AMERICA ONLINE INC, 8-K/A, 1999-04-21

AMERICA ONLINE INC
8-K/A, 1999-04-21
COMPUTER PROGRAMMING, DATA PROCESSING, ETC.

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 8-K/A

CURRENT REPORT

Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

Date of Report (Date of Earliest Event Reported): March 17, 1999

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 2. Acquisition of Assets

This Form 8-K/A amends the Current Report on Form 8-K filed on March 26,
1999 to incorporate Item 7 (a), the Financial Statements of Business Acquired.

On March 17, 1999, America Online, Inc. ("America Online", the "Company" or
"AOL") completed the merger with Netscape Communications Corporation
("Netscape") pursuant to the terms of the previously reported Agreement and Plan
of Merger, dated as of November 23, 1998 (the "Merger Agreement"), by and among
America Online, a Delaware corporation, Apollo Acquisition Corp., a Delaware
corporation and a wholly-owned subsidiary of America Online ("Apollo"), and
Netscape, a Delaware corporation. Apollo merged with and into Netscape (the
"Merger"), with Netscape surviving the merger as a wholly-owned subsidiary of
America Online, effective as of March 17, 1999. Each share of Netscape common
stock was converted into the right to receive 0.9 of a share of AOL common
stock. The conversion ratio was determined through arm's length negotiations.
The Merger Agreement is incorporated herein by reference from America Online's
Current Report on Form 8-K for an event dated November 23, 1998.

The Company exchanged approximately 95 million shares of common stock for
all the outstanding common shares of Netscape. The merger was accounted for
under the pooling-of-interests method of accounting and, accordingly, the
accompanying financial statements and footnotes have been restated to include
the operations of Netscape for all periods presented. Netscape historical
results have been recast to conform to AOL's June 30 year-end. In addition,
adjustments have been made to Netscape's reported revenues to conform revenue
recognition policies. America Online mainly recognizes these revenues ratably
over the term of the contract.

In this Current Report on Form 8-K/A, the Company is restating its
financial statements and footnotes presented in the Form 10-K for the fiscal
year ended June 30, 1998 that have been impacted by the merger of Netscape. For
a complete understanding of the Company's results presented herein, refer to
America Online's Annual Report on Form 10-K for the fiscal year ended June 30,
1998, Current Report on Form 8-K dated November 9, 1998 and Netscape's Form
10-K/A for the period ended October 31, 1998. For more current and additional
information, refer to America Online's Quarterly Reports on Form 10-Q for fiscal
year 1999 already on record for the periods ended September 30, 1998 and
December 31, 1998. For additional information on the Netscape merger, refer to
Note 19 of the Notes to Supplemental Consolidated Financial Statements.

Item 7. Financial Statements and Exhibits

(a) Financial Statements of Businesses Acquired

Reference is made to the financial statements listed under the heading "(a)
(1) Supplemental Consolidated Financial Statements" of Item 14 hereof, which
financial statements are incorporated herein by reference in response to this
Item 7.

2.1 Agreement and Plan of Merger, dated as of November 23, 1998, by and
among America Online, Inc., Apollo Acquisition Corp. and Netscape
Communications Corporation (filed as Exhibit 2.1 to America Online's
current report on Form 8-K for an event dated November 23, 1998 and
incorporated herein by reference)

23 Consent of Independent Auditors

99.1 Press Release dated March 17, 1999 (filed as Exhibit 99.1 to America
Online's current report on Form 8-K for an event dated March 17, 19998
and incorporated herein by reference)
<PAGE>

Supplemental Selected Financial Data

<TABLE>

Selected Supplemental 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>
Subscription services..................... $2,183 $1,478 $1,024 $352 $102
Advertising, commerce and other .......... 541 308 111 50 17
Enterprise solutions...................... 365 411 188 23 3
-------- -------- ------- -------- ------
Total revenues............................ 3,089 2,197 1,323 425 122

Income (loss) from operations............. (116) (485) 64 (41) -
Net income (loss) (1)..................... (71) (485) 35 (55) (2)
Income (loss) per common share:
Net income (loss) per share-diluted....... $(0.08) $(0.58) $0.04 $(0.09) $ -
Net income (loss) per share-basic......... $(0.08) $(0.58) $0.05 $(0.09) $ -
Weighted average shares outstanding:
Diluted................................... 923 838 944 587 459
Basic..................................... 923 838 751 587 459

As of June 30,
----------------------------------------
1998 1997 1996 1995 1994
-------- -------- ------- -------- ------
(Amounts in millions)
Balance Sheet Data:
Working capital (deficiency).............. $104 $(40) $72 $18 $41
Total assets.............................. 2,867 1,501 1,271 459 159
Total debt................................ 372 52 25 24 9
Stockholders' equity...................... 991 610 705 242 101
- ------------------

(1) Net loss in the fiscal year ended June 30, 1998, includes charges of $75
million related to mergers and restructurings, $94 million related to
acquired in-process 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 contract
terminations, $24 million for a legal settlement and $9 million related to
acquired in-process research and development. Net income in the fiscal year
ended June 30, 1996, includes charges of $17 million for acquired
in-process research and development and $8 million in merger related costs.
Net loss in the fiscal year ended June 30, 1995, includes charges of $50
million for acquired in-process research and development and $2 million for
merger expenses.
</TABLE>

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Operations

Fiscal 1998 Compared to Fiscal 1997

Subscription Services Revenues

For fiscal 1998, subscription services revenues increased from $1,478
million to $2,183 million, or 48%, over fiscal 1997. This increase was comprised
of an increase in AOL subscription services revenues of $637 million as well as
CompuServe subscription services revenues of $88 million, which began in
February 1998, partially offset by a $20 million decrease in subscription
services revenues from the Company's internet service, Global Network Navigator
("GNN"), which was discontinued in fiscal 1997. The increase in AOL subscription
services 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 2.7% increase in the average monthly subscription services
revenue per AOL North American subscriber. The average monthly subscription
services revenue per AOL North American subscriber increased from $17.48 in
fiscal 1997 to $17.95 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 76%, from $308 million in fiscal 1997 to
$541 million in fiscal 1998. The increase was driven primarily by more
advertising on the Company's AOL service and Netcenter portal as well as an
increase in electronic commerce fees. Advertising and electronic commerce fees
increased by 144%, from $147 million in fiscal 1997 to $358 million in fiscal
1998. Fiscal 1998 advertising and electronic commerce revenues include revenues
associated with warrants earned in connection with the Company's agreement with
Tel-Save, Inc. to sell long distance service to AOL members. Additional revenues
can be earned going forward based on the growth of the number of long distance
subscribers and the value of the warrants earned.

Enterprise Solutions Revenues

Enterprise solutions revenues, which consist principally of product
licensing fees, technical support, consulting, and, to a lessor extent, training
services decreased by 11%, from $411 million in fiscal 1997 to $365 million in
fiscal 1998. The decrease was due to offering the stand-alone Netscape Navigator
and Communicator browsers for free starting in January 1998 offset by an 18%
increase in product sales related to server applications and consulting
services.
<PAGE>

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, consulting, technical
support/training and billing, host computer and network equipment costs, the
costs of merchandise sold, royalties paid to information and service providers
and royalties paid for licensed technologies. For fiscal 1998, cost of revenues
increased from $1,162 million to $1,810 million, or 56%, over fiscal 1997, and
increased as a percentage of total revenues from 52.9% to 58.6%.

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, providing customer support, consulting, technical support/training and
billing. Data network costs increased primarily as a result of the larger member
base and more usage per member. 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 member base and more usage by members. Personnel and related costs
associated with operating the data centers, data network, providing customer
support and billing increased primarily as a result of the requirements of
supporting a larger data network, a larger member base and increased
subscription services revenues. Personnel and related costs associated with
consulting and technical support/training increased due to providing additional
customer support and professional services.

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 coupled with the decrease
in revenues related to the high margin stand-alone Netscape Navigator and
Communicator browsers 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 9 of the Notes to Supplemental Consolidated Financial Statements.
<PAGE>

Sales and Marketing and Write-Off of Deferred Subscriber Acquisition Costs

Sales and marketing expenses include the costs to acquire and retain
subscribers, the operating expenses associated with the sales and marketing
organizations and other general marketing costs. For fiscal 1998 sales and
marketing expenses increased from $608 million to $623 million, or 2%, over
fiscal 1997, and decreased as a percentage of total revenues from 27.7% to
20.2%. The increase in sales and marketing expenses for fiscal 1998 was mainly
attributable to an increase in Netcenter staffing and related sales commissions,
partially offset by a decrease in subscriber acquisition costs. The decrease as
a percent of revenues was mainly due to the 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 Supplemental Consolidated Financial Statements.

For fiscal 1998, sales and marketing expenses, before capitalization and
amortization, decreased from $679 million to $623 million, or 8.2%, over fiscal
1997, and decreased as a percentage of total revenues from 30.9% to 20.2%. The
decrease in sales and 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 $195 million to $239 million, or 23%, over fiscal 1997, and
decreased as a percentage of total revenues from 8.9% to 7.7%. The increase in
product development costs was primarily due to an increase in personnel costs
resulting from the Company's acquisitions of Actra Business Systems LLC
("Actra"), KIVA Software Corporation ("KIVA") and the online service of
CompuServe (see Note 9 of the Notes to Supplemental Consolidated Financial
Statements). The decrease in product development costs as a percentage of total
revenues was primarily a result of the substantial growth in revenues.

