<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1998
COMMISSION FILE NUMBER- 0-19836
AMERICA ONLINE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 54-1322110
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF IDENTIFICATION NO.)
INCORPORATION OR
ORGANIZATION)
22000 AOL WAY
DULLES, VIRGINIA 20166-9323
(ADDRESS OF PRINCIPAL (ZIP CODE)
EXECUTIVE OFFICES)
Registrant's telephone number, including area code: (703) 448-8700
Securities registered pursuant to section 12(b) of the Act:
<TABLE>
<CAPTION>
(NAME OF EACH EXCHANGE
(TITLE OF EACH CLASS) ON WHICH REGISTERED)
--------------------- -----------------------
<S> <C>
Common Stock, par value $.01 per share New York Stock Exchange
Preferred Share Purchase Rights New York Stock Exchange
</TABLE>
Securities registered pursuant to section 12(g) of the Act: None
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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
As of August 31, 1998, the aggregate market value of voting stock held by
non-affiliates of the registrant, based upon the closing sales price for the
registrant's common stock, as reported on the New York Stock Exchange, was
approximately $18.4 billion (calculated by excluding shares owned beneficially
by directors and officers).
Number of shares of registrant's common stock outstanding as of August 31,
1998: 226,331,037
DOCUMENTS INCORPORATED BY REFERENCE
The following documents (or parts thereof) are incorporated by reference
into the following parts of this Form 10-K: Certain information required in
Part III of this Form 10-K is incorporated from the registrant's Proxy
Statement for its 1998 Annual Meeting of Stockholders.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
America Online, Inc., including its subsidiaries ("America Online" or the
"Company"), is the global leader in the interactive communications and
services medium, with approximately $2.6 billion in revenue during fiscal
1998, including $2,161 million of online service revenues and $439 million of
advertising, commerce and other revenues. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations." The Company
operates two worldwide Internet online services: America Online, with more
than 13 million members, and CompuServe, with approximately 2 million members,
as of August 1998. The Company generates revenues from membership and usage
fees, as well as increasingly from other sources, which include advertising
and commerce sales.
The Company's mission, through its three product groups, AOL Interactive
Services, CompuServe Interactive Services and AOL Studios, and AOL
International is to build a global medium as central to people's lives as the
telephone or television . . . and even more valuable. To accomplish this
mission, the Company is implementing a multiple brand strategy, supported by a
common infrastructure, to build programming and other content and services as
a foundation for growth in subscribers and revenues.
AOL Interactive Services operates the Company's flagship AOL service and
manages the AOL Instant Messenger service and the AOL.COM and AOL NetFind
products, as well as content properties, such as Entertainment Asylum. The
AOL.COM Web site offers features including MyNews, a personalized news
service, as well as the AOL Instant Messenger service and other features and
programming. AOL NetMail, which will allow AOL members to send and receive
electronic mail on the Web, is in beta testing.
The Company acquired the online services business of CompuServe Corporation
in January 1998. That business now comprises the Company's CompuServe
Interactive Services product group ("CompuServe"). CompuServe targets the
busy, adult audience that relies on its service as a resource to provide
needed information and services quickly and efficiently. At the end of the
Company's fiscal year, CompuServe launched its version 4.0 software, providing
instant messaging technology and other enhancements. The Company is planning
to launch the next generation of CompuServe software during 1999, with further
navigational and other improvements.
AOL Studios builds new businesses and brands, targeting specific interactive
audiences for the AOL and CompuServe services and the Internet. Under AOL
Studios are Digital City, Inc. (owned approximately 80% by the Company and 20%
by the Tribune Company), a local content and community guide, delivering local
news and information in 50 U.S. markets, and ICQ, an Internet-based trial
instant communications and chat technology the Company acquired in June 1998
that appeals to young, Web-savvy adults worldwide.
AOL International manages the AOL and CompuServe services outside the United
States. The Company offers its AOL and CompuServe branded services in Canada
through a wholly-owned subsidiary, in Europe through joint ventures with
Bertelsmann AG, and in Japan through a joint venture with Mitsui & Co., Ltd.
and Nihon Keizai Shimbun, Inc. (Nikkei) and through a local distributor, and
offers access to these services in over 100 countries. See "International
Expansion."
The Company employs a diversified portfolio approach in designing and
implementing its network services. The AOLnet is the Company's data
communications network, which the Company expanded during fiscal 1998 to
approximately 800,000 modems, resulting in increased network capacity, higher
speed access, and
1
<PAGE>
reduced per-hour data communication costs. The portfolio of AOL networks is
available in approximately 1,500 cities in more than 100 countries worldwide.
See "Network Services."
America Online was incorporated in Delaware on May 24, 1985. The Company's
principal executive offices are located at 22000 AOL Way, Dulles, Virginia
20166-9323. Its telephone number at that address is (703) 448-8700. Inquiries
also may be sent to the Company's Internet address, AOL [email protected], or to the
America Online address, AOL IR.
PRODUCTS AND SERVICES
The AOL Service
The Company's AOL service provides subscribers with a global, interactive
community offering a wide variety of content, features and tools. The AOL
service also includes simple access to the Internet with search functionality
through AOL NetFind. The range of content, features, and tools offered on the
AOL service includes the following:
--Online Community--America Online promotes interactive community through
electronic mail services, public bulletin boards, the Buddy List feature (for
members to keep an up-to-the moment account of whether fellow members are
online, subject to a blocking feature), the AOL Instant Messenger service,
which allows members to communicate online instantaneously without having to
access an electronic mailbox, an online community center, public or private
"meeting rooms" and interactive conversations (chat). Guest interviews, with
participation by members, take place at live "auditorium" events.
--Channel Line-Up--Content on the AOL service is organized into channels,
allowing members to navigate the service easily to find areas of interest.
Each of the following nineteen channels offers informational content and
commerce and community opportunities: AOL Today, News, Sports, Influence,
Travel, International, Personal Finance, WorkPlace, Computing, Research &
Learn, Entertainment, Games, Interests, Lifestyles, Shopping, Health,
Families, Kids Only and Local. Content providers on the AOL service include
ABC News, CBS SportsLine, Hachette Filipacchi Magazines, Bloomberg, The New
York Times and Business Week.
--Personalization and Control Features--Members can personalize their
experience on the AOL service through a number of features and tools,
including a reminder service that sends e-mail in advance of important events,
stock portfolios that automatically update market prices, Mail Controls, which
allow members to limit who may send them e-mail and to block certain types of
e-mail, Favorite Places, which allows members to mark particular web sites or
AOL areas, and Portfolio Direct and News Profiles, which send stories of
particular interest to members. The AOL service offers Parental Controls to
help parents form their children's online experience, including tools that
limit access to particular AOL areas or Web sites or to certain features (for
example, the AOL Instant Messenger service, sending or receiving files
attached to e-mail or embedded pictures in e-mail, or access to premium
services). Marketing Preferences allow members to elect not to receive certain
marketing offers.
The AOL.COM Web Site
The Company launched its web site, AOL.COM (http://www.AOL.COM) in October
1995, which offers Internet users (who may not be AOL members) content,
features and tools, including AOLNetFind, an Internet search and rating tool,
and the AOL Instant Messenger service, which allows Internet users to
communicate real-time with their friends and family. AOL.COM also offers AOL
members the opportunity to exchange e-mail on the Internet, without signing
onto the service, and My News, a personalized news service. Content provided
on
2
<PAGE>
the AOL.COM site includes news, shopping, Web search services, classified
advertisements, and white and yellow pages directories. The Company plans to
continue to expand content and services available through the AOL.COM Web
site.
The CompuServe Service
The Company's CompuServe Interactive Services product group manages the
CompuServe service in the U.S. and Canada. The CompuServe service is available
in over 500 cities worldwide, including in the U.S., Canada and Europe. See
"International Expansion." The CompuServe online service targets an audience
of busy adults, who look to their Internet online service as a way to answer
questions and solve problems. To serve these interests, CompuServe aims to
make the online experience productive, enjoyable, fast and easy. At the end of
the fiscal year, the Company launched the CompuServe 4.0 software upgrade,
which introduced to the service the CompuServe Instant Messenger feature and
other enhancements. Like the AOL service, the CompuServe service organizes its
content into channels, including: News & Weather, Personal Finance, Business,
Research, Sports & Recreation, Arts & Entertainment, Home & Hobbies,
Lifestyles, Computing Support, International, Local, Travel, Health, Car Club,
Shopping, Games, Sight & Sound, Forum Center, Member Center and Communications
Center.
AOL Studios
AOL Studios' goal is to build, launch, manage and scale new businesses and
brands, targeting specific interactive audiences. Under AOL Studios are
Digital City and ICQ.
Digital City
The Company's subsidiary, Digital City, Inc., which is owned in part by the
Tribune Company, provides local interactive content and services on the AOL
service, AOL.COM, AOL NetFind, CompuServe, Netscape's NetCenter and on the
Worldwide Web. Digital City offers a network of local content and community
guides in 50 U.S. cities, including Atlanta, Boston, Chicago, Dallas, Denver,
Los Angeles, Minneapolis, New York, Orlando, Philadelphia, San Diego, San
Francisco, and Washington, D.C. Local content provided by Digital City
includes original and third-party news, sports, weather, a local guide service
with directory and classified listings, and an interactive forum.
ICQ
The Company acquired the trial ICQ ("I seek you") instant communications and
chat technology in June 1998. ICQ is an Internet-based communications Web
portal site, located at http://www.icq.com. By the end of fiscal 1998, the ICQ
trial software had been downloaded 13.9 million times, and was being used
actively by 6.8 million users. The Company acquired the ICQ technology with
its focus on interactive community, intending that it become an all-service
Web portal with a permanent desktop presence.
ADVERTISING AND COMMERCE
An important component of the Company's business strategy is to increase
non-subscription based revenues, including advertising and commerce revenues
and revenues from the sale of merchandise, which the Company believes are
increasingly important to its growth and success. The Company continues to
establish a wide variety of relationships with advertising and commerce
partners in order to grow and diversify its non-subscription based revenues
and to provide subscribers on the Company's interactive services with access
to a broad selection of
3
<PAGE>
competitively priced, easy-to-order products and services. The Company offers
its advertising partners a variety of customized programs, which may include
guaranteed numbers of impressions and select sponsorship of particular online
areas for designated time periods. As merchants recognize a value in reaching
the Company's large and active subscriber base, the Company has been able to
earn additional revenues by offering selected merchants exclusive rights to
market particular goods or services within the Company's online services. The
Company provides its commerce partners certain marketing and promotional
opportunities and in return seeks cash payments, the opportunity for revenue
sharing, and competitive pricing and online conveniences for subscribers.
Certain of the transactions also include an equity component for the Company.
The Company seeks to continue to expand the scope and number of, and revenues
from, its relationships with advertising and commerce partners, including
expanding these relationships across the Company's multiple brands and into
the international services.
During fiscal 1998, the Company entered into numerous advertising and
commerce agreements, of which approximately 50 provided for payments to the
Company of $1 million or more, including agreements with American Greetings,
Barnes and Noble, Preview Travel, Unilever, Software.net, REALTOR.COM, Digital
Courier Technologies, Inc. (Videos Now) and Fragrance Counter. In many
instances, the Company has enhanced the content provided on the AOL service
through the arrangements, and has increased revenues. For example, the Company
entered into a three-year agreement with Intuit under which Intuit will
provide tax, mortgage and other financial content on the Personal Finance
channel of the AOL service and the Personal Finance Web Channel on AOL.COM,
will make $30 million in payments to AOL over the period of the agreement and
AOL will have the additional potential for revenue sharing from Intuit
offerings. The Company also entered into two-year pacts in June and July 1998
with four leading online brokerages for exclusive placement in the brokerage
center on the Personal Finance channel of the AOL service for combined total
payments of up to approximately $100 million, subject to meeting certain
conditions. Moreover, the Company's alliance with Eastman Kodak on the new
"You've Got Pictures" service expected to be launched in 1999 includes
advertising commitments by Eastman Kodak and revenue sharing features. During
fiscal 1998, Barnes and Noble significantly expanded its relationship with the
Company with a four-year, $40 million agreement for extensive placement and
visibility throughout the AOL service.
The advertising and commerce agreements entered into during fiscal 1998 were
in addition to arrangements entered into in prior fiscal years that continued
in fiscal 1998. For example, the Company has agreements with Tel-Save
Holdings, Inc. ("Tel-Save"), CUC International Inc. (now known as Cendant
Corporation), and 1-800-FLOWERS. Under the agreement with Tel-Save, it is the
exclusive provider of consumer long-distance telecommunications services to be
marketed to AOL members by the Company on the AOL service. The Company
received $100 million in cash when the agreement was entered into in fiscal
1997, and the parties have a revenue sharing arrangement that, based upon
subscriber usage levels of the Tel-Save product offering, provides the Company
with an opportunity to earn additional revenues. The agreement also provided
for warrants issued to America Online to purchase Tel-Save common stock. Tel-
Save offers AOL subscribers competitive pricing and online billing. The
Company has entered into numerous other relationships with advertisers and
online merchants to promote their goods and services within the AOL Shopping
Channel and throughout other areas of the AOL service.
Extending opportunities for advertising and commerce revenues through its
multiple brands and services is a goal of the Company. The Company continued
this practice in fiscal 1998 by entering into agreements for advertising and
placement on the AOL service, the CompuServe service, on AOL.COM and on the
international services. For example, CompuServe reached an agreement with Tel-
Save to offer its competitively priced long-distance telephone service to
members of the CompuServe service. In addition, CompuServe has expanded its
relationship with Florists' Transworld Delivery (FTD). In August 1998,
Unilever, a global leader in consumer
4
<PAGE>
packaged goods, joined AOL in a three-year global interactive marketing
agreement. Under the agreement, as many as 100 Unilever brands will receive a
prominent presence throughout the AOL service. Unilever brand advertising may
also appear on the CompuServe service and Unilever will have an advertising
presence on several of AOL's international services for specific packaged
goods categories. Additionally, AOL Europe, the joint venture between America
Online and Bertelsmann, reached an agreement with N2K Inc., an online music
entertainment company, to make N2K's Music Boulevard the exclusive music
partner for AOL's European services.
The Company offers for sale to subscribers on the AOL service a number of
computer and Internet online goods and services, including hardware and
software products and books, and AOL logo merchandise. The Company promotes
its merchandise principally by means of promotional "pop-up" screens and makes
its merchandise available in online stores, including in various channel
stores and in specialized seasonal or other targeted shops.
NETWORK SERVICES
America Online employs a diversified portfolio approach in designing,
structuring and operating its network services. America Online manages AOLnet,
a TCP/IP network of third party network service providers, including Sprint
Corporation, BBN Corporation, a part of GTE Internetworking, and WorldCom,
Inc.'s wholly-owned subsidiaries ANS Communications, Inc. (acquired from the
Company) and UUNet Technologies, Inc. The Company anticipates continuing to
expand AOLnet, in order to increase its network capacity, provide its members
with higher speed access, and reduce data network costs on a per-hour basis.
During fiscal 1998, the system was upgraded to handle the standard v.90 modem
protocol for high-speed 56.6 kbps (kilobits per second) access and the Company
added modems at a rate of approximately 25,000 monthly to expand to
approximately 800,000 modems. The AOL service grew as of August 1998 to permit
over 750,000 simultaneous users, the exchange of up to 34 million e-mail
messages a day and up to 290 million Instant Message communications a day.
AOLnet offers members of the AOL service in North America local telephone
numbers in approximately 790 cities. In total, the AOL service is available in
approximately 1,500 cities in more than 100 countries.
The Company's ability to reduce data network costs on a per-hour basis and
to expand the network capacity may be limited or impaired under certain
circumstances. The Company enters into multiple-year data communications
agreements to support AOLnet. In connection with those agreements, the Company
may commit to purchase certain minimum data communications services or to pay
a fixed cost for the network services. Accordingly, if the number of
subscribers or usage significantly decreases, network costs will not
correspondingly decrease. In addition, supply shortages exist from time to
time for local exchange carrier lines from local telephone companies that the
Company requires to expand network capacity. The expansion of AOLnet requires
a substantial investment in telecommunications equipment, which the Company is
financing principally through leasing. Supply shortages or the failure to
obtain the necessary financings for the buildout of AOLnet could impair the
Company's ability to expand network capacity.
The CompuServe service currently relies on data network services provided
pursuant to a Network Services Agreement among America Online, CompuServe
Incorporated, a wholly-owned subsidiary of WorldCom, and UUNet Technologies,
Inc. with an initial term ending December 31, 2002, subject to possible
extension by the Company under certain circumstances. Under the agreement, the
Company has made certain commitments to use such network services for the
CompuServe service. The smooth operation of and access capacity on the
CompuServe service are dependent on the network services provided under the
agreement and would be adversely affected by service failures of the network
services provider. The CompuServe service is available in over 500 cities
worldwide.
5
<PAGE>
MARKETING
The goals of the Company's marketing programs are to attract and retain
members. The Company markets its products and services through a broad array
of programs and strategies, including broadcast advertising campaigns, direct
mail, magazine inserts and advertisements, co-marketing, cross-promotion,
bundling agreements and alternate media. In addition to its marketing programs
directed specifically to member acquisition, the Company also actively markets
its brands through traditional campaigns (broadcast television, radio and
print publications), and through more innovative means, such as its
association with the upcoming film "You've Got Mail," and through extensive
online and offline cross-promotion supplied by a wide variety of AOL's
interactive services partners. Additionally, through bundling agreements with
major personal computer manufacturers, America Online is a featured Internet
service on a range of computers made by Acer America, Compaq Computer
Corporation, Packard Bell NEC, Inc. (which will also promote the CompuServe
service), Hewlett Packard, and IBM. The multi-year agreements provide that
pre-installed AOL software will be available by clicking on an AOL icon during
the computer's initial setup process. Through an agreement with Microsoft
Corp., the AOL service is accessible via a desktop folder on the Windows 95
and 98 operating systems (and will be available on future versions of the
Windows operating system through the term of the agreement).
The final version of AOL's next-generation software, AOL 4.0, became
available to members for downloading in July 1998, and is to be followed by a
broad-scale consumer launch of AOL 4.0 that will culminate with the mailing of
CD-ROMs to members and potential customers. Overall, however, the Company's
marketing strategy is expected to continue to emphasize bundling agreements.
Although the Company continues to market its products via direct mail
programs, such programs are directed to more narrowly targeted consumer groups
and, accordingly, are more cost-efficient than they were in the past.
America Online utilizes specialized retention programs designed to increase
customer loyalty and satisfaction and to maximize customer subscription life.
These retention programs include regularly scheduled online events and
conferences; the regular addition of new content, services and software
programs; and online promotions of upcoming online events and new features.
The Company also provides a variety of support mechanisms such as online
support and 24-hour telephone customer support services.
INTERNATIONAL EXPANSION
America Online has forged partnerships with international companies to
create a global community of interactive services. As of August 1998, the AOL
and CompuServe services had more than 2.5 million members outside the United
States. The Company's acquisition of the CompuServe service significantly
expanded its membership in its online internet services in Europe and Japan.
The Company offers its AOL and/or CompuServe branded services in Canada and,
through joint ventures, in Austria, France, Germany, Japan, Sweden,
Switzerland and the United Kingdom. AOL global members are able to access
these services in over 100 countries. The Company's international strategy is
to provide consumers with local services in key international markets
featuring local language, content, marketing and community. Each of these
services is marketed under the AOL or CompuServe brand name and provides
seamless access to the U.S. and other international services, extending the
AOL community worldwide.
Central to the Company's strategy has been the formation of strategic
alliances with strong international partners and the provision of access for
all members of international services. In addition, U.S. and global
subscribers to the AOL service can access selected content and communities
offered on the Company's other global services.
6
<PAGE>
America Online intends to continue to expand its global services through
joint ventures and on its own, capitalizing on the growth of consumer personal
computer ownership in key world markets. The Company intends to offer online
services, through a joint venture with Bertelsmann, in Australia in the fall
of 1998 and, through a license and distribution arrangement, in Hong Kong in
1999. For AOL international subscribers traveling outside of their home
countries, the Company will continue the expansion of international access to
its services.
Europe
America Online, through joint ventures with Bertelsmann AG, one of the
world's largest media companies, provides the AOL service and/or the
CompuServe service in Austria, France, Germany, the Netherlands, Sweden,
Switzerland and the United Kingdom. Each of these services provides European
consumers with local content and communities via local access networks and is
interconnected with the other AOL and CompuServe services. Through this
strategic partnership, the Company plans to extend these services into
additional markets in Europe. The AOL joint venture, AOL Europe, consists of
Bertelsmann and America Online each owning 50%, except in Germany and France.
In Germany, Axel Springer Verlag, Germany's largest newspaper publisher, holds
a 10% equity participation and the joint venture holds 90%. The CompuServe
joint venture, CompuServe Europe, consists of Bertelsmann and America Online
each owning 50%, except in France. In France, the Company has entered into
agreements that provide for Cegetel, a leading private telecommunications
operator in France, and Canal+, a leading European media and communications
company, to acquire a 55% interest in AOL France and CompuServe France. AOL
France and CompuServe France will operate under the joint leadership of the
four partners. Bertelsmann is a minority stockholder in America Online with
less than a 2.5% stake, and has designated Dr. Thomas Middelhoff,
Bertelsmann's Chairman-Designate, a member of the Company's Board of
Directors.
Canada
AOL Canada is tailored to the Canadian marketplace, offering members
localized client software, billing in Canadian dollars and thirteen channels
featuring Canadian content that is programmed in conjunction with its Canadian
partners. The service also provides message boards, discussion forums, e-mail,
and easy access to the Internet through an integrated Web browser. AOL
Canada's key partners include: Citytv, a broadcaster and program producer;
MuchMusic, Canada's first national music cable television channel; Canada
Trust, a leading Canadian financial institution; Green Line Investor Services,
a division of TD Securities and Canada's largest discount broker; and Reuters,
a 24-hour a day multimedia online news service from the world's leading news
and financial information company.
Japan
In April 1997, America Online launched AOL Japan through a partnership with
Mitsui & Co., one of the world's largest international trading companies, and
Nihon Keizai Shimbun (Nikkei), a leading Japanese media company and a primary
business-information source for Japanese executives. The joint venture, AOL
Japan, Inc., consists of Mitsui & Co. owning 40%, Nikkei 10% and America
Online 50%. Mitsui and Nikkei have contributed experience and credibility in
the Japanese market, as well as initial funding for the launch of the Japanese
service. AOL Japan offers AOL-branded interactive consumer services in Japan
with a broad range of localized Japanese language content.
Access to the CompuServe service (in English) is available in Japan through
a local distributor.
7
<PAGE>
Australia
In October 1997, America Online announced the formation of AOL Australia, a
joint venture with Bertelsmann, to bring the AOL service to Australia. The
Company expects the launch to occur in the fall of 1998. As with the European
services, the Australian service will be a local service with local content
and billing.
Hong Kong
AOL and the Hong Kong-based China Internet Corporation Limited (CIC) have
entered into agreements for an AOL-branded service for Hong Kong consumers
expected to be launched in 1999. The AOL Hong Kong service will be built on
the AOL U.S. service and will provide original local content in both Chinese
and English, with most local content being developed or provided by CIC.
SERVICE DELIVERY AND DISTRIBUTION TECHNOLOGIES
Today, America Online supports a variety of software platforms, hardware
devices and conduits for delivery of the service. Software platforms include
primarily the Windows (3.1, 95 and 98) and Macintosh operating systems. The
Company has upgraded AOLnet to support the v.90 standard for high speed
access, and is investing in the development of alternative technologies to
deliver its services, including cable modems, Digital Subscriber Line (xDSL)
access, and ISDN and wireless technologies. During fiscal 1998, the Company
launched the first nationwide field trials of xDSL broadband service. The
Company plans to offer its members this higher-speed option when it becomes
easy-to-use and commercially viable for the mass market. The next generation
of the CompuServe software planned for launch in 1999 will share the AOL
service technology platform.
The Company also intends to make the AOL service available on new platforms
that may be developed in the future, such as television, wireless telephones,
hand-held computers and other devices, as consumer demand, technology and
commercial viability permit. In June 1998, the Company acquired NetChannel,
Inc., a Web-enhanced television company, to pursue a competitive offering
within this distribution technology.
COMPETITION
The Company competes in a rapidly-changing marketplace with a wide range of
other companies in the communications, advertising, entertainment and
information, media, 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 personal computer
manufacturers 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., 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. 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.
8
<PAGE>
The development of midband and broadband distribution technologies,
including cable Internet access services offered by @Home Network, 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 and
satellite companies, is intensifying 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 yet
an additional competitive alternative to the offerings of the Company. The
Company has acquired NetChannel, 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.
Some of the present competitors and potential future competitors of the
Company may have greater financial, technical, marketing and/or personnel
resources than the Company. The competitive environment could (i) require
price reductions and increased spending on marketing, network capacity,
content procurement and product development, (ii) limit the Company's
opportunities to enter into and/or renew agreements with content providers and
distribution partners, (iii) limit its ability to develop new products and
services, (iv) limit its ability to continue to grow its subscriber base, (v)
result in increased attrition in the Company's subscriber base and (vi)
negatively impact the Company's ability to meet its business objective of
increasing advertising, commerce and other revenues. Any of the foregoing
events could have an impact on revenues or result in an increase in costs as a
percentage of revenues, which could have a material adverse effect on the
Company's business, financial condition and operating results.
EMPLOYEES
As of June 30, 1998, the Company had approximately 8,500 full-time
employees. America Online believes that its relations with its employees are
good. None of the Company's employees is represented by a labor union, and the
Company has never experienced a work stoppage.
PROPRIETARY RIGHTS
The Company relies upon a combination of contract provisions and patent,
copyright, trademark and trade secret laws to protect its proprietary rights
in its products. America Online distributes its products under agreements that
grant members a license to use its products and services and relies on the
protections afforded by the copyright laws to protect against the unauthorized
reproduction of its products. In addition, America Online attempts to protect
its trade secrets and other proprietary information through agreements with
employees and consultants. America Online has also filed for several patents
for technology relating to the Internet and online industry. Although America
Online intends to protect its rights vigorously, there can be no assurance
that these measures will be successful.
America Online seeks to protect the source code of its products as a trade
secret and as an unpublished copyright work. America Online also has obtained
federal trademark registration of the name America Online, AOL and the
Company's triangle design logo and has trademark rights worldwide to many
other proprietary names including, AOL.COM, Digital City, AOL Instant
Messenger, AOLnet, Buddy List, and "You've Got Mail."
America Online believes that due to the rapid pace of innovation within its
industry, factors such as the technological and creative skills of its
personnel are more important in establishing and maintaining a leadership
position within the industry than are the various legal protections of its
technology.
America Online believes that its products, trademarks and other proprietary
rights do not infringe on the proprietary rights of third parties. From time
to time, however, America Online has received communications
9
<PAGE>
from third parties asserting that features or contents of certain of its
services may infringe copyrights, patents and other rights of such parties. No
litigation is pending in this area that would have a material adverse effect
on America Online's ability to develop, market and sell its products or
operate its services. There can be no assurance that third parties will not
assert infringement claims against, America Online in the future with respect
to current or future features or contents of services or that any such
assertion may not result in litigation or require America Online to enter into
royalty arrangements.
REGULATORY ENVIRONMENT; PUBLIC POLICY
In the United States and most countries in which the Company conducts its
major operations, the Company is not currently subject to direct regulation
other than pursuant to laws applicable to businesses generally. Adverse
changes in the legal or regulatory environment relating to the interactive
online services and Internet industry in the United States, Europe, Japan or
elsewhere could have a material adverse effect on the Company's business,
financial condition and operating results. A number of legislative and
regulatory proposals from various international bodies and foreign and
domestic governments in the areas of telecommunication regulation, access
charges, encryption standards, content regulation, consumer protection,
advertising, intellectual property, privacy, electronic commerce, and
taxation, among others, are now under consideration. The Company is unable at
this time to predict which, if any, of such proposals may be adopted and, if
adopted, whether such proposals would have an adverse effect on the Company's
business, financial condition and operating results.
Moreover, the manner in which existing domestic and foreign laws (including
Directive 95/46/EC of the European Parliament and of the European Council on
the protection of individuals with regard to the processing of personal data
and on the free movement of such data) will or may be applied to online
service and Internet access providers is uncertain, as is the effect on the
Company's business given different possible applications. Similarly, the
Company is unable to predict the effect on the Company from the potential
future application of various domestic and foreign laws governing content,
export restrictions, privacy, consumer protection, export controls on
encryption technology, tariffs and other trade barriers, intellectual property
and taxes.
The Company actively works both in the United States and internationally
with industry groups and alliances as well as public interest groups and
representatives of government on issues affecting the interactive media,
including issues such as privacy measures and policies, obscenity and
pornography, consumer protection, taxation of interactive services and use,
regulation of means of access to the Internet, and intellectual property
issues such as the application of copyright laws to the interactive medium.
For example, the Company is a member of the Internet Alliance, an Internet
industry association, and the Online Privacy Alliance formed to address
privacy issues in the interactive medium and is a member of the steering
committees of TRUSTe and BBB Online, each of which is developing enforcement
systems for private sector commitments to fair information practice
principles. The Company believes that industry-led standards to address issues
facing the interactive medium will result in workable solutions without
restricting the further development of the medium. The Company seeks to
educate representatives of industry, government and public interest groups on
the benefits to society of the new interactive services medium and of the
greater likelihood of society's achieving those benefits through the
independent industry-led and market driven approaches outlined above. In the
Company's view, such an approach will provide a greater acceptance of the
medium by consumers around the world and a more favorable environment for the
acceptance of the Company's products and services. Some of the issues the
Company is focusing on are the protection of privacy, online tools to permit
user choice of content, prosecution of online crimes, safeguarding of
children, enhancement of online security, education and learning, online
community activities, fostering citizen and parental education and involvement
and protection of intellectual property. The Company has adopted internal
policies and principles regarding these areas and has implemented
10
<PAGE>
features in its services, such as its Parental Controls feature, chat safety
tips posted prominently on the Kids Only channel of the AOL service, and the
Notify AOL feature that enables members to report inappropriate activity on
the AOL service, as further support for its standards. The Company is unable
at this time to predict whether this approach will be adopted by government
and whether the positive regulatory environment being sought by this approach
will be forthcoming.
