FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] Quarterly Report under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended: September 30, 1999
OR
[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number:
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 Identification No.)
incorporation or organization)
22000 AOL Way, Dulles, Virginia 20166-9323
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (703) 265-1000
Former name, former address, and former year, if changed since last report:
Not applicable
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
Indicate the number of shares outstanding of each of the Issuer's classes of
Common Stock, as of the latest practicable date.
Title of each class
Common stock $.01 par value
Shares outstanding on October 15, 1999.............................1,117,743,377
<PAGE>
AMERICA ONLINE, INC.
INDEX
Page
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets - September 30, 1999
and June 30, 1999 3
Condensed Consolidated Statements of Operations - Three
months ended September 30, 1999 and 1998 4
Condensed Consolidated Statements of Cash Flows - Three
months ended September 30, 1999 and 1998 5
Condensed Consolidated Statement of Changes in
Stockholders' Equity - Three months ended
September 30, 1999 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
PART II. OTHER INFORMATION 17
Item 6. Exhibits 17
Signatures 18
<PAGE>
<TABLE>
<CAPTION>
AMERICA ONLINE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in millions, except share data)
September 30, June 30,
1999 1999
------------- --------
(Unaudited)
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents........................................................... $1,330 $ 887
Short-term investments.............................................................. 429 537
Trade accounts receivable, less allowances of $55 and $54, respectively............. 346 323
Other receivables................................................................... 122 79
Prepaid expenses and other current assets........................................... 181 153
------------ ---------
Total current assets................................................................ 2,408 1,979
Property and equipment at cost, net................................................. 744 657
Other assets:
Investments including available-for-sale securities................................. 2,760 2,151
Product development costs, net...................................................... 110 100
Goodwill and other intangible assets, net........................................... 422 454
Other assets and deferred income taxes.............................................. 58 7
------------ ---------
$6,502 $5,348
============ =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable.............................................................. $ 88 $ 74
Other accrued expenses and liabilities.............................................. 941 795
Deferred revenue.................................................................... 711 646
Accrued personnel costs............................................................. 195 134
Deferred network services credit.................................................... 76 76
------------ ---------
Total current liabilities........................................................... 2,011 1,725
Long-term liabilities:
Notes payable....................................................................... 341 348
Deferred revenue.................................................................... 111 30
Other liabilities................................................................... 12 15
Deferred network services credit.................................................... 178 197
------------ ---------
Total liabilities................................................................... 2,653 2,315
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares authorized, no shares issued
or outstanding at September 30 and June 30, 1999.................................. - -
Common stock, $.01 par value; 1,800,000,000 shares authorized,
1,116,859,792 and 1,100,893,933 shares issued and outstanding at
September 30 and June 30, 1999, respectively..................................... 11 11
Additional paid-in capital.......................................................... 3,079 2,703
Accumulated other comprehensive income - unrealized gain on
available-for-sale securities, net................................................ 424 168
Retained earnings................................................................... 335 151
------------ ---------
Total stockholders' equity.......................................................... 3,849 3,033
------------ ---------
$6,502 $5,348
============ =========
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
AMERICA ONLINE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in millions, except per share data)
(Unaudited)
Three months ended
September 30,
1999 1998
-------- --------
Revenues:
<S> <C> <C>
Subscription services..................................................... $ 995 $ 723
Advertising, commerce and other........................................... 350 175
Enterprise solutions...................................................... 122 101
-------- --------
Total revenues............................................................ 1,467 999
Costs and expenses:
Cost of revenues.......................................................... 791 583
Sales and marketing....................................................... 209 174
Product development....................................................... 67 67
General and administrative................................................ 117 82
Amortization of goodwill and other intangible assets...................... 18 16
-------- --------
Total costs and expenses.................................................. 1,202 922
Income from operations... ................................................ 265 77
Other income, net......................................................... 37 5
-------- --------
Income before provision for income taxes.................................. 302 82
