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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number 001-34419

 

 

AOL INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   20-4268793

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

770 Broadway

New York, NY

  10003
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: 212-652-6400

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  x      Accelerated filer  ¨
Non-accelerated filer  ¨      Smaller reporting company  ¨
(Do not check if a smaller reporting company)   

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of May 4, 2012, the number of shares of the Registrant’s common stock, par value $0.01 per share, outstanding was 93,510,354.

 

 

 


Table of Contents

AOL INC.

TABLE OF CONTENTS

 

               Page
    Number    
 

PART I. FINANCIAL INFORMATION

  
      Cautionary Statement Concerning Forward-Looking Statements      1   
   Item 2.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     2   
   Item 3.    Quantitative and Qualitative Disclosures About Market Risk      18   
   Item 4.    Controls and Procedures      19   
   Item 1.    Financial Statements      20   

PART II. OTHER INFORMATION

  
   Item 1.    Legal Proceedings      33   
   Item 1A.    Risk Factors      34   
   Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds      34   
   Item 6.    Exhibits      34   

Signatures

     35   

Exhibit Index

     36   


Table of Contents

AOL INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

     Page
    Number    
 

Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2012 and 2011

     20   

Consolidated Balance Sheets as of March 31, 2012 and December 31, 2011

     21   

Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2012 and 2011

     22   

Consolidated Statements of Equity for the Three Months Ended March 31, 2012 and 2011

     23   

Note 1: Description of Business, Basis of Presentation and Summary of Significant Accounting Policies

     24   

Note 2: Income (Loss) Per Common Share

     26   

Note 3: Goodwill

     26   

Note 4: Business Acquisitions, Dispositions and Other Significant Transactions

     27   

Note 5: Income Taxes

     28   

Note 6: Stockholders’ Equity

     29   

Note 7: Equity-Based Compensation

     29   

Note 8: Restructuring Costs

     31   

Note 9: Commitments and Contingencies

     31   

Note 10: Segment Information

     32   


Table of Contents

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q (“Quarterly Report”) contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 regarding business strategies, market potential, future financial and operational performance and other matters. Words such as “anticipates,” “estimates,” “expects,” “projects,” “forecasts,” “intends,” “plans,” “will,” “believes” and words and terms of similar substance used in connection with any discussion of future operating or financial performance identify forward-looking statements. These forward-looking statements are based on management’s current expectations and beliefs about future events. As with any projection or forecast, they are inherently susceptible to uncertainty and changes in circumstances. Except as required by law, we are under no obligation to, and expressly disclaim any obligation to, update or alter any forward-looking statements whether as a result of such changes, new information, subsequent events or otherwise.

Various factors could adversely affect our operations, business or financial results in the future and cause our actual results to differ materially from those contained in the forward-looking statements, including those factors discussed in detail in “Item 1ARisk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011 (“Annual Report”). In addition, we operate a web services company in a highly competitive, rapidly changing and consumer- and technology-driven industry. This industry is affected by government regulation, economic, strategic, political and social conditions, consumer response to new and existing products and services, technological developments and, particularly in view of new technologies, the continued ability to protect intellectual property rights. Our actual results could differ materially from management’s expectations because of changes in such factors.

Achieving our business and financial objectives, including growth in operations and maintenance of a strong balance sheet and liquidity position, could be adversely affected by the factors discussed or referenced in “Item 1ARisk Factors” in our Annual Report as well as, among other things:

 

   

changes in our plans, strategies and intentions;

 

   

continual decline in market valuations associated with our cash flows and revenues;

 

   

the impact of significant acquisitions, dispositions and other similar transactions;

 

   

our ability to attract and retain key employees;

 

   

any negative unintended consequences of cost reductions, restructuring actions or similar efforts, including with respect to any associated savings, charges or other amounts;

 

   

market adoption of new products and services;

 

   

the failure to meet earnings expectations;

 

   

asset impairments;

 

   

decreased liquidity in the capital markets;

 

   

our ability to access the capital markets for debt securities or bank financings; and

 

   

the impact of “cyber warfare” or terrorist acts and hostilities.

In addition, matters relating to the sale of our patents and their related patent applications to Microsoft Corporation (“Microsoft”) are subject to uncertainty and changes in circumstances, including, but not limited to the approval of the transaction by antitrust authorities and the satisfaction of the other closing conditions to the transaction as well as to factors that could affect the manner, timing and amount of the return of any of the sale proceeds to AOL shareholders including the need for AOL to retain cash for its business or to satisfy liabilities.

References in this Quarterly Report to “we,” “us,” the “Company,” and “AOL” refer to AOL Inc., a Delaware corporation.

 

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AOL INC.

PART I - ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our results of operations and financial condition together with our consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report as well as the discussion in the “Item 1—Business” section of our Annual Report. This discussion contains forward-looking statements that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including those discussed in “Item 1A—Risk Factors” in our Annual Report and “Cautionary Statement Concerning Forward-Looking Statements” herein.

