<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the quarterly period ended: September 30, 1996
OR
[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number:
0-19836
America Online, Inc.
(Exact name of registrant as specified in its charter)
Delaware 54-1322110
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
22000 AOL Way, Dulles, Virginia 20166-9323
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (703) 448-8700
Former name, former address, and former year, if changed since last report: Not
applicable
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
Indicate the number of shares outstanding of each of the Issuer's classes of
Common Stock, as of the latest practicable date.
Title of each class
Common stock $.01 par value
Shares outstanding on October 31,
1996................................................93,986,529
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AMERICA ONLINE, INC.
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets-September 30, 1996 and
June 30, 1996 3
Consolidated Statements of Operations-Three
months ended September 30, 1996 and 1995 4
Consolidated Statements of Cash Flows-Three
months ended September 30, 1996 and 1995 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
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<TABLE>
<CAPTION>
AMERICA ONLINE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
September 30, 1996 June 30, 1996
ASSETS (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 91,154 $ 118,421
Short-term investments 11,081 10,712
Trade accounts receivable 41,257 42,939
Other receivables 41,123 29,674
Prepaid expenses and other current assets 70,100 68,832
Total current assets 254,715 270,578
Property and equipment at cost, net 109,343 101,277
Other assets:
Product development costs, net 55,218 44,330
Deferred subscriber acquisition costs,
net - 314,181
License rights, net 6,867 4,947
Other assets 42,183 35,878
Deferred income taxes 18,662 135,872
Goodwill, net 51,925 51,691
$ 538,913 $ 958,754
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 115,317 $ 105,904
Accrued personnel costs 9,850 15,719
Other accrued expenses and liabilities 134,536 127,898
Deferred revenue 45,593 37,950
Current portion of long-term debt and
capital lease obligations 2,098 2,435
Total Current Liabilities 307,394 289,906
Long-term liabilities:
Notes payable 19,051 19,306
Deferred income taxes 18,662 135,872
Minority Interests 12,908 -
Other liabilities 1,981 1,168
Total liabilities 359,996 446,252
Stockholders' equity:
Preferred stock, $.01 par value;
5,000,000 shares authorized,
1,000 shares issued and outstanding
at September 30, 1996 and June 30, 1996 1 1
Common stock, $.01 par value,
300,000,000 shares authorized,
93,810,944 and 92,626,000 shares
issued and outstanding at September
30, 1996 and June 30, 1996,
respectively 938 926
Additional paid-in capital 539,434 519,342
Accumulated deficit (361,456) (7,767)
Total stockholders' equity 178,917 512,502
$ 538,913 $ 958,754
See accompanying notes.
</TABLE>
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<TABLE>
<CAPTION>
AMERICA ONLINE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)
Three months ended
September 30,
1996 1995
(Unaudited)
<S> <C> <C>
Revenues:
Online service revenues $ 311,132 $ 178,479
Other revenues 38,850 19,423
Total revenues 349,982 197,902
Costs and expenses:
Cost of revenues 188,223 119,077
Marketing 75,872 36,924
Product development 19,326 9,580
General and administrative 35,564 20,480
Write-off of deferred subscriber
acquisitions costs 385,221 -
Acquired research and development - 16,981
Amortization of goodwill 1,920 1,663
Total costs and expenses 706,126 204,705
Loss from operations (356,144) (6,803)
Other income 2,455 832
Loss before provision for income
taxes (353,689) (5,971)
Provision for income taxes - (4,936)
Net loss $ (353,689) $ (10,907)
Loss per share: $ (3.80) $ (0.14)
Weighted average shares
outstanding 93,169 77,147
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
AMERICA ONLINE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
Three months ended September 30,
1996 1995
(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (353,689) $ (10,907)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Write-off of deferred subscriber
acquisition costs 385,221 -
Depreciation and amortization 13,193 6,016
Amortization of subscriber acquisition costs 59,189 15,984
Charge for acquired research and development - 16,981
Changes in assets and liabilities:
Trade accounts receivable 2,228 (3,042)
Other receivables (6,279) 2,414
Prepaid expenses and other current assets (946) (13,329)
Deferred subscriber acquisition costs (130,229) (71,510)
Other assets (5,182) (5,446)
Trade accounts payable 8,670 36,359
Accrued personnel costs (7,179) 941
