StockTalk:
TMF Interview With America Online VP of Investor Relations Richard Hanlon
With Yi-Hsin Chang (TMF Puck)
and Brian Graney (TMF Panic)

August 26, 1998

Our guest today is Richard Hanlon, vice president of investor relations at America Online <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %>. Founded in 1985, the Dulles, Virginia-based company has rapidly grown from an upstart online service to a media powerhouse that overtook and then acquired rival CompuServe. The company now has more than 12.5 million [13 million announced on August 27] members on AOL and about 2 million members on CompuServe.

TMF: Mr. Hanlon, thank you for taking time out of your vacation to talk to us.

Hanlon: Thank you for having me.

TMF: We had a flood of questions from our readers, and one Fool wanted to know if you're related to the Hanlon brothers of E-H Motorcycle Co.

Hanlon: No, I'm not, although I wish I were, given their success. (Laughter.)

TMF: Earlier this month, AOL reported fiscal fourth quarter operating earnings, but not your net earnings. When do you expect to finalize the one-time charges and release those numbers?

Hanlon: You're absolutely right. We reported our operating earnings, very strong operating earnings, with our operating margins for the first time exceeding 11% [and] going into double digits. We did not report the final bottomline number because that's still to be determined as a result of our discussions with the SEC on the amount of the charge that we take in connection with the acquisitions of ICQ and NetChannel. We're in discussions with the SEC on the amount of the charge and expect to have that resolved reasonably soon.

TMF: Why wasn't this resolved before the earnings report?

Hanlon: That's really a question that I'm not sure I could answer given that it's not a decision that's entirely within our control. We were operating on the basis of past practice, our own practice, and the industry practice in assuming that a substantial portion of the purchase price would be eligible for a one-time charge, it being in-process R&D [research and development]. But this is a matter that the SEC is looking at very broadly across a number of industries and not just at AOL. I think that we happened to have our earnings released, and our report coincide with the moment in time when the SEC was really beginning to focus on this issue.

"We're in discussions with the SEC on the amount of the [one-time] charge and expect to have that resolved reasonably soon."

TMF: When I think of America Online, I think of a lot of different things. You have an online community, there's the Internet service provider, you fall in a lot of different categories. How do you picture America Online, and who do you think your real competitors are going to be going forward?

Hanlon: Those are two very good questions. I think, first of all, increasingly we think of America Online as a major media company, a company that has, as you said earlier, approaching 13 million subscribers who pay us a fee for the service and who increasingly are making AOL an essential part of their lives for a whole variety of reasons. In addition, I think of AOL as -- this is not my term; this is a term that has been used about us by a number of people in the financial community -- I think of AOL as the Internet's first blue chip.

If you think of the characteristics that define blue chip, they entail such things as the fact that we've been doing this for well over a dozen years. We have, as they say, an increasingly habitual relationship with our members. We have a business that comprises not one revenue stream but increasingly, beyond the service fees, the revenues to be derived from advertising and commerce. That business, of course, is growing for the industry and for AOL, the single largest company in the industry, at a dramatic rate. I think also the fact that we have our own network, and that network is really a world-class network in its ability to provide millions of people with everyday access and that can keep pace with technological changes that are happening almost daily.

Finally, I think of the fact that, you know, we have close to 9,500 people today, professionals in the organization who are working for our members and for our shareholders every single day. They, in turn, are supported by an organization that has over $1 billion in cash on its balance sheet. So, that's sort of the short answer of how I think of the company.

Who do I think our competitors are going to be? I don't know. I think that because we are in this unusual position of bringing together not just technology but so many elements of so many different kinds of media -- not just publications or broadcast outlets, but agencies, the catalog retail business, and increasingly retailing in general -- we find ourselves in the position where we're competing with an extraordinary array of small, newly formed companies on the one hand and large, well-established global media and telecommunications companies on the other hand.

The fact that the barriers to entry have typically been fairly low in this business -- they're certainly getting much higher -- means that we constantly have to look out for companies that aren't just big and established in their own fields and decide to enter the Internet online business, but also companies that start up essentially out of nowhere, get traction, build a relationship with customers, and grow very rapidly. Of course, in that case, I'm thinking of a company like Amazon.com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AMZN)") else Response.Write("(Nasdaq: AMZN)") end if %>, which has done a remarkable job.

