-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WbO6z3aVJb7MbmlE1nMIf5trYsHtnUb7a9fJli99r8elgl5LcVkHOTkD7ESUByH2 3FWiBMEfDhINRmag57gLAw== 0000912057-99-009184.txt : 19991214 0000912057-99-009184.hdr.sgml : 19991214 ACCESSION NUMBER: 0000912057-99-009184 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991213 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EARTHLINK NETWORK INC /DE/ CENTRAL INDEX KEY: 0001061566 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING, DATA PROCESSING, ETC. [7370] IRS NUMBER: 582389244 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 333-52507 FILM NUMBER: 99773550 BUSINESS ADDRESS: STREET 1: 3100 NEW YORK DR CITY: PASADENA STATE: CA ZIP: 91107 BUSINESS PHONE: 6262962400 MAIL ADDRESS: STREET 1: 3100 NEW YORK DR CITY: PASADENA STATE: CA ZIP: 91107 10-Q/A 1 FORM 10-Q/A UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999 OR /_/ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER 000-20799 EARTHLINK NETWORK, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 58-2389244 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NUMBER) 3100 NEW YORK DRIVE, PASADENA, CALIFORNIA 91107 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE) (626) 296-2400 (REGISTRANT'S TELEPHONE, INCLUDING AREA CODE) -------------------- Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value -------------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ___ There were 32,597,732 shares of Common Stock outstanding as of September 30, 1999. EARTHLINK NETWORK, INC. QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1999 TABLE OF CONTENTS PART I Item 1. Financial Statements and Supplementary Data......................... 1 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................................... 6 Item 3. Quantitative and Qualitative Disclosures About Market Risk ......... 12 PART II Item 4. Submission of Matters to a Vote of Security Holders................. 12 Item 6. Exhibits and Reports on Form 8-K.................................... 13 PART I ITEM 1. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA EARTHLINK NETWORK, INC. CONDENSED CONSOLIDATED BALANCE SHEET ASSETS
DECEMBER 31, 1998 SEPTEMBER 30, 1999 ----------------- ------------------ (AUDITED) (UNAUDITED) (in thousands) Current assets: Cash and cash equivalents $ 140,864 $ 338,315 Accounts receivable, net 4,779 10,385 Prepaid expenses 4,147 5,785 Other assets 775 6,960 ----------------- ------------------ Total current assets 150,565 361,445 Other long-term assets 564 2,995 Property and equipment, net 35,206 52,139 Intangibles, net (Note 4) 80,006 26,933 ----------------- ------------------ $ 266,341 $ 443,512 ----------------- ------------------ ----------------- ------------------ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Trade accounts payable $ 14,818 $ 22,299 Accrued payroll and related expenses 8,934 9,274 Other accounts payable and accrued liabilities 20,372 23,690 Current portion of capital lease obligations 8,341 9,337 Deferred revenue 8,831 13,826 ----------------- ------------------ Total current liabilities 61,296 78,426 Long-term debt 7,701 9,201 ----------------- ------------------ Total liabilities 68,997 87,627 Stockholders' equity: Preferred stock 41 47 Common stock 291 326 Stock subscriptions receivable (1,041) - Additional paid-in capital 330,911 577,202 Warrants to purchase common stock 597 597 Accumulated deficit (133,455) (222,287) ----------------- ------------------ Total stockholders' equity 197,344 355,885 ----------------- ------------------ $ 266,341 $ 443,512 ----------------- ------------------ ----------------- ------------------
The accompanying notes are an integral part of these financial statements 1 EARTHLINK NETWORK, INC. CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- ------------------------- 1998 1999 1998 1999 --------- --------- --------- --------- (UNAUDITED) (in thousands, except per share data) Recurring revenues $ 46,877 $ 84,627 $ 109,957 $ 224,055 Other revenues 1,699 1,931 4,897 4,490 Incremental revenues 1,248 3,016 2,786 7,273 --------- --------- --------- --------- Total revenues 49,824 89,574 117,640 235,818 Cost of recurring revenues 20,619 33,398 52,261 95,494 Cost of other revenues 252 210 408 786 Sales and marketing 10,644 38,255 26,491 79,577 General and administrative 5,871 9,781 15,426 25,456 Operations and member support 15,078 25,748 36,248 71,282 Amortization and transaction costs (Note 4) 17,754 17,673 24,962 53,019 --------- --------- --------- --------- Total operating costs and expenses 70,218 125,065 155,796 325,614 --------- --------- --------- --------- Loss from operations (20,394) (35,491) (38,156) (89,796) Interest income 1,919 4,434 2,568 12,681 Interest expense (353) (308) (1,661) (1,040) --------- --------- --------- --------- Net loss (18,828) (31,365) (37,249) (78,155) Deductions for accretion dividends (Note 5) (3,276) (3,404) (4,330) (10,677) --------- --------- --------- --------- Net loss attributable to common stockholders $ (22,104) $ (34,769) $ (41,579) $ (88,832) --------- --------- --------- --------- --------- --------- --------- --------- Basic and diluted net loss per share (Note 3) $ (0.78) $ (1.07) $ (1.64) $ (2.78) --------- --------- --------- --------- --------- --------- --------- --------- Weighted average shares 28,458 32,383 25,292 31,925 --------- --------- --------- --------- --------- --------- --------- ---------
