FORM 10-QA
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: March 31, 1997
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 April 30,1997........................... 97,852,742
AMERICA ONLINE, INC.
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets-March 31, 1997
and June 30, 1996 3
Consolidated Statements of Operations-Three
months ended March 31, 1997 and 1996 4
Consolidated Statements of Operations-Nine
months ended March 31, 1997 and 1996 5
Consolidated Statements of Cash Flows-Nine
months ended March 31, 1997 and 1996 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 21
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 22
<TABLE>
<CAPTION>
AMERICA ONLINE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
RESTATED (See Note 2)
(Amounts in thousands, except share data)
March 31, June 30,
1997 1996
ASSETS (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $197,584 $118,421
Short-term investments 250 10,712
Trade accounts receivable 58,331 49,342
Other receivables 35,129 23,271
Prepaid expenses and other current assets 75,837 65,290
Total current assets 367,131 267,036
Property and equipment at cost, net 149,214 111,090
Other assets:
Product development costs, net 67,728 44,330
Deferred subscriber acquisition costs, net - 314,181
License rights, net 9,571 4,947
Other assets 65,416 29,607
Deferred income taxes 23,005 135,872
Goodwill, net 40,455 51,691
$722,520 $958,754
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $76,499 $105,904
Accrued personnel costs 10,476 15,719
Other accrued expenses and liabilities 257,276 127,898
Deferred revenue 168,743 37,950
Current portion of long-term debt and
capital lease obligations 2,097 2,435
Total current liabilities 515,091 289,906
Long-term liabilities:
Notes payable 18,531 19,306
Deferred income taxes 23,005 135,872
Deferred revenue 68,510 -
Minority Interests 5,062 -
Other liabilities 3,881 1,168
Total liabilities 634,080 446,252
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares
authorized, 1,000 shares issued and outstanding 1 1
at March 31, 1997 and June 30, 1996
Common stock, $.01 par value, 300,000,000 shares
authorized, 97,447,032 and 92,626,000 shares
issued and outstanding at March 31, 1997
and June 30, 1996, respectively 974 926
Additional paid-in capital 582,760 519,342
Accumulated deficit (495,295) (7,767)
Total stockholders' equity 88,440 512,502
$722,520 $958,754
See accompanying notes.
</TABLE>
<TABLE>
<CAPTION>
AMERICA ONLINE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
RESTATED (See Note 2)
(Amounts in thousands, except per share data)
Three months
ended
March 31,
1997 1996
(Unaudited)
Revenues:
<S> <C> <C>
Online service revenues $381,486 $285,481
Other revenues 68,605 26,859
Total revenues 450,091 312,340
Costs and expenses:
Cost of revenues 298,774 186,238
Marketing 89,530 56,789
Product development 14,924 12,804
General and administrative 52,276 29,973
Amortization of goodwill 1,398 1,816
Settlement charges, net (96) -
Total costs and expenses 456,806 287,620
Income (loss) from operations (6,715) 24,720
Other income 1,981 1,280
Merger expenses - (848)
Income (loss) before provision for income taxes (4,734) 25,152
Provision for income taxes - (10,025)
Net income (loss) $(4,734) $15,127
Earnings (loss) per share: $(0.05) $0.14
Weighted average shares outstanding 96,283 111,232
See accompanying notes.
</TABLE>
<TABLE>
<CAPTION>
AMERICA ONLINE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
RESTATED (See Note 2)
(Amounts in thousands, except per share data)
Nine months
ended
March 31,
1997 1996
(Unaudited)
Revenues:
<S> <C> <C>
Online service revenues $1,043,838 $688,485
Other revenues 165,647 70,902
Total revenues 1,209,485 759,387
Costs and expenses:
Cost of revenues 746,368 455,019
Marketing:
Marketing 312,179 145,871
Write-off of deferred subscriber 385,221 -
acquisition costs
Product development 41,926 28,938
General and administrative 136,650 74,439
Acquired research and development - 16,981
Amortization of goodwill 4,907 5,228
Restructuring charges 48,627 -
Settlement charges, net 24,204 -
Total costs and expenses 1,700,082 726,476
Income (loss) from operations (490,597) 32,911
Other income 3,069 3,572
Merger expenses - (848)
Income (loss) before provision for income taxes (487,528) 35,635
Provision for income taxes - (21,885)
Net income (loss) $(487,528) $13,750
Income (loss) per share: $(5.16) $0.13
Weighted average shares outstanding 94,566 108,346
See accompanying notes.
