SECURITIES AND EXCHANGE COMMISSION
450 5th Street
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Date of Report: June 27, 1996
Date of Earliest
Event Reported: June 27, 1996
AMERICA ONLINE, INC.
(Exact name of registrant as specified in its charter)
Delaware 0-19836 54-1322110
(State of incorporation (Commission File Number) (IRS Employer
or organization) Identification No.)
8619 Westwood Center Drive, Vienna, Virginia 22182-2285
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (703) 448-8700
<PAGE>
Item 7. Financial Statements and Exhibits.
(a) Consolidated Financial Statements of America Online, Inc. as of June 30,
1995 and 1994 and for the three years ended June 30, 1995 to reflect the
acquisition of Johnson-Grace Company on February 1, 1996, accounted for using
the pooling of interests method.
Selected Financial Data to reflect the acquisition of Johnson-Grace Company
on February 1, 1996, accounted for using the pooling of interests method.
Management's Discussion and Analysis of Financial Condition and Results of
Operations to reflect the acquisition of Johnson-Grace Company on February 1,
1996, accounted for using the pooling of interests method.
(b) Pro forma financial information
None
(c) Exhibits
23.1 Consent of Ernst & Young LLP.
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
America Online, Inc.
We have audited the accompanying consolidated balance sheets of America
Online, Inc. as of June 30, 1995 and 1994, and the related consolidated
statements of operations, changes in stockholders' equity and cash flows for
each of the three years in the period ended June 30, 1995. The consolidated
financial statements give retroactive effect to the merger of America Online,
Inc. and Johnson-Grace Company on February 1, 1996, which has been accounted
for using the pooling of interests method as described in the notes to the
consolidated financial statements. These financial statements are the
responsibility of the management of America Online, Inc. 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of America Online,
Inc. at June 30, 1995 and 1994, and the consolidated results of their
operations and their cash flows for each of the three years in the period
ended June 30, 1995, after giving retroactive effect to the merger of Johnson-
Grace Company, as described in the notes to the consolidated financial
statements, in conformity with generally accepted accounting principles.
As discussed in Note 9 to the consolidated financial statements, in fiscal
1994 the Company changed its method of accounting for income taxes. As
discussed in Note 2 to the consolidated financial statements, in fiscal 1995
the Company changed its method of accounting for short-term investments in
certain debt and equity securities.
Ernst & Young LLP
Vienna, Virginia
February 1, 1996
<PAGE>
<TABLE>
AMERICA ONLINE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
Year ended June 30,
<S> <C> <C> <C>
1995 1994 1993
Revenues:
Online service revenues $358,498 $100,993 $38,462
Other revenues 35,792 14,729 13,522
Total revenues 394,290 115,722 51,984
Costs and expenses:
Cost of revenues 229,724 69,043 28,820
Marketing 77,064 23,548 9,745
Product development 14,263 5,288 3,080
General and administrative 42,700 13,667 8,637
Acquired research and development 50,335 - -
Amortization of goodwill 1,653 - -
Total costs and expenses 415,739 111,546 50,282
Income (loss) from operations (21,449) 4,176 1,702
Other income, net 3,074 1,810 441
Merger expenses 2,207 - -
Income (loss) before provision for
income taxes and extraordinary item (20,582) 5,986 2,143
Provision for income taxes (15,169) (3,832) (1,897)
Income (loss) before extraordinary
item (35,751) 2,154 246
Extraordinary item - tax benefit arising
from net operating loss carryforward - - 1133
Net income (loss) ($35,751) $2,154 $1,379
Earnings (loss) per share:
Income (loss) before extraordinary
item $ (0.51) $ 0.03 $ -
Net income (loss) $ (0.51) $ 0.03 $ 0.02
Weighted average shares outstanding 69,550 69,035 58,572
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
AMERICA ONLINE, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
June 30,
<S> <C> <C>
1995 1994
ASSETS
Current assets:
Cash and cash equivalents $45,877 $44,093
Short-term investments 18,672 24,052
Trade accounts receivable 32,176 8,547
Other receivables 11,381 2,286
Prepaid expenses and other current assets 25,527 5,759
Total current assets 133,633 84,737
Property and equipment at cost, net 70,919 20,414
Other assets:
Product development costs, net 18,949 7,912
Deferred subscriber acquisition costs, net 77,229 26,392
License rights, net 5,579 58
Other assets 9,121 2,823
Deferred income taxes 35,627 12,842
Goodwill, net 54,356 -
$405,413 $155,178
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 84,640 $ 15,662
Accrued personnel costs 2,863 926
Other accrued expenses and liabilities 23,509 13,076
Deferred revenue 20,021 4,488
Deferred income taxes 28,749 9,610
Revolving line of credit 484 1,690
Current portion of long-term debt and
capital lease obligations 1,845 606
Total current liabilities 162,111 46,058
Long-term liabilities:
Notes payable 17,369 5,836
Capital lease obligations 2,158 1,209
Deferred income taxes 6,878 3,232
Deferred rent 85 41
Total liabilities 188,601 56,376
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000
shares authorized, none issued - -
Common stock, $.01 par value, 300,000,000 shares
authorized, 76,728,269 and 63,103,176 shares
issued and outstanding at June 30, 1995
and 1994, respectively 767 631
Additional paid-in capital 252,668 99,567
Accumulated deficit (36,623) (1,396)
Total stockholders' equity 216,812 98,802
$ 405,413 $155,178
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
AMERICA ONLINE, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Amounts in thousands, except share data)
Additional
Common Stock Paid-in Accumulated
Shares Amount Capital Deficit Total
<S> <C> <C> <C> <C> <C>
Balances at June 30, 1992 46,271,560 $ 462 $ 26,019 $(4,870) $ 21,611
Exercise of common stock
options and warrants 3,290,576 33 856 - 889
Other - - 111 (59) 52
Tax benefit related to stock
options - - 6 - 6
Net income - - - 1,379 1,379
Balances at June 30, 1993 49,562,136 495 26,992 (3,550) 23,937
Common stock issued:
Exercise of options
and warrants 2,827,280 28 1,836 - 1,864
Sale of stock, net 10,713,760 107 66,149 - 66,256
Tax benefit related to stock
options - - 4,590 - 4,590
Net income - - - 2,154 2,154
Balances at June 30, 1994 63,103,176 630 99,567 (1,396) 98,801
Effect of immaterial
poolings 2,062,756 21 1,032 524 1,577
Balances as Restated 65,165,932 651 100,599 (872) 100,378
Common stock issued:
Exercise of options 2,905,256 29 4,655 - 4,684
Business acquisitions 4,785,354 48 75,653 - 75,701
Sale of stock, net 3,871,727 39 56,998 - 57,037
Tax benefit related to stock
options - - 14,763 - 14,763
Net loss - - - (35,751) (35,751)
Balances at June 30, 1995 76,728,269 $ 767 $ 252,668 $(36,623) $ 216,812
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
AMERICA ONLINE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
Year ended June 30,
1995 1994 1993
Cash flows from operating activities:
<S> <C> <C> <C>
Net income (loss) $(35,751) $2,154 $1,379
Adjustments to reconcile net income to net
Cash provided by operating activities:
Depreciation and amortization 12,266 2,822 1,957
Amortization of subscriber acquisition costs 60,924 17,922 7,038
Loss (Gain) on sale of property and equipment 37 5 (39)
Charge for acquired research and development 50,335 - -
Changes in assets and liabilities:
Trade accounts receivable (14,373) (4,266) (783)
Other receivables (9,085) (931) (966)
Prepaid expenses and other current assets (19,635) (2,873) (1,494)
Deferred subscriber acquisition costs (111,761) (37,424) (10,685)
Other assets (6,051) (2,542) (89)
Trade accounts payable 60,805 10,224 2,119
Accrued personnel costs 1,850 397 336
Other accrued expenses and liabilities 5,703 9,526 1,492
Deferred revenue 7,190 2,322 1,381
Deferred income taxes 14,763 3,832 759
Deferred rent 44 (52) (200)
Total adjustments 53,012 (1,038) 826
Net cash provided by operating activities 17,261 1,116 2,205
Cash flows from investing activities:
Short-term investments 5,380 (18,947) (5,105)
Purchase of property and equipment (59,255) (18,010) (2,041)
Product development costs (13,054) (5,131) (1,831)
Sale of property and equipment 180 95 62
Purchase costs of acquired businesses (20,523) - -
Net cash used in investing activities (87,272) (41,993) (8,915)
Cash flows from financing activities:
Proceeds from issuance of common stock, net 61,720 68,425 609
Principle and accrued interest payments
on revolving line of credit and
long-term debt (3,045) (7,795) (6,924)
Proceeds from line of credit
and issuance of long-term debt 13,488 14,260 7,181
Tax benefit from stock option exercises - - 6
Principal payments under capital lease
obligations (368) (83) (112)
Net cash provided by financing activities 71,795 74,807 760
Net increase (decrease) in cash and cash
equivalents 1,784 33,930 (5,950)
Cash and cash equivalents at beginning of
period 44,093 10,163 16,113
Cash and cash equivalents at end of period $ 45,877 $ 44,093 $10,163
Supplemental cash flow information
Cash paid during the period for:
Interest 1,076 577 194
Income taxes - - 15
See accompanying notes.