The accompanying notes are an integral part of these financial statements 2 EARTHLINK NETWORK, INC. CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------- ------------------------- 1998 1999 1998 1999 --------- --------- --------- --------- (UNAUDITED) (in thousands) Net cash provided by (used in) operating activities $ 2,462 $ (8,746) $ 14,398 $ (8,034) --------- --------- --------- --------- Cash flows from investing activities: Purchases of property and equipment (4,381) (11,422) (15,911) (33,625) Proceeds from sale of property and equipment - 1,195 - 1,416 Purchase of investment - (1,500) - (1,500) Purchase of intangible assets - - (9) - Transaction costs (449) - (8,861) - Net cash acquired from acquisition - - 23,750 - --------- --------- --------- --------- Net cash used in investing activities (4,830) (11,727) (1,031) (33,709) --------- --------- --------- --------- Cash flows from financing activities: Proceeds from issuance of notes payable - - 200 - Repayment of notes payable (120) - (4,507) - Proceeds from capital lease obligations 576 3,990 6,212 11,752 Principal payments under capital lease obligations (2,380) (3,801) (6,269) (9,257) Proceeds from issuance of common stock, net - - 105,329 183,099 Proceeds from stock options and warrants exercised 976 6,227 3,615 9,937 Proceeds from sale of redeemable preferred stock - - - 42,622 Proceeds from liquidation of subscription receivable - - - 1,041 --------- --------- --------- --------- Net cash (used in) provided by financing activities (948) 6,416 104,580 239,194 --------- --------- --------- --------- Net (decrease) increase in cash and cash equivalents (3,316) (14,057) 117,947 197,451 Cash and cash equivalents, beginning of period 137,713 352,372 16,450 140,864 --------- --------- --------- --------- Cash and cash equivalents, end of period $ 134,397 $ 338,315 $ 134,397 $ 338,315 --------- --------- --------- --------- --------- --------- --------- --------- Acquisition, net of cash acquired (Note 4): Issuance of convertible preferred stock $ 135,000 Transaction costs 9,914 Intangible assets (121,164) --------- Net cash acquired from acquisition $ 23,750 --------- ---------
The accompanying notes are an integral part of these financial statements 3 EARTHLINK NETWORK, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The condensed consolidated financial statements of EarthLink Network, Inc., which include the accounts of its wholly owned subsidiary, EarthLink Operations, Inc., (collectively, "EarthLink" or the "Company") for the three and nine month periods ended September 30, 1999 and the related footnote information are unaudited and have been prepared on a basis substantially consistent with the Company's audited financial statements as of December 31, 1998 contained in the Company's Annual Report on Form 10-K, as filed with the Securities and Exchange Commission (the "Annual Report"). All significant intercompany transactions have been eliminated. These financial statements should be read in conjunction with the audited consolidated financial statements and the related notes thereto contained in the Company's Annual Report. In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of normal recurring adjustments) which management considers necessary to present fairly the financial position of the Company at September 30, 1999 and the results of operations and of cash flows for the three month and nine month periods ended September 30, 1999. The results of operations for the three and nine month periods ended September 30, 1999 are not necessarily indicative of the results for the entire year ending December 31, 1999. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results may differ from those estimates. 2. RECLASSIFICATIONS Certain amounts in prior period financial statements have been reclassified to conform to the current period presentation. 3. NET LOSS PER SHARE The Company has adopted Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share" ("EPS"). SFAS No. 128 requires a dual presentation of basic and diluted EPS. Basic EPS represents the weighted average number of shares outstanding divided into net income attributable to common stockholders during a reported period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. However, the Company has not included potential common stock in the calculation of EPS as such inclusion would have an anti-dilutive effect. 