Other accrued expenses and liabilities 2,224 10,901
Deferred revenue 7,643 3,946
Deferred income taxes - 5,068
Other liabilities (155) 26
Total adjustments 328,398 5,309
Net cash used in operating activities (25,291) (5,598)
Cash flows from investing activities:
Short-term investments (369) (5,435)
Purchase of property and equipment (11,564) (5,672)
Product development costs (15,505) (6,649)
Purchase costs of acquired businesses (475) (4,159)
Net cash used in investing activities (27,913) (21,915)
Cash flows from financing activities:
Proceeds from issuance of preferred
stock in subsidiary 15,000 -
Proceeds from issuance of common stock,
net 11,529 3,113
Principle and accrued interest payments
on revolving line of credit and
long-term debt (284) (95)
Payments under capital lease obligations (308) (322)
Net cash provided by financing activities 25,937 2,696
Net decrease in cash and cash equivalents (27,267) (24,817)
Cash and cash equivalents at beginning of period 118,421 45,877
Cash and cash equivalents at end of period $ 91,154 21,060
Supplemental cash flow information
Cash paid during the period for:
Interest $ 424 $ 420
Income taxes - -
See accompanying notes.
</TABLE>
<PAGE>
AMERICA ONLINE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements,
which include the accounts of America Online, Inc. (the "Company") and its
wholly and majority owned subsidiaries, have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments, consisting only of normal
recurring accruals (with the exception of the write-off of deferred subscriber
acquisition costs as discussed in Note 3 of the Notes to Consolidated Financial
Statements), considered necessary for a fair presentation, have been included in
the accompanying unaudited financial statements. All significant intercompany
transactions and balances have been eliminated in consolidation. Prior period
financial statements are restated for business combinations accounted for under
the pooling of interests method of accounting unless the effect of the business
combination is not material to the consolidated financial statements of the
Company. Certain amounts in prior years' consolidated financial statements have
been reclassified to conform to the current year presentation. Operating
results for the three months ended September 30, 1996 are not necessarily
indicative of the results that may be expected for the full year ending June 30,
1997. For further information, refer to the consolidated financial statements
and notes thereto, included in the Company's Annual Report on Form 10-K for the
fiscal year ended June 30, 1996.
Note 2. Stockholders' Equity
In October 1995, the Company completed a public stock offering of 4,963,266
shares of common stock (adjusted for a stock split) which generated net cash
proceeds of approximately $139.5 million.
During May 1996, the Company sold 1,000 shares of Series B convertible
preferred stock (`the Preferred Stock") for approximately $28,000,000. The
Preferred Stock has an aggregate liquidation preference of approximately
$28,000,000 and accrues dividends at a rate of 4% per annum. Accrued dividends
can be paid in the form of additional shares of Preferred Stock. During May
1998, the Preferred Stock, plus accrued but unpaid dividends, automatically
converts into shares of common stock based on the fair market value of common
stock at the time of conversion.
In November 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.
<PAGE>
Note 3. Change in Accounting Estimate
As a result of a change in accounting estimate, the Company recorded a
charge of $385,221,000, as of September 30, 1996, representing the balance of
deferred subscriber acquisition costs as of that date. The Company had
previously deferred the cost of certain marketing activities, to comply with the
criteria of Statement of Position 93-7 "Reporting on Advertising Costs", and
then amortized those costs over a period determined by calculating the ratio of
current revenues related to direct response advertising versus the total
expected revenues related to this advertising, or twenty-four months, whichever
was shorter. The Company's changing business model is expected to increasingly
reduce its reliance on online service subscriber revenues for the generation of
revenues and profits, by growing high-margin other revenue streams. These
changing market dynamics, coupled with a lack of historical experience with
flat-rate pricing, create uncertainties regarding the level of expected future
economic benefits from online service subscriber revenues (See "Management's
Discussion and Analysis of Financial Condition and Results of Operations").
As a result, the Company believes it no longer has an adequate accounting basis
to support recognizing deferred subscriber acquisition costs as an asset.