ITEM 2. PROPERTIES
America Online maintains its headquarters facilities in Dulles, Virginia and
holds various properties at and near the headquarters facilities. CompuServe
has its headquarters in Columbus, Ohio and has various properties at and near
those facilities. Digital City leases office space in the United States cities
for which it provides local interactive content and services. The Company
leases office space in the following United States locations for Customer Call
Centers: Tucson, Arizona; Jacksonville, Florida; Albuquerque, New Mexico;
Oklahoma City, Oklahoma; and Ogden, Utah. The Company also maintains locations
and offices at various locations throughout the United States and the rest of
the world for general corporate purposes, including customer call centers,
office space and the headquarters of ICQ Ltd. in Israel. The following table
sets forth information on the Company's material properties:
<TABLE>
<CAPTION>
LOCATION SIZE OWNED/LEASE PURPOSE
- -------- ---- ----------- -------
<S> <C> <C> <C>
Dulles, VA................... 590,000 sq. ft. Lease(1) Corporate Headquarters
Dulles, VA................... 180,000 sq. ft. Owned Technology Center
Vienna, VA................... 110,000 sq. ft. Lease Office Space
Vienna, VA................... 170,000 sq. ft. Lease Office Space
Reston, VA................... 265,000 sq. ft. Owned(2) Technology Center
Columbus, OH................. 250,440 sq. ft. Owned Office Space
</TABLE>
- --------
(1) Following a series of transactions, in May 1996, the Company leased from a
limited partnership approximately 78 acres of unimproved land and
approximately 39 acres of improved land for use as the Company's
headquarters facilities. The initial five-year term of the lease is non-
cancelable with respect to the 39 acre parcel. After the initial term, the
Company may purchase the property or arrange for the purchase of the
property by a third party and terminate the lease. On November 14, 1997,
the Company exercised its option to purchase the approximately 78 acre
parcel.
(2) This property is held subject to a mortgage.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to various litigation matters, investigations and
proceedings, including a lawsuit filed on behalf of shareholders in federal
court in Alexandria, Virginia against the Company and its chief executive
officer and then chief financial officer alleging violations of the federal
securities laws. The Company has entered into a preliminary agreement to
settle the action, subject to negotiation of final documentation and approval
by the court. As part of the settlement, the Company will make $35 million in
payments, a substantial portion of which it expects to be covered by
insurance. A shareholder derivative suit related to such class action lawsuit
has also been filed in Delaware chancery court against certain current and
former directors of the Company and remains pending. The Company has entered
into a preliminary agreement to settle the shareholder derivative suit,
subject to negotiation of final documentation and approval by the Delaware
chancery court, on terms that will not have a material adverse effect on the
financial condition or results of operations of the Company.
11
<PAGE>
The Company, one of its subsidiaries and two officers were named in a
lawsuit alleging, among other matters, that the Company breached an agreement
and has monopolized and attempted to monopolize an alleged market for online
games. The Company filed a counterclaim alleging defamation and breach of
contract. While the complaint originally sought more than $100 million in
damages and requested injunctive relief, the parties have settled the case on
terms that will not have a material adverse effect on the financial condition
or results of operations of the Company.
In late May 1998, the Company entered into an Assurance of Voluntary
Compliance with representatives of the offices of 44 State Attorneys General
regarding the Company's advertising, consumer and marketing practices. The
Assurance provides that the Company will provide additional disclosures in its
advertising and marketing materials and individualized notice to members of
material changes in the member agreement or increases in member fees. The
Assurance also requires the Company to make a payment to the states to cover
investigative costs and fund future Internet consumer protection and education
efforts and contains other terms which will not have a material adverse effect
on the financial condition or results of operations of the Company.
The costs and other effects of pending or future litigation, governmental
investigations, legal and administrative cases and proceedings (whether civil
or criminal), settlements, judgments and investigations, claims and changes in
those matters (including those matters described above), and developments or
assertions by or against the Company relating to intellectual property rights
and intellectual property licenses, could have a material adverse effect on
the Company's business, financial condition and operating results. Management
believes, however, that the ultimate outcome of all pending litigation should
not have a material adverse effect on the Company's financial position and
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
12
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET PRICE OF COMMON STOCK
The following table sets forth the range of high and low sale prices for the
Company's Common Stock for the periods indicated:
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED: HIGH LOW
---------------------- ------ ------
<S> <C> <C>
September 30, 1996.......................................... $23.25 $12.25
December 31, 1996........................................... 22.07 11.19
March 31, 1997.............................................. 23.94 15.94
June 30, 1997............................................... 31.07 20.88
September 30, 1997.......................................... 40.25 28.25
December 31, 1997........................................... 45.63 32.00
March 31, 1998.............................................. 69.88 41.25
June 30, 1998............................................... 109.63 69.25
</TABLE>
The Company has never declared, nor has it paid, any cash dividends on its
Common Stock. The Company currently intends to retain its earnings to finance
future growth and, therefore, does not anticipate paying any cash dividends on
its Common Stock in the foreseeable future.
As of September 14, 1998, the approximate number of stockholders of record
of Common Stock was 4,408. In addition, there were approximately 237,000
beneficial holders of the Common Stock, representing persons whose stock is in
nominee or "street name" accounts through brokers.
EXCHANGE INFORMATION
The Company's Common Stock is traded on the New York Stock Exchange under
the symbol "AOL."
Options on the Company's stock are traded on the Chicago Board Options
Exchange, the American Stock Exchange, and the Pacific Stock Exchange.
RECENT SALES OF UNREGISTERED SECURITIES
None
13
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-----------------------------------
1998 1997 1996 1995 1994
------ ------ ----- ------ -----
(AMOUNTS IN MILLIONS, EXCEPT PER
SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Online service revenues..................... $2,161 $1,429 $ 992 $ 344 $ 98
Advertising, commerce and other revenues.... 439 256 102 50 17
------ ------ ----- ------ -----
Total revenues.............................. 2,600 1,685 1,094 394 115
Income (loss) from operations............... 78 (505) 65 (21) 4
Net income (loss) (1)....................... 92 (499) 30 (36) 2
Income (loss) per common share:
Net income (loss) per share-diluted....... $ 0.35 $(2.61) $0.14 $(0.26) $0.01
Net income (loss) per share-basic......... $ 0.44 $(2.61) $0.18 $(0.26) $0.02
Weighted average shares outstanding:
Diluted................................... 259 191 215 139 138
Basic..................................... 210 191 171 139 114
<CAPTION>
AS OF JUNE 30,
-----------------------------------
1998 1997 1996 1995 1994
------ ------ ----- ------ -----
(AMOUNTS IN MILLIONS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (deficiency)................ $ 36 $ (230) $ (23) $ -- $ 39
Total assets................................ 2,214 833 959 405 155
Total debt.................................. 373 52 23 22 9
Stockholders' equity........................ 598 140 513 217 99
</TABLE>
- --------
(1) Net income in the fiscal year ended June 30, 1998, includes charges of $35
million related to a restructuring, $80 million related to acquired
research and development and $17 million related to settlements. Net loss
in the fiscal year ended June 30, 1997, includes charges of $385 million
for the write-off of deferred subscriber acquisition costs, $49 million
for restructuring, $24 million for a legal settlement and $24 million for
contract terminations. Net income in the fiscal year ended June 30, 1996,
includes charges of $17 million for acquired research and development, $8
million for the settlement of a class action lawsuit, and $1 million for
merger expenses. Net loss in the fiscal year ended June 30, 1995, includes
charges of $50 million for acquired research and development and $2
million for merger expenses.
14
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
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 (through January 1998 only) 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. 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.
The growth of the Company's revenues is expected to be driven primarily by
growth in its subscriber base as well as growth in advertising, commerce and
other revenues. The growth of the subscriber base is dependent upon the
Company's ability to acquire and retain subscribers.
Effective December 1, 1996, the Company began offering several pricing
alternatives to the AOL service in the U.S. aimed at providing a variety of
price points designed to appeal to a wide range of consumers. The Company's
current pricing options are as follows:
. 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.
. An alternative offering of three hours for $4.95 per month, with
additional time priced at $2.50 per hour.
. An alternative 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 July 1997, the Company introduced premium games services, for which
members pay $1.99 per hour (after any free hours offered under promotional
programs) in addition to the regular monthly membership fee and hourly usage
charges as set forth above.
Prior to December 1, 1996, the Company's standard monthly membership fee for
its AOL service in the U.S., 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
15
<PAGE>
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"). This plan was discontinued upon the availability of the Flat-
Rate Plan on December 1, 1996.
Effective February 1, 1998, the Company offered the following 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.
. An alternative offering of $24.95 per month with no additional hourly
charge.
Subsequent to the introduction of the Flat-Rate Plan for the AOL service,
the Company experienced a significant increase in average monthly subscriber
usage and higher cost of revenues relative to total revenues. The Company has,
and plans to continue to minimize the impact of the aforementioned changes by
increasing advertising, commerce and other revenues as well as by pricing
actions and by reducing costs, on a relative basis (either on a per-hour basis
or as a percentage of total revenues), principally through network, marketing
and operating cost efficiencies.
An important component of the Company's business strategy is an increasing
reliance on advertising, commerce and other revenues, which include
advertising and related revenues, the sale of merchandise and transaction fees
associated with electronic commerce. Another important factor in the Company's
business strategy is the further reduction of the costs of operating the
Company's data network, on a per-hour basis, through volume discounts and more
efficient utilization of AOLnet, the Company's TCP/IP network. The Company's
marketing expenses as a percentage of revenues were lower in fiscal 1998 than
in fiscal 1997, primarily as a result of the improved value proposition
offered by flat-rate pricing, which has resulted in improved subscriber
acquisition and retention rates, as compared to rates achieved prior to flat-
rate pricing. However, with the recent $2.00 per month price increase for the
standard monthly membership fee, the Company may have to spend more on
marketing, advertising and customer service than in recent periods in order to
acquire and retain customers and combat potential competitive pressures and
responses. The Company's marketing strategy is expected to continue to
emphasize brand advertising as well as cost-effective bundling agreements,
where the Company's products are widely distributed with new personal
computers, the Windows operating system and other peripheral computer
equipment and software. Additionally, the Company will continue to market its
products via direct mail programs.
The growth of advertising, commerce and other revenues is important to the
Company's business objectives, as those revenues provide an important
contribution to the Company's operating results. In fiscal 1998, advertising,
commerce and other revenues totaled $439 million, an increase of $183 million,
or 71% over fiscal 1997. Among the Company's business objectives are
increasing the subscriber base and continuing to accelerate the growth in
advertising and electronic commerce and other revenues. The Company expects
that the growth in advertising, commerce and other revenues, assuming such
growth continues, will provide the Company with the opportunity and
flexibility to fund the costs associated with the increased usage resulting
from flat-rate pricing, as well as programs designed to grow the subscriber
base and meet other business objectives. Advertising, commerce and other
revenues are generated primarily from electronic commerce and advertising, and
include fees received from the sale of advertising, fees received from
companies who market their products through the Company's online services and
the sale of merchandise by the Company (principally computer hardware and
software and AOL merchandise). Advertising revenues are expected to grow in
importance as the Company continues to leverage its large, active and growing
subscriber base.
16
<PAGE>
As a result of the Company's switch to flat-rate pricing in December 1996,
which was accompanied by a dramatic increase in member usage, the Company's
operating margin declined in fiscal 1997 relative to fiscal 1996. Average
monthly subscriber usage in the first quarter of fiscal 1997, the last quarter
before the introduction of flat-rate pricing, was approximately 7 hours. In
fiscal year 1998, average monthly subscriber usage ranged between 20 and 23
hours, and was approximately 22 hours in the fourth quarter of fiscal year
1998. If current usage levels increase, further pressures on operating margins
may result. The impact of increased usage on operating margins, if it occurs,
could be offset, in whole or in part, by increases in advertising, commerce
and other revenues, increased data network operating efficiencies, reductions
in marketing and other operating expenses, pricing changes or other factors or
actions.
The Company competes in a rapidly-changing marketplace with a wide range of
other companies in the communications, advertising, entertainment and
information, media, direct mail and commerce fields. Current competitors of
the Company for usage, subscribers, advertising and electronic 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 personal computer
manufacturers who may incorporate functional equivalents to the Company's
services in their products. The Company also competes for usage and
advertising and electronic commerce revenues with companies providing Web
navigation and search services and content such as Yahoo! Inc., 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. 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.
The development of midband and broadband distribution technologies,
including cable Internet access services offered by @Home Network, 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 and
satellite companies, is intensifying 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 yet
an additional competitive alternative to the offerings of the Company. The
Company has acquired NetChannel, 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.
Some of the present competitors and potential future competitors of the
Company may have greater financial, technical, marketing and/or personnel
resources than the Company. The competitive environment could (i) require
price reductions and increased spending on marketing, network capacity,
content procurement and product development, (ii) limit the Company's
opportunities to enter into and/or renew agreements with content providers and
distribution partners, (iii) limit its ability to develop new products and
services, (iv) limit its ability to continue to grow its subscriber base, (v)
result in increased attrition in the Company's subscriber base and (vi)
negatively impact the Company's ability to meet its business objective of
increasing advertising, commerce and other revenues. Any of the foregoing
events could have an impact on revenues or result in an increase in costs as a
percentage of revenues, which could have a material adverse effect on the
Company's business, financial condition and operating results.
17
<PAGE>
RESULTS OF OPERATIONS
FISCAL 1998 COMPARED TO FISCAL 1997
ONLINE SERVICE REVENUES
For fiscal 1998, online service revenues increased from $1,429 million to
$2,161 million, or 51%, over fiscal 1997. This increase was comprised of an
increase in AOL online service revenues of $667 million as well as CompuServe
online service revenues of $85 million, which began in February 1998,
partially offset by a $20 million decrease in service revenues from the
Company's internet service, Global Network Navigator ("GNN"), which was
discontinued in fiscal 1997. The increase in AOL online service revenues was
primarily attributable to a 39% increase in the average number of AOL North
American subscribers for fiscal 1998, compared to fiscal 1997, as well as a
5.5% 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 $16.87 in fiscal 1997 to $17.79 in fiscal
1998. This increase was principally attributable to a reduction in the amount
of refunds/credits issued to subscribers in fiscal 1998.
At June 30, 1998, the Company had 12,535,000 AOL brand subscribers,
including 11,237,000 in North America and 1,298,000 in the rest of the world.
Also at that date, the Company had 2,071,000 CompuServe brand subscribers,
including 1,029,000 in North America and 1,042,000 in the rest of world.
ADVERTISING, COMMERCE AND OTHER REVENUES
Advertising, commerce and other revenues, which consist principally of
advertising and related revenues, fees associated with electronic commerce and
the sale of merchandise, increased by 71%, from $256 million in fiscal 1997 to
$439 million in fiscal 1998. The increase was driven primarily by more
advertising on the Company's AOL service as well as an increase in electronic
commerce fees. Advertising and electronic commerce fees increased by 159%,
from $98 million in fiscal 1997 to $254 million in fiscal 1998. A portion of
the advertising and electronic commerce revenues recognized in fiscal 1998
reflect revenues associated with Tel-Save, Inc. ("Tel-Save") warrants earned
by the Company during that period as a result of the sale of Tel-Save long-
distance telephone service to AOL members. The value of such warrants for
revenue recognition purposes was calculated based upon, among other variables,
the average market price of Tel-Save common stock at the end of the final
three fiscal 1998 quarters. Future revenues will be earned by the Company
based upon the growth in the number of Tel-Save long-distance telephone
subscribers and will be calculated using the number of warrants earned and the
value of those warrants. Merchandise sales decreased by 9%, from $109 million
in fiscal 1997 to $99 million in fiscal 1998. At June 30, 1998, the Company's
advertising and electronic commerce backlog, representing the contract value
of advertising and electronic commerce agreements signed, less revenues
already recognized from these agreements, was approximately $511 million, up
from approximately $180 million at June 30, 1997.
COST OF REVENUES
Cost of revenues includes network-related costs, consisting primarily of
data network costs, personnel and related costs associated with operating the
data centers, data network and providing customer support and billing, host
computer and network equipment costs, the costs of merchandise sold and
royalties paid to information and service providers. For fiscal 1998, cost of
revenues increased from $1,074 million to $1,678 million, or 56%, over fiscal
1997, and increased as a percentage of total revenues from 63.7% to 64.5%.
The increase in cost of revenues in fiscal 1998 was primarily attributable
to increases in data network costs, host computer and network equipment costs
and personnel and related costs associated with operating the data
18
<PAGE>
centers, data network and providing customer support and billing. Data network
costs increased primarily as a result of the larger customer base and more
usage by customers. Host computer and network equipment costs, consisting of
lease, depreciation and maintenance expenses, increased as a result of
additional host computer and network equipment, necessitated by the larger
customer base and more usage by customers. 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 fiscal
1998 was primarily attributable to an increase, as a percentage of total
revenues, in host computer and network equipment costs partially offset by a
decrease, as a percentage of total revenues, in royalties paid to information
and service providers.
The Company operates AOLnet, its TCP/IP data network, to provide network
capacity to its members. The Company manages and lowers its per-hour data
network costs by relying on increasing network volumes to negotiate lower
costs per network hour as well as by efficiently utilizing the network.
Pursuant to the Purchase and Sale Agreement (the "Purchase and Sale") by and
among the Company, ANS Communications, Inc. ("ANS"), a then wholly-owned
subsidiary of the Company, and WorldCom, Inc. ("WorldCom"), the Company
recorded a deferred network services credit on the balance sheet of $381
million, which is equivalent to the excess of the cash and the fair value of
the CompuServe business received over the book value of ANS. This deferred
network services credit will be amortized as a reduction of network service
expense within cost of revenues on a straight-line basis over the five year
term of the network services agreement entered into between the Company and
WorldCom. During fiscal 1998, the Company reduced cost of revenues by
approximately $32 million due to the amortization of the deferred network
services credit. For additional information regarding this transaction and the
deferred network services credit, see Note 8 of the Notes to Consolidated
Financial Statements.
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 fiscal 1998 marketing expenses decreased
from $422 million to $374 million, or 11%, over fiscal 1997, and decreased as
a percentage of total revenues from 25.0% to 14.4%. The decrease in marketing
expenses for fiscal 1998, and such expenses as a percentage of total revenues,
was primarily attributable to a decrease in subscriber acquisition costs.
The Company made a change in the first quarter of fiscal 1997 which resulted
in subscriber acquisition costs being expensed for periods subsequent to the
first quarter of fiscal 1997, versus being capitalized and amortized over
twenty-four months in the first quarter of fiscal 1997 and prior. As a result
of the aforementioned change in accounting estimate, the balance of deferred
subscriber acquisition costs as of September 30, 1996, totaling $385 million,
was written off. For additional information regarding this change, refer to
Note 3 of the Notes to Consolidated Financial Statements.
For fiscal 1998, marketing expenses, before capitalization and amortization,
decreased from $493 million to $374 million, or 24%, over fiscal 1997, and
decreased as a percentage of total revenues from 29.3% to 14.4%. The decrease
in marketing expenses for fiscal 1998, before capitalization and amortization,
was primarily attributable to a decrease in subscriber acquisition costs. The
Company was able to decrease its subscriber acquisition costs primarily as a
result of the improved value proposition offered by flat-rate pricing, which
has resulted in improved acquisition and retention rates, as compared to rates
achieved prior to flat-rate pricing.
19
<PAGE>
PRODUCT DEVELOPMENT
Product development costs include research and development expenses and
other product development costs. For fiscal 1998, product development costs
increased from $79 million to $95 million, or 20%, over fiscal 1997, and
decreased as a percentage of total revenues from 4.7% to 3.7%. The increase in
product development costs was primarily due to an increase in personnel costs
resulting from the Company's acquisition of CompuServe. The decrease in
product development costs as a percentage of total revenues was primarily a
result of the substantial growth in revenues.
GENERAL AND ADMINISTRATIVE
For fiscal 1998, general and administrative expenses increased from $127
million to $230 million, or 81%, over fiscal 1997, and increased as a
percentage of total revenues from 7.5% to 8.8%. The increase in general and
administrative costs for fiscal 1998, and such costs as a percentage of total
revenues, was primarily attributable to higher personnel costs, which included
compensatory stock option and other charges primarily related to the sale of
ANS, as well as increases in professional fees, principally related to legal
matters.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLE ASSETS
Amortization of goodwill and other intangible assets increased to $14
million in fiscal 1998 from $6 million in fiscal 1997. The increase in
amortization expense in fiscal 1998 is primarily attributable to goodwill
associated with the acquisition of CompuServe in January 1998, as well as
purchases of various companies made by the Company in late fiscal 1997 and
early fiscal 1998, partially offset by a decrease in goodwill amortization
resulting from the disposition of ANS in January 1998 and the shutdown of GNN
in the Company's fiscal 1997 restructuring.
RESTRUCTURING CHARGES
In connection with a restructuring plan adopted in the third quarter of
fiscal 1998, the Company recorded a $35 million restructuring charge
associated with the restructuring of its AOL Studios brand group. The
restructuring included the exiting of certain business activities, the
termination of approximately 160 employees and the shutdown of certain
subsidiaries and facilities. For additional information regarding this
restructuring, refer to Note 4 of the Notes to Consolidated Financial
Statements.
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 $1 million of the original
restructuring accrual in the first quarter of fiscal 1998.
ACQUIRED RESEARCH AND DEVELOPMENT
The Company incurred a total of $80 million in acquired research and
development charges in fiscal 1998 related to the acquisitions of Mirabilis,
Ltd. ("Mirabilis"), Personal Library Software, Inc. ("PLS") and NetChannel,
Inc. ("NetChannel").
In June 1998, the Company acquired the assets, including the developmental
ICQ instant communications and chat technology, and assumed certain
liabilities of Mirabilis. The ICQ technology is an enabling technology for
online communication. At the date of acquisition, Mirabilis reported 12
million registered trial users of which approximately half were active. The
Company paid $287 million in cash and may pay up to $120 million in additional
contingent purchase payments based on future performance levels. Prior to
finalizing the accounting for this acquisition, the Company consulted with the
Securities and Exchange Commission ("SEC"). The Company has concluded these
discussions and believes that the accounting for this acquisition is in
accordance with the SEC's position. The Company's Consolidated Statements of
Operations reflect a one-time write-off of the amount of purchase price
allocated to in-process research and development of $61 million.
20
<PAGE>
The Company allocated the excess purchase price over the fair value of net
tangible assets acquired to identified intangible assets. In performing this
allocation, the Company considered, among other factors, the attrition rate of
the active users of the technology at the date of acquisition (estimated to be
similar to the rate experienced by the AOL service) and the research and
development projects in-process at the date of acquisition. With regard to the
in-process research and development projects, the Company considered, among
other factors, the stage of development of each project at the time of
acquisition, the importance of each project to the overall development plan,
and the projected incremental cash flows from the projects when completed and
any associated risks. Associated risks include the inherent difficulties and
uncertainties in completing each project and thereby achieving technological
feasibility and risks related to the impact of potential changes in future
target markets.
The Company intends to incur in excess of $15 million, related primarily to
salaries, to develop the in-process technology into commercially viable
products over the next two years. Remaining development efforts are focused on
addressing security issues, architecture stability and electronic commerce
capabilities, and completion of these projects will be necessary before
revenues are produced. The Company expects to begin to benefit from the
purchased in-process research and development by its fiscal year 2000. If
these projects are not successfully developed, the Company may not realize the
value assigned to the in-process research and development projects. In
addition, the value of the other acquired intangible assets may also become
impaired.
The Company acquired PLS, a developer of information indexing and search
technologies in January 1998 and NetChannel, a web-enhanced television
company, in June 1998. These transactions were accounted for under the
purchase method of accounting. In connection with the purchases of PLS and
NetChannel, the Company recorded charges for acquired in-process research and
development of $10 million related to each acquisition. The technology, market
and development risk factors discussed above for the Mirabilis acquisition are
also relevant and should be considered with regard to the acquisitions of PLS
and NetChannel.
CONTRACT TERMINATION CHARGE
In fiscal 1997, the Company recorded a contract termination charge of $24
million, which consists of unconditional payments associated with terminating
certain information provider contracts which became uneconomic as a result of
the Company's introduction of flat-rate pricing in December 1996.
SETTLEMENT CHARGES
In fiscal 1998, the Company recorded a net settlement charge of $18 million
in connection with the settlement of the Orman v. America Online, Inc. class
action lawsuit filed in U.S. District Court for the Eastern District of
Virginia alleging violations of federal securities laws between August 1995
and October 1996. The settlement is subject to final documentation and court
approval. Included in the net settlement charge is an estimate of $17 million
in insurance receipts.
21
<PAGE>
In fiscal 1997, the Company recorded a settlement charge of $24 million in
connection with a legal settlement reached with various State Attorneys
General and a preliminary legal settlement reached with various class action
plaintiffs, 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 these settlements, 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 first quarter of fiscal 1998, the
Company revised its estimate of the total liability associated with these
matters, and reversed $1 million of the original settlement accrual.
OTHER INCOME (EXPENSE), NET
Other income (expense) consists primarily of investment income and non-
operating gains net of interest expense and non-operating charges. The Company
had other income of $14 million and $6 million in fiscal 1998 and fiscal 1997,
respectively. The increase in other income in fiscal 1998 was primarily
attributable to the sale of certain available-for-sale securities and
increases in net interest income partially offset by decreases in the
allocation of losses to minority shareholders and increases in non-operating
losses related to various investments.
PROVISION FOR INCOME TAXES
The provision for income taxes was zero in fiscal 1998 and fiscal 1997.
During 1998 the Company realized income subject to tax under accounting
principles. However, unrecognized tax benefits from fiscal 1997 were available
to reduce tax expense to zero. For additional information regarding income
taxes, refer to Note 13 of the Notes to Consolidated Financial Statements.
FISCAL 1997 COMPARED TO FISCAL 1996
ONLINE SERVICE REVENUES
For fiscal 1997, online service revenues increased from $992 million to
$1,429 million, or 44%, over fiscal 1996. This increase was primarily
attributable to a 53% increase in the quarterly average number of AOL North
American subscribers for fiscal 1997, compared to fiscal 1996, offset by a 6%
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 $17.96 in fiscal 1996 to $16.87 in fiscal 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.
ADVERTISING, COMMERCE AND OTHER REVENUES
Advertising, commerce and other revenues increased by 150%, from $102
million in fiscal 1996 to $256 million in fiscal 1997. This increase was
primarily attributable to more advertising on the Company's service, an
increase in electronic commerce fees and an increase in merchandise sales.
Advertising and electronic commerce fees increased by 717%, from $12 million
in fiscal 1996 to $98 million in fiscal 1997. Merchandise sales increased by
152%, from $43 million in fiscal 1996 to $109 million in fiscal 1997,
reflecting the impact of an expanded number of products offered for sale to
the Company's larger membership base.
The Company entered into a 40-month electronic commerce agreement in
February 1997 (the "Agreement") with Tel-Save. Under the terms of the
Agreement, the Company received $100 million in cash
22
<PAGE>
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 $24 million in advertising, commerce
and other revenues during fiscal year 1997 pursuant to the Agreement. During
fiscal year 1998, the Company entered into several amendments of this contract
with Tel-Save. These Amendments extended the term of the contract and expanded
the level of marketing services performed by the Company, in exchange for
additional cash and warrants.
COST OF REVENUES
For fiscal 1997, cost of revenues increased from $654 million to $1,074
million, or 64%, over fiscal 1996, and increased as a percentage of total
revenues from 59.8% to 63.7%.
The increase in cost of revenues was primarily attributable to an increase
in data network costs, host computer and network equipment costs, personnel
and related costs associated with operating the data centers, data network and
providing customer support and billing, 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. Host computer and network equipment costs increased primarily as a
result of additional equipment added to support customer growth. Personnel and
related costs were higher primarily due to customer support costs, which
increased 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 increase in cost of revenues as a percentage of total revenues was
primarily attributable to increases in leased equipment costs, the costs of
merchandise sold and product development amortization expense. The
aforementioned increase was partially offset by a decrease in data network
costs resulting from a lower cost per hour, due to a higher percentage of the
Company's data traffic being carried on AOLnet.
MARKETING AND WRITE-OFF OF DEFERRED SUBSCRIBER ACQUISITION COSTS
For fiscal 1997, marketing expenses increased from $220 million to $422
million, or 92%, over fiscal 1996, and increased as a percentage of total
revenues from 20.1% to 25.0%.
The increase in marketing expenses was primarily attributable to an increase
in subscriber acquisition costs, which was 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 was primarily attributable to
increases in subscriber acquisition costs and general marketing costs, which
include telemarketing and personnel. As a result of the aforementioned change
in accounting estimate, the balance of deferred subscriber acquisition costs
as of September 30, 1996, totaling $385 million, was written off. For
additional information regarding this change, refer to Note 3 of the Notes to
Consolidated Financial Statements.
For fiscal 1997, marketing expenses, before capitalization and amortization,
increased from $457 million to $493 million, or 8%, over fiscal 1996, and
decreased as a percentage of total revenues from 41.8% to 29.3%. The increase
in marketing expenses, before capitalization and amortization, was primarily
attributable to an
23
<PAGE>
increase in general marketing costs, including telemarketing and personnel.
The decrease in marketing expenses as a percentage of total revenues, before
capitalization and amortization, was primarily the result of a slight decrease
in subscriber acquisition costs, before capitalization and amortization,
combined with the substantial growth in revenues.
PRODUCT DEVELOPMENT
For fiscal 1997, product development costs increased from $58 million to $79
million, or 36%, over fiscal 1996, and decreased as a percentage of total
revenues from 5.3% to 4.7%. The increase in product development costs was
primarily due to an increase in personnel costs related to an increase in the
number of technical employees. The decrease in product development costs as a
percentage of total revenues was primarily the result of the substantial
growth in revenues, which more than offset the additional product development
costs.
