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, 1998
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 30, 1998............................ 229,072,670
<PAGE>
AMERICA ONLINE, INC.
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets - September 30, 1998
and June 30, 1998 3
Condensed Consolidated Statements of Operations - Three
months ended September 30, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows - Three
months ended September 30, 1998 and 1997 5
Condensed Consolidated Statement of Changes in
Stockholders' Equity - Three months ended
September 30, 1998 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 0
PART II. OTHER INFORMATION 18
Item 6. Exhibits and Reports on Form 8-K 18
Signatures 19
<PAGE>
<TABLE>
<CAPTION>
AMERICA ONLINE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in millions, except share data)
September 30, June 30,
1998 1998
--------------------- -------------------
ASSETS (unaudited)
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 1,253 $ 631
Trade accounts receivable, less allowances of $24 million and
$19 million, respectively 110 104
Other receivables 136 92
Prepaid expenses and other current assets 101 103
--------------------- -------------------
Total current assets 1,600 930
Property and equipment at cost, net 386 363
Other assets:
Investments including available-for-sale securities 392 449
Product development costs, net 89 88
Goodwill and other intangible assets, net 375 381
Other assets 3 3
===================== ===================
Total assets $ 2,845 $ 2,214
===================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 50 $ 87
Other accrued expenses and liabilities 481 433
Deferred revenue 252 242
Accrued personnel costs 70 56
Deferred network services credit 76 76
--------------------- -------------------
Total current liabilities 929 894
Long-term liabilities:
Notes payable 375 372
Deferred revenue 67 71
Other liabilities 5 6
Deferred network services credit 254 273
--------------------- -------------------
Total liabilities 1,630 1,616
Stockholders' equity:
Common stock, $.01 par value, 600,000,000 shares authorized, 227,603,548 and
219,641,140 shares issued and outstanding at
September 30, 1998 and June 30, 1998, respectively 2 2
Additional paid-in capital 1,420 866
Unrealized gain on available-for-sale securities 100 145
Accumulated deficit (307) (415)
--------------------- -------------------
Total stockholders' equity 1,215 598
===================== ===================
Total liabilities and stockholders' equity $ 2,845 $ 2,214
===================== ===================
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
AMERICA ONLINE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in millions, except per share data)
(unaudited)
Three months ended
September 30,
--------------------------------------------------
--------------------------------------------------
1998 1997
--------------------- ---------------------
Revenues:
<S> <C> <C>
Online service revenues $ 715 $ 434
Advertising, commerce and other revenues 143 88
--------------------- ---------------------
Total revenues 858 522
Costs and expenses:
Cost of revenues 546 327
Marketing 105 98
Product development 27 16
General and administrative 55 54
Amortization of goodwill and other intangible assets 13 2
Restructuring charge - (2)
--------------------- ---------------------
Total costs and expenses 746 495
Income from operations 112 27
Other income, net 2 5
--------------------- ---------------------
Income before provision for income taxes 114 32
Provision for income taxes (6) -
===================== =====================
Net income $ 108 $ 32
===================== =====================
Earnings per share-diluted $ 0.39 $ 0.13
Earnings per share-basic $ 0.48 $ 0.16
Weighted average shares outstanding-diluted 275 252
Weighted average shares outstanding-basic 226 202
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
AMERICA ONLINE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in millions)
(unaudited)
Three months ended September 30,
------------------------------------------
1998 1997
-------------------- ------------------
Cash flows from operating activities:
<S> <C> <C>
Net income $ 108 $ 32
Adjustments to reconcile net income to net cash provided by operating
activities:
Non-cash restructuring charges - (2)
Depreciation and amortization 49 26
Amortization of deferred network services credit (19) -
Compensatory stock options 3 20
Deferred income taxes 6 -
Gain on sale of investments - (4)
Changes in assets and liabilities:
Trade accounts receivable (5) (3)
Other receivables (44) 6
Prepaid expenses and other current assets - 9
Other assets - (2)
Investments including available-for-sale securities 4 (18)
Accrued expenses and other current liabilities 27 24
Deferred revenue and other liabilities 5 (6)
-------------------- ------------------
Total adjustments 26 50
-------------------- ------------------
Net cash provided by operating activities 134 82
Cash flows from investing activities:
Purchase of property and equipment (45) (62)
Product development costs (10) (13)
Purchase of available-for-sale securities (19) (3)
Other investing activities (13) (4)
-------------------- ------------------
Net cash used in investing activities (87) (82)
-------------------- ------------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 575 25
Proceeds from issuance of debt - 29
-------------------- ------------------
Net cash provided by financing activities 575 54
