*Update* AOL Beats Estimates, Earning 11 Cents a Share

Revenue at the combined AOL-Netscape jumps to $1.25 billion.
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America Online

(AOL)

said it earned $117 million, or 11 cents a share, for its third quarter ended March 31, beating the

First Call

consensus estimate of 9 cents a share. In the year-earlier period, the company earned $39 million, or 4 cents a share. Those numbers don't include results from

Netscape

, which AOL acquired March 17 in a pooling-of-interests transaction, or other one-time items. Revenue for the combined firm climbed to $1.25 billion from $757 million a year ago.

Ahead of the earnings report, shares of the Dulles, Va., online service provider dropped 7, or 4.3%, to close at 155.

The following story was posted at 9:10 a.m. EDT:

AOL Rolls Up Its Sleeve as Third-Quarter Earnings Loom

Like a magician who has just pulled a few rabbits from a top hat,

America Online

(AOL)

has left its audience agape -- and trying to calculate if there are still more rabbits hiding in that chapeau.

Only two weeks ago, AOL, the nation's largest online service provider, surprised analysts with the speed at which it was adding new members. A week ago, the company confirmed it was "comfortable" with analysts' estimates for the third quarter ended March 31. This afternoon the Dulles, Va., online giant will report earnings for that quarter.

This is the first quarter AOL's results will include those of

Netscape

, which it acquired during March. But the estimates that analysts are circulating, and the guidance that AOL gave analysts April 21, are for AOL on a stand-alone basis.

The consensus of analysts surveyed by

First Call

is that, on its own, AOL will earn 9 cents a share; estimates from the 34 sources polled ranged between 7 and 10 cents. At 9 cents per share, AOL is earning $98 million this quarter, as estimated by

Goldman Sachs

analyst Michael Parekh, compared with $18.6 million a year ago, as originally reported by AOL, and a pro-forma loss of $78 million for that period for AOL and Netscape combined. (AOL issued the unaudited pro-forma numbers because it is accounting for the Netscape acquisition as a pooling of interests.)

For revenue, the expectation is that AOL, on a stand-alone basis, will have its first billion-dollar quarter -- more precisely, revenue of $1.05 billion, according to Parekh. (AOL is on Goldman's recommended list, the firm's highest rating; Goldman or an affiliate has performed corporate finance services for AOL or an affiliate during the past year.)

Gross margins, which amounted to 38.5% of revenue in the second quarter, are expected to be flat or lower because of high usage in the latest period. The operating margin of 13.7% for the second quarter, which ended in December, is expected to improve slightly.

Analysts will be paying close attention to these numbers, as well as to AOL's marketing expenses and its advertising and commerce revenue, explains Henry Blodget of

Merrill Lynch

. But he doesn't expect major surprises from AOL.

"You always have questions, but things are rarely way out of whack," he says. (Blodget has a buy on AOL; Merrill hasn't done any recent underwriting for the company.) Says Mike Wallace, an analyst with

Warburg Dillon Read

, "You look for a continual uptick in the margins

and what the Netscape deal means in the near term for them." (Wallace has a strong buy on AOL; his firm hasn't done underwriting for the company.)

Even if Netscape's numbers are added to AOL's, it's not clear they'll have a major effect on the bottom line. With Netscape reporting $162 million in sales for the quarter ended Oct. 31, its last reported fiscal quarter, Parekh estimates it will contribute $160 million in revenue to AOL's March quarter but little or nothing to operating income or the bottom line.

The biggest effect of the Netscape deal was probably revealed by AOL a week ago: $103 million in pretax charges on the acquisition and related reorganization. "AOL has protected its downside," Blodget says. "The only surprise is on the upside."

AOL will also report a one-time gain of $567 million from sales of its and Netscape's stakes in

Excite

(XCIT)

. Those sales have raised AOL's free cash to $2.6 billion, a hefty piggy bank in case AOL wants to pay for an acquisition with currency other than its stock.

Of course, analysts on the AOL conference call will be paying attention to how

CompuServe

and

ICQ

, elements of the company's multibrand strategy, are working out. But AOL had already given plenty of guidance for its main service, disclosing earlier this month that it has 17 million members worldwide. While it's adding subscribers at a slower pace than at its holiday season peak, AOL is still signing up members at twice the rate it did last year, points out

PaineWebber

analyst James Preissler. (PaineWebber hasn't underwritten for AOL recently.) Other facts AOL disclosed include the following: Members are averaging 55 minutes online daily, up nearly 10 minutes from a year ago, and prime-time usage amounts to about 1.1 million simultaneous users, up 63% from a year ago.

But how well can AOL translate this usage into advertising and e-commerce revenue? The company reported advertising and e-commerce revenue of $126 million for the second quarter and showed a $729 million backlog in advertising and e-commerce revenue at Dec. 31. Goldman's Parekh counts up to $286 million in publicly announced deals during the March quarter.

So maybe there will be some upside surprise on e-commerce. In the meantime, as the report of AOL's billion-dollar quarter approaches, it's worth taking a look back at the March 1995 quarter, the first time revenue broke $100 million. It was back before AOL had flat-rate pricing. The quarter closed a more than month before AOL started offering users access to the World Wide Web. Back then, skeptics -- such as

The Wall Street Journal

, in a page-one story that ran during January 1996 -- suggested that the rise of the Internet would mean the fall of AOL.

Surprise, surprise.