Provision for income taxes................................................ (118) (6)
-------- --------
Net income................................................................ $ 184 $ 76
======== ========
Earnings per share:
Earnings per share-diluted................................................ $ 0.14 $ 0.06
Earnings per share-basic.................................................. $ 0.17 $ 0.08
Weighted average shares outstanding-diluted............................... 1,287 1,199
Weighted average shares outstanding-basic................................. 1,110 997
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
AMERICA ONLINE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in millions)
(Unaudited)
Three months ended
September 30,
1999 1998
------- -------
Cash flows from operating activities:
<S> <C> <C>
Net income ............................................................................ $ 184 $ 76
Adjustments to reconcile net income to net cash provided by operating activities:
Non-cash restructuring charges......................................................... 2 -
Amortization of deferred network services credit....................................... (19) (19)
Depreciation and amortization.......................................................... 79 67
Compensatory stock options............................................................. 3 3
Deferred income taxes.................................................................. 117 6
Changes in assets and liabilities, net of the effects of acquisitions and dispositions:
Trade accounts receivable............................................................ (24) (43)
Other receivables.................................................................... (43) (44)
Prepaid expenses and other current assets............................................ (27) (9)
Other assets......................................................................... (52) 4
Investments including available-for-sale securities.................................. (99) 4
Accrued expenses and other current liabilities....................................... 204 30
Deferred revenue and other liabilities............................................... 147 45
------- -------
Total adjustments...................................................................... 288 44
------- -------
Net cash provided by operating activities.............................................. 472 120
Cash flows from investing activities:
Purchase of property and equipment..................................................... (134) (63)
Product development costs.............................................................. (18) (10)
Proceeds from sale of investments...................................................... - 14
Purchase of investments, including available-for-sale securities....................... (94) (82)
Proceeds of short-term investments, net................................................ 108 89
Other investing activities............................................................. 15 (13)
------- -------
Net cash used in investing activities.................................................. (123) (65)
Cash flows from financing activities:
Proceeds from issuance of common stock, net........................................... 97 602
Principal and accrued interest payments on line of credit and debt..................... (3) (1)
Proceeds from line of credit and issuance of debt...................................... - 1
------ -------
Net cash provided by financing activities.............................................. 94 602
------ -------
Net increase in cash and cash equivalents.............................................. 443 657
Cash and cash equivalents at beginning of period....................................... 887 677
------- -------
Cash and cash equivalents at end of period............................................. $1,330 $1,334
======= =======
Supplemental cash flow information
Cash paid during the period for:
Interest............................................................................... $ 2 $ 5
======= =======
See accompanying notes.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
AMERICA ONLINE, INC.
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Amounts in millions, except share data)
(Unaudited)
Accumulated
Common Stock Additional Other
----------------------- Paid-In Comprehensive Retained
Shares Amount Capital Income, Net Earnings Total
-------------- ------- --------- --------------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
Balances at June 30, 1999................. 1,100,893,933 $ 11 $ 2,703 $ 168 $ 151 $3,033
Common stock issued:
Exercise of options.................... 15,907,999 - 97 - - 97
Amortization of compensatory
stock options.......................... - - 3 - - 3
Unrealized gain on
available-for-sale securities, net..... - - 157 256 - 413
Conversion of debt........................ 57,860 - 1 - - 1
Tax benefit related to stock options...... - - 118 - - 118
Net income................................ - - - - 184 184
-------------- ------- --------- --------------- ------------ ---------
Balances at September 30, 1999............ 1,116,859,792 $ 11 $ 3,079 $ 424 $ 335 $3,849
============== ======= ========= =============== ============ ========
See accompanying notes.
</TABLE>
<PAGE>
AMERICA ONLINE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements,
which include the accounts of America Online, Inc. (the "Company") and its
wholly and majority owned subsidiaries, have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments, consisting only of normal
recurring accruals considered necessary for a fair presentation, have been
included in the accompanying unaudited financial statements. All significant
intercompany transactions and balances have been eliminated in consolidation.
Operating results for the three months ended September 30, 1999 are not
necessarily indicative of the results that may be expected for the full year
ending June 30, 2000. For further information, refer to the consolidated
financial statements and notes thereto, included in the Company's Annual Report
on Form 10-K for the fiscal year ended June 30, 1999.
