Time Warner Settles AOL Suit for $2.4 Billion

A $3 billion charge to cover a big litigation reserve pushes the second quarter to a loss.
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Time Warner

(TWX)

agreed to pay $2.4 billion to settle class action suits alleging bubble-era accounting misdeeds at America Online.

The New York company also posted a second-quarter loss while missing Wall Street's pro forma earnings and revenue estimates, and set plans for a $5 billion stock buyback. Time Warner reaffirmed its 2005 full-year targets.

Time Warner said it will reserve a total of $3 billion to settle outstanding securities fraud litigation. The company said that in addition to the $2.4 billion payment it will make to the plaintiff class, it will seek to have the government direct the $450 million Time Warner paid in related

Securities and Exchange Commission

and Justice Department settlements to the class. The company said it would reserve an additional $600 million to cover other possible lawsuit settlements.

"Reaching an agreement in principle to settle this securities litigation and reserving for it and all other related matters mark important steps toward putting these matters behind us," said CEO Dick Parsons. "By working to resolve these issues now, we're aiming to avoid the costs, risks and distractions of protracted litigation. Even after considering the reserve, our balance sheet remains strong."

Settling should help to

erase a major uncertainty hanging over the company: its liability for aggressive revenue recognition and other practices at AOL, dating back to before the completion of the AOL-Time Warner merger in 2001. Time Warner has been seen as itching to move forward with a sale, spinoff or initial public offering of its cable TV subsidiary, and now that the company has reached terms with civil litigants as well as regulators, Parsons could get a chance to take a freer hand in reshaping the company.

Time Warner, then known as AOL Time Warner, originally disclosed the SEC and DOJ investigations in the summer of 2002, saying that the feds were looking at issues including AOL's advertising arrangements and methods AOL used to report subscriber numbers. Following its own internal investigation, Time Warner in early 2003 restated earlier financial statements for 2001 and 2002, reflecting a decision to reduce previously reported AOL advertising and commerce revenue by $190 million.

For the second quarter ended June 30, Time Warner lost $321 million, or 7 cents a share, reversing the year-ago continuing operations profit of $882 million, or 19 cents a share. Revenue slipped to $10.74 billion from $10.86 billion a year ago, missing the $10.96 billion Thomson First Call analyst consensus estimate.

The latest quarter included the $3 billion legal reserve and a $27 million loss on the company's

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option. These items were offset in part by a $925 million gain on the sale of Time Warner's remaining stake in

Google

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, a $36 million gain on the sale of an investment in Columbia House, a $5 million gain on the sale of a building at AOL and a $3 million gain related to the 2004 sale of Netscape Security Solutions.

In addition, the income tax provision reflected tax benefits of $1.2 billion, associated primarily with the impact of state tax law changes in Ohio and New York enacted in the second quarter of 2005 and the settlement accrual related to the securities litigation. Excluding those items, the latest-quarter profit was 18 cents a share, a penny shy of the Wall Street estimate.

"Our performance this quarter, which faced very difficult prior-year comparisons, keeps us on track to achieve our full-year objectives," Parsons said. "Importantly, we generated industry-leading Free Cash Flow of $2 billion through the first half of the year, demonstrating the vitality of our businesses."

Expected revenue declines at the company's movie and AOL segments were offset almost entirely by growth at the cable, networks and publishing segments, Time Warner said. The company said adjusted operating income before depreciation and amortization declined 3% to $2.6 billion, reflecting tough comparisons in the movie business. The company reported an operating loss of $1.2 billion, reversing year-ago operating income of $1.8 billion.

As of June 30, net debt totaled $13 billion, down $3.2 billion from $16.2 billion at the end of 2004.

Time Warner reaffirmed its expectation that its 2005 full-year growth rate in adjusted operating income before depreciation and amortization will be in the high-single digits, as compared to $9.9 billion in 2004. This expectation reflects anticipated revenue gains and margin expansion, the company said.

Time Warner shares fell 21 cents early Wednesday to $17.21.