Introduction

Management’s discussion and analysis of financial condition and results of operations (“MD&A”) is a supplement to the accompanying consolidated financial statements and provides additional information on our business, recent developments, results of operations, liquidity and capital resources and critical accounting policies. MD&A is organized as follows:

 

   

Overview. This section provides a general description of our business and outlook for 2012, as well as recent developments we believe are important in understanding our results of operations and financial condition or in understanding anticipated future trends.

 

   

Results of operations. This section provides an analysis of our results of operations for the three months ended March 31, 2012 and 2011.

 

   

Liquidity and capital resources. This section provides a discussion of our current financial condition and an analysis of our cash flows for the three months ended March 31, 2012 and 2011. This section also provides an update to the discussion in our Annual Report of our customer credit risk and includes a discussion of the amount of financial capacity available to fund our future commitments and ongoing operating activities.

 

   

Critical accounting policies. This section identifies those accounting policies that are considered important to our results of operations and financial condition and require significant judgment and estimates on the part of management.

Overview

Our Business

We are a leading global web services company with a suite of compelling brands and offerings and a substantial worldwide audience. Our business spans online content, products and services that we offer to consumers, publishers and advertisers. We are focused on attracting and engaging internet consumers and providing valuable online advertising services. We market our offerings to advertisers on both AOL Properties and the Third Party Network under the brand “AOL Advertising.” Through the Advertising.com Group, we provide third party publishers with premium products and services intended to make their websites attractive to brand advertisers, such as video and custom content production, in addition to offering ad serving and sales of third party advertising inventory. Our AOL-brand access subscription service, which we offer consumers in the United States for a monthly fee, is a valuable distribution channel for AOL Properties.

 

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PART I - ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

 

AOL Properties include our owned and operated content, products and services in the Huffington Post Media Group (“HPMG”), AOL Services and Local and Mapping strategy areas. AOL Properties also include co-branded websites owned or operated by third parties for which certain criteria have been met, including that the internet traffic has been assigned to us. We generate advertising revenues from AOL Properties through the sale of display advertising and search and contextual advertising. Display advertising revenue is generated by the display of graphical advertisements and other performance-based advertising. We offer advertisers marketing and promotional opportunities to purchase specific placements of advertising directly on AOL Properties (i.e., in particular locations and on specific dates). In addition, we offer advertisers the opportunity to bid on unreserved advertising inventory on AOL Properties utilizing our proprietary scheduling, optimization and delivery technology. We collectively refer to revenue associated with these offerings as premium display advertising revenue. Finally, advertising inventory on AOL Properties not sold directly to advertisers, as described above, may be included for sale to advertisers with inventory purchased from third-party publishers in the Third Party Network. Search and contextual advertising revenue is generated when a consumer clicks on a text-based advertisement on AOL Properties. These text-based advertisements are either generated from a consumer-initiated search query or placed on sites targeted by advertisers based on the content of the websites.

We also generate advertising revenues through the sale of advertising on third party websites, which we collectively refer to as the Third Party Network. Our advertising offerings on the Third Party Network consist primarily of the sale of display advertising and also include search and contextual advertising. In order to generate advertising revenues on the Third Party Network, we have historically had to incur higher traffic acquisition costs (“TAC”) as compared to advertising on AOL Properties.

Growth of our advertising revenues depends on our ability to attract consumers and increase engagement on AOL Properties by offering compelling content, products and services, as well as on our ability to provide effective advertising solutions and optimize our inventory monetization. In order to attract consumers and generate increased engagement, we have developed and acquired, and intend to continue to develop and potentially acquire, content, products and services designed to meet these goals. These actions include the development and acquisition of a number of platforms that are designed to facilitate the production, aggregation, distribution and consumption of national and local content. Additionally, through the creation of the HPMG, we have accelerated our strategy to deliver a scaled and differentiated array of premium news, analysis, commentary, entertainment and community engagement.

Historically, our primary subscription service has been our subscription access service. To supplement our subscription access service, we are marketing new products and services that are either third party or AOL-developed products. We earn performance-based fees in relation to marketing third party products and services. We offer these products to our current and former access subscribers as well as other internet consumers.

Visibility into advertising revenue is limited due to the fact that many advertising agreements are executed during the quarter that advertising is displayed. During the second quarter of 2012, we expect that our total revenues will continue to decline as compared to the same period in 2011. We expect the overall decline to be driven by declines in subscription revenue and search and contextual advertising revenue, primarily due to the decline in our domestic AOL-brand access subscribers, partially offset by growth in Third Party Network revenue. We expect the rate of decline in both subscription revenue and search and contextual advertising revenue to be lower than the rate of decline in the second quarter of 2011.

Key indicators to understanding our operating results include:

 

   

Growth of advertising revenues;

 

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Unique visitors to AOL Properties;

 

   

Monthly average churn and average paid tenure of our AOL-brand access subscribers;

 

   

Our investment in the local online market, which we believe is a potential growth area; and

 

   

Our ability to manage our operating cost structure.