Note 4. Income Taxes
The effective income tax rate varied from the federal statutory tax rate as
follows:
<TABLE>
Quarter
Ended
9/30/96
<S> <C>
Statutory rate: (34.0%)
State income taxes-net of federal
income tax benefit (4.0)
Valuation allowance on net deferred
tax benefit 38.0
Tax Rate -%
</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 product development costs.
As of September 30, 1996, the Company had available net operating loss
carryforwards of approximately $471,000,000 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
2012. To the extent that net operating loss carryforwards, when realized,
relate to stock option deductions, the resulting benefits will be credited to
stockholders' equity.
<PAGE>
Significant components of the Company's deferred tax liabilities and assets
as of September 30, 1996 are as follows:
<TABLE>
Deferred tax liabilities
<S> <C>
Capitalized software costs $ 18,662,000
Net deferred tax liabilities $ 18,662,000
Deferred tax assets:
Net operating loss carryforward $ 178,158,000
Total deferred tax assets 178,158,000
Value allowance for deferred assets (159,496,000)
Net deferred tax assets $ 18,662,000
</TABLE>
Note 5. Business Combinations
On August 5, 1996, the Company purchased 100% of the outstanding common stock of
the ImagiNation Network, Inc. ("INN"), by issuing 362,500 shares of its common
stock for a total purchase price of approximately $14.5 million. The acquisition
was accounted for under the purchase method and accordingly, the assets and
liabilities were recorded based upon their fair values at the date of
acquisition. The results of operations, for the three months ended September 30,
1996, include INN's operations from the date of acquisition.
The following pro forma information is not necessarily indicative of the
combined results that would have occurred had the acquisition taken place at the
beginning of the period, nor is it necessarily indicative of results that may
occur in the future.
<TABLE>
(in thousands, except per share data)
Pro Forma
Three Three months
months ended
ended 9/30/95 9/30/96
(unaudited)
<S> <C> <C>
Revenues $ 349,982 $ 197,902
Loss from operations (357,707) (10,143)
Net loss (355,251) (14,234)
Loss per share $ (3.81) $ (0.18)
</TABLE>
<PAGE>
Note 6. Legal Proceedings
Various legal proceedings have arisen against the Company in the ordinary
course of business. In the opinion of management, these proceedings involve
amounts which would not have a material effect on the financial position of the
Company if such proceedings were disposed of unfavorably. See also Part II,
Item 1. Legal Proceedings.
Note 7. Subsequent Event
On October 29, 1996 the Company announced a series of initiatives to fully
leverage its global assets in consumer networks, content and access, by more
closely aligning its business structure with emerging opportunities in the
interactive market, and to further distinguish its flagship online brand as the
leader in value, content and service. These initiatives included a new
corporate structure as well as a new standard monthly membership fee, and other
pricing alternatives, for its online service. In conjunction with these
initiatives, the Company will take a one-time restructuring charge of up to $75
million in the second quarter of fiscal 1997. Principal items expected to be
included in the charge are severance and related benefits for staff reductions,
lease and contract terminations, and other costs.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
The following information should be read in conjunction with the
consolidated financial statements and the notes thereto included in Item 1 of
this Quarterly Report, and the consolidated financial statements and the notes
thereto and Management's Discussion and Analysis of Financial Condition and
Results of Operations contained in the Company's Annual Report on Form 10-K for
the year ended June 30, 1996.
The Company generates two types of revenues, online service revenues and
other revenues. Online service revenues are generated by customers subscribing
to the Company's online services. Other revenues are non-subscription based and
are generated from the Company's base of subscribers as well as businesses.
Other revenues include revenues from sources such as the sale of merchandise,
the provision of data network services, transaction fees and advertising.
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. The
Company's standard monthly membership fee for its AOL service, which includes
five hours of service, is $9.95, with a $2.95 hourly fee for usage in excess of
five hours per month.
In May 1996, the Company announced an additional pricing plan for its AOL
service aimed at improving retention among its heavier users. This pricing plan
(the "Value Plan"), which became effective July 1, 1996, includes 20 hours of
service for $19.95 per month, with a $2.95 hourly fee for usage in excess of 20
hours per month.
