Earthlink scrambles to fund expansion.

EarthLink Network Inc., the Pasadena-based internet service provider, is going through some growing pains as it fights for market share.

Last month, Earthlink's quest for more cash to fuel its growth led it to say - mistakenly - in its second quarter earnings report that it did not have sufficient cash on hand. The company's stock price subsequently fell from $12 to $11.63 the day of the announcement and then drifted down another dollar over the next 10 days before recovering to almost $12 late last week.

EarthLink refiled a revised version of its quarterly report with the Securities and Exchange Commission, saying it did have enough cash to operate and that the previous report was incorrect.

EarthLink is a mid-sized Internet service provider - smaller than major industry players like Netcom Communications Services Inc. and America On-Line. Its most direct competitor is MindSpring Enterprises Inc. of Atlanta. Unlike the major players, EarthLink and MindSpring both lease the phone lines, modem hanks and other equipment necessary to run an Internet service from other service providers.

According to EarthLink Chief Executive Garry Betty, the company is close to completing a private placement in which investors will agree to put $10 million into the company.

So far, he said, EarthLink has received commitments for about $9 million.

Investor George Soros, who already holds roughly 10 percent of EarthLink shares, has committed $5 million toward the private placement, an Earthlink spokesman said. Three EarthLink board members have also announced their commitments to the placement.

"We hope to have the placement completed by the end of September," Betty said. "Any short-term concerns we have about financing we are addressing."

Betty said the error on the quarterly earnings report was the result of "overcautious attorneys who disclosed the worst-case scenario as part of our attempt to raise funds.

"We have enough money on hand to meet our needs through the end of the year," he added. "But we will need additional money come January."

The $10 million would be used to continue to build the company's Internet infrastructure to accommodate a rapidly expanding subscriber base.

"It costs about $15 per subscriber each month to provide Internet service. We charge $20 a month," Betty said. "That leaves us a margin of $5 a month, which is great as long as we don't have to spend $6.4 million to lay the groundwork for future subscribers."

Betty said the company has spent $6.4 million so far this year on capital improvements, including building a new data center in Pasadena.

Betty said that the operating margin will continue to be insufficient for the company's capital needs until the subscriber base reaches about 500,000 people some time next year. Currently, EarthLink has about 340,000 customers.

Growing pains in the Internet service provider industry are by no means limited to EarthLink. Many of its competitors - including Netcom, PSINet and MindSpring - have seen their revenues rise rapidly; however, their expenses have gone up faster as they have sought new customers and expanded their networks.

"Most of the companies I follow have either just gone through this stage or are going through it right now," said David Takata, who tracks Internet service providers at Gruntal & Co.

"At this stage, acquisitions and mergers look good to these kinds of companies," Takata added.

In recent months, GTE Corp. acquired BBN Planet, and Intermedia Communications Inc. purchased Digex Inc. Also, PSINet recently sold a 20 percent stake to IIXC Inc.

However, EarthLink's Betty said there were no plans to merge with another company or sell a stake in the company to outside investors.

As for EarthLink's stock price, Takata said that stock values for the entire industry have trended down. "Most Internet service providers are now trading at below their initial public offering level because of concerns about the ability of companies in the industry to turn a profit."

Takata said he is particularly concerned about Microsoft's entry into the Internet market through content agreements. "They offer a comparable price and get pretty nice content for it. With their history of exclusive agreements, all other Internet service providers could be hurt."

EarthLink's most recent drop, he said, was in line with other Internet service providers.

In the second quarter, EarthLink reported $18.9 million in revenues, up nearly threefold from the second quarter of 1996. However, its operating expenses rose to $26.2 million, almost double the $13.4 million in the second quarter of 1996. Overall the company lost $7.8 million in the second quarter, compared with a loss of $6.8 million in the like period a year ago.