Note 2. Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share for the three months ended September 30, 1999 and 1998:
<TABLE>
Three months ended
September 30,
(in millions except for per share data) 1999 1998
-------- --------
Basic earnings per share:
<S> <C> <C>
Net income available to common shareholders................................... $ 184 $ 76
-------- --------
Weighted average shares outstanding........................................... 1,110 997
Basic earnings per share...................................................... $ 0.17 $ 0.08
======== ========
Diluted earnings per share:
Net income available to common shareholders................................... $ 184 $ 76
Interest on convertible debt, net of tax...................................... 2 -
-------- --------
Adjusted net income available to common shareholders
assuming conversion........................................................ $ 186 $ 76
-------- --------
Weighted average shares outstanding........................................... 1,110 997
Effect of dilutive securities:
Employee stock options..................................................... 157 174
Warrants................................................................... - 28
Convertible debt........................................................... 20 -
-------- --------
Adjusted weighted average shares and assumed conversions...................... 1,287 1,199
======== ========
Diluted earnings per share.................................................... $ 0.14 $ 0.06
======== ========
</TABLE>
<PAGE>
Note 3. Comprehensive Income
For the three months ended September 30, 1999 and 1998, comprehensive
income was $440 million and $31 million, respectively. The difference between
net income and comprehensive income for each period presented is due to net
unrealized gains or losses on available-for-sale securities.
Note 4. Merger and Restructuring Charges
During fiscal 1999, the Company recorded the following charges related to
mergers and restructurings:
o Approximately $15 million of direct costs primarily related to the
mergers of MovieFone, Inc. ("MovieFone"), Spinner Networks
Incorporated ("Spinner") and Nullsoft, Inc. ("Nullsoft"). These
charges primarily consisted of investment banker fees, severance and
other personnel costs, fees for legal and accounting services and
other expenses directly related to the transaction.
o Approximately $78 million of direct costs primarily related to the
mergers of Netscape and When, Inc. 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 investment banker fees, severance and other personnel
costs (related to the elimination of approximately 850 positions),
fees for legal and accounting services and other expenses directly
related to the transaction.
o Approximately $2 million in merger related costs in connection with
the merger of AtWeb, Inc. These expenses were primarily associated
with fees for investment banking, legal and accounting services,
severance costs and other related charges in connection with the
transaction.
The following table summarizes the activity during the period ended
September 30, 1999. The balance of the restructuring accrual is included in
other accrued expenses and liabilities on the consolidated balance sheet and is
expected to be paid by the end of this fiscal year.
<TABLE>
(in millions)
Balance Balance
June 30, Non Cash September 30,
1999 Items Payments 1999
------------- -------- -------- --------
Banking, legal, regulatory
<S> <C> <C> <C> <C>
and accounting fees........... $ 4 $ - $ (3) $ 1
Severance and related costs..... 11 (2) (3) 6
Facilities shutdown costs....... 8 - (1) 7
Miscellaneous expenses.......... (3) - - (3)
------------- -------- -------- --------
Total........................... $20 $ (2) $ (7) $11
============= ======== ======== ========
</TABLE>
Note 5. Segment Information
There are no intersegment revenues between the two reportable segments.
Shared support service functions such as human resources, facilities management
and other infrastructure support groups are allocated based on usage or
headcount, where practical, to the two operating segments. Charges that cannot
be allocated are reported as general & administrative costs and are not
allocated to the segments. Special charges determined to be significant are
reported separately in the Consolidated Statements of Operations and are not
assigned or allocated to the segments. All other accounting policies are applied
consistently to the segments, where applicable.
<PAGE>
A summary of the segment financial information is as follows:
<TABLE>
Three months ended
September 30,
1999 1998
------------ -----------
(Amounts in millions)
Revenues:
<S> <C> <C>
Interactive Online Services................. $1,345 $ 898
Enterprise Solutions........................ 122 101
------------ -----------
Total revenues.......................... $1,467 $ 999
Income (loss) from operations:
Interactive Online Services (1)............. $ 356 $ 166
Enterprise Solutions (2)................... 26 (7)
General & Administrative.................... (117) (82)
------------ -----------
Total income from operations............ $ 265 $ 77
1. For the periods ended September 30, 1999 and 1998, Interactive Online
Services include goodwill and other intangible assets amortization of $18
million and $16 million, respectively.
2. Enterprise Solutions amortization of goodwill and other intangible assets
is immaterial for periods presented.
</TABLE>
Note 6. Subsequent Events
On October 20, 1999, the Company entered into a strategic relationship with
Gateway, Inc. to increase growth of the Company's services. As part of the
agreement, the Company will invest $800 million in common and preferred stock in
Gateway, Inc. over a two-year period. Of the $800 million, $180 million will be
the Company's common stock and the remainder will be cash. In addition, Gateway,
Inc. will make an $85 million commitment to market software and Gateway, Inc.
products and services on the Company's brands. The Company expects to take a
pre-tax charge of $30 million in connection with its acquisition of an interest
in Gateway.net subscribers in the quarter in which the transaction closes.