4. INTANGIBLE ASSETS AND AMORTIZATION AND TRANSACTION COSTS In June 1998, the Company consummated its strategic alliance with Sprint Corporation (the "Sprint Transaction"). Intangible assets acquired in the Sprint Transaction are valued as follows: (IN THOUSANDS) --------------- Member base $ 65,000 Marketing and distribution agreement 20,000 Goodwill 36,164 --------------- $121,164 =============== The assets are being amortized on a straight-line basis over the estimated useful lives as follows: member base amortized over 18 months, the Marketing and Distribution Agreement amortized over 5 and 10 years, which are the life of the portion of the contract related to Sprint's provision of additional customers and the overall contract life relative to the co-branding feature, respectively, and the excess of consideration over the fair value of net assets acquired (goodwill) over 18 months. As such, the member base and goodwill will be fully amortized by December 31, 1999.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------ ------------------------------ 1998 1999 1998 1999 ------------ ------------ ------------ ------------ (in thousands) Member base $10,833 $10,833 $14,444 $32,500 Marketing and distribution agreement 813 813 1,083 2,438 Goodwill 6,108 6,027 8,038 18,081 ------------ ------------ ------------ ------------ Total $17,754 $17,673 $23,565 $53,019 ============ ============ ============ ============
In addition, a non-recurring Sprint Transaction cost of $1,397,000 was recorded in June 1998. 4 EARTHLINK NETWORK, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 5. DEDUCTIONS FOR ACCRETION DIVIDENDS ON CONVERTIBLE PREFERRED STOCK The Convertible Preferred Stock issued to Sprint pays liquidation dividends for the first five years in the form of increases in its Liquidation Value. The adjustments of $3.4 million and $10.7 million recorded during the three and nine month periods ended September 30, 1999, respectively, represent liquidation dividends of $2.2 million and $6.5 million, based on a 3% dividend and accretion dividends of $1.2 million and $4.2 million, respectively, related to the beneficial conversion feature of the Convertible Preferred Stock. 6. AGREEMENT TO MERGE WITH MINDSPRING ENTERPRISES In September 1999 EarthLink and MindSpring Enterprises Inc. agreed to merge into a newly formed public company, in a transaction to be accounted for as a pooling of interests, with MindSpring stockholders receiving one share of the new company stock for each share of MindSpring stock, and EarthLink stockholders receiving 1.615 shares of the new company stock in exchange for each share of EarthLink stock. The combined company will be known as EarthLink and will trade under the Nasdaq symbol "ELNK." Subject to certain conditions, including regulatory approvals and approval by both companies' stockholders, the transaction is expected to close in the first quarter 2000. 7. INVESTMENTS In July 1999, the Company committed to invest in eCompanies Venture Group, LP, ("EVG"), a limited partnership formed to invest in domestic emerging growth companies, and eCompanies LLC a partnership formed to create, develop and invest in Internet related ventures. EarthLink Founder and Chairman, Sky Dayton is a founding partner in both partnerships. In July 1999 EarthLink invested $1.5 million in EVG and has committed to invest an additional $8.5 million and $2.0 million in EVG and eCompanies, respectively. The investments are accounted for under the cost method of accounting as the Company does not have the ability to exercise significant influence over the partnerships' operating or financial policies. Any distributions of earnings from the partnerships, will be recorded as income when declared. 8. SACRAMENTO CALL CENTER In September 1999, the Company entered into a ten year lease for a facility to house its permanent Sacramento Call Center. Rent commitments for the 95,000 square feet of space are as follows:
YEAR ENDING DECEMBER 31, IN THOUSANDS ----------------------------- ------------ 1999 (from September 1, 1999) $ 591 2000 1,773 2001 1,963 2002 2,059 2003 2,116 2004 2,135 Thereafter 10,426 ------------ $ 21,063 ------------ ------------
