration of its products.
NETCOM's Product Development activities began in late 1993. Product
Development expenditures were $6,020,000 $2,240,000 and $328,000 in 1996, 1995
and 1994, respectively.
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Telecommunications Infrastructure
The Company maintains an extensive telecommunications infrastructure that
enables it to provide nationwide digital Internet connectivity services to its
subscribers. The Company's worldwide network of local access numbers gives
subscribers in those areas access to the Internet by means of a dedicated line
or local telephone call. NETCOM's ability to offer efficient worldwide access to
the Internet is due in part to the Company's high-capacity telecommunications
data network, configured exclusively for facilitating Internet access. The
Company's United States network is comprised of a fiber optic T-3, 45Mbps
backbone together with other high-speed data connections between the T-3
backbone and the Company's local access numbers. The T-3 backbone connects to
Internet gateways in Santa Clara (at two sites), California; San Jose,
California; Newark, New Jersey; Chicago, Illinois and in Washington, D.C. In
addition, the Company has Internet gateways in London, United Kingdom and
Toronto, Canada.
NETCOM maintains two telecommunications centers in the U.S. One at its San
Jose, California headquarters and the other in Dallas, Texas. Through these
centers the Company's technical staff constantly monitors network utilization
and security, including equipment at individual local access numbers, to ensure
reliable Internet connectivity service. The San Jose center also supports the
Company's Shell accounts, E-mail and USENET news groups for NETCOM's subscribers
nationwide. The Dallas center reduces the Company's dependence on its San Jose
Facilities. However, this measure will not eliminate the significant risk to the
Company's operations from a natural disaster or other unanticipated event at one
of these two sites. See "Risk Factors -- Dependence on Network Infrastructure;
Risk of System Failure; Security Risks." Internationally, the Company has
telecommunications centers in London, United Kingdom and Toronto, Canada.
The Company is continuing to optimize and increase the capacity and
capabilities of its telecommunications network. NETCOM continues to add ATM
switches (Asynchronous Transfer Mode), and plans to continue increasing capacity
as the customer base increases. Additionally, the Company has efforts currently
underway to increase the available dial-up speeds. As of December 31, 1996, the
Company had local access numbers in a total of 331 locations, including 80 in
the United Kingdom and 22 in Canada, as described on the following pages.
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<TABLE>
<S> <C> <C> <C> <C>
Alabama Colorado Indiana New Jersey Pennsylvania
Birmingham Colorado Springs Bloomington Atlantic City Allentown
Huntsville Denver Ft. Wayne Cherry Hill Harrisburg
Arkansas Ft. Collins Indianapolis Eatontown Philadelphia
Little Rock Connecticut Kansas Hackensack Pittsburgh
Arizona Danbury Kansas City Jersey City Reading
Phoenix Hartford Topeka Morristown Valley Forge
Tucson New Haven Wichita New Brunswick Wilkes Barre
California Stamford Kentucky Newark Rhode Island
Alameda Delaware Lexington Paterson/Pessiac Providence
Antioch Wilmington Louisville Pennington South Carolina
Bakersfield District of Columbia Louisiana Princeton Charleston
Benecia/Vallejo Washington Baton Rouge Trenton Columbia
Corona Florida New Orleans Westfield Greenville
Del Mar Boca Raton Maryland New Mexico Tennessee
Escondido Clearwater/St. Pete Baltimore Albuquerque Chattanooga
Fairfield Cocoa Columbia Santa Fe Knoxville
Fremont Daytona Beach Frederick New York Memphis
Fresno Deland Rockville Albany Nashville
Hayward Fort Walton Beach Massachusetts Binghamton Texas
Hollister Ft. Lauderdale Amherst Buffalo Austin
Irvine/Santa Anna Ft. Meyers Boston Garden City/Long Is/Mineola Bryan
La Puente/Covina Gainesville Framingham New York City Dallas
Long Beach Jacksonville Lawrence Poughkeepsie El Paso
Los Angeles Miami Lowell Rochester/Webster Ft. Worth
Mission Viejo Orlando Springfield Ronkonkoma/Holbrook Harlingen
Modesto Pensacola Taunton Syracuse/Liverpool Houston
Monterey Sarasota Wellesley Utica/Rome San Antonio
Morgan Hill Tallahassee Worcester White Plains Utah
Napa Tampa Michigan North Carolina Ogden
Ontario West Palm Beach Ann Arbor Charlotte Orem
Palm Springs Georgia Detroit Raleigh/RTP/Durham Salt Lake City
Palo Alto Athens Grand Rapids Wilmington Virginia
Pasadena Atlanta Kalamazoo Winston/Salem Leesburg
Petaluma Augusta East Lansing Ohio Norfolk
Pleasanton Macon Pontiac Akron Richmond
Sacramento Savannah Warren Cincinnati Roanoke
Salinas Idaho Minnesota Cleveland Vienna
San Bernardino Boise Minneapolis Columbus Woodbridge
San Diego Illinois Rochester Dayton Washington
San Francisco/Daly City Alsip Missouri Elyria Everett
San Jose Aurora Springfield Hamilton Kennewick
San Luis Obispo Champaign St. Louis Toledo Olympia/Lacey
San Mateo Chicago Nebraska Youngstown Seattle
San Rafael Chicago/Downtown Lincoln Oklahoma Silverdale
Santa Barbara Joliet Omaha Oklahoma City Spokane
Santa Clarita Moline Nevada Tulsa Tacoma
Santa Cruz Oakbrook/Dwnrs Grv Las Vegas Oregon Vancouver
Santa Maria Palatine/N. Chicago Reno Eugene West Virginia
Santa Rosa Peoria New Hampshire Portland/Beaverton Martinsburg
Stockton Rockford Manchester Salem Wisconsin
Temecula Waukegan Nashua Appleton/Gbay
Thousand Oaks Iowa Portsmouth Kenosha
Ventura Des Moines Madison
Victorville Milwaukee
Walnut Creek
Woodland
Woodland Hills
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Canada United Kingdom Doncaster Leeds Pitlochry
Brantford Alford Dunnon Leicester Pontypridd
Cornwall Appleby Duns Liverpool Preston
Calgary Ayr Durham Lochgilphead Rangeworthy
Edmonton Bellingham Edinburgh London Reading
Georgetown Berwick on tweed Evesham Manchester Ripon
Halifax Birmingham Frodsham Markyate Rothbury
Hamilton Boroughbridge Glasgow Martin Scunthorpe
Kitchener Bourton on the water Glastonbury Matlock Settle
London Brechin Gloucester Mertsham Sheffield
Milton Brecon Great Shefford Moffat Shepton Mallet
Montreal Bridgewater Halifax Monmouth Stirling
Newmarket Bridgnorth Hawkshead Nettlebed Tobermory
Oshawa Bristol Hexham New Galloway Weedon
Ottawa Brodick Hitchin New Luce Wellingborough
St. Catherine's Bromyard Killin Newark Wetherby
Stratford Burntwood Killingholme Newcastle Wolverhampton
Toronto Cardiff Kinloch Rannoch Nottingham Workington
Vancouver Carlisle Ladybank Oakham
Victoria Congleton Lanark Oban
Windsor Coventry Lancaster Peebles
Winnipeg
Woodstock
</TABLE>
Competition
The market for Internet services is competitive. There are few barriers to
entry, and the Company expects that competition will continue to intensify in
the future. 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. Since the Internet
service industry emerged, the number of competitors has grown to over 3,000 in
the U.S. alone. The Company competes or expects to compete directly or
indirectly with the following categories of companies: (1) other national
commercial Internet services providers, such as Performance Systems
International, Inc. and Bolt, Beranek & Newman, Inc., (2) established on-line
services companies which offer Internet connectivity, such as America Online
("AOL"), CompuServe Inc., Prodigy Services Company and Microsoft Network, (3)
national long distance carriers such as American Telephone and Telegraph Company
("AT&T"), MCI Communications Corporation, Sprint Corporation and
Worldcomm/MFS/UUNet Technologies, (4) regional telephone companies, such as
Pacific Bell and Bell Atlantic, (5) cable operators, such as
Tele-Communications, Inc., Time Warner and Cox Communications, and (6) other
local and regional ISPs.
The Company believes that its ability to compete successfully in the market
for Internet services 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; the Company's ability to support existing and emerging industry
standards; and industry and general economic trends.
Increased competition could result in significant reductions in the average
revenue per customer of the Company's services. In addition, increased pressure
to obtain and retain additional higher revenue subscribers could result in
increased sales and marketing expenses and related subscriber acquisition costs,
which could materially adversely affect the Company's profitability. See "Risk
Factors -- Competition."
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Marketing and Distribution
The Company's primary focus is on providing high quality Internet solutions
to businesses and individuals. In order to achieve this objective, the Company
engages in marketing and advertising activities, alliances with key strategic
partners, seminars in targeted regional markets, and distribution via both
direct and indirect channels. The Company's current marketing efforts emphasize
its strategy of focusing on providing premium services to businesses and
individuals through integrated product offerings. The campaign incorporates the
theme of productivity and efficiency and includes an emphasis on the full range
of NETCOM solutions. The Company's current distribution channels include the
following:
OEM: Original equipment manufacturer ("OEM") arrangements with computer,
hardware, software and modem manufacturers account for a significant portion of
the Company's new accounts. The Company's CPU OEM partners include Hewlett
Packard Company, Acer America Corporation, and NEC Corporation. The Company has
also entered into a number of bundling arrangements with software companies,
including Netscape and Microsoft. Partnerships with modem manufacturers such as
US Robotics Corporation and Global Village Communication, Inc. account for a
significant portion of OEM activity. New agreements with companies such as Cisco
Systems, Inc. and Farallon Communications, Inc. will be increasingly focused on
website hosting and dedicated access.
VAR: As NETCOM increases its focus on providing solutions to small and
medium business segments, the Value Added Resellers ("VAR") who support this
segment will become an increasingly active channel of distribution, selling the
entire suite of NETCOM products. The network of NETCOM VARs are supported by
NETCOM sales representatives both in the regional territories and in the
Telesales center.
Retail: A significant portion of the Company's new accounts is generated
through retail distribution of NETCOMplete CDs, which currently are offered in
two versions. One is offered at a suggested retail price of $4.95; the other is
a larger package featuring extensive third party software and books for a
suggested retail price of $39.95. NETCOM's retail partners include national
chains such as CompUSA, Circuit City, and Computer City, as well as regional
entities such as Fry's Electronics. NETCOM distributes to Retail partners
through national distributors such as Ingram Micro and TechData, and through
regional distributors such as Liuski International. Retail coverage is also
provided via the OEM agreements detailed above.
Direct Sales: A significant portion of NETCOM's business is conducted
through inbound and outbound Telesales efforts. Telesales supports business
generated by direct marketing activities, trade shows and referrals, and is
aligned to support the focus on targeted regional markets.
Customer Support
The Company believes that it is important to provide prompt and effective
assistance to its subscribers. The Company provides network monitoring and
technical assistance services 24 hours a day, seven days a week. Most support
personnel respond to telephone inquiries and inquiries from E-mail, faxes and
letters. There are also a significant number of personnel dedicated to building
automated support systems such as on-line knowledgebases, fax-on-demand systems,
and interactive voice response systems that allow customers to get the
information they need at any time. The demands on the Company's customer support
resources have increased with the Company's rapidly expanding subscriber base,
and NETCOM has from time to time experienced difficulties in providing adequate
levels of support. NETCOM is continually taking steps to help ensure that
customer support resources keep pace with projected increases in subscribers.
During 1996, the Company increased its number of worldwide customer support
staff by 164 to 288 on December 31, 1996 from 124 on December 31, 1995. NETCOM
also implemented automated support services such as the WebTech Online
Knowledgebase, the SupportFacts fax-on-demand system, and an Interactive Voice
Response system, which significantly increased the support group's capacity to
handle queries and improve customer satisfaction. The Company intends to
continue to improve its customer support capabilities in order to keep pace with
expansion of the Company's subscriber base, however, there can be no assurance
that the Company's resources will be successful in doing so. See "Risk Factors
- -- Management of Growth; Dependence on Key Personnel and New Hires."
11
<PAGE>
Intellectual Property and Other Proprietary Rights
The Company relies on a combination of worldwide copyright and trademark
laws, trade secrets, software security measures, license agreements and
nondisclosure agreements to protect its proprietary technology and software
products. The Company currently has no domestic or foreign patents or patent
applications pending. However, the Company does have registered or pending
trademarks in various countries including the U.S. The Company from time to
time receives notices claiming that it is infringing the proprietary rights of
third parties. Any such claims could be time-consuming, result in costly
litigation, cause product shipment delays or lead the Company to enter into
royalty or licensing agreements rather than disputing the merits of such claims.
For a more extensive discussion on Intellectual Property and Proprietary Rights,
see "Risk Factors -- Limited Intellectual Property Protection."
Employees
As of December 31, 1996, NETCOM employed 759 persons, including 163 in
operations, 288 in customer support, 162 in marketing and distribution, 110 in
general and administration and 36 in website and software integration, all of
whom are full-time employees. None of NETCOM's employees are represented by a
labor union and NETCOM considers its employee relations to be good.
12
<PAGE>
<TABLE>
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
(in thousands, except loss per share and other operating data)
ANNUAL
<CAPTION>
Year Ended December 31,
---------------------------------------------
1996 1995 1994
-------------- ------------- ------------
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues $ 120,540 $ 52,422 $ 12,359
Loss from operations $ (48,723) $ (16,246) $ (105)
Net loss $ (44,265) $ (14,064) $ (100)
Net loss per share $ (3.85) $ (1.68) $ (0.02)
Shares used in computing net loss per share 11,498 8,350 5,927
As of December 31,
---------------------------------------------
BALANCE SHEET DATA: 1996 1995 1994
-------------- ------------- ------------
Cash and cash equivalents $ 73,408 $ 146,001 $ 20,938
Working capital 53,646 $ 131,917 $ 15,551
Total assets 169,634 $ 202,680 $ 35,649
Stockholders' equity 144,791 $ 185,466 $ 27,964
OTHER OPERATING DATA (Unaudited):
EBITDA (A)
Domestic $ (5,091,000) $(5,815,000) $1,096,000
International $(15,206,000) $ (486,000) $ -
Approximate Number of subscribers 580,000 308,000 $ 73,000
(A) Earnings before interest, taxes, depreciation and amortization
("EBITDA") is not intended to represent cash flow from operations and
should not be considered as an alternative to net loss as an indicator
of the Company's operating performance or to cash flows as a measure of
liquidity. The Company believes EBITDA is a measure used by analysts,
investors and other interested parties in the on-line and Internet
services industries. Accordingly, this information has been disclosed
herein to permit a more complete analysis of the Company's operating
performance.
</TABLE>
<TABLE>
QUARTERLY (Unaudited)
<CAPTION>
1996 1995 (B)
---------------------------------------------- ---------------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
- -------------------------------------------------- ---------- ----------- ------------ ---------- ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues $ 36,379 $ 32,036 $ 28,023 $ 24,102 $ 19,672 $ 14,724 $ 10,528 $ 7,498
Loss from operations $ (12,554) $ (14,923) $ (12,943) $ (8,303) $ (6,494) $ (5,001) $ (3,239) $ (1,512)
Net loss $ (11,490) $ (13,606) $ (12,595) $ (6,574) $ (5,446) $ (4,449) $ (2,878) $ (1,291)
Net loss per share $ (0.99) $ (1.17) $ (1.09) $ (0.59) $ (0.55) $ (0.49) $ (0.37) $ (0.19)
OTHER OPERATING DATA:
Approximate number of subscribers at
end of period 580,000 562,000 479,000 391,000 308,000 233,000 169,000 114,000
(B) Beginning in August 1995, results include the operations of Professional
Internet Consulting, Inc. ("PICnet") which was acquired by the Company
in August 1995.
</TABLE>
13
<PAGE>
Risk Factors
The following factors, in addition to the other information contained
elsewhere herein, should be considered carefully in evaluating the Company and
its business.
Operating Losses; Fluctuations in Operating Results. Although the Company
has experienced revenue growth in each of its fiscal quarters since
incorporation, it experienced net losses of $100,000 for 1994, $14,064,000 for
1995 and $44,265,000 for 1996, and had an accumulated deficit of $62,042,000 as
of December 31, 1996. The consolidated net loss incurred during 1996 included a
loss of $17,706,000, which includes amounts spent domestically, related to the
start up of international operations.