</TABLE>
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization
America Online, Inc. ("the Company") was incorporated in the State of
Delaware in May 1985. The Company, based in Vienna, Virginia, is a leading
provider of online services, offering its subscribers a wide variety of
services, including e-mail, online conferences, entertainment, software,
computing support, interactive magazines and newspapers, and online classes,
as well as easy and affordable access to services of the Internet. In
addition, the Company is a provider of data network services, new media and
interactive marketing services, and multimedia and CD-ROM production
services.
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
affiliates owned twenty percent or more and corporate joint ventures are
accounted for under the equity method. Other securities in companies owned
less than twenty percent are accounted for under the cost method.
Business Combinations - Business combinations which have been accounted
for under the purchase method of accounting include the results of operations
of the acquired business from the date of acquisition. Net assets of the
companies acquired are recorded at their fair value to the Company at the
date of acquisition.
Other business combinations have been accounted for under the pooling of
interests method of accounting. In such cases, the assets, liabilities, and
stockholders' equity of the acquired entities were combined with the
Company's respective accounts at recorded values. Prior period financial
statements have been restated to give effect to the merger unless the effect
of the business combination is not material to the financial statements of
the Company.
Revenue and cost recognition- Online service revenue is recognized over the
period services are provided. Other revenue, consisting principally of
marketing, data network and multimedia production services, as well as
development and royalty revenues, are recognized as services are rendered.
Deferred revenue consists principally of third-party development funding not
yet recognized and monthly subscription fees billed in advance.
Property and equipment- Property and equipment are depreciated or amortized
using the straight-line method over the estimated useful life of the asset,
which ranges from 5 to 40 years, or over the life of the lease.
Property and equipment under capital leases are stated at the lower of the
present value of minimum lease payments at the beginning of the lease term or
fair value at inception of the lease.
Deferred subscriber acquisition costs- Subscriber acquisition costs are
deferred and charged to operations over a twelve or eighteen month period
(straight-line method) beginning the month after such costs are incurred.
These costs, which relate directly to subscriber solicitations, principally
include printing, production and shipping of starter kits and the costs of
obtaining qualified prospects by various targeted direct marketing programs
(i.e., direct marketing response cards, mailing lists) and from third parties
are recorded separately from ordinary operating expenses. No indirect costs
are included in subscriber acquisition costs. To date, all subscriber
acquisition costs have been incurred for the solicitation of specific
identifiable prospects. Costs incurred for other than those targeted at
specific identifiable prospects for the Company's services, and general
marketing, are expensed as incurred.
The Company's services are sold on a monthly subscription basis. Subscriber
acquisition costs incurred to obtain new subscribers are recoverable from
revenues generated by such subscribers within a short period of time after
such costs are incurred.
Effective July 1, 1992, the Company changed, from twelve months to eighteen
months, the period over which it amortizes the cost of deferred subscriber
acquisition costs relating to marketing activities in which the Company's
starter kit is bundled with and distributed by a third-party marketing
company. The change in accounting estimate was made to more accurately match
revenues and expenses. Based on the Company's experience and the
distribution channels used in such marketing activities, there is a greater
time lag between the time the Company incurs the cost for the starter kits
and the time the starter kits begin to generate new customers than with
direct marketing activities. Also, the period over which new subscribers
(and related revenues) are generated is longer than that experienced with the
use of traditional independent, direct marketing activities. The effect of
this change in accounting estimate for the year ended June 30, 1993 was to
increase income before extraordinary item and net income by $264,000 ($.01
per share).
In the first quarter of fiscal 1995 the Company adopted the provisions of
Statement of Position ("SOP") 93-7 "Reporting on Advertising Costs" which
provides guidance on financial reporting on advertising costs. The adoption
of SOP 93-7 had no effect on the Company's financial position or results of
operations.
Product development costs- The Company capitalizes costs incurred for the
production of computer software used in the sale of its services. Costs
capitalized include direct labor and related overhead for software produced
by the Company and the costs of software purchased from third parties. All
costs in the software development process which are classified as research
and development are expensed as incurred until technological feasibility has
been established. Once technological feasibility has been established, such
costs are capitalized until the software is commercially available. To the
extent the Company retains the rights to software development funded by third
parties, such costs are capitalized in accordance with the Company's normal
accounting policies. Amortization is provided on a product-by-product basis,
using the greater of the straight-line method or current year revenue as a
percent of total revenue estimates for the related software product not to
exceed five years, commencing the month after the date of product release.
Product development costs consist of the following:
<TABLE>
Year ended June 30,
1995 1994
(in thousands)
<S> <C> <C>
Balance, beginning of year $ 7,912 $ 3,915
Costs capitalized 13,054 5,132
Costs amortized (2,017) (1,135)
Balance, end of year $ 18,949 $ 7,912
</TABLE>
The accumulated amortization of product development costs related to the
production of computer software totaled $7,902,000, and $5,885,000 at June
30, 1995 and 1994, respectively.
Included in product development costs are research and development costs
totaling $5,277,000, $2,453,000, and $1,297,000 and other product development
costs totaling $6,977,000, $1,050,000 and $579,000 in the years ended June
30,1995, 1994 and 1993, respectively.
License rights- The cost of acquired license rights is amortized using the
straight-line method over the term of the agreement for such license rights,
ranging from one to three years.
Goodwill - Goodwill consists of the excess of cost over the fair value of
net assets acquired and certain other intangible assets relating to purchase
transactions. Goodwill and intangible assets are amortized over periods
ranging from 5 - 10 years.
Operating lease costs- Rent expense for operating leases is recognized on a
straight-line basis over the lease term. The difference between rent expense
incurred and rental payments is charged or credited to deferred rent.
Cash, cash equivalents and short-term investments- The Company considers all
highly liquid investments with an original maturity of three months or less
to be cash equivalents. In fiscal 1995, the Company adopted Statement of
Financial Accounting Standards No. 115 ("SFAS 115"), "Accounting for Certain
Investments in Debt and Equity Securities." The adoption was not material to
the Company's financial position or results of operations. The Company has
classified all debt and equity securities as available-for-sale. Available-
for-sale securities are carried at fair value, with unrealized gains and
losses reported as a separate component of stockholders' equity. Realized
gains and losses and declines in value judged to be other-than-temporary on
available-for-sale securities are included in other income. Available-for-
sale securities at June 30, 1995, consisted of U.S. Treasury Bills and other
obligations of U.S. Government agencies totaling $7,579,000 and U.S.
