AMERICA ONLINE INC, 8-K, 1999-02-17

AMERICA ONLINE INC
8-K, 1999-02-17
COMPUTER PROGRAMMING, DATA PROCESSING, ETC.

Previous: ALLIANCE NORTH AMERICAN GOVERNMENT INCOME TRU INC, 24F-2NT, 1999-02-17

Next: AMERICA ONLINE INC, S-4, 1999-02-17

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 8-K

CURRENT REPORT
Pursuant to Sextion 13 or 15(d)
of the Securities Exchange Act OF 1934

Date of Report (Date of Earliest Event Reported): November 9, 1998

Commission File Number- 001-12143

AMERICA ONLINE, INC.
(Exact name of registrant as specified in its charter)

Delaware 54-1322110
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

22000 AOL Way 20166-9323
Dulles, Virginia (zip code)
(Address of principal executive offices)

Registrant's telephone number, including area code: (703) 265-1000

- -------------------------------------------------------------------------------

<PAGE>

Item 5. Other Events

America Online, Inc. (the "Company") completed its merger with
PersonaLogic, Inc. ("PersonaLogic") on November 9, 1998, in which PersonaLogic
became a wholly owned subsidiary of the Company. The Company exchanged
approximately 345,000 shares of common stock for all the outstanding common and
preferred shares of PersonaLogic. The merger was accounted for under the
pooling-of-interests method of accounting and, accordingly, the accompanying
financial statements have been restated to include the operations of
PersonaLogic for all periods presented. In this Form 8-K, the Company is
restating its financial statements presented in the Form 10-K for fiscal year
end June 30, 1998 that have been impacted by the merger of PersonaLogic. This
Form 8-K does not reflect any changes from the pending merger with Netscape
Communications Corporation, as that transaction has not yet closed. For a
complete understanding of the Company's results presented herein, refer to the
Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1998.
For more current and further information, refer to the Forms 10-Q for fiscal
year 1999 already on record for the periods ended September 30, 1998 and
December 31, 1998.

Item 7. Financial Statements and Exhibits

23.3 Consent of Independent Auditors

<PAGE>

Item 6. Selected Financial Data
<TABLE>

Selected Consolidated Financial and Other Data

Year Ended June 30,
-----------------------------------------
1998 1997 1996 1995 1994
-------- -------- ------ -------- ------
(Amounts in millions, except per share data)
Statement of Operations Data:
<S> <C> <C> <C> <C> <C>
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............. 73 (505) 65 (21) 4
Net income (loss) (1)..................... 88 (499) 30 (36) 2
Income (loss) per common share:
Net income (loss) per share-diluted....... $0.34 $(2.61) $0.14 $(0.26) $0.01
Net income (loss) per share-basic......... $0.42 $(2.61) $0.18 $(0.26) $0.02
Weighted average shares outstanding:
Diluted................................... 260 191 215 139 138
Basic..................................... 210 191 171 139 114

As of June 30,
----------------------------------------
1998 1997 1996 1995 1994
-------- -------- ------ -------- ------
(Amounts in millions)
Balance Sheet Data:
Working capital (deficiency).............. $36 $(230) $(23) $- $39
Total assets.............................. 2,215 833 959 405 155
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.

<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

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 $1,679 million, or 56%, over fiscal
1997, and increased as a percentage of total revenues from 63.7% to 64.6%.
<PAGE>

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 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.

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 $97 million, or 23%, 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.
<PAGE>

General and Administrative

For fiscal 1998, general and administrative expenses increased from $127
million to $232 million, or 83%, over fiscal 1997, and increased as a percentage
of total revenues from 7.5% to 8.9%. 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.

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.
<PAGE>

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.

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 $15 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.
<PAGE>

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 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 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.
<PAGE>

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

Contract Termination Charge

Settlement Charge

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.
<PAGE>

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 $608 million, from $323 million at June 30, 1997 to $931 million at
June 30, 1998, while current liabilities increased by $342 million, from $553
million to $895 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 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.
<PAGE>

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, retention and brand
marketing to expand its subscriber base, as well as in network, computing and
support infrastructure. Additionally, the Company expects to use a portion of
its cash for the acquisition and subsequent funding of technologies, content,
products or businesses complementary to the Company's current business. The
Company anticipates that available cash and cash provided by operating
activities will be sufficient to fund its operations for the next twelve months.