These losses are also reflected in the Company's declining operating
margins, which decreased from a loss of .8% for 1994 to a loss of 31% for 1995
and a loss of 40% for 1996. The 1996 margins include the expenses related to
start up operations in two countries which had negligible revenue thus
decreasing margins. The Company's current focus is on targeting the business
customer (individuals and groups) which should result in increased revenues per
subscriber and at reduced subscriber growth rates. The Company will continue to
grow its expenses related to product development, marketing, sales, general and
administrative, network, and customer support. In addition, the Company is
seeking to expand its operations to international markets with partners in
select markets. The costs associated with the penetration of new international
markets where Internet services are not well established, could further impact
cash flow and operating performance. As a result, the Company expects that it
may incur substantial losses in 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.
Changes in the Company's subscriber base or in subscribers usage patterns
may increase costs as a percentage of revenues. These changes 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 demands for its 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.
In view of the competitive nature of its market, the Company has adopted
strategies designed to attract the business customer. Such strategies, and any
promotional measures the Company may adopt in the future in pursuit of these
strategies, may result in an increase in costs as a percentage of revenues. 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 these factors or 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 its 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.
Competition. The market for Internet services is increasingly competitive
and there are few barriers to entry. 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.
14
<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 other national and regional
commercial Internet services providers, with established on-line services
companies which offer Internet connectivity, with national long distance
carriers, with regional telephone companies with cable operators and with other
local and regional ISPs.
Increased competition in general could result in significant reductions in
the average selling price of the Company's services. In addition, the Company
expects to see increased pressure to obtain and retain additional subscribers
that 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 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 financial resources, technical resources, technical expertise or marketing
and support capabilities to continue to compete successfully.
Management of Growth; Dependence on Key Personnel and New Hires. The
Company has in the past and may in the future experience a strain on its
management, operations and financial resources as a result of the Company's
growth. The Company's ability to effectively manage growth will require it to
continue to implement and improve its operational, financial and management
information systems and to train, motivate and manage its employees, as well as
to expand its existing local access numbers. These demands will require the
addition of new management personnel and the development of additional expertise
by existing management. In particular, the demands on the Company's
telecommunications infrastructure and customer support resources have grown
rapidly with the Company's rapidly expanding subscriber base, and NETCOM has
from time to time experienced difficulties meeting the demand for its
connectivity services. Capacity constraints have occurred, and may in the future
occur, both at the level of particular local access numbers and in connection
with system-wide services that are provided from the Company's facilities in San
Jose, California and Dallas, Texas. The Company has experienced difficulties in
providing an adequate level of customer service and support. NETCOM is taking
steps to improve its telecommunications infrastructure and customer support
resources in order to support increases in the service to and the number of
subscribers. A failure to enhance customer support resources adequately to
support increases in subscribers, or to adequately expand and enhance its
telecommunications infrastructure, may materially adversely affect the Company's
business, operating results and financial condition. There can be no assurance
that the Company's customer support or other resources will be sufficient to
manage any future growth in the Company's business or that the Company will be
able to implement in whole or in part its expansion program, and any failure to
do so could have a material adverse effect on the Company's business, operating
results and financial condition.
Although the Company continues to invest significant resources in its
telecommunications infrastructure and customer support resources, the Company
continues to experience attrition of its subscribers over time as a result of a
number of factors, including difficulties associated with management of growth.
There can be no assurance that the Company will be able to improve its ability
to retain its subscribers or to attract sufficient new subscribers to offset
periodic losses of existing subscribers.
The Company's significant growth in its number of employees, the scope of
its operations and the geographic area of its operations has resulted in broader
responsibilities and challenges for the Company's management. There can be no
assurances that financial and operational issues that exceed the capacity of the
current financial and information management staff and systems will not arise.
The Company's success will depend to a significant extent on its ability to
retain existing key members of management and to attract additional qualified
financial, information systems and other management and the ability of its
executive officers to operate effectively, both independently and as a group.
Competition for such management and other personnel is intense. There can be no
assurance that the Company will be successful in attracting and retaining such
personnel, and the failure to do so could have a material adverse effect on the
Company's business, operating results and financial condition.
15
<PAGE>
Dependence on WorldCom and Other Suppliers. The Company relies on other
companies, particularly WorldCom, to provide data communications capacity via
leased telecommunications lines. A majority of the leased telecommunications
lines used by the Company are currently provided by WorldCom. If WorldCom is
unable or unwilling to provide or expand its current levels of service to the
Company in the future, the Company's operations would be materially adversely
affected. WorldCom is also a competitor to NETCOM. Although leased
telecommunications lines are available from several alternative suppliers,
including AT&T, MCI and Sprint, there can be no assurance that the Company could
obtain substitute services from other providers at reasonable or comparable
prices or in a timely fashion. The Company is also subject to risks relating to
potential disruptions in WorldCom's services, and no assurances can be given
that such interruptions will not occur in the future.
The Company is also dependent on certain third party suppliers of hardware
components. Although the Company attempts to maintain a minimum of two vendors
for each required product, certain components used by the Company in providing
its networking services are currently acquired from only one source, including
high performance routers manufactured by Cisco Systems, Inc., modems
manufactured by U.S. Robotics, Inc. and servers from Sun Microsystems. The
Company has also from time to time experienced delays in the receipt of certain
hardware components. A failure by a supplier to deliver quality products on a
timely basis, or the inability to develop alternative sources if and as
required, could result in delays that could materially adversely affect the
Company's business, operating results and financial condition.
Software and Service Development; Technological Change. The Company's
success is highly dependent upon its ability to develop new software and
services that meet changing customer requirements. The market for the Company's
services is characterized by rapidly changing technology, evolving industry
standards, emerging competition and frequent new software and service
introductions. There can be no assurance that the Company can successfully
identify new service opportunities and develop and bring new software and
services to market in a timely manner, or that software, services or
technologies developed by others will not render the Company's software,
services or technologies noncompetitive or obsolete. The Company is also at risk
to fundamental changes in the way Internet access services are delivered.
Required technological advances by the Company as the industry evolves could
include compression, full-motion video, and integration of video, voice, data
and graphics. The Company's pursuit of these technological advances may require
substantial time and expense, and there can be no assurance that the Company
will succeed in adapting its Internet service business to alternate access
devices and conduits.
Dependence on Network Infrastructure; Risk of System Failure; Security
Risks. The future success of the Company's business will depend upon the
capacity, reliability and security of its network infrastructure. The Company
has in the past experienced network problems and network slowdowns due to
limited server capacity in the Company's San Jose and Dallas Data Centers. The
Company is currently implementing systems and processes in order to improve
these problems and improve the Company's service generally. The Company must
continue to expand and adapt its network infrastructure as the number of users
and the amount of information they wish to transfer increases, and to meet
changing customer requirements. The expansion and adaptation of the Company's
network infrastructure will require substantial financial, operational and
management resources. There can be no assurance that the Company will be able to
expand or adapt its network infrastructure to meet additional demand or its
changing customer requirements on a timely basis, at a commercially reasonable
cost, or at all, or that the Company will be able to deploy successfully the
contemplated network expansion. Any failure of the Company to expand its network
infrastructure on a timely basis or to adapt it to changing customer
requirements or evolving industry standards could have a material adverse effect
on the Company's business, operating results and financial condition and results
of operations.
The Company's operations are dependent on its ability to protect its
computer equipment against damage from fire, earthquakes, power loss,
telecommunications failures and similar events. A significant portion of the
Company's computer equipment, including all of the Company's equipment devoted
to its Shell accounts, E-mail and news group services, is located at its
facilities in San Jose, California and Dallas, Texas and is subject to
significant risk to the Company's operations from a natural disaster or other
unanticipated event at one of these two sites. Any damage or failure that causes
interruptions in the Company's operations could have a material adverse effect
on the Company's business.
Despite the implementation of security measures, the Company's
infrastructure is also vulnerable to computer viruses or similar disruptive
problems caused by its customers or other Internet users. Computer viruses or
problems caused by third parties could lead to interruptions, delays or
cessation in service to the Company's customers. Furthermore, inappropriate use
of the Internet by third parties could also potentially jeopardize the security
of confidential information stored in the computer systems of the Company's
customers, which may deter certain persons from subscribing to the Company's
services.
16
<PAGE>
Dependence on Distribution and Marketing Relationships. The Company
believes that its success in penetrating markets for its Internet connectivity
services depends in large part on its ability to maintain and develop additional
relationships with leading companies that market computer products and to
cultivate alternative relationships if distribution channels change. The Company
has entered into OEM, VAR and other agreements with a number of such companies.
Many of these agreements are nonexclusive, and many of the companies with which
the Company has agreements also have similar agreements with the Company's
competitors or potential competitors. If certain of these relationships were
discontinued or renegotiated in a manner adverse to the Company, it could have a
material adverse effect on the Company. There can be no assurance that the
Company's distributors and OEM and VAR partners, many of which have
significantly greater financial and marketing resources than the Company, will
not develop and market products in competition with the Company in the future,
discontinue their relationships with the Company or form additional competing
arrangements with the Company's competitors.
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. 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 and revenue growth, the Company
must continue to 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 the Company's ability to retain its
subscribers. As a result, the Company is unable to predict future subscriber
retention rates.
Limited Intellectual Property Protection. The Company relies on a
combination of copyright and trademark laws, trade secrets, software security
measures, license agreements and nondisclosure agreements to protect its
proprietary technology and software products. The Company currently has no
domestic or foreign patents or patent applications pending. Despite the
Company's precautions, it may be possible for unauthorized third parties to
lawfully or unlawfully copy aspects of, or otherwise obtain and use, the
Company's software products and technology. In addition, the Company cannot be
certain that others will not develop substantially equivalent or superseding
proprietary technology, or that equivalent products will not be marketed in
competition with the Company's products, thereby substantially reducing the
value of the Company's proprietary rights.
From time to time the Company has received notices claiming that it is
infringing the proprietary rights of third parties, and there can be no
assurance that the Company will not become the subject of infringement claims or
legal proceedings by third parties with respect to current or future products.
In addition, the Company may initiate claims or litigation against third parties
for infringement of the Company's proprietary rights or to establish the
validity of the Company's proprietary rights. Any such claims could be
time-consuming, result in costly litigation, cause product shipment delays or
lead the Company to enter into royalty or licensing agreements rather than
disputing the merits of such claims. Moreover, an adverse outcome in litigation
or similar adversarial proceedings could subject the Company to significant
liabilities to third parties, require expenditure of significant resources to
develop noninfringing technology, require disputed rights to be licensed from
others or require the Company to cease the marketing or use of certain products,
any of which could have a material adverse effect on the Company's business,
operating results and financial condition.
To the extent the Company wishes or is required to obtain licenses to
patents or proprietary rights of others, there can be no assurance that any such
licenses will be made available on terms acceptable to the Company, if at all.
As the number of software products in the industry increases and the
functionality of these products further overlaps, the Company believes that
software developers may become increasingly subject to infringement claims. Any
such claims against the Company, with or without merit, as well as claims
initiated by the Company against third parties, can be time-consuming and
expensive to defend or prosecute and to resolve.
17
<PAGE>
Government Regulation. The Company is not currently subject to direct
regulation by the Federal Communications Commission ("FCC") or any other agency
other than regulations applicable to businesses generally; however, see
"Business--Risk Factors - Potential Liability for Content," below. Changes in
the regulatory environment relating to the Internet connectivity industry,
including regulatory changes which directly or indirectly affect
telecommunication costs or increase the likelihood or scope of competition from
regional telephone companies or others, could have an adverse effect on the
Company's business. For example, the Company is aware that certain third parties
have petitioned the FCC to require certain Internet access providers to pay
"access charges." The Company cannot predict the impact, if any, that future
regulation or regulatory changes may have on its business.
Potential Liability for Content. The Telecommunications Reform Act of 1996
(the "Act") imposes criminal penalties on anyone who distributes obscene,
lascivious or indecent communications on the Internet. The constitutionality of
portions of the Act is being challenged in litigation pending before the United
States Supreme Court. The portion of the Act prohibiting dissemination of
obscene, lascivious or indecent communications is presently enjoined pending the
outcome of the lawsuit. As an access provider, the Company may be at risk of
prosecution under the Act for communications made by others through its systems.
Such prosecution could have a material adverse effect on the Company's business,
results of operations or financial condition. In addition, the applicability to
the Internet of existing laws governing issues such as property ownership, libel
and privacy is uncertain. For example, in 1996 the Company settled a lawsuit
alleging copyright infringement against the Company relating to electronic
messages posted by an unrelated individual to a bulletin board service which is
a subscriber. New legislation or regulation with respect to on-line content
could have a material adverse effect on the Company's business, results of
operations or financial condition.
Volatility of Stock Price. The market price of the Company's common stock
has been and is expected to continue to be subject to significant fluctuations
in response to number of subscribers, announcements of technological
innovations, new products or new services by the Company or its competitors,
quarter-to-quarter variations in the Company's operating results and other
events or factors. For example, a shortfall in revenue, or number of
subscribers, or an increase in losses from levels expected by securities
analysts could have an immediate and significant adverse effect on the market
price of the Company's common stock. In addition, the stock market in recent
years has experienced extreme price and volume fluctuations that have
particularly affected the market prices of many high technology companies and
that have often been unrelated or disproportionate to the operating performance
of companies. These fluctuations, as well as general economic and market
conditions and the adverse performance of companies within the Internet market
segment, may adversely affect the market price of the common stock.
ITEM 2. DESCRIPTION OF PROPERTY
NETCOM's executive offices and telecommunications centers are located in
San Jose, California, where the Company currently leases approximately 193,000
square feet under various leases in three buildings that expire during various
months in 1999. In addition, the Company leases approximately 50,800 square feet
in Dallas, Texas for its second telecommunications center. The Company also
leases space (typically less than 500 square feet) in various geographic
locations to house the telecommunications equipment for each of its local access
numbers. The Company's Canadian subsidiary leases approximately 14,500 square
feet in Toronto, Canada. The Toronto lease expires in December 2000. The
Company's United Kingdom subsidiary leases approximately 22,800 square feet in
Bracknell, United Kingdom. The United Kingdom lease expires in March 2014.
ITEM 3. LEGAL PROCEEDINGS
The Company is from time to time involved in litigation in the course of
its business. The Company is currently involved in certain litigation and
potential claims which management believes, based on facts presently known, will
not have a material adverse effect on the Company's business, operating results
or financial condition. In addition, from time to time the Company receives
notices claiming that it is infringing the proprietary rights of third parties,
and there can be no assurance that the Company will not become the subject of
infringement claims or legal proceedings with third parties with respect to
current or future products. See "Business - Intellectual Property and Other
Proprietary Rights."
18
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
<TABLE>
The Company's executive officers, and their ages as of March 20, 1997, are
as follows:
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
David W. Garrison ................ 41 Chairman of the Board and Chief Executive Officer
Clifton T. Weatherford............ 50 Senior Vice President, Chief Financial Officer and Secretary
Michael D. Kallet................. 43 Senior Vice President, Products and Services
Scott R. Wills.................... 44 Senior Vice President, Marketing and Sales
Eric W. Spivey ................... 36 President, International
Eric V. Goffney .................. 43 Senior Vice President, Customer Support
</TABLE>
Mr. Garrison has served as NETCOM's Chairman of the Board since March 1996
and as its Chief Executive Officer since April 1995. He served as its President
and a Director since February 1995. Mr. Garrison also served as NETCOM's Chief
Operating Officer from February 1995 to April 1995. Currently, Mr. Garrison is
also serving on the Board of Directors of Traveling Software, Inc. From December
1990 to September 1994, Mr. Garrison was President of SkyTel, a division of
Mobile Telecommunications, Inc. ("MTEL"). During his association with MTEL (1990
to 1994), Mr. Garrison also held positions as Senior Vice President and Vice
President. From 1986 to 1990 Mr. Garrison served successively as Chief Operating
Officer, President, Chief Executive Officer and Chairman for Dial Page, a
regional paging carrier based in Greenville, South Carolina. Prior to that, Mr.
Garrison was a Vice President and General Manager for the Providence Journal
Company, a publishing and broadcast holding company based in Providence, Rhode
Island. Mr. Garrison received a bachelor's degree in accounting from Syracuse
University and an M.B.A. from the Harvard Business School.
Mr. Weatherford has served as NETCOM's Senior Vice President and Chief
Financial Officer since January 1996, and as Secretary since March 1996. From
February 1994 to December 1995, Mr. Weatherford was Chief Financial Officer of
Logitech, Inc. From July 1990 to January 1994, Mr. Weatherford was at Tandem
Computers Inc. where he was first Director of Finance and later Chief Financial
Officer of Ungermann Bass. Prior to that, Mr. Weatherford held various positions
at Siliconix, Inc., Applied Materials, Inc., Schlumberger Ltd. and Texas
Instruments, Inc. including assignments in Europe, Asia and the United States.