Trends, Challenges and Uncertainties Impacting Our Business

The web services industry is highly competitive and rapidly changing. Trends, challenges and uncertainties that may have a significant impact on our business, our opportunities and our ability to execute our strategy include the following:

 

   

Advertising, commerce and information continue to migrate to the internet and away from traditional media outlets. We believe this continuing trend will create strategic growth opportunities for us to attract new consumers and develop new and effective advertising solutions. Additionally, the amount of content that is available online continues to expand. We believe our strategy is aligned with this rapid expansion as we aim to create a global content brand network while providing our consumers with an array of news, analysis, commentary, entertainment and community engagement. We offer a variety of sites that we expect to continue to drive consumer engagement, focusing on target audiences such as women, local and influencers. We continue to expand our distribution of our content, products and services on multiple platforms and digital devices (e.g., PCs, laptops, mobile phones and tablets).

 

   

We believe that there is a significant strategic growth opportunity in providing local content, platforms and services covering geographic locations ranging from neighborhoods to major metropolitan areas. Patch is our community-specific news and information platform dedicated to providing comprehensive and trusted local coverage for individual towns and communities. We have been focusing on and continue to focus on developing and offering compelling local content and growing user engagement within Patch towns. We have increased our focus on local advertising and commerce opportunities as we continue the next phase of our development of Patch.

 

   

The method of internet access continues to shift away from dial-up access. This trend, along with the free availability of the vast majority of our content, products and services, has contributed to, and we expect it will continue to contribute to, the decline in the number of our current access subscribers. As a result of these factors, we expect subscription revenues to continue to decline in the future but at lesser rates of decline than we have historically experienced. We continue to expand our offerings of online products and services to our subscribers and other consumers. We have evolved our subscription offerings to provide significant value in addition to access, such as computer tools, maintenance and warranty services, online technical support, anti-virus software, identity theft protection, online and social media privacy and reputation monitoring services. We expect that these products will allow us to continue to grow new subscription services and expand our customer base beyond existing subscribers. As the number of access subscribers has declined, our remaining subscriber base has become longer tenured. We believe that subscriber churn will continue to moderate in the foreseeable future as our tenured base matures and the value of the additional products and services offered to subscribers increases.

 

   

We have made progress towards achieving our strategy through targeted acquisitions and opportunistic dispositions. As a result of our 2010 and 2011 acquisitions, we are increasing our traffic on premium

 

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RESULTS OF OPERATIONS

 

 

news, analysis, commentary, entertainment and community engagement through HPMG. We are also increasing video streams and reach through video platforms and networks offered by 5 Minutes Ltd. (“5Min”) and goviral ApS (“goviral”) and improving premium format advertising offerings through Pictela, Inc.

Recent Developments

Ad.com Japan

On February 9, 2012, we entered into a share purchase agreement with Mitsui & Company Ltd. (“Mitsui”) to purchase an additional 3% interest in a joint venture between Mitsui and AOL (“Ad.com Japan”) for approximately $1.2 million. Ad.com Japan, which operates a display advertising network business in Japan, was formed in 2006. Prior to the execution of the share purchase agreement, AOL and Mitsui each owned a 50% interest in Ad.com Japan, and we accounted for our 50% interest using the equity method of accounting. As part of the share purchase agreement, we obtained control of the board and the day-to-day operations of Ad.com Japan. Therefore, we have accounted for the incremental 3% share purchase as a business combination achieved in stages (“step acquisition”) and consolidated Ad.com Japan beginning on February 9, 2012 (“the closing date”).

Under the accounting guidance for step acquisitions, we are required to record all assets acquired, liabilities assumed and Mitsui’s non-controlling interests at fair value, and recognize the entire goodwill of the acquired business. As Mitsui has a right to put its interest to AOL in the future, the noncontrolling interest is presented as redeemable noncontrolling interest outside permanent equity in our consolidated balance sheet. As of March 31, 2012, the undiscounted redemption value of the put option held by Mitsui was calculated to be approximately $11.7 million, which is below the $13.7 million carrying value of Mitsui’s interest in Ad.com Japan. The step acquisition guidelines also require that we remeasure our preexisting investment at fair value, and recognize any gains or losses from the remeasurement. As a result of this step acquisition, we recorded a noncash gain of approximately $10.8 million in the first quarter of 2012 within other income (loss), net. For additional information on the consolidation of Mitsui, see “Note 4” in our accompanying consolidated financial statements.

Patent Portfolio Sale

On April 5, 2012, we entered into a definitive agreement (the “Purchase Agreement”) to sell approximately 800 of our patents and their related patent applications (the “Patent Portfolio”) to Microsoft, a Washington corporation, and to grant Microsoft a non-exclusive license to our retained patent portfolio, for aggregate proceeds of approximately $1.1 billion in cash (excluding transaction costs). Of this amount, $960 million is associated with the sale of the Patent Portfolio and $96 million is associated with non-exclusive license fees. The transaction is structured as a purchase of all of the outstanding shares of a wholly owned non-operating subsidiary and the direct acquisition of those patents in the Patent Portfolio not held by the subsidiary.