-------------------- ------------------
Net increase in cash and cash equivalents 622 54
Cash and cash equivalents at beginning of period 631 124
-------------------- ------------------
Cash and cash equivalents at end of period $ 1,253 $ 178
==================== ==================
Supplemental cash flow information Cash paid during the period for:
Interest $ 5 $ 1
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
AMERICA ONLINE, INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(amounts in millions, except share data)
(unaudited)
Unrealized Gain
(Loss)
Common Stock Additional on Available-
------------------------- Paid-In for-Sale Accumulated
Shares Amount Capital Securities Deficit Total
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balances at June 30, 1998 219,641,140 $ 2 $ 866 $ 145 $ (415) $ 598
Common stock issued:
Exercise of options 2,572,408 - 25 - - 25
Sale of stock, net 5,390,000 - 550 - - 550
Amortization of compensatory stock options - - 3 - - 3
Unrealized loss on available-for-sale
securities, including tax effect - - (28) (45) - (73)
Tax benefit related to stock options - - 4 - - 4
Net income - - - - 108 108
================================================================================
Balances at September 30, 1998 227,603,548 $ 2 $ 1,420 $ 100 $ (307) $ 1,215
================================================================================
See accompanying notes.
</TABLE>
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONDENSED 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 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 months ended September 30, 1998 are not necessarily indicative of the
results that may be expected for the full year ending June 30, 1999. 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, 1998.
Note 2. Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share for the three months ended September 30, 1998 and 1997:
<TABLE>
(in millions except for per share data) Three months ended September 30,
1998 1997
Numerator for basic and diluted earnings per share -
<S> <C> <C>
Income available to common stockholders $108 $32
==============================
Denominator
Denominator for basic earnings per share -
Weighted average shares 226 202
Effect of dilutive securities:
Employee stock options 42 42
Warrants 7 7
Convertible preferred stock - 1
------------------------------
------------------------------
Dilutive potential common shares 49 50
------------------------------
------------------------------
Denominator for diluted earnings per share -
Adjusted weighted average shares
and assumed conversions 275 252
==============================
Basic earnings per share $ 0.48 $ 0.16
==============================
Diluted earnings per share $ 0.39 $ 0.13
==============================
</TABLE>
<PAGE>
Note 3. Comprehensive Income
As of July 1, 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS
No. 130 establishes new rules for the reporting and display of comprehensive
income and its components in the financial statements. The adoption of SFAS No.
130 had no impact on the Company's net income or stockholders' equity. For the
three months ended September 30, 1998 and 1997, comprehensive income was $63
million and $45 million, respectively. The difference between net income and
comprehensive income for each period presented is due to unrealized gains or
losses on available-for-sale securities.
Note 4. Business Combinations
During the fiscal year ended June 30, 1998, the Company made two
significant acquisitions, the online services business of CompuServe Corporation
("CompuServe") and the assets of Mirabilis, Ltd., ("Mirabilis"). In exchange for
the online services business of CompuServe and $147 million in cash, the Company
transferred to WorldCom, Inc. all of the issued and outstanding shares of ANS
Communications, Inc., a then wholly-owned subsidiary of the Company. For $287
million in cash (and potential contingent payments of up to $120 million in
future years), the Company purchased all the outstanding assets, including the
developmental ICQ instant communications and chat technology, and assumed
certain liabilities of Mirabilis. The following unaudited pro forma information
has been prepared assuming that the acquisitions of CompuServe and Mirabilis had
taken place at the beginning of the three-month period ended September 30, 1997.
The amount of the aggregate purchase price allocated to in-process research and
development for the Mirabilis acquisition has been excluded from the pro forma
information, as it is a non-recurring item. The pro forma effect for the three
months ended September 30, 1997, would have resulted in revenues of $583
million, income from operations of $59 million, net income of $62 million, and
diluted and basic earnings per share of $0.25 and $0.31, respectively. The pro
forma financial information is not necessarily indicative of the combined
results that would have occurred had the acquisitions taken place at the
beginning of the period, nor is it necessarily indicative of results that may
occur in the future.
Note 5. Sale of Spry, Inc.
On September 10, 1998, the Company announced the sale of its
subsidiary, Spry, Inc. For financial reporting purposes, the assets and
liabilities of Spry, Inc. have been classified in the condensed consolidated
balance sheet as a net asset held for sale, which is a component of prepaid
expenses and other current assets. The sale of Spry, Inc. closed on October 15,
1998.
