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AOL Time Warner tops lowered estimates

The media mammoth reports third-quarter revenue of $9.3 billion, beating Wall Street's estimates, thanks to reduced expectations amid a slowing economy.

AOL Time Warner on Wednesday reported third-quarter revenue of $9.3 billion, beating Wall Street's estimates, but only after having reduced expectations caused by the slowing economy.

But more troubling for the media giant, analysts have begun raising flags about the future financial health of its America Online unit, pegged as the company's cash cow. The division was hit hard this quarter by the downturn in advertising, a trend that is unlikely to improve in the near future. In response, Merrill Lynch analyst Henry Blodget downgraded AOL Time Warner to "neutral" from "buy."

"While reported revenue and EBITDA were in line, we are concerned with underlying trends at AOL," Blodget wrote in a note to investors Wednesday morning. "We believe this sudden drop may be the result of the rolling off of long-term contracts priced at the height of the online advertising market.

"As a result, we are not optimistic about a near-term recovery in AOL's (advertising and commerce) revenue."

For the quarter, AOL Time Warner posted $2.5 billion in earnings before interest, taxes, depreciation and amortization (EBITDA), up from $2.1 billion in the same period last year. AOL Time Warner Chief Executive Gerald Levin reiterated that the company expects to reach double-digit EBITDA growth in 2002.

Including one-time charges, the company's net loss grew to $996 million from $902 million last year. The charges stemmed from $134 million in merger-related expenses and a $196 million noncash write-down from its investments.

Excluding certain charges, the media giant reported earnings of 30 cents a share. Analysts had expected AOL Time Warner to post a profit of 26 cents a share, according to First Call.

The report, a barometer on the condition of the media industry, was not surprising. The company last month warned that it would not reach its aggressive year-end financial goals of $40 billion in revenue and $11 billion in EBIDTA, which measures cash flow. AOL Time Warner blamed the declining advertising market and the events surrounding the Sept. 11 terrorist attacks for the shortfall.

In the aftermath of the attacks, a wave of analysts concerned about advertising growth cut revenue estimates for the quarter to $9.15 billion, according to First Call.

"I give them an A for effort and a B+ for execution," said Jordan Rohan, an equity analyst at SoundView Technology Group. "The cable networks unit showed very good cost discipline, but it looks to me that the AOL unit could lag for the next few quarters."

Advertising and commerce contracts are rolling over or having to be renegotiated, Rohan said. "Clearly, that revenue stream will be more difficult to generate in the future."

The company reported a 5 percent drop in advertising and commerce revenue, compared with the year-ago quarter, to $1.9 billion. "The market for advertising continues to look weak," J. Michael Kelly, AOL Time Warner CFO, said during a conference call with analysts.

One bright spot in the company's report was its subscription business, long touted by executives as a stabilizing force in a rocky economy. Subscriptions rose 13 percent to $4.2 billion, bolstered by membership growth in the America Online unit, Time Warner Cable's digital service and the Road Runner broadband Internet service provider. Despite these stronger subscription gains, advertising continues to drag down the company's earnings.

Here's a look at AOL Time Warner's performance by division:

• America Online: The Internet powerhouse showed a significant slowdown in its advertising revenue, reporting 5 percent growth from last year to $624 million, in contrast to last quarter's 26 percent growth to $706 million. Still, revenue in the division climbed 13 percent to $2.2 billion, $1.4 billion of which came from monthly subscription fees.

AOL added 1.3 million members for a total of 31.2 million worldwide during the period. EBITDA reached $742 million, a 22 percent increase.

• Cable Networks: Viewed as the company's other growth engine, Time Warner Cable reported 17 percent revenue growth to $1.8 billion. Subscriptions rose 15 percent to $1.6 billion; advertising and commerce rose 41 percent to $175 million. EBITDA jumped 11 percent to $791 million.

• Filmed Entertainment: The movie business grew 5 percent to $2.1 billion spurred by films such as "Rush Hour 2," "Cats & Dogs," "A.I." and "Swordfish." The division is also anticipating potential holiday blockbusters "Harry Potter and the Sorcerer's Stone" in November, and "The Lord of the Rings" in December. DVD sales grew 96 percent from last year.

• Networks: Broadcast and cable networks showed a 4 percent increase in revenue to $1.7 billion. But advertising dollars continued to hurt the division, marked by a 10 percent decline from last year. EBITDA climbed 29 percent to $450 million. The division was hit hard when CNN and local affiliates stopped running advertising for nearly a week for coverage of the Sept. 11 attacks.

• Music: Warner Music Group continued its revenue decline, down 1 percent, a result of slow CD sales and unfavorable currency exchange rates. EBITDA plummeted 21 percent to $87 million because of the revenue decline and an increase in marketing spending.

• Publishing: The company's magazine and book division reported a 4 percent revenue increase to $1.1 billion, but advertising and commerce dropped 1 percent. EBITDA climbed 41 percent to $196 million.