GENERAL AND ADMINISTRATIVE
For fiscal 1997, general and administrative costs increased from $73 million
to $127 million, or 74%, over fiscal 1996, and increased as a percentage of
total revenues from 6.7% to 7.5%. The increase in general and administrative
costs, and such costs as a percentage of total revenues, was principally
attributable to higher office-related and personnel expenses, as a result of
an increase in the number of employees and expansion of the Company's
operations. The increase in office-related and personnel expenses included
costs associated with certain subsidiaries that were present in fiscal 1997
only, including Digital City, Inc. and Imagination Network, Inc. (doing
business as WorldPlay Entertainment, "WorldPlay").
ACQUIRED RESEARCH AND DEVELOPMENT
Acquired research and development costs, totaling $17 million in fiscal
1996, related to in-process research and development purchased pursuant to the
Company's acquisition of Ubique, Ltd. ("Ubique") in September 1995.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLE ASSETS
Amortization of goodwill and other intangible assets decreased to $6 million
in fiscal 1997 from $7 million in fiscal 1996. The decrease 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 WorldPlay, which occurred in fiscal 1997. In connection with the
fiscal 1997 restructuring charge (see Note 4 of the Notes to Consolidated
Financial Statements), the Company wrote off approximately $8 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 $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.
CONTRACT TERMINATION CHARGE
In fiscal 1997, the Company recorded a contract termination charge of $24
million, which consists of unconditional payments associated with terminating
certain information provider contracts which became uneconomic as a result of
the Company's introduction of flat-rate pricing in December 1996.
24
<PAGE>
SETTLEMENT CHARGE
In fiscal 1997, the Company recorded a settlement charge of $24 million in
connection with a legal settlement reached with various State Attorneys
General and a preliminary legal settlement reached with various class action
plaintiffs, 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 these settlements, 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.
OTHER INCOME (EXPENSE), NET
Other income (expense) consists primarily of investment income and non-
operating gains net of interest expense and non-operating charges. The Company
had other income of $6 million in fiscal 1997 and other expense of $3 million
in fiscal 1996. The change in other income (expense) was primarily
attributable to the allocation of losses to minority shareholders in fiscal
1997 and a charge in fiscal 1996 for the settlement of a class action lawsuit,
partially offset by an increase in fiscal 1997 of non-operating losses related
to various investments.
PROVISION FOR INCOME TAXES
The provision for income taxes was $0 and $32 million in fiscal 1997 and
fiscal 1996, respectively. For additional information regarding income taxes,
refer to Note 13 of the Notes to Consolidated Financial Statements.
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 (used in)
operating activities was $411 million, $127 million and $(44) million in
fiscal 1998, fiscal 1997 and fiscal 1996, respectively. Net cash used in
investing activities was $459 million, $220 million and $102 million in fiscal
1998, fiscal 1997 and fiscal 1996, respectively. Included in investing
activities for fiscal 1998 was $297 million for the purchase of property and
equipment, $303 million in payments for the acquisitions of Mirabilis and
NetChannel and net proceeds of $207 million from the Company's acquisition of
CompuServe and disposition of ANS. Net cash provided by financing activities
was $555 million, $99 million and $218 million in fiscal 1998, fiscal 1997 and
fiscal 1996, respectively. Included in financing activities for fiscal 1998
were $342 million in proceeds from convertible notes issued and sold in
November 1997 (see below), $28 million in proceeds from other notes payable,
and $114 million in proceeds from the sale of common stock pursuant to
employee stock option and stock purchase plans. Included in financing
activities for fiscal 1996 was approximately $140 million in proceeds from a
public stock offering of common stock.
At June 30, 1998, the Company had working capital of $36 million, compared
to a working capital deficiency of $230 million at June 30, 1997. Current
assets increased by $607 million, from $323 million at June 30, 1997 to $930
million at June 30, 1998, while current liabilities increased by $341 million,
from $553 million to $894 million, over this same period. The increase in
current assets was primarily attributable to an increase in cash and cash
equivalents resulting from cash generated by operations and the other
activities described above. The change in current liabilities was due to
increases in other accrued expenses and liabilities, primarily related
25
<PAGE>
to an increase in accrued telecommunications costs, as well an increase in
deferred subscriber and advertising and commerce revenues, and the deferred
network services credit arising from the WorldCom Purchase and Sale
transactions. During July 1998, the Company further improved its cash and
working capital balances as a result of a public offering of common stock. The
Company sold 5,390,000 shares of common stock and raised a total of $550
million in new equity. In November 1997, the Company sold $350 million of 4%
Convertible Subordinated Notes due November 15, 2002 (the "Notes"). The Notes
are convertible into the Company's common stock at a conversion rate of
19.15938 shares of common stock for each $1,000 principal amount of the Notes
(equivalent to a conversion price of $52.19375 per share), subject to
adjustment in certain events. Interest on the Notes is payable semiannually on
May 15 and November 15 of each year, commencing on May 15, 1998. The Notes may
be redeemed at the option of the Company on or after November 14, 2000, in
whole or in part, at the redemption prices set forth in the Notes. The Company
also has available, to meet its working capital needs, a $200 million secured
revolving credit facility with no amounts outstanding as of June 30, 1998.
On January 31, 1998, the Company consummated the Purchase and Sale pursuant
to which the Company transferred to WorldCom all of the issued and outstanding
capital stock of ANS in exchange for the online services business of
CompuServe Corporation ("CompuServe"), which was acquired by WorldCom shortly
before the consummation of the Purchase and Sale, and $147 million in cash
(excluding $15 million in cash received as part of the CompuServe online
services business and after purchase price adjustments made at closing).
Immediately after the consummation of the Purchase and Sale, the Company's
European partner, Bertelsmann AG, paid $75 million to the Company for a 50%
interest in a newly created joint venture to operate the CompuServe European
online service. Each company invested an additional $25 million in cash in
this joint venture. The Company generated $207 million in net cash as a result
of the aforementioned transactions.
In June 1998, the Company purchased Mirabilis for $287 million in cash (and
contingent purchase price payments of up to $120 million) and NetChannel for
$16 million in cash. For additional information regarding these acquisitions
see Note 8 of the Notes to Consolidated Financial Statements.
The Company enters into multiple-year data communications agreements in
order to support AOLnet. In connection with those agreements, the Company may
commit to purchase certain minimum data communications services. Should the
Company not require the delivery of such minimums, the Company's per hour data
communications costs may increase. For additional information regarding the
Company's commitments see Note 10 of the Notes to Consolidated Financial
Statements.
In May 1996, the Company entered into a joint venture with Mitsui & Co.,
("Mitsui") and Nihon Keizai Shimbun, Inc. ("Nikkei") to offer interactive
online services in Japan. In connection with the agreement, the Company
received approximately $28 million through the sale of convertible preferred
stock to Mitsui. The preferred stock had an aggregate liquidation preference
of approximately $28 million and accrued dividends at a rate of 4% per annum.
Accrued dividends could be paid in the form of additional shares of preferred
stock. During May 1998, the preferred stock, together with accrued but unpaid
dividends, was converted into 392,000 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 data center capacity. The buildout of AOLnet
and the expansion of data center capacity requires a substantial investment in
telecommunications and server equipment, as well as facilities. The Company
plans to continue making significant investments in these areas. The Company
is funding these investments, which are anticipated to total approximately
$700 million in fiscal 1999, through a combination of leases, debt financing
and cash purchases.
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,
26
<PAGE>
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.
SEASONALITY
The growth in subscriber acquisitions and usage appears 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 online
services while spending more time indoors due to winter weather. However,
because of the Company's limited history with the Flat-Rate Plan (which was
adopted effective as of December 1, 1996), 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 online services as a
result of the growing market demand and utility for such services.
Beginning with the second quarter of fiscal 1998, the Company believes it
has begun to see the effects of seasonality in securing advertising
commitments. The Company expects that advertising commitments will be highest
in the second fiscal quarter each year due to calendar-year budgeting cycles
of many advertisers. However, because of the Company's recent focus on
developing advertising revenues, the Company does not know whether increases
in securing advertising commitments are due to seasonal factors or to
increased interest by advertisers in the Company's medium and distribution
channels or other factors.
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 identified have been fixed in the Company's day to day operating
environment. The AOL host system is scheduled to begin testing in October
1998, and the AOL Operations Group is scheduled to begin testing in January
1999. The international portion of the AOL service and the CompuServe service
is in the early stages of its audit. However, these services utilize the same
AOL infrastructure, so it is anticipated that additional costs of compliance
for the international portion will be immaterial.
In addition, the Company has asked 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 responses. The Company
intends to continue its efforts to monitor 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
27
<PAGE>
to support its compliance initiatives. Although the Company expects its
systems 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 that the costs required
to address the Year 2000 issue, or that the impact of a failure to achieve
substantial Year 2000 compliance, will not have a material adverse effect on
the Company's business, financial condition or results of operations. The
Company has not adopted a contingency plan to address possible risks to its
systems.
INFLATION
The Company believes that inflation has not had, and will not have in the
future, a material effect on its results of operations.
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 the following subjects: future operating results; subscriber growth
and retention; advertising and electronic commerce revenues; earnings growth
and expectations; development and success of multiple brands; new products and
services (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
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 failure to increase revenues at a rate sufficient to offset the
increase in data communications costs resulting from increasing usage.
Risks and uncertainties associated with a recently implemented price
28
<PAGE>
increase, 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 of loss of services of executive officers and other key
employees.
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.
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
diversion of the Company's management's attention from other ongoing
business concerns; and the risk of significant charges for in-process
research and development or other matters.
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 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.
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.
29
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements listed under the heading "(a)
(1) Consolidated Financial Statements" of Item 14 hereof, which financial
statements are incorporated herein by reference in response to this Item 8.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The response to this item is incorporated by reference from the Sections
titled "Management" and "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Registrant's Proxy Statement for its 1998 Annual Meeting of
Stockholders.
ITEM 11. EXECUTIVE COMPENSATION
The response to this item is incorporated by reference from the Section
titled "Executive Compensation," but not from the Sections titled "Executive
Compensation--Performance Graph" and "Executive Compensation--Report on
Executive Compensation by the Compensation and Management Development
Committee of the Board of Directors," in the Registrant's Proxy Statement for
its 1998 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The response to this item is incorporated by reference from the Section
titled "Share Ownership" in the Registrant's Proxy Statement for its 1998
Annual Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The response to this item is incorporated by reference from the Section
titled "Certain Relationships and Related Transactions" in the Registrant's
Proxy Statement for its 1998 Annual Meeting of Stockholders.
30
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Consolidated Financial Statements
The following consolidated financial statements of America Online, Inc. and
the Report of Independent Auditors thereon are included in Item 8 above:
<TABLE>
<S> <C>
Consolidated Statements of Operations for the years ended June 30,
1998, 1997, and 1996.................................................. F-2
Consolidated Balance Sheets as of June 30, 1998 and 1997............... F-3
Consolidated Statements of Changes in Stockholders' Equity for the
years ended June 30, 1998, 1997, and 1996............................. F-4
Consolidated Statements of Cash Flows for the years ended June 30,
1998, 1997, and 1996.................................................. F-5
Notes to Consolidated Financial Statements............................. F-6
Report of Management................................................... F-25
Report of Independent Auditors......................................... F-26
</TABLE>
(a)(2) Financial Statement Schedules
All financial statement schedules required by Item 14(a) (2) have been
omitted because they are inapplicable or because the required information has
been included in the Consolidated Financial Statements or Notes thereto.
(a)(3) Exhibits
The following Exhibits are incorporated herein by reference or are filed
with this report as indicated below. Copies of exhibits will be furnished,
upon request, to holders or beneficial owners of America Online, Inc. Common
Stock as of September 14, 1998, subject to payment in advance of a fee of 25
cents per page to reimburse America Online, Inc. for reproduction costs.
EXHIBIT LIST
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
2.1 Agreement and Plan of Reorganization, dated May 11, 1994, as amended,
among America Online, Inc., RCC Acquisition Corporation and RCC
Communications Corporation (Filed as Annex A to the Company's
Registration Statement on Form S-4, Registration Statement No. 33-
82030, as filed on July 24, 1994 and incorporated herein by
reference.)
2.2 Agreement and Plan of Reorganization dated as of November 8, 1994,
among America Online, Inc., BLT Acquisition Corporation, CMG
Information Services, Inc. and Booklink Technologies, Inc. (Filed as
Exhibit 1 to the Company's Current Report on Form 8-K, dated January
9, 1995 and incorporated herein by reference.)
2.3 Agreement and Plan of Merger, dated as of December 20, 1995, among
America Online, Inc., Santa's Acquisition Corp. and Johnson-Grace
Company and its Principal Shareholders (Filed as Exhibit 2.1 to the
Company's Current Report on Form 8-K, dated February 14, 1996 and
incorporated herein by reference.)
2.4 Stock Purchase Agreement, dated as of August 5, 1996, among America
Online, Inc., The ImagiNation Network, Inc. and AT&T Corp. (Filed as
Exhibit 10 to the Company's Current Report on Form 8-K, dated August
5, 1996, and incorporated herein by reference.)
</TABLE>
31
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
2.5 Purchase and Sale Agreement dated as of September 7, 1997 by and among
America Online, Inc., ANS Communications, Inc. and WorldCom, Inc.
(Filed as Exhibit 2 to the Company's Current Report on Form 8-K, dated
September 19,1997, and incorporated herein by reference.)
2.6 Agreement of Purchase and Sale dated as of June 5, 1998 by and among
America Online, Inc., AOL Acquisition Corp., R.G.A.O. Holdings Ltd.,
and Mirabilis Ltd and the Principal Stockholders (Confidential
treatment has been requested with respect to certain portions of the
Agreement). (Filed as Exhibit 2 to the Company's Current Report on
Form 8-K, dated June 11, 1998, and incorporated herein by reference.)
3.1 Restated Certificate of Incorporation of America Online, Inc. (Filed
as Exhibit 3.1 to the Company's Annual Report on Form 10-K for the
fiscal year ended June 30, 1997 and incorporated herein by reference.)
3.2 Amendment of Section A of Article 4 of the Restated Certificate of
Incorporation of America Online, Inc. (Filed as Exhibit 4.1 to the
Company's Registration Statement n Form S-3, Registration No. 333-
46633 and incorporated herein by reference.)
3.3 Certificate of Designation, Preferences and Rights of Series A-1
Junior Participating Preferred Stock of America Online, Inc.
3.4 Certificate of Elimination of Series A Junior Participation Preferred
Stock of America Online, Inc.
3.5 Restated By-Laws of America Online, Inc.
4.1 Article 4, Article 6 and Article 8 of the Restated Certificate of
Incorporation (see Exhibits 3.1 and 3.2)
4.2 Indenture, dated as of November 17, 1997 between America Online, Inc.,
as issuer, and State Street Bank and Trust Company, as trustee. (Filed
as Exhibit 4.1 to the Company's Current Report on Form 8-K, dated as
of December 2, 1997.)
4.3 Registration Rights Agreement, dated as of November 17, 1997 between
America Online, Inc. and Goldman, Sachs & Co., BT Alex. Brown
Incorporated, Lehman Brothers Inc. and Cowen & Company. (Filed as
Exhibit 4.2 to the Company's Current Report on Form 8-K, dated as of
December 2, 1997.)
4.4 Purchase Agreement dated November 12, 1997 between America Online,
Inc. and Goldman, Sachs & Co., BT Alex. Brown Incorporated, Lehman
Brothers Inc. and Cowen & Company. (Filed as Exhibit 4.3 to the
Company's Current Report on Form 8-K, dated as of December 2, 1997.)
4.5 Rights Agreement dated as of May 12, 1998, between America Online,
Inc. and BankBoston, N.A., as Rights Agent. (Filed as Exhibit 4.2 to
the Company's Quarterly Report on Form 10-Q for the quarter ended
March 31, 1998 and incorporated herein by reference.)
10.1 Master Agreement for Data Communications Service, dated July 3, 1985,
as amended on May 13, 1991, and an order for Communications Service
Network Services pursuant thereto, dated January 15, 1992, between
America Online, Inc. and GTE Telenet Communications Corporation.
(Filed as Exhibit 10.18 to the Company's Registration Statement on
Form S-1, Registration Statement No. 33-45585, as filed on February 6,
1992 and incorporated herein by reference.) (Confidential treatment
granted.)
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
10.2 The Company's Employee Stock Purchase Plan. (Filed as Exhibit 28.1 to
the Company's Registration Statement on Form S-8, Registration
Statement No. 33-48447, as filed on June 5, 1992 and incorporated
herein by reference.)
10.3 The Company's 1992 Employee, Director and Consultant Stock Option
Plan. (Filed as Exhibit 10. 24 to the Company's Registration Statement
on Form S-1, Registration Statement No. 33-45585, as filed on February
6, 1992 and incorporated herein by reference.)
10.4 The Company's Incentive Stock Option Plan, 1987 Restatement. (Filed as
Exhibit 10.25 to the Company's Registration Statement on Form S-1,
Registration Statement No. 33-45585, as filed on February 6, 1992 and
incorporated herein by reference.)
10.5 The Company's 1987 Stock Incentive Plan. (Filed as Exhibit 10.26 to
the Company's Registration Statement on Form S-1, Registration
Statement No. 33-45585, as filed on February 6, 1992 and incorporated
herein by reference.)
10.6 Amendment No. 1 to the Company's 1987 Stock Incentive Plan. (Filed as
Exhibit 10.27 to the Company's Registration Statement on Form S-1,
Registration Statement No 33-45585, as filed on February 6, 1992 and
incorporated herein by reference.)
10.7 Master Agreement for Data Communications and Warrant Purchase
Agreement dated May 25, 1993 between Sprint Communications Company
L.P. and America Online, Inc. (Filed as Exhibit 10.23 to the Company's
Annual Report on Form 10-K for the year ended June 30, 1993 and
incorporated herein by reference.)
10.8 First Amendment to Master Agreement for Data Communications, dated
June 30, 1994, between Sprint Communication Company L.P. and America
Online, Inc. (Filed as Exhibit 10.17 to the Company's Annual Report on
Form 10-K for the year ended June 30, 1994 and incorporated herein by
reference.)
10.9 Employment Agreement and related agreements entered into with Robert
W. Pittman. (Filed as Exhibit 10.15 to the Company's Annual Report on
Form 10-K for the year ended June 30, 1997 and incorporated herein by
reference.)
10.10 Employment Agreement and related agreements entered into with George
Vradenburg, III
10.11 Letter Agreement entered into with Lennert J. Leader
21.1 List of Subsidiaries
23.1 Consent of Ernst & Young LLP
24.1 Powers of Attorney
</TABLE>
33
<PAGE>
(b) Reports on Form 8-K
The following reports on Form 8-K were filed during the quarter ended June
30, 1998:
<TABLE>
<CAPTION>
FILING
ITEM # DESCRIPTION DATE
------ ----------- -------
<C> <S> <C>
7 An amended report to file the financial statements of the 4/17/98
Interactive Services Division of CompuServe Corporation
which was acquired.
2, 7 A report announcing the entering into of an Agreement of 6/11/98
Purchase and Sale between America Online, Inc., AOL
Acquisition Corp., R.G.A.O. Holdings Ltd., and Mirabilis
Ltd., as amended
5, 7 A report filing an opinion of counsel and press release 6/29/98
announcing the commencement of a $500 million common stock
offering.
</TABLE>
34
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on the 28th day
of September, 1998.
AMERICA ONLINE, INC.
/s/ J. Michael Kelly
By:__________________________________
J. Michael Kelly,
Senior Vice President, Chief
Financial Officer, Treasurer, Chief
Accounting Officer
and Assistant Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on the 28th day of September, 1998.
<TABLE>
SIGNATURE TITLE DATE
<S> <C> <C>
* Chairman of the September 28, 1998
Board, Chief
Executive Officer
(principal executive officer)
- -----------------------------------
Stephen M. Case
/s/ J. Michael Kelly Senior Vice September 28, 1998
- -----------------------------------
J. Michael Kelly
President, Chief
Financial Officer, Treasurer,
Chief Accounting
Officer and
Assistant Secretary
(principal
financial and
accounting officer)
* Director September 28, 1998
- -----------------------------------
Daniel F. Akerson
* Director September 28, 1998
- -----------------------------------
Frank J. Caufield
* Director September 28, 1998
- -----------------------------------
Robert J. Frankenberg
* Director September 28, 1998
- -----------------------------------
Alexander M. Haig, Jr.
* Director September 28, 1998
- -----------------------------------
William N. Melton
</TABLE>
35
<PAGE>
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
<S> <C> <C>
* Director September 28, 1998
- -----------------------------------
Thomas Middelhoff
* President, Chief September 28, 1998
- ----------------------------------- Operating Officer
Robert W. Pittman and Director
Director
- -----------------------------------
Colin L. Powell
Director
- -----------------------------------
Franklin D. Raines
*By: /s/J. Michael Kelly
------------------------------
J. Michael Kelly, as Attorney-in-
Fact for each of the persons
indicated
</TABLE>
36
<PAGE>
AMERICA ONLINE, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Consolidated Statements of Operations for the years ended June 30, 1998,
1997 and 1996............................................................ F-2
Consolidated Balance Sheets as of June 30, 1998 and 1997.................. F-3
Consolidated Statements of Changes in Stockholders' Equity for the years
ended June 30, 1998,
1997 and 1996............................................................ F-4
Consolidated Statements of Cash Flows for the years ended June 30, 1998,
1997 and 1996............................................................ F-5
Notes to Consolidated Financial Statements................................ F-6
Report of Management...................................................... F-25
Report of Independent Auditors............................................ F-26
</TABLE>
F-1
<PAGE>
AMERICA ONLINE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
--------------------
1998 1997 1996
------ ------ -----
(AMOUNTS IN
MILLIONS, EXCEPT
PER SHARE DATA)
<S> <C> <C> <C>
REVENUES:
Online service revenues................................. $2,161 $1,429 $ 992
Advertising, commerce and other revenues................ 439 256 102
------ ------ -----
Total revenues...................................... 2,600 1,685 1,094
COSTS AND EXPENSES:
Cost of revenues........................................ 1,678 1,074 654
Marketing
Marketing............................................. 374 422 220
Write-off of deferred subscriber acquisition costs.... -- 385 --
Product development..................................... 95 79 58
General and administrative.............................. 230 127 73
Amortization of goodwill and other intangible assets.... 14 6 7
Restructuring charges................................... 34 49 --
Acquired research and development....................... 80 -- 17
Contract termination charge............................. -- 24 --
Settlement charges...................................... 17 24 --
------ ------ -----
Total costs and expenses............................ 2,522 2,190 1,029
INCOME (LOSS) FROM OPERATIONS............................. 78 (505) 65
OTHER INCOME (EXPENSE), NET............................... 14 6 (3)
------ ------ -----
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES........... 92 (499) 62
PROVISION FOR INCOME TAXES................................ -- -- (32)
------ ------ -----
NET INCOME (LOSS)......................................... $ 92 $ (499) $ 30
====== ====== =====
EARNINGS (LOSS) PER SHARE:
Earnings (loss) per share-diluted....................... $ 0.35 $(2.61) $0.14
Earnings (loss) per share-basic......................... $ 0.44 $(2.61) $0.18
Weighted average shares outstanding-diluted............. 259 191 215
Weighted average shares outstanding-basic............... 210 191 171
</TABLE>
See accompanying notes.
F-2
<PAGE>
AMERICA ONLINE, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30,
-----------
1998 1997
------ ----
(AMOUNTS IN
MILLIONS,
EXCEPT
ASSETS SHARE DATA)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents........................................ $ 631 $124
Trade accounts receivable, less allowances of $19 million and $6
million, respectively........................................... 104 65
Other receivables................................................ 92 26
Prepaid expenses and other current assets........................ 103 108
------ ----
Total current assets........................................... 930 323
PROPERTY AND EQUIPMENT AT COST, NET................................ 363 233
OTHER ASSETS:
Investments including available-for-sale securities.............. 439 81
Restricted cash.................................................. -- 50
Product development costs, net................................... 88 73
Goodwill and other intangible assets, net........................ 381 59
Other assets..................................................... 13 14
------ ----
$2,214 $833
====== ====
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
<S> <C> <C>
CURRENT LIABILITIES:
Trade accounts payable......................................... $ 87 $ 68
Other accrued expenses and liabilities......................... 443 299
Deferred revenue............................................... 242 166
Accrued personnel costs........................................ 46 20
Deferred network services credit............................... 76 --
------ ----
Total current liabilities.................................... 894 553
LONG-TERM LIABILITIES:
Notes payable.................................................. 372 50
Deferred revenue............................................... 71 86
Other liabilities.............................................. 6 4
Deferred network services credit............................... 273 --
------ ----
Total liabilities............................................ 1,616 693
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; 5,000,000 shares authorized, 0
and 1,000 shares issued and outstanding at June 30, 1998 and
1997, respectively............................................ -- --
Common stock, $.01 par value; 600,000,000 shares authorized,
219,641,140 and 200,377,942 shares issued and outstanding at
June 30, 1998 and 1997, respectively.......................... 2 2
Unrealized gain on available-for-sale securities............... 145 17
Additional paid-in capital..................................... 866 628
Accumulated deficit............................................ (415) (507)
------ ----
Total stockholders' equity................................... 598 140
------ ----
$2,214 $833
====== ====
</TABLE>
See accompanying notes.
F-3
<PAGE>
AMERICA ONLINE, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
UNREALIZED
GAIN ON
PREFERRED STOCK COMMON STOCK ADDITIONAL AVAILABLE-
------------------ ------------------ PAID-IN FOR-SALE ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL SECURITIES DEFICIT TOTAL
--------- ------- ----------- ------ ---------- ---------- ----------- -----
(AMOUNTS IN MILLIONS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCES AT JUNE 30,
1995................... -- $ -- 153,456,536 $ 2 $253 $ -- $ (38) $217
Common stock issued:
Exercise of options
and warrants......... -- -- 20,740,676 -- 48 -- -- 48
Business acquisitions. -- -- 931,004 -- 17 -- -- 17
Sale of stock, net.... -- -- 10,123,784 -- 142 -- -- 142
Sale of preferred stock,
net.................... 1,000 -- -- -- 28 -- -- 28
Tax benefit related to
stock options.......... -- -- -- -- 32 -- -- 32
Net income.............. -- -- -- -- -- -- 30 30
--------- ------ ----------- --- ---- ---- ----- ----
BALANCES AT JUNE 30,
1996................... 1,000 -- 185,252,000 2 520 -- (8) 514
Common stock issued:
Exercise of options... -- -- 13,866,522 -- 70 -- -- 70
Business acquisitions. -- -- 758,450 -- 16 -- -- 16
Sale of stock, net.... -- -- 500,970 -- 11 -- -- 11
Unrealized gain on
available-for-sale
securities............. -- -- -- -- 11 17 -- 28
Net loss................ -- -- -- -- -- -- (499) (499)
--------- ------ ----------- --- ---- ---- ----- ----
BALANCES AT JUNE 30,
1997................... 1,000 -- 200,377,942 2 628 17 (507) 140
Common stock issued:
Exercise of options... -- -- 18,299,705 -- 109 -- -- 109
Business acquisitions. -- -- 322,782 -- 14 -- -- 14
Sale of stock, net.... -- -- 248,711 -- 7 -- -- 7
Amortization of
compensatory stock
options................ -- -- -- -- 30 -- -- 30
Unrealized gain on
available-for-sale
securities............. -- -- -- -- 78 128 -- 206
Conversion of preferred
stock to common stock.. (1,000) -- 392,000 -- -- -- -- --
Net income.............. -- -- -- -- -- -- 92 92
--------- ------ ----------- --- ---- ---- ----- ----
BALANCES AT JUNE 30,
1998................... -- $ -- 219,641,140 $ 2 $866 $145 $(415) $598
========= ====== =========== === ==== ==== ===== ====
</TABLE>
See accompanying notes.
F-4
<PAGE>
AMERICA ONLINE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-----------------------
1998 1997 1996
------ ------- ------
(AMOUNTS IN MILLIONS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)................................... $ 92 $ (499) $ 30
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Write-off of deferred subscriber acquisition
costs............................................. -- 385 --
Non-cash restructuring charges..................... 11 22 --
Depreciation and amortization...................... 132 65 35
Amortization of deferred network services credit... (32) -- --
Charge for acquired research and development....... 80 -- 17
Compensatory stock options......................... 30 -- --
Gain on sale of investments........................ (17) -- (2)
Amortization of subscriber acquisition costs....... -- 59 126
Changes in assets and liabilities, net of the
effects of acquisitions and dispositions:
Trade accounts receivable........................ 1 (16) (17)
Other receivables................................ (67) 2 (12)
Prepaid expenses and other current assets........ 28 (44) (40)
Deferred subscriber acquisition costs............ -- (130) (363)
Other assets..................................... (12) (6) (11)
Investments including available-for-sale
securities...................................... (40) (30) 5
Accrued expenses and other current liabilities... 146 105 137
Deferred income taxes............................ -- -- 33
Deferred revenue and other liabilities........... 59 214 18
------ ------- ------
Total adjustments.............................. 319 626 (74)
------ ------- ------
NET CASH PROVIDED BY (USED IN) OPERATING
ACTIVITIES........................................ 411 127 (44)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment.................. (297) (149) (58)
Product development costs........................... (51) (57) (33)
Proceeds from sale of investments................... 24 -- --
Purchase of available-for-sale securities........... (18) (3) (12)
Net payments for acquisitions of
Mirabilis/NetChannel............................... (303) -- --
Other investing activities.......................... (21) (11) 1
Net proceeds from acquisition of
CompuServe/disposition of ANS...................... 207 -- --
------ ------- ------
NET CASH USED IN INVESTING ACTIVITIES.............. (459) (220) (102)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common and preferred
stock, net......................................... 114 99 217
Proceeds from sale and leaseback of property and
equipment.......................................... 70 20 --
Principal and accrued interest payments on line of
credit and debt.................................... (50) (21) (2)
Proceeds from line of credit and issuance of debt... 371 51 3
Restricted cash..................................... 50 (50) --
------ ------- ------
NET CASH PROVIDED BY FINANCING ACTIVITIES.......... 555 99 218
------ ------- ------
NET INCREASE IN CASH AND CASH EQUIVALENTS............. 507 6 72
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR........ 124 118 46
------ ------- ------
CASH AND CASH EQUIVALENTS AT END OF YEAR.............. $ 631 $ 124 $ 118
====== ======= ======
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the year for:
Interest........................................... $ 14 $ 2 $ 2
</TABLE>
See accompanying notes.