<PAGE>
On October 29, 1996, the Company announced a new standard monthly
membership fee and several new pricing alternatives aimed at providing price
points for a wide range of consumers. These new pricing alternatives, which
will be available beginning December 1, 1996, are as follows:
* A standard monthly membership fee providing unlimited use of AOL, including
the Internet, for $19.95 per month. Subscribers can also choose to prepay
for two years in advance at the monthly rate of $14.95 or one year in
advance at the monthly rate of $17.95.
* An alternative offering three hours of AOL for $4.95 per month, with
additional time priced at $2.50 per hour.
* An alternative offering a rate of $9.95 per month for unlimited use of AOL -
for those subscribers who already have an Internet connection and use this
connection to access AOL.
The Company plans to transition members to the $19.95 standard monthly
membership fee unless alternative available pricing is selected. The transition
will take place beginning with the members' first billing cycle in December
1996, although members will be allowed to accelerate this change to December 1,
1996 upon request. Existing members may retain the $9.95 / five hour pricing
upon request.
As a result of the introduction of unlimited use pricing for AOL and the
Internet, as detailed above, the Company's Internet service, Global Network
Navigator ("GNN"), will be discontinued no later than March 1997, and its
members transitioned onto AOL. The Company had previously launched GNN in
October 1995.
The growth of the Company's online service revenues is expected to be
driven primarily by growth in its subscriber base. The growth of the subscriber
base is dependent upon the Company's ability to acquire and retain subscribers.
The Company acquires new subscribers to its services through an introductory
trial offer. The Company's ability to continue to acquire new subscribers is
dependent upon people continuing to register for its introductory trial offer.
The Company experienced generally lower overall retention rates for
the AOL service during fiscal 1996 compared to fiscal 1995. Retention rates for
AOL subscribers who were early in their membership terms decreased more than the
overall retention rate, with the largest quarterly percentage decrease occurring
in the fourth quarter of fiscal 1996. The Company believes that factors
contributing to these decreases include: (1) competition from an increasing
number of service providers; (2) the availability of alternative pricing models
from competitors, including flat-rate pricing; and (3) an increase in less-
qualified new subscribers as a result of increased direct marketing to the mass
consumer audience. The Company believes that the introduction in July 1996 of
the Value Plan (which will be discontinued upon the availability of the new
flat-rate standard monthly membership fee), the new version of AOL introduced in
late fiscal 1996, and the introduction of new pricing alternatives (including
flat-rate pricing) available beginning December 1, 1996, address many of the
factors which most directly affect retention. In addition, the Company plans to
increase spending on programs designed to improve trial conversion and retention
rates. Although the Company experienced higher monthly retention rates in the
first quarter of fiscal 1997 compared to the fourth quarter of fiscal 1996, the
Company cannot predict the overall future rate of retention.
<PAGE>
The average total usage hours per member per month, for AOL
subscribers, is expected to increase in fiscal 1997 over fiscal 1996. The
Company believes that the principal factor contributing to this expected
increase will be the availability of the Value Plan through November 1996 and
the $19.95 per month flat-rate standard monthly membership fee available
thereafter, which will allow members to spend more time online at less cost.
As a result, the Company anticipates that there will be an increase in the
number of hours of usage relative to online service revenues, and because the
Company does not have any historical operating experience with flat-rate
pricing, there are uncertainties regarding the level of future economic benefits
from online service subscriber revenues. Overall average monthly online
service revenue per AOL subscriber in fiscal 1997 is expected to be lower than
in fiscal 1996.
Other revenues are generated primarily from the sale of merchandise, data
network services, transaction fees and advertising. The growth of other revenues
is important to the Company's business objectives. In the first quarter of
fiscal 1997, other revenues represented approximately 11% of total revenues.