Mr. Weatherford holds a B.B.A. in finance from the University of Houston.
Mr. Kallet has served as NETCOM's Senior Vice President of Technology,
Operations and Support since August 1996. Serving in the same capacity, in March
1997, his title changed to Senior Vice President, Products and Services. From
December 1995 to August 1996, Mr. Kallet served as NETCOM's Vice President of
Software Engineering. Prior to joining NETCOM, Mr. Kallet was the proprietor of
MK Management Consultants from October 1994 to November 1995. He served as
senior vice president of development for Walker Interactive from December 1993
to October 1994. From April 1992 to September 1993 he was at Verity as Vice
President of R&D. Mr. Kallet was at Software Publishing Company (1988-1992)
where he drove the development of multiple versions of the Harvard Graphics
product line. Mr. Kallet received a bachelor of science degree in physics from
Worcester Polytechnic Institute.
Mr. Wills joined NETCOM in 1996 as general manager of On-Line Services and
since September as Senior Vice President, Marketing and Sales. Prior to joining
the Company, he was at Zing Systems where served as Senior Vice President from
March 1994 to December 1995. From February 1983 to July 1993 Mr. Wills served as
president and CEO of Wills and Evans where he founded and managed an advertising
agency. Mr. Wills holds a bachelor of arts degree from Boston College,
graduating Magna Cum Laude.
Mr. Spivey joined NETCOM in January 1996 as President, NETCOM
International. From September 1993 to December 1995, Mr. Spivey was Vice
President and Chief Executive Officer for Dun & Bradstreet Information Services
in Australia and New Zealand. In this role, he also held management
responsibility for the data center and systems development for the entire
Asia-Pacific and Latin America regions. From June 1991 to August 1993, Mr.
Spivey was the Chief Executive responsible for Dun & Bradstreet's operations in
Mexico and Central America. From early 1990 to May 1991, Mr. Spivey was
Director, Strategic Analysis & Acquisitions for A.C. Nielsen Company,
responsible for worldwide acquisitions and customer and competitive strategic
analysis. From September 1985 to early 1990, Mr. Spivey held a number of key
strategy and acquisition positions at the Corporate and divisional units for the
Dun & Bradstreet Corporation. Mr. Spivey graduated from the University of
California Santa Barbara with a B.A. in Economics and Environmental Studies and
from University of Texas, Austin with an M.B.A.
19
<PAGE>
Mr. Goffney joined NETCOM in September 1995 as Senior Vice President,
Customer Support. From April 1990 to September 1995, Mr. Goffney was Director of
Support Services at Lotus Development Corporation's cc:Mail division. From 1988
to 1990, he served as the Technical Support Manager for Software Publishing
Corporation ("SPC") where he built and managed SPC's technical support call
center. Mr. Goffney's background also includes positions as Technical Support
Manager for Lotus Development Corporation's Information Services Division
(1985-1988), Systems Engineer for Control Data Corporation (1983-1985), and a
five year career with the U.S. Navy. Mr. Goffney received a B.A. in psychology
from Kent State University.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company has never declared or paid cash dividends. The Company's common
stock trades under the symbol "NETC" on the Nasdaq National Market. The
following table sets forth the range of high and low closing sale prices for the
common stock:
<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
1995
First Quarter..................................... $30.00 $22.00
Second Quarter.................................... $27.13 $20.00
Third Quarter..................................... $47.13 $25.63
Fourth Quarter.................................... $82.75 $36.00
1996
First Quarter..................................... $38.00 $20.38
Second Quarter.................................... $44.00 $23.88
Third Quarter..................................... $27.13 $16.00
Fourth Quarter.................................... $18.50 $13.00
On March 20, 1997, there were approximately 11,683,286 holders of record of
the Company's common stock.
</TABLE>
20
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
The Company's revenues are derived from providing high quality Internet
solutions to business and individual customers mainly through monthly dial-up
and dedicated connection fees. Revenues from monthly subscriptions have
increased substantially since the Company's inception as a result of increases
in the Company's subscriber base and diversification of product offerings. This
subscriber growth, in turn, has resulted from the growth of the Internet
services market generally, the expansion of the Company's distribution channels
and the increase in the Company's local access numbers.
The Company believes its NETCOMplete software contributed to its strong
subscriber growth. The versatility of the NETCOMplete software offers customers
an Internet access, with Microsoft Internet Explorer or Netscape Navigator 3.0,
support, software and service solution for Windows 3.1, Windows 95 and
Macintosh. NETCOMplete features point-and-click graphical user interfaces
providing subscribers with easy-to-use access to the Internet's applications and
resources.
The Company has chosen to adopt strategies designed to attract business
customers and grow its subscriber base. To accomplish this objective the Company
is developing partnering relationships to more effectively deliver services to
customers and is also implementing aggressive promotional programs.
Additionally, in order to continue to realize revenue growth, the Company must
increase revenue per customer and expand it's customer base. 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 its
telecommunications infrastructure, customer support capabilities, new services
offerings and software releases will ensure subscriber retention. For more
information on risks facing the Company, see "Risk Factors" on page 14.
Currently, sales to small businesses and individuals represents a majority
of the Company's revenues. Small business and individual revenues are comprised
primarily of recurring dial-up revenues. The Company's dial-up accounts are
billed monthly pursuant to a pre-authorized credit card account or are prepaid
annually. In addition, the Company also receives revenues from non-dial-up
services, primarily related to business customers. These revenues include
dedicated connections, virtual web server hosting and domain name services.
Revenues from dedicated connections includes recurring revenue, usage charges,
web site storage charges, and equipment sales. The Company charges set-up fees
on certain of these services.
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. The Company continues to expect that
it will incur net losses for the foreseeable future. The Company has expanded
its operations internationally to Canada and the United Kingdom. In addition, in
September 1996, the Company announced plans to form a joint-venture in Brazil
with Grupo Itamarati, a Brazilian conglomerate. The Company will continue it's
expansion internationally which could require substantial expenditures. 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.
Years Ended December 31, 1996 and 1995
Revenues increased 130% to $120,540,000 from $52,422,000 in 1995. The
increase in revenues was due to a significant increase in the number of dial-up
subscribers, dedicated connections and web hosting accounts, which the Company
attributes to the growth in the Internet market generally, the increase in the
number of the Company's local access areas, the Company's release of
enhancements to its software, and continued expansion of the Company's sales,
distribution and promotional activities. Subscribers increased by 88% to
approximately 580,000 accounts as of December 31,1996 from 308,000 accounts as
of December 31, 1995. The Company's international subsidiaries accounted for
$2,485,000 of total revenues and 31,000 accounts.
21
<PAGE>
The Company's cost of revenues increased 141% to $88,396,000 in 1996 from
36,641,000 in 1995, increasing to 73% from 70% of revenues, respectively. The
increase in the cost of revenues (in absolute terms) during 1996 was primarily
attributable to the Company's international expansion, sales tax charges,
increased network, data communication and depreciation costs associated with the
increased number of subscribers and network improvements and with expansion of
the Company's operations and customer support staff. The amount relating to
international operations in 1996 was $7,725,000. The increase as a percentage of
revenues was primarily due to the Company's expansion internationally. The
Company expects that the cost of revenues will continue to increase in absolute
dollars as the Company plans to increase its worldwide subscriber base and
expand its infrastructure, including increased depreciation expenses from
capital expenditures associated with network enhancements and capacity demand.
Although no assurances can be given, the Company expects gross margin to
increase as it expects revenue per customer to increase with the change in the
target customer.
Total product development expenses increased 169% to $6,020,000 from
$2,240,000 in 1995, increasing to 5% from 4% of revenues, respectively. Of the
1996 product development expenses, $54,000 related to international operations.
The Company plans to continue its expenditures on product development as the
Company develops new software products and upgrades its existing products.
Accordingly, research and development expenses are expected to increase in
absolute dollars.
Sales and marketing expenses increased 173% to $51,237,000 from $18,771,000
in 1995, increasing to 43% from 36% of revenues, respectively. The increase in
sales and marketing expenses was due primarily to increased costs associated
with the Company's international subsidiaries' sales and marketing expenses and
subscriber acquisition activity in the U.S. The total amount relating to
international operations in 1996 was $9,579,000 which includes costs incurred
domestically relating to international operations. In addition, growth of costs
associated with subscriber acquisition, the addition of management personnel and
marketing programs in the U.S. attributed to the increase. 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 Company's direct response
advertising costs associated with subscriber acquisitions are capitalized in
accordance with the AICPA's Statement of Position 93-7 and amortized over a
twelve-month period using the straight-line method. The Company capitalized
subscriber acquisition costs of approximately $14,368,000 and $5,505,000 and
amortized and wrote off approximately $12,225,000 and $2,755,000 for 1996 and
1995, respectively. In 1996, of the amounts capitalized and amortized,
$1,839,000 and $818,000, respectively related to international operations.
General and administrative expenses increased 114% to $23,610,000 in 1996
from $11,016,000 in 1995, as a percent of revenues, general and administrative
expenses decreased to 20% from 21%, respectively. The dollar increase was
primarily attributable to additional administrative personnel, bad debt expense,
additional corporate facility expenses and international operations.
International operations accounted for $2,507,000 of general and administrative
expenses during 1996. General and administrative expenses are expected to
continue to increase in absolute dollars and although no assurances can be
given, the Company expects general and administrative expenses to decrease as a
percentage of revenues as its revenue base increases without commensurate
increases in general and administrative costs.
Interest income and other increased to $5,681,000 in 1996 from $2,197,000
in 1995. This change is primarily the result of the investment of the proceeds
from the Company's public offerings in December 1994, May 1995 and November
1995, primarily in commercial paper.
The higher cost of revenues and operating expenditures incurred in fiscal
1996, as described above, resulted in a net loss of $44,265,000 as opposed to a
net loss of $14,064,000 for 1995, notwithstanding the period to period revenue
growth. This reflected the Company's strategy to invest in its international
operations as well as in the growth of its subscriber base and local access
numbers.
The provision for income taxes for 1996 and 1995 consisted solely of
foreign taxes and state minimum taxes as the Company had pre-tax losses in both
years.
22
<PAGE>
Years Ended December 31, 1995 and 1994
Revenues increased 324% to $52,422,000 in 1995 from $12,359,000 in 1994.
The increase in revenues was due to a significant increase in subscribers, which
the Company attributes to the growth in the Internet market generally, the
increase in the number of the Company's local access numbers and the Company's
July 1994 introduction of its NetCruiser software. Subscribers increased by 322%
to approximately 308,000 accounts as of December 31, 1995 from approximately
73,000 accounts as of December 31, 1994. The continued expansion of the
Company's sales force, promotional activities and operations department also
contributed to the Company's increase in revenues.
The Company's cost of revenues increased 446% to $36,641,000 in 1995 from
$6,711,000 in 1994, increasing to 70% from 54% of revenues, respectively. The
increase in the cost of revenues (in absolute terms and as a percentage of
revenues) during 1995 was primarily attributable to increases in data
communication costs associated with the increase in the number of subscribers,
expansion of the Company's customer services and operations staff to support
growth, and increased depreciation expense relating to capital expenditures for
local access numbers expansion and network improvements.
Total product development expenses increased 583% to $2,240,000 in 1995
from $328,000 in 1994, increasing to 4% from 3% of revenues, respectively. The
Company capitalized development expenditures of approximately $240,000 in 1995
in connection with the development of the Macintosh Internet access software and
capitalized development expenditures of approximately $232,000 in 1994 in
connection with the initial development of NetCruiser. Amounts capitalized are
amortized over the estimated useful life of approximately three years.
Sales and marketing expenses increased 509% to $18,771,000 in 1995 from
$3,080,000 in 1994, increasing to 36% from 25% 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. Certain direct
response advertising costs associated with subscriber acquisition are
capitalized in accordance with the AICPA's Statement of Position 93-7 and
amortized over a twelve-month period using the straight line method. The Company
capitalized subscriber acquisition costs of approximately $5,505,000 and
$924,000 and amortized approximately $2,755,000 and $223,000 for 1995 and 1994,
respectively.
General and administrative expenses increased 370% to $11,016,000 in 1995
from $2,345,000 in 1994, increasing to 21% from 19% of revenues, respectively.
This increase was primarily attributable to hiring additional administrative and
accounting personnel and incurring additional corporate facility costs. General
and administrative expenses for fiscal 1995 also included settlement of
litigation with a former officer and director of the Company aggregating
$270,000.
Interest income and other increased to $2,197,000 in 1995 from $5,000 in
1994. This change is primarily the result of the investment of the proceeds from
the Company's public offerings in December 1994, May 1995 and November 1995,
primarily in commercial paper.
The higher cost of revenues and higher operating expenditures incurred in
fiscal 1995, as described above, resulted in a net loss of $14,064,000, as
opposed to a net loss of $100,000 for 1994, notwithstanding the period to period
revenue growth. This reflected the Company's strategy to invest in the growth of
its subscriber base and local access numbers.
The provision for income taxes for 1995 and 1994 consisted solely of state
minimum taxes since the Company had pretax losses in both years.
23
<PAGE>
Liquidity and Capital Resources
The Company has funded its operations to date through cash generated from
the collection of revenues and private and public sales of equity securities.
The Company's operating activities provided (used) cash of approximately
($21,651,000), ($461,000) and $4,922,000 for 1996, 1995 and 1994, respectively.
During 1996 cash used in operations was primarily due to the loss incurred
during the year and increases in deferred subscriber costs and prepaid expenses
as well as a decrease in accounts payable. These uses were partially offset by
increases in depreciation, amortization and other non-cash losses and increases
in other accrued expenses and payroll. In 1995, cash used in operations was
primarily due to the loss incurred during the year in addition to increases in
deferred subscriber costs offset by depreciation and amortization and other
non-cash losses and increases in other accounts payable, accrued expenses and
payroll.
The Company's investing activities have consisted primarily of equipment
purchases for network expansion and facilities, and amounted to $53,992,000,
$44,742,000 and $11,375,000 for 1996, 1995 and 1994, respectively.
The Company's financing activities provided $2,351,000, $170,294,000 and
$27,315,000 for 1996, 1995 and 1994, respectively. For 1996 proceeds from
financing activities resulted from issuance of common stock through exercises of
stock options during the year. For 1995, financing activities consisted
primarily of proceeds from the Company's public offerings in May 1995 and
November 1995. Although the Company has no material capital commitments, a
substantial portion of the proceeds of its public offerings have been used, and
are expected to continue to be used, for additional equipment purchases,
subscriber acquisition and international expansion.
As of December 31, 1996, the Company had cash and cash equivalents of
$73,408,000 and working capital of $53,646,000. Overall, the Company used cash
of $73,292,000 in 1996. The Company chose not to renew its line of credit during
1996. However, in the future, the Company may choose to open new lines of
available credit, at its discretion. In December, 1996, the Company entered into
capital lease financing agreements which could cover a significant portion of
its 1997 capital needs. The Company expects to use the lease financing for
certain of its network enhancement programs. The Company believes that existing
cash and cash equivalents, together with existing sources of liquidity and the
lease financing obtained in late 1996, will be sufficient to fund its
operations, capital expenditures, working capital and other cash requirements.
However, the Company expects to continue to experience operating losses and to
have negative cash flow from operations and to continue to incur capital
expenditures for the foreseeable future. To the extent that these sources are
insufficient to fund the Company's activities in the short or long term, the
Company may need to raise additional funds through public or private financing.
There can be no assurance that additional financing will be available or, if
available, will be on terms acceptable to the Company.
24
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
NETCOM On-Line Communication Services, Inc.
We have audited the accompanying consolidated balance sheets of NETCOM
On-Line Communication Services, Inc. as of December 31, 1996 and 1995, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1996. 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 in accordance with generally accepted auditing
standards. 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
NETCOM On-Line Communication Services, Inc. at December 31, 1996 and 1995 and
the consolidated results of its operations and its cash flows for each of the
three years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
ERNST & YOUNG LLP
San Jose, California
February 5, 1997
25
<PAGE>
<TABLE>
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
<CAPTION>
December 31,
----------------------
ASSETS 1996 1995
--------- ---------
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 73,408 $ 146,001
Short term investments 849 --
Accounts receivable, net of allowance for doubtful accounts
of $896 and $225 in 1996 and 1995, respectively 1,284 1,453
Inventory 464 206
Prepaid expenses 2,484 1,471
--------- ---------
Total current assets 78,489 149,131
Property and equipment at cost, net 84,373 46,724
Deferred subscriber acquisition costs, net 5,595 3,452
Deposits and other assets 1,177 3,373
--------- ---------
Total assets $ 169,634 $ 202,680
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 7,517 $ 11,389
Accrued payroll and related expenses 3,727 2,154
Other accrued expenses and liabilities 10,669 2,421
Deferred revenue 2,930 1,250
--------- ---------
Total current liabilities 24,843 17,214
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.01 par value; 5,000,000 authorized and
none issued -- --
Common stock, $0.01 par value; authorized shares - 40,000,000;
11,630,900 and 11,096,100 shares issued and outstanding
at December 31, 1996 and 1995, respectively 116 111
Additional paid-in capital 205,506 203,160
Accumulated deficit (62,042) (17,777)
Cumulative translation adjustment and other 1,211 (28)
--------- ---------
Total stockholders' equity 144,791 185,466
--------- ---------
Total liabilities and stockholders' equity $ 169,634 $ 202,680
========= =========
See accompanying notes.
