(FORTUNE Magazine) – There's a new vibe at America Online (which, like FORTUNE, is owned by AOL Time Warner). Gone, of course, is the swagger that propelled executives during the years when AOL was the dominant online force, Everyman's entry point to the Internet. But the long faces of employees--painfully visible last year when regulators began to investigate the division's accounting practices and some investors were calling for AOL's sale--also seem to have vanished. On a recent August morning, AOL headquarters in Dulles, Va., is infused with something like optimism. Banners in the lobby hail the arrival of AOL 9.0, an upgrade of the unit's Internet-access software that's winning rave reviews. A few managers volunteer that they are again jazzed to come to the office. Even Jonathan Miller, the restrained chairman of the AOL unit, strikes an upbeat note. "We've made a remarkable amount of progress given the amount of distraction," he says, allowing a small grin to creep across his usually expressionless face.

Miller, 46, indeed has a few things to smile about. Since his arrival a year ago, the former USA Interactive executive has quietly cut costs associated with running AOL's huge network and customer-service operations. Thanks to such measures, AOL expects to generate roughly $1 billion in free cash flow this year, despite a plunge in online ad sales. Most important, AOL, which had $9.1 billion in revenue last year and is the second-biggest division in AOL Time Warner, seems to have gotten its creative mojo back. It has hatched a whole batch of user-friendly features in AOL 9.0 and at last has a strategy to hold on to customers who want high-speed Internet access. Today some 1.4 million users pay $15 a month to access their AOL accounts, as well as content such as video clips from CNN and highlights of baseball games, over a broadband pipe provided by a phone company or cable operator. "A year ago we had no plan for broadband," says Miller. "It is just part of what the company does now."

Not everything Miller has done makes obvious sense. His strangest move has been to ask the AOL Time Warner board to consider removing "AOL" from the corporate name; it's a topic the board could consider as early as its September meeting. Miller says a name change would help the online unit's brand by distancing it from the controversies surrounding its parent company. That's a bit rich, given that most of the corporation's troubles stem from the merger with that selfsame AOL unit. (See "Why AOL's Accounting Problems Keep Popping Up" and other stories in the fortune.com archive.) And while Don Logan, AOL Time Warner's media and communications group chairman, and Miller both deny it, more than a few people think erasing "AOL" from the AOL Time Warner name could be a prelude to a spinoff or sale of the AOL unit.

Whatever ultimately happens to the online division, Miller still has a lot to fix. Advertising sales are expected to be down 50% this year, compounding a 38% drop in 2002. Subscription sales, which now account for nearly 90% of the unit's revenue, are up slightly due to rising prices abroad, but the brand is losing customers at home. Some 500,000 of AOL's 26 million U.S. subscribers bolted in the second quarter alone, most opting for cheaper dial-up services or high-speed connections from cable and phone operators.

The competition is only going to get tougher as the Baby Bells lower prices and offer discounts to entice customers away from dial-up service. SBC Communications, the giant Texas phone company, has teamed with Yahoo to deliver a broadband service not unlike AOL's, with music channels, video clips, and personalized content. Cable operators, too, are looking for ways to improve their plain-vanilla portals. Then there's perennial rival Microsoft, which has just announced its own add-on service for broadband. Nor does it help AOL's cause that most of the excitement over digital fare is going on elsewhere, in places like Apple's online music store.

AOL's competitive position is just part of the problem. It's still under the cloud of an SEC investigation into allegations that it improperly booked items such as stock-ownership warrants in some of its partners as advertising revenue. The commission has also reportedly raised questions about whether the AOL unit padded its user numbers by granting bulk subscriptions to corporations, which then sold the AOL service at discounts.

Miller's approach has been to try to stabilize the unit by cutting costs, getting rid of deadbeat subscribers (some 350,000 have been dropped as a result of an internal audit), and improving AOL's products. Miller, who helped build Match.com and Expedia at USA Interactive (now called InterActive Corp.), comes across as a glass-half-empty kind of guy. During an interview in his unadorned office, once occupied by former AOL Time Warner chairman Steve Case, he sets a cautious tone: "I've tried to be very realistic in my message to employees. I tell them, 'Here's what we've accomplished. Here's what we haven't.'"

AOL management insists that the online division will be able to post double-digit growth in operating earnings in 2004 and beyond by expanding operations in Europe, boosting sales of online ads, selling subscribers more add-on fare such as telecom services, and expanding its broadband features. While each broadband subscriber remains less profitable than a traditional dial-up customer, AOL sees broadband as a platform for selling new kinds of advertising (think videos instead of banner ads) and so-called premium services, such as movies or music, that are only practical to download on fatter pipes. If AOL can keep its dial-up customers happy and at the same time get broadband right, says Logan, "we can create a formula that will drive double-digit growth for some time to come."

"I came into the job on April Fool's day, which probably tells you something." Lisa Hook, president of AOL's broadband business, is sitting in a conference room, breezily recalling her early efforts forging plans to deliver high-speed services to AOL customers. AOL's strength has always been the way it welcomes people into an online community. But as more people see how quickly and easily they can get onto the Internet with broadband, AOL's $23.90-per-month dial-up service has lost some luster. Today more than 18 million homes in the U.S., about a fourth of online households, have broadband--and most of them are former dial-up customers. Researchers at the Yankee Group in Boston predict that in 2007 the number of broadband homes will surpass the number of homes with dial-up.

Hook, 45, and her team quickly figured out that AOL needed to do more than take its existing dial-up product and distribute it over broadband pipes. Instead AOL had to create something altogether different. "It's like being at the dawn of the television business," says Hook, a lawyer by training.