5 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. This Report contains certain forward-looking statements with respect to the Company's operations, industry, financial condition and liquidity. These statements, which are typically introduced by phrases such as "the Company believes", "anticipates", "estimates" or "expects" certain conditions to exist, reflect management's best current assessment of a number of risks and uncertainties. The Company's actual results could differ materially from the results anticipated in these forward-looking financial statements as a result of certain factors described in this report. See "Safe Harbor Statement." THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE ACCOMPANYING UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES THERETO AND THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES THERETO CONTAINED IN THE ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998. OVERVIEW We are a leading Internet service provider, or ISP, providing reliable nationwide Internet access and related value-added services to our individual and business members. Our member base has grown rapidly, making us one of the world's leading ISPs. We believe this growth is the result of our efforts to enhance our members' Internet experience through simple, rapid and reliable access to the Internet, high quality service, and member support and enhanced services. At September 30, 1999, our member base included approximately 1,566,000 paying members and an additional 66,000 members having trial accounts. In September 1999 EarthLink and MindSpring Enterprises Inc. agreed to merge into a newly formed public company, in a transaction to be accounted for as a pooling of interests, with MindSpring stockholders receiving one share of the new company stock for each share of MindSpring stock, and EarthLink stockholders receiving 1.615 shares of the new company stock in exchange for each share of EarthLink stock. The combined company will be known as EarthLink and will trade under the Nasdaq symbol "ELNK." Subject to several conditions, including regulatory approvals, approval by both companies' shareholders, and certain third-party consents, the transaction is expected to close in the first quarter 2000. We provide our members with a core set of features through our standard Internet service, which provides unlimited Internet access and several related services for a $19.95 monthly fee. We also offer a variety of broadband and premium services to both our individual and business members. Recurring revenues, which are generally paid for in advance with credit cards, consist of monthly fees charged to members for Internet access and other ongoing services including business Web site hosting, national ISDN, LAN ISDN, DSL and frame relay connections and, in certain areas, cable access. We derive incremental revenues by leveraging the value of our member base and user traffic through promotional and content partnerships, online advertising, and electronic commerce. We recognize access fees and certain incremental revenues ratably over the period services are provided. Other revenues generally represent cancellation fees attributable to certain term marketing programs and one-time, non-refundable set up fees. Other revenues are recorded as earned. Cost of recurring revenues principally includes telecommunications costs and depreciation expense on equipment used in network operations for ongoing member services. Fees paid to third party providers for dial-up access to their respective nationwide systems of POPs are included in telecommunications costs. Cost of other revenues principally includes expenses associated with new member registration and cost of products sold. Cost of incremental revenues is immaterial and is included in cost of other revenues. 6 RESULTS OF OPERATIONS The following table sets forth the percentage of total revenues represented by certain items on the Company's statements of operations for the periods indicated:
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, -------------------- -------------------- 1998 1999 1998 1999 ---- ---- ---- ---- Revenues: Recurring revenues 94% 95% 94% 95% Other revenues 3 2 4 2 Incremental revenues 3 3 2 3 ---- ---- ---- ---- Total revenues 100% 100% 100% 100% Operating costs and expenses: Cost of recurring revenues 41 37 44 41 Cost of other revenues 1 - - - Sales and marketing 21 43 23 34 General and administrative 12 11 13 11 Operations and member support 30 29 31 30 Amortization and transaction costs (1) 36 20 21 22 ---- ---- ---- ---- 141 140 132 138 ---- ---- ---- ---- Loss from operations (41) (40) (32) (38) Interest income 3 5 - 5 ---- ---- ---- ---- Net loss (38%) (35%) (32%) (33%) ---- ---- ---- ---- ---- ---- ---- ---- EBITDA (2) 2% (14%) (4%) (9%) ---- ---- ---- ---- ---- ---- ---- ----