F-5
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION
America Online, Inc. ("the Company") was incorporated in the State of
Delaware in May 1985. The Company, based in Dulles, Virginia, is the leading
provider of international Internet online services, offering its subscribers a
wide variety of services, including electronic mail, conferencing, software,
computing support, interactive magazines and newspapers and online classes, as
well as easy access to services of the Internet. In addition, the Company
provides businesses with fully managed services that include Internet
connections, remote dial access, security solutions, Virtual Private Network
and Web hosting services.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION The consolidated financial statements include
the accounts of the Company and its subsidiaries. All significant intercompany
accounts and transactions have been eliminated.
BUSINESS COMBINATIONS Business combinations which have been accounted for
under the purchase method of accounting include the results of operations of
the acquired business from the date of acquisition. Net assets of the
companies acquired are recorded at their fair value to the Company at the date
of acquisition. Amounts allocated to in-process research and development are
expensed in the period of acquisition.
Other business combinations have been accounted for under the pooling of
interests method of accounting. In such cases, the assets, liabilities and
stockholders' equity of the acquired entities were combined with the Company's
respective accounts at recorded values. Prior period financial statements have
been restated to give effect to the merger unless the effect of the business
combination is not material to the financial statements of the Company.
REVENUE RECOGNITION Online service revenues are recognized over the period
that services are provided. Other revenues, which consist principally of
electronic commerce and advertising revenues, as well as data network service
revenues, are recognized as the services are performed or when the goods are
delivered. Deferred revenue consists primarily of prepaid electronic commerce
and advertising fees and monthly and annual prepaid subscription fees billed
in advance.
PROPERTY AND EQUIPMENT Property and equipment are depreciated or amortized
using the straight-line method over the following estimated useful lives:
<TABLE>
<S> <C>
Computer equipment and internal software................... 3 to 5 years
Buildings and related improvements......................... 15 to 40 years
Leasehold improvements..................................... 4 to 10 years
Furniture and fixtures..................................... 5 years
</TABLE>
SUBSCRIBER ACQUISITION COSTS The Company accounts for subscriber acquisition
costs pursuant to Statement of Position 93-7, "Reporting on Advertising Costs"
("SOP 93-7"). As a result of the Company's change in accounting estimate (see
Note 3), effective October 1, 1996, the Company began expensing all costs of
advertising as incurred.
Prior to October 1, 1996, the Company accounted for the cost of direct
response advertising as deferred subscriber acquisition costs to comply with
the criteria of SOP 93-7. These costs consist solely of the costs of
F-6
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
marketing programs which result in subscriber registrations without further
effort required by the Company. Direct response advertising costs, relate
directly to subscriber solicitations and principally include the printing,
production and shipping of starter kits and the costs of obtaining qualified
prospects by various targeted direct marketing programs and from third
parties. These subscriber acquisition costs have been incurred for the
solicitation of specifically identifiable prospects. The deferred costs were
amortized, beginning the month after such costs were incurred, 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. All other costs
related to the acquisition of subscribers, as well as general marketing costs,
were expensed as incurred. No indirect costs are included in deferred
subscriber acquisition costs.
On a quarterly basis, management reviewed the estimated future operating
results of the Company's subscriber base in order to evaluate the
recoverability of deferred subscriber acquisition costs and the related
amortization period. Management's assessment of the recoverability and
amortization period of deferred subscriber acquisition costs was subject to
change based upon actual results and other factors.
PRODUCT DEVELOPMENT COSTS The Company's online service is comprised of
various features which contribute to the overall functionality of the service.
The overall functionality of the service is delivered primarily through the
Company's four products (AOL and CompuServe for Windows and Macintosh). The
Company capitalizes costs incurred for the production of computer software
used in the sale of its services. Capitalized costs include direct labor and
related overhead for software produced by the Company and the cost of software
purchased from third parties. All costs in the software development process
which are classified as research and development are expensed as incurred
until technological feasibility has been established. Once technological
feasibility has been established, such costs are capitalized until the
software has completed beta testing and is generally available. To the extent
the Company retains the rights to software development funded by third
parties, such costs are capitalized in accordance with the Company's normal
accounting policies. Amortization, a cost of revenue, is provided on a
product-by-product basis, using the greater of the straight-line method or the
current year revenue as a percent of total revenue estimates for the related
software product, not to exceed five years, commencing the month after the
date of product release. Quarterly, the Company reviews and expenses the
unamortized cost of any feature identified as being impaired. The Company also
reviews recoverability of the total unamortized cost of all features and
software products in relation to estimated online service and relevant other
revenues and, when necessary, makes an appropriate adjustment to net
realizable value.
Capitalized product development costs consist of the following:
<TABLE>
<CAPTION>
YEAR ENDED
JUNE 30,
-------------
1998 1997
(IN MILLIONS) ----- -----
<S> <C> <C>
Balance, beginning of year................................ $ 73 $ 44
Costs capitalized......................................... 51 56
Costs amortized........................................... (36) (27)
----- -----
Balance, end of year...................................... $ 88 $ 73
===== =====
</TABLE>
The accumulated amortization of product development costs related to the
production of computer software totaled $72 million and $43 million at June
30, 1998 and 1997, respectively.
F-7
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Included in product development costs are research and development costs
totaling $38 million, $23 million and $22 million and other product
development costs totaling $57 million, $56 million and $36 million in the
years ended June 30, 1998, 1997 and 1996, respectively.
INVESTMENTS The Company has various investments, including foreign joint
ventures, that are accounted for under the equity method of accounting. All
investments in which the Company has the ability to exercise significant
influence over the investee, but less than a controlling voting interest, are
accounted for under the equity method of accounting. Under the equity method
of accounting, the Company's share of the investee's earnings or loss is
included in consolidated operating results. To date, the Company's basis and
current commitments in its investments accounted for under the equity method
of accounting have been minimal. As a result, these investments have not
significantly impacted the Company's results of operations or its financial
position.
All other investments, for which the Company does not have the ability to
exercise significant influence or for which there is not a readily
determinable market value, are accounted for under the cost method of
accounting. Dividends and other distributions of earnings from investees, if
any, are included in income when declared. The Company periodically evaluates
the carrying value of its investments accounted for under the cost method of
accounting and as of June 30, 1998 and 1997, such investments were recorded at
the lower of cost or estimated net realizable value.
GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill and other intangible assets
relate to purchase transactions and are amortized on a straight-line basis
over periods ranging from 2-10 years. As of June 30, 1998 and 1997,
accumulated amortization was $12 million. The Company periodically evaluates
whether changes have occurred that would require revision of the remaining
estimated useful life of the assigned goodwill or render the goodwill not
recoverable. If such circumstances arise, the Company would use an estimate of
the undiscounted value of expected future operating cash flows to determine
whether the goodwill is recoverable.
CASH, CASH EQUIVALENTS, INVESTMENTS AND RESTRICTED CASH The Company
considers all highly liquid investments with an original maturity of three
months or less to be cash equivalents. The Company has classified all debt and
equity securities as available-for-sale. Available-for-sale securities are
carried at fair value, with unrealized gains and losses reported as a separate
component of stockholders' equity. Realized gains and losses and declines in
value judged to be other-than-temporary on available-for-sale securities are
included in other income. The cost basis for realized gains and losses on
available-for-sale securities is determined on a specific identification
basis.
As of June 30, 1998, the Company had additional available-for-sale equity
investments (classified in other long-term assets) in public companies with a
fair market value of $266 million and a cost basis of $32 million. The
unrealized gain of $145 million, net of tax, has been recorded as a separate
component of stockholders' equity. Included in the $266 million is an
investment in Excite, Inc. of $230 million.
As of June 30, 1997, the Company had an available-for-sale equity investment
(classified in other long-term assets) in a public company with a fair market
value of $38 million and a cost basis of $9 million. The unrealized gain of
$17 million, net of tax, has been recorded as a separate component of
stockholders' equity.
Restricted cash was related to a financial covenant required under the
Company's senior secured revolving credit facility ("Credit Facility"). For
further information on the Credit Facility, refer to Note 11.
F-8
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In January 1997, the Securities and Exchange Commission issued new rules
requiring disclosure of the Company's accounting policies for derivatives and
market risk disclosure. The Company does not have any derivative financial
instruments as of June 30, 1998, and believes that the interest rate risk
associated with its borrowings and market risk associated with its available-
for-sale securities are not material to the results of operations of the
Company. The available-for-sale securities subject the Company's financial
position to market rate risk.
FINANCIAL INSTRUMENTS The carrying amounts for the Company's cash and cash
equivalents, trade accounts and other receivables, restricted cash, other
assets, trade accounts payable, accrued expenses and liabilities and other
liabilities approximate fair value. The fair market value for notes payable
(see Note 11) and investments including available-for-sale securities (see
Note 2) is based on quoted market prices where available.
BARTER TRANSACTIONS The Company barters advertising for products and
services. Such transactions are recorded at the lower of the estimated fair
value of the products or services received or given. Revenue from barter
transactions is recognized when advertising is provided, and services received
are charged to expense when used.
NET INCOME (LOSS) PER COMMON SHARE The Company calculates net income (loss)
per share as required by SFAS No. 128, "Earnings per Share." SFAS 128 replaced
the calculation of primary and fully diluted earnings per share with the basic
and diluted earnings per share. Unlike primary earnings per share, basic
earnings per share excludes any dilutive effect of stock options, warrants and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. Earnings per share
amounts have been restated to conform to SFAS 128 requirements where
appropriate (see Note 7).
STOCK-BASED COMPENSATION During 1997, the Company adopted SFAS No. 123,
"Accounting for Stock-Based Compensation." The provisions of SFAS No. 123
allow companies to either expense the estimated fair value of stock options or
to continue to follow the intrinsic value method set forth in APB Opinion 25,
"Accounting for Stock Issued to Employees" ("APB 25") but disclose the pro
forma effects on net income (loss) had the fair value of the options been
expensed. The Company has elected to continue to apply APB 25 in accounting
for its stock option incentive plans (see Note 15).
RECLASSIFICATION Certain amounts in prior years' consolidated financial
statements have been reclassified to conform to the current year presentation.
USE OF ESTIMATES The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ from those estimates.
RECENT PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board
("FASB") issued SFAS No. 130, "Reporting Comprehensive Income," which requires
companies to report by major components and in total, the change in its net
assets during the period from non-owner sources. The FASB also issued SFAS No.
131, "Disclosures about Segments of an Enterprise and Related Information,"
which establishes annual and interim reporting standards for a company's
operating segments and related disclosures about its products, services,
geographic areas and major customers. Both Statements are effective for fiscal
years beginning after December 15, 1997. Adoption of these standards will not
impact the Company's consolidated financial position,
F-9
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
results of operations or cash flows, and any effect, while not yet determined
by the Company, will be limited to the presentation of its disclosures.
NOTE 3. CHANGE IN ACCOUNTING ESTIMATE
As a result of a change in accounting estimate, the Company recorded a
charge of $385 million ($2.02 per share), as of September 30, 1996,
representing the balance of deferred subscriber acquisition costs as of that
date. The Company previously had 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. For further
information on subscriber acquisition costs, refer to Note 2. The Company's
changing business model, which includes flat-rate pricing for its online
service, increasingly is expected to 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. 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 4. RESTRUCTURING CHARGES
In connection with a restructuring plan adopted in the third quarter of
fiscal 1998, the Company recorded a $35 million restructuring charge
associated with the restructuring of its AOL Studios brand group. The
restructuring included the exiting of certain business activities, the
termination of approximately 160 employees and the shutdown of certain
subsidiaries and facilities. The restructuring charge is comprised of costs to
terminate third party agreements associated with exiting certain business
activities totaling $15 million, severance related costs of $11 million, the
write-off of impaired assets of $7 million and facilities shutdown and other
costs of $2 million.
The following table summarizes the activity in the restructuring accrual
during the fiscal year ended June 30, 1998. The balance of the restructuring
accrual at June 30, 1998 is included in other accrued expenses and liabilities
on the consolidated balance sheet and is anticipated to be paid in fiscal
1999.
<TABLE>
<CAPTION>
(IN MILLIONS)
<S> <C>
Restructuring charge................................... $35
Payments............................................... (18)
Non-cash adjustments................................... (13)
---
Restructuring accrual at June 30, 1998................. $ 4
===
</TABLE>
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 $1 million of the original
restructuring accrual.
F-10
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 5. CONTRACT TERMINATION CHARGE
In fiscal 1997, the Company recorded a contract termination charge of $24
million, which consisted of unconditional payments associated with terminating
certain information provider contracts which became uneconomic as a result of
the Company's introduction of flat-rate pricing in December 1996. Subsequent
to the contract terminations, the Company entered into new agreements with
these information providers.
NOTE 6. SETTLEMENT CHARGES
In fiscal 1998, the Company recorded a net settlement charge of $18 million
in connection with the settlement of the Orman v. America Online, Inc., class
action lawsuit filed in the U.S. District Court for the Eastern District of
Virginia alleging violations of federal securities laws between August 1995
and October 1996. The settlement is subject to final documentation and court
approval. At June 30, 1998, the Company had accrued a settlement charge of $35
million in other accrued expenses and liabilities and a receivable of $17
million related to the estimated insurance receipts in other receivables.
In fiscal 1997, the Company recorded a settlement charge of $24 million in
connection with a legal settlement reached with various State Attorneys
General and a preliminary legal settlement reached with various class action
plaintiffs, 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 its subscribers. Pursuant to these settlements, 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 plan
violated consumer protection laws. In fiscal 1998, the Company revised its
estimate of the total liability associated with these matters and reversed $1
million of the original settlement accrual.
F-11
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 7. EARNINGS (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted earnings
(loss) per share for the years ended June 30, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
(IN MILLIONS EXCEPT FOR PER SHARE DATA) ----- ------ -----
<S> <C> <C> <C>
Numerator for basic and diluted earnings per share -- Net
income (loss)............................................. $ 92 $ (499) $ 30
===== ====== =====
Denominator
Denominator for basic earnings per share -- Weighted aver-
age shares................................................ 210 191 171
Effect of dilutive securities:
Employee stock options................................... 42 -- 35
Warrants................................................. 7 -- 9
Convertible debt......................................... -- -- --
Convertible preferred stock.............................. -- -- --
----- ------ -----
Dilutive potential common shares........................... 49 -- 44
----- ------ -----
Denominator for diluted earnings per share -- Adjusted
weighted average shares and assumed conversions........... 259 191 215
===== ====== =====
Basic earnings (loss) per share............................ $0.44 $(2.61) $0.18
===== ====== =====
Diluted earnings (loss) per share.......................... $0.35 $(2.61) $0.14
===== ====== =====
</TABLE>
NOTE 8. BUSINESS COMBINATIONS
PURCHASE TRANSACTIONS
Acquisition of CompuServe Corporation
In January 1998, the Company consummated a Purchase and Sale Agreement (the
"Purchase and Sale") by and among the Company, ANS Communications, Inc.
("ANS"), a then wholly-owned subsidiary of the Company, and WorldCom, Inc.
("WorldCom") pursuant to which the Company transferred to WorldCom all of the
issued and outstanding capital stock of ANS in exchange for the online
services business of CompuServe Corporation ("CompuServe"), which was acquired
by WorldCom shortly before the consummation of the Purchase and Sale, and $147
million in cash (excluding $15 million in cash received as part of the
CompuServe online services business and after purchase price adjustments made
at closing). The transaction was accounted for under the purchase method of
accounting and, accordingly, the assets and liabilities were recorded based
upon their fair values at the date of acquisition.
Prior to the sale, ANS was a data communications and network service
provider whose primary customer was the Company. The Company sold ANS and its
network infrastructure, related equipment and personnel capable of managing
the network and simultaneously executed a network services agreement (the
"Services Agreement") with WorldCom. The Services Agreement calls for WorldCom
to provide network management services and data communications services for a
five-year period. WorldCom will utilize the purchased ANS assets to provide
such services to the Company. The sale of ANS was an integral part of the
Services Agreement.
F-12
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Services Agreement provides the Company with exclusive use during peak
usage periods of ANS's portion of the Company's analog dial up network sold
with ANS (the "Network") and provides that the title to the modems and related
equipment necessary to operate the Network will revert to the Company upon
termination or expiration of the Services Agreement. The Company will then pay
an amount equal to book value of the modems as set forth on ANS's financial
statements and will assume any operating lease arrangements for modems as of
such date. The Services Agreement provides the Company with significant
continuing involvement and influence over the ANS network assets sold.
The excess of the cash and the fair value of the CompuServe business
received over the book value of ANS amounted to $381 million, which will be
amortized on a straight-line basis over the five-year term of the Services
Agreement as a reduction of network services expense within cost of revenues.
Such amount has been classified as a deferred network services credit on the
consolidated balance sheet. During the year ended June 30, 1998, the Company
reduced cost of revenues by approximately $32 million due to the amortization
of the deferred network services credit.
In connection with the acquisition of CompuServe, the Company preliminarily
recorded approximately $106 million in goodwill and other intangible assets,
which are being amortized on a straight-line basis over periods of three to
seven years.
Immediately after the consummation of the Purchase and Sale, the Company's
European partner, Bertelsmann AG, paid $75 million to the Company for a 50%
interest in a newly created joint venture to operate the CompuServe European
online service. Both the Company and Bertelsmann AG invested an additional $25
million in cash in this joint venture. The Company will account for this
transaction under the equity method of accounting in accordance with the terms
of the securities issued in the joint venture.
Based on the current level of commitments that the Company has with
WorldCom, aggregate modem payments under the Services Agreement will
approximate $1.5 billion over the term of the Services Agreement.
Acquisition of Mirabilis, Ltd.
In June 1998, the Company purchased the assets, including the developmental
ICQ instant communications and chat technology, and assumed certain
liabilities of Mirabilis Ltd. ("Mirabilis") for $287 million in cash.
Mirabilis was a development stage enterprise that had generated no revenues.
In addition, contingent purchase payments, based on future performance levels,
of up to $120 million may be made over three years beginning in the Company's
fiscal year 2001. Prior to finalizing the accounting for this acquisition, the
Company consulted with the Securities and Exchange Commission ("SEC"). The
Company has concluded these discussions and believes that the accounting for
this acquisition is in accordance with the SEC's position. The acquisition was
accounted for under the purchase method of accounting and, accordingly, the
results of operations are included in the financial statements as of the date
of acquisition, and the assets and liabilities were recorded based upon their
fair values at the date of acquisition.
The Company has allocated the excess purchase price over the fair value of
net tangible assets acquired to the following identifiable intangible assets:
goodwill and strategic value, existing technology, base of trial users, ICQ
tradename and brand and in-process research and development. As of the
acquisition date, technological feasibility of the in-process technology has
not been established and the technology has no alternative future
F-13
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
use; therefore, the Company has expensed the amount of purchase price
allocated to in-process research and development of approximately $61 million
as of the date of the acquisition in accordance with generally accepted
accounting principles.
The amount of purchase price allocated to in-process research and
development was determined by estimating the stage of development of each in-
process research and development project at the date of acquisition,
estimating cash flows resulting from the expected revenues generated from such
projects, and discounting the net cash flows back to their present value using
a discount rate of 25%, which represents a premium to the Company's cost of
capital. The estimated revenues assume average compound annual revenue growth
rates of 135% during 2000 - 2004. Estimated total revenues from the purchased
in process projects peak in the year 2004 and decline through 2006 as other
new products are expected to be introduced. These projections are based on
management's estimates of market size and growth, expected trends in
technology and the expected timing of new product introductions. The remaining
identified intangibles, including goodwill that may result from any future
contingent purchase payments, will be amortized on a straight-line basis over
lives ranging from 5 to 10 years. If these projects are not successfully
developed, the Company may not realize the value assigned to the in-process
research and development projects. In addition, the value of the other
acquired intangible assets may also become impaired.
The following unaudited pro forma information has been prepared assuming
that the sale of ANS and the acquisitions of CompuServe and Mirabilis had
taken place at the beginning of the respective periods presented. 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 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.
<TABLE>
<CAPTION>
PRO FORMA
FOR THE YEARS
ENDED JUNE 30,
---------------
1998 1997
(IN MILLIONS, EXCEPT PER SHARE DATA) ------- -------
(UNAUDITED)
<S> <C> <C>
Revenue................................................. $ 2,734 $ 2,002
Income (loss) from operations........................... $ 162 $ (473)
Net income (loss)....................................... $ 176 $ (467)
Earnings (loss) per share--diluted...................... $ 0.68 $ (2.44)
Earnings (loss) per share--basic........................ $ 0.84 $ (2.44)
</TABLE>
Other Business Combinations
In January 1998, the Company acquired Personal Library Software, Inc.
("PLS"), a developer of information indexing and search technologies, in a
transaction that was accounted for under the purchase method of accounting.
The total purchase price was approximately $15 million, comprised of
approximately $9 million in stock and $6 million in assumed liabilities. In
connection with this transaction, the Company recorded a charge for acquired
in-process research and development of $10 million in the quarter ended March
31, 1998.
F-14
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In June 1998, the Company acquired NetChannel, Inc. ("NetChannel") a web-
enhanced television company, in a transaction accounted for under the purchase
method of accounting. Total purchase price was approximately $31 million,
comprised of $16 million in cash and $15 million in assumed liabilities. In
connection with this transaction, the Company recorded a charge of
approximately $10 million for acquired in-process research and development in
the quarter ended June 30, 1998.
In August 1996, the Company purchased 100% of the outstanding common stock
of the ImagiNation Network, Inc. ("INN"), by issuing 725,000 shares of its
common stock for a total purchase price of approximately $15 million. The
acquisition was accounted for under the purchase method of accounting and,
accordingly, the assets and liabilities were recorded based upon their fair
values at the date of acquisition.
In September 1995, the Company acquired Ubique, Ltd. ("Ubique"), an Israeli
company, in a transaction accounted for under the purchase method of
accounting. A total of 777,064 shares of the Company's common stock were
issued and approximately $2 million was paid in exchange for all the
outstanding equity and related rights of Ubique. Additionally, 87,792 shares
of the Company's common stock were reserved for outstanding stock options
issued by Ubique and assumed by the Company. Approximately $17 million of the
aggregate purchase price was allocated to in-process research and development
and was charged to the Company's operations at the time of the acquisition.
The proforma effect of the PLS, NetChannel, INN and Ubique transactions are
immaterial for all periods presented.
POOLING TRANSACTION
In February 1996, the Company completed its merger with Johnson-Grace
Company ("Johnson-Grace"), in which Johnson-Grace became a wholly-owned
subsidiary of the Company. The Company exchanged 3,235,556 shares of common
stock for all the outstanding common and preferred stock of Johnson-Grace.
Additionally, 144,858 shares of the Company's common stock were reserved for
outstanding stock options issued by Johnson-Grace and assumed by the Company.
The merger was accounted for under the pooling of interests method of
accounting and, accordingly, the accompanying consolidated financial
statements were restated to include the accounts and operations of Johnson-
Grace for all periods presented prior to the merger. In connection with the
merger of the Company and Johnson-Grace, merger expenses of $1 million were
recognized during 1996.
Johnson-Grace had a fiscal year end of March 31 and, accordingly, the
Company's retained earnings were adjusted by $1 million to reflect Johnson-
Grace's results of operations for the three months ended June 30, 1995, which
were not included in the Company's results of operations.
Johnson-Grace's revenues, adjusted for intercompany sales, during the nine
months ended March 31, 1996, and the years ended June 30, 1995 and 1994, were
minimal. During the nine months ended March 31, 1996, and the year ended June
30, 1995, Johnson-Grace's net loss was $4 million and $2 million,
respectively.
F-15
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 9. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
JUNE 30,
---------
1998 1997
(IN MILLIONS) ---- ----
<S> <C> <C>
Land........................................................... $ 24 $ 4
Buildings and related improvements............................. 98 38
Leasehold and network improvements............................. 90 50
Furniture and fixtures......................................... 14 11
Computer equipment and internal software....................... 216 159
Construction in progress....................................... 23 28
---- ----
465 290
Less accumulated depreciation and amortization................. 102 57
---- ----
Net property and equipment..................................... $363 $233
==== ====
</TABLE>
The Company's depreciation and amortization expense for the years ended June
30, 1998, 1997 and 1996 totaled $69 million, $18 million and $14 million,
respectively.
NOTE 10. COMMITMENTS AND CONTINGENCIES
The Company leases facilities and equipment primarily under several long-
term operating leases, certain of which have renewal options. Future minimum
payments under non-cancelable operating leases with initial terms of one year
or more consist of the following:
<TABLE>
<CAPTION>
(IN MILLIONS)
YEAR ENDING JUNE 30,
--------------------
<S> <C>
1999.............................................................. $ 219
2000.............................................................. 163
2001.............................................................. 85
2002.............................................................. 35
2003.............................................................. 14
Thereafter........................................................ 10
-----
$ 526
=====
</TABLE>
The Company's rental expense under operating leases in the years ended June
30, 1998, 1997 and 1996, totaled approximately $243 million, $143 million and
$48 million, respectively.
The Company has guaranteed monthly usage levels of data and voice
communications with some of its network providers and commitments related to
the construction of an additional office building. The remaining commitments
are $897 million, $886 million, $845 million and $813 million for the years
ending June 30, 1999, 2000, 2001 and 2002, respectively. The related expense
for the years ended June 30, 1998, 1997 and 1996, was $958 million, $405
million and $278 million, respectively.
F-16
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company is a party to various litigation matters, investigations and
proceedings, including a lawsuit filed on behalf of shareholders against the
Company and its chief executive officer and then chief financial officer
alleging violations of the federal securities laws. That class action lawsuit
was filed in federal court in Alexandria, Virginia against the Company, its
officers, outside directors and its auditors in February 1997. In July 1997,
the court dismissed the complaint, finding that the allegations of the
complaint were not sufficiently specific. The plaintiffs filed an amended
complaint in September 1997, this time naming the Company, its chief executive
officer and its chief financial officer as defendants. The Company has entered
into a preliminary agreement to settle the action, subject to negotiation of
final documentation and approval by the court. As part of the settlement, the
Company will make $35 million in payments, a substantial portion of which it
expects to be covered by insurance. A shareholder derivative suit related to
such class action lawsuit has also been filed in Delaware chancery court
against certain current and former directors of the Company and remains
pending. The Company has entered into a preliminary agreement to settle the
shareholder derivative suit, subject to negotiation of final documentation and
approval by the Delaware chancery court, on terms that will not have a
material adverse effect on the financial condition or results of operations of
the Company.
The Company, one of its subsidiaries and two officers are named in a lawsuit
alleging, among other matters, that the Company breached an agreement and has
monopolized and attempted to monopolize an alleged market for online games.
The Company filed a counterclaim alleging defamation and breach of contract.
While the complaint originally sought more than $100 million in damages and
requested injunctive relief, the parties have settled the case on terms that
will not have a material adverse effect on the financial condition or results
of operations of the Company.
In late May 1998, the Company entered into an Assurance of Voluntary
Compliance with representatives of the offices of 44 State Attorneys General
regarding the Company's advertising, consumer and marketing practices. The
Assurance provides that the Company will provide additional disclosures in its
advertising and marketing materials and individualized notice to members of
material changes in the member agreement or increases in member fees. The
Assurance also requires the Company to make a payment to the states to cover
investigative costs and fund future Internet consumer protection and education
efforts and contains other terms which will not have a material adverse effect
on the financial condition or results of operations of the Company.
The costs and other effects of pending or future litigation, governmental
investigations, legal and administrative cases and proceedings (whether civil
or criminal), settlements, judgments and investigations, claims and changes in
those matters (including those matters described above), and developments or
assertions by or against the Company relating to intellectual property rights
and intellectual property licenses, could have a material adverse effect on
the Company's business, financial condition and operating results. Management
believes, however, that the ultimate outcome of all pending litigation should
not have a material adverse effect on the Company's financial position and
results of operations.
NOTE 11. NOTES PAYABLE
During September 1997, the Company borrowed approximately $29 million in a
refinancing of one of its office buildings. The note is collateralized by the
Company's office building and carries interest at a fixed rate of 7.46%. The
note amortizes on a straight-line basis over a term of 25 years and if not
paid in full at the end of 10 years, the interest rate, from that point
forward, is subject to adjustment.
F-17
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
On November 17, 1997, the Company sold $350 million of 4% Convertible
Subordinated Notes due November 15, 2002 (the "Notes"). The Notes are
convertible into the Company's common stock at a conversion rate of 19.15938
shares of common stock for each $1,000 principal amount of the Notes
(equivalent to a conversion price of $52.19375 per share), subject to
adjustment in certain events and at the holders option. Interest on the Notes
is payable semiannually on May 15 and November 15 of each year, commencing on
May 15, 1998. The Notes may be redeemed at the option of the Company on or
after November 14, 2000, in whole or in part, at the redemption prices set
forth in the Notes. At June 30, 1998, the fair value of the Notes exceeded the
carrying value by $385 million as estimated by using quoted market prices.
Notes payable at June 30, 1997, totaled $50 million and consists of a two
year senior secured revolving credit facility ("Credit Facility"). The Company
anticipates using the Credit Facility for the purpose of supporting its
continuing growth and network expansion. The interest rate on the Credit
Facility is 100 basis points above the London Interbank Offered Rate and
interest is paid periodically, but at least quarterly. The Credit Facility is
subject to certain financial covenants and is payable in full at the end of
the two year term, on July 1, 1999. As of June 30, 1998, there are no
outstanding amounts on the Credit Facility.
