Time Warner said today it is establishing a $500 million legal reserve stemming from the ongoing federal probes of its America Online unit and plans to restate the accounting for its stake in its AOL Europe unit for periods prior to 2002.
By establishing the $500 million reserve, Time Warner, for the first time, is quantifying what a settlement of the long-running probe of AOL may cost the media company and setting aside funds to pay for it.
The accounting investigations by the Securities and Exchange Commission and the Department of Justice revolve around the way Time Warner and America Online reported financial results and counted subscribers before and after the companies merged.
"The Company has established reserves totaling $500 million in connection with the pending SEC and DOJ investigations," Time Warner said in a statement.
"This amount represents the Company's current best estimate of the amounts that would be involved ultimately to resolve these investigations," it said. "The Company believes that some portion of the amount reserved will be available for related shareholder litigation. The Company has not established any reserves associated with the shareholder and civil litigation due to their preliminary status and because it is unable to reasonably estimate a range of possible loss."
For the third quarter, Time Warner reported a decline in profits as the $500 million one-time charge related to the AOL probe dragged down results. Net income in the quarter was $499 million (11 cents a share) compared to $541 million (12 cents) in the same period last year.
Revenue at Time Warner increased from $9.5 billion to nearly $10 billion in the quarter. In its earnings release for the third quarter, Time Warner said the Securities and Exchange Commission and Justice Department probes of Dulles-based AOL are continuing. Among other things, the probe is complicating Time Warner's efforts to expand its cable division because the SEC has indicated it will not approve the issuance of stock for the unit while the probe is pending.
Time Warner said that discussions with the SEC have led it to conclude that it needs to restate financial results for its ownership of AOL Europe for the 2000 and 2001 fiscal years, which may also affect results for the year ended December 31, 2002.
The changes relate to Time Warner's use of the wrong accounting method, which led it to fail to fully include, or consolidate, the results of AOL Europe for those periods, the company said. Time Warner disclosed that it should have consolidated AOL Europe's financial results after it acquired the right to buy 80 percent of Bertelsmann's holdings in AOL Europe in January 2002.
In the third quarter ended September 30, AOL's ongoing loss of subscribers to faster and cheaper Internet services continued. America Online reported 22.7 million U.S. subscribers, a drop of 646,000 from the prior quarter and 2 million users less than the same period last year. Overseas, AOL Europe reported 6.3 million subscribers, a drop of 8,000 from the prior quarter and 33,000 less than the prior year.
As previously reported, AOL is preparing to slash its workforce by more than 700 employees in early December. The cost cutting, mostly at its Northern Virginia headquarters, is linked to the continuing loss of subscribers.
Advertising revenue, which has been surging online, also grew at AOL. But the division's financial results for the quarter were dampened by subscriber losses.
AOL's sales in the quarter rose 1 percent to $2.1 billion, reflecting a $79 million surge in advertising revenue, an increase of 44 percent, which was offset partly by a $52 million drop in subscription revenue, a decline of 3 percent.
The growth in ad revenue included a $30 million jump in domestic paid search ads and a $35 million increase related to AOL's acquisition this summer of Advertising.com.
Operating results at AOL received a boost from the Internet firm's successful efforts to slash computer network and telecommunications expenses. That enabled it to report operating income of $261 million, an increase of $111 million, or 74 percent.