The Purchase Agreement may be terminated by mutual written consent, by either party (i) if a non-appealable statute, rule, regulation, order or decree prevents the transaction; (ii) if all of the closing conditions of the other party have been satisfied but the other party fails to consummate the sale within two business days, or (iii) if the closing shall not have occurred within six months of signing, provided that such date may be extended by either party by 180 days. If Microsoft elects to utilize the 180 day extension, a per day fee will apply. Microsoft would be required to pay us a termination fee of $211.2 million if the transaction is terminated pursuant to its terms for any of the above reasons other than by mutual written consent, if our failure to perform a covenant is the cause of the termination or if the conditions to the agreement are met and we fail to close the transaction within two business days.

 

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PART I - ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

 

Based on utilization of tax losses generated by the sale of the non-operating subsidiary and existing deferred tax assets, we do not expect the $1.1 billion proceeds to result in material cash taxes. For additional information on this transaction, see “Note 4” in our accompanying consolidated financial statements.

Stock Repurchase Program

On August 10, 2011, our Board of Directors approved a stock repurchase program, which authorizes us to repurchase up to $250 million of our outstanding shares of common stock from time to time through August 2012. Repurchases are subject to market conditions, share price and other factors. Repurchases have been and will be made in accordance with applicable securities laws in the open market or in private transactions and may include derivative transactions. As of May 9, 2012, we repurchased a total of 14.8 million shares at a weighted-average price of $14.11 per share (approximately $209 million) under this program.

Key Metrics

Audience Metrics

We utilize unique visitor numbers to evaluate the performance of AOL Properties. In addition, we utilize unique visitor numbers to evaluate the reach of our total advertising network, which includes both AOL Properties and the Third Party Network. Unique visitor numbers provide an indication of our consumer reach. Although our consumer reach does not correlate directly to advertising revenue, we believe that our ability to broadly reach diverse demographic and geographic audiences is attractive to brand advertisers seeking to promote their brands to a variety of consumers without having to partner with multiple content providers. AOL’s unique visitor numbers also include unique visitors attributable to co-branded websites owned by third parties for which certain criteria have been met, including that the internet traffic has been assigned to us through a traffic assignment letter. For the three months ended March 31, 2012, approximately 5.3% of our unique visitors to AOL Properties were attributable to co-branded websites owned by third parties where the internet traffic was assigned to us.

The source for our unique visitor information is a third party (comScore Media Metrix, or “Media Metrix”). While we are familiar with the general methodologies and processes that Media Metrix uses in estimating unique visitors, we have not performed independent testing or validation of Media Metrix’s data collection systems or proprietary statistical models, and therefore we can provide no assurance as to the accuracy of the information that Media Metrix provides.

The following table presents our unique visitor metrics for the periods presented (in millions):

 

     Three Months Ended
March 31,
 
       2012          2011    

Domestic average monthly unique visitors to AOL Properties

     108        112  

Domestic average monthly unique visitors to AOL Advertising Network

     186        179  

Subscriber Access Metrics

The primary metrics we monitor for our subscription access service are monthly average churn and average paid tenure. Monthly average churn represents on average the percentage of AOL-brand access subscribers that terminate or cancel our services each month, factoring in new and reactivated subscribers. The domestic

 

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PART I - ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

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AOL-brand access subscriber monthly average churn was 2.0% and 2.5% for the three months ended March 31, 2012 and 2011, respectively. Average paid tenure represents the average period of time subscribers have paid for domestic AOL-brand internet access. The average paid tenure of the remaining domestic AOL-brand access subscribers has been increasing, and was approximately 11.5 years and 10.3 years for the three months ended March 31, 2012 and 2011, respectively.

Results of Operations

Revenues

The following table presents our revenues, by revenue type, for the periods presented (in millions):

 

     Three Months Ended
March 31,
        
       2012          2011          % Change    

Revenues:

        

Advertising

   $ 330.1      $ 313.7        5  % 

Subscription

     182.1        215.4        (15 )% 

Other

     17.2        22.3        (23 )% 
  

 

 

    

 

 

    

Total revenues

   $       529.4      $       551.4        (4 )% 
  

 

 

    

 

 

    

The following table presents our revenues, by revenue type, as a percentage of total revenues for the periods presented:

 

     Three Months Ended March 31,  
               2012                         2011             

Revenues:

     

Advertising

     62%         57%   

Subscription

     34           39     

Other

     4           4     
  

 

 

    

 

 

 

Total revenues

                         100%                             100%   
  

 

 

    

 

 

 

Advertising Revenues

Advertising revenues are generated on AOL Properties through display advertising and search and contextual advertising, as described in “Overview – Our Business” herein. Agreements for advertising on AOL Properties typically take the form of impression-based contracts in which we provide impressions in exchange for a fixed fee (generally stated as cost-per-thousand impressions), time-based contracts in which we provide a minimum number of impressions over a specified time period for a fixed fee or performance-based contracts in which performance is measured in terms of either “click-throughs” when a user clicks on a company’s advertisement or other user actions such as product/customer registrations, survey participation, sales leads or product purchases. In addition, agreements with advertisers can include other advertising-related elements such as content sponsorships, exclusivities or advertising effectiveness research.