Note 6. Common Stock Offering
During July 1998, the Company completed a public offering of common
stock. The Company sold 5,390,000 shares of common stock and raised aggregate
proceeds of $550 million in new equity.
<PAGE>
Note 7. Recent Pronouncements
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which is required to be adopted in years
beginning after June 15, 1999. The Statement permits early adoption as of the
beginning of any fiscal quarter after its issuance. The Statement will require
the Company to recognize all derivatives on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through income.
If the derivative is a hedge, depending on the nature of the hedge, changes in
the fair value of derivatives will either be offset against the change in fair
value of the hedged assets, liabilities, or firm commitments through earnings or
recognized in other comprehensive income until the hedged item is recognized in
earnings. The ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings. The Company has not yet determined if it
will early adopt and what the effect of SFAS No. 133 will be on the earnings and
financial position of the Company.
Note 8. Subsequent Events
On October 21, 1998, the Company's stockholders approved an amendment
to the Company's Restated Certificate of Incorporation to increase the
authorized number of shares of common stock from 600,000,000 to 1,800,000,000.
On October 27, 1998, the Company announced that its Board of Directors
approved a two-for-one common stock split. On the payment date of November 17,
1998, stockholders will receive one additional share for each share owned on the
record date of November 3, 1998. The impact of this stock split is not reflected
in the accompanying financial statements.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The Company generates two types of revenues: online service revenues
and advertising, commerce and other revenues. Online service revenues are
generated from customers subscribing to the Company's AOL service and, effective
February 1, 1998, the CompuServe service. Advertising, commerce and other
revenues are non-subscription based and are generated from the Company's base of
subscribers, as well as businesses. Advertising, commerce and other revenues
consist of advertising and related revenues, the sale of merchandise and
transaction fees associated with electronic commerce, as well as other revenues,
which consist primarily of data network service revenues generated by ANS
Communications, Inc. (through its sale in January 1998) as well as royalty fees
and development revenues.
Currently, the Company's online service revenues are generated
primarily from subscribers paying a monthly membership fee. The Company offers
several pricing alternatives to the AOL service in the U.S. designed to appeal
to a wide range of consumers. Most customers subscribing to the AOL service pay
a standard monthly membership fee of $21.95, with no additional hourly charges
(the "Flat-Rate Plan"). Subscribers can also choose to prepay for one year in
advance at the monthly rate of $19.95. The Company increased the price of its
Flat-Rate Plan from $19.95 per month to $21.95 per month, and the effective
monthly rate of the annual plan from $17.95 per month to $19.95 per month,
effective at the start of each member's monthly billing cycle in April 1998.
Those subscribers who were currently on the annual plan were not subject to an
increase until their renewal date. These increases were implemented in order to
fund the continued improvement of members' online experience and to keep pace
with the cost to the Company of members' increased usage. Other pricing options
available include an offering of three hours for $4.95 per month, with
additional time priced at $2.50 per hour, and an offering of $9.95 per month for
unlimited use--for those subscribers who have an Internet connection other than
through AOL and use this connection to access AOL services. In order to ensure
the competitiveness of its offerings, the Company has historically conducted
tests of alternative pricing plans, and will continue to do so in future
periods.
<PAGE>
Effective February 1, 1998, the Company offered two price plans for the
CompuServe service: a standard monthly membership offering of five hours for
$9.95 per month, with additional time priced at $2.95 per hour and an
alternative offering of $24.95 per month with no additional hourly charge.
In addition to the revenues generated from online service
subscriptions, advertising, commerce and other revenues are an important
component of the Company's business objectives and provide an important
contribution to the Company's operating results. The Company has continued to
see a general trend of increased average monthly subscriber usage since the
introduction of flat-rate pricing in December 1996. In the first quarter of
fiscal 1999, average daily subscriber usage rose to nearly 47 minutes, compared
to approximately 40 minutes in the first quarter of fiscal 1998. If current
usage levels increase, further pressures on operating margins may result. The
Company expects that the growth in advertising, commerce and other revenues,
assuming such growth continues, will provide it with the opportunity and
flexibility to fund the costs associated with the increased usage resulting from
flat-rate pricing, and will help fund programs designed to grow the subscriber
base within its various brands and meet other business objectives.
