UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended: June 30, 1997
-------------
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _________ to _________
Commission File Number 0-25216
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
(Exact name of the 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)
Registrant's telephone number: (408) 881-3516
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No __
Number of shares outstanding of the registrant's common stock, par value $.01
per share, as of August 8, 1997 was 11,732,673.
1
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NETCOM ON-LINE COMMUNICATION SERVICES, INC.
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements . . . . . . . . . . . 3
Condensed Consolidated Balance Sheets as of
June 30, 1997 and December 31, 1996 . . . . . . . . . . . . . 3
Condensed Consolidated Statements of Operations and Other
Operating Data for the Three Months Ended June 30, 1997
and June 30, 1996 . . . .. . . . . . . . . . . . . . . . . . . 4
Condensed Consolidated Statements of Operations and Other
Operating Data for the Six Months Ended June 30, 1997
and June 30, 1996 . . . . . . . . . . . . . . . . . . . . . . 5
Condensed Consolidated Statements of Cash Flows
for the Six Months Ended June 30, 1997
and June 30, 1996 . . . . . . . . . . . . . . . . . . . . . . 6
Notes to Condensed Consolidated Financial Statements . . . . . . . 7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations . . . . . . . 10
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . 18
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . 18
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
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
customer acquisition and retention. For a discussion of such risks, see "Risk
Factors" on page 15. 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.
2
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PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
<TABLE>
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<CAPTION>
June 30, December 31,
1997 1996
--------- -----------
(Unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents ........................................ $ 69,614 $ 73,408
Short term investments ........................................... 413 849
Accounts receivable, net ......................................... 2,008 1,284
Prepaid expenses and other current assets ........................ 3,384 2,948
--------- ---------
Total current assets ................................... 75,419 78,489
Property and equipment at cost, net .............................. 82,147 84,373
Deferred subscriber acquisition costs, net ....................... 2,868 5,595
Deposits and other assets ........................................ 1,042 1,177
--------- ---------
Total assets ...................................... $ 161,476 $ 169,634
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Trade accounts payable ........................................... $ 7,611 $ 7,517
Accrued payroll and related expenses ............................. 3,749 3,727
Other accrued expenses and liabilities ........................... 12,516 10,669
Deferred revenue ................................................. 4,360 2,930
Short term capital lease obligations ............................. 2,213 --
--------- ---------
Total current liabilities .............................. 30,449 24,843
--------- ---------
Long term capital lease obligations .............................. 4,297 --
--------- ---------
Commitments and contingencies
Stockholders' equity:
Common stock ............................................... 117 116
Additional paid-in capital ................................. 206,373 205,506
Accumulated deficit ........................................ (80,432) (62,042)
Cumulative translation adjustment and other ................ 672 1,211
--------- ---------
Total stockholders' equity ............................. 126,730 144,791
--------- ---------
Total liabilities and stockholders' equity ........ $ 161,476 $ 169,634
========= =========
See accompanying notes
</TABLE>
<PAGE>
<TABLE>
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS AND
OTHER OPERATING DATA
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<CAPTION>
Three Months Ended
---------------------
June 30, June 30,
1997 1996
-------- --------
(unaudited)
<S> <C> <C>
Revenues .................................. $ 41,020 $ 28,023
Costs and expenses:
Cost of revenues ........................ 29,151 20,531
Product development ..................... 1,683 1,391
Sales and marketing ..................... 13,057 12,549
General and administrative .............. 5,718 6,495
Restructuring and related charges ....... 1,712 --
-------- --------
Total costs and expenses .............. 51,321 40,966
-------- --------
Loss from operations ...................... (10,301) (12,943)
Gain (loss) on investment ................. 256 (1,200)
Interest income and other ................. 872 1,552
-------- --------
Loss before provision for income taxes .... (9,173) (12,591)
Provision for income taxes ................ 6 3
-------- --------
Net loss .................................. $ (9,179) $(12,594)
======== ========
Net loss per share ........................ $ (0.79) $ (1.09)
======== ========
Shares used in computing net loss per share 11,683 11,534
======== ========
OTHER OPERATING DATA:
EBITDA (See Note 8) ..................... $ (1,406) $ (7,611)
======== ========
Approximate number of subscribers at
end of period ........................ 560 479