<PAGE>

AMERICA ONLINE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

Year ended June 30,
----------------------
1998 1997 1996
------ -------- ------
(Amounts in millions,
except per share data)
Revenues:
<S> <C> <C> <C>
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...................................... 1,679 1,074 654
Marketing
Marketing............................................. 374 422 220
Write-off of deferred subscriber acquisition costs.... - 385 -
Product development................................... 97 79 58
General and administrative............................ 232 127 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.............................. 2,527 2,190 1,029
Income (loss) from operations......................... 73 (505) 65
Other income (expense), net........................... 15 6 (3)
------ -------- ------
Income (loss) before provision for income taxes....... 88 (499) 62
Provision for income taxes............................ - - (32)
------ -------- ------
Net income (loss)..................................... $88 $(499) $30
====== ======== ======

Earnings (loss) per share:
Earnings (loss) per share-diluted..................... $0.34 $(2.61) $0.14
Earnings (loss) per share-basic....................... $0.42 $(2.61) $0.18
Weighted average shares outstanding-diluted........... 260 191 215
Weighted average shares outstanding-basic............. 210 191 171

See accompanying notes.
</TABLE>

<PAGE>

AMERICA ONLINE, INC.

CONSOLIDATED BALANCE SHEETS

June 30,
----------------
1998 1997
--------- ------
(Amounts in millions,
except share data)
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents............................................................... $631 $124
Trade accounts receivable, less allowances of $19 million and $6 million, respectively.. 105 65
Other receivables....................................................................... 92 26
Prepaid expenses and other current assets............................................... 103 108
--------- ------
Total current assets.................................................................... 931 323

Property and equipment at cost, net..................................................... 363 233

Other assets:
Investments including available-for-sale securities..................................... 449 81
Restricted cash......................................................................... - 50
Product development costs, net.......................................................... 88 73
Goodwill and other intangible assets, net............................................... 381 59
Other assets............................................................................ 3 14
--------- ------
$2,215 $833
========= ======

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Trade accounts payable........................................................... ...... $87 $68
Other accrued expenses and liabilities................................... .............. 433 299
Deferred revenue.......................................................... ............. 242 166
Accrued personnel costs................................................. ............... 57 20
Deferred network services credit..................................... .................. 76 -
------- ------
Total current liabilities............................................. ................. 895 553

Long-term liabilities:
Notes payable....................................................... ................... 372 50
Deferred revenue..................................................... .................. 71 86
Other liabilities..................................................... ................. 6 4
Deferred network services credit...................................... ................. 273 -
------- ------
Total liabilities................................................... ................... 1,617 693

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, 219,986,247 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.......................................................... ... 874 628
Accumulated deficit................................................................. ... (423) (507)
------- ------
Total stockholders' equity........................................................ ..... 598 140
------- ------
$2,215 $833
======= ======

See accompanying notes.
</TABLE>

<PAGE>

AMERICA ONLINE, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

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

Effect of PersonaLogic pooling........... - - 345,107 - 8 - (4) 4
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.......................... - - - - - - 88 88
------ ------ ----------- ------ ------- --------- -------- ------
Balances at June 30, 1998............... - $ - 219,986,247 $2 $ 874 $ 145 $ (423) $598
====== ====== =========== ====== ======= ========= ======== ======

See accompanying notes.
</TABLE>

AMERICA ONLINE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

Year ended June 30,
---------------------
1998 1997 1996
------ ------- ------
(Amounts in millions)
Cash flows from operating activities:
<S> <C> <C> <C>
Net income (loss)...................................................................... $88 $(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.......................................................... 135 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......................................... 147 105 137
Deferred income taxes.................................................................. - - 33
Deferred revenue and other liabilities................................................. 59 214 18
------ ------- ------
Total adjustments...................................................................... 323 626 (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............................................................................... $10 $2 $2

See accompanying notes.
</TABLE>

<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:

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

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 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.

<PAGE>

AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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:

Year ended
June 30,
-----------
(in millions) 1998 1997
----- -----
Balance, beginning of year.. $73 $44
Costs capitalized........... 51 56
Costs amortized............. (36) (27)
----- -----
Balance, end of year........ $88 $73
===== =====

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.

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.

<PAGE>

AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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.

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 Compensatio. 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).

<PAGE>

AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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, 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.