On October 28, 1999, 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 1,800,000,000 to 6,000,000,000.
On October 28, 1999, the Board of Directors of the Company declared a
two-for-one common stock split, to be effected in the form of a stock dividend.
On the payment date of November 22, 1999, stockholders will receive one
additional share for each share owned on the record date of November 8, 1999.
The impact of this stock split is not reflected in the accompanying financial
statements.
Note 7. Legal Proceedings
The Department of Labor ("DOL") is investigating the applicability of the
Fair Labor Standards Act ("FLSA") 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 the law. The Company is cooperating with the DOL, but is
unable to predict the outcome of the DOL's investigation. Former volunteers have
sued the Company on behalf of an alleged class consisting of current and former
volunteers, alleging violations of the FLSA and comparable state statutes. The
Company believes the claims have no merit and intends to defend them vigorously.
The Company cannot predict the outcome of the claims or whether other former or
current volunteers will file additional actions.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Founded in 1985, America Online, Inc., (the "Company") based in Dulles,
Virginia, is the world's leader in interactive services, Web brands, Internet
technologies and electronic commerce services. The Company operates two
worldwide subscription based Internet online services, the AOL service, with
more than 19 million members, and the CompuServe service, with more than 2
million members; several leading Internet brands including ICQ, AOL Instant
Messenger and Digital City, Inc.; the Netscape Netcenter and AOL.COM Internet
portals; the Netscape Communicator client software, including the Netscape
Navigator browser; AOL MovieFone, the nation's number one movie listing guide
and ticketing service; and Spinner and Nullsoft, leaders in Internet music.
Through its strategic alliance with Sun Microsystems, Inc., the Company also
develops and offers easy-to-deploy, end-to-end electronic commerce and
enterprise solutions for companies operating in and doing business on the
Internet.
Consolidated Results of Operations
Revenues
The following table and discussion highlights the revenues of the Company
for the three months ended September 30, 1999 and 1998:
<TABLE>
Three Months Ended
September 30,
1999 1998
--------------- ---------------
(Dollars in millions)
Revenues:
<S> <C> <C> <C> <C>
Subscription services................................... $ 995 67.8% $ 723 72.4%
Advertising, commerce and other......................... 350 23.9 175 17.5
Enterprise solutions.................................... 122 8.3 101 10.1
------- ------- ------- -------
Total revenues.......................................... $1,467 100.0% $ 999 100.0%
</TABLE>
Subscription Services Revenues
For the three months ended September 30, 1999, subscription services
revenues, which are generated mainly from subscribers paying a monthly
membership fee, increased from $723 million to $995 million, or 38%, over the
three months ended September 30, 1998. This increase is comprised of an increase
in AOL subscription services revenues of $268 million, as well as an increase in
CompuServe subscription services revenues of $4 million. The increase in AOL
subscription services revenues was primarily attributable to a 36% increase in
the average number of AOL revenue generating subscribers for the three months
ended September 30, 1999, compared to the three months ended September 30, 1998,
as well as a 3% increase in the average monthly subscription services revenue
per AOL subscriber.
At September 30, 1999, the Company had approximately 18.7 million AOL
service subscribers, including 16.2 million in the United States and 2.5 million
in the rest of the world. Also at that date, the Company had approximately 2.2
million CompuServe service subscribers, with 1.3 million in the United States
and 900,000 in the rest of the world.
<PAGE>
Advertising, Commerce and Other Revenues
The following table summarizes the material components of advertising,
commerce and other revenues for the three months ended September 30, 1999 and
1998:
<TABLE>
Three Months Ended
September 30,
1999 1998
--------------- ---------------
(Dollars in millions)
<S> <C> <C> <C> <C>
Advertising and electronic commerce fees................ $ 272 77.7% $ 132 75.4%
Merchandise............................................. 47 13.4 21 12.0
Other................................................... 31 8.9 22 12.6
------- ------- ------- -------
Total advertising, commerce and other revenues.......... $ 350 100.0% $ 175 100.0%
</TABLE>
Advertising, commerce and other revenues, which consist principally of
advertising and related revenues, fees associated with commerce and the sale of
merchandise across the Company's multiple brands, increased by 100%, from $175
million in the quarter ended September 30, 1998 to $350 million in the quarter
ended September 30, 1999. The increase is primarily attributable to additional
advertising on the Company's AOL service, Netcenter portal, and from the
Company's other brands, as well as an increase in commerce fees. Advertising and
commerce fees increased by 106%, from $132 million in the three months ended
September 30, 1998 to $272 million in the three months ended September 30, 1999.