======== ========
See accompanying notes
</TABLE>
<PAGE>
<TABLE>
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND OTHER OPERATING DATA
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<CAPTION>
Six Months Ended
----------------------
June 30, June 30,
1997 1996
--------- ---------
(unaudited)
<S> <C> <C>
Revenues ............................................ $ 80,025 $ 52,125
Costs and expenses:
Cost of revenues .................................. 57,550 37,161
Product development ............................... 3,287 2,644
Sales and marketing ............................... 26,942 22,283
General and administrative ........................ 11,346 11,283
Restructuring and related charges ................. 1,712 --
--------- ---------
Total costs and expenses ........................ 100,837 73,371
--------- ---------
Loss from operations ................................ (20,812) (21,246)
Gain (loss) on investment ........................... 633 (1,200)
Interest income ..................................... 1,802 3,285
--------- ---------
Loss before provision for income taxes .............. (18,377) (19,161)
Provision for income taxes .......................... 13 7
--------- ---------
Net loss ............................................ $ (18,390) $ (19,168)
========= =========
Net loss per share .................................. $ (1.58) $ (1.68)
========= =========
Shares used in computing net loss per share ......... 11,679 11,379
========= =========
Other operating data:
EBITDA (See Note 8) ............................... $ (2,656) $ (10,637)
========= =========
Approximate number of subscribers at
end of period .................................. 560 479
========= =========
See accompanying notes
</TABLE>
<PAGE>
<TABLE>
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<CAPTION>
Six Months Ended
----------------------
June 30, June 30,
1997 1996
--------- ---------
(unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net loss ............................................................. $(18,390) $(19,168)
Adjustments to reconcile net loss to net cash
used in operating activities:
Non-cash portion of restructuring charges ........................ 992 --
Depreciation and amortization .................................... 17,523 11,809
Loss on disposal of assets ....................................... 55 124
(Gain) loss on investments ....................................... (634) 1,200
Changes in assets and liabilities:
Accounts receivable, net ....................................... (724) (965)
Prepaid expenses and other current assets ...................... (436) (1,704)
Deferred subscriber acquisition costs, net ..................... (3,160) (7,909)
Deposits and other assets ...................................... 135 (264)
Trade accounts payable ......................................... 120 5,790
Accrued payroll and related expenses ........................... 22 1,261
Other accrued expenses and liabilities ......................... 1,847 3,336
Deferred revenue ............................................... 1,430 1,505
-------- --------
Total adjustments ................................................ 17,170 14,183
-------- --------
Net cash used in operating activities .................................. (1,220) (4,985)
-------- --------
Investing activities
Purchase of property and equipment ................................... (5,340) (31,239)
Proceeds from sale of short term investments ......................... 836 --
Proceeds from property and equipment insurance settlement ............ 253 --
Investment in McKinley ............................................... -- (500)
-------- --------
Net cash used in investing activities .................................. (4,251) (31,739)
-------- --------
Financing activities
Proceeds from issuance of debt ....................................... 1,578 --
Repayment of debt..................................................... (601) --
Proceeds from exercise of stock options and purchases under
employee stock purchase plan ....................................... 868 1,482
-------- --------
Net cash provided by financing activities .............................. 1,845 1,482
-------- --------
Net decrease in cash and cash equivalents .............................. (3,626) (35,242)
Effects of exchange rates on cash ...................................... (168) 85
Cash and cash equivalents at beginning of period ....................... 73,408 146,001
-------- --------
Cash and cash equivalents at end of period ............................. $ 69,614 $110,844
======== ========
Supplemental disclosures of cash flow information
Interest paid .......................................................... $ 172 $ -
======== ========
Income taxes paid ...................................................... $ 13 $ 7
======== ========
Supplemental information on noncash investing and financing activities:
Purchases of equipment under capital lease obligations ................. $ 5,533 $ -
======== ========
See accompanying notes
</TABLE>
<PAGE>
NETCOM ON-LINE COMMUNICATION SERVICES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. INTERIM PERIODS
The unaudited interim information has been prepared on the same basis
as the annual consolidated financial statements and, in the opinion of the
Company's management, reflects normal recurring adjustments necessary for a fair
presentation of the information for the periods presented. Operating results for
any quarter are not necessarily indicative of results for any future periods.