- ------------------- (1) Represents amortization expense for the periods ended September 30, 1999 and 1998 and a one time transaction cost of $1,397,000 resulting from the June 1998 Sprint transaction. (2) Represents earnings (loss) before depreciation and amortization, interest income and expense and income tax expense. EBITDA is not determined in accordance with generally accepted accounting principles, is not indicative of cash used by operating activities and should not be considered in isolation from an alternative to, or more meaningful than measures of performance determined in accordance with generally accepted accounting principles. RECURRING REVENUES The Company experienced substantial growth in revenues for the three and nine month periods ended September 30, 1999 as compared to the corresponding periods of 1998. The increase in recurring revenues of 80% from $46.9 million in the quarter ended September 30, 1998 to $84.6 million in the quarter ended September 30, 1999 was primarily due to an increase in the Company's member base from 815,000 at September 30, 1998 to 1,566,000 at September 30, 1999. 7 OTHER REVENUES
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30, ENDED SEPTEMBER 30, ------------------ INCREASE -------------------- INCREASE 1998 1999 (DECREASE) 1998 1999 (DECREASE) ------- ------- ---------- ------- ------- ---------- (in thousands) Dial-up set up fees $ 771 $ 493 $ (278) $ 2,310 $ 990 $ (1,320) Other fees 928 1,438 510 2,587 3,500 913 ------- ------- ---------- ------- ------- ---------- Total other revenues $ 1,699 $ 1,931 $ 232 $ 4,897 $ 4,490 $ (407) ------- ------- ---------- ------- ------- ---------- ------- ------- ---------- ------- ------- ----------
The decrease in dial-up set up fees was primarily due to the Company's willingness to waive set up fees for dial-up members acquired through certain marketing programs. The Company expects this trend to continue for dial-up set up fees. The increase in other fees was due to an increase in the number of premium services sold such as web-site hosting, broadband services and cancellation fees attributable to certain term marketing programs. INCREMENTAL REVENUES The Company continued to focus on deriving additional revenue from marketing activities targeted to its active member base. Incremental revenues increased 131% from $1.3 million to $3.0 million and 161% from $2.8 million to $7.3 million during the three and nine month periods ended September 30, 1999, respectively, as compared to the corresponding periods of 1998. The principal component of the Company's incremental revenue strategy is its Premier Partnership Program through which the Company offers and sells promotional packages that provide advertisers with access to the multiple points of contact EarthLink has with its members. The Company also sells content space and advertising on its various online properties such as the Personal Start Page and its bi-monthly print magazine, "bLink". COST OF RECURRING REVENUES
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30, -------------------------------------------- --------------------------------------------- PERCENT OF PERCENT OF PERCENT OF PERCENT OF RECURRING RECURRING RECURRING RECURRING 1998 REVENUES 1999 REVENUES 1998 REVENUES 1999 REVENUES -------- ---------- -------- ---------- -------- ---------- -------- ---------- (in thousands, except percentages) Recurring revenues $ 46,877 100% $ 84,627 100% $109,957 100% $224,055 100% Cost of recurring revenues 20,619 44 33,398 39 52,261 48 95,494 43
The decrease in the cost of recurring revenues as a percentage of recurring revenues was primarily due to the Company's ability to negotiate more favorable contracts with third party access providers and to effectively manage communications costs per member. COST OF OTHER REVENUES Cost of other revenues decreased 17% during the three months ended September 30, 1999 as compared to the corresponding period of 1998 due to a reduction in ISDN equipment sold to members and the price of ISDN service. Cost of other revenues increased 93% during the nine months ended September 30, 1999 as compared to the corresponding period of 1998 due to increases in royalties paid to software vendors and the costs of providing a electronic commerce. 8 SALES AND MARKETING Sales and marketing expenses consist primarily of advertising, direct response mailings, sales compensation, bounties, communications costs related to trial members, salaries and the cost of promotional material. Sales and marketing expenses increased 260% from $10.6 million to $38.2 million during the three month periods ended September 30, 1998 and 1999, respectively, and 200% from $26.5 million to $79.6 million in the nine months ended September 30, 1999 as compared to the same period in 1998. The increase was primarily due to management's increased emphasis on organic growth through marketing strategies including expanding sales and marketing efforts, increased sales commissions and increased marketing personnel headcount. Sales, marketing and other direct costs associated with the acquisition of members are generally expensed as incurred. OPERATIONS AND MEMBER SUPPORT Operations and member support expenses consist primarily of costs associated with technical support and member service, as well as costs associated with operating the data center and MIS