</TABLE>
<TABLE>
<CAPTION>
AMERICA ONLINE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
RESTATED (See Note 2)
(Amounts in thousands)
Nine months ended
March 31,
1997 1996
(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $(487,528) $13,750
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Write-off of deferred subscriber acquisition costs 385,221 -
Non-cash restructuring charges 22,478 -
Depreciation and amortization 45,517 23,679
Amortization of subscriber acquisition costs 59,189 76,173
Loss on sale of property and equipment - 44
Charge for acquired research and development - 16,981
Changes in assets and liabilities:
Trade accounts receivable (9,443) (12,255)
Other receivables (6,953) (1,989)
Prepaid expenses and other current assets (12,767) (14,570)
Deferred subscriber acquisition costs (130,229) (276,559)
Other assets (36,627) (18,129)
Trade accounts payable (30,148) 51,653
Accrued personnel costs (6,553) 4,547
Other accrued expenses and liabilities 117,197 60,641
Deferred revenue 199,303 13,506
Deferred income taxes - 21,885
Other liabilities 2,351 247
Total adjustments 598,536 (54,146)
Net cash provided by (used in) operating activities 111,008 (40,396)
Cash flows from investing activities:
Short-term investments 10,462 8,542
Purchase of property and equipment (60,788) (40,934)
Product development costs (45,193) (22,675)
Purchase costs of acquired businesses (475) (5,857)
Net cash used in investing activities (95,994) (60,924)
Cash flows from financing activities:
Proceeds from issuance of preferred stock in
subsidiary 15,000 -
Proceeds from issuance of common stock, net 50,017 173,607
Principle and accrued interest payments on revolving
line of credit and long-term debt (801) 2,217
Payments under capital lease obligations (67) (1,179)
Net cash provided by financing activities 64,149 174,645
Net increase in cash and cash equivalents 79,163 73,325
Cash and cash equivalents at beginning of period 118,421 45,877
Cash and cash equivalents at end of period $197,584 $119,202
Supplemental cash flow information
Cash paid during the period for:
Interest $1,300 $1,251
Income taxes - -
See accompanying notes.
</TABLE>
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 those adjustments discussed in Notes
4, 7 and 8 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. Certain amounts in prior years'
consolidated financial statements have been reclassified to conform to the
current year presentation. Operating results for the three and nine months
ended March 31, 1997 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. Restatement
After discussions with the Staff of the Securities and Exchange Commission, the
accompanying consolidated financial statements for the three and nine month
periods ended March 31, 1997, have been restated by $7.376 million. The Company
has restated the aforementioned financial statements to (1) reverse $7 million
of revenue in connection with a commerce agreement with a long distance
telephone service provider, and instead recognize this revenue on a straight-
line basis over the 40-month term of the agreement beginning March 1, 1997,
resulting in $175,000 of revenue, rather than $7 million, being recognized in
the March 31, 1997 quarter; (2) recognize an additional $725,000 in revenue
associated with certain other aspects of the aforementioned commerce agreement,
which represents a portion of such revenues to be earned on straight-line basis
over the 40-month term of the agreement; (3) record $1.276 million in additional
information provider expense resulting from the reversal of credits taken in the
March 31, 1997 quarter as a result of new information provider agreements,
credits that will now be recognized in the Company's fourth quarter ended June
30, 1997, the period in which the new information provider agreements were
signed; (4) reclassify product development amortization expense out of product
development expense to cost of revenues, where it will be reported in future
periods and (5) reclassify capitalized network costs to leasehold improvements.
The effects of these adjustments on the accompanying consolidated financial
statements as of and for the three and nine month periods ended March 31, 1997
are summarized below:
<TABLE>
Three months ended Nine months ended
March 31, 1997 March 31, 1997
As As
Originally As Originally As
Reported Restated Reported Restated
<S> <C> <C> <C> <C>
Total stockholders' equity $ 70,116 $ 88,440 $ 70,116 $ 88,440
Other revenues $ 74,705 $ 68,605 $ 171,747 $ 165,647
Cost of revenues $288,215 $298,774 $ 721,812 $ 746,368
Product development $ 24,207 $ 14,924 $ 65,206 $ 41,926
Restructuring charge - - $ 74,327 $ 48,627
Net income (loss) $ 2,642 $ (4,734) $(505,852) $(487,528)
Net income (loss) per share $ 0.02 $ (0.05) $ (5.35) $ (5.16)
</TABLE>
The reclassifications noted in items (4) and (5) above are included in the
accompanying financial statements for all periods presented. In addition, the
As Restated numbers above include the effect of adjustments pursuant to the
Company's Form 10-QA for the period ended December 31, 1996.
Note 3. 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 $139,500,000.
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.
Note 4. 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, which includes flat-rate
pricing for its online service, is expected to increasingly reduce its reliance
on online service subscriber revenues for the generation of revenues and
profits. This changing business model, coupled with a lack of historical
experience with flat-rate pricing, created 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 believed it no longer had an
adequate accounting basis to support recognizing deferred subscriber acquisition
costs as an asset.
Note 5. Income Taxes
The effective income tax rate varied from the federal statutory tax rate as
follows:
<TABLE>
Quarter Nine Months
Ended Ended
3/31/97 3/31/97
<S> <C> <C>
Statutory rate (35.0%) (35.0%)
State income taxes - net of federal
income tax benefit (3.0) (3.0)
Valuation allowance on net deferred
tax benefit 38.0 38.0
Tax Rate -% -%
</TABLE>
The Company has adjusted the effective income tax rate for the quarter
ended March 31, 1997 to reflect the anticipated results for the entire fiscal
year ended June 30, 1997.