General and Administrative

For fiscal 1998, general and administrative expenses increased from $220
million to $323 million, or 47%, over fiscal 1997, and increased slightly as a
percentage of total revenues from 10.0% to 10.5%. 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 and related 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.
<PAGE>

Amortization of Goodwill and Other Intangible Assets

Amortization of goodwill and other intangible assets increased to $24
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 acquisitions of CompuServe in January 1998, DigitalStyle
Corporation ("DigitalStyle") and Portola Communications, Inc. ("Portola") in
June 1997, and Actra in December 1997, 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.

Acquired In-Process Research and Development

The Company incurred a total of $94 million in acquired in-process research
and development charges in fiscal 1998 related to the acquisitions of Mirabilis,
Ltd. ("Mirabilis"), Actra, 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 Supplemental Consolidated Statements of Operations
reflect a one-time write-off of the amount of purchase price allocated to
in-process research and development of $60 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.

The Company acquired Actra, a developer of commerce applications for
conducting business-to-business and business-to-consumer commerce on the
internet in December 1997, 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 purchase of Actra, the Company recorded
charges for acquired in-process research and development of $14 million. In
connection with the purchases of PLS and NetChannel, the Company recorded
charges for acquired in-process research and development in fiscal 1998 of $10
million related to each acquisition.
<PAGE>

The Company incurred a total of $9 million ($5 million and $4 million,
respectively) in acquired in-process research and development charges in fiscal
1997 related to the acquisitions of Portola and DigitalStyle in June 1997.

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 Actra, PLS, NetChannel, Portola and DigitalStyle.

Merger, Restructuring and Contract Termination 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.

At the end of the second and beginning of the third quarters of fiscal
1998, the Company recorded a $35 million restructuring charge related to the
implementation of certain restructuring actions mainly related to the Enterprise
organization. These actions were aimed at reducing its cost structure, improving
its competitiveness, and restoring sustainable profitability. The restructuring
plan resulted from decreased demand for certain Enterprise products and the
adoption of a new strategic direction. The restructuring included a reduction in
the workforce (approximately 400 employees), the closure of certain facilities,
the write-off of non-performing operating assets, and third-party royalty
payment obligations relating to canceled contracts.

In the fiscal year ended 1998, the Company recognized merger costs of $6
million related to the acquisition of Kiva consisting mainly of investment
banking, legal and accounting services.

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 the first
quarter of fiscal 1998, 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.

In the third quarter of 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.

Refer to Notes 4, 5 and 9 of the Notes to Supplemental Consolidated
Financial Statements for further information related to the restructurings,
contract terminations and merger costs.
<PAGE>

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, net

Other income, net consists primarily of investment income and non-operating
gains net of interest expense and non-operating charges. The Company had other
income of $29 million and $10 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) Benefit for Income Taxes

The (provision) benefit for income taxes was $16 and $(10) million in
fiscal 1998 and fiscal 1997, respectively. During 1998 the Company realized
income subject to tax under accounting principles. However, unrecognized tax
benefits from fiscal 1997 were available to reduce the tax expense. For
additional information regarding income taxes, refer to Note 15 of the Notes to
Supplemental Consolidated Financial Statements.
<PAGE>

Fiscal 1997 Compared to Fiscal 1996

Subscription Services Revenues

For fiscal 1997, subscription services revenues increased from $1,024
million to $1,478 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 5.8%
decrease in the average monthly subscription services revenue per AOL North
American subscriber. The average monthly subscription services revenue per AOL
North American subscriber decreased from $18.55 in fiscal 1996 to $17.48 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 177%, from $111
million in fiscal 1996 to $308 million in fiscal 1997. This increase was
primarily attributable to more advertising on the Company's service and
Netcenter portal, an increase in electronic commerce fees and an increase in
merchandise sales. Advertising and electronic commerce fees increased by 635%,
from $20 million in fiscal 1996 to $147 million in fiscal 1997. Merchandise
sales increased by 153%, 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.

Enterprise Solutions Revenues

Enterprise solutions revenues increased 119% from $188 million in fiscal
1996 to $411 million in fiscal 1997. The increase is mainly attributable to an
increased product line, increased unit shipments of existing products and
general growth in the internet-related software products in the corporate
environment.

Cost of Revenues

For fiscal 1997, cost of revenues increased from $696 million to $1,162
million, or 67%, over fiscal 1996, and increased slightly as a percentage of
total revenues from 52.6% to 52.9%.

<PAGE>
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, consulting, technical support/training and billing,
the costs of merchandise sold, royalties paid to information and service
providers and royalties paid for licensed technologies. Data network costs
increased primarily as a result of the larger member base and more usage per
member. 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 member 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 mostly 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 and the substantial growth in
higher margin revenue streams.

Sales and Marketing and Write-Off of Deferred Subscriber Acquisition Costs

For fiscal 1997, sales and marketing expenses increased from $297 million
to $608 million, or 105%, over fiscal 1996, and increased as a percentage of
total revenues from 22.4% to 27.7%.

The increase in sales and 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. In addition,
sales and marketing expenses increased as a result of the continued expansion of
the Enterprise sales organizations including the costs of opening new sales
offices, increased commissions on increased revenues and continued investment in
sales and marketing capabilities in Europe and Asia Pacific. The increase in
sales and 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 and the expansion of the
Enterprise sales organizations. 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 Supplemental
Consolidated Financial Statements.

For fiscal 1997, sales and marketing expenses, before capitalization and
amortization, increased from $534 million to $679 million, or 27%, over fiscal
1996, and decreased as a percentage of total revenues from 40.4% to 30.9%. The
increase in sales and marketing expenses, before capitalization and
amortization, was primarily attributable to an increase in general marketing
costs, including telemarketing and personnel. The decrease in sales and
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 $110 million to
$195 million, or 77%, over fiscal 1996, and increased as a percentage of total
revenues from 8.3% to 8.9%. The increase in product development costs, and such
costs as a percentage of total revenues, was primarily due to an increase in
personnel costs related to an increase in the number of technical employees to
support and expand the various product offerings.

General and Administrative

For fiscal 1997, general and administrative costs increased from $124
million to $220 million, or 77%, over fiscal 1996, and increased as a percentage
of total revenues from 9.4% to 10.0%. 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").

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 Supplemental
Consolidated Financial Statements), the Company wrote off approximately $8
million of capitalized goodwill associated with GNN.

Acquired In-Process Research and Development

Acquired in-process 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.

Merger, Restructuring and Contract Termination Charges

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.

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.
<PAGE>

In fiscal 1996, the Company recognized merger costs totaling $8 million
related to the acquisitions of InSoft, Inc. ("InSoft"), Collabra Software, Inc.
("Collabra"), Netcode Corporation ("Netcode") and Paper Software, Inc. ("Paper")
consisting mainly of investment banking, legal and accounting services. Refer to
Notes 4, 5 and 9 of the Notes to Supplemental Consolidated Financial Statements
for further information related to the restructurings, contract terminations and
merger costs.

Settlement Charge

Other Income, net

The Company had other income, net of $10 million in fiscal 1997 and $5
million in fiscal 1996. The change in other income, net was primarily
attributable to the allocation of losses to minority shareholders in fiscal 1997
and a charge in fiscal 1996 for the settlement of a class action lawsuit,
partially offset by an increase in fiscal 1997 of non-operating losses related
to various investments.

Provision for Income Taxes

The provision for income taxes was $10 and $34 million in fiscal 1997 and
fiscal 1996. For additional information regarding income taxes, refer to Note 15
of the Notes to Supplemental 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 operating activities
was $437 million, $131 million and $2 million in fiscal 1998, fiscal 1997 and
fiscal 1996, respectively. Net cash used in investing activities was $527
million, $394 million and $261 million in fiscal 1998, fiscal 1997 and fiscal
1996, respectively. Included in investing activities for fiscal 1998 was $383
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 $571 million, $277 million and $373 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 $131 million in proceeds from the sale of common stock
pursuant to employee stock option and stock purchase plans. Included in
financing activities for fiscal 1997 and 1996 was approximately $158 million and
$140 million, respectively, in proceeds from public stock offerings of common
stock.

At June 30, 1998, the Company had working capital of $104 million, compared
to a working capital deficiency of $40 million at June 30, 1997. Current assets
increased by $549 million, from $709 million at June 30, 1997 to $1,258 million
at June 30, 1998, while current liabilities increased by $405 million, from $749
million to $1,154 million, over this same period. The increase in current assets
was primarily attributable to an increase in cash and cash equivalents and
short-term investments 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. 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.
<PAGE>

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
21,560,000 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 76.63572
shares of common stock for each $1,000 principal amount of the Notes (equivalent
to a conversion price of $13.04844 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.

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,
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 9 of the Notes to Supplemental 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 12 of the Notes to Supplemental Consolidated
Financial Statements.

