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AOL Q2 2012 Results: Revenue Beats - 971M Profit

July 25, 2012

AOL chalked up Q2 net income on Wednesday of $970.8 million, or $10.17 per share, after losing $11.8 million, or 11 cents per share last year. Total revenue was down 2 percent to $531.1 million, but beat expectations of $519.4 million.

ďTodayís results represent a significant milestone for AOL as we returned to Adjusted OIBDA growth for the first time in four years," said Tim Armstrong, Chairman and CEO. ďThe strong results and consumer performance we announced today are clear signs our strategic and operating efforts are translating into significant financial progress.Ē

Revenue Trends:

  • AOLís total revenue declined 2%, its lowest rate of decline in 7 years.
  • Global Advertising revenue grew 6%, its fifth consecutive quarter of year-over-year growth, reflecting:
    • 2% year-over-year global display revenue growth, compared to a 1% and 5% decline on a reported and pro-forma basis, respectively in Q1 (pro-forma includes revenue from The Huffington Post in both periods).
    • 9% year-over-year growth in combined AOL Properties Display and Third Party Network revenue, which totaled $251.3 million for the quarter.
    • 19% growth in Third Party Network revenue, its fifth consecutive quarter of year-over-year growth.
    • The lowest rate of search and contextual revenue decline in over three years of 1%, driven primarily by continued double digit growth in search revenue on AOL.com.
  • Subscription revenue trends continued to improve meaningfully with a 12% decline in subscribers the lowest rate of decline in five years, while monthly average churn of 1.7% was the lowest rate of churn in over a decade.

Profitability Trends:

  • AOL grew Adjusted OIBDA 120% year-over-year, the first quarter of year-over-year growth in over 4 years.
  • AOLís operating income and Adjusted OIBDA was positively impacted by $96.0 million related to income from licensing patents to Microsoft Corporation, and negatively impacted by $8.8 million of costs related to the proxy contest, $7.6 million of expenses associated with settling a state tax matter in Virginia and $5.6 million of costs related to the patent sale. Excluding those items, the remaining Q2 2012 Adjusted OIBDA of $94.6 million reflects an increase of $18 million year-over-year.
  • Operating income was also positively impacted by the $945.8 million gain on sale of patents (net of transaction costs) in Q2.

Product/Consumer Trends:

  • AOL continued to make progress in key internet growth areas:
    • Video: AOL grew its videos, video views and video revenue at double-digit rates both year-over-year and quarter-over-quarter and video ad impressions grew at triple-digits year-over-year in Q2 2012.
    • Brand Advertising: The number of advertisers purchasing Project Devil ads grew at triple digits year-over-year in Q2 2012 and over 50% of Project Devil advertisers in Q1 2012 repurchased in Q2 2012.
    • Local: Patch grew traffic and engagement at double digit rates year-over-year and quarter-over-quarter, while revenue grew over 100% year-over-year in Q2 2012.
    • Traffic: Unique visitors in Q2 2012 were 112 million, growing 4% from Q1 2012 and 5% from Q4 2011.

Asset, Cash & Cash Flow Trends:

  • On June 15th, AOL closed its $1.056 billion patent transaction with Microsoft Corporation.
  • On June 28th, AOL announced the first step in a multi-stage approach in returning 100% of the patent transaction proceeds to shareholders through a $400 million Dutch Tender offer. The tender offer expires at 5 pm New York time on August 2nd unless extended or terminated earlier.
  • AOL had approximately $1.5 billion of cash at June 30, 2012. Q2 cash provided by operating activities and Free Cash Flow were $167.2 million and $136.8 million, up 52% and 77% year-over-year, respectively, benefiting primarily from the growth in operating income, driven primarily by the income from licensing of certain patents to Microsoft Corporation.

Global advertising revenue grew 6% year-over-year in Q2 2012, reflecting double-digit growth in Third Party Network revenue and growth in international display revenue, partially offset by declines in search and contextual revenue.

Global display revenue grew 2% year-over-year reflecting continued double-digit growth in international display advertising. Domestic display advertising revenue was flat year-over-year, versus a 1% and 5% decline on a reported and pro-forma basis, respectively in Q1 (pro-forma includes revenue from The Huffington Post in both periods). Domestic display revenue reflects growth in reserved inventory pricing and Patch revenue, partially offset by a decline in reserved impressions sold. International display revenue growth reflects continued growth in both the U.K. and Canada.

Third Party Network revenue increased $17.8 million, reflecting 11% growth in Advertising.com and $7.5 million related to the inclusion of Ad.com Japan. AOL began consolidating the joint venture in Q1 as a result of acquiring a controlling interest in the joint venture. Advertising.com growth reflects an increase in publishers on the network and increased sales of higher margin premium packages and products.