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 March 31, 1997, the Company had available net operating loss
carryforwards of approximately $685,000,000 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.
Significant components of the Company's deferred tax liabilities and assets
as of March 31, 1997 are as follows:
<TABLE>
Deferred tax liabilities:
<S> <C>
Capitalized software costs $ 23,005,000
Net deferred tax liabilities $ 23,005,000
Deferred tax assets:
Net operating loss carryforward $ 260,192,000
Other 4,437,000
Total deferred tax assets 264,629,000
Valuation allowance for deferred assets (241,624,000)
Net deferred tax assets $ 23,005,000
</TABLE>
Note 6. 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 and nine months ended March
31, 1997, 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
Nine months Nine months
ended 3/31/97 ended 3/31/96
(unaudited)
<S> <C> <C>
Revenues $ 1,209,485 $ 759,387
Income (loss) from operations (492,160) 23,066
Net income (loss) (489,090) 3,967
Earnings (loss) per share $ (5.17) $ 0.04
</TABLE>
Note 7. Legal Proceedings
The following disclosure is provided as of the quarter ended March 31,
1997. For recent developments, refer to Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Recent Developments.
The Company is involved in various legal proceedings, including pending
litigation. In February 1997, a class action lawsuit (Orman v. America Online,
Inc., et al.) was filed against the Company, its officers and directors and
its outside auditors alleging violations of the federal securities laws
between August 10, 1995 and October 29, 1996. A shareholder derivative suit
related to the Orman lawsuit has also been filed against the Company's
directors in Delaware chancery court. The Company believes that it has valid
defenses to all litigation pending against it, including the Orman case, and all
cases against the Company are, and will continue to be, vigorously defended.
Management is unable to make a meaningful estimate of the amount or range of
loss that could result from an unfavorable outcome of all pending litigation.
It is possible that the Company's results of operations or cash flows in a
particular quarter or annual period or its financial position could be
materially affected by an ultimate unfavorable outcome of certain pending
litigation. Management believes, however, that the ultimate outcome
of all pending litigation should not have a material adverse effect on the
Company's financial position.
In the quarter ended December 31, 1996, the Company recorded a charge of
$24,300,000 related to a legal settlement reached with various State Attorneys
General to resolve potential claims arising out of the Company's introduction of
flat-rate pricing and its representation that it would provide unlimited access
to subscribers. Pursuant to this legal settlement, the Company agreed to make
payments to subscribers, according to their usage of the AOL service, who may
have been injured by their reliance on the Company's claim of unlimited access.
These payments do not represent refunds of online service revenues, but are
rather the compromise and settlement of allegations that the Company's
advertising of unlimited access under its flat-rate pricing plan violated
consumer protection laws. In the quarter ended March 31, 1997, as a result of a
change in accounting estimate, the Company recorded a benefit of $5,996,000
related to the aforementioned legal settlement, representing the Company's
revised estimate of the total liability associated with this matter.
In the quarter ended March 31, 1997, the Company recorded a charge of
$5,900,000 related to a preliminary legal settlement reached with various class
action plaintiffs, who had filed suit against the Company in connection with
the Company's introduction of flat-rate pricing, that pertained to many of the
same issues contained in the legal settlement with the State Attorneys General
in the preceding paragraph. The preliminary legal settlement with the class
action plaintiffs extends and expands the relief provided to qualifying
subscribers under the State Attorneys General settlement.
Note 8. Restructuring Charge
In connection with a restructuring plan adopted in the second quarter of
fiscal 1997, the Company recorded a $48,627,000 restructuring charge associated
with the Company's change in business model, the reorganization of the Company
into three operating units, the termination of approximately 300 employees, and
the shutdown of certain operating divisions and subsidiaries.
The components of the provision are as follows:
<TABLE>
<S> <C>
Write-off of impaired assets and discontinued businesses $ 31,215,000
Severance and personnel related 8,734,000
Other expenses 8,678,000
Total restructuring charge $ 48,627,000
</TABLE>
Included in the category of write-off of impaired assets and discontinued
businesses are the costs associated with the termination of the GNN service and
the write-off of the related goodwill. Additionally, the write-off of impaired
assets and discontinued businesses category includes charges associated with
unrealizable software development costs and certain prepaid marketing materials
which are no longer usable under the Company's new business model which includes
the flat-rate pricing structure. The severance and personnel related category
includes the costs associated with terminating approximately 300 employees.
The other expenses category consists primarily of costs incurred as a result
of the requirements made by various regulatory bodies in connection with the
Company's termination of its former pricing program.
The following table summarizes the activity in the restructuring accrual
during the quarter ended March 31, 1997. The balance of the restructuring
accrual at March 31, 1997 is included in other accrued expenses and liabilities
on the balance sheet.