NOTE 12. OTHER INCOME (EXPENSE)
The following table summarizes the components of other income:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
------------------------
1998 1997 1996
(IN MILLIONS) ------- ------ ------
<S> <C> <C> <C>
Interest income................................... $ 27 $ 7 $ 7
Interest expense.................................. (13) (2) (1)
Allocation of losses to minority shareholders..... 6 15 --
Equity investment income/(losses)................. (7) (5) (1)
Gain (loss) on investments........................ 7 (9) 1
Other income (expense)............................ (6) -- (9)
------- ------ ------
$ 14 $ 6 $ (3)
======= ====== ======
</TABLE>
NOTE 13. INCOME TAXES
The provision for income taxes is attributable to:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
----------------------
1998 1997 1996
(IN MILLIONS) ------ ------ ------
<S> <C> <C> <C>
Income before provision for income taxes............... $ -- $ -- $ 32
------ ------ ------
Charge in lieu of taxes attributable to the Company's
stock option plans.................................... -- -- 32
------ ------ ------
$ -- $ -- $ 32
====== ====== ======
</TABLE>
F-18
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The provision for income taxes differs from the amount computed by applying
the statutory federal income tax rate to income before provision for income
taxes. The sources and tax effects of the differences are as follows:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-----------------------
1998 1997 1996
(IN MILLIONS) ------ ------- ------
<S> <C> <C> <C>
Income tax at the federal statutory rate of 35%...... $ 32 $ (175) $ 21
State income tax, net of federal benefit............. 6 (15) 3
Nondeductible charge for purchased research and de-
velopment........................................... 28 -- 6
Valuation allowance changes affecting the provision
for income taxes.................................... (73) 187 1
Other................................................ 7 3 1
------ ------- -----
$ -- $ -- $ 32
====== ======= =====
</TABLE>
As of June 30, 1998, the Company has net operating loss carryforwards of
approximately $1,014 million for tax purposes which will be available to
offset future taxable income. If not used, these carryforwards will expire
between 2001 and 2013. To the extent that net operating loss carryforwards,
when realized, relate to stock option deductions, the resulting benefits will
be credited to stockholders' equity.
The Company's income tax provision was computed based on the federal
statutory rate and the average state statutory rates, net of the related
federal benefit.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
JUNE 30
------------
1998 1997
(IN MILLIONS) ----- -----
<S> <C> <C>
Short term:
Short term deferred tax assets:
Restructure reserve........................................... $ 23 $ 8
Valuation allowance........................................... (18) (7)
---- ----
Total....................................................... $ 5 $ 1
==== ====
Long term:
Long term deferred tax liabilities:
Capitalized software costs.................................... (33) (24)
Unrealized gain on available-for-sale securities.............. (89) --
---- ----
Total....................................................... (122) (24)
Long term deferred tax assets:
Net operating loss carryforwards.............................. 385 300
Deferred network services credit.............................. 131 --
Valuation allowance........................................... (399) (275)
---- ----
Total....................................................... 117 25
---- ----
Net long term deferred liabilities.............................. $ (5) $ (1)
==== ====
</TABLE>
F-19
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The valuation allowance for deferred tax assets increased by $135 million in
fiscal 1998. The increase in this allowance was primarily due to the current
year exercise of stock options, which will result in future tax deductions.
The related benefit of $309 million is recorded to stockholders' equity as it
is realized. This increase was offset by (1) the generation of deferred tax
liabilities of approximately $89 million arising from the tax effect of
unrealized gains on available-for-sale securities, recorded against
stockholders' equity and (2) the utilization of net operating losses relating
to book taxable income of approximately $73 million resulting in valuation
allowance changes affecting the provision for income taxes.
The Company has net operating loss carryforwards for tax purposes ("NOLs")
and other deferred tax benefits that are available to offset future taxable
income. Only a portion of the NOLs is attributable to operating activities.
The remainder of the NOLs is attributable to tax deductions related to the
exercise of stock options.
Prior to the third quarter of fiscal 1998, the Company followed the practice
of computing its income tax expense using the assumption that current year
stock option deductions were used first to offset its financial statement
income. NOLs could then offset any excess of financial statement income over
current year stock option deductions. Because stock option deductions are not
recognized as an expense for financial reporting purposes, the tax benefit of
stock option deductions must be credited to additional paid-in capital with an
offsetting income tax expense recorded in the income statement.
The Company changed its accounting for income taxes to recognize the tax
benefits from current and prior years' stock option deductions after
utilization of NOLs from operations (i.e., NOLs determined without deductions
for exercised stock options) to reduce income tax expense. Because stock
option deductions would have been utilized for financial accounting purposes
in prior years under both accounting methods due to the absence of NOLs from
operations, this accounting change had no effect on 1997 and prior years' tax
provisions or additional paid-in capital. The effect of this change was to
increase net income and diluted earnings per share for the year ended June 30,
1998 by $73 million and $0.28, respectively.
The Company's deductible temporary differences related to operations and
exercised stock options amounted to:
<TABLE>
<CAPTION>
JUNE 30,
-----------
1998 1997
(IN MILLIONS) ----- -----
<S> <C> <C>
Operations.................................................... $442 $648
Stock options................................................. $977 $163
</TABLE>
When realization of the deferred tax asset is more likely than not to occur,
the benefit related to the deductible temporary differences attributable to
operations will be recognized as a reduction of income tax expense. The
benefit related to the deductible temporary differences attributable to stock
option deductions will be credited to additional paid-in capital.
NOTE 14. CAPITAL ACCOUNTS
COMMON STOCK At June 30, 1998 and 1997, the Company's $.01 par value common
stock authorized was 600,000,000 shares with 219,641,140 and 200,377,942
shares issued and outstanding, respectively. At June 30, 1998, 70,149,776
shares were reserved for the exercise of issued and unissued common stock
options, a warrant and convertible debt, and 337,901 shares were reserved for
issuance in connection with the Company's Employee Stock Purchase Plan.
F-20
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
PREFERRED STOCK In February 1992, the Company's stockholders approved an
amendment and restatement of the certificate of incorporation which authorized
the future issuance of 5,000,000 shares of preferred stock, $.01 par value,
with rights and preferences to be determined by the Board of Directors.
During May 1996, the Company sold 1,000 shares of Series B convertible
preferred stock ("the Preferred Stock") for approximately $28 million. The
Preferred Stock had an aggregate liquidation preference of approximately $28
million and accrued dividends at a rate of 4% per annum. Accrued dividends
could be paid in the form of additional shares of Preferred Stock. During May
1998, the Preferred Stock, plus accrued but unpaid dividends, automatically
converted into 392,000 shares of common stock based on the fair market value
of common stock at the time of conversion.
WARRANT In connection with an agreement with one of the Company's
communications providers, the Company has an outstanding warrant, exercisable
through March 31, 1999, subject to certain performance standards specified in
the agreement, to purchase 7,200,000 shares of common stock at a price of
$1.95 per share.
SHAREHOLDER RIGHTS PLAN The Company adopted a new shareholder rights plan on
May 12, 1998 (the "New Plan"). The New Plan was implemented by declaring a
dividend, distributable to stockholders of record on June 1, 1998, of one
preferred share purchase right (a "Right") for each outstanding share of
common stock. All rights granted under the Company's former shareholder rights
plan adopted in fiscal 1993 were redeemed in conjunction with the
implementation of the New Plan and the former plan was terminated. Each Right
under the New Plan will initially entitle registered holders of the common
stock to purchase one one-thousandth of a share of the Company's new Series A-
1 Junior Participating Preferred Stock ("Series A-1 Preferred Stock") at a
purchase price of $900 per one one-thousandth of a share of Series A-1
Preferred Stock, subject to adjustment. The Rights will be exercisable only if
a person or group (i) acquires 15% or more of the common stock or (ii)
announces a tender offer that would result in that person or group acquiring
15% or more of the common stock. Once exercisable, and in some circumstances
if certain additional conditions are met, the New Plan allows stockholders
(other than the acquirer) to purchase common stock or securities of the
acquirer having a then current market value of two times the exercise price of
the Right. The Rights are redeemable for $.001 per Right (subject to
adjustment) at the option of the Board of Directors. Until a Right is
exercised, the holder of the Right, as such, has no rights as a stockholder of
the Company. The Rights will expire on May 12, 2008 unless redeemed by the
Company prior to that date.
STOCK SPLITS In November 1994, April 1995, November 1995 and March 1998, the
Company effected two-for-one splits of the outstanding shares of common stock.
Accordingly, all data shown in the accompanying consolidated financial
statements and notes has been retroactively adjusted to reflect the stock
splits.
NOTE 15. STOCK PLANS
Options to purchase the Company's common stock under various stock option
plans have been granted to employees, directors and consultants of the Company
at fair market value at the date of grant. Generally, the options become
exercisable over periods ranging from one to four years and expire ten years
from the date of grant. The effect of applying SFAS No. 123 on 1998 and 1997
pro forma net income (loss) as stated below is not necessarily representative
of the effects on reported net income (loss) for future years due to, among
other things, the vesting period of the stock options and the fair value of
additional stock options in future years. Had compensation cost for the
Company's stock option plans been determined based upon the fair value at the
grant
F-21
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
date for awards under the plans consistent with the methodology prescribed
under SFAS No. 123, the Company's net income (loss) in 1998, 1997 and 1996
would have been approximately $(11) million, $(541) million and $15 million,
or $(0.05) per share, $(2.83) per share and $0.07 per share, respectively, on
a diluted basis. The fair value of the options granted during 1998, 1997 and
1996 are estimated at $21.10 per share, $4.50 per share and $8.18 per share,
respectively, on the date of grant using the Black-Scholes option-pricing
model with the following assumptions: no dividend yield, volatility of 65%, a
risk-free interest rate of 5.51% for 1998, 5.69% for 1997 and 5.38% for 1996,
and an expected life of 0.45 years from date of vesting. A summary of stock
option activity is as follows:
<TABLE>
<CAPTION>
NUMBER WEIGHTED-
OF AVERAGE EXERCISE
SHARES PRICE
----------- ----------------
<S> <C> <C>
BALANCE AT JUNE 30, 1995.......................... 71,359,058 $ 4.52
Granted......................................... 10,405,718 $17.03
Exercised....................................... (12,870,676) $ 2.75
Forfeited....................................... (4,290,514) $ 9.57
----------- ------
BALANCE AT JUNE 30, 1996.......................... 64,603,586 $ 6.55
Granted......................................... 12,831,926 $14.97
Exercised....................................... (13,866,522) $ 4.95
Forfeited....................................... (6,215,870) $11.74
----------- ------
BALANCE AT JUNE 30, 1997.......................... 57,353,120 $ 8.26
Granted......................................... 17,158,403 $45.14
Exercised....................................... (18,299,705) $ 5.98
Forfeited....................................... (4,370,973) $19.41
----------- ------
BALANCE AT JUNE 30, 1998.......................... 51,840,845 $20.36
=========== ======
</TABLE>
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- ------------------------
WEIGHTED-
NUMBER AVERAGE WEIGHTED- WEIGHTED-
OUTSTANDING REMAINING AVERAGE NUMBER AVERAGE
RANGE AS OF CONTRACTUAL EXERCISE EXERCISABLE AS EXERCISE
OF EXERCISE PRICE 6/30/98 LIFE (IN YEARS) PRICE OF 6/30/98 PRICE
----------------- ----------- -------------- --------- -------------- ---------
<S> <C> <C> <C> <C> <C>
$0.01 to $3.81.......... 12,016,936 5.6 $ 2.89 8,334,728 $ 2.69
$3.82 to $9.61.......... 10,582,740 6.7 $ 7.65 6,098,420 $ 7.56
$9.65 to $21.37......... 11,396,103 8.0 $14.08 2,552,642 $14.12
$22.00 to $49.00........ 12,777,174 9.1 $34.34 810,229 $28.25
$50.00 to $106.50....... 5,067,892 9.6 $67.23 5,546 $95.39
---------- --- ------ ---------- ------
$0.01 to $106.50........ 51,840,845 7.6 $20.36 17,801,565 $ 7.19
========== === ====== ========== ======
</TABLE>
EMPLOYEE STOCK PURCHASE PLAN In May 1992, the Company's Board of Directors
adopted an Employee Stock Purchase Plan ("the ESPP"). Under the ESPP,
employees of the Company who elect to participate are granted options to
purchase common stock at a 15 percent discount from the market value of such
stock. The ESPP permits an enrolled employee to make contributions to purchase
shares of common stock by having withheld from his or her salary an amount
between 1 percent and 10 percent of compensation. The ESPP is
F-22
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
administered by the Stock and Option Subcommittee of the Compensation and
Management Development Committee of the Board of Directors. The total number
of shares of common stock that may be issued pursuant to options granted under
the ESPP is 1,600,000. A total of 1,262,099 shares of common stock has been
issued under the ESPP.
NOTE 16. EMPLOYEE BENEFIT PLAN
SAVINGS PLAN The Company has a savings plan ("the Savings Plan") that
qualifies as a deferred salary arrangement under Section 401(k) of the
Internal Revenue Code. Under the Savings Plan, participating employees may
defer a portion of their pretax earnings, up to the Internal Revenue Service
annual contribution limit. The Company matches 50% of each employee's
contributions up to a maximum matching contribution of 3% of the employee's
earnings. The Company's matching contribution to the Savings Plan was
approximately $5 million, $3 million and $1 million in the years ended June
30, 1998, 1997 and 1996, respectively.
NOTE 17. SUBSEQUENT EVENTS
During July 1998, the Company completed a public offering of common stock.
The Company sold 5,390,000 shares of common stock and raised a total of $550
million in new equity. The Company intends to use the proceeds for general
operating purposes, including investing in the continued growth of its
business and providing greater flexibility to capitalize on the growing number
of opportunities available as the industry continues to consolidate.
As of September 25, 1998 the fair market value of the investment in Excite,
Inc. had declined to $201 million.
NOTE 18. 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 have
been classified in the consolidated balance sheet as a net asset held for
sale, which is a component of prepaid expenses and other current assets.
F-23
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 19. QUARTERLY INFORMATION (UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------
(AMOUNTS IN MILLIONS, EXCEPT PER SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
SHARE DATA) ------------- ------------ --------- --------
<S> <C> <C> <C> <C>
FISCAL 1998(1)(3)
Online service revenues......... $ 434 $ 483 $ 576 $ 668
Advertising, commerce and other
revenues....................... 88 109 118 124
------ ------ ------ ------
Total revenues................ 522 592 694 792
Income from operations.......... 26 34 16 2
Net income...................... 31 35 19 7
Net income per share--diluted... $ 0.13 $ 0.15 $ 0.08 $ 0.03
Net income per share--basic..... $ 0.16 $ 0.17 $ 0.09 $ 0.03
FISCAL 1997(2)(3)(4)
Online service revenues......... $ 311 $ 351 $ 381 $ 386
Advertising, commerce and other
revenues....................... 39 58 69 90
------ ------ ------ ------
Total revenues................ 350 409 450 476
Loss from operations............ (356) (128) (6) (15)
Net loss........................ (353) (129) (5) (12)
Net loss per share--diluted..... $(1.90) $(0.69) $(0.03) $(0.06)
Net loss per share--basic....... $(1.90) $(0.69) $(0.03) $(0.06)
====== ====== ====== ======
</TABLE>
- --------
(1) Net income in the fiscal year ended June 30, 1998, includes charges of $35
million in the quarter ended March 31, 1998 related to a restructuring,
$10 million and $71 million in the quarters ended March 31, 1998 and June
30, 1998, respectively, related to acquired research and development and
$18 million and a $1 million benefit in the quarters ended June 30, 1998
and December 31, 1997, respectively, related to settlements.
(2) Net loss in the fiscal year ended June 30, 1997, includes charges of $385
million in the quarter ended September 30, 1996 for the write-off of
deferred subscriber acquisition costs, $49 million in the quarter ended
December 31, 1996, for restructuring, $24 million in the quarter ended
December 31, 1996, for a legal settlement and $24 million in the quarter
ended June 30, 1997, for contract terminations.
(3) The sum of per share earnings (loss) does not equal earnings (loss) per
share for the year due to equivalent share calculations which are impacted
by the Company's losses, fluctuations in the Company's common stock market
prices and the timing (weighting) of shares issued.
(4) The Company recorded a benefit of approximately $6 million in cost of
revenues in the quarter ended June 30, 1997, resulting from the
retroactive application of beneficial rates contained in certain new
information provider contracts consummated in that quarter.
F-24
<PAGE>
REPORT OF MANAGEMENT
To Our Stockholders:
The management of America Online, Inc. is responsible for the integrity and
objectivity of the financial and operating information contained in this
Annual Report on Form 10-K, including the consolidated financial statements
covered by the Report of Independent Auditors. These statements were prepared
in conformity with generally accepted accounting principles and include
amounts that are based on the best estimates and judgments of management,
which it believes are reasonable under the circumstances.
The Company maintains a system of internal accounting policies, procedures
and controls designed to provide management with reasonable assurance that
assets are safeguarded against loss from unauthorized use or disposition, and
that transactions are executed in accordance with management's authorization
and recorded properly.
Ernst & Young LLP audits the Company's financial statements in accordance
with generally accepted auditing standards and provides an objective,
independent review of the Company's internal control and the fairness of its
reported financial condition and results of operations.
In addition, the Audit Committee of the Board of Directors, consisting
solely of outside directors, meets periodically with management and the
independent auditors to review internal accounting controls, audit results and
accounting principles and practices, and annually recommends to the Board of
Directors the selection of independent auditors.
STEPHEN M. CASE
Chairman of the Board and Chief
Executive Officer
J. MICHAEL KELLY
Senior Vice President and Chief
Financial Officer
F-25
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
America Online, Inc.
We have audited the accompanying consolidated balance sheets of America
Online, Inc. as of June 30, 1998 and 1997, and the related consolidated
statements of operations, changes in stockholders' equity and cash flows for
each of the three years in the period ended June 30, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatements. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of America
Online, Inc. at June 30, 1998 and 1997, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
June 30, 1998, in conformity with generally accepted accounting principles.
As discussed in Note 13 to the consolidated financial statements, in 1998
the Company changed its method of accounting for income taxes.
ERNST & YOUNG LLP
Vienna, Virginia
September 25, 1998
F-26
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description
<C> <S>
3.3 Certificate of Designation, Preferences and Rights of Series A-1 Junior
Participating Preferred Stock of America Online, Inc.
3.4 Certificate of Elimination of Series A Junior Participation Preferred
Stock of America Online, Inc.
3.5 Restated By-Laws of America Online, Inc.
10.10 Employment Agreement and related agreements entered into with George
Vradenburg, III.
10.11 Letter agreement entered into with Lennert J. Leader.
21.1 List of Subsidiaries.
23.1 Consent of Ernst & Young LLP.
24.1 Powers of Attorney.
</TABLE>
<PAGE>
Exhibit 3.3
CERTIFICATE OF DESIGNATION, PREFERENCES AND RIGHTS
of
SERIES A-1 JUNIOR PARTICIPATING PREFERRED STOCK
of
AMERICA ONLINE, INC.
---------------------------------
America Online, Inc., a corporation organized and existing under the
General Corporation Law of the State of Delaware (hereinafter called the
"Corporation"),
DOES HEREBY CERTIFY:
That, pursuant to authority conferred upon the Board of Directors of this
Corporation (the "Board of Directors") by the Restated Certificate of
Incorporation of this Corporation, and pursuant to the provisions of Section 151
of Title 8 of the Delaware Code, the Board of Directors, at a meeting of its
members held on May 12, 1998, adopted a resolution providing for the
designations, preferences and relative, participating, optional or other rights,
and the qualifications, limitations or restrictions thereof, of five hundred
thousand (500,000) shares of the Corporation's Preferred Stock, par value one
cent ($.01) per share, which resolution is as follows:
RESOLVED: That pursuant to the authority granted to and vested in the Board of
Directors of this Corporation in accordance with the provisions of the
Restated Certificate of Incorporation, the Board of Directors hereby
designates a series of Preferred Stock, par value $.01 per share, and
hereby fixes the designation and number of shares, and the relative
rights, preferences, and limitations thereof (in addition to any
provisions set forth in the Restated Certificate of Incorporation
which are applicable to preferred stock of all classes and series) as
follows:
Series A-1 Junior Participating Preferred Stock. The preferences, privileges
- -----------------------------------------------
and restrictions granted to or imposed on the Corporation's Series A-1 Junior
Participating Preferred Stock, par value $.01 per share, or the holders thereof,
are as follows:
Section 1. Designation and Amount. The shares of such series shall be
----------------------
designated as "Series A-1 Junior Participating Preferred Stock" (the "Series A-1
Preferred Stock") and the number of shares constituting the Series A-1 Preferred
Stock shall be five hundred thousand (500,000). Such number of shares may be
increased or decreased by resolution of the Board of Directors; provided, that
--------
no decrease shall reduce the number of shares of Series A-1 Preferred Stock to a
number less than the number of shares then outstanding plus the number of shares
reserved for issuance upon the exercise of outstanding options, rights or
warrants or upon the
<PAGE>
conversion of any outstanding securities issued by the Corporation convertible
into Series A-1 Preferred Stock.
Section 2. Dividends and Distributions.
---------------------------
(A) Subject to the rights of the holders of any shares of any series
of Preferred Stock (or any similar stock) ranking prior and superior to the
Series A-1 Preferred Stock with respect to dividends, the holders of shares
of Series A-1 Preferred Stock, in preference to the holders of Common
Stock, $.01 par value (the "Common Stock"), of the Corporation, and of any
other junior stock, shall be entitled to receive, when, as and if declared
by the Board of Directors out of funds legally available for the purpose,
quarterly dividends payable in cash on the first day of March, June,
September and December in each year (each such date being referred to
herein as a "Quarterly Dividend Payment Date"), commencing on the first
Quarterly Dividend Payment Date after the first issuance of a share or
fraction of a share of Series A-1 Preferred Stock, in an amount per share
(rounded to the nearest cent) equal to the greater of (a) $1 or (b) subject
to the provision for adjustment hereinafter set forth, 1000 times the
aggregate per share amount of all cash dividends, and 1000 times the
aggregate per share amount (payable in kind) of all non-cash dividends or
other distributions, other than a dividend payable in shares of Common
Stock or a subdivision of the outstanding shares of Common Stock (by
reclassification or otherwise), declared on the Common Stock since the
immediately preceding Quarterly Dividend Payment Date or, with respect to
the first Quarterly Dividend Payment Date, since the first issuance of any
share or fraction of a share of Series A-1 Preferred Stock. In the event
the Corporation shall at any time declare or pay any dividend on the Common
Stock payable in shares of Common Stock, or effect a subdivision or
combination or consolidation of the outstanding shares of Common Stock (by
reclassification or otherwise than by payment of a dividend in shares of
Common Stock) into a greater or lesser number of shares of Common Stock,
then in each such case the amount to which holders of shares of Series A-1
Preferred Stock were entitled immediately prior to such event under clause
(b) of the preceding sentence shall be adjusted by multiplying such amount
by a fraction, the numerator of which is the number of shares of Common
Stock outstanding immediately after such event and the denominator of which
is the number of shares of Common Stock that were outstanding immediately
prior to such event.
(B) The Corporation shall declare a dividend or distribution on the
Series A-1 Preferred Stock as provided in paragraph (A) of this Section
immediately after it declares a dividend or distribution on the Common
Stock (other than a dividend payable in shares of Common Stock); provided
that, in the event no dividend or distribution shall have been declared on
the Common Stock during the period between any Quarterly Dividend Payment
Date and the next subsequent Quarterly Dividend Payment Date, a dividend of
$1 per share on the Series A-1 Preferred Stock shall nevertheless be
payable on such subsequent Quarterly Dividend Payment Date.
2
<PAGE>
(C) Dividends shall begin to accrue and be cumulative on outstanding
shares of Series A-1 Preferred Stock from the Quarterly Dividend Payment
Date next preceding the date of issue of such shares, unless the date of
issue of such shares is prior to the record date for the first Quarterly
Dividend Payment Date, in which case dividends on such shares shall begin
to accrue from the date of issue of such shares, or unless the date of
issue is a Quarterly Dividend Payment Date or is a date after the record
date for the determination of holders of shares of Series A-1 Preferred
Stock entitled to receive a quarterly dividend and before such Quarterly
Dividend Payment Date, in either of which events such dividends shall begin
to accrue and be cumulative from such Quarterly Dividend Payment Date.
Accrued but unpaid dividends shall not bear interest. Dividends paid on the
shares of Series A-1 Preferred Stock in an amount less than the total
amount of such dividends at the time accrued and payable on such shares
shall be allocated pro rata on a share-by-share basis among all such shares
at the time outstanding. The Board of Directors may fix a record date for
the determination of holders of shares of Series A-1 Preferred Stock
entitled to receive payment of a dividend or distribution declared thereon,
which record date shall be not more than 60 days prior to the date fixed
for the payment thereof.
Section 3. Voting Rights. The holders of shares of Series A-1 Preferred
-------------
Stock shall have the following voting rights:
(A) Subject to the provision for adjustment hereinafter set forth,
each share of Series A-1 Preferred Stock shall entitle the holder thereof
to 1000 votes on all matters submitted to a vote of the stockholders of the
Corporation. In the event the Corporation shall at any time declare or pay
any dividend on the Common Stock payable in shares of Common Stock, or
effect a subdivision or combination or consolidation of the outstanding
shares of Common Stock (by reclassification or otherwise than by payment of
a dividend in shares of Common Stock) into a greater or lesser number of
shares of Common Stock, then in each such case the number of votes per
share to which holders of shares of Series A-1 Preferred Stock were
entitled immediately prior to such event shall be adjusted by multiplying
such number by a fraction, the numerator of which is the number of shares
of Common Stock outstanding immediately after such event and the
denominator of which is the number of shares of Common Stock that were
outstanding immediately prior to such event.
(B) Except as otherwise provided herein, in any other Certificate of
Designation creating a series of Preferred Stock or any similar stock, or
by law, the holders of shares of Series A-1 Preferred Stock and the holders
of shares of Common Stock and any other capital stock of the Corporation
having general voting rights shall vote together as one class on all
matters submitted to a vote of stockholders of the Corporation.
3
<PAGE>
(C) Except as set forth herein, or as otherwise provided by law,
holders of Series A-1 Preferred Stock shall have no special voting rights
and their consent shall not be required (except to the extent they are
entitled to vote with holders of Common Stock as set forth herein) for
taking any corporate action.
Section 4. Certain Restrictions.
--------------------
(A) Whenever quarterly dividends or other dividends or distributions
payable on the Series A-1 Preferred Stock as provided in Section 2 are in
arrears, thereafter and until all accrued and unpaid dividends and
distributions, whether or not declared, on shares of Series A-1 Preferred
Stock outstanding shall have been paid in full, the Corporation shall not:
(i) declare or pay dividends, or make any other
distributions, on any shares of stock ranking junior (either as to
dividends or upon liquidation, dissolution or winding up) to the
Series A-1 Preferred Stock;
(ii) declare or pay dividends, or make any other
distributions, on any shares of stock ranking on a parity (either as
to dividends or upon liquidation, dissolution or winding up) with the
Series A-1 Preferred Stock, except dividends paid ratably on the
Series A-1 Preferred Stock and all such parity stock on which
dividends are payable or in arrears in proportion to the total amounts
to which the holders of all such shares are then entitled;
(iii) redeem or purchase or otherwise acquire for consideration
shares of any stock ranking junior (either as to dividends or upon
liquidation, dissolution or winding up) to the Series A-1 Preferred
Stock, provided that the Corporation may at any time redeem, purchase
or otherwise acquire shares of any such junior stock in exchange for
shares of any stock of the Corporation ranking junior (either as to
dividends or upon dissolution, liquidation or winding up) to the
Series A-1 Preferred Stock; or
(iv) redeem or purchase or otherwise acquire for consideration
any shares of Series A-1 Preferred Stock, or any shares of stock
ranking on a parity with the Series A-1 Preferred Stock, except in
accordance with a purchase offer made in writing or by publication (as
determined by the Board of Directors) to all holders of such shares
upon such terms as the Board of Directors, after consideration of the
respective annual dividend rates and other relative rights and
preferences of the respective series and classes, shall determine in
good faith will result in fair and equitable treatment among the
respective series or classes.
(B) The Corporation shall not permit any subsidiary of the
Corporation to
4
<PAGE>
purchase or otherwise acquire for consideration any shares of stock of the
Corporation unless the Corporation could, under paragraph (A) of this
Section 4, purchase or otherwise acquire such shares at such time and in
such manner.
Section 5. Reacquired Shares. Any shares of Series A-1 Preferred Stock
-----------------
purchased or otherwise acquired by the Corporation in any manner whatsoever
shall be retired and canceled promptly after the acquisition thereof. All such
shares shall upon their cancellation become authorized but unissued shares of
Preferred Stock and may be reissued as part of a new series of Preferred Stock
subject to the conditions and restrictions on issuance set forth herein, in the
Restated Certificate of Incorporation, or in any other Certificate of
Designation creating a series of Preferred Stock or any similar stock or as
otherwise required by law.
Section 6. Liquidation, Dissolution or Winding Up. Upon any liquidation,
--------------------------------------
dissolution or winding up of the Corporation, no distribution shall be made (1)
to the holders of shares of stock ranking junior (either as to dividends or upon
liquidation, dissolution or winding up) to the Series A-1 Preferred Stock
unless, prior thereto, the holders of shares of Series A-1 Preferred Stock shall
have received $1000 per share, plus an amount equal to accrued and unpaid
dividends and distributions thereon, whether or not declared, to the date of
such payment, provided that the holders of shares of Series A-1 Preferred Stock
shall be entitled to receive an aggregate amount per share, subject to the
provision for adjustment hereinafter set forth, equal to 1000 times the
aggregate amount to be distributed per share to holders of shares of Common
Stock, or (2) to the holders of shares of stock ranking on a parity (either as
to dividends or upon liquidation, dissolution or winding up) with the Series A-1
Preferred Stock, except distributions made ratably on the Series A-1 Preferred
Stock and all such parity stock in proportion to the total amounts to which the
holders of all such shares are entitled upon such liquidation, dissolution or
winding up. In the event the Corporation shall at any time declare or pay any
dividend on the Common Stock payable in shares of Common Stock, or effect a
subdivision or combination or consolidation of the outstanding shares of Common
Stock (by reclassification or otherwise than by payment of a dividend in shares
of Common Stock) into a greater or lesser number of shares of Common Stock, then
in each such case the aggregate amount to which holders of shares of Series A-1
Preferred Stock were entitled immediately prior to such event under the proviso
in clause (1) of the preceding sentence shall be adjusted by multiplying such
amount by a fraction the numerator of which is the number of shares of Common
Stock outstanding immediately after such event and the denominator of which is
the number of shares of Common Stock that were outstanding immediately prior to
such event.