Corporate Debt Obligations totaling $11,093,000. At June 30, 1995, the
estimated fair value of these securities approximated cost.
Net income (loss) per common share- Net income (loss) per share is
calculated by dividing income (loss) before extraordinary item and net income
(loss) by the weighted average number of common and, when dilutive, common
equivalent shares outstanding during the period.
Reclassification- Certain amounts in prior years' consolidated financial
statements have been reclassified to conform to the current year
presentation.
3. Business Combinations
Pooling transactions
On August 19, 1994, Redgate Communications Corporation ("RCC") was merged
with and into a subsidiary of the Company. The Company exchanged 3,578,600
shares of common stock for all of the outstanding common and preferred stock
and warrants of RCC. Additionally, 802,296 shares of the Company's common
stock were reserved for outstanding stock options issued by RCC and assumed
by the Company. The merger was accounted for under the pooling of interests
method of accounting, and accordingly, the accompanying consolidated
financial statements have been restated for all periods prior to the
acquisition to include the financial position, results of operations and cash
flows of RCC. Effective August 1994, RCC's fiscal year-end has been changed
from December 31 to June 30 to conform to the Company's fiscal year-end.
Revenues and net earnings (loss) for the individual entities are as follows:
<TABLE>
Three months ended
September 30, Year ended June 30,
(in thousands) 1994 (unaudited) 1994 1993
Total revenues:
<S> <C> <C> <C>
AOL $ 50,783 $104,410 $ 40,019
RCC 3,813 11,312 11,965
Less intercompany sales (173) - -
$ 54,423 $115,722 $51,984
Net income (loss):
AOL $ 2,828 $ 5,814 $ 4,057
RCC (42) (3,660) (2,678)
Merger expenses (1,710) - -
$ 1,076 $ 2,154 $1,379
</TABLE>
In connection with the merger of the Company and RCC, merger expenses of
$1,710,000 were recognized during 1995.
On February 1, 1996, the Company completed its merger with Johnson-Grace
Company (JG), in which JG became a wholly-owned subsidiary of the Company.
The Company issued 1,617,778 shares of its common stock for all the
outstanding common and preferred stock of JG. Additionally, 72,429 shares of
the Company's common stock were reserved for outstanding stock options issued
by JG and being assumed by the Company. The merger was accounted for as a
pooling of interests, and accordingly, the accompanying consolidated
financial statements have been restated for all periods prior to the
acquisition to include the financial position, results of operations and cash
flows of JG.
Revenues and net earnings (loss) for the individual entities are as follows:
<TABLE>
Year ended June 30,
(in thousands) 1995 1994 1993
Total revenues:
<S> <C> <C> <C>
AOL $ 394,290 $ 115,722 $ 51,984
JG - - -
$ 394,290 $ 115,722 $ 51,984
Net income (loss):
AOL $ (33,647) $ 2,550 $ 1,532
JG (2,104) (396) (153)
$ (35,751) $ 2,154 $ 1,379
</TABLE>
The consolidated financial statements for all years prior to the merger have
been restated to include JG's results for the twelve months ended March 31.
Effective February 1, 1996, JG's fiscal year-end has been changed from March
31, to June 30 to conform to the Company's fiscal year-end. In connection
with the merger of the Company and JG, merger expenses of $848,000 were
recognized during the third quarter of fiscal 1996.
During fiscal 1995, Medior, Inc. and Wide Area Information Servers, Inc.
were merged into subsidiaries of the Company. The Company issued 2,164,038
shares of its common stock in the transactions. The transactions were
accounted for under the pooling of interests method of accounting. Prior
year financial statements have not been restated for the transactions because
the effect would not be material to the operations of the Company.
Purchase Transactions
During fiscal 1995, the Company acquired Navisoft, Inc. ("Navisoft"),
BookLink Technologies, Inc. ("BookLink"), Advanced Network and Services, Inc.
("ANS") and Global Network Navigator, Inc. ("GNN"), in transactions accounted
for under the purchase method of accounting. The Company paid a total of
$97,669,000 of which $75,697,000 was in stock and $21,972,000 was in cash for
the acquisitions. Of the aggregate purchase price, approximately $50,335,000
was allocated to in-process research and development and $55,314,000 was
allocated to goodwill and other intangible assets.
The following unaudited pro forma information relating to the BookLink and
ANS acquisitions is not necessarily an indication of the combined results
that would have occurred had the acquisitions taken place at the beginning of
the period, nor is it necessarily an indication of the results that may occur
in the future. Pro forma information for Navisoft and GNN is immaterial to
the operations of the consolidated entity. The amount of the aggregate
purchase price allocated to in-process research and development for both the
Navisoft and BookLink acquisitions has been excluded from the pro forma
information as it is a non-recurring item.
<TABLE>
Year ended June 30,
1995 1994
(in thousands, except per share data)
<S> <C> <C>
Revenues $ 410,147 $135,785
Income (loss) from operations 20,962 (5,897)
Pro forma income (loss) 9,101 (5,090)
Pro forma income (loss) per share $ 0.10 $ (0.09)
</TABLE>
4. Property and Equipment
Property and equipment consist of the following:
<TABLE>
June 30,
1995 1994
(in thousands)
<S> <C> <C>
Computer equipment $49,454 $12,418
Furniture and fixtures 5,222 1,516
Buildings 13,800 5,648
Land 6,075 2,052
Building improvements 6,284 1,343
Property under capital leases 8,486 2,686
Leasehold improvements 3,074 306
92,395 25,969
Less accumulated depreciation
and amortization 21,476 5,555
Net property and equipment $70,919 $ 20,414
</TABLE>
5. License Rights
License rights consist of the following:
<TABLE>
June 30,
1995 1994
(in thousands)
<S> <C> <C>
License rights $7,529 $ 959
Less accumulated amortization (1,950) (901)
$5,579 $ 58
</TABLE>
6. Commitments and Contingencies
The Company leases equipment under several long-term capital and operating
leases. Future minimum payments under capital leases and non cancelable
operating leases with initial terms of one year or more consist of the
following:
<TABLE>
Capital Leases Operating Leases
(in thousands)
<S> <C> <C>
Year ending June 30,
1996 $ 1,675 $ 21,007
1997 1,255 21,274
1998 657 19,453
1999 310 8,711
2000 103 3,511
Thereafter - 2,636
Total minimum lease payments 4,000 $ 76,592
Less amount representing interest (412)
Present value of net minimum capital
lease payments, including current
portion of $1,430 $ 3,588
</TABLE>
The Company's rental expense under operating leases in the years ended June
30, 1995, 1994 and 1993 totaled approximately $10,120,000, $2,910,000, and
$2,155,000, respectively.
Communication networks-The Company has guaranteed monthly usage levels of
data and voice communications with one of its vendors. The remaining
commitments are $113,400,000, $59,000,000, $9,000,000 and $6,750,000 for the
years ending June 30, 1996, 1997, 1998 and 1999, respectively. The related
expense for the years ended June 30, 1995, 1994 and 1993 was $138,793,000,
$40,315,000 and $11,226,000, respectively.
Contingencies- Various legal proceedings have arisen against the Company in
the ordinary course of business. In the opinion of management, these
proceedings will not have a material effect on the financial position of the
Company.
7. Notes Payable
Notes payable at June 30, 1995 totaled approximately $18 million and consist
primarily of amounts borrowed to finance the purchases of two office
buildings. The notes are collateralized by the respective properties. The
notes have a variable interest rate equal to 105 basis points above the 30
day London Interbank Offered Rate and a fixed interest rate of 8.48% per
annum at June 30, 1995. Aggregate maturities of notes payable for the years
ended June 30, 1996, 1997, 1998, 1999, 2000 and thereafter are $415,000,
$429,000, $445,000, $462,000, $480,000 and $15,553,000 respectively.