<TABLE>
<S> <C>
Restructuring accrual at December 31, 1996 $ 12,823,000
Payments ( 6,805,000)
Non-cash adjustments ( 2,541,000)
Restructuring accrual at March 31, 1997 $ 3,477,000
</TABLE>
Note 9. Earnings per Share
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share." SFAS
No. 128 establishes a different method of computing net income per share than is
currently required under the provisions of Accounting Principles Board Opinion
No. 15. Under SFAS No. 128, the Company will be required to present both basic
net income per share and diluted net income per share. Basic net income (loss)
per share would have been $(0.05) and $0.17 for the three months ended March 31,
1997 and 1996, respectively, and $(5.16) and $0.16 for the nine months ended
March 31, 1997 and 1996, respectively. The impact of SFAS No. 128 on the
calculation of diluted net income per share for the aforementioned periods would
not have been material. The Company plans to adopt SFAS No. 128 in its fiscal
quarter ending December 31, 1997 and at that time all historical net income per
share data presented will be restated to conform to the provisions of SFAS No.
128.
Note 10. Cash and Cash Equivalents
The Company considers all highly liquid investments with an original
maturity date of three months or less to be cash equivalents. At March 31,
1997, approximately $16,000,000 of the Company's cash and cash equivalents was
temporarily restricted in conjunction with certain leasing activities of the
Company.
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 advertising and electronic commerce revenues, which
consist of the sale of merchandise, advertising and related revenues, and
transaction fees, as well as other revenues, which consist primarily
of data network service revenues.
Currently, the Company's online service revenues are generated primarily
from subscribers paying a monthly membership fee. Prior to December 1, 1996, a
significant portion of online service revenues were comprised of hourly charges
based on usage in excess of the number of hours of usage provided as part of the
monthly fee. With the introduction of flat-rate pricing, as described below,
the portion of online service revenues which are generated from hourly charges
has decreased substantially.
Effective December 1, 1996, the Company began offering several pricing
alternatives aimed at providing price points for a wide range of consumers.
These pricing alternatives are as follows:
* A standard monthly membership fee providing complete access to AOL,
including the Internet, for a flat monthly fee of $19.95, with no additional
hourly charges (the "Flat-Rate Plan"). 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 at 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.
Prior to December 1, 1996, the Company's standard monthly membership fee
for its AOL service, which included five hours of service, was $9.95 per month,
with a $2.95 hourly fee for usage in excess of five hours per month. Existing
members at December 1, 1996, could retain the $9.95 / five hour pricing upon
request. For the period July 1, 1996, through November 30, 1996, the Company
also offered a pricing plan which included 20 hours of service for $19.95 per
month, with a $2.95 hourly fee for usage in excess of 20 hours per month (the
"Value Plan"). The Value Plan was discontinued upon the availability of the
Flat-Rate Plan on December 1, 1996.
Subsequent to the introduction of the Flat-Rate Plan, the Company
experienced a significant increase in the average usage hours per member per
month, and an attendant decrease in the average revenue per member-hour. The
Company also experienced higher cost of revenues relative to total revenues.
The Company plans to minimize the impact of the aforementioned changes by
growing other revenues as well as decreasing costs, on a relative basis
(either on a per hour basis or as a percentage of total revenues), principally
through operating cost efficiencies and contract renegotiations. The relative
cost decreases are expected to include such costs as the per hour costs of the
Company's data network, marketing costs and other costs.
As a result of the introduction of the Flat-Rate Plan for AOL and the
Internet, as detailed above, the Company's Internet service, Global Network
Navigator ("GNN"), has been discontinued. The Company had launched GNN in
October 1995.
The growth of the Company's online service revenues, assuming such growth
continues, 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) the lack of a flat-rate pricing
plan for the AOL service; and (2) 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, the new
version of AOL introduced in late fiscal 1996, and the introduction of the Flat-
Rate Plan on 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. The Company
experienced sequentially higher retention rates in the first and second quarters
of fiscal 1997 compared to the fourth quarter of fiscal 1996. Retention rates
decreased in the third quarter of fiscal 1997 relative to the first and second
quarters of fiscal 1997. During the third quarter, retention rates were lowest
in January 1997, which the Company believes was primarily a result of
cancellations associated with the high number of registrations that occurred in
December 1996, cancellations associated with network access problems experienced
by certain subscribers, and cancellations associated with the transition of
subscribers to a higher standard monthly fee. Monthly retention rates improved
sequentially for the period February 1997 through April 1997.
The average total usage hours per member per month, for AOL subscribers,
has increased in fiscal 1997 over fiscal 1996. The Company believes that the
principal factor contributing to this increase has been the availability of the
Value Plan through November 1996 and the Flat-Rate Plan available thereafter,
which have allowed members to spend more time online at less cost. As a result,
the Company has experienced an increase in the number of hours of usage relative
to online service revenues, and because the Company has limited 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, principally as a result of the
availability in fiscal 1997 of the Value and Flat-Rate Plans.