Search and contextual revenue trends continued to improve year-over-year with a 1% decline representing the lowest rate of decline in over 3 years. Search and contextual revenue declines primarily reflect a 12% decline in domestic AOL-brand access subscribers and fewer queries from cobranded portals and international markets, largely offset by continued growth in search revenue on AOL.com.

Subscription revenue declines reflect a 12% decline in domestic AOL-brand access subscribers. The decline in subscription revenue was the lowest level of decline in over 5 years with the trend improvements reflecting continued improvements in churn and 2% growth in average revenue per user (ARPU). Monthly average churn fell from 2.2% in Q2 2011 to 1.7% in Q2 2012, driven primarily by significant subscriber retention efforts and by the continued maturation of the tenured base. ARPU growth reflects the impact of the price rationalization program AOL began in late Q3 2011, which significantly reduced the number of price points and more clearly defined and enhanced the value of our product offerings for consumers.

Other revenue declines primarily reflect lower mobile carrier revenues. Revenue from mobile carriers represented 28% of total ďOther revenueĒ in Q2 2011 and 18% in Q2 2012.

Profitability

AOLís Adjusted OIBDA grew meaningfully year-over-year primarily reflecting $96.0 million related to income from licensing patents to Microsoft, growth in advertising revenue, lower general and administrative expenses and lower costs of revenues. Adjusted OIBDA was negatively impacted by $8.8 million of costs related to the proxy contest, $7.6 million of expenses associated with settling a state tax matter in Virginia and $5.6 million of costs related to the patent sale. Excluding the positive impact of the licensing income and the negative impacts of the proxy contest, tax settlement and patent transaction expenses, the remaining Adjusted OIBDA of $94.6 million was $18 million higher than Q2 2011. General and administrative expenses declined year-over-year reflecting a decline in personnel costs including reduced corporate headcount and a reduction in marketing costs. Costs of revenues continued to decline in Q2 2012, driven by lower network related expenses, personnel costs and reduced content costs related primarily to AOLís reduced reliance on freelancers. Cost of revenues declines were partially offset by $8.1 million of increased TAC, as a result of continued growth in third party network advertising revenue. In addition to the above, operating and net income year-over-year growth primarily reflects the gain on the sale of a portion of our patent portfolio to Microsoft (net of transaction costs) and a $24.1 million reduction in depreciation and amortization in Q2 2012 versus Q2 2011. The year-over-year decline in depreciation and amortization primarily reflects a decline of $17.3 million related to certain intangible assets being fully amortized and the decommissioning of certain network equipment.

Tax

AOL had pre-tax income from operations of $1,058.1 million and a related income tax expense of $87.5 million, resulting in an effective tax rate of 8.3% for the three months ended June 30, 2012, as compared to a negative effective tax rate of 57.3% for the three months ended June 30, 2011. The effective tax rate for the three months ended June 30, 2012 differed substantially from the statutory U.S. federal income tax rate of 35.0% primarily due to the tax impact of the patent transaction with Microsoft. The patent transaction consisted of two elements: first, the sale of patents and the stock of a subsidiary, and second, the licensing of AOLís retained patent portfolio, resulting in pre-tax income of $1,041.8 million. No material cash taxes will be paid, due to existing net operating losses which offset substantially all of the ordinary income. However, for book purposes, this transaction resulted in income tax expense of $71.5 million. The tax expense relates primarily to ordinary income realized on the transaction, the majority of which is due to the licensing portion. In addition, the transaction created a significant net capital loss, for which a valuation allowance was recorded. In addition to the impacts of the patent transaction on income tax expense, AOL also had foreign losses that did not produce a tax benefit.

Cash Flow

Q2 2012 cash provided by operating activities was $167.2 million, while Free Cash Flow was $136.8 million. Cash provided by operating activities and Free Cash Flow growth reflects the growth in operating income driven primarily by patent license income.

Modified Dutch Tender Offer

On June 28, 2012, AOL announced the first step in the multi-stage process of returning 100% of the patent transaction proceeds to shareholders through a $400 million modified Dutch auction tender offer. The $400 million aggregate purchase price of shares of common stock sought in the tender offer includes the approximately $40 million remaining from the initial $250 million stock repurchase authorized in August of 2011. The tender offer began on the date of the announcement, June 28, 2012, and will expire at 5:00 PM Eastern Time (ET) on August 2, 2012 unless extended or terminated earlier. Through the modified Dutch tender offer, AOLís shareholders will have the opportunity to tender some or all of their shares at a price within the range of $27.00 to $30.00 per share. If the tender offer is fully subscribed, then shares of common stock having an aggregate purchase price of $400 million will be purchased, representing approximately 14% to 16% of AOLís issued and outstanding shares as of June 14, 2012 (depending on the final purchase price).

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