The following information should be read in conjunction with the financial
statements and the notes contained in the Company's Annual Report on Form 10-KSB
for the year ended December 31, 1996.
2. DEFERRED SUBSCRIBER ACQUISITION COSTS, NET
Subscriber acquisition costs, which relate directly to potential
subscribers, are recorded separately from ordinary operating costs and do not
include indirect 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.
The Company capitalized subscriber acquisition costs of approximately
$1,846,000 and $4,889,000 for the three months ended June 30, 1997 and June 30,
1996, respectively. Amortization and write-offs of deferred subscriber
acquisition costs for the three months ended June 30, 1997 and June 30, 1996 was
$2,759,000 and $2,423,000, respectively. The Company capitalized subscriber
acquisition costs of approximately $3,072,000 and $7,909,000 for the six months
ended June 30, 1997 and June 30, 1996, respectively. Amortization and write-offs
of deferred subscriber acquisition costs for the six months ended June 30, 1997
and June 30, 1996 was $5,799,000 and $4,393,000, respectively.
3. PROPERTY AND EQUIPMENT AT COST, NET
<TABLE>
Property and equipment consist of the following (in thousands):
<CAPTION>
June 30, December 31,
-------- ------------
1997 1996
---- ----
(unaudited)
<S> <C> <C>
Property and equipment at cost $ 117,330 $ 107,476
Less: accumulated depreciation and
amortization (35,183) (23,103)
-------- --------
Property and equipment at cost, net $ 82,147 $ 84,373
======== ========
</TABLE>
7
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4. NET LOSS PER SHARE
Net loss per share is computed using the weighted average number of
shares of common stock and dilutive common stock equivalent shares from stock
options (using the treasury stock method).
In February 1997, the Financial Accounting Standards Board issued
Statement No. 128, ("SFAS 128") "Earnings per Share," which the Company is
required to adopt on December 31, 1997. SFAS 128 requires changes to the method
currently used to compute earnings per share and to restate all prior periods.
The new requirements for calculating primary earnings per share exclude the
dilutive effect of stock options. The impact of SFAS 128 on the calculation of
historically reported primary or fully diluted earnings per share for the period
subsequent to the Company's initial public offering is not expected to be
material, as the Company has recorded losses and has therefore excluded the
impact of stock options, as these would have been anti-dilutive.
5. STOCKHOLDERS' EQUITY
<TABLE>
The components of the stockholders' equity are as follows (in
thousands, except share amounts):
<CAPTION>
Cumulative
Common Additional Translation Total
Stock Paid-In Accumulated Adjustment Stockholders'
Shares Amount Capital Deficit and Other Equity
------------ ------------ --------------- --------------- ------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996 11,630,900 $ 116 $ 205,506 $ (62,042) $ 1,211 $ 144,791
Issuance under employee stock
purchase plan 36,200 1 411 - - 412
Exercise of stock options 47,500 - 456 - - 456
Cumulative translation
adjustment - - - - (234) (234)
Unrealized gain - - - - (305) (305)
Net loss - - - (18,390) - (18,390)
------------ ------------ --------------- --------------- ------------- -------------
Balance at June 30, 1997 11,714,600 $ 117 $ 206,373 $ (80,432) $ 672 $ 126,730
============ ============ =============== ================ ============= =============
</TABLE>
6. RESTRUCTURING AND RELATED CHARGES
Restructuring and related charges of $1,712,000 during 1997 are the
result of a decision by management to restructure operations of the Company's
subsidiary in the United Kingdom. The restructure charge includes $720,000 in
accrued expenses for costs to terminate excess leased office facilities, a
$356,000 write-down of previously capitalized deferred subscriber acquisition
costs and a $636,000 write-off of office equipment, furniture and building
improvements as a result of consolidating office space. Additionally, the
Company will terminate certain employees of the United Kingdom subsidiary,
resulting in a third quarter 1997 charge for severance costs of approximately
$200,000.
