Stock off amid wow of a Dow

NEW YORK — The Securities and Exchange Commission has opened an inquiry into AOL Time Warner accounting procedures.

The inquiry, revealed by CEO Richard Parsons as he discussed second quarter financial results, overshadowed news of the company’s first quarterly profit since the mega-merger and revenues that beat Wall Street estimates.

And on a day when the market roared to its biggest single-day gain in 15 years, AOL TW stock dropped 15¢. All other media stocks gained ground, led by Viacom, up more than 7%. MGM gained more than 6% and Disney and Vivendi were each up more than 5%.

Parsons indicated during a conference call with analysts and investors that the SEC probe was launched after articles in the Washington Post questioned some of AOL’s dealings in 2000-01.

Among the claims: AOL allowed a British entertainment company to buy advertising instead of paying an arbitration award in a legal dispute. The company also apparently improperly shifted revenue among two divisions, and it sold ads on behalf of eBay, booking the sales as its own revenue.

AOL’s shares eased 1.3% to $11.40 and were down further in after-hours trading as Wall Streeters said the SEC bombshell spooked investors and overshadowed the quarterly report, which showed continued weakness at America Online and a boffo quarter for the film studio — led by homevideo.

Reported income of $394 million in the second quarter swung from a $734 million loss the year before on a huge one-time accounting charge. Excluding all one-time items, cash earnings were flat from the prior period.

Revenue rose 10% to $10.6 billion.

Parsons said AOL TW auditor Ernst & Young had signed off on “all but one of the transactions” questioned by the Post article at the time. The firm has since re-examined the deal and has put in writing that the transactions and the way they were accounted for was appropriate. He said AOL TW execs contacted the SEC before the Post stories ran, and then again afterwards..

The SEC “said they are conducting a fact-finding inquiry. We have said we will work with them,” he added.

SEC probe unusual

While not unprecedented, the SEC probe into AOL is clearly unusual and could lead to further scrutiny of how the entertainment industry keeps its books.

Aside from the high-profile securities fraud investigation into MGM owner Giancarlo Parretti in the early ’90s, such SEC inquiries have been infrequent over the last decade.

There was a federal inquiry into eyebrow-raising stock sales at MCA in 1991, when it was taken over by Matsushita, and into insider trading by a banking adviser to Time Warner named Ed Aboodi in 1994, but these probes were isolated incidents and did not result in any criminal action.

On the conference call, Parsons lavished praise on Jeff Bewkes and Don Logan, who weren’t on the call. The HBO and Time Inc. toppers were recently appointed to top posts at the parent company, splitting up oversight of the content and subscription businesses and reporting directly to Parsons.

Case, Pittman defended

Parsons also blasted last week’s “instant analysis” of outgoing chief operating officer Bob Pittman as “unfair and unfortunate.” And he defended AOL TW chairman Steve Case, calling him a “valuable thought partner.”

The America Online founder is increasingly under fire for his low profile as AOL floundered, dragging AOL Time Warner stock down with it.

AOL’s cash flow plunged 27% for the quarter, although price hikes helped boost revenue 20%. The online advertising climate remains dismal. Marketing costs were higher, and the company was squeezed by the termination of a deal with iPlanet on the content side. Parsons indicated there are no immediate plans to ink carriage deals with outside cable operators.

Year-on-year comparisons should ease up in the fourth quarter, execs said, since AOL’s troubles first hit the radar in late 2001. And the search continues for a new CEO for the unit. But analysts seemed disappointed by the figures and confused by chief financial officer Wayne Pace’s upbeat full-year forecast.

Films shine

Meanwhile, Hollywood shined through as filmed entertainment cash flow rose 31% and revenue jumped 26%. The uptick was driven by the video release of Warner Bros.’ “Harry Potter and the Sorcerer’s Stone” and “Ocean’s Eleven” — along with theatrical releases of “Scooby Doo,” “Insomnia” and “Divine Secrets of the Ya Ya Sisterhood.”

Warner Home Video reported record revenue of more than $1 billion for the quarter — including sales from nontheatrical titles such as “Friends” from Warner Bros. Television and HBO’s “Sex and the City” and “The Sopranos.”

Digital, ads fuel cable

At Time Warner cable, cash flow rose 12% and revenue increased 18%, buoyed by programmers hawking new channel launches on digital cable and increased intercompany advertising. Parsons and Pace said the cable plants are upgraded and the bulk of the unit’s fixed investment is behind it — meaning higher margins going forward. Pricing is also robust. The average subscribers pays $62 a month.

TV networks’ cash flow fell 5%. Revenue rose 7%. Company cited strong gains at HBO — offset by higher marketing, programming and newsgathering expenses at the Turner Networks plus higher reserves as payments dwindled from cable systems operated by bankrupt Adelphia Communications.

At Warner Music, cash flow rose 17% and revenue was up 4%.

In publishing, cash flow rose 14% on an 8% revenue increase.

(Meredith Amdur and the Associated Press contributed to this report.)

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