8. Other Income
The following table summarizes the components of other income:
<TABLE>
Year ended June 30,
1995 1994 1993
(in thousands)
<S> <C> <C> <C>
Interest income $ 3,979 $ 1,658 $ 577
Interest expense (1,062) (577) (172)
Other 157 729 36
$ 3,074 $ 1,810 $ 441
</TABLE>
9. Income Taxes
The provision for income taxes is attributable to:
<TABLE>
Year ended June 30,
1995 1994 1993
(in thousands)
<S> <C> <C> <C>
Income before extraordinary item $15,169 $ 3,832 $ 1,897
Tax benefit arising from net operating
loss carryforward
- - (1,133)
$15,169 $ 3,832 $ 764
Current $ - $ - $ 5
Deferred 15,169 3,832 759
$15,169 $ 3,832 $ 764
</TABLE>
The provision for income taxes differs from the amount computed by applying
the statutory federal income tax rate to income before provision for income
taxes and extraordinary item. The sources and tax effects of the differences
are as follows:
<TABLE>
Year ended June 30,
1995 1994 1993
(in thousands)
<S> <C> <C> <C>
Income tax at the federal statutory rate
of 34% $(6,998) $ 2,035 $ 729
State income tax, net of federal benefit 1,597 403 200
Losses relating to RCC - 1,259 916
Nondeductible merger expenses 750 - -
Nondeductible charge for purchased
research and development 17,114 - -
Loss, for which no tax benefit was derived 2,347 135 52
Other 359 - -
$15,169 $3,832 $1,897
</TABLE>
Deferred income taxes arise because of differences in the treatment of income
and expense items for financial reporting and income tax purposes, primarily
relating to deferred subscriber acquisition and product development costs.
As of June 30, 1995, the Company has net operating loss carryforwards of
approximately $109 million for tax purposes which will be available, subject
to certain annual limitations, to offset future taxable income. If not used,
these loss carryforwards will expire between 2001 and 2010. To the extent
that net operating loss carryforwards, when realized, relate to stock option
deductions, the resulting benefits will be credited to stockholders' equity.
The Company's income tax provision was computed based on the federal
statutory rate and the average state statutory rates, net of the related
federal benefit.
Effective July 1, 1993 the Company changed its method of accounting for
income taxes from the deferred method to the liability method required by
FASB Statement No. 109, "Accounting for Income Taxes." As permitted under
the new rules, prior years' financial statements have not been restated.
No increase to net income resulted from the cumulative effect of adopting
Statement No. 109 as of July 1, 1993. The deferred tax asset increased by
approximately $5,965,000 as a result of the adoption. Similarly, the
deferred tax liability, stockholders' equity and the valuation allowance
increased by approximately $3,173,000, $759,000 and $2,033,000 respectively.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax liabilities and assets are as
follows:
<TABLE>
June 30,
(in thousands) 1995 1994
Deferred tax liabilities:
<S> <C> <C>
Capitalized software costs $ 7,008 $ 2,962
Deferred member acquisition costs 28,619 9,880
Net deferred tax liabilities $ 35,627 $ 12,842
Deferred tax assets:
Net operating loss carryforwards $ 39,000 $ 17,510
Total deferred tax assets 39,000 17,510
Valuation allowance for deferred assets (3,373) (4,668)
Net deferred tax assets $35,627 $ 12,842
</TABLE>
10.Capital Accounts
Common stock- At June 30, 1995 and 1994 the Company's $.01 par value common
stock authorized was 100,000,000 and 20,000,000 shares, respectively, with
76,728,269 and 63,103,176 shares issued and outstanding, respectively. At
June 30, 1995, 47,994,355 shares were reserved for the exercise of issued and
unissued common stock options and warrants, and 578,230 shares were reserved
for issuance in connection with the Company's Employee Stock Purchase Plan.
During April 1995, the Company sold approximately 5% of its common stock for
approximately $54 million to Bertelsmann, AG in connection with a joint
venture.
Preferred Stock- In February 1992, the Company's stockholders approved an
amendment and restatement of the certificate of incorporation which
authorized the future issuance of 5,000,000 shares of preferred stock, $.01
par value, with rights and preferences to be determined by the Board of
Directors. As of June 30, 1995 no shares of preferred stock had been issued.
Warrants- Under a December 1992 licensing and development agreement with
Apple Computer, Inc. ("Apple"), the Company issued warrants to Apple to
purchase 4,000,000 shares of common stock at an exercise price of $3.13 per
share.
In connection with an agreement with the Company's primary communications
provider, the Company issued warrants, exercisable through March 31, 1999,
subject to certain performance standards specified in the agreement, to
purchase 3,600,000 shares of common stock at a price of $3.91 per share.
Shareholder Rights Plan-During fiscal 1993, the Company adopted a shareholder
rights plan and distributed a dividend of one preferred share purchase right
(a "Right") for each outstanding share of the Company's common stock. The
Rights become exercisable in certain limited circumstances involving a
potential business combination or change of control transaction of the
Company. Each Right initially entitles registered holders of the Company's
common stock to purchase one one-hundredth of a share of the Company's new
Series A Junior Participating Preferred Stock ("Series A Preferred Stock") at
a price of $150.00 per one one-hundredth of a share of Series A Preferred
Stock. Following certain other events after the Rights have become
exercisable, each Right entitles its holder to purchase for $150.00 an amount
of common stock of the Company or, in certain circumstances, securities of
the acquirer, having a then-current market value of two times the exercise
price of the Right. The Rights are redeemable for one cent per right at the
option of the Board of Directors. Until a Right is exercised, the holder of
the Right , as such, has no rights as a shareholder of the Company. The
Rights expire on May 3, 2003 unless redeemed prior to that date.
Stock Splits-On November 25, 1994 and April 27, 1995 the Company effected two-
for-one splits of the outstanding shares of common stock. Accordingly, all
data shown in the accompanying consolidated financial statements and notes
has been retroactively adjusted to reflect the stock splits.
11. Stock Plans
Incentive stock option plan-In June 1985, the Company approved and adopted an
incentive stock option plan ("the 1985 Plan"). The 1985 Plan provides for the
grant of options to purchase common stock to eligible employees of the
Company. The 1985 Plan is administered by the Compensation Committee of the
Board of Directors. The 1985 Plan will terminate in December 1995. The total
number of shares of common stock that may be issued pursuant to options
granted under the 1985 Plan is 6,005,744. The issued options vest over three-
year or four-year periods and are exercisable for ten years following the
date of the grant.
The following table summarizes incentive stock option activity under the 1985
Plan:
<TABLE>
Number of shares Option price
per share
<S> <C> <C>
Balance at June 30, 1992 4,383,688 $0.06 - $1.13
Granted - -
Exercised (806,472) $0.06 - $1.13
Forfeited (28,480) $1.13
Balance at June 30, 1993 3,548,736 $0.06 - $1.13
Granted - -
Exercised (940,432) $0.06 - $1.13
Forfeited (4,400) $1.13
Balance at June 30, 1994 2,603,904 $0.06 - $1.13
Granted - -
Exercised (517,540) $0.06 - $1.13
Forfeited (61,300) $1.13
Balance at June 30, 1995 2,025,064 $0.06 - $1.13
</TABLE>
At June 30, 1995, 1,786,384 options were exercisable. There have been
3,881,572 options exercised under the 1985 Plan.
Stock incentive plan-In December 1987, the Company's Board of Directors
adopted a stock incentive plan ("the 1987 Plan"). The 1987 Plan provides for
the grant of options to purchase common stock and awards of restricted common
stock to employees and independent contractors of the Company. The 1987 Plan
is administered by the Compensation Committee of the Board of Directors. The
total number of shares of common stock that may be issued pursuant to options
granted under the 1987 Plan or pursuant to stock awards is 8,016,000. The
issued options vest over three-, four- or five-year periods and are
exercisable for ten years following the date of grant.
