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To: Lizzie Tudor who wrote (38472)	2/6/1999 7:27:00 PM
From: KeepItSimple	Read Replies (3) \| Respond to of 164684

The problem with shipping for E-tailers is that it will ALWAYS cost more to ship 1000 items to different customers than it will to ship 1000 items to 1 customer. That's the first rule of shipping, in case you hadn't noticed. If this is not clear to you guys yet- it will always cost more for amazon to ship 1000 books all over the country individually, than it will for barnes and noble to ship a truckload of 1000 books to 1 location. It's basic physics. Economic slight of hand doesnt even enter into the equation! (sorry covey) Take away the sales tax that isnt currently collected by the feds, and you find another catalog sales company. Not worth 20 billion. No way.

To: Lizzie Tudor who wrote (38472)	2/7/1999 11:14:00 AM
From: Glenn D. Rudolph	Read Replies (1) \| Respond to of 164684

14 predicted (recall that this is where AOL takes the inventory on the goods it is selling). Historically, neither the Street nor the company has included this merchandising figure in their ad/commerce reporting, forcing us to rely on the pure ad/commerce figure as a measure of the growth in AOL's advertising and electronic commerce efforts. The December quarter's pure ad/commerce number came in $2 million lower than our projections in what most industry observers believe to have been a remarkably strong advertising and e-tailing quarter. We would encourage investors to keep in mind, however, that at $126 million (up 23% q/q), AOL's pure ad/commerce represents a nice pick-up given the absolute size of this revenue stream (keep in mind that Yahoo! and Excite reported $76 million and $54 million in advertising and commerce revenue in their December quarters and grew them at 40% and 23% sequential rates respectively). That said, we're still trying to figure out if AOL has switched their strategy on the merchandising front: a few quarters ago the stated strategy was to pare back this revenue because the “real estate” it was consuming could be used more effectively and profitably by selling it to ad/commerce partners. Has that strategy changed? Not sure. For its part, backlog grew from $598 million in September to $729 million (up 22% q/q), which should help visibility on this very important revenue stream in the quarters ahead. We understand that a good chunk of the March quarter's ad/commerce revenue is already in the bag, thanks to the visibility provided by this backlog portfolio of deals. Sales And Marketing Expenses Were A Touch Higher Than We Were Predicting. Total S&M expenses were $132 million (13.8%), about $5 million and 50 basis points more than our model thanks to the growing responsibility that AOL has for growing a portfolio of brands. More than 50% of the absolute increase in S&M went toward marketing efforts for CompuServe and Digital Cities, suggesting that, though we used to view the S&M line as simply supporting AOL's core business, it's probably appropriate to think about AOL's marketing spending across their brand portfolio (especially with the upcoming addition of Netscape. Despite the slightly higher than expected S&M number, AOL was able to post great subscriber growth numbers and spend a remarkably small amount of dollars on customer acquisition and branding. AOL's December quarter is another great data point for our thesis that branding spending is becoming more discretionary and acquisition spending is becoming more efficient. With scale this statement becomes even more true. Expanding Gross Margins Were The Model's True Standout Gross margin showed a nice (and thoroughly surprising) up-tick sequentially (from 36.4% to 38.5%). Though the continued shift toward higher margin ad/commerce revenue was one source of the upside, the primary element was greater network efficiencies and the (long awaited) benefits of those network cost savings from WorldCom that AOL received as part of their CompuServe transaction. Currently, AOL's network cost per hour is $0.42 per hour, versus $0.43 per hour in September. There is still reason to believe that Worldcom could deliver network costs on the order of 25- 45% lower ($0.25-$0.35 per hour) over time, but since the agreement calls for Worldcom to supply only incremental traffic above AOL's current needs, we anticipate much of the benefit remains in FY00 and beyond. Remember that AOL's COGS, prior to flat rate pricing, were in the 55-60% range; we expect AOL to at least start towards that figure heading sometime in FY00. For now, however, the popularity of the service and the likelihood of continued nice subscriber growth keep network costs running high, though at these nicely higher levels.