Section 7. Consolidation, Merger, etc. In case the Corporation shall
---------------------------
enter into any consolidation, merger, combination or other transaction in which
the shares of Common Stock are exchanged for or changed into other stock or
securities, cash and/or any other property, then in any such case each share of
Series A-1 Preferred Stock shall at the same time be similarly exchanged or
changed into an amount per share, subject to the provision for adjustment
hereinafter set forth, equal to 1000 times the aggregate amount of stock,
securities, cash and/or any other property (payable in kind), as the case may
be, into which or for which each share of
5
<PAGE>
Common Stock is changed or exchanged. In the event the Corporation at any time
declares or pays any dividend on the Common Stock payable in shares of Common
Stock, or effects a subdivision or combination or consolidation of the
outstanding shares of Common Stock (by reclassification or otherwise than by
payment of a dividend in shares of Common Stock) into a greater or lesser number
of shares of Common Stock, then in each such case the amount set forth in the
preceding sentence with respect to the exchange or change of shares of Series A-
1 Preferred Stock shall be adjusted by multiplying such amount by a fraction,
the numerator of which is the number of shares of Common Stock outstanding
immediately after such event and the denominator of which is the number of
shares of Common Stock that were outstanding immediately prior to such event.
Section 8. No Redemption. The shares of Series A-1 Preferred Stock shall
-------------
not be redeemable.
Section 9. Rank. The Series A-1 Preferred Stock shall rank junior with
----
respect to the payment of dividends and the distribution of assets to all other
series of the Corporation's Preferred Stock.
Section 10. Amendment. The Restated Certificate of Incorporation of the
---------
Corporation shall not be amended in any manner which would materially alter or
change the powers, preferences or special rights of the Series A-1 Preferred
Stock so as to affect them adversely without the affirmative vote of the holders
of at least two-thirds of the outstanding shares of Series A-1 Preferred Stock,
voting together as a single class.
6
<PAGE>
IN WITNESS WHEREOF, America Online, Inc. has caused this certificate to be
executed by its SVP & CFO this 29th day of May, 1998.
/s/LENNERT J. LEADER
Lennert J. Leader
7
<PAGE>
Exhibit 3.4
CERTIFICATE OF ELIMINATION
OF
SERIES A JUNIOR PARTICIPATION PREFERRED STOCK
OF
AMERICA ONLINE, INC.
Pursuant to the provisions of Section 151(g) of the General Corporation Law
of the State of Delaware, it is hereby certified that:
1. The name of the corporation is America Online, Inc. (hereinafter referred to
as the "Corporation").
2. The series of shares of stock of the Corporation to which this certificate
relates is "Series A Junior Participating Preferred Stock", par value $.01 per
share (the "Series A Preferred Stock").
3. The voting powers, designations, preferences, and the relative,
participating, optional, or other rights, and the qualifications, limitations,
and restrictions of the Series A Preferred Stock were provided for in
resolutions adopted by the Board of Directors of the Corporation dated April 23,
1993 pursuant to authority expressly vested in it by the provisions of the
Restated Certificate of Incorporation of the Corporation. A certificate setting
forth said resolutions has been heretofore filed with the Secretary of State of
the State of Delaware pursuant to the provisions of Section 151(g) of the
General Corporation Law of the State of Delaware.
4. The Board of Directors of the Corporation has adopted the following
resolution:
RESOLVED: That none of the authorized shares of the original Series A
Junior Participating Preferred Stock of the Corporation are
outstanding and none of such shares will be issued and that the
officers of the Corporation be, and each hereby is, authorized
and directed to file a Certificate of Elimination of such Series
A Junior Participating Preferred Stock of the Corporation setting
forth this Resolution with the Secretary of State of the State of
Delaware for the purpose of eliminating from the Restated
Certificate of Incorporation of the Corporation all reference to
the original Series A Junior Participating Preferred Stock of the
Corporation.
IN WITNESS WHEREOF, America Online, Inc. has caused this Certificate to be
signed by its duly authorized officer this 10th day of June, 1998.
AMERICA ONLINE, INC.
By: /s/LENNERT J. LEADER
Lennert J. Leader
Senior Vice President, Chief Financial
Officer, Treasurer, Chief Accounting
Officer and Assistant Secretary
<PAGE>
EXHIBIT 3.5
AMERICA ONLINE, INC.
RESTATED BY-LAWS
ARTICLE I - STOCKHOLDERS
--------- ------------
Section 1. Annual Meeting. An annual meeting of the stockholders, for the
---------- --------------
election of directors to succeed those whose terms expire and for the
transaction of such other business as may properly come before the meeting,
shall be held at such place, on such date, and at such time as the board of
directors shall each year fix.
Section 2. Special Meetings. Special meetings of the stockholders, for
---------- ----------------
any purpose or purposes prescribed in the notice of the meeting, may be called
by the Chief Executive Officer or the board of directors, by the affirmative
vote of a majority of the Whole Board and shall be held at such place, on such
date, and at such time as shall be fixed by the board of directors or the person
calling the meeting. The term "Whole Board" shall mean the total number of
authorized directors, whether or not there exists any vacancies in previously
authorized directorships.
Section 3. Notice of Meetings. Written notice of the place, date, and
---------- ------------------
time of all meetings of the stockholders shall be given, not less than ten (10)
nor more than sixty (60) days before the date on which the meeting is to be
held, to each stockholder entitled to vote at such meeting, except as otherwise
provided herein or required by law (meaning, here and hereinafter, as required
from time to time by the Delaware General Corporation Law or the Certificate of
Incorporation of the Corporation, as amended and restated from time to time).
When a meeting is adjourned to another place, date or time, written notice
need not be given of the adjourned meeting if the place, date and time thereof
are announced at the meeting at which the adjournment is taken; provided,
however, that if the date of any adjourned meeting is more than thirty (30) days
after the date for which the meeting was originally noticed, or if a new record
date is fixed for the adjourned meeting, written notice of the place, date, and
time of the adjourned meeting shall be given in conformity herewith. At any
adjourned meeting, any business may be transacted that might have been
transacted at the original meeting.
Section 4. Quorum. At any meeting of the stockholders, the holders of a
---------- ------
majority of the voting power of the shares of the stock entitled to vote at the
meeting, present in person or by proxy, shall constitute a quorum for all
purposes, unless or except to the extent that the presence of a larger number
may be required by law. Where a separate vote by a class or classes, or series
thereof, is required, a majority of the voting power of the shares of such class
or classes, or series, present in person or represented by proxy shall
constitute a quorum entitled to take action with respect to that vote on that
matter.
If a quorum shall fail to attend any meeting, the chairman of the meeting
or the holders of a majority of the voting power of the shares of stock entitled
to vote who are present, in person or by proxy, may adjourn the meeting to
another place, date, or time.
1
<PAGE>
Section 5. Organization. Such person as the board of directors may have
---------- ------------
designated or, in the absence of such a person, the Chairman of the Board or, in
his absence, such person as may be chosen by the holders of a majority of the
shares entitled to vote who are present, in person or by proxy, shall call to
order any meeting of the stockholders and act as chairman of the meeting. In
the absence of the Secretary of the Corporation, the secretary of the meeting
shall be such person as the chairman of the meeting appoints.
Section 6. Conduct of Business. The chairman of any meeting of
---------- -------------------
stockholders shall determine the order of business and the procedure at the
meeting, including such regulation of the manner of voting and the conduct of
discussion as may seem to him in order. The chairman of any meeting of
stockholders may adjourn the meeting at any time and from time to time to permit
the orderly conduct of the business of the meeting. The date and time of the
opening and closing of the polls for each matter upon which the stockholders
will vote at the meeting shall be announced at the meeting.
Section 7. Notice of Stockholder Business and Nominations.
------- ----------------------------------------------
A. Annual Meetings of Stockholders.
-------------------------------
(1) Nominations of persons for election to the board of directors and
the proposal of business to be considered by the stockholders may be made at an
annual meeting of stockholders (a) pursuant to the Corporation's notice of
meeting, (b) by or at the direction of the board of directors or (c) by any
stockholder of the Corporation who was a stockholder of record at the time of
giving of notice provided for in this Section, who is entitled to vote at the
meeting and who complies with the notice procedures set forth in this Section.
(2) For nominations or other business to be properly brought before an annual
meeting by a stockholder pursuant to clause (c) of paragraph (A)(1) of this
Section, the stockholder must have given timely notice thereof in writing to the
Secretary of the Corporation and such other business must otherwise be a proper
matter for stockholder action. To be timely, a stockholder's notice shall be
delivered to the Secretary at the principal executive offices of the Corporation
not later than the close of business on the sixtieth (60) day nor earlier than
the close of business on the ninetieth (90th) day prior to the first anniversary
of the preceding year's annual meeting; provided, however, that in the event
that the date of the annual meeting is more than thirty (30) days before or more
than sixty (60) days after such an anniversary date, notice by the stockholder
to be timely must be so delivered not earlier than the close of business on the
ninetieth (90) day prior to such annual meeting and not later than the close of
business on the later of the sixtieth (60th) day prior to such annual meeting or
the close of business on the tenth (10th) day following the day on which public
announcement of the date of such meeting is first made by the Corporation. Such
stockholder's notice shall set forth (a) as to each person whom the stockholder
proposes to nominate for election or reelection as a director all information
relating to such person that is required to be disclosed in solicitations of
proxies for election of directors, or is otherwise required, in each case
pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended
(the "Exchange Act") (including such person's written consent to being named in
the proxy statement as a nominee and to serving as a director if elected); (b)
as to any other business that the stockholder proposes to bring before the-
meeting, a brief description of the business desired to be brought before the
meeting, the reasons for conducting such business at the
2
<PAGE>
meeting and any material interest in such business of such stockholder and the
beneficial owner, if any, on whose behalf the proposal is made; and (c) as to
the stockholder giving the notice and the beneficial owner, if any, on whose
behalf the nomination or proposal is made (i) the name and address of such
stockholder, as they appear on the Corporation's books, and of such beneficial
owner and (ii) the class and number of shares of the Corporation that are owned
beneficially and held of record by such stockholder and such beneficial owner.
(3) Notwithstanding anything in the second sentence of paragraph
(A)(2) of this Section to the contrary, in the event that the number of
directors to be elected to the board of directors of the Corporation is
increased and there is no public announcement by the corporation naming all of
the nominees for director or specifying the size of the increased board of
directors at least seventy (70) days prior to the first anniversary of the
preceding year's annual meeting (or, if the annual meeting is held more than
thirty (30) days before or sixty (60) days after such anniversary date, at least
seventy (70) days prior to such annual meeting), a stockholder's notice required
by this Section shall also be considered timely, but only with respect to
nominees for any new positions created by such increase, if it shall be
delivered to the Secretary at the principal executive office of the Corporation
not later than the close of business on the tenth (10th) day following the day
on which such public announcement is first made by the Corporation.
B. Special Meetings of Stockholders.
--------------------------------
Only such business shall be conducted at a special meeting of
stockholders as shall have been brought before the meeting pursuant to the
Corporation's notice of meeting. Nominations of persons for election to the
board of directors may be made at a special meeting of stockholders at which
directors are to be elected pursuant to the Corporation's notice of meeting (a)
by or at the direction of the board of directors or (b) provided that the board
of directors has determined that directors shall be elected at such meeting, by
any stockholder of the Corporation who is a stockholder of record at the time of
giving of notice of the special meeting, who shall be entitled to vote at the
meeting and who complies with the notice procedures set forth in this Section.
In the event the Corporation calls a special meeting of stockholders for the
purpose of electing one or more directors to the board of directors, any such
stockholder may nominate a person or persons (as the case may be), for election
to such positions) as specified in the Corporation's notice of meeting, if the
stockholder's notice required by paragraph (A)(2) of this Section shall be
delivered to the Secretary at the principal executive offices of the Corporation
not earlier than the ninetieth (90th) day prior to such special meeting nor
later than the close of business of the sixtieth (60th) day prior to such
special meeting or the tenth (10th) day following the day on which public
announcement is first made of the date of the special meeting and of the
nominees proposed by the board of directors to be elected at such meeting.
C. General.
-------
(1) Only such persons who are nominated in accordance with the
procedures set forth in this Section shall be eligible to serve as directors and
only such business shall be conducted at a meeting of stockholders as shall have
been brought before the meeting in accordance with the procedures set forth in
this Section. Except as otherwise provided by law or these by-laws, the
chairman of the meeting shall have the power and duty to determine whether a
nomination or any business proposed to be brought before the meeting was made or
proposed, as the case may be, in
3
<PAGE>
accordance with the procedures set forth in this Section and, if any proposed
nomination or business is not in compliance herewith to declare that such
defective proposal or nomination shall be disregarded.
(2) For purposes of this Section, "public announcement" shall mean
disclosure in a press release reported by the Dow Jones News service, Associated
Press or comparable national news service or in a document publicly filed by the
Corporation with the Securities and Exchange Commission pursuant to Section 13,
14 or 15(d) of the Exchange Act.
(3) Notwithstanding the foregoing provisions of this Section
pertaining to notice requirements under Delaware corporate law for shareholders
to nominate persons for election to the Board and to bring proposals of other
business properly before other shareholders at an annual or special meeting of
shareholders, a shareholder shall comply with all applicable requirements of the
Exchange Act and the rules and regulations thereunder in order to have any such
proposal included in the proxy materials provided to shareholders in connection
with such meeting. Nothing in this Section shall be deemed to affect any rights
of shareholders to request inclusion of proposals in the Corporation's proxy
materials pursuant to Rule 14a-8 under the Exchange Act, provided that
shareholders comply with the requirements thereunder, or any rights of the
holders of any series of Preferred stock to elect directors under specified
circumstances.
Section 8. Proxies and Voting. At any meeting of the stockholders, every
---------- ------------------
stockholder entitled to vote may vote in person or by proxy authorized by an
instrument in writing or by a transmission permitted by law filed in accordance
with the procedure established for the meeting. Any copy, facsimile
telecommunication or other reliable reproduction of the writing or transmission
created pursuant to this Section may be substituted or used in lieu of the
original writing or transmission for any and all purposes for which the original
writing or transmission could be used, provided that such copy, facsimile
telecommunication or their reproduction shall be a complete reproduction of the
entire original writing or transmission.
All voting, including on the election of directors but excepting where
otherwise required by law, may be by voice vote. Any vote not taken by voice
shall be taken by ballots, each of which shall state the name of the stockholder
or proxy voting and such other information as may be required under the
procedure established for the meeting. The Corporation may, and to the extent
required by law, shall, in advance of any meeting of stockholders, appoint one
or more inspectors to act at the meeting and make a written report thereof. The
Corporation may designate one or more persons as alternate inspectors to replace
any inspector who fails to act. If no inspector or alternate is able to act at
a meeting of stockholders, the person presiding at the meeting may, and to the
extent required by law, shall, appoint one or more inspectors to act at the
meeting. Each inspector, before entering upon the discharge of his duties,
shall take and sign an oath faithfully to execute the duties of inspector with
strict impartiality and according to the best of his ability.
Except as otherwise provided in the terms of any class or series of
Preferred Stock of the Corporation, all elections shall be determined by a
plurality of the votes cast, and except as otherwise required by law, all other
matters shall be determined by a majority of the votes cast affirmatively or
negatively.
Section 9. Stock List. A complete list of stockholders entitled to vote
---------- ----------
at any meeting of stockholders, arranged in alphabetical order for each class of
stock and showing the address of each
4
<PAGE>
such stockholder and the number of shares registered in such stockholder's name,
shall be open to the examination of any such stockholder, for any purpose
germane to the meeting, during ordinary business hours for a period of at least
ten (10) days prior to the meeting either at a place within the city where the
meeting is to be held, which place shall be specified in the notice of the
meeting, or, if not so specified, at the place where the meeting is to be held.
The stock list shall also be kept at the place of the meeting during the
whole time thereof and shall be open to the examination of any such stockholder
who is present. This list shall presumptively determine the identity of the
stockholders entitled to vote at the meeting and the number of shares held by
each of them.
ARTICLE II - BOARD OF DIRECTORS
---------- ------------------
Section 1. General Powers, Number and Term of Office. The business and
------- -----------------------------------------
affairs of the Corporation shall be under direction of its board of directors.
The number of directors who shall constitute the Whole Board shall be such
number as the board of directors shall from time to time have designated. The
board of directors shall be divided into three classes, as nearly equal in
number as possible. The term of office of the first class shall expire at the
1992 annual meeting of stockholders or any special meeting in lieu thereof, the
term of office of the second class shall expire at the 1993 annual meeting of
stockholders or any special meeting in lieu thereof, and the term of office of
the third class shall expire at the 1994 annual meeting of stockholders or any
special meeting in lieu thereof. At each annual meeting of stockholders or
special meeting in lieu thereof following such initial classification, directors
elected to succeed those directors whose terms expire shall be elected for a
term of office to expire at the third succeeding annual meeting of stockholders
or special meeting in lieu thereof after their election and until their
successors are duly elected and qualified.
Section 2. Vacancies and Newly Created Directorships. Subject to the
---------- -----------------------------------------
rights of the holders of any class or series of Preferred Stock, and except as
otherwise determined by the board of directors or required by law, newly created
directorships resulting from any increase in the authorized number of directors
or any vacancies in the board of directors resulting from death, resignation,
retirement, disqualification, removal from office or other cause may be filled
only by a majority vote of the directors then in office, though less than a
quorum, or the sole remaining director; directors so chosen shall hold office
for a term expiring at the annual meeting of stockholders at which the term of
office of the class to which they have been elected expires, if applicable, and
if no such classes shall have been established, at the next annual meeting of
stockholders and until such director's successor shall have been duly elected
and qualified. No decrease in the number of authorized directors constituting
the board shall shorten the term of any incumbent director.
Section 3. Resignation. Any director may resign at any time upon written
---------- -----------
notice to the Corporation at its principal place of business or to the Chief
Executive Officer or Secretary. such resignation shall be effective upon receipt
unless it is specified to be effective at some other time or upon the happening
of some other event.
Section 4. Regular Meetings. Regular meetings of the board of directors
---------- ----------------
shall be held at such place or places, on such date or dates, and at such time
or times as shall have been established by
5
<PAGE>
the board of directors and publicized among all directors. A notice of each
regular meeting shall not be required.
Section 5. Special Meetings. Special meetings of the board of directors
---------- ----------------
may be called by a majority of the Whole Board or by the Chairman of the Board
or Chief Executive Officer and shall be held at such place, on such date, and at
such time as they or he shall fix. Notice of the place, date, and time of each
such special meeting shall be given each director by whom it is not waived by
mailing written notice not less than five (5) days before the meeting or by
telegraphing or telexing or by facsimile transmission of the same not less than
twenty-four (24) hours before the meeting. Unless otherwise indicated in the
notice thereof, any and all business may be transacted at a special meeting.
Section 6. Quorum. At any meeting of the board of directors, a majority
---------- ------
of the Whole Board shall constitute a quorum for all purposes. If a quorum
shall fail to attend any meeting, a majority of those present may adjourn the
meeting to another place, date, or time, without further notice or waiver
thereof.
Section 7. Participation in Meetings by Conference Telephone. Members of
---------- -------------------------------------------------
the board of directors, or of any committee thereof, may participate in a
meeting of the board of directors or committee by means of conference telephone
or similar communications equipment by means of which all persons participating
in the meeting can hear each other and such participation shall constitute
presence in person at such meeting.
Section 8. Conduct of Business. At any meeting of the board of directors,
---------- -------------------
business shall be transacted in such order and manner as the board of directors
may from time to time determine, and all matters shall be determined by the vote
of a majority of the directors present, except as otherwise provided herein or
required by law. Action may be taken by the board of directors without a
meeting if all members of the board of directors who are then in office consent
thereto in writing, and the writing or writings are filed with the minutes of
proceedings of the board of directors.
Section 9. Powers. The board of directors may, except as otherwise
---------- ------
required by law, exercise all such powers and do all such acts and things as may
be exercised or done by the corporation, including, without limiting the
generality of the foregoing, the unqualified power:
(1) To declare dividends from time to time in accordance with law;
(2) To purchase or otherwise acquire any property, rights or privileges on
such terms as it shall determine;
(3) To authorize the creation, making and issuance, in such form as it may
determine, of written obligations of every kind, negotiable or non-negotiable,
secured or unsecured, to borrow funds and guarantee obligations, and to do all
things necessary in connection therewith;
(4) To remove any officer of the Corporation with or without cause, and
from time to time to devolve the powers and duties of any officer upon any other
person for the time being;
(5) To confer upon any officer of the Corporation the power to appoint,
remove and suspend subordinate officers, employees and agents;
6
<PAGE>
(6) To adopt from time to time such stock option, stock purchase bonus or
other compensation plans for directors, officers, employees and agents of the
Corporation and its subsidiaries as it may determine;
(7) To adopt from time to time such insurance, retirement, and other
benefit plans for directors, officers, employees and agents of the Corporation
and its subsidiaries as it may determine; and
(8) To adopt from time to time regulations not inconsistent herewith, for
the management of the Corporation's business and affairs.
Section 10. Compensation of Directors. Directors, as such, may receive,
----------- -------------------------
pursuant to resolution of the board of directors, fixed fees and other
compensation for their services as directors, including, without limitation,
their services as members of committees of the board of directors.
ARTICLE III - COMMITTEES
----------- ----------
Section 1. Committees of the Board of Directors. The board of directors,
---------- ------------------------------------
by a vote of a majority of the board of directors, may from time to time
designate committees of the board of directors, with such lawfully delegable
powers and duties as it thereby confers, to serve at the pleasure of the board
of directors and shall, for those committees and any others provided for herein,
elect a director or directors to serve as the member or members, designating, if
it desires, other directors as alternate members who may replace any absent or
disqualified member at any meeting of the committee. Any such committee, to the
extent provided in the resolution of the board of directors, shall have and may
exercise all the powers and authority of the board of directors in the
management of the business and affairs of the Corporation, and may authorize the
seal of the Corporation to be affixed to all papers which may require it: but
no such committee shall have the power or authority in reference to (i)
approving or adopting, or recommending to the stockholders, any action or matter
expressly required by the Delaware General Corporation Law to be submitted to
the stockholders for approval or (ii) adopting, amending or repealing any by-law
of the Corporation. In the absence or disqualification of any member of any
committee and any alternate member in his or her place, the member or members of
the committee present at the meeting and not disqualified from voting, whether
or not he or she or they constitute a quorum, may by unanimous vote appoint
another member of the board of directors to act at the meeting in the place of
the absent or disqualified member.
Section 2. Conduct of Business. Each committee of the board of directors
---------- -------------------
may determine the procedural rules for meeting and conducting its business and
shall act in accordance therewith, except as otherwise provided herein or
required by law. Adequate provisions shall be made for notice to members of all
meetings of committees. One-third (1/3) of the members of any committee shall
constitute a quorum unless the committee shall consist of one (1) or two (2)
members, in which event one (1) member shall constitute a quorum; and all
matters shall be determined by a majority vote of the members present. Action
may be taken by any committee without a meeting if all members thereof consent
thereto in writing, and the writing or writings are filed with the minutes of
the proceedings of such committee.
7
<PAGE>
ARTICLE IV - OFFICERS
---------------------
Section 1. Generally. The officers of the Corporation shall consist of a
---------- ---------
President, one or more Vice Presidents, a Secretary, a Treasurer and such other
officers as may from time to time be appointed by the board of directors,
including, without limiting the generality of the foregoing, a Chairman of the
Board, a Chief Executive officer and a Vice Chairman of the Board. officers
shall be elected by the board of directors, which shall consider that subject at
its first meeting after every annual meeting of stockholders. Each officer
shall hold office until his successor is elected and qualified or if earlier,
until he dies, resigns, is removed or becomes disqualified, unless a shorter
term is specified by the board of directors at the time of election of such
officer. Any number of offices may be held by the same person.
Section 2. Chief Executive Officer. The Chief Executive Officer shall be
---------- -----------------------
the chief executive officer of the Corporation and shall, subject to the
direction of the board of directors, have general supervision and control of its
business. Unless otherwise provided by resolution of the board of directors,
the Chief Executive Officer shall preside at all meetings of the stockholders
and, in the absence of the Chairman of the Board, if any, at meetings of the
board of directors. The Chief Executive Officer shall have general supervision
and direction of all of the officers, employees and agents of the Corporation.
Section 3. Chairman of the Board. The Chairman of the Board, if any,
---------- ---------------------
shall preside at all meetings of the board of directors at which he is present
and shall have such authority and perform such duties as may be prescribed by
these by-laws or from time to time determined by the board of directors. The
Chairman of the Board shall have power to sign all stock certificates, contracts
and other instruments of the Corporation which are authorized.
Section 4. Vice Chairman of the Board. The Vice Chairman of the Board, if
---------- --------------------------
any, shall have such powers and duties as may be delegated to him by the board
of directors. To the extent not otherwise provided herein, the Vice Chairman of
the Board shall perform the duties and exercise the powers of the Chairman of
the Board in the event of the Chairman's absence or disability.
Section 5. President. Except for meetings at which the Chief Executive
---------- ---------
Officer or the Chairman of the Board, if any, presides, the President shall, if
present, preside at all meetings of stockholders, and if a director, at all
meetings of the board of directors. The President shall, subject to the control
and direction of the Chief Executive Officer and the board of directors, have
and perform such powers and duties as may be prescribed by these by-laws or from
time to time be determined by the Chief Executive Officer or the board of
directors. The President shall have power to sign all stock certificates,
contracts and other instruments of the Corporation which are authorized.
Section 6. Vice President. Each Vice President shall have such powers and
---------- --------------
duties as may be delegated to him by the board of directors, the Chief Executive
Officer and the President. One (1) Vice President shall be designated by the
board of directors to perform the duties and exercise the powers of the
President in the event of the President's absence or disability.
Section 7. Treasurer. The Treasurer shall have the responsibility for
---------- ---------
maintaining the financial records of the Corporation. The Treasurer shall make
such disbursements of the funds of the
8
<PAGE>
Corporation as are authorized and shall render from time to time an account of
all such transactions and of the financial condition of the Corporation. The
Treasurer shall also perform such other duties as the board of directors may
from time to time prescribe.
Section 8. Secretary. The Secretary shall issue all authorized notices
---------- ---------
for, and shall keep minutes of, all meetings of the stockholders and the Board
of Directors. The Secretary shall have charge of the corporate books and shall
perform such other duties as the board of directors may from time to time
prescribe.
Section 9. Delegation of Authority. The board of directors may from time
---------- -----------------------
to time delegate the powers or duties of any officer to any other officers or
agents, notwithstanding any provisions hereof.
Section 10. Removal. Any officer of the Corporation may be removed at any
----------- -------
time, with or without cause, by the board of directors or the Chief Executive
Officer.
Section 11. Resignation. Any officer may resign by giving written notice
----------- -----------
of his resignation to the Chairman of the Board, if any, the President, or the
Secretary, or to the board of directors at a meeting of the board, and such
resignation shall become effective at the time specified therein.
Section 12. Bond. If required by the board of directors, any officer
----------- ----
shall give the Corporation a bond in such sum and with such surety or sureties
and upon such terms and conditions as shall be satisfactory to the board of
directors, including without limitation a bond for the faithful performance of
the duties of his office and for the restoration to the Corporation of all
books, papers, vouchers, money and other property of whatever kind in his
possession or under his control and belonging to the Corporation.
Section 13. Action with Respect to Securities of Other Corporations.
----------- -------------------------------------------------------
Unless otherwise directed by the board of directors, the President or the Chief
Executive officer or any officer of the Corporation authorized by the President
or the Chief Executive Officer shall have power to vote and otherwise act on
behalf of the corporation, in person or by proxy, at any meeting of stockholders
of or with respect to any action of stockholders of any other corporation in
which this Corporation may hold securities and otherwise to exercise any and all
rights and powers which this corporation may possess by reason of its ownership
of securities in such other corporation.
ARTICLE V - INDEMNIFICATION OF DIRECTORS AND OFFICERS
--------- -----------------------------------------
Section 1. Right to Indemnification. Each person who was or is made a
---------- ------------------------
party or is threatened to be made a party to or is otherwise involved in any
action, suit or proceeding, whether civil, criminal, administrative or
investigative, by reason of the fact that he is or was a director or an officer
of the Corporation or is or was serving at the request of the Corporation as a
director, officer, employee or agent of another corporation or of a partnership,
joint venture, trust or other enterprise, including service with respect to an
employee benefit plan (hereinafter an "Indemnitee"), whether the basis of such
proceeding is alleged action in an official capacity as a director, officer,
employee or agent or in any other capacity while serving as a director, officer,
employee or agent, shall be indemnified and held harmless by the Corporation to
the fullest extent authorized by the Delaware
9
<PAGE>
General Corporation Law, as the same exists or may hereafter be amended (but, in
the case of any such amendment, only to the extent that such amendment permits
the Corporation to provide broader indemnification rights than such law
permitted the Corporation to provide prior to such amendment), against all
expense, liability and loss (including attorneys' fees, judgments, fines, ERISA
excise taxes or penalties and amounts paid in settlement) reasonably incurred or
suffered by such Indemnitee in connection therewith; provided, however, that,
except as provided in Section 3 of this Article with respect to proceedings to
enforce rights to indemnification, the Corporation shall indemnify any such
Indemnitee in connection with a proceeding (or part thereof) initiated by such
Indemnitee only if such proceeding (or part thereof) was authorized by the board
of directors of the Corporation.