The Company has continued to experience improved subscriber acquisition
and retention rates, which it believes is related to the improved value
proposition offered by flat-rate pricing and other benefits. Although the
Company's marketing expense has declined, as a percentage of revenues, from the
first quarter of fiscal 1998 compared to the first quarter of fiscal 1999, the
Company intends to increase its marketing expenditures in the next quarter in
conjunction with the introduction of version 4.0 of the AOL software. The
Company may also need to increase its expenditures on marketing in future
periods in order to acquire and retain customers and to address potential
competitive pressures.
The Company competes in a rapidly-changing marketplace with a wide
range of other companies in the communications, advertising, entertainment and
information, media, software, technology, direct mail and commerce fields.
Current competitors of the Company for usage, subscribers, advertising and
commerce include online services (for example, the Microsoft Network, AT&T
WorldNet and Prodigy Services Company), various national and local Internet
service providers using industry-standard browser and navigational software,
long distance and regional telephone companies who may offer competing services
directly to their customers as part of their telephone service (among others,
AT&T Corp., MCI WorldCom, Inc. and various regional Bell operating companies),
cable companies, and suppliers of operating systems or browsers, or personal
computer or other OEMs (such as personal digital assistants and enhanced mobile
phones) who may incorporate functional equivalents to the Company's services in
their products. The Company also competes for usage and advertising and commerce
revenues with companies providing Web navigation and search services and
content, such as Yahoo! Inc., Netscape Communications Corporation, Infoseek
Corporation, CNET, Inc., Lycos, Inc. and Excite, Inc. Additionally, the Company
competes for viewership and revenues with global media companies such as
newspapers, radio and television stations and content providers, such as CBS
Corporation, The Walt Disney Company and Time Warner, Inc., and with direct
marketing and telemarketing companies. Certain of such media companies have
formed alliances and made investments in services competing with the Company,
such as CNET's and NBC's joint ownership of the SNAP! Internet service and The
Walt Disney Company's purchase of a stake in Infoseek.
<PAGE>
The development of broadband distribution technologies, including cable
Internet access services offered by @Home Network (whose investors include:
Cablevision Systems Corporation ("Cablevision"), Comcast Corporation
("Comcast"), Cox Communications, Inc. ("Cox") and Tele-Communications, Inc.
("TCI")), Road Runner Group (owned by Time Warner, Inc. and MediaOne, Inc. (a
subsidiary of US WEST Media Group)), advanced telephone-based access services
offered through digital subscriber line (xDSL) technologies offered by local
telecommunications companies and other advanced digital services offered by
broadcast, satellite and wireless companies, is adding to the competition to
which the Company is subject. Emerging convergent technologies offering
combinations of television and interactive computer services, such as those
offered by WebTV, offer another competitive alternative to the offerings of the
Company. The Company has acquired NetChannel, Inc. (now known as AOLTV, Inc.),
in order to pursue a competitive offering within these distribution
technologies, but there can be no assurance that its technology will be
commercially successful.
Results of Operations
Online Service Revenues
For the three months ended September 30, 1998, online service revenues
increased from $434 million to $715 million, or 65%, over the three months ended
September 30, 1997. This increase comprises an increase in AOL online service
revenues of $233 million, as well as CompuServe online service revenues of $48
million, which began in February 1998. The increase in AOL online service
revenues was primarily attributable to a 40% increase in the average number of
AOL North American subscribers for the three months ended September 30, 1998,
compared to the three months ended September 30, 1997, as well as a 10% increase
in the average monthly online service revenue per AOL North American subscriber.
The average monthly online service revenue per AOL North American subscriber
increased from $17.36 in the three months ended September 30, 1997 to $19.11 in
the three months ended September 30, 1998. This increase was principally
attributable to the increase in the Flat-Rate Plan membership fee from $19.95 to
$21.95, which became effective in April 1998.
At September 30, 1998, the Company had approximately 13,486,000 AOL
service subscribers, including 12,041,000 in North America and 1,445,000 in the
rest of the world. Also at that date, the Company had approximately 2,007,000
CompuServe brand subscribers, including 973,000 in North America and 1,034,000
in the rest of the world.
Advertising, Commerce and Other Revenues
Advertising, commerce and other revenues, which consist principally of
advertising and related revenues, fees associated with commerce and the sale of
merchandise, increased by 63%, from $88 million in the quarter ended September
30, 1997 to $143 million in the quarter ended September 30, 1998. The increase
was driven primarily by more advertising on the Company's AOL service as well as
an increase in commerce fees. Advertising and commerce fees increased by 140%,
from $43 million in the three months ended September 30, 1997 to $103 million in
the three months ended September 30, 1998. Merchandise sales decreased, in line
with management expectations, by 24%, from $25 million in the three months ended
September 30, 1997 to $19 million in the three months ended September 30, 1998.