Other revenues are generated primarily from advertising and electronic
commerce and the provision of data network services. The growth of other
revenues is important to the Company's business objectives. In the third
quarter of fiscal 1997, other revenues represented approximately 15% of total
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 advertising and
electronic commerce. 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, and Internet
service providers, such as Prodigy and the Microsoft Network, and including
various national and local independent Internet service providers as well as
long distance and regional telephone companies, including, among others, AT&T
Corporation, MCI Communications Corporation and various regional Bell operating
companies, are likely to enhance and more aggressively market their service
offerings. In addition, new competitors, including branded search engines and
various media and telecommunications companies, have entered or announced plans
to enter the online services and Internet markets, resulting in greater
competition for the Company. Some of the direct competitors and possible future
competitors referred to above may have greater financial, technical, marketing
or personnel resources than the Company. The competitive environment could have
the following effects: require pricing programs resulting in lower prices 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 its
ability to develop new products and services; limit the Company's ability to
grow its subscriber base; result in increased attrition in the Company's
subscriber base; and negatively impact the Company's ability to meet its
business objective of changing its business model into one in which increasingly
more revenues and profits are generated from sources other than online service
subscription revenues, such as advertising and electronic commerce. 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.
Results of Operations
Online Service Revenues
For the three months ended March 31, 1997, online service revenues
increased from $285,481,000 to $381,486,000, or 34%, over the three months ended
March 31, 1996. This increase was primarily attributable to a 46% increase in
the average number of AOL North American subscribers for the quarter ended March
31, 1997, compared to the prior year comparable quarter, offset by a 10%
decrease in the average monthly online service revenue per AOL North American
subscriber. The average monthly online service revenue per AOL North American
subscriber decreased from $18.72 in the three months ended March 31, 1996 to
$17.02 in the three months ended March 31, 1997. This decrease was
principally attributable to the availability of the Flat-Rate Plan beginning
in December 1996.
For the nine months ended March 31, 1997, online service revenues increased
from $688,485,000 to $1,043,838,000, or 52%, over the nine months ended March
31, 1996. This increase was primarily attributable to a 60% increase in the
quarterly average number of AOL North American subscribers for the nine
months ended March 31, 1997, compared to the prior year comparable period,
offset by a 7% decrease in the average monthly online service revenue per AOL
North American subscriber. The average monthly online service revenue per AOL
North American subscriber decreased from $18.14 in the nine months ended March
31, 1996 to $16.94 in the nine months ended March 31, 1997. This decrease was
principally attributable to the availability of the Value Plan from July 1996
through November 1996, and the Flat-Rate Plan beginning in December 1996.
Other Revenues
For the three months ended March 31, 1997, other revenues, which consist of
advertising and electronic commerce revenues, as well as other revenues,
increased from $26,859,000 to $74,705,000, or 178%, over the three months ended
March 31, 1996. For the nine months ended March 31, 1997, other revenues
increased from $70,902,000 to $171,747,000, or 142%, over the nine months ended
March 31, 1996. The increase in both periods was primarily attributable to an
increase in advertising and electronic commerce revenues, driven primarily by
increases in the sale of merchandise and advertising and related revenues.
The Company entered into a 40-month electronic commerce agreement in
February 1997 (the "Agreement") with long distance telephone service provider
Tel-Save, Inc. Under the terms of the Agreement, the Company received $100
million in cash and warrants valued at $20 million (the "minimum contract
value") as consideration related to a Tel-Save product offering to the Company's
subscribers. The Agreement also contains a revenue-sharing arrangement that,
based upon subscriber usage levels of the Tel-Save product offering, provides
the Company with an opportunity to earn in excess of the $120 million minimum
contract value. The Company recognized $5.9 million in other revenues during
the quarter ended March 31, 1997 pursuant to the Agreement. In the aggregate,
the Company expects to recognize approximately $50 million of revenue pursuant
to the Agreement during calendar year 1997, related principally to certain
market exclusivities, production and development performance milestones, the
prorated value of the warrants and other promotional commitments and
deliverables. The Tel-Save product offering is expected to launch prior to the
end of calendar year 1997. Given the evolving nature of transactions involving
electronic commerce, the Company cannot predict whether electronic commerce
agreements containing similar types of revenue-producing activities will become
frequent in the future.
Cost of Revenues
Cost of revenues includes network-related costs, consisting primarily of
data network 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 March 31, 1997,
cost of revenues increased from $186,238,000 to $298,774,000, or 60%, over the
three months ended March 31, 1996, and increased as a percentage of total
revenues from 59.6% to 66.4%. For the nine months ended March 31, 1997, cost of
revenues increased from $455,019,000 to $746,368,000, or 64%, over the nine
months ended March 31, 1996, and increased as a percentage of total revenues
from 59.9% to 61.7%.
The increase in cost of revenues for the three and nine month periods ended
March 31, 1997 was primarily attributable to an increase in data network costs,
leased equipment costs, customer support costs, the costs of merchandise sold,
and royalties paid to information and service providers. Data network costs
increased primarily as a result of the larger customer base and more usage by
customers. Leased equipment costs increased primarily as a result of additional
host computer and network equipment. 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 and network access
problems encountered by subscribers upon the introduction of the Flat-Rate Plan.