The following table summarizes stock incentive option activity under the 1987
Plan:
<TABLE>
Number of shares Option price
per share
<S> <C> <C>
Balance at June 30, 1992 6,630,528 $0.13 - $1.13
Granted - -
Exercised (2,226,856) $0.13 - $1.13
Forfeited (29,200) $0.25
Balance at June 30, 1993 4,374,472 $0.13 - $1.13
Granted - -
Exercised (1,455,248) $0.13 - $1.13
Forfeited - -
Balance at June 30, 1994 2,919,224 $0.13 - $1.13
Granted - -
Exercised (1,296,088) $0.13 - $1.13
Forfeited (40,000) $0.25
Balance at June 30, 1995 1,583,136 $0.13 - $1.13
</TABLE>
At June 30, 1995, 1,553,936 options were exercisable. There have been
6,321,768 options exercised under the 1987 Plan.
1992 Employee, Director and Consultant Stock Option Plan-In February 1992,
the Company approved and adopted an employee, director and consultant stock
option plan ("the 1992 Plan"). The 1992 Plan provides for the grant of
either incentive stock options or non-qualified stock options. Incentive
stock options may be granted under the 1992 Plan to employees of the Company
and its affiliates. Non-qualified stock options may be granted to
consultants, directors, employees or officers of the Company and its
affiliates. The 1992 Plan provides for an annual grant to each non-employee
director on November 1 of an option to purchase 5,000 shares of common stock
at an exercise price equal to the fair market value of the common stock on
such date and vesting in one year. The 1992 Plan is administered by the
Compensation Committee of the Board of Directors. The total number of shares
that may be issued pursuant to options granted under the 1992 Plan is
36,080,000. The issued options vest over one, three, or four-year periods
and are exercisable for ten years following the date of grant.
<TABLE>
Number of shares Option price
per share
<S> <C> <C>
Balance at June 30, 1992 24,000 $1.78
Granted 6,430,800 $1.59 - $ 4.59
Exercised - -
Forfeited (16,000) $1.84
Balance at June 30, 1993 6,438,800 $1.59 - $ 4.59
Granted 2,917,200 $4.66 - $ 9.13
Exercised (375,280) $1.59 - $ 3.75
Forfeited (214,400) $1.59 - $ 9.00
Balance at June 30, 1994 8,766,320 $1.59 - $ 9.13
Granted 23,587,196 $6.95 - $22.00
Exercised (863,604) $1.59 - $ 9.13
Forfeited (920,400) $1.59 - $18.85
Balance at June 30, 1995 30,569,512 $1.59 - $22.00
</TABLE>
At June 30, 1995, 2,983,348 options were exercisable. There have been
1,238,884 options exercised under the 1992 Plan.
At June 30, 1995, the Company had 1,561,723 common stock options outstanding
relating to options which were assumed by the Company in connection with
various business combinations. The options are exercisable at prices ranging
from $0.17 to $14.26 and vest over the next four years. At June 30, 1995,
475,242 options were exercisable.
Employee Stock Purchase Plan-In May 1992, the Company's Board of Directors
adopted an Employee Stock Purchase Plan ("the ESPP"). Under the ESPP,
employees of the Company and its subsidiaries who elect to participate are
granted options to purchase common stock at a 15 percent discount from the
market value of such stock. The ESPP permits an enrolled employee to make
contributions by having withheld from his or her salary an amount between 1
percent and 10 percent of compensation to purchase shares of common stock.
The ESPP is administered by the Compensation Committee of the Board of
Directors. The total number of shares of common stock that may be issued
pursuant to options granted under the ESPP is 800,000. A total of 221,770
shares of common stock have been issued under the ESPP.
12. Employee Benefit Plan
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 4% of the employee's earnings. The
Company's matching contribution to the Savings Plan was approximately
$358,000 and $168,000 in the years ended June 30, 1995 and 1994,
respectively.
13. Subsequent Events
Purchase Transaction
In August 1995 the Company acquired Ubique, Ltd, an Israeli company. The
Company paid approximately $15 million ($1.5 million in cash and $13.5
million in common stock) in the transaction, which is to be accounted for
under the purchase method of accounting. A substantial portion of the
purchase price was allocated to in-process research and development and
charged to the Company's operations in the first quarter of fiscal 1996.
Stockholders' Equity
In October 1995 the Company completed a public stock offering of 4,963,266
shares of common stock at a price of approximately $29 per share.
In October 1995, the Shareholders of the Company approved an increase of its
authorized common stock to 300,000,000 shares. On November 28, 1995 the
Company effected a two-for-one split of the outstanding shares of common
stock. Accordingly, all data shown in the accompanying consolidated
financial statements and notes has been retroactively adjusted to reflect the
stock split.
14. Events (unaudited) subsequent to the date of the independent auditor's
report.
Joint Venture
In May 1996, the Company entered into a joint venture with Mitsui & Co., Ltd.
(Mitsui) and Nihon Keizai Shimbun, Inc., (Nikkei) to offer interactive online
services in Japan. The joint venture will consist of the Company owning 50%,
Mitsui 40% and Nikkei 10% . Mitsui and Nikkei will contribute approximately
$56 million to fund the launch of the service. In addition, Mitsui purchased
1,000 shares of convertible preferred stock in the Company for approximately
$28 million. The preferred stock is convertible to common stock and converts
upon the second anniversary of the formation of the joint venture, together
with an accrued dividend of 4% payable in common stock.
Legal Proceedings
From July 1995 through November 1995, thirteen class action suits were filed
against the Company in a number of state courts seeking unspecified damages
for alleged breach of contract, fraud and unfair trade practices arising from
the Company's billing practices. The primary substantive allegations in each
case involve claims of overcharging customers arising out of changes to the
Company's billing system relating to the costs the Company incurs in
providing telecommunications services. The cases allege that certain aspects
of the Company's billing practices were not disclosed to customers. Based
upon information presently available, management believes that these
proceedings will not have a material adverse effect on the financial position
of the Company.
<TABLE>
Quarterly Information (unaudited)
QUARTER ENDED
September 30 December 31 March 31 June 30 Total
Fiscal 1995 (1),(3)
<S> <C> <C> <C> <C> <C>
Online service
revenues $ 50,056 $ 69,712 $ 95,391 $138,916 $354,075
Other revenues 6,880 6,683 13,713 12,976 40,252
Total revenues 56,936 76,395 109,104 151,892 394,327
Income (loss) from
operations 4,202 (35,867) (491) 10,713 (21,443)
Net income (loss) 1,076 (39,339) (3,296) 5,794 (35,765)
Net income (loss) per
share (2) $0.01 $(0.10) $(0.04) $ 0.06 $(0.51)
Fiscal 1994(1),(3)
Online service revenues $14,299 $20,292 $28,853 $37,549 $100,993
Other revenues 4,780 4,239 2,836 2,874 14,729
Total revenues 19,079 24,531 31,689 40,423 115,722
Income from operations 423 412 1,823 1,240 3,898
Net income (loss) 204 (29) 1,173 522 1,870
Net income per
share $ - $ - $ 0.01 $ 0.01 $ 0.02
</TABLE>
(1) Historical financial information for amounts previously reported in
fiscal 1995 has been adjusted to account for pooling of interests
transactions.
(2) The sum of per-share earnings (loss) does not equal earnings (loss) per
share for the year due to equivalent share calculations which are impacted by
the Company's loss in 1995 and by fluctuations in the Company's common stock
market prices.
(3) The sum of the quarterly financial information does not agree to the
Company's Consolidated Statement of Operations due to the pooling of
interests restatement of Johnson-Grace Company which combines JG's March 31
financial results with the Company's June 30 fiscal year end.
