The Wall Street Journal

1. Big Charge Ends Attempt By AOL to Spin Wall Street

Last spring, some University of Maryland business students submitted a paper on America Online -- concluding that the highflying stock was overpriced. Jeffrey Hooke, the professor, sent me a copy, but I tossed it out.

It is obvious now I should have passed it on to the postgrads and other certified analysts at Morgan Stanley, Merrill Lynch, Goldman Sachs and Alex. Brown. These firms, being not incidentally underwriters for AOL, were bullish.

They have had a tough ride, from $70 to $25, but that is no shame. They also liked AOL on the way up, and every analyst misses a call. The shame is that information that could have led them to exit AOL at the top was in front of their face, but its seeming importance was minimized by AOL's aggressive accounting and relentless spinning of Wall Street.

As accountant or spinner, AOL was hardly unique. It's common to take expenses out of quarterly statements and tuck them in a one-time ritual bath. It's common to spoon-feed analysts, particularly friendly analysts. It's common, when results disappoint, to unveil a new "model" that renders past disappointments meaningless. And trying to steer a stock like a guided missile is nothing new, especially for companies that rely for cash on periodic underwritings and that pay the brass primarily in options. AOL, for those recently returned from extended safari, is the biggest on-line consumer services company.

It carpet-bombed the country with disks, spending $363 million, a third of its revenue, on promotion in its last fiscal year. But it booked only $126 million of that as an expense. The rest of its marketing was considered a capital asset, to be amortized over two years. This was controversial, because, according to other-than-bullish analysts, it was unclear from AOL's disclosures whether the average customer was staying that long. In the meantime, the "asset" represented by marketing was building fast, as were looming amortization charges.

Last week, AOL threw in the towel -- sort of -- by saying it would take a one-time charge of $385 million, reducing to vapor what Ernst & Young had certified as solid assets nine weeks earlier, and would expense all future marketing. According to accounting sleuth Howard Schilit, AOL is gaming the numbers even now. "Instead of expensing when they should have, AOL said, 'We'll expense it tomorrow,'" he says. With the special charge, "tomorrow never comes."

AOL's recent 10-k suggests that, without the big bath, it might have been under pressure to amortize more quickly and penalize earnings more. Its filing flagged its amortization practice as subject to quarterly review. Asked whether it was pushed by its accountant (who didn't return a call), Lennert Leader, the chief financial officer, called the question "not relevant." And, he said, "We take strong exception to any notion that we are playing games." He brushed off the idea that any problems led to the accounting change, which he said was caused by AOL's switch to a new pricing scheme.

"Look at the track record," an AOL spokesman added. "For the past 16 quarters this company delivered on expectations of revenues, profits and subscribers." When it was pointed out that AOL not only delivered profits but now will charge them off (every dime and more it had "earned"), he replied that the accounting was standard and proper. And indeed it was. Accountants often choose between accepted but differing standards. As Abraham Briloff said of AOL's auditors 15 months ago, they should strive for the standard that best reflects economic reality, not the "invidious" alternative of mere acceptability. Every Wall Street analyst -- bull and bear -- was of course aware that AOL was deferring its marketing costs. Bulls will now reply that as the numbers were known, the accounting form was irrelevant to their analysis. But the bulls dismissed the accounting issue while enthusiastically trumpeting AOL's reported (now vaporized) "profits." By calling them profits, they tended to overlook or minimize that AOL was in a price war with Internet access providers and spending more cash than it was taking in. Alex. Brown analyst Steven Eskenazi now says, "I never claimed AOL earned a dime." But his reports uncritically reported their profits. "While we have NEVER positioned AOL as an earnings story," he wrote in June, "we can't help but be tempted by its 1997 P/E of 42 times." Last week, the night before AOL's announcement, the company wined and dined Alex. Brown and other favored analysts at Manhattan's Essex House. Next morning, as AOL was overhauling its accounting and corporate alignment, the analysts were magically ready with new earnings forecasts (caveat emptor) through 1998. In the Internet business, in which AOL is certainly a legitimate contender for subscriptions, advertising, content and merchandising sales, 1998 is a long way away.

Various neutral analysts have had less access to AOL, but distance has served them. Cowen & Co.'s Jeff Goverman wrote in March, AOL "may be losing money on each subscriber." Smith Barney, Off Wall Street Consulting Group, and others, said similar. Perhaps, AOL should have paid attention. Having a stock in the stratosphere reinforces any management's tendency to believe it is on course, marketing wisely, etc. AOL's Mr. Leader vigorously disputes that AOL spins the news. "This company has been very forthright. We should be commended for acknowledging mistakes and reaching out" and talking to investors, bullish and otherwise, he says. Maybe. But the danger in spin artistry is always that the spinner will believe the spin.