8
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7. INCOME TAXES
The provision for income taxes for the three months ended June 30, 1997
and 1996, in the amount of $6,000 and $3,000, respectively, and for the six
months ended June 30, 1997 and 1996 in the amount of $13,000 and $7,000,
respectively, consists entirely of international and state minimum taxes since
the Company incurred pre-tax losses in each period.
8. OTHER OPERATING DATA
Earnings before interest, taxes, depreciation and amortization
("EBITDA") has been included in other operating data. The Company believes
EBITDA is a cash flow 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.
9
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following information should be read in conjunction with the
condensed consolidated financial statements and the notes thereto included in
Item 1 of this Quarterly Report, and the financial statements and the notes
thereto and Management's Discussion and Analysis of Financial Condition and
Results of Operations contained in the Company's Annual Report on Form 10-KSB
for the year ended December 31, 1996.
OVERVIEW
The Company's revenues are derived from providing Internet solutions to
business and individual customers, principally through monthly dial-up,
dedicated connection and web hosting services. Revenues from monthly
subscriptions have increased substantially since the Company's inception as a
result of increases in the Company's customer base and diversification of
product offerings. Customer growth has resulted from the growth of the Internet
services market generally, the expansion of the Company's services and
distribution channels and the increase in the Company's local access numbers.
Currently, sales to small businesses and individuals represent a
majority of the Company's revenues. Small business and individual revenues are
comprised primarily of recurring dial-up, web site hosting and dedicated
connection revenues. Revenues from dedicated connections include recurring
revenue and usage charges. In addition, the Company also receives revenues from
non-access services, primarily from business customers. These revenues include,
virtual web server hosting, domain name services and equipment sales. The
Company charges set-up fees on certain of these services. A majority of the
Company's accounts are billed monthly pursuant to a pre-authorized credit card
account or are prepaid annually.
The Company recently introduced new products designed to better meet
the needs of people using the Internet for small business applications. These
include products which provide greater dial-up access reliability and customer
support for additional monthly charges, dedicated line services to connect to
local area networks and web servers and web hosting services. The Company
believes that these services should result in higher average revenue per
subscriber in the future.
The Company is also committed to expanding its customer base by various
means, including developing relationships with corporate partners in order to
deliver new products and services to customers. The Company's ability to improve
revenues and operating margins will depend in part on its ability to attract new
customers and retain its existing customers. There can be no assurance that the
Company's investments in its telecommunications infrastructure, customer support
capabilities, new services offerings and software releases will ensure a high
level of customer retention. For more information on risks facing the Company,
see "Risk Factors" on page 15.
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 expects that it will
incur net losses for at least the next two to three years. The
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Company has operating subsidiaries in Canada and the United Kingdom and has
formed a joint-venture in Brazil with Grupo Itamarati, a Brazilian conglomerate.
There can be no assurance that revenue growth will continue or that the Company
will be able to achieve and then sustain profitability or positive cash flow.
RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 1997
REVENUES
Revenues increased by $12,997,000, or 46.4%, to $41,020,000 for the
three months ended June 30, 1997 from $28,023,000 for the three months ended
June 30, 1996. Revenues increased by $27,900,000, or 53.5%, to $80,025,000 for
the six months ended June 30, 1997 from $52,125,000 for the six months ended
June 30, 1996. The revenue increase was due to an increase in the number of
dial-up, dedicated and web hosting customers, which the Company attributes to
the growth in the Internet market generally, the Company's release of
enhancements to its software, and continued expansion of the Company's sales and
distribution activities. Additionally, the revenue increase was partially the
result of an increase in the average revenue per customer which resulted from an
increase in the mix of dedicated and web hosting customers relative to dial-up
customers and an increase in the amount of higher priced dial-up products.