Selected Consolidated Financial and Other Data
<TABLE>
Year Ended June 30,
1995 1994 1993 1992 1991
(in thousands, except per share data)
Statement of Operations Data:
<S> <C> <C> <C> <C> <C>
Online service revenues $ 358,498 $ 100,993 $ 38,462 $ 26,226 $19,515
Other revenues 35,792 14,729 13,522 12,527 10,646
Total revenues 394,290 115,722 51,984 38,753 30,161
Income (loss) from
operations (21,449) 4,176 1,702 3,685 1,341
Income (loss) before
extraordinary item (35,751) 2,154 246 2,344 1,100
Net income (loss) (1) (35,751) 2,154 1379 3,768 1,761
Income (loss) per common share:
Income (loss) before
extraordinary item $ (0.51) $ 0.03 $ - $ 0.05 $ 0.03
Net income (loss) $ (0.51) $ 0.03 $ 0.02 $ 0.08 $ 0.05
Weighted average shares
outstanding 69,550 69,035 58,572 45,656 38,608
Balance Sheet Data:
Working capital (deficiency)$ (28,478) $ 38,679 $10,498 $12,363 $ (966)
Total assets 405,413 155,178 39,279 31,144 11,534
Total debt 21,856 9,341 2,959 2,672 1,865
Stockholders' equity
(deficiency) 216,812 98,802 23,785 21,611 (8,623)
Other Data (at fiscal
year end):
Subscribers 3,005 903 303 182 131
</TABLE>
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
The Company has experienced a significant increase in revenues over the
past three fiscal years. The higher revenues have been principally produced
by increases in the Company's subscriber base resulting from growth of the
online services market, the introduction of a Windows version of America
Online in the middle of fiscal 1993, which greatly increased the available
market for the Company's service, as well as the expansion of its services
and content. Additionally, revenues have increased as the average monthly
revenue per subscriber has risen steadily during the past three years,
primarily as a result of an increase in the average monthly paid hours of use
per subscriber.
The Company's online service revenues are generated primarily from
subscribers paying a monthly membership fee and hourly charges based on usage
in excess of the number of hours of usage provided as part of the monthly
fee. Through December 31, 1994, the Company's standard monthly membership
fee, which includes five hours of service, was $9.95, with a $3.50 hourly fee
for usage in excess of five hours per month. Effective January 1, 1995, the
hourly fee for usage in excess of five hours per month decreased from $3.50
to $2.95, while the monthly membership fee remained unchanged at $9.95.
The Company's other revenues are generated primarily from providing new
media and interactive marketing services, data network services, and
multimedia and CD-ROM production services. Additionally, the Company
generates revenues related to online transactions and advertising, as well as
development and licensing fees.
In fiscal 1995 the Company acquired RCC, NaviSoft, BookLink, ANS, WAIS,
Medior and Global Network Navigator, Inc. Additionally, in August 1995, the
Company entered into an agreement to acquire Ubique. For additional
information relating to these acquisitions, refer to Notes 3 and 13 of the
Notes to Consolidated Financial Statements.
The online services market is highly competitive. The Company believes
that existing competitors, which include, among others, CompuServe, Prodigy
and MSN, are likely to enhance their service offerings. In addition, new
competitors have announced plans to enter the online services market,
resulting in greater competition for the Company. The competitive
environment could require new pricing programs and increased spending on
marketing, content procurement and product development; limit the Company's
opportunities to enter into and/or renew agreements with content providers
and distribution partners; limit the Company's ability to grow its subscriber
base; and result in increased attrition in the Company's subscriber base.
Any of the foregoing events could result in an increase in costs as a
percentage of revenues, and may have a material adverse effect on the
Company's financial condition and operating results.
During September 1995, the Company modified the components of subscriber
acquisition costs deferred and will be expensing certain subscriber
acquisition costs as incurred, effective July 1, 1995. All costs capitalized
before this change will continue to be amortized. The effect of this change
for the year ended June 30, 1995 (including the amortization of amounts
capitalized as of June 30, 1994) would have been to increase marketing costs
by approximately $8 million. This change will have a greater impact on the
Company's marketing costs in fiscal 1996, as the Company expects to
significantly increase subscriber acquisition activity, including those
subscriber acquisition expenditures which the Company will be expensing as
incurred.
In addition, effective July 1, 1995, the Company changed the period over
which it amortizes subscriber acquisition costs from twelve and eighteen
months to twenty-four months. Based on the Company's historical average
customer life experience, the change in amortization period is being made to
more appropriately match subscriber acquisition costs with associated online
service revenues. The effect of this change in accounting estimate for the
year ended June 30, 1995 would have been to decrease the amount of the
amortization of subscriber acquisition costs by approximately $27 million.
While this change will thereby positively impact operating margins, the
Company expects that any such positive impact will be partially offset by
increased investments in marketing and other business activities during
fiscal 1996 and the decision, effective July 1, 1995, to expense certain
subscriber acquisition costs as incurred.
Results of Operations
Fiscal 1995 Compared to Fiscal 1994
Online Service Revenues. For fiscal 1995, online service revenues
increased from $100,993,000 to $358,498,000, or 255%, over fiscal 1994. This
increase was primarily attributable to a 289% increase in revenues from IBM-
compatible subscribers and a 196% increase in revenues from Macintosh
subscribers as a result of a 273% increase in the number of IBM-compatible
subscribers and a 143% increase in the number of Macintosh subscribers. The
percentage increase in online service revenues in fiscal 1995 was greater
than the percentage increase in subscribers principally due to an increase in
the average monthly online service revenue per subscriber, which increased
from $15.00 in fiscal 1994 to $17.10 in fiscal 1995.
Other Revenues. Other revenues, consisting principally of new media and
interactive marketing services, data network services, multimedia and CD-ROM
production services, and development and licensing fees, increased from
$14,729,000 in fiscal 1994 to $35,792,000 in fiscal 1995. This increase was
primarily attributable to data network revenues and multimedia and CD-ROM
production service revenues from companies acquired during fiscal 1995.
Cost of Revenues. Cost of revenues includes network-related costs,
consisting primarily of data and voice communication costs, costs associated
with operating the data center and providing customer support, royalties paid
to information and service providers and other expenses related to marketing
and production services. For fiscal 1995, cost of revenues increased from
$69,043,000 to $229,724,000, or 233%, over fiscal 1994, and decreased as a
percentage of total revenues from 59.7% to 58.3%.
The increase in cost of revenues was primarily attributable to an increase
in data communication costs, customer support costs and royalties paid to
information and service providers. Data communication costs increased
primarily as a result of the larger customer base and more usage by
customers. Customer support costs, which include personnel and telephone
costs associated with providing customer support, were higher as a result of
the larger customer base and a large number of new subscriber registrations.
Royalties paid to information and service providers increased as a result of
a larger customer base and more usage and the Company's addition of more
service content to broaden the appeal of the America Online service.
The decrease in cost of revenues as a percentage of total revenues is
primarily attributable to a decrease in expenses related to marketing
services and personnel related costs as a percentage of total revenues,
partially offset by an increase in data communication costs as a percentage
of total revenues, primarily resulting from an increase in higher baud speed
usage at a higher variable rate as well as lower hourly pricing for online
service revenue which became effective January 1, 1995.
Marketing. Marketing expenses include the costs to acquire and retain
subscribers and other general marketing expenses. Subscriber acquisition
costs are deferred and charged to operations over a twelve or eighteen month
period, using the straight-line method, beginning the month after such costs
are incurred. For additional information regarding the accounting for
deferred subscriber acquisition costs, refer to Note 2 of the Notes to
Consolidated Financial Statements. For fiscal 1995, marketing expenses
increased from $23,548,000 to $77,064,000, or 227%, over fiscal 1994, and
decreased as a percentage of total revenues from 20.3% to 19.5%. The increase
in marketing expenses was primarily due to an increase in the number and size
of marketing programs to expand the Company's subscriber base. The decrease
in marketing expenses as a percentage of total revenues is primarily
attributable to a decrease as a percentage of total revenues in personnel
related costs.