In May 1996, the Company entered into a joint venture with Mitsui & Co.,
("Mitsui") and Nihon Keizai Shimbun, Inc. ("Nikkei") to offer interactive online
services in Japan. In connection with the agreement, the Company received
approximately $28 million through the sale of convertible preferred stock to
Mitsui. The preferred stock had an aggregate liquidation preference of
approximately $28 million and accrued dividends at a rate of 4% per annum.
Accrued dividends could be paid in the form of additional shares of preferred
stock. During May 1998, the preferred stock, together with accrued but unpaid
dividends, was converted into 1,568,000 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>

Year 2000 Compliance

America Online utilizes a significant number of computer software programs
and operating systems across its entire organization, including applications
used in operating its online services and Web sites, the proprietary software of
the AOL and CompuServe services, Netscape software products, member and customer
services, network access, content providers, joint ventures and various
administrative and billing functions. To the extent that these applications
contain source codes that are unable to appropriately interpret the upcoming
calendar year 2000, some level of modification, or even possibly replacement may
be necessary.

In 1997, America Online appointed a Year 2000 Task Force to perform an
audit to assess the scope of America Online's risks and bring its applications
into compliance. This Task Force is undertaking its assessment of America
Online's company-wide compliance and is overseeing testing. America Online's
system hardware components, client and host software, current versions of
Netscape software products and corporate business and information systems are
currently undergoing review and testing. To date, America Online has experienced
very few problems related to Year 2000 testing, and the problems that have been
identified are in the process of being fixed.

The Company intends to make Year 2000 compliant certain versions of the
client software for the AOL service and the CompuServe service that are
available on the Windows and Macintosh operating systems, as well as versions of
Netscape software products that are currently shipped. These versions of the
software incorporate proprietary software and third-party component software
that may not be Year 2000 compliant, and testing continues. A patch or upgrade
may be required for members or customers using some of these versions to achieve
Year 2000 compliance. Over the coming months, the Company will be working to
obtain and make available any required patches or upgrades at no cost to members
of the online services and to communicate their availability. The Company also
will make available at no additional cost to customers any required patch to the
versions of Netscape software products currently being shipped to customers and
communicate their availability. In addition, the Company will be encouraging
members and customers to upgrade to versions of the software that are expected
to be Year 2000 compliant, if they have not already done so.

In addition, America Online is continuing to gather information from its
vendors, joint venture partners and content partners about their progress in
identifying and addressing problems that their computer systems may face in
correctly processing date information related to the Year 2000. America Online
intends to continue its efforts to seek reassurances regarding the Year 2000
compliance of vendors, joint venture partners and content partners. In the event
any third parties cannot timely provide America Online with content, products,
services or systems that meet the Year 2000 requirements, the content on America
Online's services, access to America Online's services, the ability to offer
products and services and the ability to process sales could be materially
adversely affected.

The costs incurred through March 1999 to address Year 2000 compliance were
approximately $7 million. America Online currently estimates it will incur a
total of approximately $20 million in costs to support its compliance
initiatives. America Online cannot predict the outcome of its Year 2000 program,
whether third party systems are or will be Year 2000 compliant, the costs
required to address the Year 2000 issue, or whether a failure to achieve
substantial Year 2000 compliance will have a material adverse effect on America
Online's business, financial condition or results of operations. Failure to
achieve Year 2000 compliance could result in interruptions in the work of its
employees, the inability of members and customers to access the Company's online
services and Web sites or errors and defects in the Netscape products. This, in
turn, may result in the loss of subscription services revenue, advertising and
commerce revenue or enterprise solution revenue, the inability to deliver
minimum guaranteed levels of traffic, diversion of development resources, or
increased service and warranty costs. Occurrence of any of these may also result
in additional remedial costs and damage to reputation.

America Online is in the process of developing a contingency plan to
address possible risks to its systems. It is America Online's intention to
implement its contingency plan no later than July 1999.
<PAGE>

Quantitative and Qualitative Disclosures about Market Risk

The Company is exposed to immaterial levels of market risks, including
changes in foreign currency exchange rates and interest rates. Market risk is
the potential loss arising from adverse changes in market rates and prices, such
as foreign currency exchange and interest rates. The Company does not enter into
derivatives or other financial instruments for trading or speculative purposes.
The Company only enters into financial instruments to manage and reduce the
impact of changes in foreign currency exchange rates. In June 1998, the Company
initiated hedging activities to mitigate the impact on intercompany balances of
changes in foreign exchange rates. The Company is using foreign currency forward
exchange contracts as a vehicle for hedging these intercompany balances. A
foreign currency forward exchange contract obligates the Company to exchange
predetermined amounts of specified foreign currencies at specified exchange
rates on specified dates and to make or receive an equivalent U.S. dollar
payment equal to the value of such exchange. For these contracts that are
designated and effective as hedges, realized and unrealized gains and losses
resulting from changes in the spot exchange rate (including those from open,
matured, and terminated contracts) are included in other income, and net
discounts or premiums (the difference between the spot exchange rate and the
forward exchange rate at inception of the contract) are also accreted or
amortized to other income, over the life of each contract, using the
straight-line method. These gains and losses offset gains and losses on
intercompany balances, which are also included in other income. The related
amounts due to or from counterparties are included in other assets or other
liabilities. In general, these foreign currency forward exchange contracts
mature in three months or less. The estimated fair value of the contracts are
immaterial due to their short-term nature.

<PAGE>

Supplemental Consolidated Financial Statements

<TABLE>

AMERICA ONLINE, INC.
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF OPERATIONS

Year ended June 30,
-----------------------
1998 1997 1996
------- -------- ------
(Amounts in millions,
except per share data)
Revenues:
<S> <C> <C> <C>
Subscription services................................... $2,183 $1,478 $1,024
Advertising, commerce and other......................... 541 308 111
Enterprise solutions.................................... 365 411 188
------- -------- ------
Total revenues.......................................... 3,089 2,197 1,323

Costs and expenses:
Cost of revenues........................................ 1,810 1,162 696
Sales and marketing
Sales and marketing.................................. 623 608 297
Write-off of deferred subscriber acquisition costs... - 385 -
Product development..................................... 239 195 110
General and administrative.............................. 323 220 124
Amortization of goodwill and other intangible assets.... 24 6 7
Acquired in-process research and development............ 94 9 17
Merger, restructuring and contract termination charges.. 75 73 8
Settlement charges...................................... 17 24 -
------- -------- ------
Total costs and expenses................................ 3,205 2,682 1,259

Income (loss) from operations........................... (116) (485) 64
Other income, net....................................... 29 10 5
------- -------- ------
Income (loss) before provision for income taxes......... (87) (475) 69
(Provision) benefit for income taxes.................... 16 (10) (34)
------- -------- ------
Net income (loss)....................................... $(71) $(485) $35
======= ======== ======

Earnings (loss) per share:
Earnings (loss) per share-diluted....................... $(0.08) $(0.58) $0.04
Earnings (loss) per share-basic......................... $(0.08) $(0.58) $0.05
Weighted average shares outstanding-diluted............. 923 838 944
Weighted average shares outstanding-basic............... 923 838 751

See accompanying notes.
</TABLE>

<PAGE>

<TABLE>

AMERICA ONLINE, INC.
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS

June 30,
----------------
1998 1997
--------- ------
(Amounts in
millions, except
ASSETS share data)
Current assets:
<S> <C> <C>
Cash and cash equivalents............................................................... $672 $191
Short-term investments.................................................................. 146 112
Trade accounts receivable, less allowances of $34 and $23, respectively................. 192 230
Other receivables....................................................................... 92 26
Deferred tax assets..................................................................... 43 25
Prepaid expenses and other current assets............................................... 113 125
--------- ------
Total current assets.................................................................... 1,258 709

Property and equipment at cost, net..................................................... 502 344

Other assets:
Investments including available-for-sale securities..................................... 531 187
Restricted cash......................................................................... - 50
Product development costs, net.......................................................... 88 73
Goodwill and other intangible assets, net............................................... 471 109
Other assets............................................................................ 17 29
--------- -----
$2,867 $1,501
====== ======

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Trade accounts payable................................................................... $119 $105
Other accrued expenses and liabilities................................................... 461 324
Deferred revenue......................................................................... 419 279
Accrued personnel costs.................................................................. 79 41
Deferred network services credit......................................................... 76 -
------- ------
Total current liabilities................................................................ 1,154 749

Long-term liabilities:
Notes payable............................................................................ 372 52
Deferred revenue......................................................................... 71 86
Other liabilities........................................................................ 6 4
Deferred network services credit......................................................... 273 -
------- ------
Total liabilities........................................................................ 1,876 891

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; 1,800,000,000 shares authorized, 969,340,398 and
888,039,588 shares issued and outstanding at June 30, 1998 and 1997, respectively...... 10 9
Additional paid-in capital............................................................. 1,424 1,094
Unrealized gain on available-for-sale securities....................................... 144 19
Accumulated deficit.................................................................... (587) (512)
------- ------
Total stockholders' equity............................................................. 991 610
------- ------
$2,867 $1,501
======= ======