Copyright 1996 Dow Jones & Company, Inc. All Rights Reserved.

The Wall Street Journal Interactive Edition -- November 8, 1996

2. AOL Reports Its Loss Nears $354 Million After Big Charge


NEW YORK -- America Online Inc. posted a quarterly loss of nearly $354 million after taking a whopping $385 million charge to abandon a controversial accounting tactic.

The charge, which was expected, represented a write-off of the enormous marketing costs AOL has racked up in its quest to sign up new members. The nation's largest computer on-line service historically deferred those costs over a two-year period instead of expensing them up front -- allowing the company to report quarterly profits and postponing the day of reckoning for its marketing expenditures.

AOL recorded a loss of $3.80 a share for the fiscal first quarter ended Sept. 30. This compares with a loss of $10.9 million, or 14 cents a share, in the year-earlier period, which included a one-time charge. Excluding that charge, AOL's year-earlier net income was $6.1 million, or six cents a share. Revenue rose 77% to $350 million, a rise from $197.9 million a year earlier.

But last year's operating profit was reported under AOL's old accounting methods, which the company had justified as a better way to match expenses with subscriber revenue. As those "deferred subscriber acquisition costs" mounted into the hundreds of millions, the company was forced last week by investor concerns to cease the accounting practice.

AOL said that, before Thursday's charge, its earnings would have been $19 million, or 17 cents a share. But that profit was calculated under the now-abandoned deferred-cost method. With the new accounting method in place, analysts expect a loss at AOL in the second quarter.

Tumultuous Time

The move to scrap the accounting method comes at a tumultuous time for AOL, which has faced tremendous price competition from Internet-service providers. Last week, the company abandoned its hourly charges by creating a new flat-rate price of $19.95 a month, which will erase the hefty monthly revenue the company received from heavy users. The financial impact on the company's subscriber revenue, which is still uncertain, has forced AOL to develop alternative revenue streams from new businesses, such as on-line advertising revenue and fees from the electronic sale of goods.

Thus far, those alternative revenue streams amount to only 10% of the company's quarterly revenue. AOL said it generated $38.8 million in revenue from other sources, which has some analysts concerned about the success of its shift to relying on other revenue streams. On Wednesday, Lisa Thompson, vice president at Prudential Securities Inc., launched coverage of AOL with a "hold" rating.

High Risks

"At the valuation the company's at and the fact that they're living life on the edge, the risks are too high to get into this stock," said Ms. Thompson, noting that advertising and electronic commerce are still largely "untried" to date. "This will not be a painless transition," she said.

AOL said its "other revenue" category grew 24% from the previous quarter and could grow 50% to roughly $60 million in the next quarter. It has 50 on-line advertisers, up from six last year. The company also said it has added 400,000 new subscribers in the quarter, bringing the total to 6.9 million. In October, AOL said it improved its retention record, adding a net 250,000 new subscribers compared with the 100,000 new subscribers the company was adding each month during the summer.

"Hopefully with the distraction of capitalization no longer an issue, we look forward to investors looking at the important aspects of our business," said Lennert Leader, AOL's chief financial officer.

Thursday's results were released after the close of market, where AOL's share price continues to languish. Its stock was down $1.125 to $24 in New York Stock Exchange composite trading.

Copyright 1996 Dow Jones & Company, Inc. All Rights Reserved.

The Wall Street Journal Interactive Edition -- October 30, 1996

3. AOL Plans $385 Million Charge Related to Accounting Change


NEW YORK -- America Online Inc. disclosed plans to take a pretax charge of $385 million to reverse a much-criticized accounting approach that had let the company post quarterly profits by forgoing the immediate write-off of massive marketing expenses.

The big charge will be taken against the fiscal first quarter ended Sept. 30, and a separate charge of up to $75 million is set for the current quarter to cover restructuring expenses. The charges are part of the on-line service company's new counterpunch to growing competition from Internet access providers. America Online Tuesday reorganized into three new divisions, named a star media executive to run one of them, and unveiled its first-ever discount plan for unlimited access. AOL had resisted that pricing move, which could hurt revenues.

The accounting charge is more than five times as large as the total pretax earnings that AOL had reported for the past five fiscal years combined. It underscores just how massive the company's marketing efforts have been-and how illusory its profits may have been. The change raises the question of whether AOL will be able to report much profit at all in future quarters.

