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How much longer can America Online Inc continue to pull the wool over investor’s eyes? For a bit longer yet it seems. We reported the end of year results from AOL Friday, and the fact that the company restated its second and third quarter results following discussions with the Securities & Exchange Commission.

By Nick Patience

Well it seems that some on Wall Street have finally seen the light and have had enough of the company and its over-inflated stock price, which of course Wall Street is responsible for. And the analyst backlash has also begun against AOL’s accounting practices, which can be described as questionable at best. The most likely move for any company that has an over-inflated stock price but is in danger of feeling the wrath of the Street is to go for a quick stock split to help boost the price, but there’s no word on one of those just yet. Even after the restatement of the company’s second and third quarters, the net ‘profit’ in the fourth quarter of $10.9m is less than 1996’s $16.1m, which was after a $5.3m charge. That in itself is not a disaster, but what it should do is cause analysts to adjust their long-term forecasts for AOL, but apparently not just yet. Most of the Street reaffirmed their ratings, which are usually around the buy or strong buy area. The second quarter restatement is for the move of a $25.4m charge for the termination of certain content provider contracts from Q2 to Q4, which means that profit in Q2 is now about $25m higher. Q3 is also restated, changing a profit of two cents a share into a loss of five cents a share. That swap is due to the readjustment of the marketing deal with Tel-Save Inc, whereby Tel-Save’s long-distance services are advertised on AOL exclusively. The company recognized $12m revenue (from a project total of $100m) from the deal in Q3. However, the agreement was for three and a half years and it now says it will recognize $5m of it in Q3, with the remaining $7m split over the rest of the contract, some 40 months, which seems a more reasonable way of accounting for such a lengthy deal. It is also exactly the same kind of accounting sleight of hand the SEC pulled AOL up short for when it tried to apply it to its marketing costs for recruiting subscribers. It used to spread them out over two years, which presumed that all the subscribers hung around for that long, which was far from the case. But more importantly, the timing shift in the third quarter means a fourth quarter benefit of $1.8m, or $0.02 per share, which wipes out the two cents premium on First Call’s estimate. And just where is the progress so many news reports have been talking about following the results announcement? Many of them seem to have been swung by chief executive Steve Case’s charisma on the call to press and analysts late Thursday. Comparing the fourth quarter of 1997 and 1996 it goes like this. Total revenues: $475,743 vs $334,467. Cost of revenues: $294,394 vs $183,619. Cost of marketing: $97,081 vs $66,839. Which means that revenues less these costs was static: $84,268 vs $84,009, and margins fell to 18% from 25% year-on-year. Is that progress from one year to the next? Picking over the rest of AOL’s reporting we come to the balance sheet. As was the case at the end of the second quarter the current liabilities outstripped the current assets, this time by more than 40%, which raises question about the company’s solvency, and more basic still, how does it pay it’s short term bills? One analyst said late Thursday, Companies with such ugly balance sheets should have their stock taken behind the barn for a real whipping. Well trading throughout Friday, although heavier than usual, showed the stock holding up admirably, despite numerous threats on chat forums for analysts threatening to short the stock dramatically – many were predicting a fall on the day of about 15 points. It ended up down just $1.375 at $70.1225, the lowest point only being $68.625. So much for that. Meantime chief executive Steve Case is predicting 10 million users by the end of the year. That

will no doubt be achieved and the user base will be leveraged accordingly to help the company’s standing with investors – remember the selling telephone numbers scam a couple of weeks back?. But how long are AOL users prepared to put up with having to cancel the innumerable offers before getting through to the basic service? Do they really buy these services just because they appear on AOL? Do advertisers really think that a user base that gives up on a subscription service so quickly after signing up is such a valuable asset? AOL is a pure marketing play with an online service on the side. And that online service doesn’t appear to be earning the company that much money – online service revenues rose 1% from Q3 to Q4. We have been saying for some time that AOL is overvalued and gets a far too easy time from those supposedly in the know. One thing we know, however, is that AOL has never made any money as a public company. If you add up all its net income and losses you’ll find that it comes to a loss. Go figure.

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CBR Staff Writer

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