See accompanying notes.
</TABLE>

<PAGE>

<TABLE>

AMERICA ONLINE, INC.
SUPPLEMENTAL 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..... - $- 654,236,114 $6 $297 $- $(62) $241
Common stock issued:

Exercise of options, warrants and ESPP............ - - 84,801,764 1 195 - - 196
Business acquisitions............................. - - 7,323,589 - 22 - - 22
Sale of stock, net................................ - - 74,371,999 1 148 - - 149
Sale of preferred stock, net...................... 1,000 - - - 28 - - 28
Amortization of compensatory stock options........ - - - - 2 - - 2
Unrealized gain on available-for-sale securities - - - - - 2 - 2
Tax benefit related to stock options.............. - - - - 32 - - 32
Net income........................................ - - - - - - 35 35
------ ---- ----------- ---- ------- ------------ -------- ------
Balances at June 30, 1996......................... 1,000 - 820,733,466 8 724 2 (27) 707
Common stock issued:
Exercise of options and ESPP...................... - - 58,329,319 1 93 - - 94
Business acquisitions............................. - - 6,195,803 - 82 - - 82
Sale of stock, net................................ - - 2,781,000 - 157 - - 157
Amortization of compensatory stock options........ - - - - 2 - - 2
Unrealized gain on available-for-sale securities.. - - - - 11 17 - 28
Tax benefit related to stock options.............. - - - - 25 - - 25
Net loss.......................................... - - - - - - (485) (485)
------ ---- ----------- ---- ------- ------------ -------- ------

Balances at June 30, 1997......................... 1,000 - 888,039,588 9 1,094 19 (512) 610
Effect of pooling restatement..................... - - 1,380,428 - 8 - (4) 4
Common stock issued:
Exercise of options and ESPP...................... - - 75,321,933 1 133 - - 134
Business acquisitions............................. - - 3,030,449 - 80 - - 80
Amortization of compensatory stock options........ - - - - 33 - - 33
Unrealized gain on available-for-sale securities.. - - - - 78 125 - 203
Conversion of preferred stock to common stock..... (1,000) - 1,568,000 - - - - -
Tax expense related to stock options.............. - - - - (2) - - (2)
Net loss.......................................... - - - - - - (71) (71)
-------- ---- ----------- ---- ------- ------------ -------- -----
Balances at June 30, 1998......................... - $- 969,340,398 $10 $1,424 $144 $ (587) $991
======== ==== =========== ==== ======= ============ ======== =====

See accompanying notes.
</TABLE>

AMERICA ONLINE, INC.
SUPPLEMENTAL 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)...................................................................... $(71) $(485) $35
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Write-off of deferred subscriber acquisition costs..................................... - 385 -
Non-cash restructuring charges......................................................... 32 22 -
Depreciation and amortization.......................................................... 188 93 42
Amortization of deferred network services credit....................................... (32) - -
Charge for acquired in-process research and development................................ 94 9 17
Compensatory stock options............................................................. 32 2 2
Deferred income taxes.................................................................. (18) (1) 33
Gain on sale of investments............................................................ (27) - (2)
Amortization of subscriber acquisition costs........................................... - 59 126
Changes in assets and liabilities, net of the effects of acquisitions and dispositions:
Trade accounts receivable............................................................ 78 (122) (65)
Other receivables.................................................................... (67) 2 (12)
Prepaid expenses and other current assets............................................ 28 (50) (50)
Deferred subscriber acquisition costs................................................ - (130) (363)
Other assets......................................................................... (5) (15) (14)
Investments including available-for-sale securities.................................. (40) (30) 5
Accrued expenses and other current liabilities....................................... 141 130 182
Deferred revenue and other liabilities............................................... 104 262 66
------ ------- ------
Total adjustments...................................................................... 508 616 (33)
------ ------- ------
Net cash provided by operating activities.................................... 437 131 2

Cash flows from investing activities:
Purchase of property and equipment..................................................... (383) (230) (115)
Product development costs.............................................................. (51) (57) (33)
Proceeds from sale of investments...................................................... 87 26 110
Purchase of investments, including available-for-sale securities........................ (166) (208) (256)
Maturity of investments................................................................ 103 83 32
Net (payments) proceeds for acquisitions/dispositions of subsidiaries.................. (96) 3 -
Other investing activities............................................................. (21) (11) 1
------ ------- ------
Net cash used in investing activities.................................................. (527) (394) (261)

Cash flows from financing activities:
Proceeds from issuance of common and preferred stock, net.............................. 131 278 374
Proceeds from sale and leaseback of property and equipment............................. 70 20 -
Principal and accrued interest payments on line of credit and debt..................... (1) (22) (4)
Proceeds from line of credit and issuance of debt...................................... 371 1 3
------ ------- ------
Net cash provided by financing activities.............................................. 571 277 373
------ ------- ------
Net increase in cash and cash equivalents.............................................. 481 14 114
Cash and cash equivalents at beginning of year......................................... 191 177 63
------ ------- ------
Cash and cash equivalents at end of year............................................... $672 $191 $177
====== ======= ======
Supplemental cash flow information
Cash paid during the year for:
Interest............................................................................... $10 $2 $2

See accompanying notes.
</TABLE>

<PAGE>

AMERICA ONLINE, INC.
NOTES TO SUPPLEMENTAL 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 world
leader in interactive services, Web brands, Internet technologies, and
E-commerce services. America Online, Inc. operates: two worldwide Internet
services, the AOL service, with more than 17 million members, and the CompuServe
service, with approximately 2 million members; several leading Internet brands
including Digital City, Inc.; Netcenter, ICQ and AOL.com portals; and the
Netscape Navigator and Communicator browsers. The Company also develops and
offers easy-to-deploy, end-to-end E-commerce and enterprise solutions for
companies operating in and doing business on the Internet.

Note 2. Summary of Significant Accounting Policies

Principles of Consolidation. The supplemental 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 (see Note 9).

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. Subscription services revenues are recognized over the
period that services are provided. Other revenues, which consist principally of
electronic commerce and advertising revenues, Enterprise sales which include
software licenses and services, 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.

Beginning in fiscal 1998, the Company adopted Statement of Position 97-2
"Software Revenue Recognition" as amended by Statement of Position 98-4. The
effect of adoption did not have a material impact on the Company's results of
operations. The Company recognizes the revenue allocable to software licenses
upon delivery of the software product to the end-user, unless the fee is not
fixed or determinable or collectibility is not probable. In software
arrangements that include more than one element, the Company allocates the total
arrangement fee among each deliverable based on the relative fair value of each
of the deliverables determined based on vendor-specific objective evidence.
<PAGE>

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.. 2 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.

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 subscription 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 (the AOL service and the CompuServe service 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.
<PAGE>

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.

Based on the Company's product development process related to the
Enterprise business, costs incurred between completion of the working model and
the point at which the product is ready for general release have been
insignificant and have not been capitalized.

Included in product development costs are research and development costs
totaling $182 million, $139 million and $74 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.

Foreign Currency. Translation and Hedging of Intercompany Balances Assets
and liabilities of the Company's wholly-owned foreign subsidiaries are
translated into U.S. dollars at year-end exchange rates, and revenues and
expenses are translated at average rates prevailing during the year. Translation
adjustments are included as a component of stockholders' equity. Foreign
currency transaction gains and losses, which have been immaterial, are included
in results of operations. In June 1998, the Company initiated hedging activities
to mitigate the impact on intercompany balances of changes in foreign exchange
rates. In general, these foreign currency forward exchange contracts mature in
three months or less. The estimated fair value of the contracts is immaterial
due to their short-term nature.

Investments. The Company has various investments, including foreign and
domestic joint ventures, that are accounted for under the equity method of
accounting. All investments in which the Company has the ability to exercise
significant influence over the investee, but less than a controlling voting
interest, are accounted for under the equity method of accounting. Under the
equity method of accounting, the Company's share of the investee's earnings or
loss is included in consolidated operating results. To date, the Company's basis
and current commitments in its investments accounted for under the equity method
of accounting have been minimal. As a result, these investments have not
significantly impacted the Company's results of operations or its financial
position.

All other investments, for which the Company does not have the ability to
exercise significant influence or for which there is not a readily determinable
market value, are accounted for under the cost method of accounting. Dividends
and other distributions of earnings from investees, if any, are included in
income when declared. The Company periodically evaluates the carrying value of
its investments accounted for under the cost method of accounting and as of June
30, 1998 and 1997, such investments were recorded at the lower of cost or
estimated net realizable value.

Goodwill and Other Intangible Assets. Goodwill and other intangible assets
relate to purchase transactions and are amortized on a straight-line basis over
periods ranging from 2-10 years. As of June 30, 1998 and 1997, accumulated
amortization was $24 million and $12 million, respectively. 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
(see Note 8).
<PAGE>

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 material 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. The Company sells products to customers in
diversified industries, primarily in the Americas, which includes Canada and
Latin America, Europe and the Asia Pacific region. The Company performs ongoing
credit evaluations of its customers' financial condition and generally does not
require collateral on product sales. The Company maintains reserves to provide
for estimated credit losses. Actual credit losses could differ from such
estimates.