At September 30, 1998, the Company's advertising and commerce backlog,
representing the contract value of advertising and commerce agreements signed,
less revenues already recognized from these agreements, was approximately $598
million, up from approximately $224 million at September 30, 1997.
<PAGE>
Cost of Revenues
Cost of revenues includes network-related costs, consisting primarily
of data network costs and costs associated with network equipment, personnel and
related costs associated with operating the data centers, data network and
providing customer support and billing, royalties paid to information and
service providers, the costs of merchandise sold and product development
amortization expense. For the three months ended September 30, 1998, cost of
revenues increased from $327 million to $546 million, or 67%, over the three
months ended September 30, 1997, and increased as a percentage of total revenues
from 62.6% to 63.6%.
The increase in cost of revenues in the three months ended September
30, 1998 was primarily attributable to increases in data network costs as well
as personnel and related costs associated with operating the data centers, data
network and providing customer support and billing. Data network costs increased
primarily as a result of the larger customer base and an increased usage per
customer. Personnel and related costs associated with operating the data
centers, data network and providing customer support and billing increased
primarily as a result of the requirements of supporting a larger data network, a
larger customer base and increased online service revenues.
The increase in cost of revenues as a percentage of total revenues in
the three months ended September 30, 1998 was primarily attributable to an
increase, as a percentage of total revenues, in network-related costs, partially
offset by decreases, as a percentage of total revenues, in personnel and related
costs associated with operating the data centers, data network and providing
customer support and billing, product development amortization expense and the
costs of merchandise sold. The increase in network-related costs as a percentage
of revenues was primarily driven by an increase in daily member usage, from an
average of 40 minutes per day in the three months ended September 30, 1997 to an
average of 47 minutes per day in the three months ended September 30, 1998.
Marketing
Marketing expenses include the costs to acquire and retain subscribers
and other general marketing costs. For the three months ended September 30,
1998, marketing expenses increased from $98 million to $105 million, or 7%, over
the three months ended September 30, 1997, and decreased as a percentage of
total revenues from 18.8% to 12.2%. The increase in marketing expenses for the
three months ended September 30, 1998 was primarily attributable to an increase
in subscriber acquisition costs. The decrease in marketing expenses as a
percentage of total revenues for the three months ended September 30, 1998 was
primarily a result of the substantial growth in revenues.
Product Development
Product development costs include research and development expenses and
other product development costs. For the three months ended September 30, 1998,
product development costs increased from $16 million to $27 million, or 69%,
over the three months ended September 30, 1997, and remained flat as a
percentage of total revenues at 3.1%. The increase in product development costs
was primarily attributable to an increase in personnel costs as a result of an
increase in the number of technical employees.
General and Administrative
For the three months ended September 30, 1998, general and
administrative expenses increased from $54 million to $55 million, or 2%, over
the three months ended September 30, 1997, and decreased as a percentage of
total revenues from 10.3% to 6.4%. The increase in general and administrative
costs for the three months ended September 30, 1998 was primarily attributable
to higher personnel costs and professional fees, partially offset by costs
incurred by the Company in the three months ended September 30, 1997 for
compensatory stock options and other charges related to the sale of ANS
Communications, Inc.
<PAGE>
Amortization of Goodwill and Other Intangible Assets
Amortization of goodwill and other intangible assets increased to $13
million in the three months ended September 30, 1998 from $2 million in the
three months ended September 30, 1997. The increase in amortization expense in
the three months ended September 30, 1998 is primarily attributable to goodwill
associated with the acquisitions of the CompuServe service in January 1998 and
Mirabilis, Ltd. and NetChannel, Inc. in June 1998 partially offset by the sale
of ANS in January 1998.
Restructuring Charge
In connection with a restructuring plan adopted in the second quarter
of fiscal 1997, the Company recorded a $49 million 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. As
of September 30, 1997, substantially all of the restructuring activities had
been completed and the Company reversed $2 million of the original restructuring
accrual in the first quarter of fiscal 1998.