AOL's current broadband offering, launched in April a year after Hook took charge, is a work in progress: It's certainly easier to navigate and looks better than what you get from basic broadband, but it doesn't feel like a new medium. For $15 a month, atop the $30 to $50 monthly fee a user pays to a cable or phone company for broadband access, a subscriber gets a bunch of extras such as a firewall and CD-quality online radio. The biggest selling point seems to be "rich media" content: AOL has been striking deals with media companies and serving fare like ABC breaking news and baseball video clips to its broadband subscribers. Most recently AOL announced plans to make NFL football previews and highlights available. AOL says it offers its broadband customers content that would cost more than $115 a month if it were purchased a la carte. (AOL also offers the broadband package to some 800,000 customers who signed up for broadband service directly through AOL, which has wholesale relationships with various phone and cable companies.)

Four months into its broadband strategy, the company is getting passing marks but no better. Analyst Tom Wolzien of Sanford C. Bernstein figures AOL has converted fewer than half of its dial-up defectors into subscribers to its broadband service. To retain more customers, analysts say, AOL will have to offer more than sports clips and news headlines.

Hook and her team are working on features that go beyond that sort of "repurposed" content, and AOL's planned food channel offers a glimpse of what that new medium could look like. AOL is pulling recipes from Cooking Light and the Southern Progress magazines--all published by Time Inc., another AOL Time Warner division--and aggregating them in a database for AOL customers. The customers will be able to use broadband's always-on capability to quickly search for recipes based on what's in their cupboards, and send real-time messages and tips to other home cooks. There is talk of adding how-to cooking videos to the service.

Such cooperation between AOL and any of its corporate siblings would have been nearly unthinkable a year ago. Executives and employees from the other divisions found the AOL leaders who executed the merger with Time Warner either standoffish (Steve Case) or implausibly optimistic (former chief operating officer Bob Pittman) while the combined company was floundering. Even before regulators started investigating AOL's accounting, the online unit became an object of blame for everything that was wrong with the corporation.

The antagonism has ebbed, due in part to the departures of Case (he still sits on the board) and Pittman. Moreover, some AOL employees believe that intense oversight by Time Warner veteran Logan--he visits Dulles weekly--shields the online unit from potshots from the other divisions. Still, some insiders and a few analysts worry that AOL isn't listening hard enough to the suggestions of other divisions of the company. Says Wolzien: "I don't think that the online business has yet recognized the intellectual depth and marketing savvy that exists in the rest of the company."

AOL isn't betting on broadband for all of its growth, of course. Total ad revenues are still down because the controversial long-term deals that AOL struck with advertisers during the boom years are ending, but new ad sales are finally starting to pick up. In the second quarter the unit booked $96 million in new ads, up from $72 million a year earlier, if you exclude sales of ads to other AOL Time Warner divisions. AOL hopes to win back some dial-up customers with the newest version of its software, which boasts Microsoft Outlook--like e-mail, beefed-up spam and parental controls, and a service that lets family members share and update one another's calendars. This fall the company also plans to roll out special, graphics-heavy services for kids and teens that will look totally different from their parents' AOL. "This is a product that says to customers, 'You've got to come back to AOL,'" says David Gang, head of products for the online unit.

Still, hustling for ad sales and dial-up customers won't begin to offset the pain if the competition in broadband heats up. Lower prices for broadband could help the unit by making AOL's $15 add-on service seem like less of a luxury, Miller says. But if customers flee its dial-up service en masse, its sales force will have a hard time keeping up with defectors. "The only thing I genuinely worry about is if a price war between the telephone companies and cable operators creates a migration [of AOL dial-up customers] faster than we can make up for it in broadband growth," says Miller. In fact, AOL executives, while recognizing that people want faster Internet connections, are hoping that they won't make the switch to broadband too quickly. Miller went out of his way to stress that broadband growth appears to be slowing. (Residential high-speed users grew 8% in the second quarter, compared with 10% in the first three months of the year.) He shouldn't take too much comfort in those numbers, however. Experts say poor marketing by broadband providers--not lack of consumer demand--contributed to the tepid response.

Some investors maintain that the online unit can't possibly stand up to the broadband players in the long run, and that AOL Time Warner should accept defeat and simply milk the online unit for cash for as long as it can. Cut investments in new products, they say, and halt expensive marketing efforts, then use the cash extracted from AOL's loyal users to help pay down the corporation's $24.2 billion in net debt. It is an appealing financial strategy, but one that strikes AOL executives as defeatist. "It's terrible on the employees," Logan says. "You take away the motivation for people to be innovative and look for ways to manage the business better." The only time a harvesting strategy makes sense, he says, is if a business has no growth prospects. "If we believed that," Logan adds, "we should consider doing something else with that part of the company."

For now, the online division seems to be focused on running its business well. But it remains unclear what role AOL ultimately will play at AOL Time Warner. Miller thinks it can be an important conduit for distributing AOL Time Warner content, and Logan suggests that it could form the basis of a broader communications business, especially as AOL pushes into voice-messaging and calling services.

You can tell by the executives' divergent answers that such planning is a long way off. Fortunately for AOL, its recent successes seem to have bought the online unit a little time to prove itself. "Do I hope that in 12 months I feel good about the direction AOL is going? Yes," Logan says, though he cautions that plenty of things remain unclear about the future of the Internet, including the rate at which customers will move to broadband. "Hopefully, in a year we'll be comfortable about what we'll see for the next two years." AOL can only hope investors are just as patient.

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