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Subscriber loss dampens AOL gains

One-time gains triple AOL Time Warner's profits in the second quarter amid subscriber seepage and SEC questions about accounting for ad deals.

AOL Time Warner reported on Wednesday a rise in quarterly profits from strong performance in its movie business, but its America Online unit continued to suffer from a falloff in subscribers and in advertising revenue.

In the second quarter ended June 30, AOL's online unit reported it lost 846,000 subscribers compared with the previous quarter. In addition, it said online advertising revenue plummeted 48 percent compared with the same period last year.

Company executives lowered their expectations for the unit, saying subscriber declines would cause its overall revenue to fall by a single-digit percentage in 2003. Previously, they said revenue would be flat for the year.

"In the investor's mind, they thought (subscriber loss) was behind them," said Paul Kim, an analyst at equity research firm Kim & Company. "But this report raises more questions about AOL's business."

Alongside the earnings announcement, AOL Time Warner said an investigation by the Securities and Exchange Commission had determined that two advertising deals with Germany's Bertelsmann may have been inappropriately treated in its accounts. AOL Time Warner said that the accounting was appropriate.

For the second quarter, AOL Time Warner said its net profit rose to $1.1 billion, or 23 cents a diluted share. That compares with a net profit, excluding one-time items, of $394 million, or 9 cents a diluted share, in the same period in 2002. Revenue for the quarter jumped 6 percent to $10.8 billion.

Wall Street analysts, on average, expected earnings of 10 cents a share and revenue of $10.65 billion, according to tracking firm First Call.

AOL Time Warner executives said they expect 2003 revenue to grow by about 5 percent from $41 billion in 2002.

The company was able to reduce its debt by $2.1 billion from $26.3 billion last quarter to $24.2 billion. The reduction stemmed from the sale of its 50 percent interest in cable TV channel Comedy Central to Viacom and from a $750 million cash payment from Microsoft to settle an antitrust lawsuit filed by AOL Time Warner. Debt reduction is likely to continue to be a major priority for the company.

However, one debt-reduction initiative may be suspended. The company's planned public offering of Time Warner Cable remains at a standstill, despite expectations that the division could be spun off this summer. AOL Time Warner CEO Richard Parsons said the spin-off would now be based on strategic factors rather than on previously stated debt-reduction factors.

"We will continue to evaluate whether to establish a cable-only currency," Parsons said during a call with Wall Street analysts.

Most of this quarter's financial highlights came from AOL Time Warner's traditional media businesses--especially its movie business, which benefited from ticket sales for "The Matrix Reloaded." Other areas, such as cable TV channel HBO and its magazine publishing business, also showed strong growth.

Online: More subscriber losses
However, troubles at its America Online (AOL) unit persisted, with the division losing 846,000 narrowband subscribers. The fall was caused by the maturing narrowband market, subscribers' defection to broadband, an increase in churn and the removal of subscribers who violated service agreements or failed to complete the registration process, AOL Time Warner CFO Wayne Pace said during a conference call with Wall Street analysts.

As of the end of June, AOL had 25.4 million U.S. subscribers, down from 26.2 million the previous quarter. The unit had 21.4 million paying subscribers, 17.9 million subscribing to its full $23.90 unlimited plan; the rest on limited or "bring your own access" (BYOA) plans. Executives also reclassified 250,000 former paid subscribers as trial and promotional users, bringing that total to 4 million.

Executives said AOL's broadband subscribers totaled 2.2 million. That number combines people on the BYOA plan, under which members pay $14.95 monthly to access the online service via their own broadband provider, along with people who access the service through AOL's deals with digital subscriber line (DSL) and cable modem providers. AOL Time Warner's Pace said the online division added about 300,000 new broadband customers last quarter, based on these metrics.

Meanwhile, the unit's advertising and commerce revenue declined 48 percent from last year, while "other" revenue declined 62 percent on the reduction of its promotional merchandise business. Subscription revenue grew 6 percent, pushed by gains at AOL Europe from favorable currency exchange rates and higher subscription rates.

AOL Time Warner expects the online unit's 2003 revenue to decline by a single-digit percentage from the $9.1 billion reported in 2002. Advertising and commerce will be down 35 percent to 45 percent, with cash flow either unchanged or down by a single-digit percentage from the $1.5 billion reported in 2002.

Parsons and Pace both heralded AOL's upcoming launch of 9.0 Optimized, the new version of its online service, which is slated for release later this summer. AOL is making a push to stem defections to broadband by investing its resources in refurbishing its service. Throughout the summer, the unit has released many new test versions of AOL 9.0 Optimized.

Reuters contributed to this report.