During the second quarter of 1997, the Company experienced growth in non-dial up
services and a decrease in dial up accounts. The total number of customers
increased to approximately 560,000 accounts as of June 30, 1997 from
approximately 479,000 accounts as of June 30, 1996.
International revenues increased by $2,876,000 to $3,107,000 for the
three months ended June 30, 1997 compared to the same period in 1996.
International revenues increased by $5,228,000 to $5,486,000 for the six months
ended June 30, 1997 compared to the same period in 1996.
COST OF REVENUES
The Company's cost of revenues was $29,151,000 for the three months
ended June 30, 1997 and $20,531,000 for the three months ended June 30, 1996,
decreasing to 71.1% from 73.3% of revenues, respectively. Domestic gross margin
for the quarter ended June 30, 1997 and June 30, 1996 was 32.2% and 32.3%,
respectively. Consolidated gross margin for the same period was 28.9% and 26.7%,
respectively. The decrease in consolidated cost of revenues as a percentage of
revenues was primarily attributable to the Company's increase in international
customers to more fully utilize the network and data communication capacity and
decreases in payroll expenses and depreciation costs relative to revenues. The
Company's international operations cost of revenues for the three months ended
June 30, 1997 was $3,452,000, an increase of $1,739,000 over the same period in
1996. The Company expects that cost of revenues will continue to increase in
absolute dollars in the foreseeable future.
Cost of revenues was $57,550,000 for the six months ended June 30, 1997
and $37,161,000 for the six months ended June 30, 1996, increasing to 71.9% from
71.3% of revenues, respectively. Domestic gross margin for the six months ended
June 30, 1997 and June 30, 1996 was 31.7% and 33.2%, respectively. Consolidated
gross margin for the same period was 28.1% and
11
<PAGE>
28.7%, respectively. The increase in cost of revenue as a percentage of revenue
for the six month period is primarily attributable to increased customer usage,
the Company's international expansion, 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 Company's international operations cost of revenues for the
six months ended June 30, 1997 was $6,647,000, an increase of $4,146,000 over
the same period in 1996.
PRODUCT DEVELOPMENT
Product development expenses were $1,683,000 for the three months ended
June 30, 1997 and $1,391,000 for the three months ended June 30, 1996,
representing 4.1% and 5.0% of revenues, respectively. Product development
expenses were $3,287,000 for the six months ended June 30, 1997 and $2,644,000
for the six months ended June 30, 1996, representing 4.1% and 5.1% of revenues,
respectively. International product development expenses for the three and six
months ended June 30, 1997 were $294,000 and $592,000, respectively. The Company
plans to continue its expenditures on product development as the Company
develops new software products and upgrades existing products. It is expected
that product development expenses as a percentage of revenue will remain
relatively stable.
SALES AND MARKETING
Sales and marketing expenses increased $508,000, or 4.0%, to
$13,057,000 for the three months ended June 30, 1997 from $12,549,000 for the
three months ended June 30, 1996. Sales and marketing expenses increased
$4,659,000, or 20.9%, to $26,942,000 for the six months ended June 30, 1997 from
$22,283,000 for the six months ended June 30, 1996. Although sales and marketing
expenses increased in absolute dollars, as a percentage of revenues, the sales
and marketing expenses decreased to 31.8% from 44.8% of revenues, respectively,
during the quarter and decreased to 33.7% from 42.7%, respectively, during the
six months. The increase in absolute dollars was primarily due to increased
costs associated with the Company's international expansion, the addition of
management personnel and an increase in marketing programs. The decrease in
sales and marketing expenses as a percent of revenues was primarily due to
reduced subscriber acquisition costs and payroll expenses increasing more slowly
than revenues. Additionally, during 1997, the Company began selling disks and
charging the disk costs to cost of revenues as they were shipped. Prior to 1997,
certain disk costs were capitalized as deferred subscriber acquisition costs and
amortized to sales and marketing expense over twelve months, as the disks were
distributed free of charge.