Other Income, Net
Other income, net consists primarily of investment income and
non-operating gains net of interest expense and non-operating charges. The
Company had other income of $2 million and $5 million in the three months ended
September 30, 1998 and 1997, respectively. The decrease in other income in the
three months ended September 30, 1998 was primarily attributable to an increase
in non-operating losses related to various investments, a reduction to zero in
gains on the sale of certain available-for-sale securities and a decrease in the
allocation of losses to minority shareholders, partially offset by an increase
in net interest income.
Provision for Income Taxes
The provision for income taxes was $6 million and zero in the three
months ended September 30, 1998 and 1997, respectively. Income tax expense for
the three months ended September 30, 1998 includes $5 million for U.S. federal
and state income taxes and $1 million for foreign taxes. Utilization of
operations-related deferred tax benefits reduced the Company's U.S. federal and
state income tax expense by $40 million and $13 million in the three months
ended September 30, 1998 and 1997, respectively. As of September 30, 1998 the
Company had net operating loss carryforwards available to offset future U.S.
federal taxable income of approximately $1.1 billion.
Liquidity and Capital Resources
The Company has financed its operations through cash generated from
operations, the sale of its capital stock and the sale of convertible notes. The
Company has financed its investments in facilities and telecommunications
equipment principally through leasing. Net cash provided by operating activities
was $134 million and $82 million in the three months ended September 30, 1998
and 1997, respectively. Net cash used in investing activities was $87 million
and $82 million in the three months ended September 30, 1998 and 1997,
respectively. Net cash provided by financing activities was $575 million and $54
million in the three months ended September 30, 1998 and 1997, respectively.
Included in financing activities for the three months ended September 30, 1998
were $550 million in aggregate proceeds from a public stock offering of its
common stock. The Company also has available, to meet its working capital needs,
a $200 million secured revolving credit facility with no amounts outstanding as
of September 30, 1998.
The Company uses its working capital to finance ongoing operations and
to fund marketing and the development of its products and services. The Company
plans to continue to invest in subscriber acquisition, retention and brand
marketing 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.
<PAGE>
Seasonality
The number of subscriber acquisitions and the amount of usage per
subscriber appear 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 and following the holiday season, when new computer and software owners
are discovering Internet services while spending more time indoors due to winter
weather. However, the Company does not know whether such increases in subscriber
acquisitions and usage are primarily attributable to seasonal factors or to
increased demand for Internet services as a result of the growing market demand
and utility for such services.
Year 2000 Compliance
The Company utilizes a significant number of computer software programs
and operating systems across its entire organization, including applications
used in operating the AOL service, the CompuServe service, their proprietary
software, member services, network access, content providers, joint ventures and
various administrative and billing functions. To the extent the Company's
software applications contain source codes that are unable to appropriately
interpret the upcoming calendar year 2000, some level of modification, or even
possibly replacement of such applications may be necessary. The Company has
appointed a Year 2000 Task Force to perform an audit to assess the scope of the
Company's risks and bring its applications into compliance. This Task Force is
undertaking its assessment of the Company's compliance and has begun testing the
AOL corporate business and information systems. To date, the Company has
experienced very few problems related to Year 2000 testing, and those problems
that have been identified are in the process of being fixed. The AOL Host system
will begin testing in early November 1998, and the AOL Operations group is on
schedule to begin testing in January 1999. The international portion of the AOL
service and the CompuServe service continues to move forward with system
inventory gathering as well as an analysis of common systems. The international
services utilize the same AOL infrastructure, so it is anticipated that
additional costs of compliance for the international portion will be minimal.
In addition, the Company is in the process of asking its vendors, joint
venture partners and content partners about their progress in identifying and
addressing problems that their computer systems may face in correctly processing
date information related to the Year 2000, but has received very few complete
responses. The Company intends to continue its efforts to seek reassurances
regarding the Year 2000 compliance of vendors, joint venture partners and
content partners. In the event any third parties cannot timely provide the
Company with content, products, services or systems that meet the Year 2000
requirements, the content on the Company's services, access to the Company's
services, the ability to offer products and services and the ability to process
sales could be materially adversely affected.
The costs incurred by the Company during fiscal 1998 to address Year
2000 compliance were approximately $500,000. The Company estimates it will incur
up to approximately $5 million in direct costs during fiscal 1999 to support its
compliance initiatives. Although the Company expects its proprietary software to
be Year 2000 compliant on or before December 31, 1999, it cannot predict the
outcome or the success of its Year 2000 program, or that third party systems are
or will be Year 2000 compliant, or the costs required to address the Year 2000
issue, or whether a failure to achieve substantial Year 2000 compliance will
have a material adverse effect on the Company's business, financial condition or
results of operations. The Company is in the process of developing a contingency
plan to address possible risks to its systems. It is the Company's intention to
implement its contingency plan no later than July 1999.