</TABLE>
26
<PAGE>
<TABLE>
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
<CAPTION>
Year Ended December 31,
-----------------------------------
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Revenues $ 120,540 $ 52,422 $ 12,359
Costs and expenses:
Cost of revenues 88,396 36,641 6,711
Product development 6,020 2,240 328
Sales and marketing 51,237 18,771 3,080
General and administrative 23,610 11,016 2,345
--------- --------- ---------
Total costs and expenses 169,263 68,668 12,464
Loss from operations (48,723) (16,246) (105)
Loss on investments (1,200) -- --
Interest income and other 5,681 2,197 5
--------- --------- ---------
Loss before provision for income taxes (44,242) (14,049) (100)
Provision for income taxes (23) (15) --
--------- --------- ---------
Net loss $ (44,265) $ (14,064) $ (100)
========= ========= =========
Net loss per share $ (3.85) $ (1.68) $ (0.02)
========= ========= =========
Shares used in computing net loss per share 11,498 8,350 5,927
========= ========= =========
See accompanying notes.
</TABLE>
27
<PAGE>
<TABLE>
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except share amounts)
<CAPTION>
Retained Cumulative
Common Stock Additional Earnings Translation Total
--------------------- Paid-in (Accumulated Adjustment Stockholders'
Shares Amount Capital Deficit) and Other Equity
---------- ------ ---------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1993 3,571,400 $ 36 $ 462 $ 47 $ -- $ 545
Repurchase of common stock for cash (1,026,800) (10) (192) (3,447) -- (3,649)
Proceeds from issuance and conversion of preferred
stock, net of issuance costs of $35,000 and
accretion to redemption value of $500,000 2,200,200 22 10,214 (213) -- 10,023
Proceeds from issuance of common stock, net of
issuance costs 1,850,000 18 20,869 -- -- 20,887
Exercise of stock options 129,700 1 257 -- -- 258
Net loss -- -- -- (100) -- (100)
---------- ------ ---------- --------- -------- ---------
Balance at December 31, 1994 6,724,500 67 31,610 (3,713) -- 27,964
Proceeds from issuance of common stock, net of
issuance costs 3,750,000 38 169,177 -- -- 169,215
Issuance of common stock for the acquisition of
Professional Internet Consulting, Inc. 32,200 -- 1,000 -- -- 1,000
Issuance of common stock for investment in The
McKinley Group, Inc. 12,600 -- 300 -- -- 300
Exercise of stock options and purchase under
employee stock purchase plan and other 576,800 6 1,073 -- -- 1,079
Cumulative translation adjustment -- -- -- -- (28) (28)
Net loss -- -- -- (14,064) -- (14,064)
---------- ------ ---------- --------- -------- ---------
Balance at December 31, 1995 11,096,100 111 203,160 (17,777) (28) 185,466
Exercise of stock options and purchase under
employee stock purchase plan and other 534,800 5 2,346 -- -- 2,351
Unrealized gains on available for sale investments -- -- -- -- 540 540
Cumulative translation adjustment -- -- -- -- 699 699
Net loss -- -- -- (44,265) -- (44,265)
---------- ------ ---------- --------- -------- ---------
Balance at December 31, 1996 11,630,900 $ 116 $ 205,506 $ (62,042) $ 1,211 $ 144,791
========== ====== ========== ========= ======== =========
See accompanying notes.
</TABLE>
28
<PAGE>
<TABLE>
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
<CAPTION>
Year Ended December 31,
------------------------------------
1996 1995 1994
---------- --------- ----------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net loss $ (44,265) $ (14,064) $ (100)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 29,626 9,945 1,201
Loss on disposal of assets 286 1,311 --
Loss on investment 1,200 -- --
Changes in assets and liabilities:
Accounts receivable 169 (3) (1,411)
Inventory (258) (115) 54
Prepaid expenses (1,013) (670) (781)
Deposits and other assets (657) (477) (203)
Trade accounts payable (3,872) 5,944 5,209
Accrued payroll and related expenses 1,573 1,480 424
Other accrued expenses and liabilities 8,248 1,898 250
Deferred subscriber costs (14,368) (5,505) (924)
Deferred revenue 1,680 (205) 1,203
---------- --------- ----------
Total adjustments 22,614 13,603 5,022
---------- --------- ----------
Net cash provided by (used for) operating activities (21,651) (461) 4,922
INVESTING ACTIVITIES:
Purchase of property and equipment (53,992) (43,361) (11,143)
Cash acquired from PICnet -- 59 --
Investment in affiliates -- (1,200) --
Product development costs -- (240) (232)
---------- --------- ----------
Net cash used in investing activities (53,992) (44,742) (11,375)
FINANCING ACTIVITIES:
Proceeds from sale of redeemable convertible
perferred stock, net of issuance costs -- -- 10,023
Proceeds from issuance of common stock, net of issuance costs 2,351 170,294 21,146
Repurchase of common stock -- -- (3,650)
Retained earnings distribution to stockholders -- -- (179)
Proceeds received from term loan -- -- 4,000
Principal payments on term loan -- -- (4,000)
Principal payments on notes payable -- -- (25)
---------- --------- ----------
Net cash provided by financing activities 2,351 170,294 27,315
---------- --------- ----------
Net increase in cash and cash equivalents (73,292) 125,091 20,862
Effect of exchange rates on cash 699 (28) --
Cash and cash equivalents at beginning of period 146,001 20,938 76
---------- --------- ----------
Cash and cash equivalents at end of period $ 73,408 $ 146,001 $ 20,938
========== ========= ==========
SCHEDULE OF NONCASH TRANSACTIONS:
Stock issued for investments in affiliates $ -- $ 1,300 $ --
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION:
Interest paid $ -- $ 7 $ 38
Income taxes paid $ 23 $ 8 $ 46
See accompanying notes
</TABLE>
29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 Organization
NETCOM On-Line Communication Services, Inc. ("NETCOM" or the "Company") was
incorporated in the state of California in August 1992. In October 1994, the
Company reincorporated in the state of Delaware. The Company provides Internet
solutions to subscribers in the United States, the United Kingdom and Canada.
Note 2 Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany accounts and transactions
have been eliminated. Investments in affiliated companies representing less than
a 20% interest and for which there is no ability to exert significant influence,
are carried at cost.
Estimates and Assumptions
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.
Revenue Recognition
Monthly subscription service revenue is recognized over the period services
are provided. Subscription service and equipment revenues, which require the use
of Company-provided installation of equipment at a subscriber's location, are
recognized when the service is commenced.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original
maturity (at the date of purchase) of three months or less and insignificant
interest rate risk to be the equivalent of cash for the purposes of the balance
sheet presentation and statement of cash flows.
Accounts Receivable and Deferred Revenue
The Company generally bills for subscription service, including network and
dial-up connection services and initial one-time setup fees, on the first day of
each month for which service is provided. Deferred revenue consists primarily of
prepaid monthly subscriptions and also, to a lesser extent, billings to
customers for equipment shipped that has not been installed at customer
locations.
Inventory
Inventory consists of purchased goods and is stated at the lower of cost or
market on a first-in, first-out basis.
Property and Equipment
Property and equipment are carried at cost and depreciated or amortized
using the straight-line method over the estimated useful life of the assets,
which is generally three to five years. Leasehold improvements are amortized by
the straight-line method over the shorter of their estimated useful lives or the
term of the related lease, whichever is shorter.
The Company adopted the 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", effective beginning January 1, 1996. The impact of
the adoption did not have a material impact on the Company's financial
statements.
30
<PAGE>
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 printing, production and shipping of starter packages 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. It is possible that these estimates of
anticipated future gross revenues could be reduced in the future. The Company's
management is constantly evaluating the estimates used. As a result, the
amortization period of the subscriber acquisition costs related directly to
subscriber solicitations could be reduced. Furthermore, the carrying amount of
the deferred subscriber costs of $5,595,000 could be reduced in the future.
Subscriber acquisition costs, which relate directly to potential
subscribers, are recorded separately from ordinary operating costs. Deferred
subscriber acquisition costs capitalized during fiscal years 1996 and 1995 were
$14,368,000 and $5,505,000, respectively. Amortization and write-offs for fiscal
years 1996, 1995 and 1994 were $12,225,000, $2,755,000 and $223,000,
respectively.
The amount charged to advertising expense was $7,526,000 in 1996,
$4,534,000 in 1995 and $694,000 in 1994.
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, low-risk instruments. Concentrations of credit risk with respect to
trade receivables are limited due to the large number of customers comprising
the Company's customer base.
Translation Adjustments
The functional currency for all foreign operations is the local currency.
As such, all assets and liabilities denominated in foreign currencies are
translated at the exchange rate on the balance sheet date. Revenues, costs, and
expenses are translated at weighted average rates of exchange prevailing during
the period. Translation adjustments are accumulated as a separate component of
shareholders' equity. Gains and losses resulting from foreign currency
transactions are included in income.
Net Loss Per Share
Except as noted below, net income per share is computed using the weighted
average number of shares of common stock and dilutive common stock equivalent
shares from convertible preferred stock (using the if-converted method) and from
stock options (using the treasury stock method). Pursuant to the Securities and
Exchange Commission Staff Accounting Bulletins, common stock and common
equivalent shares issued by the Company at prices below the public offering
price during the twelve-month period prior to the Company's initial public
offering have been included in the calculation as if they were outstanding for
all periods prior to the offering presented regardless of whether they are
dilutive (using the treasury stock method).
Income Taxes
Income taxes are accounted for under Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes." Under this method, deferred
tax assets and liabilities are determined based on differences between the
financial reporting and tax bases 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.
Accounting for Stock Options
In October 1995, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123, "Accounting for Stock-Based Compensation." The Company adopted
SFAS No. 123 in 1996. As allowed by SFAS No. 123, the Company applies APB 25 for
purposes of determining net income and adopts the pro forma disclosure
requirements of SFAS No. 123.
Reclassifications
Certain prior period amounts have been reclassified to conform to the
current period presentation.
31
<PAGE>
Note 3 Investments
The Company has classified all investments as available-for-sale.
Available-for-sale securities are carried at fair market value based on quoted
market prices with unrealized gains and losses, net of tax, reported in
stockholders' equity. Realized gains and losses and declines in value judged to
be other-than-temporary on available-for-sale securities are included in
investment income. Interest on securities classified as available-for-sale is
included in investment income.
<TABLE>
The following is a summary of available-for-sale securities, at December
31, 1996 and December 31, 1995:
<CAPTION>
December 31,
------------------------------------
1996 1995
--------------- ---------------
(in thousands)
<S> <C> <C>
Commercial paper $ 61,149 $ 27,977
US government obligations - 107,764
Money market instruments 7,265 5,447
Equity securities 849 -
--------------- ---------------
69,263 141,188
Included in cash and cash equivalents 68,414 141,188
--------------- ---------------
Included in short term investments $ 849 $ -
=============== ===============
</TABLE>
At December 31, 1996 and 1995, the estimated fair value of the commercial
paper, US government obligations and money market instruments approximated cost,
and the amount of gross unrealized gains and losses was not significant. The
cost of equity securities was $309,000 and unrealized gains totaled $540,000.
All commercial paper and money market instruments mature within one year.
Note 4 Property and Equipment
Property and equipment consist of the following:
<TABLE>
<CAPTION>
December 31,
----------------------
1996 1995
--------- ---------
(in thousands)
<S> <C> <C>
Equipment $ 87,771 $ 47,217
Leasehold improvements 7,893 868
Furniture, fixtures, and other 10,286 2,357
Construction in process 1,526 3,676
--------- ---------
107,476 54,118
Less accumulated depreciation and amortization (23,103) (7,394)
--------- ---------
Net property and equipment $ 84,373 $ 46,724
========= =========
</TABLE>
Depreciation expense was $16,873,000, $6,563,000 and $157,000 for 1996,
1995 and 1994, respectively.
Note 5 Acquisitions
In August 1995, the Company completed the acquisition of Professional
Internet Consulting, Inc. ("PICnet") pursuant to an Agreement and Plan of
Reorganization in a transaction accounted for using the purchase method of
accounting. As consideration for all of the outstanding shares of PICnet, the
Company issued 32,207 shares of its common stock at an approximate fair market
value of $31.05 per share with a total value of approximately $1,000,000.
Additionally, the Company acquired net liabilities with a fair value of
approximately $373,000. The resulting consideration in excess of assets acquired
totaling $1,373,000 represents the goodwill acquired. The goodwill is being
amortized over a period of up to eighteen months. The results of PICnet have
been included in the consolidated financial statements beginning in August 1995.
32
<PAGE>
In June 1995, the Company acquired Series A Common Stock in the McKinley
Group, Inc. ("McKinley") in exchange for $1,200,000 cash and $300,000 of common
stock. In 1996 Excite, Inc.("Excite") acquired all of the outstanding shares of
McKinley and the Company received shares in Excite in exchange for its
investment in McKinley. The Company recorded a loss of $1,200,000 in 1996 to
reflect the estimated value of the shares received.
Note 6 Industry Segment Reporting
The Company operates in one principal industry segment, as a provider of
Internet solutions, and markets its services internationally through foreign
subsidiaries. The Company's services are provided primarily to the individual
and small business markets.
<TABLE>
Geographic financial information is as follows:
<CAPTION>
Year ended December 31,
1996 1995 1994
------------- ------------- ----------
(in thousands)
<S> <C> <C> <C>
Net revenues:
United States $ 118,055 $ 52,422 $ 12,359
International 2,485 - -
------------- ------------- ----------
Consolidated $ 120,540 $ 52,422 $ 12,359
============= ============= ===========
Loss from operations:
United States $ (34,697) $ (15,263) $ (105)
International (14,026) (983) -
------------- ------------- ----------
Consolidated $ (48,723) $ (16,246) $ (105)
============= ============= ===========
Identifiable assets:
United States $ 153,564 $ 199,208 $ 35,649
International 16,070 3,472 -
------------- ------------- ----------
Consolidated $ 169,634 $ 202,680 $ 35,649
============= ============= ===========
</TABLE>
Intersegment sales and transfers are not material. Net revenues is based on
the location of the entity providing service. Loss from operations represents
total net revenues less costs and expenses, and does not include other income or
income taxes. Identifiable assets of geographic areas are those assets used in
the Company's operations in each area. In September 1996, the Company signed a
joint-venture agreement with a Brazilian conglomerate. No significant operating
costs were incurred during 1996 relating to the joint-venture.
Note 7 Commitments and Contingencies
Legal Proceedings
The Company is subject to legal proceedings and claims which have arisen in
the ordinary course of its business and have not been finally adjudicated. In
the opinion of management, settlement of these actions when ultimately concluded
will not have a material adverse effect on trends in results of operations or
the financial condition of the Company. This conclusion is based upon current
facts and circumstances, however, and it is possible that a change in the facts
and circumstances relating to such legal proceedings and claims could result in
a development that would have a material adverse effect on the results of
operations or financial condition of the Company.
33
<PAGE>
The Company has operating leases for all of its premises. The Company's
rental expenses under operating leases in the years ended December 31, 1996,
1995 and 1994 totaled approximately $5,152,000, $1,603,000 and $348,000,
respectively. Future minimum lease payments for all leases are as follows:
<TABLE>
<CAPTION>
Fiscal year (in thousands)
<S> <C>
1997 $6,072
1998 6,091
1999 5,330
2000 2,108
2001 1,436
Thereafter 1,051
-------
Total minimum lease payments $22,088
=======
</TABLE>
Telecommunications Lines
The Company has guaranteed monthly usage levels with its primary
communications vendor. The yearly commitment in each of the years 1997, 1998,
1999 and 2000 is $7,200,000. In 2001, the commitment is $4,800,000. These
amounts are exclusive of usage discounts.