In addition to advertising revenues generated on AOL Properties, we also generate revenues from our advertising offerings on the Third Party Network. To generate revenues on the Third Party Network, we purchase advertising inventory from publishers (both large and small) in the Third Party Network using proprietary

 

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optimization, targeting and delivery technology to best match advertisers with available advertising inventory. Advertising arrangements for the sale of Third Party Network inventory typically take the form of impression-based contracts or performance-based contracts.

Advertising revenues on AOL Properties and the Third Party Network for the three months ended March 31, 2012 and 2011 are as follows (in millions):

 

     Three Months Ended
March 31,
        
         2012              2011            % Change    

AOL Properties:

        

Display

   $ 130.3      $ 128.5        1 %   

Search and Contextual

     89.6        95.8        (6)%   
  

 

 

    

 

 

    

Total AOL Properties

     219.9        224.3        (2)%   

Third Party Network

     110.2        89.4        23 %   
  

 

 

    

 

 

    

Total advertising revenues

   $       330.1      $       313.7        5 %   
  

 

 

    

 

 

    

Advertising revenues increased $16.4 million for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011, reflecting an increase in Third Party Network revenue and global display revenue, partially offset by declines in search and contextual revenue. The increase in Third Party Network revenue of $20.8 million relates primarily to an increase in advertisers and publishers, and increased sales of premium packages and products. In addition, Third Party Network revenue increased by $6.4 million as a result of the consolidation of Ad.com Japan beginning in the first quarter of 2012 and an additional month of goviral revenue, which was acquired on January 31, 2011. The increase in display revenue of $1.8 million primarily relates to growth in reserved inventory pricing, Patch revenue and international revenue, primarily in the UK, partially offset by a decline in reserved impressions sold. Domestic search and contextual revenue declined $4.2 million primarily related to fewer domestic queries, due to a 14% year-over-year decrease in domestic AOL-brand access subscribers and from cobranded portals. International search and contextual revenue declines of $2.0 million were due to fewer queries primarily in the United Kingdom. These declines in search and contextual revenue include offsetting impacts related to growth in search revenue on AOL.com of $6.3 million.

Revenues Associated with Google

For all periods presented in this Quarterly Report, we have had a contractual relationship with Google Inc. (“Google”) whereby we generate revenues through paid text-based search and contextual advertising on AOL Properties provided by Google, which represent a significant percentage of the advertising revenues generated by AOL Properties. For the three months ended March 31, 2012 and 2011, the revenues associated with the Google relationship (substantially all of which were search and contextual revenues generated on AOL Properties) were $84.5 million and $88.2 million, respectively.

Subscription Revenues

The number of domestic AOL-brand access subscribers was 3.1 million and 3.6 million at March 31, 2012 and 2011, respectively. Domestic average monthly revenue per AOL-brand access subscriber (“ARPU”) was $17.88 and $17.96 for the three months ended March 31, 2012 and 2011, respectively. We include in our subscriber numbers individuals, households and entities that have provided billing information and completed the registration process sufficiently to allow for an initial log-on to the AOL access service. Individuals who have

 

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registered for our free offerings, including subscribers who have migrated from paid subscription plans, are not included in the AOL-brand access subscriber numbers presented above. Subscribers to our subscription access service contribute to our ability to generate advertising revenues.

Subscription revenues declined 15% for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011. The decline was due to an approximate 14% decrease in the number of domestic AOL-brand access subscribers between March 31, 2011 and March 31, 2012. Subscription revenue for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011 also includes a favorable impact related to the simplified pricing structure initiated in late 2011.

Other Revenues

Other revenues consist primarily of licensing revenues from licensing our proprietary ad serving technology to third parties through our subsidiary, ADTECH, licensing revenues from third-party customers of MapQuest’s business-to-business services and fees associated with our mobile e-mail and instant messaging functionality from mobile carriers. In addition, other revenue also includes revenue from ticket sales related to technology events hosted by TechCrunch and production fees for videos produced by StudioNow.

Other revenues decreased 23% for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011, due primarily to a decrease in revenues from our mobile messaging services as mobile carriers continue to move away from paying on a per message basis, a decline in third party web hosting revenues and a decrease in transition services revenue. These declines were partially offset by an increase in StudioNow revenues and ADTECH licensing revenues.

Geographical Concentration of Revenues

For the periods presented herein, a significant majority of our revenues have been generated in the United States. Substantially all of the non-United States revenues for these periods were generated by our European operations (primarily in the United Kingdom). We expect the significant majority of our revenues to continue to be generated in the United States for the foreseeable future. See “Note 1” in our accompanying consolidated financial statements for further discussion of our geographical concentrations.

