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time the starter kits begin to generate new custom-
Balance, end of year $18,914 $7,912
ers than with direct marketing activities. Also, the
period over which new subscribers (and related rev-
The accumulated amortization of product
enues) are generated is longer than that experi-
development costs related to the production of com-
enced with the use of traditional independent,
puter software totaled $7,894,000, and
direct marketing activities. The effect of this change
$5,885,000 at June 30, 1995 and 1994, respec-
in accounting estimate for the year ended June 30,
1993 was to increase income before extraordinary
item and net income by $264,000 ($.01 per Included in product development costs are
share). research and development costs totaling
$3,856,000, $2,126,000, and $1,130,000 and
In the ¬rst quarter of ¬scal 1995 the Company
other product development costs totaling
adopted the provisions of Statement of Position
$6,977,000, $1,050,000 and $579,000 in the
(“SOP”) 93-7, “Reporting on Advertising Costs,”
years ended June 30, 1995, 1994 and 1993,
which provides guidance on ¬nancial reporting on
advertising costs. The adoption of SOP 93-7 had no
effect on the Company™s ¬nancial position or results License rights “ The cost of acquired license
of operations. rights is amortized using the straight-line method
over the term of the agreement for such license
Product development costs “ The Company rights, ranging from one to three years.
capitalizes cost incurred for the production of com-
Goodwill “ Goodwill consists of the excess of
puter software used in the sale of its services. Costs
cost over the fair value of net assets acquired and
capitalized include direct labor and related over-
certain other intangible assets relating to purchase
head for software produced by the Company and
transactions. Goodwilll and intangible assets are
the costs of software purchased from third parties.
amortized over periods ranging from 5“10 years.
All costs in the software development process which
are classi¬ed as research and development are
Operating lease costs “ Rent expense for oper-
expensed as incurred until technological feasibility
ating leases is recognized on a straight-line basis
has been established. Once technological feasibility
over the lease term. The difference between rent
has been established, such costs are capitalized until
expense incurred and rental payments is charged or
the software is commercially available. To the extent
credited to deferred rent.
the Company retains the rights to software develop-
ment funded by third parties, such costs are capital- Cash, cash equivalents and short-term invest-
ments “ The Company considers all highly liquid
ized in accordance with the Company™s normal
investments with an original maturity of three
accounting policies. Amortization is provided on a
months or less to be cash equivalents. In ¬scal
product-by-product basis, using the greater of the
1995, the Company adopted Statement of Financial
straight-line method or current year revenue as a
78 Strategy Analysis

Strategy Analysis

Accounting Standards No. 115 (”SFAS 115”), years™ consolidated ¬nancial statements have been
“Accounting for Certain Investments in Debt and reclassi¬ed to conform to the current year presenta-
Equity Securities.” The adoption was not material to tion.
the Company™s ¬nancial position or results of oper-
ations. The Company has classi¬ed all debt and 3. Business Combination
equity securities as available-for-sale. Available-for-
Pooling Transactions
sale securities are carried at fair value, with unreal-
ized gains and losses reported as a separate com- On August 19, 1994, Redgate Communica-
ponent of stockholders™ equity. Realized gains and tions Corporation (“RCC”) was merged with and
losses and declines in value judged to be other- into a subsidiary of the Company. The Company
than-temporary on available-for-sale securities are exchanged 1,789,300 shares of common stock for
included in other income. Available-for-sale securi- all of the outstanding common and preferred stock

America Online
ties at June 30, 1995, consisted of U.S. Treasury Bills and warrants of RCC. Additionally, 401,148 shares
and other obligations of U.S. Government agencies of the Company™s common stock were reserved for
totaling $7,579,000 and U.S. corporate debt obli- outstanding stock options issued by RCC and
gations totaling $11,093,000. At June 20, 1995, assumed by the Company. The merger was
the estimated fair value of these securities approxi- accounted for under the pooling of interests method
mated cost. of accounting, and accordingly, the accompanying
consolidated ¬nancial statements have been
Net income (loss) per common share “ Net
restated for all periods prior to the acquisition to
income (loss) per share is calculated by dividing
include the ¬nancial position, results of operations
income (loss) before extraordinary item and net
and cash ¬‚ows of RCC. Effective August 1994,
income (loss) by the weighted average number of
RCC™s ¬scal year-end has been changed from
common and, when dilutive, common equivalent
December 31 to June 30 to conform to the Com-
shares outstanding during the period.
pany™s ¬scal year-end.
Reclassi¬cation “ Certain amounts in prior
Revenues and net earnings (loss) for the individ-
ual entities are as follows:

Three months ended
Year ended June 30,
September 30, 1994
1994 1993

(in thousands)
Total revenues:
AOL $50,783 $104,410 $40,019
RCC 3,813 11,312 11,965
Less intercompany sales (173) ” ”
$54,423 $115,722 $51,984
Net income (loss):
AOL $ 3,018 $ 6,210 $ 4,210
RCC (42) (3,660) (2,678)
Merger expenses (1,710) ” ”
$ 1,266 $ 2,550 $ 1,532
Strategy Analysis

2-47 Part 2 Business Analysis and Valuation Tools

In connection with the merger of the Company Year ended June 30,
and RCC, merger expenses of $1,710,000 were 1995 1994
recognized during 1995.
(in thousands except per share data)
Revenues $410,147 $135,785
During ¬scal 1995, Medior, Inc. and Wide Area
Income (loss) from
Information Servers, Inc. were merged into subsid-
operations 23,117 (5,465)
iaries of the Company. The Company issued
Pro forma income
1,082,019 shares of its common stock in the trans-
(loss) 11,205 (4,694)
actions. The transactions were accounted for under
Pro forma income
the pooling of interests method of accounting. Prior (loss) per share $ 0.25 $ (0.16)
year ¬nancial statements have not been restated for
the transactions because the effect would not be
4. Property and Equipment
material to the operations of the Company.
America Online

Property and equipment consist of the following:
Purchase Transactions

During ¬scal 1995, the Company acquired June 30,
NaviSoft, Inc. (“NaviSoft”), BookLink Technologies, 1995 1994
Inc. (“BookLink”), Advanced Network & Services,
(in thousands)
Inc. (“ANS”) and Global Network Navigator, Inc., in
Computer equipment $49,167 $12,418
transactions accounted for under the purchase
Furniture and ¬xtures 4,992 1,398
method of accounting. The Company paid a total of Buildings 13,800 5,648
$97,669,000, of which $75,697,000 was in stock Land 6,075 2,052
and $21,972,000 was in cash for the acquisitions. Building improvements 6,284 1,343
Of the aggregate purchase price, approximately Property under capital
$50,335,000 was allocated to in-process research leases 8,486 2,686
and development and $55,314,000 was allocated Leasehold improvements 3,059 306
to goodwill and other intangible assets. 91,863 25,851
Less accumulated depreci-
The following unaudited pro forma information ation and amortization (21,397) ( 5,545)
relating to the BookLink and ANS acquisitions is not Net property and equip-
necessarily an indication of the combined results ment $70,466 $20,306
that would have occurred had the acquisitions taken
place at the beginning of the period, nor is neces-
5. License Rights
sarily an indication of the results that may occur in
the future. Pro forma information for NaviSoft and
Global Network Navigator, Inc. is immaterial to the License rights consist of the following:
operations of the consolidated entity. The amount of
the aggregate purchase price allocated to in-pro- June 30,
cess research and development for both the Navi- 1995 1994
Soft and BookLink acquisitions has been excluded
(in thousands )
from the pro forma information as it is a non-recur- License rights $ 7,484 $ 954
ring item. Less accumulated amorti-
zation (1,947) (901)
$ 5,537 $ 53
80 Strategy Analysis

Strategy Analysis

6. Commitments and Contingencies

The Company leases equipment under several
long-term capital and operating leases. Future mini-
mum payments under capital leases and noncancel-
able operating leases with initial terms of one year
or more consist of the following:

Capital Leases Operating Leases
(in thousands)
Year ending June 30,
1996 $1,654 $20,997

America Online
1997 1,236 21,264
1998 641 19,450
1999 310 8,711
2000 103 3,511
Thereafter ” 2,636
Total minimum lease payments 3,944 $76,569

Less amount representing interest (402)
Present value of net minimum capital lease payments,
including current portion of $1,415 $3,542

amounts borrowed to ¬nance the purchases of two
The Company™s rental expense under operating
of¬ce buildings. The notes are collateralized by the
leases in the years ended June 30, 1995, 1994
respective properties. The notes have a variable
and 1993 totaled approximately $10,001,000,
interest rate equal to 105 basis points above the 30
$2,889,000, and $2,155,000, respectively.
day London Interbank Offered Rate and a ¬xed
Communication networks “ The Company has interest rate of 8.48% per annum at June 30, 1995.
guaranteed monthly usage levels of data and voice Aggregate maturities of notes payable for the years
communications with one of its vendors. The ended June 30, 1996, 1997, 1998, 1999, 2000
remaining commitments are $113,400,000, and thereafter are $415,000, $429,000,
$59,000,000, $9,000,000 and $6,750,000 for the $445,000, $462,000, $480,000 and
years ending June 30, 1996, 1997, 1998 and $15,553,000, respectively.
1999, respectively. The related expense for the years
ended June 30, 1995, 1994 and 1993 was
8. Other Income
$138,793,000, $40,315,000 and $11,226,000,
The following table summarizes the compo-
Contingencies “ Various legal proceedings have nents of other income:


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