(in millions)
-----
Restructuring charge.................... $35
Payments................................ (18)
Non-cash adjustments.................... (13)
-----
Restructuring accrual at June 30, 1998.. $4
=====

<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.

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>

(in millions except for per share data) 1998 1997 1996
----- -------- -----
<S> <C> <C> <C>
Numerator for basic and diluted earnings per share - Net income (loss)........... $88 $(499) $30
===== ======== =====
Denominator
Denominator for basic earnings per share - Weighted average shares............... 210 191 171
Effect of dilutive securities:
Employee stock options........................................................... 43 - 35
Warrants......................................................................... 7 - 9
Convertible debt................................................................. - - -
Convertible preferred stock...................................................... - - -
----- -------- -----
Dilutive potential common shares................................................. 50 - 44
----- -------- -----
Denominator for diluted earnings per share - Adjusted weighted average shares
and assumed conversions...................................................... 260 191 215
===== ======== =====
Basic earnings (loss) per share.................................................. $0.42 $(2.61) $0.18
===== ======== =====
Diluted earnings (loss) per share................................................ $0.34 $(2.61) $0.14
===== ======== =====
</TABLE>

<PAGE>

AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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.

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.

<PAGE>

AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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 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.

Pro Forma
For the years
ended June 30,
---------------

(in millions, except per share data) 1998 1997
------ --------
(unaudited)
Revenue............................. $2,734 $2,002
Income (loss) from operations....... $157 $(473)
Net income (loss)................... $172 $(467)
Earnings (loss) per share-diluted... $0.66 $(2.44)
Earnings (loss) per share-basic..... $0.82 $(2.44)

<PAGE>

AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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.

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.

<PAGE>

AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 9. Property and Equipment

Property and equipment consist of the following:

June 30,
---------
(in millions) 1998 1997
---- ----
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........ 217 159
Construction in progress........................ 23 28
---- ----
465 290
Less accumulated depreciation and amortization.. 103 57
---- ----
Net property and equipment...................... $363 $233
==== ====

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:

(in millions)
Year ending June 30,
-------------------- -----
1999................ $219
2000................ 163
2001................ 85
2002................ 35
2003................ 14
Thereafter.......... 10
-----
$ 526
=====

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.

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.

<PAGE>

AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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.

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.

<PAGE>

AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 12. Other Income (Expense)

The following table summarizes the components of other income:

Year ended June 30
-----------------
(in millions) 1998 1997 1996
----- ----- -----
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)......................... (5) - (9)
----- ----- -----
$15 $6 $(3)
===== ===== =====

Note 13. Income Taxes

The provision for income taxes is attributable to:
<TABLE>

Year Ended June 30,
-------------------
(in millions) 1998 1997 1996
------ ------ -----
<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>

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>

Year Ended June 30,
------------------
(in millions) 1998 1997 1996
----- ------- ----
<S> <C> <C> <C> <C>
Income tax at the federal statutory rate of 35%....................... $31 $(175) $21
State income tax, net of federal benefit.............................. 6 (15) 3
Nondeductible charge for purchased research and development........... 28 - 6
Valuation allowance changes affecting the provision for income taxes.. (72) 187 1
Other................................................................. 7 3 1
----- ------- ----
$ - $- $32
===== ======= ====
</TABLE>

As of June 30, 1998, the Company has net operating loss carryforwards of
approximately $1,022 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.

<PAGE>

AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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>

June 30
-------------
(in millions) 1998 1997
------ ------
Short term:
Short term deferred tax assets:
<S> <C> <C>
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.................. 388 300
Deferred network services credit.................. 131 -
Valuation allowance............................... (402) (275)
------ ------
Total............................................. 117 25
------ ------
Net long term deferred liabilities................ $(5) $(1)
====== ======
</TABLE>

The valuation allowance for deferred tax assets increased by $138 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.

<PAGE>

AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

The Company's deductible temporary differences related to operations and
exercised stock options amounted to:

June 30,
-----------
(in millions) 1998 1997
----- -----
Operations..... $450 $648
Stock options.. $977 $163

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 219,986,247 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.

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.