Note 8 Employee Benefit Plans
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
Interpretations in accounting for its employee stock awards because, as
discussed below, the alternative fair value accounting provided for under SFAS
No. 123, "Accounting for Stock-Based Compensation," requires use of option
valuation models that were not developed for use in valuing employee stock
options. Under APB 25, when the exercise price of the Company's employee
stock options equals the market price of the underlying stock on the date of
grant, no compensation expense is recognized.
1993 Stock Option Plan
In 1993, the Company approved and adopted its 1993 Stock Option Plan (the
"Plan"). The Plan is administered by the Stock Option Committee of the Board of
Directors. The Plan provides for the granting of options to purchase common
stock to eligible employees, directors and consultants of the Company. A total
of 3,153,571 shares of common stock may be issued pursuant to options granted
under the Plan. The options generally vest over three-to-five-year periods and
are exercisable for up to ten years following the date of grant. The following
table summarizes stock option activity:
<TABLE>
<CAPTION>
Options Outstanding
----------------------------
Weighted-
Number Average
of Exercise
Shares Price
---------- -------
<S> <C> <C>
Balance at December 31, 1993 284,200 $ 0.56
Granted 627,500 $ 6.86
Exercised (129,700) $ 2.01
Forfeited (83,800) $ 1.54
----------
Balance at December 31, 1994 698,200 $ 5.83
Granted 1,265,600 $ 30.33
Exercised (258,500) $ 2.57
Forfeited (19,900) $ 19.94
----------
Balance at December 31, 1995 1,685,400 $ 24.56
Granted 848,700 $ 25.95
Exercised (193,400) $ 6.08
Forfeited (449,700) $ 28.70
----------
Balance at December 31, 1996 1,891,000 $ 26.09
==========
</TABLE>
34
<PAGE>
At December 31, 1996 and December 31, 1995, approximately 588,200 and
335,600 options, respectively, were exercisable under the Plan.
In addition, in January 1994, the Company granted options, under individual
stock option agreements, to purchase 562,500 and 62,500 shares of common stock
(of which 40,200 shares expired upon the director's resignation in October 1994)
at an exercise price per share of $0.80 to the Company's former Chairman of the
Board and Chief Technical Officer and a former director of the Company,
respectively. These options, which were granted outside the Plan, vested in full
upon the Company's December 1994 public offering. During 1995, 291,400 of the
options were exercised outside the Plan. The remaining 293,400 options were
exercised during 1996.
The following table summarizes information about the Company's stock
options outstanding at December 31, 1996:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------------------------- ------------------------------
Weighted-Average
Range of Number Remaining Weighted-Average Number Weighted-Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
--------------- ----------- ---------------- -------------- ----------- --------------
<C> <C> <C> <C> <C> <C>
$ 0.56 6,600 6.78 $ 0.56 6,600 $ 0.56
$ 2.24 12,540 7.25 $ 2.24 9,550 $ 2.24
$ 4.48 14,200 7.43 $ 4.48 9,300 $ 4.48
$ 7.84 - $11.20 67,280 7.74 $ 8.15 47,300 $ 8.20
$13.00 - $19.50 318,460 8.71 $16.21 120,410 $14.59
$22.25 - $32.75 1,126,800 8.79 $26.43 332,240 $25.76
$34.25 - $51.00 287,420 9.16 $37.30 48,380 $38.21
$52.50 57,500 8.95 $52.50 14,370 $52.50
$63.50 200 8.84 $63.50 50 $63.50
--------- ---------
$ 0.56 - $63.50 1,891,000 8.77 $26.09 588,200 $22.74
========= =========
</TABLE>
During 1996 and early in 1997, certain outstanding options were exchanged
at the election of the option holder. In September 1996, 67,408 shares were
exchanged and repriced for 39,995 shares and in January 1997, 457,846 shares
were exchanged and repriced for 272,084 shares. On the effective date of the
trade in, eligible options were issued at a price lower than the traded in
option and at a price higher than the market value. The trade in ratio was set
such that the number of old options times their option price approximates the
new number of options times their exercise price. This program was offered to
all employees excluding members of the Board of Directors and Officers of the
Company. However, option holders participating in the first exchange were not
eligible for the second program.
Employee Stock Purchase Plan
In 1994, the Board of Directors of the Company approved and adopted an
Employee Stock Purchase Plan (the "ESPP") to provide employees of the Company
with an opportunity to purchase common stock through payroll deductions. Under
the ESPP, 200,000 shares of common stock have been reserved for issuance,
subject to anti-dilution adjustments. The ESPP became effective upon the
effectiveness of the Company's initial public offering in December 1994. Each
offering period under the ESPP is six months long, although the Board of
Directors has the authority to determine the duration of offering periods, up to
a maximum of 27 months. Eligible employees may participate in the ESPP by
authorizing payroll deductions of an amount determined by the Board of
Directors. The amount of authorized payroll deductions may not be less than 1%
nor more than 10% of an employee's initial cash compensation, not to exceed
$25,000 per year. Amounts withheld are applied at the end of every six-month
accumulation period to purchase shares of common stock, but not more than 2,500
shares, or such other number of shares as the Board of Directors shall
determine.
Participants may withdraw their contributions at any time before stock is
purchased, and such contributions will be returned to the participants without
interest. The purchase price is equal to 85% of the lower of (i) the market
price of common stock immediately before the beginning of the applicable period
or (ii) the market price of common stock at the time of the purchase. As of
December 31, 1996, 75,390 shares of common stock have been purchased under the
ESPP.
35
<PAGE>
Pro Forma Information
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, which also requires that the information be determined
as if the Company has accounted for its employee stock options (including shares
issued under the stock purchase plan) granted subsequent to December 31, 1994
under the fair value method. The fair value for these options was estimated at
the date of grant using a Black-Scholes option pricing model with the following
weighted-average assumptions for 1995 and 1996: risk-free interest rate of 6%,
a zero percent dividend yield, volatility factor of the expected market price
of the Company's common stock of 80% for both years; and a weighted-average
expected life of the option of 1.6 years from vest date.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
The weighted average estimated fair value of stock options granted during
1996 and 1995 was $16.73 and $18.44 per share, respectively. The weighted
average estimated fair value of shares granted under the Employee Stock Purchase
Plan during 1996 and 1995 was $5.75 and $7.18 respectively.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows:
<TABLE>
<CAPTION>
For the year ended December 31,
-------------------------------------
1996 1995
----------- -----------
(in thousands, except per share amounts)
<S> <C> <C>
Net loss - as reported $ (44,265) $ (14,064)
=========== ===========
Net loss - pro forma $ (56,143) $ (18,879)
=========== ===========
Net loss per share - as reported $ (3.85) $ (1.68)
=========== ===========
Net loss per share - pro forma $ (4.88) $ (2.26)
=========== ===========
</TABLE>
The effect on pro forma disclosures of applying SFAS No. 123 are not likely
to be representative of the effects on pro forma disclosures in future years.
Because SFAS No. 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until 1997.
Employee Savings Plan
The Company 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.
The Company matches 50% of each employee's contributions up to a maximum of 6%
of the employee's eligible earnings. Company matches vest over four years.
36
<PAGE>
Note 5 Income Taxes
The provision for income taxes for 1996, 1995 and 1994 in the amount of
$23,000, $15,000 and zero consists entirely of international and state minimum
taxes since the Company incurred pre-tax losses in each year.
<TABLE>
Significant components of the Company's deferred tax assets and liabilities
for federal and state income taxes are as follows:
<CAPTION>
December 31,
--------------------------------
1996 1995
------------- -----------
(in thousands)
<S> <C> <C>
Deferred tax assets
Net operating loss carryforwards $ 27,829 $ 6,752
Deferred revenue 1,087 502
Other, net 3,503 1,310
------------- -----------
Total deferred tax assets 32,419 8,564
Valuation allowance (31,104) (6,658)
------------- -----------
$ 1,315 $ 1,906
============= ===========
Deferred tax liabilities
Deferred subscriber acquisition costs $ (1,153) $ (1,297)
Accelerated depreciation and amortization (162) (609)
------------- -----------
$ (1,315) (1,906)
============= ===========
</TABLE>
Realization of deferred tax assets is dependent on future earnings, the
timing and amount of which are uncertain. Accordingly, a valuation allowance, in
an amount equal to the net deferred tax assets as of December 31, 1996 and 1995
has been established to reflect these uncertainties. The change in the valuation
allowance was a net increase of $24,446,000 and $6,568,000 in 1996 and 1995,
respectively. Approximately $10,000,000 of the valuation allowance at December
31, 1996 is attributable to the tax benefits of disqualifying dispositions of
stock received through incentive stock options and the Company's employee stock
purchase plan, the benefit of which will be credited to additional paid-in
capital when realized.
At December 31, 1996, the Company had federal, state and foreign net
operating loss carryforwards of approximately $63,000,000, $27,000,000 and
$14,000,000, respectively, which will expire in the years 1999 through 2011.
Utilization of net operating loss carryforwards may be subject to limitations if
it should be determined that there has been a change in ownership of more than
50% of the value of the Company's stock.
37
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
A. Directors and Executive Officers.
See Part I, "Executive Officers of the Registrant." As permitted by General
Instruction E(3) to Form 10-KSB, the information called for by this item with
respect to Directors is incorporated by reference from the section of the
Company's 1996 definitive proxy statement entitled "Election of Directors,"
which proxy statement will be filed no later than April 30, 1997.
B. Compliance with Section 16(a) of the Exchange Act.
As permitted by General Instruction E(3) to Form 10-KSB, the information
called for by this item is incorporated by reference from the section of the
Company's 1997 definitive proxy statement entitled "Compliance with Section
16(a) of the Exchange Act," which proxy statement will be filed no later than
April 30, 1997.
ITEM 10. EXECUTIVE COMPENSATION
As permitted by General Instruction E(3) to Form 10-KSB, the information
called for by this item is incorporated by reference from the section of the
Company's 1997 definitive proxy statement entitled "Executive Compensation,"
which proxy statement will be filed no later than April 30, 1997.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
As permitted by General Instruction E(3) to Form 10-KSB, the information
called for by this item is incorporated by reference from the section of the
Company's 1997 definitive proxy statement entitled "Security Ownership of
Certain Beneficial Owners and Management," which proxy statement will be filed
no later than April 30, 1997.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
As permitted by General Instruction G(3) to Form 10-KSB, the information
called for by this item is incorporated by reference from the section of the
Company's 1997 definitive proxy statement entitled "Certain Relationships and
Related Transactions," which proxy statement will be filed no later than April
30, 1997.
38
<PAGE>
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
Exhibit No. Description
3.1(2) Amended and Restated Certificate of Incorporation.
3.1a(5) Certificate of Designation, Preferences and Rights of the Series C
Participating Preferred Stock of the Registrant.
3.2(5) Amended and Restated Bylaws.
4.1(1) Specimen Common Stock Certificate.
10.1(1) Office Building Lease by and between Pacific Gateway Properties,
Inc. and the Registrant dated February 1, 1994.
10.2(1) Office Building Lease between Pacific Gateway Properties, Inc. and
the Registrant dated May 11, 1994.
10.3(1) Office Building Lease between Pacific Gateway Properties, Inc. and
the Registrant dated August 26, 1994.
10.4(1) Amended and Restated Registration Rights Agreement among the
Registrant and certain stockholders of the Registrant dated
September 9, 1994.
10.5(1) Amended and Restated Stockholders Agreement among the Registrant
and certain stockholders of the Registrant dated September 9,
1994.
10.6(5) 1993 Stock Option Plan, as amended.
10.7(1) 1994 Employee Stock Purchase Plan.
10.8(1) Form of Incentive Stock Option Agreement used in connection with
1993 Stock Option Plan.
10.9(1) Form of Nonstatutory Stock Option Agreement used in connection
with 1993 Stock Option Plan.
10.10(1) Form of Indemnity Agreement.
10.11(1) Agreement between the Registrant and Dwight Ryan dated October 1,
1993.
10.12(1) Loan and Security Agreement between the Registrant and Silicon
Valley Bank dated May 1994.
10.13(1) Collateral Assignment, Patent Mortgage and Security Agreement
between the Registrant and Silicon Valley Bank dated May 26, 1994.
10.14(1) Loan Modification Agreement between the Registrant and Silicon
Valley Bank dated September 13, 1994.
10.15(1) Stock Purchase Agreement entered into September 9, 1994 among the
Registrant, Robert J. Rieger and the purchasers of the
Registrant's Series B Preferred Stock.
10.16(1) Stock Purchase Agreement entered into September 9, 1994 among the
Registrant, Robert A. Rositano, Sr. and the purchasers of the
Registrant's Series B Preferred Stock.
10.17(1) Form of Stock Repurchase Agreement entered into September 9, 1994
between the Registrant and certain stockholders of the Registrant.
10.18(1) Shareholders Agreement among Robert J. Rieger, Ruthann Plucknett,
Robert A. Rositano, Sr., Janice Rositano and the Registrant dated
October 20, 1994.
10.19(1) Independent Contractor Agreement between Stephen Getsy and the
Registrant dated December 8, 1994.
10.20(1) Brochure Bundling Agreement between the Registrant and Hayes
Microcomputer Products, Inc. dated April 28, 1994.
10.21(1) Joint Marketing and Distribution Agreement between the Registrant
and Tandem Computers Incorporated dated October 18, 1994.
10.22(1) Agreement between the Registrant and Auto-Graphics dated July 17,
1994.
10.23(1) Terms and Conditions agreed upon by the Registrant and ClariNet
Communications Corp. dated September 30, 1994.
10.24(1) Revenue Plan Application for service between the Registrant and
WilTel, Inc. dated October 1, 1994, as amended effective November
1, 1994.
10.25(1) Distribution Agreement between the Registrant and Ingram Micro
Inc. dated September 15, 1994.
10.26(1) Letter Agreement between the Registrant and Silicon Valley Bank
dated November 9, 1994.
10.27(2) Employee letter agreement between the Registrant and David W.
Garrison, dated February 1, 1995.
10.28(2) Distribution Agreement dated January 18, 1995 between the
Registrant and Merisel Americas, Inc.
10.29(3) Employee letter agreement between the Registrant and Rick C.
Francis dated April 24, 1995.
39
<PAGE>
Exhibit No. Description
10.30(3) Employee letter agreement between the Registrant and Donald P.
Hutchison dated April 25, 1995.
10.31(3) Employee letter agreement between the Registrant and Robert E.
Tomasi dated April 25, 1995.
10.32(3) Amendment to David W. Garrison employee letter agreement, dated as
of April 20, 1995.
10.33(4) Loan and Security Agreement between the Registrant, Silicon Valley
Bank and Imperial Bank dated May 31, 1995.
10.34(3) Settlement Agreement and Mutual Release, among the Registrant,
John A. Whalen, Jr. and other parties.
10.35(3) Employee Letter Agreement between the Registrant and Donald P.
Hutchison, dated May 9, 1995.
10.36(4) Employee Letter Agreement between the Registrant and John Zeisler,
dated as of July 17, 1995.
10.37(4) Employee Letter Agreement between the Registrant and Eric V.
Goffney, dated as of August 22, 1995.
10.38(5) Horizon Center Office Lease Agreement between the Registrant and
Horizon Center LLC, dated as of December 11, 1995.
10.39(5) Rights Agreement between the Registrant and Chemical Mellon
Shareholder Services, LLC, as Rights Agent, dated as of March 7,
1996.
10.40(5) Employee Letter Agreement between the Registrant and Clifton
Thomas Weatherford, dated as of December 19, 1995.
10.41(5) Employee Letter Agreement between the Registrant and Eric W.
Spivey, dated as of December 19, 1995.
10.42(5) Lease Agreement between Park West E-3 Associates and the
Registrant, dated as of February 23, 1996.
10.43(6) Stockholder Rights Agreement dated as of March 7, 1996.
10.44(7) Amended and Restated 1993 Stock Option Plan.
10.45 First Amendment to Employee Letter Agreement between the
Registrant and Eric V. Goffney, dated as of November 1, 1996.
10.46 Transition Agreement and Release between the Registrant and Donald
Hutchison, dated November 1, 1996.
10.47 1993 Stock Option Plan, as amended.
11.1 Statement of computation of earnings per share.
21.1 Subsidiaries.
23.1 Consent of Ernst & Young LLP.
24.1 Power of Attorney (see page 41).
- -----
(1) Incorporated by reference to the exhibit of the same number from
the Company's Registration Statement on Form SB-2, No.
33-86012-LA, as amended.
(2) Incorporated by reference to the Company's Form 10-KSB for the fiscal year
ended December 31, 1994.