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 13) and investments including available-for-sale securities (see Note 8) is
based on quoted market prices where available.

Barter Transactions. The Company barters advertising for products and
services. Such transactions are recorded at 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 No. 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 exclude any dilutive effect of stock options, warrants
and convertible securities. Diluted earnings per share are very similar to the
previously reported fully diluted earnings per share. Earnings per share amounts
have been restated to conform to SFAS No. 128 requirements where appropriate
(see Note 7).

Stock-Based Compensation. During 1997, the Company adopted SFAS No. 123,
"Accounting for Stock-Based Compensation." The provisions of SFAS No. 123 allow
companies to either expense the estimated fair value of stock options or to
continue to follow the intrinsic value method set forth in APB Opinion 25,
"Accounting for Stock Issued to Employees" ("APB 25") but disclose the pro forma
effects on net income (loss) had the fair value of the options been expensed.
The Company has elected to continue to apply APB 25 in accounting for its stock
option incentive plans (see Note 17).

Reclassification. Certain amounts in prior years' supplemental consolidated
financial statements have been reclassified to conform to the current year
presentation. To conform the classification of bad debt between the Company and
Netscape, the Company has reclassified bad debt expense from a net revenue
presentation and now reflects this expense as a component of General and
Administrative costs in all periods presented.

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.
<PAGE>

In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which is required to be adopted in years
beginning after June 15, 1999. The Statement permits early adoption as of the
beginning of any fiscal quarter after its issuance. The Statement will require
the Company to recognize all derivatives on the balance sheet at fair value.
Derivatives that are not hedges must be adjusted to fair value through income.
If the derivative is a hedge, depending on the nature of the hedge, changes in
the fair value of derivatives will either be offset against the change in fair
value of the hedged assets, liabilities, or firm commitments through earnings or
recognized in other comprehensive income until the hedged item is recognized in
earnings. The ineffective portion of a derivative's change in fair value will be
immediately recognized in earnings. The Company has not yet determined if it
will early adopt and what the effect of SFAS No. 133 will be on the earnings and
financial position of the Company.

SOP 98-9, "Modification of SOP 97-2, Software Revenue Recognition, With
Respect to Certain Transactions" was issued in December 1998 and addresses
software revenue recognition as it applies to certain multiple-element
arrangements. SOP 98-9 also amends SOP 98-4, "Deferral of the Effective Date of
a Provision of SOP 97-2", to extend the deferral of application of certain
passages of SOP 97-2 through fiscal years beginning on or before March 15, 1999.
All other provisions of SOP 98-9 are effective for transactions entered into in
fiscal years beginning after March 15, 1999. The Company will comply with the
requirements of this SOP as they become effective and this is not expected to
have a material effect on the Company's revenues and earnings.

Note 3. Change in Accounting Estimate

As a result of a change in accounting estimate, the Company recorded a
charge of $385 million ($0.46 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

<PAGE>

At the end of the second and beginning of the third quarters of fiscal
1998, the Company recorded a $35 million restructuring charge associated with
actions aimed at reducing its cost structure, improving its competitiveness, and
restoring sustainable profitability mainly related to the Enterprise
organization. The restructuring plan resulted from decreased demand for certain
Netscape products and the adoption of a new strategic direction. The
restructuring included a reduction in the workforce (approximately 400
employees), the closure of certain facilities, the write-off of non-performing
operating assets, and third-party royalty payment obligations relating to
canceled contracts.

The following table summarizes the activity in the restructuring accruals
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 supplemental consolidated balance sheet and is anticipated to be paid in
fiscal 1999.

<TABLE>

(in millions)
Balance
Restructuring Non Cash June 30,
Charges Items Payments Transfers 1998
------------- -------- -------- --------- --------

<S> <C> <C> <C> <C> <C>
Termination of third
party agreements.............. $20 $(6) $(13) $- $1
Severance and related costs..... 23 (2) (19) (1) 1
Write-off of impaired assets.... 16 (18) - 2 -
Facilities shutdown costs....... 11 (7) - (1) 3
------------- -------- -------- --------- --------
Total........................... $70 $(33) $(32) $ - $ 5
============= ======== ======== ========= ========
</TABLE>

In connection with a restructuring plan adopted in the second quarter of
fiscal 1997, the Company recorded a $49 million restructuring charge associated
with the Company's change in business model, the reorganization of the Company
into three operating units, the termination of approximately 300 employees and
the shutdown of certain operating divisions and subsidiaries. As of September
30, 1997, substantially all of the restructuring activities had been completed
and the Company reversed $1 million of the original restructuring accrual.

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.
<PAGE>

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).......... $(71) $(485) $35
======= ======== =====
Denominator
Denominator for basic earnings per share - Weighted average shares.............. 923 838 751
Effect of dilutive securities:
Employee stock options.......................................................... - - 155
Warrants........................................................................ - - 37
Convertible debt................................................................ - - -
Convertible preferred stock..................................................... - - 1
------ -------- -----
Dilutive potential common shares................................................ - - 193
------ -------- -----
Denominator for diluted earnings per share - Adjusted weighted average shares
and assumed conversions.......................................................... 923 838 944
======= ======== =====
Basic earnings (loss) per share.................................................$(0.08) $(0.58) $0.05
======= ======== =====
Diluted earnings (loss) per share...............................................$(0.08) $(0.58) $0.04
======= ======== =====
</TABLE>

Note 8. Cash and Available-for-Sale Investments

The following table details the Company's available-for-sale investments
and their contractual maturities:

<TABLE>

(in millions)
June 30, 1998
-----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
--------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Municipal notes and bonds............................ $177 $ - $ - $177
Market auction preferred stock....................... 12 - - 12
Certificates of deposit.............................. 7 - - 7
Equity investments................................... 66 238 (4) 300
--------- ---------- ---------- ----------
$262 $238 $ (4) $496
========= ========== ========== ==========

Included in cash and cash equivalents................ $ 2 $ - $ - $ 2
Included in short-term investments................... 146 - - 146
Included in long-term investments.................... 114 238 (4) 348
--------- ---------- ---------- ----------
$262 $238 $ (4) $496
========= ========== ========== ==========

Due within one year.................................. $148 $ - $ - $148
Due after one year through five years................ 114 238 (4) 348
--------- ---------- ---------- ----------
$262 $238 $ (4) $496
========= ========== ========== ==========

June 30, 1997
-----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
--------- ---------- ---------- ----------
Municipal notes and bonds............................ $186 $ - $ - $186
Market auction preferred stock....................... 33 - - 33
Certificates of deposit.............................. 16 - - 16
Equity investments................................... 32 32 - 64
--------- ---------- ---------- ----------
$267 $32 $ - $299
========= ========== ========== ==========

Included in cash and cash equivalents................ $ 42 $ - $ - $ 42
Included in short-term investments................... 112 - - 112
Included in long-term investments.................... 113 32 - 145
--------- ---------- ---------- ----------
$267 $32 $ - $299
========= ========== ========== ==========

Due within one year.................................. $154 $ - $ - $154
Due after one year through five years................ 113 32 - 145
--------- ---------- ---------- ----------
$267 $32 $ - $299
========= ========== ========== ==========
</TABLE>

<PAGE>

Note 9. Business Combinations

Purchase Transactions

Acquisitions of Portola Communications, Inc., DigitalStyle Corporation and Actra
Business Systems LLC

In June 1997, the Company acquired Portola Communications, Inc. ("Portola")
and DigitalStyle Corporation ("DigitalStyle"), each a private company. The
Company purchased all of the outstanding capital stock of each of the
corporations and assumed all of their outstanding stock options in exchange for
an aggregate of approximately 1.8 million shares of the Company's common stock
and options. At the time of acquisition by the Company, options previously
outstanding for the acquired entities were exchanged for the Company's options
with similar terms. The fair value of the Company's options exchanged for
outstanding options in the stock of the acquired companies at the time of the
acquisitions was included as part of the purchase price of the respective
companies. The acquisitions were accounted for as purchase transactions in the
accompanying financial statements. The purchase price for Portola approximated
$35 million, which primarily consisted of $34 million of stock issued and $1
million of direct acquisition costs. The purchase price for DigitalStyle
approximated $26 million, which consisted primarily of $23 million of stock
issued and $2 million of direct acquisition costs. The aggregate purchase prices
were allocated to the fair value of the assets acquired. At the acquisition
date, Portola's primary in process research and development ("IPR&D") projects
involved work performed in the area of high-performance messaging systems with
an IMAP configuration. DigitalStyle's IPR&D projects primarily involved Web
graphics tools and Java-based animation.

In December 1997, the Company acquired the remaining equity interests of
Actra Business Systems LLC ("Actra") in exchange for an aggregate of
approximately 1.7 million shares of the Company's common stock and approximately
573,000 options at the time of acquisition by the Company, rights to Actra
options previously outstanding were exchanged for the Company's options with
similar terms. The fair value of the Company's options exchanged for rights to
Actra outstanding options at the time of the acquisition was included as part of
the purchase price. The acquisition was accounted for as a purchase transaction.
Actra had an aggregate purchase price of approximately $68 million, which
primarily consisted of $66 million of stock and stock options issued and $2
million of direct acquisition costs. The aggregate purchase price was allocated
to the fair value of the assets acquired. At the acquisition date, Actra's
primary IPR&D projects involved the design and delivery of next-generation
Internet commerce applications.