Product Development. Product development costs include research and
development expenses, other product development costs and the amortization of
software costs. For fiscal 1995, product development expenses increased from
$5,288,000 to $14,263,000, or 170%, over fiscal 1994, and decreased as a
percentage of total revenues from 4.6% to 3.6%. The increase in product
development costs was primarily attributable to an increase in personnel
costs related to an increase in the number of technical employees. The
decrease in product development costs as a percentage of total revenues was
principally a result of the substantial growth in revenues, which more than
offset the additional product development costs. Product development costs,
before capitalization and amortization, increased by 126% in fiscal 1995.
General and Administrative. Fiscal 1995, general and administrative costs
increased from $13,667,000 to $42,700,000, or 212%, over fiscal 1994, and
decreased as a percentage of total revenues from 11.8% to 10.8%. The increase
in general and administrative expenses was principally attributable to higher
office and personnel expenses related to an increase in the number of
employees. The decrease in general and administrative costs as a percentage
of total revenues was a result of the substantial growth in revenues, which
more than offset the additional general and administrative costs, combined
with the semi-variable nature of many of the general and administrative
costs.
Acquired Research and Development. Acquired research and development
costs, totaling $50,335,000, relate to in-process research and development
purchased pursuant to the Company's acquisitions of two early stage Internet
technology companies, BookLink and NaviSoft. The purchased research and
development relating to the BookLink and NaviSoft acquisitions was the
foundation of the development of the Company's Internet related products.
Amortization of Goodwill. Amortization of goodwill relates to the
Company's acquisition of ANS, which resulted in approximately $44 million in
goodwill. The goodwill related to the ANS acquisition is being amortized on
a straight-line basis over a ten year period.
Other Income. Other income consists primarily of investment and rental
income net of interest expense. For fiscal 1995, other income increased from
$1,810,000 to $3,074,000. This increase was primarily attributable to an
increase in interest income generated by higher levels of cash available for
investment, partially offset by a decrease in rental income and an increase
in interest expense.
Merger Expenses. Non-recurring merger expenses totaling $2,207,000 were
recognized in fiscal 1995 in connection with the mergers of the Company with
RCC, WAIS and Medior.
Provision for Income Taxes. The provision for income taxes was $3,832,000
and $15,169,000 in fiscal 1994 and fiscal 1995, respectively. For additional
information regarding income taxes, refer to Note 9 of the Notes to
Consolidated Financial Statements.
Net Loss. The net loss in fiscal 1995 totaled $35,751,000. The net loss
in fiscal 1995 included charges of $50,335,000 for acquired research and
development and $2,207,000 for merger expenses.
Fiscal 1994 Compared to Fiscal 1993
Online Service Revenues. For fiscal 1994, online service revenues
increased from $38,462,000 to $100,993,000, or 163%, over fiscal 1993. This
increase was primarily attributable to a 198% increase in revenues from IBM-
compatible subscribers and a 145% increase in revenues from Macintosh
subscribers as a result of a 230% increase in the number of IBM-compatible
subscribers and a 174% increase in the number of Macintosh subscribers. The
percentage increase in subscribers in fiscal 1994 was greater than the
percentage increase in online service revenues due to the timing, during the
year, of when subscribers were added. The majority of subscribers were added
during the second half of the year, therefore there was not a full year
impact on revenues. This was partially offset by an increase in average
monthly net service revenue per subscriber, which increased from $14.20 in
fiscal 1993 to $15.00 in fiscal 1994.
Other Revenues. Other revenues, consisting primarily of new media and
interactive marketing services and development fees, increased from
$13,522,000 in fiscal 1993 to $14,729,000 in fiscal 1994.
Cost of revenues. For fiscal 1994, cost of revenues increased from
$28,820,000 to $69,043,000, or 140%, over fiscal 1993, and increased as a
percentage of total revenues from 55.4% to 59.7%.
The increase in cost of revenues was primarily attributable to an increase
in data communication costs, customer support costs and royalties paid to
information and service providers. Data communication costs increased
primarily as a result of the larger customer base and more usage by
customers. Customer support costs, which include personnel and telephone
costs associated with providing customer support, were higher as a result of
the larger customer base and a large number of new subscriber registrations.
Royalties paid to information and service providers increased as a result of
a larger customer base and more usage and the Company adding more service
content to broaden the appeal of the America Online service.
The increase in cost of revenues as a percentage of total revenues is
primarily attributable to data communication costs and is associated with (i)
an increase in no-charge trial hours as a result of the high number of new
subscriber registrations relative to the existing customer base; (ii) a
higher percentage of usage during more costly daytime periods partially
offset by more favorable pricing under an agreement with the Company's
primary communications provider, and (iii) an increase in usage relative to
net service revenues as a result of the introduction of a price change in May
1993. The increase attributable to data communications costs was partially
offset by a decrease as a percentage of total revenues in production costs
related to marketing services. The Company introduced a price change in the
spring of 1993. Prior thereto, the Company's standard pricing was a monthly
membership fee of $7.95 which included two hours of use each month, with five
no-charge trial hours and no membership fee in the first month. Additional
usage beyond that included with the membership was charged at $6.00 per hour.
Effective May 1, 1993, the Company increased the monthly membership fee to
$9.95 and increased the number of hours included to five per month.
Additionally, the number of no-charge trial hours in the first month of
membership was increased from five to ten. Effective July 1, 1993, the
hourly fee for usage beyond that included with the membership was lowered to
$3.50.
Marketing. For fiscal 1994, marketing expenses increased from $9,745,000
to $23,548,000, or 142%, over fiscal 1993, and increased as a percentage of
total revenues from 18.7% to 20.3%. The increase in marketing expenses was
primarily due to an increase in the number and size of marketing programs to
expand the Company's America Online subscriber base. In addition, personnel
costs were higher to support the number and size of marketing programs.
Product Development. For fiscal 1994, product development costs increased
from $3,080,000 to $5,288,000, or 72%, over fiscal 1993, and decreased as a
percentage of total revenues from 5.9% to 4.6%. The increase in product
development costs was attributable to an increase in personnel costs related
to an increase in the number of employees. The decrease in product
development costs as a percentage of total revenues was a result of the
substantial growth in revenues for the year, which more than offset the
additional product development costs. Product development costs, before
capitalization and amortization, increased by 103% in fiscal 1994.
General and Administrative. For fiscal 1994, general and administrative
expenses increased from $8,637,000 to $13,667,000, or 58%, over fiscal 1993,
and decreased as a percentage of total revenues from 16.6% to 11.8%. The
increase in general and administrative costs was principally attributable to
higher personnel, office and travel expenses related to an increase in the
number of employees. The decrease in general and administrative costs as a
percentage of total revenues was a result of the substantial growth in
revenues for the year combined with the fixed nature of many of the general
and administrative costs.
Other lncome. For fiscaI I994, other income increased from $441,000 to
$1,810,000.This increase was primarily attributable to an increase in
interest income generated by higher levels of cash available for investment
in fiscal 1994, as well as rental income received as a result of the purchase
of one of the Company's office buildings and its leasing of space to third
parties, which was partially offset by interest expense on the loan obtained
to purchase the building.
Provision for Income Taxes. The provision for income taxes was $1,897,000
and $3,832,000 in fiscal 1993 and fiscal 1994, respectively. The tax
provision in fiscal 1993, with the exception of $764,000, was offset by the
utilization of a net operating loss carryforward that has been reflected as
an extraordinary item. For additional information regarding income taxes,
refer to Note 9 of the Notes to Consolidated Financial Statements.
Net Income. Net income in fiscal 1994 totaled $2,154,000.