"The earnings numbers were meaningless -- they were a house of cards," said Neeraj Vohra, an analyst at Wheat First Butcher Singer Inc. Mr. Vohra noted that AOL had reported fiscal 1996 earnings of 47 cents a share before charges, but had run up "deferred subscriber acquisition costs" of $1.37 a share, more than wiping out full-year earnings.

The effort also quickly raised speculation that AOL might be setting itself up for a sale. "A potential acquirer would be a large, conservative company. They wouldn't want to acquire a company that has aggressive accounting but, instead, a company more in line with their own," Mr. Vohra said.

Denied by CEO

But AOL Chairman and Chief Executive Steve Case denied that the company is preparing for a sale. He said it has had "no discussions and no interest in pursuing them."

AOL had staunchly defended the accounting method it will now abandon. As AOL spent huge sums on advertising and free trials to lure newcomers, it spread each quarter's expenses over up to two years rather than deduct the costs immediately. Backed by its outside accountants, the company had argued that spreading the costs over two years was a justifiable way to match expenses against revenue flows that would emerge later.

Mr. Case said scrapping this controversial method is aimed at stemming Wall Street concerns that had dogged the company for years. "In one fell swoop we're addressing the needs of Main Street and the concerns of Wall Street," he said of the accounting change and new pricing. "We've decided it's best not to spend all our time in this debate over accounting practices. There will be no argument over the quality of earnings."

News of the accounting change sent Wall Street analysts scrambling for their red pens. Mary Meeker of Morgan Stanley & Co., who had been projecting profit of $1 a share for fiscal 1997, now expects a per-share loss of three cents and a $130 million reduction in revenue. "AOL indicated that it would bite the bullet" on subscriber acquisition costs, Ms. Meeker, one of the company's biggest boosters, said in a report issued Tuesday. "We hope that the worst is over," she wrote, referring to the slide in AOL's stock price this year.

Stock Climbs $1

AOL shares rose on the news of the accounting change. They closed at $25.625, up $1, in composite trading on the New York Stock Exchange.

AOL has been struggling with annual customer-churn rates of 30% to 40% by some estimates, as some users quit the on-line service to use cheaper Internet access providers. Now it hopes to stem such defections by offering users unlimited access for $19.95 each month; previously, AOL had charged $19.95 for 20 hours and $2.95 for each additional hour.

"We've spent large amounts of cash to market a product that arguably wasn't responsive to market needs," said Lennert Leader, AOL's chief financial officer. AOL hopes its average cost of acquiring a subscriber can decline somewhat if the flat-rate plan can curb defections. Mr. Leader said he expects to see a 10% decrease in subscriber acquisition costs because of the new discount plan.

AOL said the one-time charge of as much as $75 million in the current quarter is to reorganize and shut down Global Network Navigator, the Internet-only service it started just over a year ago.

Pricing Details

In addition to the unlimited pricing plan, AOL offered a new monthly rate of $9.95 for users who already subscribe to a rival but want to tap into AOL's exclusive content. Hoping to boost short-term cash flow, the company further offered an even steeper discount to subscribers who pay up-front for two full years of service: $14.95 a month for unlimited usage. Those who sign up for a year and pay in advance will be charged $17.95 a month.

That will help AOL's cash flow, which was at a negative $66.7 million before a stock offering in fiscal 1996. Though the company said it will have roughly $70 million in positive cash flow after the fiscal first half, Mr. Leader said the new up-front offers could let AOL collect as much as an additional $100 million in revenues.

He added that the company hopes to gain more revenues from advertising and on-line sale of goods. Such alternative revenues accounted for as much as $40 million in the September quarter -- a number he expects will grow by 50% to $60 million for the December quarter.

News of the charge was buried in a flurry of other announcements. AOL said it reorganized into three groups and appointed former MTV executive Robert W. Pittman, who was elected to AOL's board earlier this year, to head one of them. That group, AOL Networks, will be responsible for the consumer Internet service. A second division, AOL Studios, will develop new on-line content and the third, ANS Communications, will continue to deploy high-speed networking for AOL and for business customers.

The restructuring will eliminate the need for a president and chief operating officer, a post left vacant after former Federal Express Corp. executive William Razzouk left just four months after taking the job. Instead, much of the responsibilities for the consumer on-line service division will fall on Mr. Pittman's shoulders. "He's going to fit into the culture a lot more seamlessly than Razzouk could," said Jamie Kiggen, analyst at Cowen & Co., adding that Mr. Pittman has "a real understanding of how these new media companies have evolved."