functions to maintain member accounts. Operations and member support expenses increased 70% from $15.1 million to $25.7 million during the three month periods ended September 30, 1998 and 1999, respectively and 97% from $36.2 million to $71.3 million during the nine months ended September 30, 1998 and 1999, respectively. These increases reflect (1) the increase in members from 815,000 as of September 30, 1998 to 1,566,000 as of September 30, 1999, (2) the opening of the Company's two Sacramento call centers in April 1999 and September 1999 and (3) management's focus on retaining existing members by providing superior service and devoting significant resources to expanding technical support staff and network operations capabilities. The number of employees engaged in operations and member support activities was 1,553 and 1,633 at September 30, 1998 and 1999, respectively. GENERAL AND ADMINISTRATIVE General and administrative expenses consist primarily of costs associated with the accounting and human resources departments, professional expenses, bad debt, credit card processing and executive compensation. General and administrative expenses increased 66% from $5.9 million to $9.8 million during the three months ended September 30, 1998 and 1999, and 66% from $15.4 million to $25.5 million in the nine months ended September 30, 1999 as compared to the same period in 1998. The increase was primarily due to increases in payroll, depreciation expense and credit card processing fees. The rise in payroll costs was primarily due to growth in headcount. In October 1998, the Company occupied an additional 55,000 square feet of its data center facility, and monthly rent increased from $66,000 to $92,000. The increase in depreciation expense was due to the acquisition of office equipment and the build-out of leasehold improvements. The increase in credit card processing fees was due to the increase in the Company's member base and increases in fees charged by credit card companies. INTANGIBLE ASSETS AND AMORTIZATION AND TRANSACTION COSTS In June 1998, the Company consummated its strategic alliance with Sprint Corporation (the "Sprint Transaction"). Intangible assets acquired in the Sprint Transaction are valued as follows: (IN THOUSANDS) --------------- Member base $ 65,000 Marketing and distribution agreement 20,000 Goodwill 36,164 --------------- $121,164 =============== The assets are being amortized on a straight-line basis over the estimated useful lives as follows: member base amortized over 18 months, the Marketing and Distribution Agreement amortized over 5 and 10 years, which are the life of the portion of the contract related to Sprint's provision of additional customers and the overall contract life relative to the co-branding feature, respectively, and the excess of consideration over the fair value of net assets acquired (goodwill) over 18 months. As such, the member base and goodwill will be fully amortized by December 31, 1999.
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------ ------------------------------ 1998 1999 1998 1999 ------------ ------------ ------------ ------------ (in thousands) Member base $10,833 $10,833 $14,444 $32,500 Marketing and distribution agreement 813 813 1,083 2,438 Goodwill 6,108 6,027 8,038 18,081 ------------ ------------ ------------ ------------ Total $17,754 $17,673 $23,565 $53,019 ============ ============ ============ ============
In addition, a non-recurring Sprint Transaction cost of $1,397,000 was recorded in June 1998. 9 INTEREST INCOME Interest income increased from $1.9 million to $4.4 million and from $2.6 million to $12.7 million during the three and nine months ended September 30, 1998 and 1999, respectively. The increases were primarily due to an increase in average cash balances available for investment. INTEREST EXPENSE Interest expense decreased from $353,000 to $308,000 and from $1.7 million to $1.0 million during the three months and nine months ended September 30, 1998 and 1999, respectively. The decreases were primarily due to the aging of capital lease obligations. As capital lease obligations have aged, a greater portion of lease payments has been attributed to principal payments rather than interest expense. Furthermore, management has been able to obtain lower effective interest rates on new lease obligations. LIQUIDITY AND CAPITAL RESOURCES Cash used by operating activities was $8.7 million and $8.0 million during the three and nine month periods ended September 30, 1999, respectively. During the three months ended September 30, 1999, the effect of the Company's net loss of $31.4 million was offset by non-cash expenses, such as depreciation and amortization expenses, of $23.1 million. During the nine months ended September 30, 1999, the Company's net loss of $78.2 million was offset by non-cash expenses, such as