The costs of merchandise sold increased as a result of an increase in
merchandise revenues. 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
computation of payments to information providers in the March 1997 quarter
under usage-based contracts then in effect was calculated by using the average
revenue per hour from the preceding quarter, the December 1996 quarter, and
usage from the March 1997 quarter. The calculated average revenue per hour was
reduced as a result of increased usage in the December 31, 1996 quarter relative
to revenues. This decrease in rate was substantially offset by the increase in
usage in the March quarter, which resulted from the availability of flat-rate
pricing. In the December 1996 quarter, the computation of payments to
information providers under usage-based contracts then in effect was calculated,
for the months of October 1996 and November 1996, by using a $2.95 revenue rate
per hour and usage from the same months. In the month of December 1996, the
computation of payments to information providers under usage-based contracts was
calculated by using the average revenue per hour from the preceding quarter, the
September 1996 quarter, and usage from the month of December 1996.
The increases in cost of revenues as a percentage of total revenues for the
three and nine months ended March 31, 1997 were primarily attributable to
increases in leased equipment costs and the costs of merchandise sold. The
increase in cost of revenues as a percentage of total revenues for the nine
months ended March 31, 1997 was partially offset by a decrease in data network
costs resulting from a lower cost per hour, due to a higher percentage of
traffic generated on AOLnet.
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
data network costs on a per hour basis. 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 a lower overall data network per
hour cost.
As a result of the introduction of the Flat-Rate Plan and the expected
significant increase in total usage hours, and an attendant decrease in average
revenue per member-hour, certain significant information provider contracts
have become uneconomic. The Company began negotiations with these information
providers in the December 31, 1996 quarter to terminate these contracts and
enter into new information provider contracts, effective January 1, 1997, which
will be structured as either flat-fee contracts or usage-based contracts under
which royalty payments to those information providers will be calculated using
an average revenue per member-hour rather than a fixed hourly revenue rate, and
thus will be economic to the Company as royalties under those contracts will
not be significantly impacted by increases in usage, assuming that present and
expected usage patterns continue. As a result of these new information
provider contracts, royalties paid to information providers are not expected to
materially impact cost of revenues in the future. Substantially all of the new
information provider contracts were consummated in the quarter ended June 30,
1997, and the effects of those contracts, including the retroactive provisions,
will be recorded in that period.
Marketing and Write-off of Deferred Subscriber Acquisition Costs
Marketing expenses include the costs to acquire and retain subscribers and
other general marketing costs. For the three months ended March 31, 1997,
marketing expenses increased from $56,789,000 to $89,530,000, or 58%, over the
three months ended March 31, 1996, and increased as a percentage of total
revenues from 18.2% to 19.9%. For the nine months ended March 31, 1997,
marketing expenses increased from $145,871,000 to $312,179,000, or 114%, and
increased as a percentage of total revenues from 19.2% to 25.8%.
The increase in marketing expenses for the three and nine month periods
ended March 31, 1997, was primarily attributable to an increase in subscriber
acquisition expenses, which were impacted by a change in accounting estimate at
September 30, 1996, that resulted in subscriber acquisition costs being
currently expensed for periods subsequent to the first quarter of fiscal 1997,
versus being capitalized and amortized over twenty-four months in fiscal 1996
and in the first quarter of fiscal 1997. The increase in marketing expenses as
a percentage of total revenues for the three months ended March 31, 1997 was
primarily attributable to an increase in general marketing expenses, including
personnel and telemarketing, as well as retention marketing. The increase in
marketing expenses as a percentage of total revenues for the nine months ended
March 31, 1997 was primarily attributable to an increase in subscriber
acquisition expenses. As a result of the aforementioned change in accounting
estimate, the balance of deferred subscriber acquisition costs as of September
30, 1996, totaling $385,221,000, was written off. For additional information
regarding this change, refer to Note 4 of the Notes to Consolidated Financial
Statements.
For the three months ended March 31, 1997, marketing expenses, before
capitalization and amortization, decreased from $145,002,000 to $89,530,000, or
38%, over the three months ended March 31, 1996, and decreased as a percentage
of total revenues from 46.4% to 19.9 %. For the nine months ended March 31,
1997, marketing expenses, before capitalization and amortization, increased from
$346,257,000 to $383,219,000, or 11%, and decreased as a percentage of total
revenues from 45.6% to 31.7%.
The decrease in marketing expenses for the three months ended March 31,
1997, before capitalization and amortization, was primarily attributable to a
decrease in acquisition related marketing costs, designed to keep the subscriber
base relatively flat versus the prior quarter as the Company expanded its
network capacity to handle the additional demand which resulted from the
introduction of flat-rate pricing. The decrease in marketing expenses as a
percentage of total revenues for the three months ended March 31, 1997, before
capitalization and amortization, was primarily the result of the aforementioned
decrease in costs, combined with the substantial growth in revenues.
The increase in marketing expenses for the nine months ended March 31,
1997, before capitalization and amortization, was primarily attributable to an
increase in general marketing expenses, including personnel and telemarketing,
as well as retention marketing. The decrease in marketing expenses as a
percentage of total revenues for the nine months ended March 31, 1997, before
capitalization and amortization, was primarily the result of the Company having
a more competitively priced product offering, as well as the substantial growth
in revenues, which more than offset the additional marketing expenses.