Operating Costs and Expenses

The following table presents our operating costs and expenses for the periods presented (in millions):

 

     Three Months Ended March 31,  
           2012                  2011                  % Change        

Costs of revenues

   $     384.6      $     388.9        (1)%   

General and administrative

     96.2        120.7        (20)%   

Amortization of intangible assets

     9.8        24.2        (60)%   

Restructuring costs

     7.4        27.8        (73)%   

Loss on disposal of consolidated business

     -            1.6        (100)%   

 

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The following table represents our operating costs and expenses as a percentage of revenues for the periods

presented:

 

     Three Months Ended
March 31,
 
     2012     2011  

Operating costs and expenses:

    

Costs of revenues

     73     71

General and administrative

     18       22  

Amortization of intangible assets

     2       4  

Restructuring costs

     1       5  
  

 

 

   

 

 

 

Total operating costs and expenses

     94     102
  

 

 

   

 

 

 

Costs of Revenues

The following categories of costs are generally included in costs of revenues: personnel and facilities costs, TAC, network-related costs, non-network depreciation and amortization and other costs of revenues. TAC consists of costs incurred through arrangements in which we acquire third-party online advertising inventory for resale and arrangements whereby partners distribute our free products or services or otherwise direct traffic to AOL Properties. TAC arrangements have a number of different economic structures, the most common of which are: payments based on a cost per thousand impressions or based on a percentage of the ultimate advertising revenues generated from the advertising inventory acquired for resale and payments for direct traffic delivered to AOL Properties priced on a per click basis (e.g., search engine marketing fees). These arrangements are primarily on a variable basis; however, the arrangements can also be on a fixed-fee basis, which often carry reciprocal performance guarantees by the counterparty, or a combination of fixed and variable.

Costs of revenues for the three months ended March 31, 2012 and 2011 are as follows (in millions):

 

     Three Months Ended March 31,  
     2012      2011      % Change
from 2011 to
2012
 

Costs of revenues:

        

Personnel costs

   $ 162.1      $     158.5        2 %   

Facilities costs

     14.0        12.9        9 %   

TAC

     80.8        71.4        13 %   

Network-related costs

     40.8        48.4        (16)%   

Non-network depreciation and amortization

     16.4        18.6        (12)%   

Other costs of revenues

             70.5                79.1        (11)%   
  

 

 

    

 

 

    

Total costs of revenues

   $     384.6      $     388.9        (1)%   
  

 

 

    

 

 

    

Costs of revenues decreased for the three months ended March 31, 2012 as compared to the same period in 2011.

The increase in personnel and facilities costs for the three months ended March 31, 2012 as compared to the same period in 2011 is primarily due to 2011 headcount increases related to our 2011 acquisitions and Patch. The additional headcount drove an increase of $11.5 million. This increase was partially offset by a decrease in headcount in non-strategic areas.

 

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TAC increased for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011, primarily due to the increase in Third Party Network advertising revenues, which resulted in higher variable revenue share payments to our publishing partners (including a $4.2 million increase in TAC as a result of our consolidation of Ad.com Japan).

The decrease in network-related costs is primarily due to efforts to align our cost with our strategy, including the decommissioning of certain network equipment, and to a lesser extent, the decline in the number of domestic AOL-brand access subscribers.

Other costs of revenues decreased for the three months ended March 31, 2012 as compared to the same period in 2011 due to declines in internal content development costs of $13.1 million and billing expenses of $1.4 million due to the decline in AOL brand-access subscribers, partially offset by increased costs of $2.0 million relating to the launch of paid services products, increased sales and use tax reserves of $2.0 million and an increase in ad serving expense of $2.0 million.

General and Administrative

General and administrative expenses decreased $24.5 million for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011. The decrease was due to a decline in personnel costs of $14.1 million including the impact of reduced corporate headcount and reduced stock compensation expense resulting from vesting of certain stock awards in December 2011, a decline in consulting costs of $5.5 million and a decline in legal costs of $1.2 million.

We expect operating expenses in the second quarter of 2012 to be higher than the first quarter of 2012 due to costs related to the 2012 proxy contest.

Amortization of Intangible Assets

Amortization of intangible assets results primarily from acquired intangible assets including acquired technology, customer relationships and trade names. Amortization of intangible assets decreased $14.4 million for the three months ended March 31, 2012 as compared to the same period in 2011, primarily related to the $19.6 million impact of certain intangible assets being fully amortized in 2011, partially offset by an increase of $5.0 million resulting from our 2011 and 2012 acquisitions.

Restructuring Costs

For the three months ended March 31, 2012, we incurred $7.4 million in restructuring costs related to organizational changes made in an effort to improve our ability to execute our strategy. These restructuring costs were primarily related to involuntary terminations of employees.

We incurred $27.8 million of restructuring costs for the three months ended March 31, 2011 related to our restructuring activities to better align our organizational structure and costs with our strategy. This amount includes costs incurred as a result of our acquisition of The Huffington Post and costs incurred as a result of the reassessment of our operations in India. The majority of the costs incurred related to involuntary employee terminations.

 

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Operating Income (Loss)

Operating income was $31.4 million for the three months ended March 31, 2012 as compared to operating loss of $11.8 million for the three months ended March 31, 2011. This change from operating loss to operating income was primarily due to the declines in general and administrative costs, amortization of intangible assets and restructuring costs, partially offset by the decline in revenues.

