April 24, 2002 4:25 PM PDT

Merger costs weigh on AOL earnings

AOL Time Warner lost $54.2 billion in the first quarter of 2002, the company said Wednesday, due largely to an anticipated accounting charge stemming from the merger that created the media and Internet powerhouse last year.

The company reported revenue of $9.8 billion, up 4 percent over the same period last year. Earnings before interest, taxes, depreciation and amortization (EBITDA), a common benchmark for the performance of media companies, were up 3 percent to $2.05 billion.

Cash earnings increased 13 percent to 18 cents a share, beating Wall Street consensus estimates of 14 cents a share, according to First Call.

AOL Time Warner executives reaffirmed forecasts for revenue growth of between 5 percent and 8 percent for the year, but they lowered expectations for EBITDA growth to 5 percent to 9 percent, down from 8 percent to 12 percent--a development that some analysts called overdue.

Weighing down companywide earnings was a $54 billion noncash goodwill charge reflecting the depreciated value of AOL's acquisition of Time Warner since the deal closed. The massive write-down stems from new federal accounting rules that require companies to report acquisitions under the purchase method of accounting, which was intended to provide more clarity to investors.

The write-off has no direct bearing on the company's operations. But it has nevertheless been taken as a distillation of problems at the media and Internet behemoth, which has sputtered since combining last January in a much-touted $106 billion merger. In the past fifteen months, the company's stock has fallen by about two-thirds and CEO Gerald Levin has announced his resignation, effective May 25.

As expected, Wednesday's earnings report highlighted ongoing weakness in the advertising market that has hurt media companies across the board.

Companywide advertising and commerce revenues for the period were down 13 percent to $1.8 billion.

"Overall, except for online advertising, the performance of our businesses remains at least as strong as we expected when we provided our earlier outlook," CEO-elect Richard Parsons said in a statement, "and we anticipate that they will collectively drive growth this year."

Paul Kim, an analyst with Kaufman Bros. in New York, said the earnings report was unsurprising in most details, but it offered welcome hints that the incoming Parson regime is ready to offer greater openness to analysts and investors than the company has offered in the past.

"The tone was great," he said. "It was more honest and direct than the fourth-quarter call--and that's far more important than any numbers they could have produced."

Kim noted that the company cleared up some worrying questions about the company's partnership structures with Advance/Newhouse and AT&T relating to Time Warner Entertainment, offering reassurances that the company did not intend to load up on debt to buy them out.

In addition, Kim said, the company was right to lower its EBITDA outlook.

Focus on America Online
AOL Time Warner saw some impressive successes in some of its widespread businesses, such as its film studios and even its music division, which saw a 5 percent uptick in revenue after months of declines.

Still, Wall Street's gaze has been riveted on the America Online side of the business, which has come under fire for declining advertising revenue and slow broadband upgrades. Investor concern over the AOL side of the business has been perceived as a key factor in dragging down AOL Time Warner's stock toward its 52-week low, resulting in speculation that the media giant would consider spinning off the AOL division.

Meanwhile, the AOL division has undergone a management shuffle that has replaced former CEO Barry Schuler with AOL Time Warner co-chief operating officer Robert Pittman. Pittman has since hired executives to head AOL's flagship service as well as its advertising sales division.

The America Online unit, once touted as the company's "jewel in the crown," posted revenues of $2.29 billion, down slightly from last year, when it reported $2.3 billion on a pro forma basis for the first quarter. AOL reported EBITDA of $433 million, down 15 percent from the $507 million reported for the same period in 2001.

Advertising and commerce for the division was down 31 percent compared with last year, including the value of intercompany advertising from other AOL Time Warner divisions. Intercompany spending companywide increased from $71 million in the first quarter of 2001 to $131 million for the current period.

AOL also saw a steep 44 percent decline in content and other revenue to $79 million, due in part to the end of its iPlanet partnership with Sun Microsystems.

Despite the sharp drop in advertising revenue, Pittman said the unit offset the declines on the revenue line through strong subscriber growth. The company reported a net gain of 1.4 million AOL subscribers for the first three months of the year, for a total of 34.6 million members.

Pittman expects the service to attract about half of all new dial-up subscribers in 2002, but he said that sign-ups have historically slowed during the last half of the year. He also warned that growth in Latin America could lag.

Answering critics of the company's broadband strategy, Pittman said that the company plans to offer both high-speed and dial-up service in response to consumer demand.

"We have to make sure we're taking advantage of consumer adoption," he said. "Our job to is to pace our customers, not get ahead and not get behind them."

AOL currently counts about 3 million members who connect to the service using broadband, he said.

As evidence of consumer adoption trends, Pittman said that the majority of those users have chosen to pay the full $23.90 price for an unlimited dial-up access account. High-speed members frequently access the service using dial-up, which offers greater ubiquity than broadband for now, he said.

While the company said that the poor outlook for advertising would weigh down EBITDA in the coming months, Parsons and Pittman expressed guarded optimism of a turnaround in the battered space.

"We're not being Pollyana-ish," said Parsons, who in a Q&A with analysts emphasized the company's growth estimates against the backdrop of lowered expectations for the year. "We don't see the sun coming up on the horizon...but we do see a light at the end of the tunnel."

 

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