(3) Incorporated by reference to the exhibit of the same number from
the Company's Registration Statement on Form SB-2, No.
33-91634-LA, as amended.
(4) Incorporated by reference to the exhibit of the same number from
the Company's Registration Statement on Form SB-2, No. 33-98910,
as amended.
(5) Incorporated by reference to the Company's Form 10-KSB for the fiscal
year ended December 31, 1995.
(6) Filed with the Commission on March 18, 1996 and is incorporated by
reference.
(7) Filed with the Commission on May 14, 1996 and is incorporated by
reference.
B. Reports on Form 8-K.
None.
40
<PAGE>
SIGNATURES
Pursuant to the requirement of Section 13 or 15(d) 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: March 27, 1997
By /s/ DAVID W. GARRISON
-----------------------------------
David W. Garrison
Chairman of the Board and
Chief Executive Officer
DATE: March 27, 1997
By /s/ CLIFTON T. WEATHERFORD
-----------------------------------
Clifton T. Weatherford
Senior Vice President,
Chief Financial Officer and Secretary
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints David W. Garrison and Clifton T.
Weatherford and both of them, as his attorney-in-fact, with full power of
substitution, for him in any and all capacities, to sign any amendments to this
Report on Form 10-KSB and to file the same, with exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
hereby ratifying and confirming all that said attorney-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ DAVID W. GARRISON Chairman of the Board, President and March 27, 1997
- ----------------------------- Chief Executive Officer
David W. Garrison (Principal Executive Officer)
/s/ CLIFTON T. WEATHERFORD Senior Vice President, Chief Financial Officer and March 27, 1997
- ----------------------------- Secretary
Clifton T. Weatherford (Principal Financial and Accounting Officer)
/s/ STEPHEN J. GETSY Director March 27, 1997
- -----------------------------
Stephen J. Getsy
/s/ LEO J. HINDERY, JR. Director March 27, 1997
- -----------------------------
Leo J. Hindery, Jr.
/s/ GARY P. MADDEN Director March 27, 1997
- -----------------------------
Gary P. Madden
/s/ CHARLES C. TOWNSEND III Director March 27, 1997
- -----------------------------
Charles C. Townsend III
</TABLE>
41
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
FIRST AMENDMENT TO EMPLOYEE LETTER AGREEMENT
Mr. Eric Goffney
41961 Paseo Padre Parkway
Fremont, CA 94539
Dear Eric:
This letter sets forth an amendment to the Employee Letter Agreement
between you and NETCOM On-Line Communication Services, Inc. ("NETCOM") dated
August 22, 1995. By signing this letter, you will be agreeing to an amendment to
the Agreement as set forth below.
1. The first paragraph of Section 1 of the Agreement is hereby amended to
read in full as follows:
"1. Salary. You will be paid a monthly base salary of $15,000 which
covers all hours worked. Generally, your salary will be reviewed annually,
but the Board of Directors reserves the right to increase your salary from
time to time. Any such change, to be effective, must be reflected in a
writing signed by an officer of the Company (other than you) and approved
by the Board of Directors. Your salary will be paid in accordance with the
normal payroll practices of NETCOM."
2. The first two sentences of Section 5(a) of the Agreement are hereby
amended to read in full as follows:
"(a) General Term. The term of your employment shall be two years
commencing on November 1, 1996, unless earlier terminated pursuant to this
Section 5. Notwithstanding anything to the contrary herein, the Board of
Directors may terminate your employment with or without cause at any time;
provided, however, that if you are terminated without cause (other than as
a result of disability or death) within two years of the date that you sign
this Agreement, you will receive salary continuation, payable in accordance
with NETCOM's standard payroll practices for a period equal to the lesser
of (i) six months or (ii) the remainder of the two-year term of this
Agreement (the "Continuation Period"), in lieu of notice.
3. Please note that the Agreement, as supplemented by this Amendment,
supersedes any prior agreements, representations or promises of any kind,
whether written, oral, express or implied between the parties hereto with
respect to the subject matter herein. It constitutes the full, complete and
exclusive agreement between you and NETCOM with respect to the subject
<PAGE>
matter herein. The Agreement, as amended hereby, may only be modified by a
writing signed by you and by the Company and approved by the Board of Directors.
Except as amended hereby, the Agreement shall continue in full force and effect.
In order to confirm your agreement with and acceptance of these terms,
please sign one copy of this letter and return it to NETCOM. The other copy is
for your records.
Very truly yours,
NETCOM ON-LINE COMMUNICATION
SERVICES, INC.
By
-----------------------------------
Title
---------------------------------
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
I agree to the terms of employment set forth in this Amendment.
Date: November 1, 1996
--------------------------------------
Eric Goffney
EXECUTION COPY
--------------
TRANSITION AGREEMENT AND RELEASE
--------------------------------
THIS TRANSITION AGREEMENT AND RELEASE (this "Agreement"), made and entered
into as of November 1, 1996 by and between NETCOM ON-LINE COMMUNICATION
----------------------------
SERVICES, INC., a Delaware corporation (the "Company"), and DONALD HUTCHISON
- -------------- ----------------
("Employee"),
W I T N E S S E T H:
WHEREAS, Employee wishes to resign from full-time employment as an officer
on November 15, 1996, and Employee and the Company have mutually agreed upon a
plan to transition Employee's duties to part-time employment at that time; and
WHEREAS, Employee and the Company are not parties to any written or oral
employment agreements, other than that certain Employee Letter Agreement by and
between Employee and the Company, dated as of May 9, 1995 (the "Employment
Agreement"):
NOW, THEREFORE, in consideration of the mutual promises and covenants
herein contained, the parties hereto agree as follows:
1. Resignation as Officer and Full-Time Employee; Amendment of Employment
----------------------------------------------------------------------
Agreement. As of November 15, 1996 (the "Effective Date"), Employee hereby
- ---------
voluntarily and irrevocably resigns as an officer of the Company and agrees to
become a part-time employee of the Company, as provided in Section 8 hereof.
Notwithstanding anything to the contrary herein or therein, the Employment
Agreement is hereby amended to reflect
(i) Employee's change of title and responsibili- ties as set forth in
the first paragraph of this Section 1;
(ii) that except as provided in Section 2 below, Employee shall not be
entitled to any salary continuation, severance benefits or other
compensation from the Company upon or after his resignation of full-time
employment or any termination of such employment by the Company, with or
without cause, that except as provided in Section 2 below, the Company
shall not have any liability or obligation to Employee upon any of such
events and that the six (6) months salary continuation upon certain events
provided for in Section 7 of the Letter Agreement is superseded by Section
2 below; and
-1-
<PAGE>
(iii) that Employee shall be permitted to participate in NETCOM's
officer's bonus plan with respect to services rendered during 1996 as if
Employee had been an employee during the entire calendar year 1996,
notwithstanding that Employee shall cease being a full-time employee prior
to January 31, 1997.
2. Compensation and Benefits During the Interim Period. Unless earlier
---------------------------------------------------
terminated due to a breach of any of the conditions set forth in Section 3
hereof after the Effective Date, Employee shall be entitled, upon the
termination of his full-time employment with the Company (other than as the
result of a termination with cause as defined in the Employment Agreement) to
receive the following:
(a) Salary Continuation. Employee shall be eligible to receive salary
-------------------
continuation for a period beginning on the Effective Date and ending on January
31, 1997 (the "Interim Period"), on a regular basis in accordance with normal
payroll practices and procedures and less regular payroll deductions. Not later
than January 31, 1997, Employee shall receive, in a lump sum, an amount equal to
his salary for the period from February 1, 1997 through and including May 9,
1997, less regular payroll deductions.
(b) Bonus. Employee shall be permitted to participate in NETCOM's officer's
-----
bonus plan with respect to services rendered during 1996 as if Employee had been
an employee during the entire calendar year 1996, notwithstanding that Employee
shall cease being a full-time employee prior to December 31, 1996. Employee
understands that although he will participate in the officer's bonus plan, there
is no assurance or guarantee that a bonus will be paid to Employee.
(c) Additional Vesting of Stock Options. Employee currently has two
-----------------------------------
outstanding options to purchase Common Stock of the Company (the "Options") and
has no other rights to purchase securities of the Company. The first Option
represents 22,321 shares (of which 12,650 shares have been exercised), and the
second Option represents 66,964 shares. Subject to the conditions set forth
herein and therein, these Options shall continue to vest at the rate set forth
therein until January 31, 1997 (the "Vesting Continuation Period"). On January
31, 1997, all remaining unvested Options shall vest and shall be completely
exercisable; provided that if Employee shall have breached this Agreement or if
Employee shall then be in breach of this Agreement, then no further vesting
shall occur on such date. Employee shall be entitled to exercise any vested
options, and such options shall not terminate until April 30, 1997. Employee
shall be subject to, and comply with, all insider trading policies of the
Company until three (3) calendar
-2-
<PAGE>
days have elapsed after the Company's announcement of earnings for its
September 30, 1996 quarter.
(d) Medical Benefits. Effective as of the Effective Date, Employee shall be
----------------
granted COBRA coverage for a period of 18 months beginning on the Effective
Date, with respect to the medical and dental benefits Employee has enjoyed prior
to the Effective Date. The Company shall assume and pay the cost of such COBRA
coverage for Employee. Effective as of the Effective Date, Employee shall no
longer be covered by, or be entitled to coverage under, the Company's life,
accidental death, and disability benefit plans.
(e) Dial-Up Account; Phone Number. Employee shall be provided with a
-----------------------------
dial-up internet access account by the Company and shall be entitled to retain
his telephone number with the Company, in each case until January 31, 1997.
(f) Benefits. Except as described in this Section 2, Employee shall
--------
continue to be eligible for other employee benefits, except as specifically
required by law, during the Interim Period, including, without limitation,
accrual of vacation pay and participation in the Company's stock purchase plan
or stock option plan; provided that all of such benefits shall terminate on
January 31, 1997. Notwithstanding anything to the contrary herein, accrued
vacation pay shall be paid as of January 31, 1997.
3. Conditions To Salary Continuation, Loan Forgiveness and Additional
------------------------------------------------------------------
Vesting. The rights of Employee to salary continuation under Section 2(a) and to
- -------
additional vesting of stock options under Section 2(b) are subject to continued
satisfaction until January 31, 1997 of the following conditions, which require
that Employee shall not have:
(a) directly or indirectly, alone or as a partner, officer, director,
employee, consultant, agent or stockholder of any company, engage in any
business activity involving product or services that provide
interconnectivity over either public or private networks for either
commercial or nonprofit use, including, but not limited to America Online,
Inc., CompuServe, Prodigy, UUNET Technologies, Performance Systems
International, AT&T (with respect to that portion of that entity or any of
its divisions or subsidiaries engaged in the business of providing Internet
access), Netscape Communications Corporation, Microsoft and NetManage, Inc.
(the "Named Competitors") or in any other business activity directly or
indirectly in competition with any of the products or services being
actively developed, marketed, distributed or sold by the Company (a
"Competitor") (Notwithstanding the foregoing,
-3-
<PAGE>
companies whose business is primarily the sale of software, and which
do not offer products or services that compete with Company products or
services shall not be considered "Competitors.);
(b) solicited or actively encouraged any of the Company's employees or
consultants to leave the Company, or hired any of them to work for himself
or any entity that he is affiliated with in any capacity (provided that
Employee shall be entitled to solicit and/or hire any of such persons 90
days after they cease to be an employee of or consultant to the Company, if
Employee has not solicited such person prior thereto), with the exception
of Pillsbury Madison & Sutro LLP, Ernst & Young LLP and Heidrich &
Struggles, Inc.;
(c) materially breached, his Proprietary Information Agreement with
the Company or any similar agreement with the Company;
(d) induced, or attempted to induce, any custo- mers of the Company
not to purchase services from the Company;
(e) ceased to be an employee of the Company (other than as a result of
a termination without "cause," as defined in Section 8);
(f) revoked his acceptance of this Agreement pursuant to Section
6(b)(i) hereof or the release delivered pursuant to Section 6 below; or
(g) failed to execute and deliver to the Company without further
consideration on January 31, 1997 a release, dated as of such date, in the
form of Exhibit A hereto.
4. Arbitration. The parties agree that any dispute arising out of the
-----------
employment relationship between them, including any decision by the Company to
terminate Employee's rights hereunder as a result of a violation of any of the
conditions of Section 3 hereof, shall be resolved by arbitration as described in
Section 6 of the Employment Agreement.
5. Employee's Representations. EMPLOYEE HEREBY REPRESENTS
--------------------------
AND WARRANTS TO THE COMPANY THAT HE HAS FULLY REVIEWED THIS
AGREEMENT, AND THE TRANSACTIONS CONTEMPLATED HEREBY, AND THAT HE
FULLY UNDERSTANDS THIS AGREEMENT AND SUCH TRANSACTIONS. IN
CONNECTION WITH THIS REVIEW, EMPLOYEE HAS HAD AN OPPORTUNITY TO
CONSULT WITH LEGAL, FINANCIAL AND OTHER ADVISORS OF HIS
CHOOSING, AND IF HE HAS DECIDED NOT TO DO SO, SUCH CHOICE WAS
-4-
<PAGE>
HIS VOLUNTARY DECISION. THE TERMS OF THIS AGREEMENT ARE VOLUNTARILY
ACCEPTED BY EMPLOYEE WITHOUT DURESS OR COERCION.
6. Mutual Release.
--------------
(a) General Release by Employee. Employee, on behalf of himself, his family
---------------------------
members and his and their heirs and successors, assigns, attorneys and agents,
hereby releases and forever discharges the Company, as well as its officers,
attorneys, directors, employees, shareholders and agents, and their successors
and assigns (collectively "Company Releasees") from any and all claims,
contracts, liabilities, damages, expenses and causes of action, whether in law
or in equity, known or unknown, which he ever had or now has against one or more
of the Company Releasees (collectively "Claims"), to the extent such Claims
relate in any way directly or indirectly, in whole or in part to: Employee's
resignation as a full-time employee and officer pursuant to Section 1 hereof,
the fact that Employee is or was an employee, officer, shareholder or agent of
the Company; any services performed by Employee for the Company; Employee's
employment or non-employment by the Company; any alleged harassment suffered by
Employee during his employment at the Company; any status, term or condition of
such employment; any physical or mental harm or distress arising from such
termination, employment or non-employment; any claims based upon federal, state
or local laws prohibiting employment discrimination, including but not limited
to claims of discrimination under the Fair Employment and Housing Act or Title
VII of the 1964 Civil Rights Act; breach of contract or any other legal basis.
(b) Age Discrimination in Employment Act.
------------------------------------
(i) Pursuant to the Age Discrimination in Employment Act of 1967 ("ADEA"),
as amended by the federal Older Workers Benefit Protection Act, Employee has
twenty-one (21) days after delivery of this Agreement to him to accept the offer
set forth in this Agreement by signing the Agreement and delivering it to the
Company, although he may accept the offer by signing and delivering the
Agreement before such date. If he accepts the offer by executing this Agreement,
he shall have a period of seven (7) days from the date immediately following the
date of his execution of this Agreement during which he may revoke his
acceptance.
(ii) Employee has the right to consult an attorney before executing this
Agreement and the waiver and release contained herein. Pursuant to ADEA, the
Company hereby advises him to do so if he has not already done so.
(iii) The waiver and release contained in Section 6(a) of this Agreement
shall be deemed to include a waiver and release of rights or claims arising
under ADEA, other than such rights
-5-
<PAGE>
or claims as may arise after the date this Agreement is executed by Employee.
(iv) In accordance with ADEA, Employee's execution of this Agreement will
constitute his acknowledgement that (A) he has been advised in writing of his
right to consult with an attorney prior to executing this Agreement and the
waiver and release contained herein; (B) he is aware that the waiver and release
contained herein applies to rights or claims he may have under ADEA; and (C) as
consideration for executing this Agreement, including the waiver and release
contained herein, he has received additional benefits and compensation of value,
to which he would not otherwise be entitled.
(c) Waiver of Other Recourse. Employee understands that various federal,
------------------------
state and local laws prohibit age, sex, national origin, race and other forms of
employment discrimination and that these laws are enforced through the U.S.
Equal Employment Opportunity Commission, and similar state and local agencies.
Employee understands that if he believed that his treatment by the Company had
violated any of these laws, he could consult with these agencies and file a
charge with them. Instead, Employee has voluntarily decided to accept the
Company's offer in this Agreement and to waive and release any and all claims he
may now have under such laws.