Other Income Statement Amounts

The following table presents our other income statement amounts for the periods presented (in millions):

 

     Three Months Ended March 31,  
         2012              2011              % Change      

Other income (loss), net

   $     8.4      $     0.6         NM   

Income tax provision (benefit)

     18.8        (15.9)         NM   

Other Income (Loss), Net

Other income (loss), net was $8.4 million for the three months ended March 31, 2012 as compared to other income (loss), net of $0.6 million for the three months ended March 31, 2011. This increase was due primarily to the $10.8 million gain related to the consolidation of Ad.com Japan, partially offset by unfavorable foreign currency impacts of $3.5 million.

Income Tax Provision (Benefit)

We recorded income from operations before income taxes of $39.8 million and related income tax expense of $18.8 million, which resulted in an effective tax rate of 47.2% for the three months ended March 31, 2012, as compared to an effective tax rate of 142.0% for the three months ended March 31, 2011. Our effective tax rate for the three months ended March 31, 2012 differed from the statutory U.S. federal income tax rate of 35.0% primarily due to foreign losses that did not produce a tax benefit and due to a change in state tax rates. Our effective tax rate for three months ended March 31, 2011 differed from the statutory U.S. federal income tax rate of 35.0% primarily due to $7.1 million of income tax benefit associated with a worthless stock deduction related to the sale of a subsidiary in the first quarter of 2011 and favorable adjustments of $8.2 million related to escrow disbursements from prior acquisitions for which we concluded we will be able to recognize a tax benefit.

Adjusted OIBDA

We use Adjusted OIBDA as a supplemental measure of our performance. We define Adjusted OIBDA as operating income before depreciation and amortization excluding the impact of restructuring costs, non-cash equity-based compensation, gains and losses on all disposals of assets (including those recorded in costs of revenues) and non-cash asset impairments and write-offs. We consider Adjusted OIBDA to be a useful metric for management and investors to evaluate and compare the ongoing operating performance of our business on a consistent basis across reporting periods, as it eliminates the effect of non-cash items such as depreciation of tangible assets, amortization of intangible assets that were primarily recognized in business combinations, asset impairments and write-offs, as well as the effect of restructurings and gains and losses on asset sales, which we do not believe are indicative of our core operating performance. We exclude the impacts of equity-based compensation to allow us to be more closely aligned with the industry and analyst community. A limitation of this measure, however, is that it does not reflect the periodic costs of certain capitalized tangible and intangible

 

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assets used in generating revenues in our business or the current or future expected cash expenditures for restructuring costs. The Adjusted OIBDA measure also does not include equity-based compensation, which is and will remain a key element of our overall long-term compensation package. Moreover, the Adjusted OIBDA measures do not reflect gains and losses on asset sales or impairment charges and write-offs related to goodwill, intangible assets and fixed assets which impact our operating performance. We evaluate the investments in such tangible and intangible assets through other financial measures, such as capital expenditure budgets, investment spending levels and return on capital.

Adjusted OIBDA is a non-GAAP financial measure and may be different than similarly-titled non-GAAP financial measures used by other companies. The presentation of this financial information is not intended to be considered in isolation or as a substitute for the financial information prepared and presented in accordance with generally accepted accounting principles (“GAAP”).

The following table presents our reconciliation of Adjusted OIBDA to operating income (loss) (in millions):

 

    Three Months Ended March 31,  
    2012     2011     % Change  

Operating income (loss)

  $ 31.4      $ (11.8)        NM      

Add: Depreciation

    36.1        44.4        (19)%   

Add: Amortization of intangible assets

    9.8        24.2        (60)%   

Add: Restructuring costs

    7.4        27.8        (73)%   

Add: Equity-based compensation

    8.6        10.4        (17)%   

Add: Asset impairments and write-offs

    0.9        1.5        (40)%   

Add: Losses/(gains) on disposal of consolidated businesses, net

           1.6        (100)%   

Add: Losses/(gains) on other asset sales

    (0.4)         1.0        NM      
 

 

 

   

 

 

   

Adjusted OIBDA

  $     93.8      $     99.1        (5)%   
 

 

 

   

 

 

   

Adjusted OIBDA declined for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011 due to the declines in revenues, partially offset by the declines in general and administrative costs discussed above.

Liquidity and Capital Resources

Current Financial Condition

Historically, the cash we generate has been sufficient to fund our working capital, capital expenditure and financing requirements. Forecasts of future cash flows are dependent on many factors, including future economic conditions and the execution of our strategy. We expect to fund our ongoing working capital, investing and financing requirements, including future repurchases of common stock, through our existing cash balance and cash flows from operations. Increases in cash flows from operations are achieved when growth from our online advertising services more than offsets the decline in domestic AOL-brand access subscribers. In order for us to achieve an increase in earnings from advertising services, we believe it will be important to increase the number and engagement of consumers who visit our properties, to enable us to increase our overall volume of display advertising sold, including through our higher-priced channels, and to maintain or increase pricing for advertising. Advertising revenues, however, are more unpredictable and variable than our subscription revenues, and are more likely to be adversely affected during economic downturns, as spending by advertisers tends to be cyclical in line with general economic conditions.

