October 23, 2002 4:59 PM PDT

Investigation leads AOL to restate revenue

update AOL Time Warner on Wednesday reported flat third-quarter earnings and said it will restate past financial results following an internal audit of its America Online division.

The media conglomerate said the restatement would reduce revenue by $190 million and would erase $97 million in qualified earnings from its books over a 21-month period. Previously, the company said it was examining three deals worth a total of $49 million in revenue.

The restatement affects financial results for the period between Sept. 30, 2000, and June 30, 2002.

AOL Time Warner CEO Richard Parsons said the company does not anticipate further financial restatements stemming from the investigation.

"We have devoted a significant amount of time and resources to our review and, based on the substantial work we have done to date, do not expect any further restatements from it," Parsons said in a statement. "This restatement will not affect the company's committed liquidity, which includes over $8 billion of cash and unused bank facilities."

In the most recent quarter, the company earned 19 cents per share on revenue of $10 billion. A survey of analysts expected the company to report a profit of 18 cents per share on revenue of $9.9 billion, according to First Call.

Earnings before interest, taxes, depreciation and amortization (EBITDA) fell 1 percent year over year to $2.2 billion, despite double-digit growth from the company's core businesses, such as cable networks, publishing and music. The decline in EBITDA was attributed to the poor performance by AOL.

Free cash flow reached $1.4 billion for the quarter.

Parsons reiterated Wednesday that he expects the company to be in line with revenue and EBITDA estimates for the fiscal year. AOL Time Warner expects 2002 revenue to grow between 5 and 8 percent, with EBITDA growth in the low end of a 5 percent to 9 percent range.

The restatement fell within the range expected by some analysts.

"It was well within reason, and it settled many peoples' fears," said Jordan Rohan, an equity analyst at SoundView Technology Group. "It was the fear that it would include hundreds of millions of dollars of revenues at divisions other than AOL. It is clear the worst did not play out."

AOL shares closed at $13.53 in regular trading, up 3 cents for the day. In after-hours trading, the shares were trading at about $14.45.

AOL's numbers
In terms of the AOL division's financial performance, the division's EBITDA in the third quarter plummeted 30 percent while revenue declined 7 percent. AOL's advertising and commerce revenue took a huge hit, dropping 48 percent from last year to $321 million. Advertising accounted for $267 million of the total.

Of the $267 million in advertising, $164 million came from long-term contracts that run out in 2003, the company said.

AOL's primary business of selling Internet service subscriptions showed a 15 percent increase in revenue. Subscriber growth, however, remained essentially flat at 35.3 million, from 35.1 million last quarter. Of these subscribers, 26.7 million were from the U.S. while 6.1 million were from Europe. However, subscribers in Latin America declined by 71,000.

Out of the 26.7 million subscribers in the United States, 18.8 million are paying the full $23.90 a month fee, 3.6 million are paying reduced fares--such as AOL's $14.95 a month "Bring Your Own Access" plan--1.4 million are on PC bundling arrangements and another 2.9 million subscribers are using the service for free, through promotions and trial period offers.

AOL: the dent in the crown
The restatement will primarily hit AOL, which will have its revenue reduced by $168 million. The remaining $22 million will come from AOL Time Warner divisions that maintained internal advertising deals with AOL.

The restatement amounts to about 1 percent of AOL's total revenue for the period, about 3.4 percent of its advertising and commerce revenue, and about 1.9 percent of total EBITDA for the division.

Most of the revenue reduction, about $66 million, will affect the period ending Sept. 30, 2000, which was shortly after AOL and Time Warner announced their intention to merge. During this period, AOL and Time Warner underwent a laborious merger review process by federal regulators who were concerned that the combination would create unfairness in the market for high-speed services. The deal reportedly was at risk of dissolving during this period.

AOL Time Warner also is being investigated by the Securities and Exchange Commission and the Department of Justice over its accounting practices. The SEC has also been investigating AOL's former head of business affairs, David Colburn, who allegedly structured many of the questionable deals. Colburn left the company in August.

Plugging holes in AOL
In an earnings conference call, AOL Time Warner's Parsons said the company plans to hold an all-day meeting for Wall Street analysts outlining AOL's recovery plans. Currently, division CEO Jonathan Miller and Don Logan, the chairman of AOL Time Warner's media and communications group, are completing a strategic examination for the business. The results will be presented to analysts on Dec. 3.

The meeting will be a "balanced mix of where we are today and the beginning of a roadmap of where we're going," Parsons said Wednesday.

Parsons also mentioned that AOL executives will offer a glimpse of a new broadband product.

AOL has been in a quandary with its broadband efforts. On one hand, it risks losing its dial-up member base to competing broadband services offered by telephone and cable companies. However, by pushing its own broadband service it also risks cannibalizing its dial-up business, which offers better margins than broadband because AOL must share revenue with cable systems such as AT&T Broadband.

Still, Parsons said the company is developing a high-speed product that will hopefully convince potential broadband subscribers to sign up for AOL. "Having a viable broadband product is what's going to drive penetration," he said.

 

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