depreciation and amortization expenses of $68.1 million. Cash used in investing activities was $11.7 million and $33.7 million during the three and nine month periods ended September 30, 1999, respectively. Capital equipment purchases were $11.4 million and $33.6 million during the three and nine month periods ended September 30, 1999, respectively. Cash proceeds from sales of capital equipment were $1.2 million and $1.4 million during the three and nine month periods ended September 30, 1999, respectively. In September 1999 the Company made an initial investment in a limited partnership of $1.5 million. Cash provided by financing activities was approximately $6.4 million and $239.2 million during the three and nine month periods ended September 30, 1999, respectively. Proceeds from the exercise of stock options and warrants were $6.2 million during the three months ended September 30, 1999. Proceeds and principal payments under capital leases were $4.0 million and $3.8 million, respectively, during the three months ended September 30, 1999. Sale leaseback transactions are recorded at cost, which approximates the fair market value of the property and, therefore, no gains or losses are recorded. The property continues to be depreciated by the Company. A financing obligation representing the proceeds is recorded and reduced based upon payments under the lease agreement. Proceeds from the exercise of stock options and warrants were $9.9 million during the nine months ended September 30, 1999. In January 1999, the Company completed a follow on public offering of 2.4 million shares of its Common Stock at $73.63 per share. In conjunction with the offering, Sprint exercised its preemptive rights to maintain its existing ownership level in the Company. Accordingly, Sprint purchased 808,000 shares of which 201,000 shares were Common Stock and 607,000 shares were Series B Convertible Preferred Stock (having the same rights and preferences as the Series A Convertible Preferred Stock already held by Sprint). Net proceeds from the sale of Common Stock were $183.1 million. Net proceeds from the sale of Series B Convertible Preferred Stock to Sprint were approximately $42.6 million. Proceeds and principal payments under capital leases were $11.8 million and $9.3 million, respectively, during the nine months ended September 30, 1999. As of September 30, 1999, the Company had cash and cash equivalents of approximately $338.3 million. The Company believes that available cash will be sufficient to meet the Company's operating expenses and capital requirements for the next 12 months. EarthLink has available a $50 million credit facility from Sprint in the form of convertible senior debt, increasing to $100 million by June 5, 2001, at an interest rate of 6% per annum. The Company's capital requirements depend on numerous factors, including the rate of market acceptance of the Company's services, the Company's ability to maintain and expand its member base, the rate of 10 expansion of the Company's network infrastructure, the level of resources required to expand the Company's marketing and sales programs, information systems and research and development activities, the availability of hardware and software provided by third-party vendors and other factors. YEAR 2000 Many existing computer programs use only two digits to identify a year. These programs were designed and developed without addressing the impact of the upcoming change in the century. If not corrected, many computer software applications could fail or create erroneous results by, at or beyond the year 2000. We utilize software, computer technology and other services internally developed and provided by third-party vendors that may fail due to the year 2000 phenomenon. For example, we are dependent on the institutions involved in processing our members' credit card payments for Internet services. We are also dependent on telecommunications vendors and leased dial up access vendors to maintain network reliability. We have completed our assessment of the year 2000 readiness of our third-party supplied software, computer technology and other services. Based upon testing and vendor supplied documentation, we believe that all of our material third party providers are year 2000 compliant and that all other providers are substantially ready. We tested our own proprietary software and internal systems and determined them to be year 2000 compliant. We anticipate that our systems, including components thereof provided by third-party vendors, will operate properly when the year 2000 event occurs. The most reasonably likely worst-case year 2000 scenario would be for one or more of our network service providers to fail thereby making it difficult or impossible for members to dial-up and access the Internet; however, we maintain agreements with several nationwide network service providers including UUNET, Sprint, PSINet and Level 3, and have the ability to switch our members among the networks of these providers. Therefore, should any of these providers be unable to provide our members with Internet access as a result of year 2000 problems, we believe our redundant network arrangements will adequately accommodate our dial-up access needs. Total costs incurred in connection with our year 2000 readiness efforts have been and are expected to continue to be minimal. 