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AOL’s sunny forecasts outshine gloomy facts

New York, Oct. 14: Six months after America Online bought Time Warner, the merged company’s top executives rejected arguments from its chief financial officer that they should back down from their ambitious promises to Wall Street, three senior executives involved in the company’s deliberations now say.

Instead, the executives waited two more months, until September 2001, to publicly acknowledge that the company would badly miss the financial projections made at the time of the merger.

The chief financial officer, J. Michael Kelly, made his case while preparing AOL Time Warner’s second-quarter earnings report in July 2001, arguing that a prolonged downturn in the advertising market was jeopardising the company’s promise of an annual operating profit, excluding certain charges, of $ 11 billion in the merger’s first year, the senior executives said.

But Kelly’s boss, Gerald M. Levin, the former chief executive, and Robert W. Pittman, the former co-chief operating officer, overruled him, arguing that the combination of new company-wide advertising deals and deep cost cuts could still make up for any shortfalls, the senior executives said.

Richard D. Parsons, then co-chief operating officer and now chief executive, heard Kelly’s arguments but remained largely quiet on the subject, these executives said, while Stephen M. Case, the company’s chairman, was largely absent from the deliberations and did not get involved. In the end, after the September 11 attacks, the company missed its target by $ 1.35 billion.

Corporate chief executives and financial officers often have spirited debates about their projections, and Kelly eventually signed off on the company’s public statements. But his caution in July 2001 suggests that AOL Time Warner’s top executives may have been more aware of the risks to the company’s results than they have previously acknowledged.

Kelly was the executive most directly responsible for the company’s financial reports and was the chief financial officer of AOL before the merger, so he had a unique familiarity with its books as well as those of the merged company.

The Securities and Exchange Commission and the Justice Department are investigating the possibility that AOL temporarily inflated its advertising revenue around the time it acquired Time Warner, and one question they are asking is how much Kelly and his colleagues knew about the precariousness of AOL’s finances, people involved in the investigations have said.

New information emerging in light of the investigations suggests that even by the time the merger was complete, AOL’s advertising and marketing revenue — the most crucial component of the combined company’s profits and growth — already depended on a variety of unusual deals creating the temporary but unsustainable appearance of strong demand for its services. More than $ 500 million of AOL’s advertising, marketing and other revenue between June 2000 and July 2001 derived from anomalous soon-to-expire deals.

The question of what the company’s top executives knew, or should have known, about the undisclosed risks hiding in AOL’s apparently robust results has become central to the company’s credibility on Wall Street.

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