While such other revenues currently represent a relatively small percentage of
total revenues, a substantial portion of the Company's margins are associated
with these revenues. Among the Company's business objectives are increasing the
subscriber base and continuing to accelerate the change in its business model
into one in which increasingly more revenues and profits are generated from
sources other than online service subscription revenues, such as merchandise
sales, the provision of data network services, transaction fees and advertising,
which generally carry higher margins than online service revenues. The Company
expects that the growth in other revenues, assuming such growth continues, will
be the primary source of future profit growth, and will provide the Company with
the opportunity and flexibility to fund programs designed to grow the subscriber
base and meet other business objectives.
The online services and Internet markets are highly competitive. The
Company believes that existing competitors, which include, among others,
commercial Internet-based online services such as CompuServe, Prodigy and the
Microsoft Network, and Internet service providers, including various national
and local independent Internet service providers as well as long distance and
regional telephone companies, are likely to enhance and more aggressively market
their service offerings. In addition, new competitors, including Internet
directory services and various media and telecommunication companies, have
entered or announced plans to enter the online services and Internet markets,
resulting in greater competition for the Company. The competitive environment
could have the following effects: require additional pricing programs and
increased spending on marketing, network capacity, 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 have an
impact on revenues and result in an increase in costs as a percentage of
revenues. These factors may have a material adverse effect on the Company's
financial condition and operating results.
<PAGE>
Results of Operations
Online Service Revenues
For the three months ended September 30, 1996, online service revenues
increased from $178,479,000 to $311,132,000, or 74%, over the three months ended
September 30, 1995. This increase was primarily attributable to a 72% increase
in the number of AOL and GNN North American subscribers. The average monthly
online service revenue per AOL North American subscriber decreased from $17.71
in the three months ended September 30, 1995 to $16.86 in the three months ended
September 30, 1996. This decrease was principally attributable to the
availability of Value Plan in July 1996, as well as lost revenues and credits
issued to subscribers related to a service outage in August 1996.
Other Revenues
For the three months ended September 30, 1996, other revenues, consisting
principally of the sale of merchandise, data network services, transaction fees
and advertising increased from $19,423,000 to $38,850,000, or 100%, over the
three months ended September 30, 1995. The increase was primarily attributable
to an increase in the sale of merchandise, transaction fees and advertising
revenues.
Cost of Revenues
Cost of revenues includes network-related costs, consisting primarily of
data and voice communication costs, costs associated with operating the data
centers and providing customer support, royalties paid to information and
service providers, and the costs of merchandise sold. For the three months
ended September 30, 1996 cost of revenues increased from $119,077,000 to
$188,223,000, or 58%, over the three months ended September 30, 1995, and
decreased as a percentage of total revenues from 60.2% to 53.8%.
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 primarily as a result of the larger
customer base. 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 AOL service. The costs of
merchandise sold increased as a result of an increase in merchandise revenues.
The decrease in cost of revenues as a percentage of total revenues for the
three months ended September 30, 1996 is primarily attributable to a decrease in
data communication costs resulting from lower costs per hour, due to a higher
percentage of traffic generated on the Company's lower cost network, AOLnet.
This decrease was partially offset by increases in leased equipment costs and
the costs of merchandise sold.
The Company is building AOLnet, a TCP/IP data network, in order to increase
its network capacity, provide its members with higher speed access, and reduce
the costs of data communication. As the Company rapidly builds AOLnet, it plans
to continue to manage an increasingly higher percentage of its total traffic to
this network, which would lead to greater network utilization and a lower
overall AOLnet per hour cost . The buildout of AOLnet requires a substantial
investment in telecommunications equipment, which the Company is financing
primarily through leasing.
<PAGE>
The Company expects that future gross margins will be lower than those
achieved in recent periods. While the Company expects high-margin other
revenues will increase, and expects that the growth and management of AOLnet
will provide lower per hour data communication costs, it is anticipated that
these factors will be more than offset by an increase in the total usage hours,
primarily as a result of the introduction of flat-rate pricing.
Marketing and Write-off of Deferred Subscriber Acquisition Costs
For the three months ended September 30, 1996, marketing expenses increased
from $36,924,000 to $75,872,000, or 105%, over the three months ended September
30, 1995, and increased as a percentage of total revenues from 18.7% to 21.7%.
The increase in marketing expenses and as a percentage of revenues was primarily
attributable to an increase in the size and number of marketing programs
designed to expand the Company's subscriber base.
