October 22, 2002 10:24 AM PDT

Accounting woes loom over AOL

AOL Time Warner said it will update Wall Street analysts on an internal investigation of accounting practices at its troubled America Online unit when it reports third-quarter earnings Wednesday.

The probe is not expected to result in a dramatic restatement of AOL's past earnings, having so far focused on just three deals totaling $49 million. Still, investors are watching the investigation closely at a time when accounting scandals have rocked Wall Street.

On Monday, two former executives at AOL advertiser Homestore.com pleaded guilty to inflating revenue at the online real estate listing company by $46.4 million in 2001. It is so far unclear whether those transactions are related to any accounting irregularities at AOL.

An AOL Time Warner representative said the company will provide an update on the internal review, but declined to provide details.

The accounting investigation comes as AOL Time Warner is bracing for its latest tough quarter due to a steep decline in advertising and e-commerce revenue at its online unit.

The media giant is expected to report a net profit of 18 cents a share for the third quarter 2002 on revenue of $9.9 billion, according to an analyst survey conducted by First Call. Analysts expect AOL Time Warner will show continued strength in its traditional media businesses such as its film, publishing and cable divisions. But ongoing financial problems at AOL will overshadow the company's otherwise robust results.

Wednesday's earnings report will also mark AOL's first period under the leadership of its newly appointed CEO Jonathan Miller. The former USA Interactive executive was tapped to help turn around AOL's myriad problems, including its online advertising woes, a slowdown of its subscriber growth, and the improvement of its AOL flagship service.

"We're expecting more of the same from what happened the last couple of quarters, with the exception that now hopefully Jonathan Miller will be able to set the tone for what will be a gradual turnaround for AOL," said Youssef Squali, an equity analyst at First Albany.

The past few quarters have shown a clear divergence between AOL Time Warner's traditional and new media businesses. While its cable, film and publishing divisions showed earnings growth, the AOL unit last quarter witnessed a 42 percent decline in its online advertising revenue from the previous year.

Further exacerbating AOL's problems, AOL Time Warner last quarter disclosed that the Securities and Exchange Commission was conducting an investigation of the AOL unit's accounting practices. The investigation came as a series of news reports alleged AOL may have boosted its online advertising earnings amid signs of an impending collapse in ad revenue.

Two weeks after disclosing the SEC investigation, AOL Time Warner announced it would begin an internal audit focusing on three deals worth $49 million.

All eyes on AOL
AOL is eager to put its latest chapter behind it and look to the future. Miller is overseeing a strategic overhaul of the division and will present his plans to Wall Street analysts in December.

AOL is also riding high from last week's launch of AOL 8.0, the newest version of its proprietary flagship online service. During the launch last week, Miller announced that AOL would discontinue its use of pop-up ads from third parties in a push to improve the service. The decision was an attempt to prevent existing subscribers from leaving AOL now that its subscriber growth has shown signs of a slowdown.

Indeed, last quarter AOL said it added 492,000 new subscribers, which paled in comparison to the 1.3 million new subscribers added over the same period last year.

AOL Time Warner earnings come on the eve of Microsoft's launch of MSN 8, the software giant's latest attempt to unseat AOL's online dominance. Microsoft will unveil MSN on Thursday in New York's Central Park at an event hosted by Chairman Bill Gates. The company is touting the new product as a significant overhaul for MSN.

Still, the most immediate concern will be turning around AOL's sagging online advertising business. Already, AOL's relationship with advertisers may be on the mend, despite a history of alleged bad relations with agencies and advertising clients, according to Jordan Rohan, a SoundView Technology Group equity analyst.

"They just have to accept responsibility for past actions, apologize and move forward," Rohan said.

 

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