Time Warner Inc. has launched an internal investigation to determine whether America Online improperly accounted for losses at its European division before and after the AOL-Time Warner merger in 2001, the media giant disclosed yesterday.
During the period in question, AOL Europe posted significant losses that Dulles-based America Online did not incorporate in its own financial results, according to public filings. Time Warner said it may have to restate earnings as a result of its review.
The bookkeeping under scrutiny involved the sale of a small stake in AOL Europe to Goldman Sachs Group, which temporarily reduced AOL's ownership in AOL Europe to below 50 percent, according to a recent article in Business Week. Since it was no longer a majority stockholder, AOL reported AOL Europe's results separately from its own.
The maneuvers may have helped AOL keep its earnings and stock price up prior to its January 2001 merger with Time Warner, the article said. AOL eventually repurchased the stake from Goldman to again become the majority shareholder.
"The company has recently begun a review of the accounting related to the consolidation of, and equity accounting for, its interest in AOL Europe," Time Warner said in a filing with the Securities and Exchange Commission. "It is possible that further restatement of the company's financial statements may be necessary."
Time Warner revealed the internal probe in a footnote to a quarterly financial statement it released yesterday -- a report that showed a 10 percent gain in revenue for the three-month period ended June 30 compared with the same quarter a year ago.
The new revelations come amid federal probes by the SEC and the Justice Department into AOL's reporting of domestic subscriber numbers and financial results before and after the Time Warner merger.
Time Warner spokesman Ed Adler declined comment on the matter.
The fresh problems suggest that the federal probe hanging over Time Warner and America Online is dragging on and expanding, rather than wrapping up swiftly.
Yesterday, Time Warner Chief Financial Officer Wayne Pace said the SEC probe is preventing the corporation from seriously considering plans it once had to issue stock in its Time Warner Cable division that could be used for acquisitions.
"We currently have no thoughts about an IPO because of the thinking that the SEC would not be in a position to review that," Pace said during a meeting with Wall Street analysts. He said the company is now considering alternatives to an IPO: "We are thinking about all of our other strategies in the event we do decide to expand our cable footprint."
Time Warner remains at odds with the SEC over a variety of other issues, most notably its accounting for $400 million paid in 2002 by Bertelsmann AG to AOL that the Internet firm booked as ad revenue. The SEC is holding fast to its position that Bertelsmann overpaid AOL as part of a complicated transaction intended to help the online company artificially boost its advertising numbers.
In its quarterly financial report yesterday, Time Warner said AOL ad sales surged 23 percent during the recent three-month period, its first year-over-year ad revenue increase in almost three years. That jump pleased Wall Street analysts, who had been waiting to see whether America Online's ad revenue would begin to benefit more from the increase in overall spending on Internet advertising.
The $42 million increase in AOL ad sales was driven by higher revenue from its partnership with Google Inc., the nation's leading search engine. About 75 percent of the increase, or $31 million of the higher ad revenue, came from ad sales linked to search.
To garner a larger share of the Internet ad boom, AOL, which remains the biggest online service in the nation, recently announced the $435 million acquisition of Baltimore-based Advertising.com.
Don Logan, vice chairman of Time Warner, said the company will seek early next year to increase America Online's ad revenue by attempting to attract non-AOL subscribers to a beefed-up AOL.com Web site that will include content from the Time Inc. stable of magazines.
AOL has been struggling to retain subscribers, many of whom are defecting to high-speed Internet services offered by telephone and cable companies. The number of AOL users in the United States fell by 668,000 to 23.4 million in the second quarter from the same period last year, and the number of subscribers in Europe fell 88,000, to 6.3 million.
The losses occurred chiefly among subscribers who use AOL to reach the Internet over dial-up telephone connections. AOL lost 1.3 million dial-up subscribers during the quarter, but it added 630,000 high-speed users, bringing the high-speed total to more than 4 million.
In the same quarter last year, AOL reported that it had lost a total of 845,000 subscribers, which the company attributed partly to cleaning up its books to remove nonpaying customers.
In the second quarter this year, Time Warner's revenue overall jumped nearly 10 percent, to $10.9 billion from $9.9 billion in the same period last year. The company's motion picture, television network and cable divisions all produced double-digit percentage growth in the quarter, led by the strong box office performance of the movie "Harry Potter and the Prisoner of Azkaban."
"We had very strong earnings in the second quarter," said chief executive Richard D. Parsons. "All of our operating segments contributed to the company's growth." Wall Street analysts generally agreed that the world's biggest media company turned in a solid performance in the quarter.
Nevertheless, Time Warner profit fell in the quarter due to a number of one-time transactions that boosted net income in the same period last year.
Net income in the quarter fell to $777 million (17 cents a share) from $1.06 billion (23 cents) last year.
The prior-year period included $600 million in gains from the sale of a 50 percent stake in the Comedy Central cable channel and other assets, as well as a $760 million gain from the settlement of a legal dispute with Microsoft Corp.
Time Warner updated its financial projections for 2004, saying it expects operating income for the far-flung media giant and its AOL division to grow at a slightly faster rate than it had previously expected.
Parsons emphasized that he was encouraged by the long-term outlook for America Online, which has been cutting its computer network and telecommunications expenses as its subscriber base has fallen.
"It has executed an impressive financial turnaround," Parsons said. "We are in a position for AOL to grow in 2005 and beyond. The AOL advertising business is emerging as one of the most exciting growth opportunities in our company."