Liquidity and Capital Resources
The Company has financed its operations through cash generated from
operations, sale of its common stock and funding by third parties for certain
product development activities. Net cash provided by operating activities
was $2,205,000, $1,116,000 and $17,261,000 for fiscal 1993, fiscal 1994 and
fiscal 1995, respectively. Included in operating activities were
expenditures for deferred subscriber acquisition costs of $10,685,000,
$37,424,000 and $111,761,000 in fiscal 1993, fiscal 1994 and fiscal 1995,
respectively. Net cash used in investing activities was $8,915,000,
$41,993,000 and $87,272,000 in fiscal 1993, fiscal 1994 and fiscal 1995,
respectively. Investing activities included $20,523,000 in fiscal 1995
related to business acquisitions, substantially all of which were related to
the acquisition of ANS.
In December 1993 the Company completed a public stock offering of 4,000,000
shares of common stock which generated net cash proceeds of approximately
$62.7 million.
In April 1995 the Company entered into a joint venture with Bertelsmann to
offer interactive online services in Europe. In connection with the
agreement, the Company received approximately $54 million through the sale of
approximately 5% of its common stock to Bertelsmann.
The Company leases the majority of its equipment under noncancelable
operating leases, and as part of its network portfolio strategy is building
AOLnet, its data communications network. The buildout of this network
requires a substantial investment in telecommunications equipment, which the
Company plans to finance principally through leasing. In addition, the
Company has guaranteed minimum commitments under certain data and voice
communication agreements. The Company's future lease commitments and
guaranteed minimums are discussed in Note 6 of the Notes to Consolidated
Financial Statements.
The Company uses its working capital to finance ongoing operations and to
fund marketing and content programs and the development of its products and
services. The Company plans to continue to invest aggressively in
acquisition marketing and content programs to expand its subscriber base, as
well as in computing and support infrastructure. Additionally, the Company
expects to use a portion of its cash for the acquisition and subsequent
funding of technologies, products or businesses complementary to the
Company's current business. Apart from its agreement to acquire Ubique, as
discussed below, the Company has no agreements or understandings to acquire
any businesses. The Company anticipates that available cash and cash
provided by operating activities will be sufficient to fund its operations
for the next fiscal year.
Various legal proceedings have arisen against the Company in the ordinary
course of business. In the opinion of management, these proceedings will not
have a material effect on the financial position of the Company.
The Company believes that inflation has not had a material effect on its
results of operations.
In August 1995 the Company acquired Ubique, Ltd, an Israeli company. The
Company paid approximately $15 million ($1.5 million in cash and $13.5
million in common stock) in the transaction, which is to be accounted for
under the purchase method of accounting. A substantial portion of the
purchase price was allocated to in-process research and development and
charged to the Company's operations in the first quarter of fiscal 1996.
Seasonality
In April 1996 the Company began to see the effects of seasonality in
both member acquisitions and in the amount of time spent by customers using
its services. Member acquisition is expected to be highest in the second and
third fiscal quarters, when sales of new computers and computer software are
highest due to the holiday season. Customer usage is expected to be lower in
the summer months due largely to extended daylight hours and competing
outdoor leisure activities.
Forward-Looking Statements
In connection with the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995, America Online, Inc. (the
"Company") wishes to caution readers that the following important factors
could cause the Company's actual results to differ materially from those
projected in forward-looking statements made by, or on behalf of, the
Company:
- - Factors related to increased competition from existing and new
competitors, including price reductions and increased spending on marketing
and product development; limitations on the Company's opportunities to enter
into and/or renew agreements with content providers and distribution
partners; limitations on its ability to develop new products and services;
limitations on its ability to continue to grow its subscriber bases;
increased membership acquisition costs; lower paid usage and increased
attrition in the Company's membership.
- - Risks related to the buildout of AOLnet, including the inability to
expand server and network capacity at a rate sufficient to satisfy subscriber
demands; the failure of any of the Company's network providers, particularly
U.S. Sprint; the failure to obtain the necessary financing for the build-out
of AOLnet; and the risk that demand will develop for the capacity AOLnet will
provide.
- - Any damage or failure to the Company's computer equipment and the
information stored in its data centers, such as damage by fire, power loss,
telecommunications failures, unauthorized intrusions and other events, that
causes interruptions in the Company's operations.
- - The Company's inability to manage its growth and to adapt its
administrative, operational and financial control systems to the needs of the
expanded entity; and the failure of management to anticipate, respond to and
manage changing business conditions.
- - The failure of the Company or its partners to successfully market, sell
and deliver its services in international markets; and risks inherent in
doing business on an international level, such as laws governing content that
differ greatly from those in the U.S., unexpected changes in regulatory
requirements, political risks, export restrictions, export controls relating
to encryption technology, tariffs and other trade barriers, fluctuations in
currency exchange rates, issues regarding intellectual property and
potentially adverse tax consequences.
- - A moderating growth rate in the sale of new computers in the U.S. and,
to some extent, internationally; general or specific economic conditions; the
ability and willingness of purchasers to substitute other services for AOL;
the perceived absolute or relative overall value of these services by the
purchasers, including the features, quality and pricing compared to other
competitive services; smaller market or slowing of market growth for such
services.
- - The amount and rate of growth in AOL's marketing, general and
administrative expenses; the implementation of new marketing programs and
promotional offers; the implementation of additional pricing programs; and
the impact of unusual items resulting from AOL's ongoing evaluation of its
business strategies, asset valuations and organizational structures.
- - Difficulties or delays in the development, production, testing and
marketing of products, including, but not limited to, a failure to ship new
products and technologies when anticipated, including, but not limited to,
new client software and new features and functionality, and the failure to
develop new technology or modify existing technology to incorporate new
standards and protocols.
- - The acquisition of businesses, fixed assets and other assets and
acquisition related risks, including successful integration and management of
acquired technology, operations and personnel, the loss of key employees of
the acquired companies, and diversion of management attention from other
ongoing business concerns; the making or incurring of any expenditures and
expenses, including, but not limited to, depreciation and significant charges
for in-process research and development or other matters; and any revaluation
of assets or related expenses.
- - The ability of the Company to diversify its sources of revenue through
the introduction of new products and services and through the development of
new revenue sources, such as advertising, transactions and merchandise sales.
- - The effects of, and changes in, trade, monetary and fiscal policies,
laws and regulations, other activities of governments, agencies and similar
organizations, and social and economic conditions, such as trade restrictions
or prohibitions, inflation and monetary fluctuations, import and other
charges, or federal, state, local and other taxes.
- - The loss of the services of executive officers and other key employees;
and the Company's continued ability to attract and retain highly skilled and
qualified personnel.
- - The costs and other effects of legal and administrative cases and
proceedings (whether civil, such as environmental and product-related, or
criminal), settlements and investigations, claims, and changes in those
items, developments or assertions by or against AOL relating to intellectual
property rights and intellectual property licenses.
- - Adoptions of new, or changes in, accounting policies, practices and
estimates and the application of such policies, practices and estimates.
- - The effects of any activities of parties with which AOL has an agreement
or understanding, including any issues affecting any investment or joint
venture in which AOL has an investment; the amount, type and cost of the
financing which AOL has, and any changes to that financing.
<PAGE>
SIGNATURE
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.
Dated: June 27, 1996
AMERICA ONLINE, INC.
By: /s/ Lennert J. Leader
Lennert J. Leader
Senior Vice President and
Chief Financial Officer
CONSENT OF INDEPENDENT AUDITORS
We consent to the use of our report dated February 1, 1996 included in Form 8-K
filed by America Online, Inc. with respect to the restated consolidated
financial statements, for the year ended June 30, 1995, reflecting the February
1, 1996 pooling of interests with Johnson-Grace Company.
/s/ Ernst & Young LLP
Ernst & Young LLP
Vienna, Virginia
June 26, 1996