Purchased IPR&D for each of the above acquisitions represents the present
value of the estimated after-tax cash flows expected to be generated by the
purchased technology, which, at the acquisition dates, had not yet reached
technological feasibility. The cash flow projections for revenues were based on
estimates of relevant market sizes and growth factors, expected industry trends,
the anticipated nature and timing of new product introductions by the Company
and its competitors, individual product sales cycles, and the estimated life of
each product's underlying technology. Estimated operating expenses and income
taxes were deducted from estimated revenue projections to arrive at estimated
after-tax cash flows. Projected operating expenses include cost of goods sold,
marketing and selling expenses, general and administrative expenses, and
research and development, including estimated costs to maintain the products
once they have been introduced into the market and are generating revenue. The
amortization tax benefit assumes that the estimated technology value will be
amortized for tax purposes over a period of 15 years. The rates utilized to
discount projected cash flows were 30% to 40% for in-process technologies and
25% for developed technology and were based primarily on venture capital rates
of return and the weighted average cost of capital for the Company at the time
of each acquisition.

As of the date of each of the acquisitions, the Company concluded that the
in-process technology had no alternative future use after taking into
consideration the potential use of the technology in different products, the
stage of development and life cycle of each project, resale of the software, and
internal use. The value of the purchased IPR&D was expensed at the time of each
of the acquisitions.
<PAGE>

Acquisition of CompuServe Online Services Business

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>

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 $60 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 Portola, DigitalStyle, Actra,
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 each applicable 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............................. $3,227 $2,517
Loss from operations................ $(53) $(482)
Net Loss............................ $ (8) $(482)
Loss per share-diluted.............. $(0.01) $(0.57)
Loss per share-basic................ $(0.01) $(0.57)
<PAGE>

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 approximately 2.9 million
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.
Approximately 3.1 million 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, approximately 350,000 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 Transactions

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 approximately 12.9 million
shares of common stock for all the outstanding common and preferred stock of
Johnson-Grace. Additionally, approximately 580,000 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
supplemental 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>

In April 1996, the Company completed its business combination with InSoft,
Inc. ("InSoft"), a provider of network-based communications and collaborative
multimedia software for the enterprise. The Company exchanged an aggregate of
approximately 1.8 million shares of common stock and options for all of the
outstanding capital stock and stock options of InSoft, a privately held company.
The business combination was treated as a pooling-of-interests for accounting
purposes, and, accordingly, the historical financial statements of the Company
have been restated as if the transaction occurred at the beginning of the
earliest period presented. In connection with the business combination, the
Company incurred direct transaction costs of approximately $5 million, which
consisted of fees for investment banking, legal and accounting services, and
other related expenses incurred in conjunction with the business combination.
Intercompany transactions between InSoft and the Company were not material.
During the year ended June 30, 1996, InSoft's revenue and net loss was
approximately $2 million and $4 million, respectively.

In April 1996, the Company completed its business combination with Netcode
Corporation ("Netcode"), a creator of a Java-based visual interface builder and
object toolkit for rapidly developing Java applications. The Company exchanged
shares of common stock and options for all of the outstanding capital stock and
stock options of Netcode, a privately held company. The business combination was
treated as a pooling-of-interests for accounting purposes. As Netcode's
historical results of operations were not material in relation to those of the
Company, the financial information prior to January 1, 1996 has not been
restated to reflect the business combination. In connection with the business
combination, the Company incurred direct transaction costs of less that $1
million which consisted of fees for legal and accounting services, and other
related expenses incurred in conjunction with the business combination.
Intercompany transactions between Netcode and the Company were not material.

In May 1996, the Company completed its business combination with Paper
Software, Inc. ("Paper"), a provider of distributed three-dimensional graphics
and maker of WebFX VRML software. The Company exchanged shares of common stock
for all of the outstanding capital stock of Paper, a privately held company. The
business combination was treated as a pooling-of-interests for accounting
purposes. As Paper's historical results of operations were not material in
relation to those of the Company, the financial information prior to January 1,
1996 has not been restated to reflect the business combination. In connection
with the business combination, the Company incurred direct transaction costs of
less than $1 million, which consisted of fees for legal and accounting services,
and other related expenses incurred in conjunction with the business
combination. Intercompany transactions between Paper and the Company were not
material.

In December 1997, the Company completed its business combination with KIVA
Software Corporation ("KIVA"). The Company exchanged approximately 5.4 million
shares of common stock, which included approximately 666,000 shares reserved for
issuance upon exercise of options granted to KIVA employees, for all of the
outstanding capital stock and options of KIVA, a privately held company. The
business combination was treated as a pooling-of-interests for accounting
purposes, and accordingly the historical financial statements of the Company
have been restated as if the transaction occurred at the beginning of the
earliest period presented. In connection with the business combination, the
Company incurred direct transaction costs of approximately $6 million, which
consisted primarily of fees for investment banking, legal and accounting
services incurred in conjunction with the business combination. Intercompany
transactions between KIVA and the Company were not material. For the year ended
June 30, 1997, KIVA's revenues were approximately $5 million and were immaterial
for the year ended June 30, 1996. For the years ended June 30, 1997 and 1996,
KIVA's net loss was approximately $6 million and $2 million respectively.

<PAGE>

In November 1995, the Company completed its business combination with
Collabra Software, Inc. ("Collabra"), a creator of collaborative computing
software. The Company exchanged approximately 3.3 million shares of common stock
and options for all of the outstanding capital stock and stock options of
Collabra, a privately held company. The business combination was treated as a
pooling-of-interests for accounting purposes and accordingly, the historical
financial statements of the Company have been restated as if the transaction
occurred at the beginning of the earliest period presented. In connection with
the business combination, the Company incurred direct transaction costs of
approximately $2 million, which consisted of fees for investment banking, legal
and accounting services, and other related expenses incurred in conjunction with
the merger.

Note 10. Segment Information

Statement of Financial Accounting Standards (SFAS) No. 14, "Financial
Reporting for Segments of a Business Enterprise" requires that financial
statements of a business enterprise include specified information relating to a
reporting entity's operation in different industries, its foreign operations and
export sales, and its major customers. SFAS No. 14 described the information to
be presented and the formats for presenting such information. It also describes
the materiality thresholds for determining the requirement to delineate this
information. After evaluating these criteria, the Company determined that there
is not a SFAS No. 14 requirement to report segments. However, management
believes that the disclosure of certain operating results may be beneficial to
the reader. For purposes of this note the Company describes its two major lines
of Internet businesses as Interactive Online Services and Enterprise Solutions.
The Interactive Online Services business mainly includes the two worldwide
Internet services, America Online and CompuServe. It also includes; the
Interactive Properties Group, a leading builder of Internet brands across
multiple services and platforms including Digital City, Inc., which offers a
network of local content and community guides, and ICQ, which provides instant
communications and chat technology. Other branded Internet services included in
this group are: AOL.COM, the world's most accessed Web Site from home; AOL
NetFind, a comprehensive guide to the Internet; AOL Instant Messenger, an
instant messaging tool available on both AOL and the Internet and as a result of
the merger of Netscape, Netcenter was added to this group. Netcenter includes
Netscape's Internet portal and client business that helps companies build, buy,
or outsource Internet applications. The Enterprise Solutions business provides a
wide range of software products, technical support, consulting and training
services. These solutions have historically enabled businesses and users to
share information, manage networks, and facilitate electronic commerce.

A summary of the segment financial information is as follows:
<TABLE>

(amounts in millions)
For the years ended June 30,
1998 1997 1996
------------ ------------ ------------
Revenues:
<S> <C> <C> <C>
Interactive Online Services................. $2,724 $1,786 $1,135
Enterprise Solutions........................ 365 411 188
------------ ------------ ------------
Total revenues.......................... 3,089 2,197 1,323

Income (loss) from operations:
Interactive Online Services (1)............. $ 411 $ (257) $ 174
Enterprise Solutions........................ (18) 98 39
General & Administrative.................... (323) (220) (124)
Other (2)................................... (186) (106) (25)
------------ ------------ ------------
Total income (loss) from operations..... $ (116) $ (485) $ 64

(1) Loss from operations for the year ended June 1997 includes $385 million
write-off of deferred subscriber acquisition costs.
(2) Other consists of all special items; merger, restructuring, contract
termination, acquired in-process research and development and settlement
charges.
</TABLE>
<PAGE>

Note 11. 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.............. 149 77
Furniture and fixtures.......................... 42 31
Computer equipment and internal software........ 340 253
Construction in progress........................ 36 34
---- ----
689 437
Less accumulated depreciation and amortization.. 186 93
Less restructuring-related adjustments.......... 1 -
---- ----
Net property and equipment...................... $502 $344
==== ====

The Company's depreciation and amortization expense for the years ended
June 30, 1998, 1997 and 1996 totaled $110 million, $46 million and $21 million,
respectively.