Inflation
The Company believes that inflation has not had a material effect on
its results of operations.
<PAGE>
Forward-Looking Statements
This report and other oral and written statements made by the Company
to the public contain and incorporate by reference forward-looking statements
within the meaning of the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995. The forward-looking statements are based on
management's current expectations or beliefs and are subject to a number of
factors and uncertainties that could cause actual results to differ materially
from those described in the forward-looking statements. Such statements address
subjects including the following: future financial and operating results;
subscriber growth and retention; advertising and electronic commerce revenues;
earnings growth and expectations; development and success of multiple brands;
new products, services, features and content (such as AOL 4.0, CompuServe 4.0
and 5.0, Digital City 2.0 and the "You've Got Pictures" service); corporate
spending; network capacity; new platforms and access and distribution
technologies; and the Company's ability to shape public policy in, for example,
telecommunications, privacy and tax areas.
The following factors, among others, could cause actual results to
differ materially from that described in the forward-looking statements:
Factors related to increased competition, including: price reductions
and increased spending; limitations on the Company's opportunities to enter
into and/or renew agreements with content and distribution providers;
limitations on its ability to grow its subscriber base; increased attrition
in the Company's subscriber base; and a negative impact on the Company's
ability to meet its business objective of increasing advertising and
electronic commerce revenues.
The risk that the Company and its data communications access providers
will be unable to provide adequate server and network capacity. Risks
associated with the fixed costs and minimum commitment nature of a
substantial majority of the Company's network services, such that a
significant decrease in demand for online services would not result in a
corresponding decrease in network costs. Risks related to the buildout of
AOLnet and the expansion of server and network capacity: the risk that
demand will not develop for the capacity created; the risk that supply
shortages for local exchange carrier lines from local telephone companies
could impede the provision of adequate network capacity; and the risk of
the failure to obtain the necessary financing. Risks related to
CompuServe's reliance on network services which are provided under a single
agreement.
Any damage or failure to the Company's computer equipment and the
information stored in its data centers.
The inability to increase revenues at a rate sufficient to offset the
increase in data communications costs resulting from increasing usage.
Risks and uncertainties associated with current or future price changes,
including: the risk that competitive offerings to the AOL service may
become more attractive to AOL members; the risk of slowing or reversing
subscriber growth or reducing subscriber retention rates and the resulting
impact on the Company's ability to generate advertising revenues; and the
risk that the Company may be required to increase marketing expenses. The
resulting risk that gross and operating margins will decrease.
The risk that because of seasonal and other factors, the Company is
unable to predict growth in usage, subscriber acquisitions and advertising
commitments.
The failure of the Company to establish new relationships with
electronic commerce, advertising, marketing, technology and content
providers or the loss of a number of relationships with such providers or
the risk of significantly increased costs or decreased revenues needed, to
maintain, or resulting from the failure to maintain, such relationships, as
the case may be.
The risk associated with accepting warrants in lieu of cash in certain
electronic commerce agreements, as the value of such warrants is dependent
upon the common stock price of the warrant issuer at the time the warrants
are earned.
<PAGE>
The risks related to the acquisition of businesses, including the
failure to successfully integrate and manage acquired technology,
operations and personnel, the loss of key employees of the acquired
companies and the risk of significant charges for in-process research and
development or other matters. The risk of loss of services of executive
officers and other key employees.
The inability of the Company to introduce new products and services;
and its inability to develop, or achieve commercial acceptance for, these
new products and services. The failure to resolve issues concerning
commercial activities via the Internet, including security, reliability,
cost, ease of use and access. The risk of adverse changes in the U.S.
regulatory environment surrounding interactive services.
The Company's inability to offer its services through advanced
distribution technologies such as cable, satellite, broadcast and enhanced
telephone distribution and the inability to offer advanced services such as
voice and full motion video. The Company's inability to develop new
technology or modify its existing technology to keep pace with
technological advances and the pursuit of these technological advances
requiring substantial expenditures.
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 that differ
greatly from those in the United States, unexpected changes in regulatory
requirements, political risks, export restrictions and controls, tariffs
and other trade barriers and fluctuations in currency exchange rates.
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 3.1 Certificate of Amendment of Restated Certificate of
Incorporation of America Online, Inc.
