Time Warner Inc. said yesterday that it is creating a $500 million reserve in response to the federal investigations of its America Online unit and that it also will restate AOL Europe's financial results for 2000 and 2001.
By establishing the fund, Time Warner is quantifying for the first time what a settlement of the long-running investigation of AOL could cost the company. The investigations, by the Justice Department and the Securities and Exchange Commission, concern how Time Warner and America Online reported financial results and counted subscribers, before and after the companies announced their plan to merge in 2000.
"This amount represents the Company's current best estimate of the amounts that would be involved ultimately to resolve these investigations," Time Warner said in a written statement issued with its third-quarter financial results. "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."
The company previously restated $190 million in revenue that it said AOL improperly booked as advertising. The $190 million was linked to a series of questionable transactions in which AOL and other companies, including HomeStore Inc., paid one another money funds in round-trip transactions that artificially increased ad revenue before the merger.
"These are clearly significant matters. We take them very seriously," Time Warner chief executive Richard D. Parsons said during a conference call with Wall Street analysts.
Parsons said he does not know when the SEC and Justice Department investigations will be over or what the cost of a settlement, including fines and penalties, might be.
Among other things, the investigations are complicating Time Warner's efforts to expand its cable television division through acquisitions because the SEC has indicated that it will not approve the issuance of stock for that unit while the investigations are pending.
For the third quarter, Time Warner reported a decline in profit as the $500 million AOL charge dragged down financial results that otherwise exceeded Wall Street's expectations. Quarterly profit was $499 million (11 cents a share), compared with $541 million (12 cents) in the third quarter of last year. Revenue was $10 billion, up from $9.5 billion.
In its announcement yesterday, the company confirmed plans to fire more than 700 AOL employees in early December. Time Warner said that it would take an estimated $50 million charge in the fourth quarter or in 2005 to account for the restructuring. The workforce cuts, mostly at AOL's Northern Virginia headquarters, are linked to the Internet firm's loss of subscribers.
Wall Street analysts were upbeat yesterday about the possibility that a legal settlement of some of AOL's accounting and financial problems might occur sooner rather than later. Time Warner stock closed yesterday at $16.59 a share, up 31 cents.
"We believe this could signal that a resolution is close," Prudential Securities said.
"While the need for further restatements (of 2001/2002 results) is disappointing, the fact that [Time Warner] now feels comfortable enough to put a dollar figure on their SEC/DOJ exposure increases our confidence that the investor overhang will disappear over the next several months," Fulcrum Partners, an independent research firm, wrote in a report. "While shareholder lawsuits are likely to follow, we believe the perception of a near-term resolution to the SEC/DOJ is clearly positive."
Time Warner said discussions with the SEC led it to conclude that it must restate financial results for AOL Europe, which it owned jointly with German media giant Bertelsmann AG. The company said it intends to restate AOL Europe's results for fiscal 2000 and 2001, which may also affect results for 2002.
The changes relate to Time Warner's apparent use of an incorrect accounting method, which led it to fail to fully include, or consolidate, the results of AOL Europe with the parent company for those years. Time Warner said 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 March 2000.
Time Warner offered two different accounting methods that might be used to restate AOL Europe's financial performance in 2000 and 2001. Both methods would lower Time Warner's profit by millions of dollars in and around the time of its merger with AOL.
In the third quarter ended Sept. 30, AOL's loss of subscribers to faster or cheaper Internet services continued. America Online reported 22.7 million U.S. subscribers, a drop of 646,000 from the second quarter and 2 million users fewer than in the third quarter last year.
The biggest loss of subscribers occurred among those who use dial-up Internet connections. AOL lost 1.9 million such subscribers, who pay $23.90 per month. The company added 470,000 customers who have other Internet connections and rely on AOL for its content.
Time Warner Vice Chairman Don Logan said that over time, AOL might eliminate different prices for dial-up and high-speed subscribers.
AOL Europe reported 6.3 million subscribers, a drop of 8,000 from the previous quarter but 33,000 more than in the third quarter of 2003.
Advertising revenue, which has been surging in general online, also grew at AOL. But the division's financial results for the quarter were dampened by the loss of subscribers.
AOL's sales in the quarter rose 1 percent, to $2.1 billion, reflecting a $79 million increase in advertising revenue, a 44 percent jump that was offset partly by a 3 percent, $52 million drop in subscription revenue. The growth in ad revenue included a $30 million increase 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 company's successful efforts to cut computer network and telecommunications expenses. It reported operating income of $261 million, an increase of $111 million, or 74 percent.