Merchandise sales increased by 124%, from $21 million in the three months ended
September 30, 1998 to $47 million in the three months ended September 30, 1999.
This increase is mainly attributable to improved response rates to advertising,
as well as a larger base of subscribers. At September 30, 1999, the Company's
advertising and commerce backlog, representing the contract value of advertising
and commerce agreements signed, less revenues already recognized from these
agreements, was approximately $2 billion, up approximately $500 million from
June 30, 1999.
Enterprise Solutions Revenues
Enterprise solutions revenues, which consist principally of product
licensing fees and fees from technical support, consulting and training services
increased by 21%, from $101 million in three months ended September 30, 1998 to
$122 million in the three months ended September 30, 1999. The increase was
primarily driven by revenues generated from the alliance with Sun Microsystems,
Inc., which did not exist during the three months ended September 30, 1998.
Costs and Expenses
The following table and discussion highlights the costs and expenses of the
Company for the three months ended September 30, 1999 and 1998:
<TABLE>
Three Months Ended
September 30,
1999 1998
--------------- ---------------
(Dollars in millions)
<S> <C> <C> <C> <C>
Total revenues.......................................... $1,467 100.0% $ 999 100.0%
Costs and expenses:
Cost of revenues........................................ $ 791 53.9% $ 583 58.4%
Sales and marketing..................................... 209 14.2 174 17.4
Product development..................................... 67 4.6 67 6.7
General and administrative.............................. 117 8.0 82 8.2
Amortization of goodwill and other intangible assets.... 18 1.2 16 1.6
------- ------- ------- -------
Total costs and expenses................................ $1,202 81.9% $ 922 92.3%
</TABLE>
<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 the three months ended
September 30, 1999, cost of revenues increased from $583 million to $791
million, or 36%, over the three months ended September 30, 1998, and decreased
as a percentage of total revenues from 58.4% to 53.9%.
The increase in cost of revenues in the three months ended September 30,
1999 was primarily attributable to increases in data network costs, as well as
personnel and related costs associated with operating the data centers, data
network and providing customer support, consulting, technical support/training
and billing. Data network costs increased primarily as a result of the larger
customer base and increased usage per customer. Personnel and related costs
associated with operating the data centers, data network and providing customer
support and billing increased primarily as a result of the requirements of
supporting a larger data network, larger customer base and increased
subscription services revenues.
The decrease in cost of revenues as a percentage of total revenues in the
three months ended September 30, 1999 was primarily attributable to growth of
the higher margin advertising, commerce and other revenues, as well as a
decrease in network-related costs as a percentage of subscription services
revenue. The decrease in network-related costs as a percentage of subscription
services revenue was primarily driven by a 19% decrease in our hourly network
cost for the three months ended September 30, 1999. This decrease was mostly
offset by an increase in daily member usage, from an average of nearly 47
minutes per day in the three months ended September 30, 1998 to an average of 55
minutes per day in the three months ended September 30, 1999.
Sales and Marketing
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 to support the Company's
multiple brands. For the three months ended September 30, 1999, sales and
marketing expenses increased from $174 million to $209 million, or 20%, over the
three months ended September 30, 1998, and decreased as a percentage of total
revenues from 17.4% to 14.2%. The increase in sales and marketing expenses for
the three months ended September 30, 1999 was primarily attributable to an
increase in direct subscriber acquisition costs related to the AOL and
CompuServe services and brand advertising across multiple brands. The decrease
in marketing expenses as a percentage of total revenues for the three months
ended September 30, 1999 was primarily a result of the substantial growth in
total revenues.
Product Development
Product development costs include research and development expenses and
other product development costs. For the three months ended September 30, 1999,
product development costs were unchanged at $67 million and decreased as a
percentage of total revenues from 6.7% to 4.6%. The decrease in product
development costs as a percentage of total revenues for the three months ended
September 30, 1999 was primarily a result of the substantial growth in total
revenues.
General and Administrative
For the three months ended September 30, 1999, general and administrative
expenses increased from $82 million to $117 million, or 43%, over the three
months ended September 30, 1998, and decreased as a percentage of total revenues
from 8.2% to 8.0%. The increase in general and administrative costs for the
three months ended September 30, 1999 was primarily attributable to higher
personnel costs, including payroll taxes associated with employee stock option
exercises. The decrease in general and administrative costs as a percentage of
total revenues for the three months ended September 30, 1999 was mainly a result
of the substantial growth in total revenues.