Section 2. Right to Advancement of Expenses. The right to indemnification
---------- --------------------------------
conferred in section 1 of this Article shall include the right to be paid by the
Corporation the expenses (including attorney's fees) incurred in defending any
such proceeding in advance of its final disposition; provided, however, that, if
the Delaware General Corporation Law requires, an advancement of expenses
incurred by an Indemnitee in his capacity as a director or officer (and not in
any other capacity in which service was or is rendered by such Indemnitee,
including, without limitation, service to an employee benefit plan) shall be
made only upon delivery to the Corporation of an undertaking, by or on behalf of
such Indemnitee, to repay all amounts so advanced if it shall ultimately be
determined by final judicial decision from which there is no further right to
appeal that such Indemnitee is not entitled to be indemnified for such expenses
under this Section 2 or otherwise. The rights to indemnification and to the
advancement of expenses conferred in Sections 1 and 2 of this Article shall be
contract rights and such rights shall continue as to an Indemnitee who has
ceased to be a director, officer, employee or agent and shall inure to the
benefit of the Indemnitee's heirs, executors and administrators. Any repeal or
modification of any of the provisions of this Article shall not adversely affect
any right or protection of an Indemnitee existing at the time of such repeal or
modification.
Section 3. Right of Indemnitees to Bring Suit. If a claim under Section 1
---------- ----------------------------------
or 2 of this Article is not paid in full by the corporation within sixty (60)
days after a written claim has been received by the Corporation, except in the
case of a claim for an advancement of expenses, in which case the applicable
period shall be twenty (20) days, the Indemnitee may at any time thereafter
bring suit against the Corporation to recover the unpaid amount of the claim.
If successful in whole or in part in any-such suit, or in a suit brought by the
Corporation to recover an advancement of expenses pursuant to the terms of an
undertaking, the Indemnitee shall also be entitled to be paid the expenses of
prosecuting or defending such suit. In (i) any suit brought by the Indemnitee
to enforce a right to indemnification hereunder (but not in a suit brought by
the Indemnitee to enforce a right to an advancement of expenses) it shall be a
defense that, and (ii) in any suit brought by the Corporation to recover an
advancement of expenses pursuant to the terms of an undertaking, the Corporation
shall be entitled to recover such expenses upon a final adjudication that, the
Indemnitee has not met any applicable standard for indemnification set forth in
the Delaware General Corporation Law. Neither the failure of the corporation
(including its board of directors, independent legal counsel, or its
stockholders) to have made a determination prior to the commencement of such
suit that indemnification of the Indemnitee is proper in the circumstances
because the Indemnitee has met the applicable standard of conduct set forth in
the Delaware General Corporation Law, nor an actual determination by the
Corporation (including its board of directors, independent legal counsel, or its
stockholders) that the Indemnitee has not met such applicable standard of
conduct, shall create a presumption that the Indemnitee has not met the
applicable standard of conduct or, in the case of such a suit brought by the
Indemnitee, be a defense to such suit. In any suit brought by the Indemnitee to
10
<PAGE>
enforce a right to indemnification or to an advancement of expenses hereunder,
or brought by the Corporation to recover an advancement of expenses pursuant to
the terms of an undertaking, the burden of proving that the Indemnitee is not
entitled to be indemnified, or to such advancement of expenses, under this
Article or otherwise shall be on the Corporation.
Section 4. Non-Exclusivity of Rights. The rights to indemnification and
---------- -------------------------
to the advancement of expenses conferred in this Article shall not be exclusive
of any other right which any person may have or hereafter acquire under any
statute, the Corporation's Certificate of Incorporation as amended from time to
time, these by-laws, any agreement, any vote of stockholders or disinterested
directors or otherwise.
Section 5. Insurance. The Corporation may maintain insurance, at its
---------- ---------
expense, to protect itself and any director, officer, employee or agent of the
Corporation or another corporation, partnership, joint venture, trust or other
enterprise against any expense, liability or loss, whether or not the
Corporation would have the power to indemnify such person against such expense,
liability or loss under the Delaware General Corporation Law.
Section 6. Indemnification of Employees and Agents of the Corporation.
---------- ----------------------------------------------------------
The Corporation may, to the extent authorized from time to time by the board of
directors, grant rights indemnification and to the advancement of expenses to
any employee or agent of the Corporation to the fullest extent of the provisions
of this Article with respect to the indemnification and advancement of expenses
of directors and officers of the Corporation.
ARTICLE VI - STOCK
------------------
Section 1. Certificates of Stock. Each stockholder shall be entitled to a
---------- ---------------------
certificate signed by, or in the name of the Corporation by, the Chairman or
Vice-Chairman of the board of directors, the President or a Vice President, and
by the Secretary or an Assistant Secretary, or the Treasurer or an Assistant
Treasurer, certifying the number of shares owned by him. Any or all of the
signatures on the certificate may be by facsimile.
Section 2. Transfers of Stock. Transfers of stock shall be made only upon
---------- ------------------
the transfer books of the Corporation kept at an office of the Corporation or by
transfer agents designated to transfer shares of the stock of the Corporation.
Except where a certificate is issued in accordance with Section 4 of this
Article, an outstanding certificate for the number of shares involved shall be
surrendered for cancellation before a new certificate is issued therefor.
Section 3. Record Date. in order that the Corporation may determine the
---------- -----------
stockholders entitled to notice of or to vote at any meeting of stockholders, or
to receive payment of any dividend or other distribution or allotment of any
rights or to exercise any rights in respect of any change, conversion or
exchange of stock or for the purpose of any other lawful action, the board of
directors may fix a record date, which record date shall not precede the date on
which the resolution fixing the record date is adopted and which record date
shall not be more than sixty (60) nor less than ten (10) days before the date of
any meeting of stockholders, nor more than sixty (60) days prior to the time for
such other action as hereinbefore described; provided, however, that if no
record date is fixed by the board of directors, the record date for determining
stockholders entitled to notice of or to vote at a
11
<PAGE>
meeting of stockholders shall be at the close of business on the day next
preceding the day on which notice is given or, if notice is waived, at the close
of business on the day next preceding the day on which the meeting is held, and,
for determining stockholders entitled to receive payment of any dividend or
other distribution or allotment of rights or to exercise any rights of change,
conversion or exchange of stock or for any other purpose, the record date shall
be at the close of business on the day on which the board of directors adopts a
resolution relating thereto.
A determination of stockholders of record entitled to notice of or to vote
at a meeting of stockholders shall apply to any adjournment of the meeting;
provided, however, that the board of directors may fix a new record date for the
adjourned meeting.
Section 4. Lost, Stolen or Destroyed Certificates. In the event of the
---------- --------------------------------------
loss, theft or destruction of any certificate of stock, another may be issued in
its place pursuant to such regulations as the board of directors may establish
concerning proof of such loss, theft or destruction and concerning the giving of
a satisfactory bond or bonds of indemnity.
Section 5. Regulations. The issue, transfer, conversion and registration
---------- -----------
of certificates of stock shall be governed by such other regulations as the
board of directors may establish.
ARTICLE VII - NOTICES
----------- -------
Section 1. Notices. Except as otherwise specifically provided herein or
---------- -------
required by law, all notices required to be given to any stockholder, director,
officer, employee or agent shall be in writing and may in every instance be
effectively given (a) by hand delivery to the recipient thereof, (b) by
depositing such notice in the mail, postage paid, (c) by sending such notice by
courier service, receipt confirmed, (d) by sending such notice by prepaid
telegram or mailgram, or (e) by other means of electronic transmission that
results in a reliable reproduction of the writing and that provides reasonable
assurance of receipt. Any such notice shall be addressed to such stockholder,
director, officer, employee or agent at his last known address as the same
appears on the books of the Corporation or to the e-mail address or pursuant to
other electronic transmission delivery instructions that has been provided by
such stockholder, director, officer, employee or agent to the Corporation for
the purpose of receipt of notices and has not been withdrawn. The time when
such notice is received, if hand delivered or sent by courier service, or when
it is dispatched, if sent by mail, telegram, mailgram or electronic
transmission, shall be the time of the giving of the notice.
Section 2. Waivers. A written waiver of any notice, signed by a
---------- -------
stockholder, director, officer, employee or agent, whether before or after the
time of the event for which notice is to be given, shall be deemed equivalent to
the notice required to be given to such stockholder, director, officer, employee
or agent. Neither the business nor the purpose of any meeting need be specified
in such a waiver.
ARTICLE VIII - MISCELLANEOUS
------------ -------------
Section 1. Facsimile Signatures. In addition to the provisions for use of
---------- --------------------
facsimile signatures elsewhere specifically authorized in these by-laws,
facsimile signatures of any officer or
12
<PAGE>
officers of the Corporation may be used whenever and as authorized by the board
of directors or a committee thereof.
Section 2. Corporate Seal. The board of directors may provide a suitable
---------- --------------
seal, containing the name of the Corporation, which seal shall be in the charge
of the Secretary. if and when so directed by the board of directors or a
committee thereof, duplicates of the seal may be kept and used by the Secretary
or Treasurer or by an Assistant Secretary or Assistant Treasurer.
Section 3. Reliance upon Books, Reports and Records. Each director, each
---------- ----------------------------------------
member of any committee designated by the board of directors, and each officer
of the Corporation shall, in the performance of his duties, be fully protected
in relying in good faith upon the books of account or other records of the
Corporation and upon such information, opinions, reports or statements presented
to the Corporation by any of its officers or employees or committees of the
board of directors so designated, or by any other person as to matters which
such director or committee member reasonably believes are within such other
person's professional or expert competence and who has been selected with
reasonable care by or on behalf of the Corporation.
Section 4. Fiscal Year. The fiscal year of the Corporation shall be as
---------- -----------
fixed by the board of directors.
Section 5. Time Periods. In applying any provision of these by-laws that
---------- ------------
requires that an act be done or not be done a specified number of days prior to
an event or that an act be done during a period of a specified number of days
prior to an event, calendar days shall be used, the day of the doing of the act
shall be excluded, and the day of the event shall be included.
Section 6. Pronouns. Whenever the content may require, any pronouns used
---------- --------
in these by-laws shall include the corresponding masculine, feminine or neuter
forms.
ARTICLE IX - AMENDMENTS
---------- ----------
These by-laws may be amended or repealed by the affirmative vote of a
majority of the Whole Board at any meeting or by the stockholders by the
affirmative vote of eighty percent (80%) of the outstanding voting power of the
then-outstanding shares of capital stock of the Corporation at any meeting at
which a proposal to amend or repeal these by-laws is properly presented.
13
<PAGE>
Exhibit 10.10
February ___, 1997
George Vradenburg
16140 Valley Meadow Place
Encino, CA 91436
Dear George:
We are very pleased to offer you the position of Senior Vice President, General
Counsel, and Secretary, America Online, Inc. ("AOL" or the "Company") reporting
directly and exclusively to Steve Case. In this position, you will be an Officer
of AOL and a member of the Company's Office of the Chairman and will be
responsible, among other matters consistent with your position and office, for
all legal and government relations matters relating to the Company. This letter
will set forth the economic and key employment conditions of our employment
offer.
A. Salary
You will earn a minimum base compensation of $380,000, payable semi-monthly,
subject to customary tax deductions. Your salary will be reviewed annually and
any upward adjustments will be within the discretion of AOL's Board of Directors
and based on your performance, contributions and/or changes in competitive
market conditions.
B. Bonus
You will participate in the Management Incentive Plan with a targeted bonus of
75% of your base pay if you and AOL meet the established performance objectives
(and proportionately greater percentages of your base pay should you and AOL
exceed the established performance objectives). The bonus payment for your first
twelve months of employment will be guaranteed at no less than 75% of your base
pay (i.e., $285,000) of which half will be paid on or about September 1, 1997,
and the remaining 50% will be paid on the anniversary of the date on which your
employment commences (the "Commencement Date").
C. Stock Options
In contemplation of, and subject to, your becoming employed by the Company, you
have been granted an option to purchase 200,000 shares of AOL common stock at an
exercise price of $27.13 per share. You will be granted an additional option to
purchase 40,000 shares of AOL common stock no later than March 15, 1997, at an
exercise price equal to the fair market value of the stock on the date of grant.
These options will vest pro rata on the vesting schedule set forth below.
<TABLE>
<CAPTION>
Vesting Date Number of Options
- ------------ ----------------
<S> <C>
Commencement Date 48,000
</TABLE>
<PAGE>
<TABLE>
<S> <C>
One year from Commencement Date 48,000
Two years from Commencement Date 48,000
Three years from Commencement Date 48,000
Four years from Commencement Date 48,000
</TABLE>
The form of Option Agreement to be entered into by you and the Company with
respect to these options is attached hereto.
D. Loan
AOL will lend you $285,000 within 30 days of the Commencement Date. This loan
must be repaid at the earliest of the termination of your employment by AOL for
"Cause" (as defined below), termination by you other than for "Good Reason" (as
defined below), or three years from the Commencement Date, with simple interest
at a rate equal to the applicable federal rate. Interest payments shall be made
annually on the anniversary of the Commencement Date.
E. Relocation
You will be required as a condition of your employment to obtain housing in the
Washington, D.C. area, to spend at least 75% of your time (subject to normal
business travel) in the area, and to engage in in-home business entertainment
(for which you will be reimbursed).
As a consequence, you will be eligible for AOL's executive relocation package (a
copy of which you have received); however, you agree that AOL will not be asked
to reimburse you for the closing costs associated with the sale of your present
LA home at any time within the first three years of your employment. Any
relocation costs paid by AOL and incurred by you following execution of this
letter agreement must be repaid if you are terminated by AOL for Cause, or if
you terminate your employment other than for "Good Reason", within the first
year of employment.
F. Housing and Travel Allowance
In addition to the AOL relocation package and in consideration of your having to
maintain a second house as a condition of your employment, AOL will provide you
with the following housing and travel allowances. These allowances must be
repaid if your employment is terminated by AOL for Cause or by you other than
for "Good Reason" within the first year of employment:
1. A lump sum payment of $200,000 to be paid within 30 days of the
Commencement Date.
2. A monthly housing allowance of $9,150 paid semi-monthly, beginning on the
Commencement Date and continuing for 24 months thereafter. This allowance
will be grossed up to provide a net housing allowance of $110,000 annually
with the gross up adjusted downward by the benefit of any tax and/or
interest deductions (i.e., that you
<PAGE>
actually take and that are not disallowed) on your Washington, D.C. area
residence.
In order to assure AOL the benefit of all properly available deductions,
you agree to claim all tax and/or interest deductions to which you may be
entitled, except to the extent you are advised by your tax advisor that you
do not have a reasonable reporting position with respect to such
deductions. AOL agrees that in the event that any such deductions are
disallowed, AOL will pay you the grossed-up amount of any tax assessment
with respect to such disallowed deductions, together with any related
penalty or interest.
3. At such time within the first three years of your employment as you
purchase a residence in the Washington, D.C. area, AOL will lend you
$400,000 for the down payment on such residence (and for furnishings),
secured by a second mortgage on such residence. Subject to the conditions
set forth below, this loan must be repaid at the earliest of termination of
your employment by AOL for Cause, termination by you other than for Good
Reason, or three years from the Commencement Date, with simple interest at
a rate equal to the applicable federal rate. Interest payments shall be
deferred until, and be paid at the time repayment of the loan is required.
G. Vacation
You will receive at least 3 weeks of vacation annually.
H. Benefits
You and your family will be entitled to participate in all AOL perquisites and
benefits provided to AOL employees generally or to AOL senior management
specifically, including sponsored health and benefits plans and life and
disability insurance plans. A summary of which you have received.
I. Key Employment Conditions
. You will devote your full business time to Company.
. As a condition to your employment, you will enter into a
Confidentiality/Non-Competition/ Proprietary Rights Agreement (the
"Confidentiality Agreement"), a copy of which is attached.
. Subject to the terms and conditions of this letter agreement, your
employment at the Company is at will and you or the Company are free to
terminate the employment relationship at any time, with or without Cause,
with the following consequences:
1. Termination by You.
------------------
(a) You may terminate your employment at any time by giving thirty
(30) days written notice of termination to the Company. Upon
any such termination, the Company may elect to relieve you of
your duties, responsibilities and
<PAGE>
authority hereunder during such thirty (30) day period, which
shall not constitute a termination for Good Reason.
(b) You may also terminate your employment at any time by giving a
notice of termination for a "Good Reason" (as defined below),
provided such notice is given within sixty (60) days of the
event or actions constituting Good Reason and sets forth in
reasonable detail the facts and circumstances claimed to
provide a basis for the termination, and provided, further, the
Company shall not have taken actions within thirty (30) days of
such notice of termination such that the circumstances
constituting a Good Reason have ceased. Your termination date
in the event of a termination under this subparagraph 1 shall
be the date set forth in the notice of termination, but in any
event not later than thirty (30) days after the date such
notice is given.
(c) As used herein, a "Good Reason" shall mean any of the
following:
(ii) a change in the location of the principal offices of the
Company to a location outside Northern Virginia, without
your consent; or
(ii) a sustained material change by the Company in your
authority or reporting relationship as Senior Vice
President and General Counsel, America Online, Inc.,
which causes your position with the Company to become of
materially less responsibility than your position
immediately following the Commencement Date, provided
that such material change is not in connection with a
termination of your employment hereunder by the Company.
Although it is the present intention of the Company that,
as General Counsel, you will have continuing
responsibility for government relations matters, any
change in the staffing or reporting arrangements for such
matters, after the first anniversary of the Commencement
Date and after good faith consultation with you, shall
not constitute "Good Reason."
2. Termination by the Company.
--------------------------
(a) Your employment may be terminated at any time by the Company
(i) with Cause by notice of termination to you, effective
immediately, except as provided in subparagraph (b) below,
unless otherwise stated in such notice, or (ii) without cause
at any time, by a notice of termination to you, effective
immediately unless otherwise stated in such notice.
(b) For purposes of this Agreement, the Company shall have "Cause"
to terminate your employment in the event of your (i)
conviction of a felony involving moral
<PAGE>
turpitude, (ii) willful and continued failure to substantially
perform your required duties under this Agreement. which
failure has not been cured within ten (10) days after written
notice thereof by the Company, provided, however, that the
Company shall only be required to give notice pursuant to this
provision as a condition of termination for Cause one time
during the term of this Agreement, (iii) intentional or
repeated violation of the Confidentiality, Non-Competition and
Proprietary Rights Agreement, or (iv) intentional or repeated
improper conduct substantially prejudicial to the business of
the Company and any of its affiliates.
3. Effect of Termination
---------------------
(a) In the event your employment hereunder is terminated by you for
a Good Reason or by the Company other than for Cause, you
shall, effective as of the termination date, become a
consultant to the Company for a term of two (2) years, subject
to the terms and conditions set forth in the Consulting
Agreement (the "Consulting Agreement") attached as Exhibit A to
the Confidentiality Agreement.
(b) In the event the Company shall terminate your employment for
Cause, or you shall terminate your employment for other than a
Good Reason, then you shall be entitled as of the termination
date to no compensation under this Agreement, except as
provided in Paragraph 4. If the Company shall terminate your
employment for Cause or you shall terminate your employment for
other than a Good Reason, then you shall be subject to the
terms and conditions set forth in the Consulting Agreement,
unless in accordance with the notice provisions thereof, the
Company in its sole discretion shall have elected to terminate
such agreement.
4. Accrued Compensation.
--------------------
In the event of your termination as an employee for any reason, you
(or your estate) shall be paid such portion of your base
compensation (and, in the event your employment is terminated by the
Company other than for Cause or by you for a Good Reason, a pro rata
portion of your annual bonus (which, for purposes of this
calculation and for purposes of calculation under the Consulting
Agreement, shall be no less than the higher of the preceding year's
bonus and the average of your bonus for the two preceding years)) as
has accrued by virtue of your service during the period prior to
termination and has not yet been paid, together with any amounts for
expense reimbursement and similar items which have been properly
incurred in accordance with the provisions hereof prior to
termination and have not yet been paid.
J. Commencement Date
The Commencement Date of your employment shall be as soon as practicable, but no
later than March 3, 1997.
<PAGE>
K. Compensation Committee Approval
The above economic and key employment conditions, have been approved by the
Compensation Committee of AOL's Board of Directors.
George, I hope you will view this offer as a very significant demonstration of
our desire to have you join our organization and be part of an incredible
opportunity to build a new medium and a great Company. If the terms of this
letter are acceptable to you, please execute the enclosed copy of this letter
and return it to me via facsimile.
We look forward to a long and mutually rewarding relationship.
Very truly yours,
/s/ Mark Stavish
Mark Stavish
Vice President, Human Resources
AGREED:
/s/ George Vradenburg
George Vradenburg, III
Date: 11/17/97
<PAGE>
Confidentiality/Non-Competition/Proprietary Rights Agreement
In consideration for the agreement of America Online, Inc., and/or its
subsidiaries or affiliates (collectively, "America Online") to employ me and as
a condition to my continued employment by America Online, I hereby agree as
follows:
1. I acknowledge that I may be furnished or may otherwise receive or have
access to information which relates to America Online's past, present or future
products, software, research, development, improvements, inventions, processes,
techniques, designs or other technical data, or regarding administrative,
management, financial, marketing or manufacturing activities of America Online,
or of a third party which provided proprietary information to America Online on
a confidential basis. All such information shall be considered by America Online
as proprietary and confidential ("Proprietary Information").
2. Both during and after the term of this Agreement, I agree to preserve and
protect the confidentiality of the Proprietary Information and all physical
forms thereof, whether disclosed to me before this Agreement is signed or
afterward. In addition, I shall not (i) disclose or disseminate the Proprietary
Information to any third party, including employees of America Online without a
need to know, (ii) remove Proprietary Information from America Online's
premises, or (iii) use Proprietary Information for my own benefit or for the
benefit of any third party.
3. The foregoing obligations shall not apply to any information which I can
establish to have (i) become publicly known without breach of this Agreement by
me, (ii) been given to me by a third party who is not obligated to maintain
confidentiality, or (iii) been developed by me prior to the date this Agreement
is signed, as established by documentary evidence. If I receive information with
uncertain confidentiality, I agree to treat such information as Proprietary
Information until I have verification from management that such information is
neither confidential nor proprietary.
4. All Proprietary Information used or generated during the course of working
for America Online is the property of America Online except for such information
that was developed by me and was published or otherwise publicly disseminated
prior to the date hereof. I agree to deliver to America Online all documents and
other tangibles (including diskettes and other storage media) containing
Proprietary Information upon termination of my employment with America Online or
otherwise within three (3) days after America Online so requests.
5. I acknowledge and agree that all writings or works of authorship, including,
without limitation, program codes or documentation, produced or authored by me
in the course of performing services for America Online, together with any
copyrights on those writings or works of authorship, are works made for hire and
the property of America Online. To the extent that any such writings or works of
authorship may not, by operation of law, be works made for hire, this Agreement
shall constitute an irrevocable assignment by me to America Online of the
ownership of, and all rights of copyright in such items, and America Online
shall have the right to obtain and hold in its own name all rights or copyright,
copyright registrations and similar
<PAGE>
protections which may be available in the works. I agree to give America Online
or its assignees all assistance reasonably required to perfect such rights.
6. I shall and hereby do assign to America Online my entire right, title and
interest in any invention, technique, process, device, discovery, improvement or
know-how, patentable or not, hereafter made or conceived solely or jointly by me
while working for America Online, which relates in any manner to the actual or
anticipated business or research and development of America Online, or is
suggested by or results from any task assigned to me or work performed by me for
or on behalf of America Online, or for which America Online equipment, supplies,
facilities, information or materials are used. I shall disclose any such
invention, technique, process, device, discovery, improvement or know-how
promptly, and execute a specific assignment of title to America Online, and do
anything else reasonably necessary to enable America Online to secure patent,
trade secret or any other proprietary rights in the United States or foreign
countries.
7. Any inventions I have made or conceived before my employment with America
Online are listed and described below. These items are excluded from this
Agreement.
8. I understand that I may continue to work on, and retain rights to, projects
of my own interest outside of America Online provided that (i) they do not fall
under paragraphs 5 or 6 above, (ii) they do not interfere in any way with my
time at work for America Online, and (iii) should any products with potential
commercial application result from any such project, America Online shall be
given the right of right refusal to purchase and market such products.
9. I shall not submit any article for publication that contains any
information relating to the business of the Company or that identifies me as an
employee or representative of the Company without receiving the prior written
consent of an officer of America Online. I will not deliver any public speech
that contains any information relating to the business of the Company or that
identifies me as any employee or representative of the Company without receiving
the prior written consent of an officer of America Online if such speech would
disclose material nonpublic information concerning the Company or would
otherwise be adverse to the interests of the Company.
10. I represent and warrant that: (i) I am able to enter into this Agreement
and that such ability is not limited or restricted by any agreements or
understandings between me and other persons or companies; (ii) I will not
disclose to America Online or its clients, or induce America Online to use or
disclose, any proprietary information or material belonging to others, except
with the written permission of the owner of such information or material; and
(iii) any information, materials or products I develop for, or any advice I
provide to, America Online shall not rely or in any way be based upon
confidential or proprietary information or trade secrets obtained or derived by
me from sources other than America Online. I hereby agree to indemnify and hold
America Online harmless from and against any and all damages, claims, costs and
expenses, including reasonable attorneys' fees, based on or arising, directly or
indirectly, from the breach of any agreement or understanding between me and
another person or company including, but
<PAGE>
not limited to, liability arising from any confidential or proprietary
information or trade secrets I have obtained from sources other than America
Online.
11. I will fully comply, and do all things necessary for America Online to
fully comply, with all appropriate U.S. Government laws and regulations, and
with the provisions of contracts between America Online and the agencies of the
U.S. government or contractors, which relate to patent rights, technical data,
or to the safeguarding of information and material.
12. While working for America Online and for a period of one year after any
termination of my employment with America Online, I will not attempt, either
directly or indirectly, to induce or attempt to influence any employee of
America Online to leave America Online's employ.
13. While working for America Online and for a period of one year after any
termination of my employment with America Online, I will not solicit business
from any of America Online's customers, either directly or indirectly, for the
benefit of anyone other than America Online or participate or assist in any way
in the solicitation of business from any such customers as an employee of or
consultant to another entity, unless the business being solicited is not
competitive with the services provided by America Online to such customers.
14. I acknowledge and agree that:
a.) (i) my contractual obligations under paragraphs 2, 10, 12 and 13 have
a unique and very substantial value to America Online, (ii) I have sufficient
assets and other skills to provide a reasonable livelihood for myself while such
paragraphs are in force, and (iii) I am subject to immediate dismissal by
America Online for any breach of those provisions and that such dismissal shall
not relieve me from my continuing obligations under this Agreement, or from the
imposition by a court of any judicial remedies, such as money damages or
equitable enforcement of those provisions.
b.) the terms and provisions of this Agreement are applicable to all
information and materials developed for, or any advice provided to,
America Online prior to the signing of this Agreement; and
c.) the termination of my employment with America Online, for any reason,
shall not relieve me from complying with the undertakings and
agreements contained herein, which call for performance prior or
subsequent to the termination date, including, but not limited to
those undertakings and agreements set forth in paragraphs 2, 4, 10, 12
and 13.
15. No act or failure to act by America Online will waive any right contained
herein. Any waiver by America Online must be in writing and signed by an
officer of America Online, to be effective.
16. This Agreement shall be binding on my heirs, executors and administrators
and on
<PAGE>
successors and assigns of America Online; however, I shall not have the right to
assign this Agreement.
17. In the event that any provision of this Agreement conflicts with the law
under which this Agreement is to be construed or if any such provision is held
invalid by a court with jurisdiction over the parties to this Agreement, such
provision shall be deemed to be restated to reflect as nearly as possible the
original intentions of the parties in accordance with applicable force and
effect.
18. This Agreement shall be governed by the laws of the Commonwealth of
Virginia as such laws are applied to contracts executed by Commonwealth of
Virginia residents and performed entirely within the Commonwealth of Virginia.
19. This document constitutes my entire Agreement with America Online with
respect to its subject matter, superseding any prior negotiations and
agreements. This Agreement may not be changed in any respect except by a written
agreement signed by both myself and an officer of America Online.
20. All remedies provided herein are cumulative and which may be available at
law or in equity.
Witness: /s/ Theresa Gevinson Signature: /s/ George Vradenburg
---------------------- ------------------------
Date: November 17, 1997 Print Name: GEORGE VRADENBURG, III
----------------- -----------------------
Date: November 17, 1997
-----------------------------
For America Online, Inc.
Signature: /s/ Stephen M. Case
--------------------
Title: Chairman of the Board and Chief Executive Officer
--------------------------------------------------
Date:_________________________
Prior inventions to be excluded from this Agreement are listed and briefly
described below:
________________________________________________________________________________
________________________________________________________________________________
________________________________________________________________________________
<PAGE>
Addendum to
Confidentiality/Non-Competition/Proprietary Rights Agreement
dated as of February __, 1997 between
America Online, Inc. and George Vradenburg, III
-----------------------------------------------
The following provisions are hereby added to, incorporated in and made a
part of the above-referenced Confidentiality/Non-Competition/Proprietary Rights
Agreement (the "Agreement") as if originally set forth therein in their entirety
(capitalized terms used and not otherwise defined in this Addendum have the
meanings given to them in the Agreement):
21. I hereby acknowledge that my employment with America Online is on an "at
will" basis. In the event that I am no longer employed by America Online as a
result of (i) the termination of my employment without "Cause" by America Online
pursuant to Section I.2(a)(ii) of the letter agreement dated February , 1997
between me and America Online (the "Employment Agreement") or (ii) the
termination of my employment by me for "Good Reason" pursuant to Section 1.1(b)
of the Employment Agreement, I will be retained by America Online as an
independent consultant in accordance with the terms of the Consulting Agreement
attached hereto as Exhibit A. Further, in the event that I am no longer employed
---------
by America Online as a result of my termination of employment pursuant to
Section 1.1(a) of the Employment Agreement or if I am terminated for "Cause" by
America Online pursuant to Section I.2(a)(i) of the Employment Agreement, I
agree to be retained by America Online as an independent consultant in
accordance with the terms of the Consulting Agreement attached hereto as Exhibit
-------
A which Consulting Agreement shall automatically become effective simultaneously
- -
with the termination of my employment, unless America Online notifies me in
writing within thirty (30) days following such termination of employment that it
elects not to have the Consulting Agreement become effective and not to pay and
provide the Non-Compete Consideration (as defined in Section 22), in which
event: (i) the Consulting Agreement shall not become effective and shall cease
and terminate and be of no force or effect, (ii) the Non-Compete Consideration
shall not be paid or provided to me, and (iii) I shall not be subject to or
bound by the restrictive covenants contained in Sections 22 and 23 below
following such termination of employment.
