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Analysts smile on AOL profits

Wall Street analysts see quarterly profits after troubled times as a sign that AOL is a viable enterprise.

Tech Industry
America Online (AOL) today bucked Wall Street's predictions by posting a slight third-quarter profit, primarily due to its slowing marketing expenses as part of a legal settlement.

After two consecutive quarters of losses and several months of being soundly beaten up by its customers, the press, and legal opponents, the earnings report is a sign that AOL is a viable company, analysts say.

Analysts had been expecting a loss of $6.7 million, or 7 cents per share, according to a First Call.

"Symbolically it carries a lot of weight," said Jamie Kiggen, managing director at investment banking firm Cowen. "Clearly it shows their power to grow earnings and sustain positive earnings going forward."

AOL reported a net income of $2.6 million, or 2 cents per share, for the period ending March 31, 1997, compared with profits of $15.1 million, or 14 cents a share, a year ago.

Steve Case, president and CEO, said he's not exactly breaking out the champagne yet.

"We're pleased that we generated a profit ahead of schedule but we also know there's a lot of work to be done," Case said.

Still, he added, the earnings "represent a turning point for AOL. Many questions have been raised about AOL and its strategies. In this quarter we've demonstrated that we're making progress on every front."

AOL also announced that third-quarter revenues climbed 46 percent over last year. The company posted revenues of $456.2 million in the quarter, up from $312.3 million a year ago.

In fact, advertising and electronic commerce revenues also were up, AOL reported. Revenues from these two sectors rose to $60.7 million in the quarter, up from $15 million a year ago.

While the numbers aren't huge, the growth is significant. When AOL went to flat-rate pricing in December, it said it would rely on advertising, commerce, and renting out its network to businesses in order to turn a profit.

AOL, said Adam Schoenfeld, an analyst at Jupiter Communications "is having really good success in non-subscriber revenues and that's always been the key."

Today's earning announcement marked the first full quarter since AOL went to flat rate pricing. Industry analysts praised the move, but it caused the company major problems.

The network became so crowded that users were effectively blocked from dialing in because there weren't enough open lines. Attorneys general who had complained to AOL on behalf of their customers reached a settlement whereby AOL agreed to give customers refunds. AOL also said it would stop marketing its service until its network connectivity improved.

AOL had been spending hundreds of millions of dollars on marketing; curtailing that effort meant it was able to turn losses into profits in the short term.

Despite incurring a variety of unusual costs related to the introduction of flat-rate pricing, the company earned a profit in the latest quarter primarily through lower marketing expenses, AOL stated in its release.

But Case said in an interview that the lower marketing costs were only one factor in the company turning a profit.

During the quarter, AOL did as promised and held its membership steady at about 8 million customers. Case said AOL would ratchet up its marketing efforts very slowly and very carefully, making sure that it takes care of its existing customers through the continued buildout of its network before it lures new ones online.

"We're still at a walk-before-you-run mode, testing marketing programs," Case said. "We want to make sure we improve access. We're slowly building back up our marketing efforts as we're confident that the quality is still there."

And for AOL, these days quality means members can get on the service. Although connectivity has improved, it's still the lowest in its class, according to Web measurement company Inverse.

Case said the company is steadily trying to improve that rate. Case acknowledged that churn--the rate at which existing subscribers leave the service--peaked in January when, not coincidentally, busy signals were also peaking. "January was the worst month in quite some time," he said. But, he added, "April was the best month we've seen in more than a year."

"This quarter means they have handled the worst of [their problems] and have been able to turn a profit, at that," said Brian Oakes, an analyst with Lehman Brothers. "They should turn a much larger profit at the easier times of the year."

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