By Jeff Fischer (TMF Jeff)

America Online

Revenues Rose 46% Over the Previous Year to a Record $456.2 Million, Earnings were $0.02 Per Share, vs. Estimates of an $0.08 Loss.

ALEXANDRIA, VA., (May 5, 1997) -- The stock of AMERICA ONLINE (NYSE: AOL) began the morning on a positive note as Hambrecht & Quist initiated coverage with a buy rating, while stating that it expected "earnings" of a five cent loss for the third quarter that was to be announced after the bell.

Today those who suggest that analysts and their underlying firms often trade on "privileged" information received no support for their argument. America Online announced a positive earnings surprise of $0.02 per share in profit, while the consensus estimate of fifteen analysts called for a loss of $0.08. While H&Q was more optimistic than peers this morning, the firm was still well off the mark with its prediction.

During the day the stock rose more than $4 (up 9.0%) to above $50 per share, ending much closer to its 52-week high of $58 1/8.

The company clocked in with impressive results after the bell. While many expected positive earnings from AOL next quarter, along with positive cash-flow, not a single analyst expected a positive outcome this quarter.

In the first full quarter since its introduction of flat-rate pricing, America Online reported net income of $2.6 million, or $0.02 per share, while revenues soared 46% over the previous year to a record $456.2 million. Revenue grew about 11% sequentially over last quarter's $409 million achieved during the strong holiday season. Importantly, non-subscription revenues nearly tripled to $74.7 million, but how much of this revenue came from a one-time payment from Tele-Save Inc. isn't known at the time of this writing. Advertising and electronic commerce revenue climbed 37 percent from the December quarter to $60.7 million, while last year they were only $15 million.

AOL earned a profit primarily through lower marketing expenses. As promised in January, the company held membership steady at 8 million subscribers while it worked to improve access for existing members. Recently AOL began marketing again, though it plans to market for new subscribers modestly, while monitoring any strain on the network.

AOL stated that usage soared during the quarter to an average of 124 million hours per month, compared to an average of 52 million hours per month before the move to flat-rate pricing. More than 80 percent of its members are on the standard $19.95 flat-rate plan.

Member cancellations increased temporarily in January due mainly to access issues, and then member retention improved as the quarter progressed. In April, both the number of "trial members" joining formally and the retention rate of current members hit their highest levels in the past year.

The company's pile of cash grew to $197.8 million at March 31st, 1997, from $130.2 million at the end of 1996. As of March 31st, AOL also had $211.2 million in deferred revenue, up $115.8 million from the $95.4 million of three months earlier. The deferred revenue primarily reflects advance subscription payments and the company's marketing agreement with Tel-Save Holdings, Inc. One year ago, the Company reported $33.5 million in deferred revenue.

Chairman and CEO Steve Case stated: "We've made good progress in laying a solid foundation for sustained profitability based on our new business model of multiple revenue streams (subscription fees, advertising, online commerce). We are also pleased to have rapidly expanded our network to meet the extraordinary level of demand for AOL. As promised, we have worked around the clock to serve our existing members first and our top priority was, and still is, improving access. At the same time, we have achieved profitability a bit ahead of schedule."

Steve Case also said, "Starting this summer, AOL will take a quantum leap forward with the roll-out of AOL 4.0 -- our next-generation software. AOL 4.0 will enrich our members' interactive experiences and reinforce our position as the industry pacesetter and value leader. We anticipate continued strong mass market demand for AOL and have an aggressive plan to keep building out and upgrading our system."

AOL's current $350 million network expansion program (which is being accomplished primarily with product from U.S. ROBOTICS (Nasdaq: USRX)) has resulted in a substantial increase in capacity. The company installed over 75,000 new modems, and the network is now able to handle 335,000 simultaneous users; though this is still well below the 10-to-1 line-to-user industry ratio, it is a vast improvement for AOL on a percentage-basis.

The company also increased its e-mail capability to handle up to 13 million pieces of mail daily -- to 25 million recipients -- making it the largest commercial e-mail system in the world; and it increased capacity to serve Web pages, now totaling more than 300 million Web hits daily. Also, the company started construction of its third data center, a 180,000 square-foot facility due to open in Fall 1997. The site will double the company's current host/server system capacity.

Interesting to this Fool, Web-usage from AOL members remained flat percentage-wise, at 20% of hours. AOL's content is apparently enough to hold the eyes of readers even as readers spend increasingly more time online. "Personal Finance" and "Games" were two of the leading content areas on the service, while for the quarter AOL's content led all categories in growth.

During the quarter the company also made significant progress in expanding AOL globally, launching "AOL Japan" on April 15th. Meanwhile, the company passed 500,000 members in Europe only sixteen months after launching the service -- the growth is ahead of estimates.

Due to the company's recent accounting policy changes and the near break-even results, the operating and net margins were down significantly from the year before; the numbers are of questionable value for comparison purposes until the company achieves a quarter or more of business "along the norm" under its revised accounting practices.

As mentioned above: At the time of this writing the amount of revenue derived from Tele-Save's initial contract payment in proportion to "other revenue" was a key question in the conference call, as shareholders searched for any "fallacies" in the strong revenue number. Other than that, the positive implications of a profitable quarter before expected weighed favorably on the quarter.

At the current price of slightly above $50, the stock trades at 3.7 times trailing sales and 3.1 times the revenue run-rate. America Online has a market cap of $5.6 billion.

* A Fool earnings  synopsis represents an effort to highlight the salient points of the earnings report and should not be taken as an authoritative accounting or transcription of the entire event. Note: Statements made by a company other than historical information may constitute forward-looking statements for which the company can claim protection under the Safe Harbor Act. Please consult the company's filings with the SEC for information on risk factors which might cause actual results to differ materially from the information contained in these forward-looking statements.

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