Amortization of Goodwill and Other Intangible Assets
Amortization of goodwill and other intangible assets increased to $18
million in the three months ended September 30, 1999 from $16 million in the
three months ended September 30, 1998. The increase in amortization expense in
the three months ended September 30, 1999 is primarily attributable to goodwill
associated with the acquisition of the CompuServe online service in January
1998, with minor subsequent adjustments.
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 recorded
other income of $37 million and $5 million in the three months ended September
30, 1999 and 1998, respectively. The increase in other income in the three
months ended September 30, 1999 was primarily attributable to interest income.
The increase in interest income is due to a higher cash balance and interest
earned on investments.
Provision for Income Taxes
The provision for income taxes was $118 million and $6 million in the three
months ended September 30, 1999 and 1998, respectively. Income tax expense for
the three months ended September 30, 1999 includes $117 million for U.S. federal
and state income taxes and $1 million for foreign taxes. As of September 30,
1999, the Company had net operating loss carryforwards of approximately $8.2
billion available to offset future U.S. federal taxable income.
Segment Results of Operations
The Company operates two major lines of business: Interactive Online
Services and Enterprise Solutions. For further information regarding segments,
refer to Note 5 of the Notes to Consolidated Financial Statements.
A summary of the segment financial information is as follows:
<TABLE>
Three months ended
September 30,
1999 1998
------------ -----------
(Amounts in millions)
Revenues:
<S> <C> <C>
Interactive Online Services................. $1,345 $ 898
Enterprise Solutions........................ 122 101
------------ -----------
Total revenues.......................... $1,467 $ 999
Income (loss) from operations:
Interactive Online Services (1)............. $ 356 $ 166
Enterprise Solutions (2)................... 26 (7)
General & Administrative.................... (117) (82)
------------ -----------
Total income from operations............ $ 265 $ 77
1. For the periods ended September 30, 1999 and 1998, Interactive Online
Services include goodwill and other intangible assets amortization of $18
million and $16 million, respectively.
2. Enterprise Solutions amortization of goodwill and other intangible assets
is immaterial for periods presented.
</TABLE>
For an overview of the segment revenues, refer to the consolidated results
of operations discussion earlier in this section.
Interactive Online Services income from operations increased from $166
million in the three months ended September 30, 1998 to $356 million in the
three months ended September 30, 1999. This increase is primarily the result of
increases in subscription services revenues and advertising, commerce and other
revenues, coupled with improved margins and a decrease in marketing expenses as
a percentage of total revenues.
Enterprise Solutions income (loss) from operations improved from a loss of
$(7) million in the three months ended September 30, 1998 to income of $26
million in the three months ended September 30, 1999. This improvement was
mainly attributable to the increase in revenues, as well as a decline in
operating expenses, as the Company began to realize efficiencies from using the
AOL infrastructure to support the Enterprise Solutions segment as well as the
other lines of businesses. In addition, Enterprise Solutions is experiencing
benefits from the Sun Alliance which was not in place a year ago.
Liquidity and Capital Resources
The Company is currently financing its operations primarily through cash
generated from operations. In addition, the Company has generated cash from the
sale of its capital stock, the sale of its convertible notes and the sale of
marketable securities it held. The Company has financed its investments in
telecommunications equipment principally through leasing. Net cash provided by
operating activities was $472 million and $120 million in the three months ended
September 30, 1999 and 1998, respectively, and increased primarily due to the
Company's increase in net income before taxes. Net cash used in investing
activities was $123 million and $65 million in the three months ended September
30, 1999 and 1998, respectively, and increased mainly due to the Company's
purchases of property and equipment. Net cash provided by financing activities
was $94 million and $602 million in the three months ended September 30, 1999
and 1998, respectively. Included in financing activities for the three months
ended September 30, 1998, was $550 million in aggregate net proceeds from a
public stock offering of its common stock. The Company currently has
approximately $450 million available under a shelf registration filed in June
1998. In May 1999, the Company filed a registration statement to raise an
additional $4.5 billion by sale of the Company's debt securities, common stock,
preferred stock depositary shares, warrants or stock purchase contracts to
purchase common stock or preferred stock. The total offering price of securities
under these registration statements, in the aggregate, will not exceed $5
billion.