Product Development
Product development costs include research and development expenses and
other product development costs. For the three months ended March 31, 1997,
product development costs increased from $12,804,000 to $14,924,000, or 17%,
over the three months ended March 31, 1996, and decreased as a percentage of
total revenues from 4.1% to 3.3%. For the nine months ended March 31, 1997,
product development costs increased from $28,938,000 to $41,926,000, or 45%,
over the nine months ended March 31, 1996, and decreased as a percentage of
total revenues from 3.8% to 3.5%. The increases in product development costs
were primarily attributable to an increase in personnel costs related to an
increase in the number of technical employees. The decreases in product
development costs as a percentage of total revenues were primarily attributable
to the substantial increases in revenues, which more than offset the additional
product development costs.
General and Administrative
For the three months ended March 31, 1997, general and administrative
expenses increased from $29,973,000 to $52,276,000, or 74%, over the three
months ended March 31, 1996, and increased as a percentage of total revenues
from 9.6% to 11.6%. For the nine months ended March 31, 1997, general and
administrative expenses increased from $74,439,000 to $136,650,000, or 84%, over
the nine months ended March 31, 1996, and increased as a percentage of total
revenues from 9.8% to 11.3%. The increases in general and administrative costs,
and such costs as a percentage of total revenues, were principally attributable
to higher office-related expenses, related to an increase in the number of
employees as well as an increase in office space. This increase in office-
related expenses included costs associated with certain subsidiaries which were
present in the fiscal 1997 periods only, including Digital City, Inc. and INN.
Additionally, there were increases in personnel costs.
Acquired Research and Development
Acquired research and development costs, totaling $16,981,000 for the nine
months ended March 31, 1996, relate to in-process research and development
purchased pursuant to the Company's acquisition of Ubique, Ltd. in September
1995.
Amortization of Goodwill
Goodwill is being amortized on a straight-line basis over periods ranging
from five to ten years. For the three months ended March 31, 1997, amortization
of goodwill decreased from $1,816,000 to $1,398,000 over the three months ended
March 31, 1996. For the nine months ended March 31, 1997, amortization of
goodwill decreased from $5,228,000 to $4,907,000 over the nine months ended
March 31, 1996. The decrease in amortization of goodwill in the three and nine
month periods ended March 31, 1997 is primarily attributable to a write-off of
the goodwill associated with GNN, partially offset by goodwill associated with
various purchases made by the Company, including INN, all of which occurred
subsequent to the third quarter of fiscal 1996. In connection with the fiscal
1997 second quarter restructuring charge (see Note 8 of the Notes to
Consolidated Financial Statements), the Company wrote-off approximately $8.2
million of capitalized goodwill associated with GNN.
Restructuring Charge
In connection with a restructuring plan adopted in the second quarter of
fiscal 1997, the Company recorded a $48,627,000 restructuring charge associated
with the Company's change in business model, the reorganization of the Company
into three operating units, the termination of approximately 300 employees, and
the shutdown of certain operating divisions and subsidiaries. For additional
information regarding this charge, refer to Note 8 of the Notes to Consolidated
Financial Statements.
Other Income
Other income consists primarily of investment income and non-operating
gains net of interest expense and non-operating charges. The Company had other
income of $1,981,000 and $1,280,000 in the three months ended March 31, 1997 and
1996, respectively. The Company had other income of $3,069,000 and $3,572,000
in the nine months ended March 31, 1997 and 1996, respectively. The increase in
other income for the three months ended March 31, 1997, was primarily
attributable to the allocation of minority interest losses partially offset by
non-operating losses related to various investments. The decrease in other
income for the nine months ended March 31, 1997 was primarily attributable to
non-operating losses related to various investments partially offset by the
allocation of minority interest losses.
Settlement Charges, Net
In the quarter ended December 31, 1996, the Company recorded a charge of
$24,300,000 related to a legal settlement reached with various State Attorneys
General to resolve potential claims arising out of the Company's introduction of
flat-rate pricing and its representation that it would provide unlimited access
to subscribers. Pursuant to this legal settlement, the Company agreed to make
payments to subscribers, according to their usage of the AOL service, who may
have been injured by their reliance on the Company's claim of unlimited access.
These payments do not represent refunds of online service revenues, but are
rather the compromise and settlement of allegations that the Company's
advertising of unlimited access under its flat-rate pricing plan violated
consumer protection laws. In the quarter ended March 31, 1997, as a result of a
change in accounting estimate, the Company recorded a benefit of $5,996,000
related to the aforementioned legal settlement, representing the Company's
revised estimate of the total liability associated with this matter.
In the quarter ended March 31, 1997, the Company recorded a charge of
$5,900,000 related to a preliminary legal settlement reached with various class
action plaintiffs which pertained to many of the same issues contained in the
legal settlement with the State Attorneys General in the preceding paragraph.
The preliminary legal settlement with the class action plaintiffs extends and
expands the relief provided to qualifying subscribers under the State Attorneys
General settlement.