(d) Release by Company. The Company hereby releases and forever discharges
------------------
Employee, his successors and assigns (collectively "Employee Releasees") from
any and all claims, demands, costs, contracts, liabilities, objections, rights,
damages, expenses, compensation and actions and causes of action of every
nature, whether in law or in equity, known or unknown, or suspected or
unsuspected, which it ever had or now has against one or more of the Employee
Releasees of any type, nature and description (collectively "Claims"), to the
extent such Claims relate in any way directly or indirectly, in whole or in part
to, or are in any way connected with or based upon: the fact that Employee is or
was an employee, officer, shareholder, consultant or agent of the Company;
Employee's resignation as a full-time employee and officer pursuant to Section 1
hereof; any services performed by Employee for the Company; Employee's
employment or non-employment by the Company; or any status, term or condition of
such employment, other than (i) breach of the Employment Agreement as amended
hereby, or (ii) any breach of Employee's Proprietary Information Agreement with
the Company.
(e) Continuing Obligations. Nothing under this Section 6 shall affect the
----------------------
parties' obligations under this Agreement, the Employment Agreement, as amended
hereby, Employee's Proprietary Information Agreement with the Company or the
Indemnity Agreement between Employee and the Company.
-6-
<PAGE>
7. Section 1542. Employee and the Company expressly waive and relinquish
------------
any and all rights which such party may have under section 1542 of the
California Civil Code, which reads as follows:
A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT
KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTING THE RELEASE,
WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENT WITH THE
DEBTOR.
8. Continued Employment. As a condition to receiving salary continuation
--------------------
during the Interim Period under Section 2(a) and vesting continuation during the
Vesting Continuation Period under Section 2(b), Employee shall be available to
perform services for the Company, from the Effective Date through the end of the
Vesting Continuation Period, on a part-time basis as a part-time employee on the
terms set forth in this Section 8, without further compensation. Employee shall
devote his efforts in the area of competitive developments in the area of
technology for (i) transport alternatives (e.g., microwave, satellite, etc.) and
(ii) internet software alternatives (e.g., products for call avoidance, internet
telephony, etc.) and shall be available on the basis of one day per week (or the
equivalent), to the extent reasonably needed to perform the above-enumerated
tasks, with a monthly report thereon to be delivered to the Company. Such report
shall include a description of potential acquisitions or business combinations
that Employee believes should be brought to the attention of the Company, and
shall contain such other information as the Company and Employee shall mutually
agree. The days, times and location at which Employee shall perform such tasks
shall be determined by the Chief Executive Officer, in his reasonable
discretion. Such services shall be ordinarily provided by Employee from his
home, although the Company may from time-to-time request that such services be
provided at its offices, in which case Employee shall be reimbursed, in advance,
for all reasonable expenses incurred in providing such services. Employee shall
not retain an office at the Company for the provision of such services. If
Employee incurs reasonable telephone, fax and other out-of-pocket expenses while
providing such services, he shall be entitled to reimbursement in accordance
with the Company's standard policies; provided that Employee shall not incur
travel or entertainment expenses in excess of $100 without the prior written
approval of the Company. The foregoing shall not preclude Employee from engaging
in civic, charitable or religious activities or from devoting his full business
efforts and time to serving as an employee, officer or director of other
companies, provided that he fulfills his responsibilities to the Company under
this Section 8.
Employee's relationship as an employee during the Vesting Continuation
Period may be terminated by the Board of Directors
-7-
<PAGE>
of the Company with or without cause. Except as otherwise provided herein,
the Options shall continue vesting (subject to meeting the other conditions
thereto set forth in Section 3) throughout the rest of the term of the Vesting
Continuation Period if such termination is without cause. A termination for
"cause" shall only be effective if Employee is first given ten (10) days' notice
and an opportunity to cure. "Cause" for purposes of this Section 8 only shall
mean consistent and willful failure to perform his duties as a part-time
employee or gross negligence after the Effective Date hereof. Employee may
resign as an employee at any time by written notice to the Company, in which
case his rights under Section 2 shall terminate.
9. Notice. Any notice to be delivered pursuant to this Agreement shall be
------
in writing and shall be deemed delivered upon service, if served personally, or
three days after deposit in the United States Mail, if mailed by first class
mail, postage prepaid, registered or certified with return receipt requested,
addressed to the other party at the address set forth herein, or such other
address as may be designated in accordance herewith:
If to Employee:
Donald Hutchison
2631 Howard Street
San Carlos, CA 94070
If to the Company:
NETCOM On-Line Communication Services, Inc.
Two North Second Street
San Jose, CA 95113
Attn: David W. Garrison, President and
Chief Executive Officer
10. Binding Effect. This Agreement shall be binding upon, and inure to the
--------------
benefit of, Employee and his heirs, personal representatives, executors and
administrators, and shall inure to the benefit of and be binding upon the
Company, its successors and assigns.
11. Amendment. This Agreement may be modified or amended only by written
---------
consent of both parties.
12. Governing Law. This Agreement shall be governed by the laws of the
-------------
State of California as if entered into between California residents and wholly
to be performed in California, notwithstanding California choice of law rules.
13. Entire Agreement. This instrument contains the entire agreement of the
----------------
parties relating to the subject matter hereof, and supersedes all prior and
contemporaneous negotiations,
-8-
<PAGE>
correspondence, understandings and agreements of the parties relating to
the subject matter hereof.
14. Severability. In the event that any provision of this Agreement is held
------------
to be invalid or unenforceable for any reason, the Company and Employee shall
replace such provision with a valid provision which most closely approximates
the intent and economic effect of the invalid or unenforceable provision, and
the remaining provisions of the Agreement shall continue in full force and
effect.
15. Waiver. The waiver by any party of any provision of this Agreement or
------
any breach of this Agreement shall not operate or be interpreted as a waiver of
any other provision or breach existing then or arising in the future.
16. Expenses. Each party shall pay all costs and expenses incurred or to be
--------
incurred by it in negotiating and preparing this Agreement and in closing and
carrying out the transactions contemplated by this Agreement.
17. Counterparts. This Agreement may be executed in two or more
------------
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same Agreement.
IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the
date first written above.
NETCOM ON-LINE COMMUNICATION
SERVICES, INC.
By
------------------------------------
Title
---------------------------------
---------------------------------------
Donald Hutchison
-9-
<PAGE>
Exhibit A
MUTUAL RELEASE
The undersigned parties, NETCOM On-Line Communication Services, Inc., Two
North Second Street, San Jose, CA 95113 (the "Company"), and Donald Hutchison,
2631 Howard Street, San Carlos, CA 94070 ("Employee"), hereby agree as follows:
1. General Release by Employee. Employee, on behalf of himself, his family
---------------------------
members and his and their heirs and successors, assigns, attorneys and agents,
hereby releases and forever discharges the Company, as well as its officers,
attorneys, directors, employees, shareholders and agents, and their successors
and assigns (collectively "Company Releasees") from any and all claims,
contracts, liabilities, damages, expenses and causes of action, whether in law
or in equity, known or unknown, which he ever had or now has against one or more
of the Company Releasees, or may have in the future (collectively "Claims"), to
the extent such Claims relate in any way directly or indirectly, in whole or in
part to: Employee's resignation as a full-time employee, officer and director
pursuant to Section 1 of the Transition Agreement and Release dated of November
1, 1996 between the parties (the "Transition Agreement"), the fact that Employee
is or was an employee, officer, shareholder or agent of the Company; the
termination of Employee's employment and other positions with the Company; any
services performed by Employee for the Company; Employee's employment or
non-employment by the Company; any alleged harassment suffered by Employee
during his employment at the Company; any status, term or condition of such
employment; any physical or mental harm or distress arising from such
termination, employment or non-employment; any claims based upon federal, state
or local laws prohibiting employment discrimination, including but not limited
to claims of discrimination under the Fair Employment and Housing Act or Title
VII of the 1964 Civil Rights Act; breach of contract or any other legal basis.
2. Release by Company. The Company hereby releases and forever discharges
------------------
Employee, his successors and assigns (collectively "Employee Releasees") from
any and all claims, demands, costs, contracts, liabilities, objections, rights,
damages, expenses, compensation and actions and causes of action of every
nature, whether in law or in equity, known or unknown, or suspected or
unsuspected, which it ever had or now has against one or more of the Employee
Releasees of any type, nature and description, or may have in the future
(collectively "Claims"), to the extent such Claims relate in any way directly or
indirectly, in whole or in part to, or are in any way connected with or based
upon: the fact that Employee is or was an employee, officer, shareholder,
consultant or agent of the Company; the termination of Employee's employment and
other positions with the Company; any services performed by Employee
A-1
<PAGE>
for the Company; Employee's employment or non-employment by the Company; or
any status, term or condition of such employment, other than, (i) breach of the
Employment Agreement, as amended, or (ii) any breach of Employee's Proprietary
Information Agreement with the Company.
3. Continuing Obligations. Nothing in this Mutual Release shall affect the
----------------------
parties' obligations under this Mutual Release, the Transition Agreement,
Employee's Employment Agreement with the Company, as amended, Employee's
Proprietary Information Agreement with the Company or the Indemnity Agreement
between Employee and the Company.
4. Section 1542. Employee and the Company expressly waive and relinquish
------------
any and all rights which such party may have under section 1542 of the
California Civil Code, which reads as follows:
A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOT
KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTING THE RELEASE,
WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENT WITH THE
DEBTOR.
IN WITNESS WHEREOF, the undersigned have executed this Mutual Release as of
this 31st of December, 1996.
NETCOM ON-LINE COMMUNICATION
SERVICES, INC.
By
-------------------------------------
Title
----------------------------------
----------------------------------------
Donald Hutchison
A-2
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
1993 STOCK OPTION PLAN
(Amended and Restated Effective as of January 23, 1997)
SECTION 1. PURPOSE.
- -------------------
The Plan was established in 1993 to offer selected employees, directors and
consultants an opportunity to acquire a proprietary interest in the success of
the Company, or to increase such interest, to encourage such selected persons to
remain in the employ of the Company and to attract new employees with
outstanding qualifications by purchasing Shares of the Company's Common Stock.
The Plan provides for the grant of Options to purchase Shares. Options granted
under the Plan may include Nonstatutory Options as well as ISOs intended to
qualify under section 422 of the Internal Revenue Code of 1986, as amended (the
"Code").
This amended and restated Plan makes changes to comply with new rules
promulgated pursuant to Section 16 of the Exchange Act.
SECTION 2. DEFINITIONS.
- -----------------------
(a) "Board of Directors" or "Board" shall mean the Board of Directors of
------------------ -----
the Company, as constituted from time to time.
(b) "Change in Control" means the occurrence of any of the following
-----------------
events:
(i) the consummation of the acquisition of fifty-one percent (51%) or
more of the outstanding Stock of the Company by one person or by two or
more persons acting as a partnership, limited partnership, syndicate or
other group pursuant to a tender offer validly made under any federal or
state law (other than a tender offer by the Company);
(ii) the consummation of a merger, consolidation or other
reorganization of the Company (other than a reincorporation of the
Company), if after giving effect to
-1-
<PAGE>
such merger, consolidation or other reorganization of the Company, the
stockholders of the Company immediately prior to such merger, consolidation
or other reorganization do not represent a majority in interest of the
holders of voting securities (on a fully diluted basis) with the ordinary
voting power to elect directors of the surviving or resulting entity after
such merger, consolidation or other reorganization;
(iii) the sale of all or substantially all of the assets of the
Company to a third party who is not an affiliate (including a Parent or
Subsidiary) of the Company;
(iv) the dissolution of the Company pursuant to action validly taken
by the stockholders of the Company in accordance with applicable state law;
or
(v) the occurrence of any other tender offer, merger, consolidation,
sale, reorganization, dissolution or other such event or series of events,
which in the opinion of a majority of the Board (as reflected in a written
resolution of the Board) has resulted in a change of control of the
Company.
(c) "Code" shall mean the Internal Revenue Code of 1986, as amended.
----
(d) "Committee" shall mean the Board of Directors and/or a committee of the
---------
Board of Directors which is authorized to administer the Plan under Section 3.
The Committee shall have membership composition which enables the Plan to
qualify under Rule 16b-3 with regard to the grant of Options to persons who are
subject to Section 16 of the Exchange Act.
(e) "Company" shall mean NETCOM On-Line Communication Services, Inc., a
-------
Delaware corporation.
(f) "Disability" shall mean that an Optionee is unable to engage in any
----------
substantial gainful activity by reason of any medically determinable physical or
mental impairment which can be expected to result in death or which has lasted,
or can be expected to last, for a continuous period of not less than twelve
months.
-2-
<PAGE>
(g) "Employee" shall mean (i) any individual who is a common-law employee
--------
of the Company or of a Subsidiary, (ii) an Outside Director, and (iii) an
independent contractor who performs services for the Company or a Subsidiary.
Service as an Outside Director or as an independent contractor shall be
considered employment for all purposes of the Plan except the second sentence of
Section 4(a).
(h) "Exchange Act" shall mean the Securities Exchange Act of 1934, as
------------
amended.
(i) "Exercise Price" shall mean the amount for which one Share may be
--------------
purchased upon exercise of an Option, as specified by the Committee in the
applicable Stock Option Agreement.
(j) "Fair Market Value" shall mean (i) the closing price of a Share on the
-----------------
principal exchange on which the Shares are trading, on the first trading day
immediately preceding the date on which the Fair Market Value is determined, or
(ii) if the Shares are not traded on an exchange, but are quoted regularly on
the Nasdaq National Market or a successor quotation system, the closing price on
the first trading day immediately preceding the date on which the Fair Market
Value is determined, or (iii) if the Shares are not traded on an exchange or
quoted on the Nasdaq National Market or a successor quotation system, the Fair
Market Value of a Share, as determined by the Committee in good faith. Such
determination shall be conclusive and binding on all persons.
(k) "ISO" shall mean an employee incentive stock option described in Code
---
section 422.
(l) "Nonstatutory Option" shall mean an employee stock option that is not
-------------------
an ISO.
(m) "Option" shall mean an ISO or Nonstatutory Option granted under the
------
Plan and entitling the holder to purchase Shares.
(n) "Optionee" shall mean an individual who holds an Option.
--------
(o) "Outside Director" shall mean a member of the Board who is not a common
----------------
law employee of the Company or a Subsidiary.
(p) "Plan" shall mean this NETCOM On-Line Communication Services, Inc. 1993
----
Stock Option Plan, as amended from time to time.
-3-
<PAGE>
(q) "Service" shall mean service as an Employee.
-------
(r) "Share" shall mean one share of Stock, as adjusted in accordance with
-----
Section 8 (if applicable).
(s) "Stock" shall mean the Common Stock of the Company.
-----
(t) "Stock Option Agreement" shall mean the agreement between the Company
----------------------
and an Optionee which contains the terms, conditions and restrictions pertaining
to his or her Option.
(u) "Subsidiary" shall mean any corporation, of which the Company and/or
----------
one or more other Subsidiaries own not less than 50 percent of the total
combined voting power of all classes of outstanding stock of such corporation. A
corporation that attains the status of a Subsidiary on a date after the adoption
of the Plan shall be considered a Subsidiary commencing as of such date.
SECTION 3. ADMINISTRATION.
- --------------------------
(a) Committee Procedures. The Committee shall designate one of the members
--------------------
of the Committee as chairperson. The Committee may hold meetings at such times
and places as it shall determine. The acts of a majority of the Committee
members present at meetings at which a quorum exists, or acts reduced to or
approved in writing by all Committee members, shall be valid acts of the
Committee.
(b) Committee Responsibilities. Subject to the provisions of the Plan, the
--------------------------
Committee shall have full authority and discretion to take the following
actions:
(i) To interpret the Plan and to apply its provisions;
(ii) To adopt, amend or rescind rules, procedures and forms relating
to the Plan; (iii) To authorize any person to execute, on behalf of the
Company, any instrument required to carry out the purposes of the Plan;
(iv) To determine when Options are to be granted under the Plan;
(v) To select the Optionees;
-4-
<PAGE>
(vi) To determine the number of Shares to be made subject to each
Option;
(vii) To prescribe the terms and conditions of each Option, including
(without limitation) the Exercise Price, the vesting or duration of the
Option (including accelerating the vesting of the Option), to determine
whether such Option is to be classified as an ISO or as a Nonstatutory
Option, and to specify the provisions of the Stock Option Agreement
relating to such Option;
(viii) To amend any outstanding Stock Option Agreement;
(ix) To determine the disposition of an Option in the event of an
Optionee's divorce or dissolution of marriage;
(x) To correct any defect, supply any omission, or reconcile any
inconsistency in the Plan and any Option;
(xi) To determine whether Options under the Plan will be granted in
replacement of other grants under an incentive or other compensation plan
of an acquired business;
(xii) To prescribe the consideration for the grant of each Option
under the Plan and to determine the sufficiency of such consideration; and
(xiii) To take any other actions deemed necessary or advisable for the
administration of the Plan.