(b) Reports on Form 8-K
The following reports on form 8-K were filed during the quarter ended September
30, 1998:
<PAGE>
<TABLE>
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
Financial Date of
Form Item Description Statements Filed Reports
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
<S> <C> <C> <C>
8-K 5,7 Reporting a statement made by Not applicable September 28, 1998
the Company in a telephone
conference with analysts and
others
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
8-K 5,7 Reporting a statement made by Not applicable August 4, 1998
the Company in a telephone
conference with analysts and
others
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
8-K/A 7 Amends form 8-K dated June 5, Financial Statements of June 5, 1998 August 21, 1998
1998 reporting a material Businesses Acquired:
acquisition of assets
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
Mirabilis Ltd. (an Israeli Development
Development Stage Corporation) as of
March 31, 1998 and the three months ended
March 31, 1998 and 1997 (unaudited)
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
Mirabilis Ltd. (an Israeli
Development Stage
Corporation) for the year
ended December 31, 1997,
for the period from July
29, 1996 (date of
incorporation) to December
31,1996 and for the period
from July 29, 1996 to
December 31, 1997
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
Pro Forma Financial Information:
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
Pro Forma Combined Condensed Balance
Sheet as of March 31, 1998 (unaudited)
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
Pro Forma Combined
Statement of Operations
for the nine month period
ended March 31, 1998
(unaudited)
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
Pro Forma Combined
Statement of Operations
for the nine month period
ended March 31, 1997
(unaudited)
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
Pro Forma Combined Statement of
Operations for the year ended June 30,
1997 (unaudited)
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
Notes to Unaudited Consolidated
Financial Statements
- ------------- ------- ------------------------------- ----------------------------------------- ----------------------
</TABLE>
<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 5, 1998 SIGNATURE: /s/Stephen M. Case
------------------------------
Stephen M. Case
Chairman of the Board and Chief
Executive Officer
DATE: November 5, 1998 SIGNATURE: /s/J. Micheal Kelly
------------------------------
J. Michael Kelly
Senior Vice President and Chief
Financial Officer
<PAGE>
Exhibit Index
Exhibit 3.1 Certificate of Amendment of Restated Certificate
of Incorporation of America Online, Inc.
<PAGE>
Exhibit 3.1
CERTIFICATE OF AMENDMENT OF RESTATED CERTIFICATE OF INCORPORATION OF AMERICA
ONLINE, INC.
America Online, Inc., a Delaware corporation duly organized and
existing under the General Corporation Law of the State of Delaware (the
"Corporation"), does hereby certify:
FIRST: That Section A of Article FOURTH of the Restated Certificate of
Incorporation is hereby amended to read in its entirety as follows:
FOURTH: A. The total number of shares of all classes of stock which the
Corporation shall have authority to issue is 1,805,000,000 shares, divided into
two classes, consisting of:
1,800,000,000 shares of Common Stock, par value one cent ($0.01) per share (the
"Common Stock"); and
5,000,000 shares of Preferred Stock, par value one cent ($0.01) per share (the
"Undesignated Preferred Stock").
SECOND: That said amendment was duly adopted in accordance with the
provisions of Section 242 of the General Corporation Law of the State of
Delaware.
IN WITNESS WHEREOF, America Online, Inc. has caused this Certificate of
Amendment to be signed by its duly authorized officer this 21st day of October,
1998.
/s/Sheila A. Clark
Sheila A. Clark
Assistant Secretary
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 3-mos
<FISCAL-YEAR-END> Jun-30-1998
<PERIOD-END> Sep-30-1998
<CASH> 1,253
<SECURITIES> 0
<RECEIVABLES> 272
<ALLOWANCES> 26
<INVENTORY> 0
<CURRENT-ASSETS> 1,600
<PP&E> 510
<DEPRECIATION> 124
<TOTAL-ASSETS> 2,845
<CURRENT-LIABILITIES> 929
<BONDS> 0
0
0
<COMMON> 2
<OTHER-SE> 1,213
<TOTAL-LIABILITY-AND-EQUITY> 2,845
<SALES> 858
<TOTAL-REVENUES> 858
<CGS> 546
<TOTAL-COSTS> 746
<OTHER-EXPENSES> 11
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4
<INCOME-PRETAX> 114
<INCOME-TAX> 6
<INCOME-CONTINUING> 114
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 108
<EPS-PRIMARY> 0.48
<EPS-DILUTED> 0.39
</TABLE>