The Company expects to continue using its working capital to finance
ongoing operations and to fund marketing programs 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, investments or businesses
complementary to the Company's current business. The Company anticipates that
cash on hand, cash provided by operating activities and cash available from the
capital markets and traditional lending markets will be sufficient to fund its
operations for the next twelve months.
Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA")
The following table and discussion summarizes EBITDA for the three months
ended September 30, 1999 and 1998:
<TABLE>
Three Months Ended
September 30,
1999 1998
------------ ------------
(Amounts in millions)
<S> <C> <C>
EBITDA...................................... $386 $153
</TABLE>
The Company defines EBITDA as net income plus: (1) provision/(benefit) for
income taxes, (2) interest expense, (3) depreciation and amortization and (4)
special charges/(gains). EBITDA is presented and discussed because the Company
considers EBITDA an important indicator of the operational strength and
performance of its business including the ability to provide cash flows to
service debt and fund capital expenditures. EBITDA, however, should not be
considered an alternative to operating or net income as an indicator of the
performance of the Company, or as an alternative to cash flows from operating
activities as a measure of liquidity, in each case determined in accordance with
generally accepted accounting principles ("GAAP").
For the three months ended September 30, 1999, EBITDA increased from $153
million to $386 million or 152% over the three months ended September 30, 1998.
The EBITDA margin (EBITDA divided by total revenues) increased from 15.3% for
the three months ended September 30, 1998 to 26.3% for the three months ended
September 30, 1999. In addition, the incremental EBITDA margin (the current
quarter increase over the year ago quarter in EBITDA of $233 million divided by
the increase in revenues of $468 million for the same periods) increased nearly
50%. This increase in the incremental EBITDA margin is mainly due to the shared
infrastructure that supports the Company's multiple brands; as these brands
begin to generate additional revenues, a larger percentage of each incremental
dollar flows to EBITDA.
Year 2000 Compliance
The Company utilizes a significant number of computer software programs and
operating systems across its entire organization, including applications used in
operating 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, the Company appointed a Year 2000 Task Force to perform an audit
to assess the scope of the Company's risks and bring its applications into
compliance. This Task Force has overseen testing and is continuing its
assessment of the Company's company-wide compliance. The Company's system
hardware components, client and host software, current versions of Netscape
software products and corporate business and information systems have been
tested and continue to be reviewed. To date, the Company has experienced few
problems related to Year 2000 testing, and the problems that have been
identified either have been addressed or are in the process of being addressed.
The Company has made 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 certain versions of
Netscape software products that are currently shipped. While the majority of AOL
and CompuServe members use proprietary client software that is compliant, a
third-party Internet browser utilized in most versions of the client software
may not be Year 2000 compliant. A free patch or upgrade will be required for
members using some versions of the client software or browser to achieve Year
2000 compliance. The Company is encouraging members of its online services to
upgrade their browser and/or their software to versions that are Year 2000
compliant, if they have not already done so. The Company is making available to
members, and is communicating that availability, free patches or upgrades that
can be downloaded from the online services. The Company has not tested, and does
not expect to certify as Year 2000 compliant, certain older versions of the AOL
and CompuServe software. The Company has developed, and is implementing over the
remainder of the year, a communication program that informs members how to
obtain the free patch or upgrade to a Year 2000 compliant version of the client
software or browser.
With respect to the Company's Netscape software business, testing has been
completed on currently shipped products and the review and analysis of the
testing results continues. The Company is making available at no additional cost
to customers any required patch or upgrade to the versions of Netscape software
products currently being shipped to customers and is communicating their
availability. In addition, the Company is encouraging 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, the Company 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. The Company
continues its efforts to seek reassurances regarding the Year 2000 compliance of
vendors, joint venture partners and content partners. In the event any third
parties cannot timely provide the Company with content, products, services or
systems that meet the Year 2000 requirements, the content on the Company's
services, access to the Company's services, the ability to offer products and
services and the ability to process sales could be materially adversely
affected.
The costs incurred through September 30, 1999 to address Year 2000
compliance were approximately $16 million. The Company currently estimates it
will incur a total of approximately $20 million in costs to support its
compliance initiatives. The Company cannot predict the outcome of its Year 2000
program, whether third party systems and component software 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 the Company's business, financial condition or results of operations.
Failure to achieve Year 2000 compliance could result in some interruptions in
the work of some employees, the inability of some 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.