The balance of deferred subscriber acquisition costs as of September 30,
1996, totaling $385,221,000, was written off as a result of a change in
accounting estimate. For additional information regarding this change, refer to
Note 3 of the Notes to Consolidated Financial Statements.
Marketing costs as a percentage of total revenues are anticipated to
increase in fiscal 1997 over fiscal 1996. This anticipated increase is
primarily attributable to the change in accounting estimate, which will result
in subscriber acquisition costs being currently expensed in fiscal 1997, versus
being capitalized and amortized over twenty-four months in fiscal 1996.
Product Development
Product development costs include research and development expenses, other
product development costs and the amortization of software costs. For the three
months ended September 30, 1996, product development costs increased from
$9,580,000 to $19,326,000, or 102%, over the three months ended September 30,
1995, and increased as a percentage of total revenues from 4.8% to 5.5%. The
increases in product development costs, and such costs as a percentage of total
revenues, were primarily attributable to increases in personnel costs related to
an increase in the number of technical employees, and an increase in the
amortization of software costs. Product development costs, before
capitalization and amortization, increased by 88%.
General and Administrative
For the three months ended September 30, 1996, general and administrative
expenses increased from $20,480,000 to $35,564,000, or 74%, over the three
months ended September 30, 1995, and decreased as a percentage of total revenues
from 10.3% to 10.2%. The increase in general and administrative costs was
principally attributable to higher office, personnel and travel expenses related
to an increase in the number of employees.
<PAGE>
Amortization of Goodwill
Amortization of goodwill increased to $1,920,000 in the three months ended
September 30, 1996 from $1,663,000 in the three months ended September 30, 1995.
Amortization of goodwill relates primarily to the Company's acquisitions of
Advanced Network & Services, Inc. and Global Network Navigator, Inc., which
resulted in approximately $56 million of goodwill. The goodwill related to
these acquisitions is being amortized on a straight-line basis over periods
ranging from five to ten years. The increase in amortization of goodwill is
attributable to goodwill associated with various purchases made by the Company,
including INN, all of which occurred subsequent to the first quarter of fiscal
1996. In connection with the fiscal 1997 second quarter restructuring charge
(see Note 7 of the Notes to Consolidated Financial Statements), the Company will
write-off approximately $8.4 million of capitalized goodwill associated with
GNN.
Other Income
Other income consists primarily of investment income and nonoperating gains
net of interest expense and nonoperating charges. Other income increased to
$2,455,000 in the three months ended September 30, 1996 from $832,000 in the
three months ended September 30, 1995. The increase in other income was
primarily attributable to the allocation of minority interest losses partially
offset by nonoperating losses related to various investments.
Provision for Income Taxes
The provision for income taxes was $0 and $4,936,000 in the three months
ended September 30, 1996 and 1995, respectively. For additional information
regarding income taxes, refer to Note 4 of the Notes to Consolidated Financial
Statements.
Net Loss
The net loss was $353,689,000 and $10,907,000 in the three months ended
September 30, 1996 and 1995, respectively. The net loss in the three months
ended September 30, 1996 included a charge of $385,221,000 for the write-off of
deferred subscriber acquisition costs. The net loss in the three months ended
September 30, 1995 included a charge of $16,981,000 for acquired research and
development.
Liquidity and Capital Resources
The Company has financed its operations through cash generated from
operations and the sale of its capital stock. The Company has financed its
investments in facilities and telecommunications equipment principally through
leasing. Net cash used in operating activities was $25,291,000 and $5,598,000
in the three months ended September 30, 1996 and 1995, respectively. Included
in operating activities were expenditures for deferred subscriber acquisition
costs of $130,229,000 and $71,510,000 in the three months ended September 30,
1996 and 1995, respectively. Net cash used in investing activities was
$27,913,000 and $21,915,000 in the three months ended September 30, 1996 and
1995, respectively. Net cash provided by financing activities was $25,937,000
and $2,696,000 in the three months ended September 30, 1996 and 1995,
respectively. Included in financing activities was $15,000,000 in the three
months ended September 30, 1996 representing proceeds from the sale of preferred
stock in a subsidiary corporation.