<PAGE>

AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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 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>

Number Weighted-
of average exercise
shares price
------------- ----------------
<S> <C> <C> <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................... 17,173,685 $45.14
Exercised................. (18,299,705) $5.98
Forfeited................. (4,370,973) $19.41
------------- ----------------
Balance at June 30, 1998.. 51,856,127 $20.36
============= ================
</TABLE>

<TABLE>

Options outstanding Options exercisable
--------------------------------------- ------------------------
Weighted-
average Weighted- Weighted-
Number remaining average Number average
Range outstanding contractual exercise exercisable as exercise
of exercise price as of 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... 12,792,456 9.1 $34.34 817,199 $28.25
$50.00 to $106.50.. 5,067,892 9.6 $67.23 5,546 $95.39
- ------------------- ------------- --------------- --------- -------------- ---------
$0.01 to $106.50... 51,856,127 7.6 $20.36 17,808,535 $7.19
============= =============== ========= ============== =========

</TABLE>

<PAGE>

AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

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 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.

On November 9, 1998, the Company completed its merger with PersonaLogic,
Inc. ("PersonaLogic"), in which PersonaLogic became a wholly owned subsidiary of
the Company. The Company exchanged approximately 345,000 shares of common stock
for all the outstanding common and preferred shares of PersonaLogic. The merger
was accounted for under the pooling-of-interests method of accounting and,
accordingly, the accompanying financial statements have been restated to include
the operations of PersonaLogic for all periods presented.

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.

<PAGE>

AMERICA ONLINE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

Note 19. Quarterly Information (unaudited)

<TABLE>

Quarter Ended
---------------------------------------------
(Amounts in millions, except per share data) September 30, December 31, March 31, June 30,
------------- ------------ --------- --------
Fiscal 1998(1)(3)
<S> <C> <C> <C> <C>
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...................... 25 33 15 -
Net income.................................. 31 33 18 6
Net income per share-diluted................ $0.12 $0.13 $0.07 $0.02
Net income per share-basic.................. $0.15 $0.16 $0.08 $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.

<PAGE>

SIGNATURE

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 17th day of
February, 1999.

AMERICA ONLINE, INC.
By: /s/ J. MICHAEL KELLY
---------------------------------------------
J. Michael Kelly,
Senior Vice President, Chief Financial Officer,
Treasurer, Chief Accounting Officer
and Assistant Secretary

<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.

/s/ ERNST & YOUNG LLP

Vienna, Virginia
September 25, 1998,
except for the last paragraph of Note 17,
as to which the date is February 15, 1999

<PAGE>

Exhibit 23.3 Consent of Independent Auditors

We consent to the incorporation by reference in the Registration Statements on:
i) Form S-3 (No.'s 333-46633 and 333-57153) and ii) Form S-8 (listed below) of
our report dated September 25, 1998 (except for the last paragraph of Note 17,
as to which the date is February 15, 1999), with respect to the consolidated
financial statements of America Online, Inc., included in the Current Report on
Form 8-K expected to be filed on February 17, 1999, with the Securities and
Exchange Commission.

1) No. 33-46607 9) No. 33-94000 17) No. 333-46635
2) No. 33-48447 10) No. 33-94004 18) No. 333-46637
3) No. 33-78066 11) No. 333-00416 19) No. 333-57143
4) No. 33-86392 12) No. 333-02460 20) No. 333-60623
5) No. 33-86394 13) No. 333-07163 21) No. 333-60625
6) No. 33-86396 14) No. 333-07559 22) No. 333-68605
7) No. 33-90174 15) No. 333-07603 23) No. 333-68631
8) No. 33-91050 16) No. 333-22027 24) No. 333-68599

/s/Ernst & Young LLP

Vienna, Virginia
February 17, 1999

<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> 219
<ALLOWANCES> 22
<INVENTORY> 13
<CURRENT-ASSETS> 931
<PP&E> 466
<DEPRECIATION> 103
<TOTAL-ASSETS> 2215
<CURRENT-LIABILITIES> 895
<BONDS> 0
0
0
<COMMON> 2
<OTHER-SE> 596
<TOTAL-LIABILITY-AND-EQUITY> 2215
<SALES> 2600
<TOTAL-REVENUES> 2600
<CGS> 1679
<TOTAL-COSTS> 2527
<OTHER-EXPENSES> 28
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 13
<INCOME-PRETAX> 88
<INCOME-TAX> 0
<INCOME-CONTINUING> 88
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 88
<EPS-PRIMARY> .42
<EPS-DILUTED> .34

</TABLE>