Provision for Income Taxes
The provision for income taxes was $0 and $10,025,000 in the three months
ended March 31, 1997 and 1996, respectively and $0 and $21,885,000 in the nine
months ended March 31, 1997 and 1996, respectively. For additional information
regarding income taxes, refer to Note 5 of the Notes to Consolidated Financial
Statements.
Net Income (Loss)
The net loss was $4,734,000 in the three months ended March 31, 1997
compared to net income of $15,127,000 in the three months ended March 31, 1996.
The net loss was $487,528,000 in the nine months ended March 31, 1997, compared
to net income of $13,750,000 in the nine months ended March 31, 1996. The net
loss in the nine months ended March 31, 1997 included $385,221,000 for the
write-off of deferred subscriber acquisition costs, a restructuring charge
of $48,627,000 and a settlement charge of $24,204,000. Net income in the nine
months ended March 31, 1996 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 provided by (used in) operating activities was $111,008,000
and $(40,396,000) in the nine months ended March 31, 1997 and 1996,
respectively. Included in operating activities were expenditures for deferred
subscriber acquisition costs of $130,229,000 and $276,559,000 in the nine months
ended March 31, 1997 and 1996, respectively; an increase in other accrued
expenses and liabilities of $117,197,000 in the nine months ended March 31,
1997, principally related to an increase in telecommunications accruals;
and an increase in deferred revenue of $199,303,000 in the nine months ended
March 31, 1997, related to service revenues as well as an increase in prepaid
advertising, which grew substantially as a result of a major advertising
contract with a reseller of voice telephone services which included a
$100,000,000 prepayment . Net cash used in investing activities was
$95,994,000 and $60,924,000 in the nine months ended March 31, 1997 and 1996,
respectively. Net cash provided by financing activities was $64,149,000 and
$174,645,000 in the nine months ended March 31, 1997 and 1996, respectively.
Included in financing activities was $15,000,000 in the nine months ended
March 31, 1997 representing proceeds from the sale of preferred stock in a
subsidiary corporation, and approximately $139,500,000 in the nine months
ended March 31, 1996 representing proceeds from a public stock offering
of common stock.
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 $28,000,000 through the sale of convertible preferred
stock to Mitsui. 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, 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 non-
cancelable operating leases, and is building AOLnet, its data communications
network, as well as expanding its host server and data center capacity. The
buildout of AOLnet and the expansion of host server and data center capacity
requires a substantial investment in telecommunications and server equipment, as
well as facilities, which the Company plans to finance principally through
leasing and debt financing. In the second half of fiscal 1997, the Company is
making investment commitments of approximately $350,000,000 in order to increase
its network, host server and data center capacity.
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 in subscriber acquisition and
retention 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, content, 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
restructuring and settlement charges.
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.
Inflation
The Company believes that inflation has not had a material effect on its
results of operations.
Recent Developments
In July 1997, the original complaint in Orman v. America Online, Inc., et
al. was dismissed against all defendants. On August 11, 1997, an amended class
action complaint was filed against the Company, its Chief Executive Officer and
its Chief Financial Officer.
The Company believes that it has valid defenses to all litigation pending
against it, including the Orman case, and all cases against the Company are, and
will continue to be, vigorously defended. Management is unable to make a
meaningful estimate of the amount or range of loss that could result from an
unfavorable outcome of all pending litigation. It is possible that the
Company's results of operations or cash flows in a particular quarter or annual
period or its financial position could be materially affected by an ultimate
unfavorable outcome of certain pending litigation. Management believes,
however, that the ultimate outcome of all pending litigation should not have a
material adverse effect on the Company's financial position.
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, network
capacity, content procurement 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 (the Flat-Rate
Plan), and other new pricing alternatives, which became 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 and the expansion of host server
and data center capacity, including the inability to expand network, host server
and data center capacity at a rate to sufficiently satisfy subscriber demands,
which accelerated substantially as a result of the introduction of flat-rate
pricing; the failure of any of the Company's network providers; the failure to
procure certain component parts required to expand AOLnet capacity, and for
which supply shortages currently exist, including modems, circuits, routers, and
local exchange carrier lines from local telephone companies; the failure to
obtain the necessary financing for the buildout of AOLnet and the expansion of
host server and data center capacity; 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, or any interruptions or
service outages caused by software defects or server and network expansion.
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.
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 merchandise sales, advertising, the provision of data
network services and transactions.
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, judgments 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.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
For a discussion of legal proceedings, refer to Note 7 of Notes to
Consolidated Financial Statements and Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Recent Developments.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None
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: September 12, 1997 SIGNATURE: /s/Stephen M. Case
Stephen M. Case
Chief Executive Officer
DATE: September 12, 1997 SIGNATURE: /s/Lennert J. Leader
Lennert J. Leader
Chief Financial Officer
(Principal Financial and Accounting
Officer)
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0
1
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<CGS> 746,368
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<INCOME-PRETAX> (487,528)
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<INCOME-CONTINUING> (487,528)
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<CHANGES> 0
<NET-INCOME> (487,528)
<EPS-PRIMARY> (5.16)
<EPS-DILUTED> (5.16)
</TABLE>