In October 1995, the Company completed a public stock offering of 4,963,266
shares of common stock (adjusted for a stock split) which generated net cash
proceeds of approximately $139.5 million.
<PAGE>
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. In connection with the agreement, the Company
received approximately $28.0 million through the sale of convertible preferred
stock to Mitsui. The preferred stock has an aggregate liquidation preference of
approximately $28.0 million and accrues dividends at a rate of 4% per annum.
Accrued dividends can be paid in the form of additional shares of preferred
stock. During May 1998, the preferred stock, together with accrued but unpaid
dividends, automatically converts into shares of common stock based on the fair
market value of common stock at the time of conversion.
The Company leases the majority of its facilities and 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 connection with the new $19.95 standard monthly membership fee, which
will be available beginning December 1, 1996, members will be offered the
opportunity to prepay for two years in advance at the monthly rate of $14.95 or
one year in advance at the monthly rate of $17.95. To the extent that members
choose either of these prepayment options, the result will be an acceleration of
cash receipts relative to associated recognized revenues.
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 subscriber
acquisition marketing and content programs to expand its subscriber base, as
well as in network, 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. The Company anticipates that available cash and cash provided
by operating activities will be sufficient to fund its operations for the next
twelve months, including certain costs associated with the fiscal 1997 second
quarter restructuring.
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. The Company may have experienced the effects of seasonality in
previous periods, but the effects, if any, were not discernible due to the
masking effect resulting from the Company's substantial growth rates in those
periods. The Company expects that seasonality will have an effect in the
future. The growth in the subscriber base 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.
Inflation
The Company believes that inflation has not had a material effect on its
results of operations.
<PAGE>
Forward-Looking Statements
In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, 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 base; increased membership acquisition costs;
lower average monthly revenue per subscriber and increased attrition in the
Company's subscriber base.
Factors related to the new standard monthly membership fee, and other new
pricing alternatives, which become available December 1, 1996, including
uncertainty of: the effect on average cost per subscriber acquisition and
retention rates; the amount of time spent by members using the AOL service
under each pricing alternative; and the percentage of members who sign up under
each pricing alternative relative to their usage patterns.
Risks related to the buildout of AOLnet, including the inability to expand
server and network capacity at a rate sufficient to satisfy subscriber demands,
which the Company expects to accelerate substantially as a result of the
introduction of flat-rate pricing; the failure of any of the Company's network
providers; the failure to obtain the necessary financing for the buildout of
AOLnet; and the risk that demand will not 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, customer support and financial control systems to
the needs of the expanded entity and subscriber base; 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.
The possibility of 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.
<PAGE>
The amount and rate of growth in the Company's marketing and 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 the Company'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, merchandise sales and the
provision of data network services.
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 litigation, governmental investigations,
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, and developments or assertions by or against
the Company 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 the Company has an
agreement or
understanding, including any issues affecting any investment or joint venture in
which the Company has an investment; the amount, type and cost of the financing
which the Company has, and any changes to that financing.
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In November 1996, the Company received communications from certain regulators
concerning the Company's announced plan to change its pricing. These regulators
have expressed concern about the Company's proposed method of implementing the
pricing change and the adequacy of notice thereof to the Company's subscribers.
The Company believes that its plan for transitioning its subscribers to the new
pricing, and its contemplated notice to subscribers, are fair and reasonable.
The Company believes that, if one or more regulators or others were to take
action against the Company with respect to these matters, the Company would
prevail. However, if the Company were not to prevail, a negative outcome
with respect to such suit or suits could have a material adverse effect
on the business of the Company.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None.
(b) Reports on Form 8-K
Form Item # Description Filing Date
Form 8-K 2, 7 August 20, 1996
<PAGE>
AMERICA ONLINE, INC.
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.
AMERICA ONLINE, INC.
DATE: November 14, 1996 SIGNATURE: /s/Stephen M. Case
Stephen M. Case
Chief Executive Officer
DATE: November 14, 1996 SIGNATURE: /s/Lennert J. Leader
Lennert J. Leader
Chief Financial Officer
(Principal Financial and
Accounting Officer)
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