22. During the period (the "Non-Compete Period") beginning with the start of
the term of my employment by America Online and ending at midnight on the second
anniversary of the effective date of the termination of my employment with
America Online, I will not anywhere in the United States or in any other country
in which America Online (directly or indirectly through any entity in which
America Online has a material ownership interest, other than solely for
investment purposes) or a licensee of America Online, in each case, is then
operating or preparing to operate, directly or indirectly own, manage, operate,
join, control, be employed by or participate in the ownership, management,
operation or control of, or be connected in any manner with, any business of the
type and character of the business then engaged in by America Online, or that is
then competitive with the business then engaged in by America Online (excluding
any company or business whose competitive business activities are wholly
incidental to the business of such company or business) (collectively, a
"Competitive Business"), whether such engagement shall be as an employer,
officer, director, owner, employee, partner,
<PAGE>
advisor, consultant, shareholder, agent or other participant in any Competitive
Business (or in any similar capacity in which I may derive an economic benefit
from a Competitive Business), provided that during the period following the
--------
termination of my employment with America Online through and including the
expiration of the Non-Compete Period, America Online shall in accordance with
the terms of the Consulting Agreement: (A) pay or cause to be paid to me an
amount equal to the same base salary and annual bonus, and provide the same
benefits, as paid and provided to me by America Online at the time of the
termination of my employment with America Online on the same terms, including
timing of payments and otherwise, as said amounts were paid and benefits
provided to me during my employment with America Online, provided that if
--------
America Online's benefit plans are modified generally for current executive
employees, America Online may elect to have such modifications apply to me and
(B) if my employment was terminated by America Online without "Cause" pursuant
to Section I.2(a)(ii) of the Employment Agreement or terminated by me for "Good
Reason" pursuant to Section 1.1(b) of the Employment Agreement, continue the
vesting of my stock options on the same basis as such stock options vested while
I was employed by America Online (collectively, the "Non-Compete Consideration")
except as otherwise provided in the Stock Option Agreement. Notwithstanding the
foregoing, I shall be permitted to make wholly passive investments in any
publicly-held Competitive Businesses provided that I shall not have a direct
--------
ownership interest or knowingly have an indirect ownership interest of more than
1% of the outstanding voting capital stock of any publicly-held Competitive
Business. Further, during the period following the termination of my employment
with America Online through and including the expiration of the Non-Compete
Period, I shall be permitted to make wholly passive investments in any
privately-held Competitive Business provided that I shall not have a direct or
--------
knowingly have an indirect ownership interest of more than 5% of the outstanding
voting capital stock of any privately-held Competitive Business and provided
--------
further that I shall have no influence or control (either directly or through
control or influence over any investment vehicle investing in any such
privately-held business) over the business or management of such privately-held
business (including, but not limited to, influence or control as an employee,
consultant or director) other than the ability to vote securities owned. For
purposes of this Agreement, any business which advertises, markets or sells its
products through the Internet or other electronical mailing systems shall not,
solely by virtue of the use of such systems to advertise, market or sell its
products, be deemed a Competitive Business.
I understand and acknowledge that, as consideration for my agreement not to
compete during the Non-Compete Period after I am no longer employed by America
Online. America Online shall pay or cause to be paid and provide to me the Non-
Compete Consideration, and I acknowledge that upon the expiration of the
Consulting Agreement or in the event America Online elects not to have the
Consulting Agreement become effective in those instances provided in Section 21
above, my America Online stock options shall thereafter cease to vest in
accordance with the 1992 Employee, Director and Consultant Stock Option Plan and
the stock option agreements. In any event, my America Online stock options shall
continue to vest during the term of the Consulting Agreement only if my
employment was terminated by America Online without "Cause" pursuant to Section
I.2(a)(ii) of the Employment Agreement or terminated by me for "Good Reason"
pursuant to Section 1.1(b) of the Employment Agreement.
<PAGE>
I further understand and acknowledge that, should I breach any of my
obligations under this Section 22, America Online will be entitled, in addition
to any other damages and remedies, to the return of all Non-Compete
Consideration previously paid to me and I will not be entitled to any further
Non-Compete Consideration.
23. I agree that any breach or threatened breach of this Agreement by me could
cause irreparable damage and that in the event of such breach America Online
shall have, in addition to any and all remedies of law, the right to an
injunction, specific performance or other equitable relief to prevent the
violation of my obligations hereunder without the necessity of any proof of
actual damages or the posting of a bond or other security.
24. Section 14 of the Agreement is supplemented by adding Sections 21, 22, and
23 to the list of Sections of this Agreement set forth in clauses in (a)(i) and
(c) of such Section 14.
IN WITNESS WHEREOF, the parties have executed this Addendum as of the _____ day
of February, 1997.
/s/ Theresa Gevinson /s/ George Vradenburg
Witness Signature
For America Online, Inc.
/s/ Stephen M. Case
- ------------------------------------
Signature
Stephen M Case
- ------------------------------------
Print Name
Chairman and Chief Executive Officer
- ------------------------------------
Title
<PAGE>
Exhibit A to the
----------------
Confidentiality Agreement
-------------------------
CONSULTING AGREEMENT
dated as of February __, 1997 between
AMERICA ONLINE, INC., a Delaware
corporation (the "Company"), and
George Vradenburg, Ill (the Consultant").
The Consultant and the Company have entered into a letter agreement dated
as of February ____,1997 (the Employment Agreement") and a Confidentiality/Non-
Competition/Proprietary Rights Agreement (the "Confidentiality Agreement") in
connection with the Consultant becoming an employee of the Company. In addition,
the Consultant has been granted by the Company options to purchase shares of
common stock, $.01 par value, of the Company, pursuant to stock option
agreements between the Consultant and the Company (the "Stock Option
Agreements") under the Company's 1992 Employee, Director and Consultant Stock
Option Plan. All capitalized terms used but not defined herein shall have the
meanings ascribed thereto in the Confidentiality Agreement.
The Company and the Consultant agree (i) in the event the Consultant's
employment is terminated by the Company without "Cause" pursuant to Section
I.2(a)(ii) of the Employment Agreement or the Consultant's employment is
terminated by the Consultant `Good Reason" pursuant to Section 1.1(b) of the
Employment Agreement, or (ii) at the Company's sole election, in the event the
Consultant's employment terminates as a result of the Consultant's termination
of employment pursuant to either Section 1.1 (a) or I.2(a)(i) of the Employment
Agreement, then from and after the effective date of the Consultant's
termination of employment (the "Termination Date"), the Consultant shall be
retained as a consultant to the Company, and the Consultant shall serve in such
capacity.
NOW, THEREFORE, in consideration of the premises set forth above and the
mutual covenants and agreements contained herein and for other good and valuable
consideration, the parties, intending to be legally bound, agree as follows:
1. Consulting Term. Subject to the provisions of Section 21 of the
---------------
Confidentiality Agreement, the Company agrees to engage the Consultant as a
consultant, and the Consultant agrees to be engaged as a consultant for the
Company, in accordance with the terms and provisions of this Agreement, for the
period commencing on the Termination Date and ending on the second anniversary
of the Termination Date (the "Consulting Term"), as follows:
(a) the nature of the consulting services to be performed by the
Consultant hereunder shall be such advisory and consultative services, in
connection with the business of the Company, as are requested of him from time
to time by the executive employees of the Company, subject to the following:
(i) during the Consulting Term, the Consultant will, as requested by
the Company, render such services for up to five (5) days per annum, such
services to be rendered by the Consultant at such location(s) and time(s) as are
reasonably requested by the Company
<PAGE>
and agreed to by the Consultant;
(ii) for the purpose of computing the amount of services rendered by
the Consultant, there shall be counted (A) the actual time spent by the
Consultant at the Company's place of business at the Company's request, (B) the
actual time spent by the Consultant in telephone consultation with, or on behalf
of, the Company, and (C) the actual time spent by the Consultant representing
the Company at any location as the Company shall have reasonably requested, and
one "day" of consulting services shall consist of one eight-hour period;
(iii) notwithstanding the foregoing, the Consultant will not be
required to render services during any period of illness which prevents him from
rendering such services; and
(iv) the Consultant agrees to perform the consulting services
assigned to him by the Company hereunder to the best of his abilities;
(v) the Consultant agrees to be bound by the Confidentiality
Agreement as if he remained an employee of the Company provided that Section
8(iii) of the Confidentiality Agreement shall not apply.
(b) notwithstanding the provisions hereof, the Company understands that
the Consultant may be an employee of other parties during the Consulting Term
and that any consulting services to be rendered by the Consultant hereunder
shall be subject to his reasonable availability from such employment;
(c) anything to the contrary contained herein notwithstanding, the Company
may terminate this Agreement at any time during the Consulting Term immediately
upon delivery of written notice to the Consultant provided that as and to the
extent provided in paragraph (d) below: (i) the Company shall remain obligated
to continue to pay and provide to the Consultant payments and benefits and (ii)
in the event the Consultant's employment was terminated without "Cause" by the
Company or by the Consultant for "Good Reason", the Consultant's stock options
shall continue to vest;
(d) as consideration for the Consultant's services rendered and for the
Consultant's other agreements hereunder, during the Consulting Term: (i) the
Company shall pay to the Consultant an amount equal to the same base salary and
annual bonus and provide to the Consultant the same benefits as paid and
provided to the Consultant by the Company at the time of termination of the
Consultant's employment, in each case on the same terms, including, timing of
payments and otherwise, as said amounts were paid and benefits provided during
the Consultant's employment with the Company provided that if the Company's
benefit plans are modified generally for current executive employees, the
Company may elect to have such modifications apply to the Consultant; and (ii)
in the event the Consultant's employment was terminated by the Company without
"Cause" pursuant to Section l.2(a)(ii) of the Employment Agreement or terminated
by the Consultant for "Good Reason" pursuant to Section 1.1(b) of the Employment
Agreement, the stock options granted to the Consultant under the terms of the
Stock Option Agreements shall continue to vest during the Consulting Term on the
same basis as such stock options vested during the Consultant's employment with
the Company except as otherwise provided in the Stock Option Agreements; and
<PAGE>
(e) during the Consulting Term, the Company will reimburse the Consultant
for all reasonable, documented expenses incurred in connection with the
performance of his services hereunder or at the Company's request.
2. Consent and Waiver. The waiver or consent by the Company of any breach by
------------------
the Consultant of any provision of this Agreement shall not operate as or be
construed as a waiver or consent of any subsequent breach thereof.
3. Amendments and Modifications. This Agreement may be amended, modified, or
----------------------------
terminated only by a written instrument executed by the parties hereto.
4. Binding Effect and Assignment. This Agreement and all of the provisions
-----------------------------
hereof shall be binding upon and inure to the benefit of the Company and the
Consultant and their respective successors and assigns; provided, however, that
--------
neither this Agreement nor any rights, benefits or obligations hereunder may be
assigned by the Consultant. Anything contained herein to the contrary
notwithstanding, this Agreement shall be of no force or effect, and neither
party shall have any obligations hereunder, in the event this Agreement does not
become effective in accordance with Section 21 of the Confidentiality Agreement.
5. Governing Law, Consent to Jurisdiction. This Agreement and the rights and
--------------------------------------
obligations of the parties hereunder shall be construed in accordance with and
governed by the law of the Commonwealth of Virginia, without giving effect to
the conflict of law principles thereof. Any legal action or proceeding with
respect to this Agreement shall be brought in the courts of the Commonwealth of
Virginia or of the United States of America for the District of Virginia. By
execution and delivery of this Agreement, each of the parties hereto accepts for
such party and in respect of such party's property, generally and
unconditionally, the jurisdiction of the aforesaid courts. Each of the parties
hereto irrevocably consents to the service of process of any of the
aforementioned courts in any such action or proceeding by the mailing of copies
thereof by certified mail, postage prepaid, to the party at its address set
forth in Paragraph 7 hereof.
6. Effect of Headings. The section and other headings herein are for
------------------
convenience only and shall not affect the construction or interpretation of this
Agreement.
7. Notices. All notices and other communications pursuant to this Agreement
-------
shall be in writing and deemed to be sufficient if contained in a written
instrument and shall be deemed given if delivered personally, telecopied, sent
by nationally recognized overnight courier or mailed by registered or certified
mail (return receipt requested), postage prepaid, to the parties at the
following address:
(i) if to the Company, to:
America Online, Inc.
22000 AOL Way
Dulles, Virginia 20166-9323
Attention: Chairman & CEO
<PAGE>
(ii) if to the Consultant, to:
the address for notice set forth on the last
page hereof;
or to such other address as the party to whom notice is to be given may have
furnished to the other parties hereto in writing in accordance herewith. Any
such notice or communication shall be deemed to have been received (A) in the
case of personal delivery or delivery by telecopier, on the date of such
delivery, (B) in the case of nationally-recognized overnight courier, on the
next business day after the date when sent and (C) in the case of mailing, on
the third business day following that on which the piece of mail containing such
communication is posted.
8. Counterparts. This Agreement may be executed in one or more counterparts,
------------
and by the parties hereto in separate counterparts, each of which shall be an
original, but all of which together shall constitute one and the same
instrument.
IN WITNESS WHEREOF, the parties hereto have caused this Consulting
Agreement to be executed and delivered as of the date first above written.
AMERICA ONLINE, INC.
By: /s/ Stephen M. Case
-----------------------------------------
Name: Stephen M. Case
Title: Chairman and Chief Executive Officer
CONSULTANT
/s/ George Vradenburg
--------------------------------------------
Signature
George Vradenburg, III
--------------------------------------------
Print Name
<PAGE>
Exhibit 10.11
December 23, 1997
Mr. Lennert Leader
SVP & Chief Financial Officer
America Online, Inc.
22000 AOL Way
Dulles, VA 20166-9323
Dear Len:
I am pleased that you have agreed to take on responsibility for managing AOL's
Investments in other companies, including our venture capital and other
partially-owned portfolio companies. Subject to our working out the details with
Miles, I also envision your having responsibility for the execution and
integration of our future acquisitions. Your new title will be President, AOL
Investments, and you will report to the Chairman and Chief Executive Officer of
America Online, Inc. You will continue to serve as a Senior Vice President of
America Online, Inc. This is a critically important assignment, and it will be
helpful to have someone in this position of your competence and experience,
someone who has my complete confidence.
While I want you to take on these new responsibilities as soon as practicable,
you recognize that we will need to recruit an outstanding financial executive to
replace you as chief financial officer. I expect you to be significantly
involved in the search for your successor in that position, and you will
continue to serve as chief financial officer until your successor is on board. I
assume that this transition period will take some three to six months, during
which time I expect that you will get started with your new responsibilities to
the extent you can do so consistent with your duties as chief financial officer
and consistent with your assistance in connection with the search for your
successor.
I am confident that you will be successful in your new role. However,
recognizing that this new assignment will be a big change for you, I want you to
have the security of knowing that you will be protected in the unforeseen event
that things don't work out. For that reason, AOL is prepared to provide you with
certain protections, as set forth below, effective immediately.
In the event that AOL terminates your employment other than for Cause (as
hereinafter defined), or you terminate your employment for Good Reason (as
hereinafter defined), the vesting of your Existing Stock Options (as hereinafter
defined) shall accelerate, so that they shall be exercisable in full (subject to
their terms and conditions) as of the date of termination of your employment. To
the extent necessary, your option agreements with respect to such Existing Stock
Options shall be deemed amended hereby, subject only to approval by the
Compensation Committee of the Board. It is understood that the change from your
current position as Senior Vice President, Chief Financial Officer to your new
position as President, AOL Investments does not constitute a condition creating
"Good Reason" for you to terminate your employment.
For purposes of this agreement, "Cause" shall be limited to your conviction of a
felony involving moral turpitude, your willful and continued failure
substantially to perform your required duties, your intentional or repeated
violation of your Confidentiality, Non-Competition and Proprietary Rights
Agreement, or your intentional or improper conduct substantially prejudicial to
the business of AOL or any of its affiliates; "Good Reason" shall be limited to
termination by you, upon 60 days notice following a sustained material (an
example of a "material" change would be your no longer reporting to the chief
executive officer of AOL) change by AOL in your reporting relationship or
authority which causes your position with AOL to become of
<PAGE>
materially less responsibility than your position immediately following
commencement of your full-time service in this new position, provided that such
material change is not In connection with termination of your employment by AOL
for Cause; and provided, further, that AOL shall not have taken such action
within 30 days of such notice of termination such that the circumstances
constituting Good Reason shall have ceased; and "Existing Stock Options" shall
mean the outstanding options listed on the attachment hereto.
Len, I am very grateful to you for your years of outstanding service as Chief
Financial Officer, and I am looking forward to working closely with you in your
challenging new position.
Sincerely,
/s/ STEVE M. CASE
Steve M. Case
<PAGE>
ATTACHMENT:
7/29/94 Grant 400,000 shares at $6.95 exercise price (100,000 shares
scheduled to vest 7/98)
10/24/96 Grant 50,000 shares at $26.25 exercise price (37,500 shares scheduled
to vest in three equal installments of 12,500 each in 10/98, 99,
00)
8/29/97 Grant 50,000 shares at $64.50 exercise price (50,000 shares scheduled
to vest in four equal installments of 12,500 each in 8/98, 99,
00, 01)
<PAGE>
EXHIBIT 21.1
------------
SUBSIDIARIES OF AMERICA ONLINE, INC.
------------------------------------
<TABLE>
<CAPTION>
JURISDICTION OF
---------------
NAME INCORPORATION
---- -------------
<S> <C>
AOL COMMUNITY, INC. Delaware
AOL FOUNDATION, INC. Delaware
AOL TV, INC. Delaware
AOL VENTURES, INC. Delaware
AOLV HUB, INC. Delaware
AOLV FASHION CHANNEL, INC. Delaware
AOLV HEALTHY LIVING CHANNEL, INC. Delaware
THRIVE J.V.
ASYLUM, INC. (DOING BUSINESS AS ENTERTAINMENT ASYLUM) California
COMPUSERVE INTERACTIVE SERVICES, INC. Delaware
COMPUSERVE INTERACTIVE SERVICES LATIN AMERICA, INC. Delaware
COMPUSERVE VENTURES INCORPORATED Ohio
COMPUSERVE WORKS OF WONDER, INC. Ohio
CYBER LEASING CORP. Delaware
DIGITAL CITY, INC. Delaware
DIGITAL STUDIOS, INC. Delaware
DIGITAL MARKETING SERVICES, INC. Delaware
EXTREME FANS, INC. (DOING BUSINESS AS REAL FANS) Illinois
GLOBAL NETWORK NAVIGATOR, INC. Delaware
ICQ NETWORKS, INC. New York
ICQ HOLDING COMPANY, INC. New York
ICQ, INC. Delaware
THE IMAGINATION NETWORK, INC. (DOING BUSINESS AS WORLDPLAY Delaware
ENTERTAINMENT, INC.)
JOHNSON-GRACE NEWCO, INC. Delaware
PERSONAL LIBRARY SOFTWARE INC. Maryland
REDGATE COMMUNICATIONS CORP. Delaware
SPRY, INC. Washington
SUNRISE CAPITAL CORPORATION Delaware
WEBSOFT, INC. Delaware
AOL FRANCE, S.A.R.L. France
AOL INTERNATIONAL FINANCE CV Netherlands
AOL FINANCE BV Netherlands
AOL HOLDINGS (UK) LIMITED United Kingdom
AOL HOLDINGS (UK) 2 LIMITED
AOL (UK) LTD. United Kingdom
COMPUSERVE INTERACTIVE SERVICES LIMITED United Kingdom
AOL AMERICA ONLINE IRELAND Ireland
AOL HOLDING GMBH Germany
AOL AMERICA ONLINE (DEUTSCHLAND) GMBH Germany
COMPUSERVE INTERACTIVE SERVICES BETEILIGUNGS Germany
& VERWALTUNGS GMBH
AMERICA ONLINE HOLDING B.V. Netherlands
AOL CANADA SERVICES, INC. Canada
</TABLE>
<PAGE>
<TABLE>
<S> <C>
AMERICA ONLINE (JAPAN), INC. Japan
AOL INTERNATIONAL LLC Delaware
AOL AUSTRALIA HOLDINGS LLC Delaware
ICQ LTD. Israel
</TABLE>
<PAGE>
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement on
Form S-3 (333-57153) and in the Registrations Statements (Form S-8) listed below
of our report dated September 25, 1998, with respect to the consolidated
financial statements of America Online, Inc., included in the Annual Report
(Form 10-K) for the year ended June 30, 1998.
<TABLE>
<S> <C> <C>
1) No. 33-46607 8) No. 33-91050 15) No. 333-07603
2) No. 33-48447 9) No. 33-94000 16) No. 333-22027
3) No. 33-78066 10) No. 33-94004 17) No. 333-46633
4) No. 33-86392 11) No. 333-00416 18) No. 333-46635
5) No. 33-86394 12) No. 333-02460 19) No. 333-46637
6) No. 33-86396 13) No. 333-07163 20) No. 333-57143
7) No. 33-90174 14) No. 333-07559 21) No. 333-60623
22) No. 333-60625
</TABLE>
ERNST & YOUNG LLP
/S/ERNST & YOUNG LLP
Vienna, Virginia
September 25, 1998
<PAGE>
Exhibit 24.1
POWER OF ATTORNEY
-----------------
I, Stephen M. Case, whose signature appears below, constitute and appoint
Stephen M. Case, J. Michael Kelly, George Vradenburg, III and Sheila A. Clark,
and each of them, my true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution in each of them, for him/her and in
his/her name, place and stead, and in any and all capacities, to sign the Form
10-K for the fiscal year ended June 30, 1998, and any required amendments or
supplements thereto, and to file the same, with all exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite or
necessary to be done in or about the premises, for all intents and purposes as
he or she might or could do in person, hereby ratifying and confirming all that
said attorneys-in-fact and agents or any of them or their or his/her substitute
or substitutes lawfully do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has caused this Power of Attorney to be
executed as of this 28th day of September, 1998.
/S/STEPHEN M. CASE
------------------
Signature
---------
STEPHEN M. CASE
---------------
Print Name
<PAGE>
POWER OF ATTORNEY
-----------------
I, Daniel F. Akerson, whose signature appears below, constitute and appoint
Stephen M. Case, J. Michael Kelly, George Vradenburg, III and Sheila A. Clark,
and each of them, my true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution in each of them, for him/her and in
his/her name, place and stead, and in any and all capacities, to sign the Form
10-K for the fiscal year ended June 30, 1998, and any required amendments or
supplements thereto, and to file the same, with all exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite or
necessary to be done in or about the premises, for all intents and purposes as
he or she might or could do in person, hereby ratifying and confirming all that
said attorneys-in-fact and agents or any of them or their or his/her substitute
or substitutes lawfully do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has caused this Power of Attorney to be
executed as of this 28th day of September, 1998.
/S/DANIEL F. AKERSON
--------------------
Signature
---------
DANIEL F. AKERSON
-----------------
Print Name
<PAGE>
POWER OF ATTORNEY
-----------------
I, Frank J. Caufield, whose signature appears below, constitute and appoint
Stephen M. Case, J. Michael Kelly, George Vradenburg, III and Sheila A. Clark,
and each of them, my true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution in each of them, for him/her and in
his/her name, place and stead, and in any and all capacities, to sign the Form
10-K for the fiscal year ended June 30, 1998, and any required amendments or
supplements thereto, and to file the same, with all exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite or
necessary to be done in or about the premises, for all intents and purposes as
he or she might or could do in person, hereby ratifying and confirming all that
said attorneys-in-fact and agents or any of them or their or his/her substitute
or substitutes lawfully do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has caused this Power of Attorney to be
executed as of this 28th day of September, 1998.
/S/FRANK J. CAUFIELD
--------------------
Signature
---------
FRANK J. CAUFIELD
-----------------
Print Name
<PAGE>
POWER OF ATTORNEY
-----------------
I, Robert J. Frankenberg, whose signature appears below, constitute and
appoint Stephen M. Case, J. Michael Kelly, George Vradenburg, III and Sheila A.
Clark, and each of them, my true and lawful attorneys-in-fact and agents, with
full power of substitution and resubstitution in each of them, for him/her and
in his/her name, place and stead, and in any and all capacities, to sign the
Form 10-K for the fiscal year ended June 30, 1998, and any required amendments
or supplements thereto, and to file the same, with all exhibits thereto and
other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing
requisite or necessary to be done in or about the premises, for all intents and
purposes as he or she might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents or any of them or their or
his/her substitute or substitutes lawfully do or cause to be done by virtue
hereof.
IN WITNESS WHEREOF, the undersigned has caused this Power of Attorney to be
executed as of this 28th day of September, 1998.
/S/ROBERT J. FRANKENBERG
------------------------
Signature
---------
ROBERT J. FRANKENBERG
---------------------
Print Name
<PAGE>
POWER OF ATTORNEY
-----------------
I, Alexander M. Haig, Jr., whose signature appears below, constitute and
appoint Stephen M. Case, J. Michael Kelly, George Vradenburg, III and Sheila A.
Clark, and each of them, my true and lawful attorneys-in-fact and agents, with
full power of substitution and resubstitution in each of them, for him/her and
in his/her name, place and stead, and in any and all capacities, to sign the
Form 10-K for the fiscal year ended June 30, 1998, and any required amendments
or supplements thereto, and to file the same, with all exhibits thereto and
other documents in connection therewith, with the Securities and Exchange
Commission, granting unto said attorneys-in-fact and agents, and each of them,
full power and authority to do and perform each and every act and thing
requisite or necessary to be done in or about the premises, for all intents and
purposes as he or she might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents or any of them or their or
his/her substitute or substitutes lawfully do or cause to be done by virtue
hereof.
IN WITNESS WHEREOF, the undersigned has caused this Power of Attorney to be
executed as of this 28th day of September, 1998.
/S/ALEXANDER M. HAIG, JR.
-------------------------
Signature
---------
ALEXANDER M. HAIG, JR.
----------------------
Print Name
<PAGE>
POWER OF ATTORNEY
-----------------
I, William N. Melton, whose signature appears below, constitute and appoint
Stephen M. Case, J. Michael Kelly, George Vradenburg, III and Sheila A. Clark,
and each of them, my true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution in each of them, for him/her and in
his/her name, place and stead, and in any and all capacities, to sign the Form
10-K for the fiscal year ended June 30, 1998, and any required amendments or
supplements thereto, and to file the same, with all exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite or
necessary to be done in or about the premises, for all intents and purposes as
he or she might or could do in person, hereby ratifying and confirming all that
said attorneys-in-fact and agents or any of them or their or his/her substitute
or substitutes lawfully do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has caused this Power of Attorney to be
executed as of this 28th day of September, 1998.
/S/WILLIAM N. MELTON
--------------------
Signature
---------
WILLIAM N. MELTON
-----------------
Print Name
<PAGE>
POWER OF ATTORNEY
-----------------
I, Thomas Middelhoff, whose signature appears below, constitute and appoint
Stephen M. Case, J. Michael Kelly, George Vradenburg, III and Sheila A. Clark,
and each of them, my true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution in each of them, for him/her and in
his/her name, place and stead, and in any and all capacities, to sign the Form
10-K for the fiscal year ended June 30, 1998, and any required amendments or
supplements thereto, and to file the same, with all exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite or
necessary to be done in or about the premises, for all intents and purposes as
he or she might or could do in person, hereby ratifying and confirming all that
said attorneys-in-fact and agents or any of them or their or his/her substitute
or substitutes lawfully do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has caused this Power of Attorney to be
executed as of this 28th day of September, 1998.
/S/THOMAS MIDDELHOFF
--------------------
Signature
---------
THOMAS MIDDELHOFF
-----------------
Print Name
<PAGE>
POWER OF ATTORNEY
-----------------
I, Robert W. Pittman, whose signature appears below, constitute and appoint
Stephen M. Case, J. Michael Kelly, George Vradenburg, III and Sheila A. Clark,
and each of them, my true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution in each of them, for him/her and in
his/her name, place and stead, and in any and all capacities, to sign the Form
10-K for the fiscal year ended June 30, 1998, and any required amendments or
supplements thereto, and to file the same, with all exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite or
necessary to be done in or about the premises, for all intents and purposes as
he or she might or could do in person, hereby ratifying and confirming all that
said attorneys-in-fact and agents or any of them or their or his/her substitute
or substitutes lawfully do or cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has caused this Power of Attorney to be
executed as of this 28th day of September, 1998.
/S/ROBERT W. PITTMAN
--------------------
Signature
---------
ROBERT W. PITTMAN
-----------------
Print Name
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-END> JUN-30-1998
<CASH> 631
<SECURITIES> 0
<RECEIVABLES> 218
<ALLOWANCES> 22
<INVENTORY> 13
<CURRENT-ASSETS> 930
<PP&E> 465
<DEPRECIATION> 102
<TOTAL-ASSETS> 2,214
<CURRENT-LIABILITIES> 894
<BONDS> 0
0
0
<COMMON> 2
<OTHER-SE> 596
<TOTAL-LIABILITY-AND-EQUITY> 2,214
<SALES> 2,600
<TOTAL-REVENUES> 2,600
<CGS> 1,678
<TOTAL-COSTS> 2,522
<OTHER-EXPENSES> 28
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 13
<INCOME-PRETAX> 92
<INCOME-TAX> 0
<INCOME-CONTINUING> 92
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 92
<EPS-PRIMARY> .44
<EPS-DILUTED> .35
</TABLE>