11 "SAFE HARBOR" STATEMENT The Management's Discussion and Analysis and other portions of this Report include "forward looking" statements within the meaning of the federal securities laws that are subject to future events, risks and uncertainties that could cause actual results to differ materially from those expressed or implied. Important factors that ether individually or in the aggregate could cause actual results to differ materially from those expressed include, without limitation, (1) that the Company will not retain or grow its member base, (2) that the Company will fail to be competitive with existing and new competitors, (3) that the Sprint alliance will not be as beneficial to the Company as management anticipates, (4) that the Company will not be able to sustain its current growth, (5) that the Company will not adequately respond to technological developments impacting the Internet, (6) that needed financing will not be available to the Company if and as needed, (7) that a significant change in the growth rate of the overall U.S. economy will occur, such that consumer and corporate spending are materially impacted, (8) that a significant reversal in the trend toward increased usage of the Internet will occur, and (9) that the Company or its vendors and suppliers may fail to timely achieve Year 2000 readiness such that there is a material adverse impact on the business, operations or financial results of the Company, (10) that a drastic negative change in the market conditions may occur, or (11) that some other unforeseen difficulties may occur. This list is intended to identify only certain of the principal factors that could cause actual results to differ materially from those describe in the forward-looking statements included herein. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 12 PART II ITEM 6. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Exhibits. The following exhibits are filed as part of this report: EXHIBIT NO. DESCRIPTION ----------- ----------- 2.1 Agreement and Plan of Reorganization, dated September 22, 1999, among EarthLink Network, Inc., MindSpring Enterprises, Inc. and WWW Holdings, Inc. (incorporated by reference to Exhibit 2.1 of the Company's Report on Form 8-K, File No. 333-52507). 2.2 Stock Option Agreement, dated September 22, 1999, between MindSpring Enterprises, Inc. and EarthLink Network, Inc. (incorporated by reference to Exhibit 2.2 of the Company's Report on Form 8-K, File No. 333-52507). 2.3 Stock Option Agreement, dated September 22, 1999, between EarthLink Network, Inc. and MindSpring Enterprises, Inc. (incorporated by reference to Exhibit 2.3 of the Company's Report on Form 8-K, File No. 333-52507). 2.4 Form of EarthLink Stockholder Agreements, dated September 22, 1999, between certain stockholders and EarthLink Network, Inc. (incorporated by reference to Exhibit 2.4 of the Company's Report on Form 8-K, File No. 333-52507). 2.5 Form of MindSpring Stockholder Agreement, dated September 22, 1999, between certain stockholders and MindSpring Enterprises, Inc. (incorporated by reference to Exhibit 2.5 of the Company's Report on Form 8-K, File No. 333-52507). 2.6 Press Release, dated September 23, 1999, announcing execution of a definitive agreement to merge with MindSpring Enterprises, Inc. (incorporated by reference to Exhibit 2.6 of the Company's Report on Form 8-K, File No. 333-52507). 10.1 Lease agreement between EarthLink Network Inc. and Prentiss Properties Natomas, L.P. a Delaware limited partnership. 27.1 Financial Data Schedule. (b) Reports on Form 8-K. See the Company's Report on Form 8-K, File No. 333-52507 filed September 30, 1999. 13 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. EARTHLINK NETWORK, INC. Date: November 15, 1999 /s/ CHARLES G. BETTY --------------------- -------------------------------------------- Charles G. Betty, President, Chief Executive Officer and Director Date: November 15, 1999 /s/ GRAYSON L. HOBERG --------------------- -------------------------------------------- Grayson L. Hoberg, Senior Vice President - Finance and Administration and Chief Financial Officer Date: November 15, 1999 /s/ RICHARD A. QUIROGA --------------------- -------------------------------------------- Richard A. Quiroga, Vice President, Corporate Controller 14 -----END PRIVACY-ENHANCED MESSAGE-----