"I think, first of all, increasingly we think of America Online as a major media company, a company that has, as you said earlier, approaching 13 million subscribers."

TMF: Is that one of the online companies that you admire the most?

Hanlon: Yes, I would say it's one of many that we have a great deal of admiration for, and, of course, we're very proud to have them as a commerce partner on AOL.com.

TMF: How do you plan to keep growing the company? Has it become harder for AOL to attract new members, to reach the 13 million member mark?

Hanlon: No, I think that it's something that we have to focus on every day. There was a concern that perhaps the early adapters were really most of the market. I think what we've proved in the last couple of years is that the Internet online business in general is just now beginning to move into the mass consumer market, and AOL is perfectly positioned to really penetrate the consumer market. I think that focus -- some would say that relentless focus -- on AOL as a consumer medium, as a consumer vehicle that is fun, engaging, easy to use, and, of course, affordable and that delivers increasingly more value to our members for the fee they pay us, I think that secret, if you will, of putting everything in one place has really contributed to us growing rapidly. I think that that growth is really just beginning.

It's not just domestic or North American growth; it's also international growth. As you know, our international services are also growing at a very rapid pace, and we've really just begun to enter the international marketplace, certainly to grow in those markets. I note that in USA Today today they're talking about the dramatic growth -- something like 20 million new users of Internet online services in just the last nine months, something like 70 million people using it today, or 35% of the adult population versus only 18 million just four years ago. But still that's 35% as opposed to 60% or 70%. We see no reason why this business shouldn't reach at least as many homes and at least as many consumer users as the telephone or television or cable or other major forms of communication.

TMF: I'd be interested to know your opinions on the advent of companies working on cable-based and also satellite-based Internet services transmission. How big of a threat do you think this will be to AOL's business, and what are you doing to keep your customers and avoid having them shift to a cable-based or satellite-based provider?

"We see no reason why this business shouldn't reach at least as many homes and at least as many consumer users as the telephone or television or cable or other major forms of communication."

Hanlon: That's an interesting question, and that's one that we hear quite a lot from people in the financial community. Really the simple answer is that we represent so many of the users -- the potential users -- for cable-based or, as you say, satellite-based or broadband generally defined, high-speed access generally defined.

Since AOL represents such a large portion of the market for Internet online services and since it also follows fairly logically that higher speed doesn't mean anything to people who don't really understand what the Internet online business is about in the first place, then it's fair to conclude that most of that market is an upgrade market, that we can reach that market very effectively through online promotion. So, I think what you have is a situation where AOL becomes an important enabler to the broad-scale adoption of higher speed access, no matter who the provider of that higher speed access is.

TMF: Several companies including Dell Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %>, Cisco Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSCO)") else Response.Write("(Nasdaq: CSCO)") end if %>, and Yahoo! <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: YHOO)") else Response.Write("(Nasdaq: YHOO)") end if %> recently declared stock splits. Why hasn't AOL followed that same strategy?

Hanlon: Actually, if you think about our history, we, as in so many things, started this practice of splitting our stock so as to make it more widely available to the average shareholder, the average individual shareholder in particular. Our first split as I recall was declared in the fall of 1994, and all in all we've had four splits, the most recent being in the spring of this year.

The principle behind those splits -- the guiding principle -- has been that we wanted to make the shares available and affordable to the broadest possible constituency of individual shareholders, not just institutions, but typically the kinds of people who use and enjoy and rely upon the service. That principle has been wonderfully borne out by the fact that -- and I was just told this a day or so ago -- we have more than doubled the number of individual accounts, shareholder accounts, since the spring of this year or in less than roughly six months. And I suspect that that growth in individual accounts would continue with another split, and it's certainly something that we look at from time to time. Of course, it's a decision that in the end is made by the board of directors.

TMF: That's all the time we have. We'd like to thank you again for sitting down and talking with us today, and we hope you have a wonderful rest of your vacation.

Hanlon: Well, thanks very much. I thoroughly enjoyed doing this with you.

TMF: We'll be back next week with a StockTalk interview with the CEO of Starbucks <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SBUX)") else Response.Write("(Nasdaq: SBUX)") end if %>, Howard Schultz.

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