Note 12. 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................ $238
2000................ 182
2001................ 104
2002................ 54
2003................ 32
Thereafter.......... 155
-----
$765
=====

The Company's rental expense under operating leases in the years ended June
30, 1998, 1997 and 1996 totaled approximately $261 million, $154 million and $51
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 will 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>

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 13. 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 76.63752
shares of common stock for each $1,000 principal amount of the Notes (equivalent
to a conversion price of $13.04844 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.

<PAGE>

Notes payable at June 30, 1997, totaled $52 million and mainly consists of
a two year senior secured revolving credit facility ("Credit Facility"). The
Company anticipates using the Credit Facility for the purpose of supporting its
continuing growth and network expansion. The interest rate on the Credit
Facility is 100 basis points above the London Interbank Offered Rate and
interest is paid periodically, but at least quarterly. The Credit Facility is
subject to certain financial covenants and is payable in full at the end of the
two year term, on July 1, 1999. As of June 30, 1998, there are no outstanding
amounts on the Credit Facility.

Note 14. Other Income, Net

The following table summarizes the components of other income:

Year ended June 30
-----------------
(in millions) 1998 1997 1996
----- ----- -----
Interest income................................ $35 $16 $15
Interest expense............................... (13) (2) (1)
Allocation of losses to minority shareholders.. 6 15 -
Equity investment losses....................... (10) (10) (1)
Gain (loss) on investments..................... 7 (9) 1
Other income (expense)......................... 4 - (9)
----- ----- -----
$29 $10 $ 5
===== ===== =====

Note 15. Income Taxes

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

Year Ended June 30,
-------------------
(in millions) 1998 1997 1996
------ ------ -----
<S> <C> <C> <C>
Income before (provision) benefit for income taxes..................... $16 $(10) $(34)
====== ====== =====
Charge in lieu of taxes attributable to the Company's stock option plans.. $ - $ - $(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>
Income (tax) benefit at the federal statutory rate of 35%.......... $29 $167 $(24)
State income (tax) benefit, net of federal benefit.................. (6) 14 (3)
Nondeductible charge for purchased research and development........... (28) (3) (6)
Valuation allowance changes affecting the provision for income taxes. 32 (181) 1
Other................................................................. (11) (7) (2)
----- ------- ----
$16 $(10) $(34)
===== ======= ====
</TABLE>

As of June 30, 1998, the Company has net operating loss carryforwards of
approximately $1,074 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>

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:

June 30
-------------
(in millions) 1998 1997
------ ------
Short term:
Short term deferred tax assets:
Restructure reserve............................... $32 $ 8
Deferred revenue.................................. 30 11
Accrued expenses and other........................ 19 13
Valuation allowance............................... (38) (7)
------ ------
Total............................................. $43 $25
====== ======
Long term:
Long term deferred tax liabilities:
Capitalized software costs........................ (33) (24)
Unrealized gain on available-for-sale securities.. (89) (1)
------ ------
Total............................................. (122) (25)

Long term deferred tax assets:
Net operating loss carryforwards.................. 412 304
Deferred network services credit.................. 131 -
Other............................................. 8 -
Valuation allowance............................... (426) (275)
------ ------
Total............................................. 125 29
------ ------
Net long term deferred asset.............. $ 3 $ 4
====== ======

The valuation allowance for deferred tax assets increased by $182 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 $321 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 $0.08, respectively.
<PAGE>

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

June 30,
-----------
(in millions) 1998 1997
----- -----
Operations..... $663 $712
Stock options..$1,009 $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 16. Capital Accounts

Common Stock. At June 30, 1998 and 1997, the Company's $.01 par value
common stock authorized was 1,800,000,000 shares with 969,340,398 and
888,039,588 shares issued and outstanding, respectively. At June 30, 1998,
280,599,104 shares were reserved for the exercise of issued and unissued common
stock options, a warrant and convertible debt, and 1,351,604 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 1,568,000 shares of common stock based on the fair market value of common
stock at the time of conversion.

In August 1995, the Company closed its initial public offering related to
its Netscape common stock. At that time, all issued and outstanding shares of
Netscape convertible preferred stock were converted into common stock.

Warrant. In connection with an agreement with one of the Company's
communications providers, the Company had an outstanding warrant, exercisable
through March 31, 1999, subject to certain performance standards specified in
the agreement, to purchase 28,800,000 shares of common stock at a price of
$0.4922 per share.
<PAGE>

Shareholder Rights Plan. The Company adopted a new shareholder rights plan
on May 12, 1998 (the "New Plan"). The New Plan was implemented by declaring a
dividend, distributable to stockholders of record on June 1, 1998, of one
preferred share purchase right (a "Right") for each outstanding share of common
stock. All rights granted under the Company's former shareholder rights plan
adopted in fiscal 1993 were redeemed in conjunction with the implementation of
the New Plan and the former plan was terminated. Each Right under the New Plan
will initially entitle registered holders of the common stock to purchase one
one-thousandth of a share of the Company's new Series A-1 Junior Participating
Preferred Stock ("Series A-1 Preferred Stock") at a purchase price of $900 per
one one-thousandth of a share of Series A-1 Preferred Stock, subject to
adjustment. The Rights will be exercisable only if a person or group (i)
acquires 15% or more of the common stock or (ii) announces a tender offer that
would result in that person or group acquiring 15% or more of the common stock.
Once exercisable, and in some circumstances if certain additional conditions are
met, the New Plan allows stockholders (other than the acquirer) to purchase
common stock or securities of the acquirer having a then current market value of
two times the exercise price of the Right. The Rights are redeemable for $.001
per Right (subject to adjustment) at the option of the Board of Directors. Until
a Right is exercised, the holder of the Right, as such, has no rights as a
stockholder of the Company. The Rights will expire on May 12, 2008 unless
redeemed by the Company prior to that date.

Stock Splits. In November 1994, April 1995, November 1995, March 1998,
November 1998 and February 1999, the Company effected two-for-one splits of the
outstanding shares of common stock. Accordingly, all data shown in the
accompanying supplemental consolidated financial statements and notes has been
retroactively adjusted to reflect the stock splits.

Note 17. 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. In certain of these plans, the Company has repurchase
rights upon the individual cessation of employment. Generally, these rights
lapse over a 48-month period. In fiscal years 1998 and 1997, the Board of
Directors authorized approximately 11 million options to be repriced. The
vesting schedules were not materially changed and no employees owning 3% or more
of the Company's common stock nor any senior executives participated in the
repricing.

The effect of applying SFAS No. 123 on 1998 and 1997 pro forma net 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 loss in 1998, 1997 and 1996 would have been approximately $287
million, $625 million and $12 million, or $0.31 per share, $0.75 per share and
$0.01 per share, respectively, on a diluted basis. The fair value of the options
granted during 1998, 1997 and 1996 are estimated at $5.28 per share, $1.13 per
share and $2.05 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:
<PAGE>

Number Weighted-
of average exercise
shares price
------------- ----------------
Balance at June 30, 1995.. 287,610,319 $ 1.15
Granted................... 47,363,383 $12.61
Exercised................. (52,370,259) $ 0.73
Forfeited................. (17,275,354) $ 2.74
------------- ----------------
Balance at June 30, 1996.. 265,328,089 $ 2.50
Granted................... 60,068,831 $18.66
Exercised................. (56,097,082) $ 1.31
Forfeited................. (29,113,176) $11.21
------------- ----------------
Balance at June 30, 1997.. 240,186,662 $ 3.31
Granted................... 85,796,199 $14.19
Exercised................. (74,237,999) $ 1.57
Forfeited................. (29,119,539) $16.72
------------- ----------------
Balance at June 30, 1998.. 222,625,323 $ 5.98
============= ================

<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 $0.95..... 48,067,744 5.6 $0.72 33,338,912 $0.67
$0.96 to $2.40..... 42,330,960 6.7 $1.91 24,393,680 $1.89
$2.41 to $5.35..... 47,610,101 8.0 $3.53 11,097,593 $3.57
$5.50 to $12.25.... 51,169,824 9.1 $8.59 3,268,796 $7.06
$12.50 to $27.38... 31,011,766 9.4 $17.45 96,702 $16.88
$27.39 to $75.89... 2,434,928 9.6 $27.51 272,442 $40.11
- ------------------- ------------- --------------- --------- -------------- ---------
$0.01 to $75.89.... 222,625,323 7.7 $5.98 72,468,125 $1.98
============= =============== ========= ============== =========
</TABLE>

Employee Stock Purchase Plan. In May 1992, the Company's Board of Directors
adopted an Employee Stock Purchase Plan ("the ESPP"). Under the ESPP, employees
of the Company who elect to participate are granted options to purchase common
stock at a 15 percent discount from the market value of such stock. The ESPP
permits an enrolled employee to make contributions to purchase shares of common
stock by having withheld from his or her salary an amount between 1 percent and
10 percent of compensation. The ESPP is 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 6,400,000. A total of
approximately 5 million shares of common stock has been issued under the ESPP.

