Updated from 7:41 a.m.

Time Warner

(TWX)

beat estimates and took steps toward settling itsdifferences with regulators.

The media and entertainment conglomerate says it will restatefinancial results in prior years to change its accounting treatment ofAOL Europe. Meanwhile, the company is establishing a $500 millionreserve related to ongoing government investigations.

The announcement of the reserve suggests that Time Warner is movingforward on an issue that has been hanging over the company's head forseveral quarters. The investigations by the

Securities and ExchangeCommission

and the Justice Department over various accounting issuesat America Online have weighed on Time Warner's stock price. Thelack of resolution has hampered the company's ability to enter thecapital markets in any restructuring of its cable TV subsidiary.

"While we're continuing to work to resolve the government'sinvestigations, we're staying focused on moving the company forward,"CEO Dick Parsons said in a statement Wednesday.

"Revenues climbed a healthy 5% over the year-ago quarter, with allof our segments contributing. I'm particularly pleased that the growthin advertising revenues is the best we've seen in years," Parsonssaid.

On a conference call with analysts, Parsons and other executivestalked up the prospects for AOL, and Parsons took time to say thatsome of Time Warner's actions in the recent auction of

MGM

(MGM) - Get Report

hadbeen reported inaccurately in the press.

For the third quarter ended Sept. 30, Time Warner reported netincome from continuing operations of $494 million, or 10 cents pershare, compared to $551 million, or 12 cents per share, one year earlier.

But eliminating, as Time Warner suggests, various one-time items-- the $500 million reserve, for example, and a $188 million gain onthe sale of

Google

(GOOG) - Get Report

-- one arrives at a 15-cent EPS, upfrom 11 cents in the third quarter of 2003. Analysts surveyed byThomson First Call had expected a 14-cent gain.

Revenue for the quarter was $9.97 billion, up from $9.5 billionone year earlier. Analysts had expected $9.86 billion in revenue.

Operating income before depreciation and amortization -- adjustedto exclude the $500 million reserve, asset impairments and asset sales-- amounted to $2.39 billion. Analysts had expected OIBDA, or EBITDA,to come in at $2.34 billion.

AOL, in the midst of adjusting to the nation'sslow transition tobroadband Internet connections, showed continuing strength inadvertising growth and continuing weakness in subscription revenue.

Ad revenue grew $79 million in the quarter, up 44%, with $30million of that coming from paid search and $35 million from the newlyacquired Advertising.com. Excluding Advertising.com, AOL ad revenuewas up 25% for the quarter, the company said.

AOL reported a loss of 646,000 U.S. subscribers to its service inthe quarter, compared to a loss of 688,000 in the year-ago quarter anda loss of 668,000 in the second quarter of this year. Merrill Lynchhad expected declines of about 555,000, while Goldman Sachs had beenexpecting only a 500,000 drop. The flagship U.S. service now has 22.7million subscribers, down 2 million over the past year.

On the call, Parsons said that Wall Street was undervaluing AOL byfixating on its shrinking business of providing dial-up connections tothe Internet rather than the growth prospects of its advertisingbusines. "We just need to get the Street to focus on it," Parsonssaid.

In addition, Don Logan, chairman of Time Warner's media andcommunications group, didn't appreciate the value of AOL's largesubscriber base and cash flow. "Having that big sub base gives us alot of leverage and a lot of advantages," he said.

To help fuel the advertising business, Logan said that next yearAOL will launch an AOL.com site to appeal to nonmembers, building onthe Web site that has been recently revamped for the benefit ofmembers accessing the service outside of their homes.

Asked about the possibility that AOL might develop its own paidsearch business instead of working with Google, Logan said, "They'regood partners. We've got a long-term agreement with them." But he alsoindicated that AOL had some freedom to develop products related tocertain elements of search. "If we need to, we have the right to walkaway later on," Logan said.

OIBDA at Time Warner Cable, the nation's second-largest operatorof cable systems, grew 10% to $824 million, reflecting revenue growthpartially offset by programming costs that are growing faster thanmajor cable and satellite operators are targeting.

The company lost 11,000 basic cable subscribers in the quarter,compared to break-even expectations. Customer additions for residentialhigh-speed data service amounted to 168,000, at the high end ofexpectations.

With Time Warner's balance sheet improving and media investorspounding the drum for greater return of cash to shareholders,executives counseled patience and trust as the company decides how todeploy its economic resources, whether that would mean investment incurrent businesses, dividends or share repurchases. "We are looking atall of the things that you would ask us to look at or expect us tolook at."

CFO Wayne Pace said investors shouldn't expectmajor decisions on that front by the end of the year.

On the subject of acquisitions, Parsons took time to criticizewhat he called "colorful" reporting about Time Warner's participationin the auction of MGM, which was ultimately won by

Sony

(SNE) - Get Report

and partnersincluding

Comcast

(CMCSA) - Get Report

.

A week to 10 days after Time Warner withdrew its bid for Sony,said Parsons, it was approached by certain "strategic partners." Thosepartners, he said, indicated that, if they had access to certain MGMassets, they could help Time Warner create a more attractive bid "without taking away from

Time Warner's economics." When Time Warnerasked MGM for time to explore that proposal, MGM asked for anonrefundable deposit of $150 million for the privilege, saidParsons, and Time Warner walked away from the deal.

The New York Times

, which Parsons didn't mention by name,told a slightly different version of those events. The

Times

story alleged that Time Warner started working on a new deal with

Toshiba

almost immediately after it publicly withdrew from bidding,and suggested that Time Warner was much more active than Parsonsindicated it was in seeking out a partner to help raise its bid. Andcontrary to Parsons' account, the

Times

story expressedskepticism that a new partner's participation could come withouteconomic cost to Time Warner.

Stemming in part from discussions with the SEC, Time Warner saidWednesday it should have consolidated the results of its AOL Europeventure with Bertelsmann starting in March 2000, when it entered intoa put/call agreement with its partner.

Previously, the company had consolidated results only after January2002, when it acquired 80% of Bertelsmann's stake.As a result, Time Warner says it will restate results for 2000 and2001, and perhaps 2002.

This accounting change is separate from another Bertelsmann-relatedaccounting issue that has dogged Time Warner for more than a year.That separate question, which remains unsettled, is whether AOL shouldhave recognized $400 million in ad revenue from two deals withBertelsmann in 2001.

The SEC, says Time Warner, continues to investigate a range oftransactions principally involving AOL, including advertisingarrangements and subscriber counts. Further restatement of financialresults may be necessary, says Time Warner. Some portion of the $500million reserve announced Wednesday will be available for shareholderlitigation, says Time Warner, but the company hasn't established anyreserves for shareholder and civil litigation, "due to theirpreliminary status and because it is unable to reasonably estimate arange of possible loss."

Time Warner reaffirmed its financial guidance for the full year,which includes the forecast that 2004 growth in adjusted OIBDA will bein the low-double-digits to low-teens range, as compared to $8.7billion in 2003.

Shares in Time Warner, which have stayed in a tight trading rangeover the past year, rose 13 cents to $16.41.

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Corrections and Clarifications.