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To: IceShark who wrote (38466)	2/7/1999 11:13:00 AM
From: Glenn D. Rudolph	Respond to of 164687

13 AOL posted fully taxed December EPS of $0.17 per share last night, three cents higher than the Street's consensus view and four pennies higher than our estimate (recall that AOL has beaten the consensus view for the last four quarters). Total revenue came in at $960 million (up 62% y/y and 12% sequentially), $7 million above our estimate, and consisted of $779 million in service revenue and $181 million in other revenue (up 64% y/y and 26% sequentially versus our model of $160 million). Both of these metrics were driven by a strong seasonal increase in subscribers. Operating margins, at 13.6%, were 150 basis points higher than our estimate, almost the entirety of which is the result of a 210 basis point increase in gross margin. We're Raising Our Numbers To Reflect The December Quarter And Higher Margins For 1999 Reflecting the December quarter's upside surprise and the fact that AOL has (again) proven that profitability can be even higher than we'd thought a few quarters ago, we are increasing our earnings estimates for 1999 from $0.56 to $0.72 and our F2000 earnings estimate from $1.00 to $1.05. Though we are increasing our advertising and commerce revenue estimate a touch (by about $20 million for the rest of F99) and our subscription revenue jumps (up by about $70 million in F99), the EPS gains come from cost savings from the increase in gross margin (which we expect to be about steady from these 38% levels) as well as a little boost from lower S&M expenses. The model, of course, will change (perhaps) significantly once the Netscape transaction is accounted for, so we'll keep our powder dry on the 2000 and beyond model for now with the understanding that it could be more significant than our current (non-Netscape) model suggests. The December Quarter Proves Again That The Business Model Has Plenty Of Dials And Levers As we like to state, AOL's model is characterized most appropriately by the level of control management has over its important drivers: sales and marketing expenses, advertising and commerce revenue, gross margins, and subscription revenue. The last several quarters have provided ample evidence that this thesis has legs and the December quarter proves it once again. Though ad/commerce revenue didn't “blow away” expectations (merchandise sales of $30mm helped the other revenue line item, while ad/commerce revenue came in about $2 million lower than we were modeling), AOL was more than able to make up for that with nice (great, actually) gains in gross margins, growing them 210 basis points sequentially to 38.5%, the highest they've been in more than 8 quarters. Subscriber Growth Was, As Reported, Huge Subscribers came in at 15.1 million in total (not including Compuserve), an addition of 1.6 million new subs in the quarter (1.2mm U.S. and 400k internationally). Given all that has been right with the model over the past few quarters, even AOL bulls have had moments of weakness over the last few weeks and quarters, fearing that subscriber growth would, sooner rather than later, succumb to the law of large numbers, saturation, or worse, both, and would start to slow. Well, clearly that's not the case. As importantly, the company was able to post such strong growth without the benefit of large marketing dollars. In our view, these conditions call for a committed optimism on the subscriber growth front well into 1999. And since this is the metric from which almost everything else flows (for now), the rest of the model should benefit commensurately in time. Ad/Commerce Revenue Was OK (Depending On How You Define It) Backlog Was Up 22% Total non-subscription revenue came in at $181 million (up 26% sequentially), $21 million better than our model thanks to an far greater level of AOL merchandising activity than we had