International sales and marketing expenses (including costs incurred
domestically relating to international operations) increased by $776,000 to
$2,945,000 for the three months ended June 30, 1997 and by $2,540,000 to
$6,180,000 for the six months ended June 30, 1997 compared to the same periods
in 1996. Sales and marketing expenses are expected to continue to increase in
absolute dollars.
Certain of the Company's subscriber acquisition costs are capitalized
and amortized over a twelve-month period using the straight-line method. The
Company capitalized subscriber
12
<PAGE>
acquisition costs of approximately $1,846,000 and $4,889,000 for the three
months ended June 30, 1997 and June 30, 1996, respectively. Amortization and
write-offs of deferred subscriber acquisition costs for the three months ended
June 30, 1997 and June 30, 1996 was $2,759,000 and $2,423,000, respectively. The
Company capitalized subscriber acquisition costs of approximately $3,072,000 and
$7,909,000 for the six months ended June 30, 1997 and June 30, 1996,
respectively. Amortization and write-offs of deferred subscriber acquisition
costs for the six months ended June 30, 1997 and June 30, 1996 was $5,799,000
and $4,393,000, respectively.
GENERAL AND ADMINISTRATIVE
General and administrative expenses decreased $777,000, or 12.0%, to
$5,718,000 for the three months ended June 30, 1997 from $6,495,000 for the
three months ended June 30, 1996, decreasing to 13.9% from 23.2% of revenues,
respectively. The dollar decrease was primarily due to costs incurred during the
same period in 1996 in establishing the Company's subsidiary in the United
Kingdom, moving a significant portion of the Company's operations into new
buildings and incurring bad debt expenses from writing-off accounts receivable
balances determined to be uncollectable. The decrease as a percent of revenues
was primarily the result of payroll related expenses increasing more slowly than
revenues.
General and administrative expenses increased $63,000, or 0.6%, to
$11,346,000 for the six months ended June 30, 1997 from $11,283,000 for the six
months ended June 30, 1996, decreasing to 14.2% from 21.6% of revenues,
respectively. The dollar increase is the result of increases in payroll related
expenses, depreciation and costs of additional office space offset by
incremental facilities charges related to moving office space, costs incurred to
establish the Company's subsidiary in the United Kingdom and additional bad debt
expenses incurred in the same period in the prior year.
International general and administrative expenses decreased by $225,000
to $628,000 for the three months ended June 30, 1997 and increased by $53,000 to
$1,316,000 for six months ended June 30, 1997 compared to the same periods in
1996. General and administrative expenses are expected to increase in absolute
dollars in the future.
RESTRUCTURING AND RELATED CHARGES
Restructuring and related charges of $1,712,000 during the three and
six months ended June 30, 1997 are the result of a decision by management to
restructure operations of the Company's subsidiary in the United Kingdom. The
restructure charge includes $1,356,000 in accrued expenses for costs to
terminate excess leased office facilities and a write-off of office equipment,
furniture and building improvements as a result of consolidating office space
and a $356,000 write-down of previously capitalized deferred subscriber
acquisition costs. Additionally, the Company will terminate certain employees of
the United Kingdom subsidiary, resulting in a third quarter 1997 charge for
severance costs of approximately $200,000.
13
<PAGE>
INTEREST INCOME AND OTHER
Net interest income and other was $872,000 and $1,552,000,
respectively, for the three months ended June 30, 1997 and 1996. Net interest
income and other was $1,802,000 and $3,285,000, respectively, for the six months
ended June 30, 1997 and 1996. The decrease was due to the Company's lower
average cash and cash equivalents during 1997 as compared to the same period in
1996. In addition, during the three months ended June 30, 1997, the Company
incurred interest expense on capital leases of $130,000 and $172,000 for the
three and six month periods ended June 30, 1997, respectively, compared to
insignificant amounts incurred during the same periods in the prior year. The
Company invests its cash and cash equivalents primarily in high grade commercial
paper and United States treasury bills.