The Company has developed a contingency plan to address possible Year 2000
risks to its systems. The plan identifies a hierarchy of critical functions,
acceptable delay times, recovery strategies to return functions to operational
status and defines the core team for managing this recovery process. The Company
will continue to modify this plan to address systems of its recent acquisitions.
Forward-Looking Statements
This report and other oral and written statements made by the Company to
the public contain and incorporate by reference forward-looking statements
within the meaning of the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995. In particular, statements regarding the following
subjects are forward-looking: future financial and operating results;
anticipated subscriber, usage and commerce growth; new and developing markets,
products, services, features and content; anticipated timing and benefits of
acquisitions and other alliances and relationships; the availability, benefits,
and timing of deployment of new access and distribution technologies; and
regulatory developments, including the Company's ability to shape public policy
in, for example, telecommunications, privacy and tax areas.
The forward-looking statements are based on management's current
expectations or beliefs and are subject to a number of factors and uncertainties
that could cause actual results to differ materially from those described in the
forward-looking statements. For a discussion of factors that could cause actual
results to differ materially from those described in the forward-looking
statements, please refer to the section entitled "Forward-Looking Statements" in
the Company's Annual Report on Form 10-K for the year ended June 30, 1999.
<PAGE>
Item 3. Quantitative and Qualitative Disclosures About Market Risk
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 is exposed to immaterial levels of market risks, including these types
of risks. The Company does not enter into derivatives or other financial
instruments for trading or speculative purposes. From time to time, the Company
has entered 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 uses 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.
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 3.1 Certificate of Amendment of Restated Certificate of
Incorporation of America Online, Inc.
(b) Reports on Form 8-K
None
<PAGE>
AMERICA ONLINE, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AMERICA ONLINE, INC.
DATE: November 2, 1999 SIGNATURE:/s/ Stephen M. Case
-----------------------
Stephen M. Case
Chairman of the Board and Chief
Executive Officer
DATE: November 2, 1999 SIGNATURE:/s/ J. Michael Kelly
------------------------
J. Michael Kelly
Senior Vice President and Chief
Financial Officer
<PAGE>
Exhibit Index
Exhibit 3.1 Certificate of Amendment of Restated Certificate of Incorporation of
America Online, Inc.
<PAGE>
Exhibit 3.1
CERTIFICATE OF AMENDMENT OF RESTATED CERTIFICATE OF INCORPORATION OF
AMERICA ONLINE, INC.
America Online, Inc., a Delaware corporation duly organized and
existing under the General Corporation Law of the State of Delaware (the
"Corporation"), does hereby certify:
FIRST: That Section A of Article FOURTH of the Restated Certificate of
Incorporation is hereby amended to read in its entirety as follows:
FOURTH: A. The total number of shares of all classes of stock which the
Corporation shall have authority to issue is 6,005,000,000 shares, divided into
two classes, consisting of:
6,000,000,000 shares of Common Stock, par value one cent ($0.01) per share
(the "Common Stock"); and
5,000,000 shares of Preferred Stock, par value one cent ($0.01) per share
(the "Undesignated Preferred Stock").
SECOND: That said amendment was duly adopted in accordance with the
provisions of Section 242 of the General Corporation Law of the State of
Delaware.
IN WITNESS WHEREOF, America Online, Inc. has caused this Certificate of
Amendment to be signed by its duly authorized officer this 28th day of October,
1999.
/s/Sheila A. Clark
Sheila A. Clark
Corporate Secretary
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 3-mos
<FISCAL-YEAR-END> Jun-30-2000
<PERIOD-END> Sep-30-1999
<CASH> 1,330
<SECURITIES> 429
<RECEIVABLES> 526
<ALLOWANCES> 58
<INVENTORY> 20
<CURRENT-ASSETS> 2,408
<PP&E> 1,127
<DEPRECIATION> 383
<TOTAL-ASSETS> 6,502
<CURRENT-LIABILITIES> 2,011
<BONDS> 0
0
0
<COMMON> 11
<OTHER-SE> 3,838
<TOTAL-LIABILITY-AND-EQUITY> 6,502
<SALES> 1,467
<TOTAL-REVENUES> 1,467
<CGS> 791
<TOTAL-COSTS> 1,202
<OTHER-EXPENSES> 2
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 5
<INCOME-PRETAX> 302
<INCOME-TAX> 118
<INCOME-CONTINUING> 184
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 184
<EPS-BASIC> .17
<EPS-DILUTED> .14
</TABLE>