Subject to the requirements of applicable law, the Committee may designate
members other than Committee members to carry out its responsibilities and may
prescribe such conditions and limitations as it may deem appropriate, except
that the Committee may not delegate its authority with regard to the selection
for participation in or the granting of Options under the Plan to persons
subject to Section 16 of the Exchange Act. All decisions, interpretations and
other actions of the Committee shall be final and binding on all Optionees, and
all persons deriving their rights from an
-5-
<PAGE>
Optionee. No member of the Committee shall be liable for any action that he
or she has taken or has failed to take in good faith with respect to the Plan or
any Option.
SECTION 4. ELIGIBILITY.
- -----------------------
(a) General Rule. Only Employees shall be eligible for designation as
------------
Optionees by the Committee. In addition, only individuals who are employed as
common-law employees by the Company or a Subsidiary shall be eligible for the
grant of ISOs.
(b) Outside Directors. Outside Directors shall also be eligible for the
-----------------
grant of Nonstatutory Options as described in this Section 4(b).
(i) Each Outside Director shall automatically be granted a
Nonstatutory Option to purchase 35,000 Shares (less any unvested Options
held by the Outside Director and subject to adjustment under Section 8) as
a result of their appointment of an Outside Director at or after the 1996
annual meeting. Upon the conclusion of each regular annual meeting of the
Company's shareholders following the annual meeting at which they were
appointed, each Outside Director who will continue serving as a member of
the Board thereafter shall receive a Nonstatutory Option to purchase 5,000
Shares (subject to adjustment under Section 8). All such Nonstatutory
Options shall vest and become exercisable six (6) months after the date of
grant at the rate of six and one-quarter percent (6.25%) upon each three
(3) month anniversary of the date the option is granted to the Outside
Director.
(ii) All Nonstatutory Options granted to an Outside Director under
this Section 4(b) shall also become exercisable in full in the event of (A)
the termination of such Outside Director's service because of death or
Disability or (B) a Change in Control of the Company.
-6-
<PAGE>
(iii) The Exercise Price of all Nonstatutory Options granted to an
Outside Director under this Section 4(b) shall be equal to one hundred
percent (100%) of the Fair Market Value of a Share on the date of grant,
payable in one of the forms described in Sections 7(a), (b) and (c).
(iv) All Nonstatutory Options granted to an Outside Director under
this Section 4(b) shall terminate on the earlier of (A) the tenth
anniversary of the date of grant of such Nonstatutory Options or (B) the
date ninety (90) days after the termination of such Outside Director's
service for any reason.
(c) Ten-Percent Shareholders. An Employee who owns more than 10 percent of
------------------------
the total combined voting power of all classes of outstanding stock of the
Company or any of its Subsidiaries shall not be eligible for the grant of an ISO
unless such grant satisfies the requirements of Code section 422(c)(5).
(d) Attribution Rules. For purposes of Subsection (b) above, in determining
-----------------
stock ownership, an Employee shall be deemed to own the stock owned, directly or
indirectly, by or for his brothers, sisters, spouse, ancestors and lineal
descendants. Stock owned, directly or indirectly, by or for a corporation,
partnership, estate or trust shall be deemed to be owned proportionately by or
for its shareholders, partners or beneficiaries. Stock with respect to which
such Employee holds an option shall not be counted.
(e) Outstanding Stock. For purposes of Subsection (b) above, "outstanding
stock" shall include all stock actually issued and outstanding immediately after
the grant. "Outstanding stock" shall not include shares authorized for issuance
under outstanding options held by the Employee or by any other person.
-7-
<PAGE>
SECTION 5. STOCK SUBJECT TO PLAN.
- ---------------------------------
(a) Basic Limitation. The aggregate number of Shares which may be issued
----------------
under the Plan (upon exercise of Options) shall not exceed three million one
hundred fifty-three thousand five hundred seventy-one (3,153,571) Shares,
subject to adjustment pursuant to Section 8, of which three hundred thousand
(300,000) Shares are reserved exclusively for grant to Outside Directors. The
aggregate number of Shares which may be issued under the Plan shall at all times
be subject to adjustment pursuant to Section 8. The number of Shares which are
subject to Options outstanding at any time under the Plan shall not exceed the
number of Shares which then remain available for issuance under the Plan. The
Company, during the term of the Plan, shall at all times reserve and keep
available sufficient Shares to satisfy the requirements of the Plan.
(b) Additional Shares. In the event that any outstanding Option for any
-----------------
reason expires or is canceled or otherwise terminated, the Shares allocable to
the unexercised portion of such Option shall again be available for the purposes
of the Plan.
SECTION 6. TERMS AND CONDITIONS OF OPTIONS.
- -------------------------------------------
(a) Stock Option Agreement. Each grant of an Option under the Plan shall be
----------------------
evidenced by a Stock Option Agreement between the Optionee and the Company. Such
Option shall be subject to all applicable terms and conditions of the Plan and
may be subject to any other terms and conditions which are not inconsistent with
the Plan and which the Committee deems appropriate for inclusion in a Stock
Option Agreement. The provisions of the various Stock Option Agreements entered
into under the Plan need not be identical.
(b) Number of Shares. Each Stock Option Agreement shall specify the number
----------------
of Shares that are subject to the Option and shall provide for the adjustment of
such number in accordance with Section 8. However, no Optionee shall be granted
Options in any fiscal year to purchase in excess of 300,000 shares of Common
Stock (subject to adjustment as set forth in Section 8 hereof);
-8-
<PAGE>
except that, an Optionee may receive Options to purchase up to 500,000
shares of Common Stock in the fiscal year of his or her initial hire (subject to
adjustment as set forth in Section 8 hereof). The Stock Option Agreement shall
also specify whether the Option is an ISO or a Nonstatutory Option.
(c) Exercise Price. Each Stock Option Agreement shall specify the Exercise
--------------
Price. The Exercise Price of an ISO shall not be less than one hundred percent
(100%) of the Fair Market Value of a Share on the date of grant, except as
otherwise provided in Section 4(b). Subject to the preceding sentence, the
Exercise Price under any Option shall be determined by the Committee in its sole
discretion. The Exercise Price shall be payable in a form described in Section
7.
(d) Withholding Taxes. As a condition to the exercise of an Option, the
-----------------
Optionee shall make such arrangements as the Committee may require for the
satisfaction of any federal, state, local or foreign tax obligations that may
arise in connection with such exercise. The Optionee shall also make such
arrangements as the Committee may require for the satisfaction of any federal,
state, local or foreign withholding tax obligations that may arise in connection
with the disposition of Shares acquired by exercising an Option. These
arrangements may include withholding (or tendering back) of Shares subject to
the Option.
(e) Exercisability. Each Stock Option Agreement shall specify the date when
--------------
all or any installment of the Option is to become exercisable. The vesting of
any Option shall be determined by the Committee in its sole discretion.
(f) Term. The Stock Option Agreement shall specify the term of the Option.
----
The term shall not exceed ten (10) years from the date of grant, except as
otherwise provided in Section 4(b). Subject to the preceding sentence, the
Committee at its sole discretion shall determine when an Option is to expire.
(g) Nontransferability. Except as permitted by the Committee and/or as set
------------------
forth in the Option, no Option shall be transferable by the Optionee other than
by will or by the laws of descent and distribution. An Option may be exercised
during the lifetime of the Optionee only by him or by
-9-
<PAGE>
his guardian or legal representative. Except as permitted by the Committee
and/or as set forth in the Option, no Option or interest therein may be
transferred, assigned, pledged or hypothecated by the Optionee during his
lifetime, whether by operation of law or otherwise, or be made subject to
execution, attachment or similar process.
(h) Exercise of Options on Termination of Service. Each Option shall set
---------------------------------------------
forth the extent to which the Optionee shall have the right to exercise the
Option following termination of the Optionee's Service with the Company and its
Subsidiaries, and the right to exercise the Option of any executors or
administrators of the Optionee's estate or any person who has acquired such
Option directly from the Optionee. Such provisions shall be determined in the
sole discretion of the Committee, need not be uniform among all Options issued
pursuant to the Plan, and may reflect distinctions based on the reasons for
termination of employment.
(i) No Rights as a Shareholder. An Optionee, or a transferee of an
--------------------------
Optionee, shall have no rights as a shareholder with respect to any Shares
covered by an Option until the date of the issuance of a stock certificate for
such Shares.
(j) Modification, Extension and Assumption of Options. Within the
-------------------------------------------------
limitations of the Plan, the Committee may modify, extend or assume outstanding
Options or may accept the cancellation of outstanding Options (whether granted
by the Company or another issuer) in return for a cash settlement and/or the
grant of new Options for the same or a different number of Shares and at the
same or a different Exercise Price.
(k) Restrictions on Transfer of Shares. Any Shares issued upon exercise
of an Option shall be subject to such rights of repurchase, rights of first
refusal and other transfer restrictions as the Committee may determine. Such
restrictions shall be set forth in the applicable Stock Option Agreement and
shall apply in addition to any restrictions that may apply to holders of Shares
generally.
-10-
<PAGE>
SECTION 7. PAYMENT FOR SHARES.
- ------------------------------
(a) General Rule. The entire Exercise Price of Shares issued under the Plan
------------
shall be payable in lawful money of the United States of America at the time
when such Shares are purchased or such other time as may be designated by the
Committee, except as provided in Subsections (b), (c) and (d) below.
(b) Surrender of Stock. To the extent that a Stock Option Agreement so
------------------
provides, payment may be made all or in part with Shares subject to the Option
and/or with Shares which have already been owned by the Optionee or the
Optionee's representative for such time period specified by the Committee and
which are surrendered to the Company in good form for transfer. Such Shares
shall be valued at their Fair Market Value on the date when the new Shares are
purchased under the Plan.
(c) Promissory Notes. To the extent that a Stock Option Agreement so
----------------
provides, payment may be made all or in part with a full recourse promissory
note executed by the Optionee. The interest rate and other terms and conditions
of such note shall be determined by the Committee. The Committee may require
that the Optionee pledge his or her Shares to the Company for the purpose of
securing the payment of such note. In no event shall the stock certificate(s)
representing such Shares be released to the Optionee until such note is paid in
full.
(d) Cashless Exercise. To the extent that a Stock Option Agreement so
-----------------
provides, payment may be made all or in part by delivery (on a form prescribed
by the Committee) of an irrevocable direction to a securities broker to sell
Shares and to deliver all or part of the sale proceeds to the Company in payment
of the aggregate Exercise Price.
SECTION 8. ADJUSTMENT OF SHARES.
- --------------------------------
(a) General. In the event of a subdivision of the outstanding Stock, a
-------
declaration of a dividend payable in Shares, a declaration of a dividend payable
in a form other than Shares in an amount that has a material effect on the value
of Shares, a combination or consolidation of the
-11-
<PAGE>
outstanding Stock into a lesser number of Shares, a recapitalization, a
reclassification or a similar occurrence, the Committee shall make appropriate
adjustments in one or more of (i) the number of Shares available for future
grants under Section 5, (ii) the number of Shares covered by each outstanding
Option or (iii) the Exercise Price under each outstanding Option.
(b) Reorganizations. In the event that the Company is a party to a merger
---------------
or reorganization, outstanding Options shall be subject to the agreement of
merger or reorganization. Such agreement may provide for the assumption of
outstanding Options by the surviving corporation or its parent or for their
continuation by the Company (if the Company is the surviving corporation);
provided, however, that if assumption or continuation of the outstanding Options
is not provided for by such agreement then the Committee shall have the option
of offering the payment of a cash settlement equal to the difference between the
amount to be paid for one Share under such agreement and the Exercise Price, in
all cases without the Optionees' consent.
(c) Reservation of Rights. Except as provided in this Section 8, an
---------------------
Optionee shall have no rights by reason of (i) any subdivision or consolidation
of shares of stock of any class, (ii) the payment of any dividend or (iii) any
other increase or decrease in the number of shares of stock of any class. Any
issue by the Company of shares of stock of any class, or securities convertible
into shares of stock of any class, shall not affect, and no adjustment by reason
thereof shall be made with respect to, the number or Exercise Price of Shares
subject to an Option. The grant of an Option pursuant to the Plan shall not
affect in any way the right or power of the Company to make adjustments,
reclassifications, reorganizations or changes of its capital or business
structure, to merge or consolidate or to dissolve, liquidate, sell or transfer
all or any part of its business or assets.
SECTION 9. LEGAL REQUIREMENTS.
- ------------------------------
Shares shall not be issued under the Plan unless the issuance and delivery
of such Shares complies with (or is exempt from) all applicable requirements of
law, including (without limitation)
-12-
<PAGE>
the Securities Act of 1933, as amended, the rules and regulations
promulgated thereunder, state securities laws and regulations and the
regulations of any stock exchange on which the Company's securities may then be
listed, and the Company has obtained the approval or favorable ruling from any
governmental agency which the Company determines is necessary or advisable.
SECTION 10. NO EMPLOYMENT RIGHTS.
- ---------------------------------
No provision of the Plan, nor any Option granted under the Plan, shall be
construed to give any person any right to become, to be treated as, or to remain
an Employee. The Company and its Subsidiaries reserve the right to terminate any
person's Service at any time and for any reason.
SECTION 11. DURATION AND AMENDMENTS.
- ------------------------------------
(a) Term of the Plan. The amended and restated Plan, as set forth herein,
----------------
shall become effective on August 15, 1996. The amended and restated Plan, as set
forth herein, shall terminate automatically 10 years after its original adoption
by the Board of Directors and may be terminated on any earlier date pursuant to
Subsection (b) below.
(b) Right to Amend or Terminate the Plan. The Board of Directors may amend
------------------------------------
the Plan at any time and from time to time. Rights and obligations under any
Option granted before amendment of the Plan shall not be materially altered, or
impaired adversely, by such amendment, except with consent of the person to whom
the Option was granted. An amendment of the Plan shall be subject to the
approval of the Company's stockholders only to the extent required by applicable
laws, regulations or rules.
(c) Effect of Amendment or Termination. No Shares shall be issued or sold
----------------------------------
under the Plan after the termination thereof, except upon exercise of an Option
granted prior to such termination. The termination of the Plan, or any amendment
thereof, shall not affect any Option previously granted under the Plan.
-13-
<PAGE>
SECTION 12. EXECUTION.
- ----------------------
To record the adoption of the amended and restated Plan by the Board of
Directors, the Company has caused its authorized officer to execute the same.
NETCOM ON-LINE COMMUNICATION SERVICES,
INC.
By
--------------------------------------
Clifton T. Weatherford
Senior Vice President, Chief Financial
Officer and Secretary
-14-
EXHIBIT 11.1
<TABLE>
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
STATEMENT OF COMPUTATION OF EARNINGS PER SHARE
<CAPTION>
Year ended
December 31,
-------------------------------------------------
1996 1995 1994
-------------- -------------- ------------
<S> <C> <C> <C>
Net income (loss) ........................................ (44,265,000) $ (14,064,000) $ (100,000)
============== ============== ============
Computation of weighted average
common and common equivalent
shares outstanding:
Common stock ..................................... 11,498,000 8,350,000 3,606,000
Options .......................................... - - -
Option shares related to
SAB No. 55, 64, and 83 ....................... - - 671,000
Convertible preferred shares
related to SAB No. 55, 64,
and 83 ....................................... - - 1,650,000
Total weighted average common
and common equivalent shares
outstanding .......................................... 11,498,000 8,350,000 5,927,000
-------------- -------------- ------------
Net income (loss) per share .............................. $ (3.85) $ (1.68) $ (0.02)
============== ============== ============
For each of the three years presented above, there is no difference between
primary and fully diluted earnings per share.
</TABLE>
Exhibit 21.1
Subsidiaries
Name Jurisdiction
NETCOM Canada Inc. ........................................... New Brunswick
Netcom Interactive, Ltd. ..................................... United Kingdom
Exhibit 23.1
Consent of Ernst & Young LLP, Independent Auditors
We consent to the incorporation by reference in the Registration Statements
(Form S-8 Nos. 33-91000, 333-03721, and 333-11775) of NETCOM On-Line
Communication Services, Inc. of our report dated February 5, 1997, with respect
to the consolidated financial statements of NETCOM On-Line communication
Services, Inc. included in the Annual Report (Form 10-KSB) for the year ended
December 31, 1996.
ERNST & YOUNG LLP
San Jose, California
March 27, 1997