NET LOSS
Revenue growth and decreases in cost of revenues and operating
expenditures as a percentage of revenue, offset by international expansion and
restructuring charges related to the UK operations, resulted in reduced net
losses of $9,179,000 and $18,390,000, for the three months and six months ended
June 30, 1997, respectively, as compared to net losses of $12,594,000 and
$19,168,000 for the three and six months ended June 30, 1996, respectively.
International net losses for the three and six months ended June 30, 1997 were
$6,124,000 and $11,306,000 as compared to net losses of $4,554,000 and
$7,212,000 for the three and six months ended June 30, 1996, respectively.
The Company believes EBITDA (Earnings before interest, taxes,
depreciation and amortization) is a cash flow measure used by analysts,
investors and other interested parties in the on-line and Internet services
industries. EBITDA for the three and six months ended June 30, 1997, resulted in
reduced losses of $1,406,000 and $2,656,000, respectively, as compared to the
losses of $7,611,000 and $10,637,000 for the three and six months ended June 30,
1996. EBITDA for the three and six months ended June 30, 1997 was positive
$306,000 and a loss of $944,000, respectively, before restructuring and related
charges of $1,712,000.
LIQUIDITY AND CAPITAL RESOURCES
The Company has funded its operations to date primarily through cash
generated from collection of revenues and private and public sales of equity
securities. The Company's operating activities generated cash of approximately
$1,295,000 and $38,000 for the three months ended June 30, 1997 and June 30,
1996, respectively. The Company's operating activities used cash of
approximately $1,220,000 and $4,985,000 for the six months ended June 30, 1997
and June 30, 1996, respectively. During the six months ended June 30, 1997, cash
used in operating activities was primarily affected by the net loss and by
deferred subscriber acquisition costs. These uses of cash were primarily offset
by depreciation and amortization and increases in other accrued expenses and
liabilities and deferred revenue. During the six months ended June 30, 1996,
cash from operations was primarily used by the net loss and increases in prepaid
expenses and other current assets and deferred subscriber acquisition costs and
partially offset by depreciation and amortization and loss on investment and
increases in accounts payable, deferred revenue, accrued payroll and related
expenses and other accrued expenses and liabilities.
14
<PAGE>
Investing activities used cash of $2,951,000 and $21,009,000 for the
three months ended June 30, 1997 and June 30, 1996, respectively. Investing
activities used cash of $4,251,000 and $31,739,000 for the six months ended June
30, 1997 and June 30, 1996, respectively. The Company's investing activities
have consisted primarily of equipment purchases for new local access areas and
network expansion. Capital expenditures were $3,284,000 and $5,340,000 for the
three and six month periods ended June 30, 1997, respectively, which were offset
mainly by the sale of short term investments.
The Company's financing activities used cash of $105,000 and provided
cash of $592,000 for the three months ended June 30, 1997 and June 30, 1996,
respectively. Financing activities provided cash of $1,845,000 and $1,482,000
for the six months ended June 30, 1997 and June 30, 1996, respectively. For the
three months ended June 30, 1997, financing activities consisted primarily of
repayments of debt relating to the capital leases entered into during the period
which was partially offset by the exercise of stock options. During the six
months ended June 30, 1997, financing activities included $1,578,000 of proceeds
from issuance of debt relating to financing of equipment. For the three and six
month periods ended June 30, 1996, financing activities consisted primarily of
proceeds from the exercise of stock options and purchases under the employee
stock purchase plan.
Although the Company has no material capital commitments (other than
for its network expansion and operating infrastructure program), a substantial
portion of the proceeds of its May 1995 and November 1995 public offerings has
been used for, and the Company expects to continue to use cash for, additional
equipment purchases and subscriber acquisition costs.
As of June 30, 1997, the Company had cash and cash equivalents of
$69,614,000 and working capital of $44,970,000. The Company used $1,761,000 and
$3,626,000 for the three and six months ended June 30, 1997, respectively.
Although the Company may seek to secure additional funding in the future, the
Company believes that existing cash and cash equivalents, together with existing
sources of liquidity, will be sufficient to fund its operations, capital
expenditures, working capital and other cash requirements for the next year, in
the absence of material competitive or operating changes.