Still, AOL's evolution is uncertain, despite the widespread support for the company's moves. "On an operating basis, what the company did better reflects the realities of the market and on an accounting basis, it better reflects the true cost of acquiring subscribers," said Jonathan Cohen, managing director at Smith Barney Inc. Are the moves adequate in the fast-paced industry? "The jury is still out on that," he said.

Copyright 1996 Dow Jones & Company, Inc. All Rights Reserved.


Dow Jones Business News -- October 29, 1996

4. America Online Shrs Up After Hours

Dow Jones News Services

America Online Inc. (AOL) shares, which gained 1 point during market hours, inched slightly higher after the close.

The Vienna, Va., company earlier said it will expense its marketing costs as they occur rather than amortize them over a 24-month period, and said it expects to take a charge of about $385 million in the first quarter and another charge of $75 million in the second quarter.

America Online added that the first-quarter charge is for the balance of deferred subscriber acquisition costs, while the second-quarter charge is for costs the company expects to incur as it aligns the organization with emerging opportunities in the interactive market.

The company also said it expects to break even in the third quarter as part of a new plan to take marketing expenses as incurred and to become profitable in the fourth quarter under the new accounting practice.

America Online shares closed at 25 5/8, but were recently bought at 25 7/8, Arrich said.

Otherwise, after-hours trading was ''a little dead,'' Arrich said.

Copyright 1996 Dow Jones & Company, Inc. All Rights Reserved.


Dow Jones Business News -- October 29, 1996

5. America Online Hopes Changes Reduce Defections, Criticism

By CARMEN FLEETWOOD Dow Jones News Services

NEW YORK -- America Online Inc. (AOL) made changes it hopes will stem the barrage of criticism about its accounting practices and the tide of customers switching to rival Internet services.

Earlier, the company said it will expense its marketing costs as they occur rather than amortize them over a 24-month period. The company expects to take a charge of about $385 million in the recently ended first quarter for the balance of deferred subscriber acquisition costs. America Online anticipates another charge of $75 million in the current quarter.

The change in the accounting practice makes it now a non- issue, according to Abhishek Gami, an analyst at Nesbitt Burns Securities Inc.

The Dulles, Va., company also changed its price structure. Among the highlights for the new program are the standard plan of unlimited usage for both America Online and the Internet at $19.95 a month and three hours of America Online for $4.95. Previously, America Online gave 20 hours of usage for $20 or $9.95 for five hours.

Many Internet-only service providers charge $19.95 for unlimited access to the Internet. Rival Microsoft Network said earlier this month it would charge $19.95 a month for unlimited Internet use and access to its exclusive Web content for the service.

''The new pricing hits at the core of the bear argument'' about America Online, said analyst Steve Eskenazi of Alex. Brown & Sons Inc. It will help the company maintain its position as ''top dog'' in the emerging industry.

Others saw the change differently.

''It is taking them to where the market is - Internet access,'' said Jeff Matthews, a fund manager at Ram Partners, ''but it is not good for them in the long run.'' He compared America Online to a privately owned turnpike, but he believes more people are attracted to the Internet, which could be seen as a superhighway that doesn't cost very much.

While America Online's old method of amortizing costs is used by a number of other subscriber-based businesses, such as Readers Digest Association Inc. (RDA), the on-line service was subject to a great deal of criticism as people suspected something was being hidden.

The ''newness of the company and industry'' might have caused the criticism, according to Robert Willens, a managing director at Lehman Brothers Inc. An old-line, successful company wouldn't necessarily be criticized for the same practice, he said.

America Online's NYSE-listed stock was up 5/8, or 2.5%, at 25 1/4 on volume of 2.9 million shares, compared with average daily volume of 2.8 million.

On one level, America Online's former practice of amortizing marketing costs might be more preferable because one of its goals is to match expenses with revenues in the periods they relate to, said Lehman's Willens. But the investment community seems to favor the more conservative accounting method.

''People will have a much clearer idea of what is happening,'' America Online Chief Executive Steve Case said in a telephone conference call with the media.

For the December quarter, America Online's management now is projecting a $32 million loss - excluding another charge - almost exclusively because of cash expensing of marketing costs, Merrill Lynch & Co. analyst Lauren Rich Fine said in a research note.

''While the earnings impact is certainly negative, we think it is more than overshadowed by the positive reaction the change in accounting should engender,'' she said.