In June 1995, the Company adopted an Employee Stock Purchase Plan ("the
Netscape ESPP") under Section 423 of the Internal Revenue Code and reserved
1,800,000 shares of common stock for issuance under the plan. In May 1998, the
Company's shareholders approved an increase to this reserve of an additional
1,350,000 shares. Additionally, the Company's Board of Directors in 1998 amended
the Netscape ESPP to increase the maximum percentage of payroll deductions which
any participant may contribute from his or her eligible compensation to 15%;
amended the Netscape ESPP from a two-year rolling offering period to a six-month
fixed offering period effective with the offering period beginning March 1999;
amended the limit to the number of shares any employee may purchase in any
purchase period to a maximum of 1,800 shares; and changed the offering dates for
each purchase period to March 1 and September 1 of each year. Under this plan,
qualified employees are entitled to purchase shares at 85% of fair market value.
Approximately 1 million shares of common stock has been issued under the
Netscape ESPP.
<PAGE>

Note 18. Employee Benefit Plan

Savings Plans. The Company has two savings plans that qualify as a deferred
salary arrangement under Section 401(k) of the Internal Revenue Code. Under the
plans, participating employees may defer a portion of their pretax earnings. In
one plan, the Company matches 50% of each employee's contributions up to a
maximum matching contribution of 3% of the employee's earnings and in the other
plan, the Company's contributions are discretionary. The Company's contributions
to plans were approximately $5 million, $3 million and $1 million in the years
ended June 30, 1998, 1997 and 1996, respectively.

Note 19. Subsequent Events

During July 1998, the Company completed a public offering of common stock.
The Company sold 21,560,000 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.

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 1.4 million 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. During the
year ended June 30, 1998, PersonaLogic's revenues and net loss were
approximately $1 million and $4 million, respectively.

On March 17, 1999, the Company completed its merger with Netscape, in which
Netscape became a wholly owned subsidiary of the Company. The Company exchanged
approximately 95 million shares of common stock for all the outstanding common
shares of Netscape. The merger was accounted for under the pooling-of-interests
method of accounting and, accordingly, the accompanying financial statements and
footnotes have been restated to include the operations of Netscape for all
periods presented. During the quarter ended March 1999, the Company expects to
record a charge of approximately $78 million of incurred direct costs primarily
related to the merger of Netscape and the Company's reorganization plans to
integrate Netscape's operations and build on the strengths of the Netscape brand
and capabilities. This charge primarily consists of banker fees, severance and
other personnel costs, fees for legal and accounting services, and other
expenses directly related to the transaction. The Company also expects to incur
in the third quarter approximately $25 million in transition and retention
costs, which will be charged to operations as incurred. For the years ended June
30, 1998, 1997 and 1996, Netscape's revenues were approximately $452 million,
$461 million and $196 million, respectively. For the years ended June 30, 1998,
1997 and 1996, Netscape's net income (loss) was approximately $(159) million,
$14 million and $6 million, respectively.

<PAGE>

Note 20. Recent Events (unaudited)

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.

On October 21, 1998, the Company's stockholders approved an amendment to
the Company's Restated Certificate of Incorporation to increase the authorized
number of shares of common stock from 600,000,000 to 1,800,000,000. The increase
in authorized shares has been reflected in the Supplemental Consolidated
Financial Statements as of June 30, 1998.

On October 27, 1998, the Company announced that its Board of Directors
approved a two-for-one common stock split. On the payment date of November 17,
1998, stockholders received one additional share for each share owned on the
record date of November 3, 1998. The impact of this stock split has been
reflected in the accompanying financial statements.

In December 1998, the Company completed its merger with AtWeb, Inc.
("AtWeb"), in which AtWeb became a wholly owned subsidiary of the Company. The
Company exchanged approximately 2.4 million shares of common stock for all the
outstanding capital stock of AtWeb. The merger was accounted for under the
pooling-of-interests method of accounting. As AtWeb's historical results of
operations were not material in relation to those of the Company, the historical
financial information, prior to November 1, 1998, have not been restated to
reflect the business combination.

From January 1999 through March 1999, The Company sold its investments in
Excite, Inc for a net gain of approximately $567 million. The Company expects to
record this amount as a gain during the quarter ended March 1999.

On January 27, 1999, the Company announced that its Board of Directors
approved a two-for-one common stock split. On the payment date of February 22,
1999, stockholders received one additional share for each share owned on the
record date of February 8, 1999. The impact of this stock split is reflected in
the accompanying financial statements.

On February 1, 1999, the Company announced that it would acquire MovieFone,
Inc., ("MovieFone") in an all-stock transaction valued at approximately $388
million. The acquisition is expected to be accounted for as a
pooling-of-interests and is expected to close in the spring of 1999, subject to
various conditions including customary regulatory approvals and approval by
MovieFone's shareholders.

During March 1999, all the exercisable warrants outstanding to one of the
Company's communications providers (see Note 16) were exercised.

During March 1999, the Company completed its business combination with
When, Inc. ("When.com"), a company that provides a personalized event directory
and calendar services. AOL exchanged shares of its common stock for all of the
outstanding capital stock of When.com, a privately held company. The business
combination was treated as a pooling-of-interests for accounting purposes. As
When.com's historical results of operations were not material in relation to
those of AOL, the financial information prior to the quarter ended March 31,
1999 has not been restated to reflect the business combination.

The Department of Labor ("DOL") is investigating the applicability of the
Fair Labor Standards Act to the Company's Community Leader program. The Company
believes the Community Leader program reflects industry practices, that the
Community Leaders are volunteers, not employees, and that the Company's actions
comply with law. The Company is cooperating with the DOL, but is unable to
predict the outcome of the DOL's investigation.
<PAGE>

Note 21. Quarterly Information (unaudited)

<TABLE>
Quarter Ended
------------------------------------------------
(Amounts in millions, except per share data) September 30, December 31, March 31, June 30,
------------- ------------ --------- --------
Fiscal 1999(1)
<S> <C> <C> <C> <C>
Subscription service revenues............... $723 $786
Advertising, commerce and other revenues.... 175 243
Enterprise solution revenues................ 101 118
------------- ------------
Total revenues.............................. 999 1,147
Income from operations...................... 80 127
Net income ........................... 79 119
Net income per share-diluted......... $0.07 $0.10
Net income per share-basic........... $0.08 $0.12

Fiscal 1998(2)(4)
Subscription service revenues............... $439 $488 $580 $676
Advertising, commerce and other revenues.... 106 131 142 162
Enterprise solution revenues................ 123 104 35 103
------------- ------------ --------- --------
Total revenues.............................. 668 723 757 941
Income (loss) from operations...................... 25 (52) (82) (7)
Net income (loss)........................... 32 (34) (78) 9
Net income (loss) per share-diluted......... $0.03 $(0.04) $(0.08) $0.01
Net income (loss) per share-basic........... $0.04 $(0.04) $(0.08) $0.01

Fiscal 1997(3)(4)(5)
Subscription service revenues............... $325 $366 $393 $394
Advertising, commerce and other revenues.... 47 66 84 111
Enterprise solution revenues................ 94 106 101 110
------------- ------------ --------- --------
Total revenues.............................. 466 538 578 615
Loss from operations........................ (348) (118) (1) (18)
Net income (loss)....................................(346) (121) 1 (19)
Net income (loss) per share-diluted.................$(.43) $(0.15) $0.01 $(0.02)
Net income (loss) per share-basic...................$(.43) $(0.15) $0.01 $(0.02)
============= ============ ========= ========
</TABLE>

The special charges referred to below include charges for restructurings,
acquired in-process research and development, mergers, settlements, write-off of
deferred subscriber acquisition costs and contract terminations.

(1) Net income in the six months ended December 31, 1998 includes special
charges of $2 million in the quarter ended December 31, 1998.

(2) Net loss in the fiscal year ended June 30, 1998, includes net charges of $42
million quarter ended December 31, 1997, $58 million in the quarter ended March
31, 1998 and $88 million in the quarter ended June 30, 1998.

(3) Net loss in the fiscal year ended June 30, 1997, includes special charges of
$385 million in the quarter ended September 30, 1996, $73 million in the quarter
ended December 31, 1996 and $33 million in the quarter ended June 30, 1997.

(4) 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.

(5) 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 20th day of
April, 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 supplemental consolidated balance sheets
of America Online, Inc. as of June 30, 1998 and 1997, and the related
supplemental 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 supplemental
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 supplemental 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 15 to the supplemental 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 second paragraph of Note 19, as to which the date is February 15,
1999 and for the third paragraph of Note 19, as to which the date is April 15,
1999

Exhibit 23 Consent of Independent Auditors

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), ii) Form S-4 333-72499 and iii)
Form S-8 (listed below) of our report dated September 25, 1998 (except for the
second paragraph of Note 19, as to which the date is February 15, 1999 and the
third paragraph of Note 19, as to which the date is April 15, 1999), with
respect to the supplemental consolidated financial statements of America Online,
Inc., included in its Current Report on Form 8-K/A expected to be filed on April
20, 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

25) 333-74521 33) 333-74537
26) 333-74523 34) 333-74539
27) 333-74525 35) 333-75451
28) 333-74527 36) 333-74543
29) 333-74529
30) 333-74531
31) 333-74533
32) 333-74535

/s/ ERNST & YOUNG LLP

Vienna, Virginia
April 15, 1999