RISK FACTORS
The following factors, in addition to the factors discussed in the
Company's Report on Form 10-KSB for the fiscal year ended December 31, 1996 and
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, $44,265,000 for 1996 and $18,390,000 in the first six months of 1997, and
had an accumulated deficit of $80,432,000 as of June 30, 1997. The net loss
incurred during the six months ending June 30, 1997 included a loss of
$11,306,000 related to international operations.
15
<PAGE>
These losses are also reflected in the Company's operating margins,
which decreased from a loss of 0.8% for 1994 to a loss of 31% for 1995 and a
loss of 40% for 1996. During the first six months of 1997, the Company's
operating margin was a loss of 26%. The 1997 operating margins improvement was
due primarily to marketing and sales expenses and payroll expenses increasing at
a slower rate than revenues. The Company's current focus is on targeting the
business customer (individuals and groups), which the Company believes will
result in increased revenues per subscriber, although at reduced subscriber
growth rates. The Company anticipates continued increases in its expenses
related to product development, marketing, sales, general and administrative,
network and customer support. There can be no assurance that revenue growth will
continue or that in the future the Company will achieve or sustain profitability
or positive cash flow from operations.
Changes in the Company's customer base or in customers' 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 customers 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 customer basis.
The Company has adopted strategies designed to attract business
customers which 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.
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.
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 Internet Service Providers.
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 customers that could
result in increased sales and marketing expenses and related
16
<PAGE>
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 customers, 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.
NEW AND UNCERTAIN MARKET. The market for Internet connectivity services
and related software products is relatively new. 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.
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 numbers of customers, 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, in number of customers,
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 in some cases have 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.
17
<PAGE>
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of Stockholders on May 28, 1997, the holders of
10,187,915 shares of common stock, representing 87.2% of the total votes
eligible to be cast, adopted following proposals by the following margins
indicated:
<TABLE>
(1) The election of the following seven candidates for Director, to serve until
the next Annual Meeting of Stockholders:
<CAPTION>
Voted For Voted Against
--------- -------------
<S> <C> <C>
C. Lee Cox 9,978,255 209,660
David W. Garrison 9,963,961 223,954
Stephen J. Getsy 9,965,218 222,697
Daniel Goldman 9,789,867 398,048
Gary P. Madden 9,662,818 525,097
David P. Mixer 9,978,782 209,133
Charles C. Townsend, III 9,967,038 220,877
</TABLE>
<TABLE>
(2) The ratification of Ernst & Young LLP as the Company's independent
auditors for the 1997 fiscal year.
<CAPTION>
Voted For Voted Against Abstained
--------- ------------- ---------
<S> <C> <C> <C>
9,896,477 269,730 21,708
</TABLE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
27.1 Financial Data Schedule
b. Reports on Form 8-K.
None.
ITEMS 1, 2, 3 AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
NETCOM ON-LINE COMMUNICATION
SERVICES, INC.
Date: August 14, 1997 By /s/ David W Garrison
-----------------------------------------
David W. Garrison
Chairman of the Board, President and
Chief Executive Officer
By /s/ Clifton T. Weatherford
-----------------------------------------
Clifton T. Weatherford
Senior Vice President,
Chief Financial Officer and Secretary
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> APR-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 69,614
<SECURITIES> 413
<RECEIVABLES> 2,008
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 75,419
<PP&E> 117,330
<DEPRECIATION> (35,183)
<TOTAL-ASSETS> 161,476
<CURRENT-LIABILITIES> 30,449
<BONDS> 0
0
0
<COMMON> 117
<OTHER-SE> 126,730
<TOTAL-LIABILITY-AND-EQUITY> 161,476
<SALES> 41,020
<TOTAL-REVENUES> 41,020
<CGS> 29,151
<TOTAL-COSTS> 51,321
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
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<INCOME-PRETAX> (9,173)
<INCOME-TAX> 6
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<CHANGES> 0
<NET-INCOME> (9,179)
<EPS-PRIMARY> (0.79)
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