Company officials said in the conference call that the third-quarter should be breakeven under the new accounting practice and that America Online should become profitable in the fourth quarter and beyond.

America Online needed to make moves to keep its position as the on-line service with the most subscribers. More than six million people use America Online, but the company has said its subscriber growth has slowed and that it has been losing people to cheaper Internet access services. Meanwhile, short interest in the company's stock has risen sharply in the past six months.

America Online issued a new version of its software in the past few months as a way to keep old members and attract new ones.

Case now expects America Online to have more than 7 million subscribers in November. America Online added about 250,000 new members in October, he said.

Case said the company has been putting in a ''member- save'' and other programs to help reduce the level of subscribers leaving the service, known as ''churn'' in industry parlance. The chief executive said the efforts have been lowering the rate of departures.

About 20% of the on-line service's subscribers are heavy users and some revenues will be lost under the new plan. Others note that the company might be able to convince subscribers who use the system less to pay more for more hours.

The challenge for America Online has shifted to trying to be profitable with its new prices, according to Arthur Newman, an analyst at Gerard Klauer Mattinson & Co.

Copyright 1996 Dow Jones & Company, Inc. All Rights Reserved.


6. America Online Announces Newer Transformation


Last month, when America Online Inc. introduced new software, a new advertising campaign and a new listing on the New York Stock Exchange, chairman Stephen M. Case called the changes "a new AOL."

On Tuesday, with the disclosure of another spate of sweeping announcements, he delivered what might be called the new, new AOL.

Responding to growing pressure from the Internet, Case announced a new pricing scheme, a new management organization, a new top manager and a new accounting policy.

"The objective today, and I think we have done this in one fell swoop," Case said with characteristic bravado, "was to address the needs of Main Street and the concerns of Wall Street."

The moves appeared to work, at least in the short term, lifting AOL's sagging stock price $1 to close at $25.625. But Case's habit of making repeated changes at America Online, even if the industry is known for its punishing pace, has tried the patience of many on Wall Street.

As one of the only remaining proprietary on-line services, America Online has increasing competition from the Internet. Although the company boasts that it has nearly 7 million subscribers and is growing rapidly, customers are spending more and more of their time bypassing its home-grown features to explore the much larger Internet.

Only a few months ago, America Online abandoned its previous pricing strategy and offered its customers 20 hours of the service a month for $19.95. The service will now match the pricing of Internet service providers like Netcom and AT&T Worldnet which charge $19.95 a month for unlimited use.

America Online will also offer a variety of other pricing options, including discounts for customers who pay for one or two years' service in advance and a minimum $4.95-a-month charge for three hours of use.

In addition, the company said that it would abandon a criticized practice of booking its heavy marketing costs as capital expenses amortized over two years. Instead, like most companies, America Online will report the costs as expenses in the quarter in which they are incurred.

As a result, the company announced a one-time $385 million charge to write down the outstanding expenses that it has yet to amortize.

There will also be an additional $75 million charge to cover the costs of a new organization that will divide the company into three distinct divisions: AOL Networks, which includes the flagship on-line service; AOL Studios, which will create services to be distributed on the network; and ANS Communications, which builds and maintains the network backbone that most AOL customers dial into.

Robert W. Pittman, an America Online board member who made his reputation making MTV into a household word in the 1980s and has most recently been chief executive of the Century 21 Real Estate Corp., will join America Online to run the new AOL Networks division.

"I've seen this movie before," Pittman told reporters in a conference call Tuesday. "It is very similar to cable networks business in the early 80s."

He and Case said that America Online would use its position as the largest on-line service to bring the Internet to the masses. "What's our No. 1 barrier out there?" Pittman asked. "Procrastination. We just have to get people to sign up."

But some analysts believe that America Online's problems are more severe, and several investors were angry about the company's accounting practices. "When you cut through the noise, the facts are that this company has never made any money," David Rocker of Rocker Partners, a New York money management firm, said.

A well-known short seller of America Online, meaning he has bet that its stock price will decline, Rocker said that the company inflated its quarterly results by spreading its high marketing costs over two years. At the same time, it was reporting costs to the government, reporting a loss to receive tax breaks.

"They have been telling the government the truth, but they tell investors something else," he said.

Case said that he was responding to such criticism by ending the practice. But Rocker and others pointed out that the $385 million charge would allow the company to write off expenses that it never had to report on its income statement.

In addition, Case told investors Tuesday that the company would report a loss in its second fiscal quarter ending in December but break even by March. Only a month ago, the company's executives were quoted as saying that they were "comfortable" with Wall Street's profit estimates.