 

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If we are unable to successfully implement our strategic plan and grow the earnings generated by our online advertising services, we may need to reassess our cost structure and/or seek other financing alternatives to fund our business. If it is necessary to seek other financing alternatives, our ability to obtain future financing will depend on, among other things, our financial condition and results of operations as well as the condition of the capital markets or other credit markets at the time we seek financing. Currently we do not have a credit rating from the credit rating agencies, so our access to the capital markets may be limited. As part of our ongoing assessment of our business and availability of capital and to enhance our liquidity position, we have divested of certain assets and product lines and may consider divesting of additional assets or product lines.

At March 31, 2012, our cash and equivalents totaled $361.9 million, as compared to $407.5 million at December 31, 2011. The decline in cash and equivalents was primarily due to employee bonus payments in January 2012 and the cash paid for the repurchase of our common stock in the first quarter of 2012, partially offset by cash provided by the remainder of our operating activities in the first quarter of 2012. Approximately 27% of our cash and equivalents as of March 31, 2012 is held internationally and is intended to be utilized to fund our foreign operations. Cash held internationally would have to be repatriated in order to be used to fund our domestic operations. If we were to repatriate funds, we would incur additional tax liabilities.

Summary Cash Flow Information

Our cash flows from operations are driven by net income adjusted for non-cash items such as depreciation, amortization, goodwill impairment, equity-based compensation expense and other activities impacting net income such as the gains and losses on the sale of assets or operating subsidiaries. Cash flows from investing activities consist primarily of the cash used in the acquisitions of various businesses as part of our strategy, proceeds received from the sale of assets or operating subsidiaries and cash used for capital expenditures. Capital expenditures and product development costs are mainly for the purchase of computer hardware, software, network equipment, furniture, fixtures and other office equipment. Cash flows from financing activities relate primarily to principal payments made on capital lease obligations and repurchases of common stock.

Operating Activities

The following table presents cash provided by operating activities for the periods presented (in millions):

 

    Three Months Ended
March 31,
 
        2012              2011      

Net income

  $ 21.0      $ 4.7   

Adjustments for non-cash and non-operating items:

   

Depreciation and amortization

    45.9        68.6   

Asset impairments and write-offs

    0.9        1.5   

(Gain) loss on investments and sale of consolidated businesses, net

    (10.8)        3.0   

Equity-based compensation

    8.6        10.4   

Deferred income taxes

    8.6        (15.6)   

All other, net, including working capital changes

    (54.3)        (68.6)   
 

 

 

   

 

 

 

Cash provided by operating activities

  $         19.9      $           4.0   
 

 

 

   

 

 

 

Cash provided by operating activities increased $15.9 million for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011. Our operating income was $31.4 million for the three

 

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months ended March 31, 2012, an increase of $43.2 million as compared to the three months ended March 31, 2011, which was the primary driver for the increase in cash provided by operating activities. This increase was offset by incentive compensation payments of $20.9 million made in the first quarter of 2012 related to prior year acquisitions.

Investing Activities

The following table presents cash used by investing activities for the periods presented (in millions):

 

    Three Months Ended
March 31,
 
            2012                     2011          

Investments and acquisitions, net of cash acquired

  $ 4.3      $ (369.7)   

Capital expenditures and product development costs

    (15.0)        (34.2)   

Other investment proceeds

    0.3        0.2   
 

 

 

   

 

 

 

Cash used by investing activities

  $         (10.4)      $         (403.7)   
 

 

 

   

 

 

 

Cash used by investing activities was $10.4 million for the three months ended March 31, 2012, as compared to $403.7 million for the three months ended March 31, 2011. The decrease in cash used by investing activities was principally due to the acquisitions of The Huffington Post and goviral during the three months ended March 31, 2011 and a decrease in capital expenditures and product development costs. In addition, investments and acquisitions, net of cash acquired, for the three months ended March 31, 2012 includes $6.9 million of cash acquired from the step acquisition of Ad.com Japan (net of $1.2 million cash paid for the additional 3% interest).

Financing Activities

The following table presents cash used by financing activities for the periods presented (in millions):

 

    Three Months Ended
March 31,
 
            2012                     2011          

Repurchase of common stock

  $ (35.8)      $   

Principal payments on capital leases

    (14.4)        (11.3)   

Tax withholdings related to net share settlements of restricted stock units

    (5.4)        (0.2)   

Decrease (increase) in cash collateral securing letters of credit

    0.2        (12.2)   

Other financing activities

    0.3        0.1   
 

 

 

   

 

 

 

Cash used by financing activities

  $         (55.1)      $         (23.6)   
 

 

 

   

 

 

 

Cash used by financing activities was $55.1 million for the three months ended March 31, 2012, compared to $23.6 million for the three months ended March 31, 2011. The cash used by financing activities for the three months ended March 31, 2012 includes $35.8 million related to the repurchase of our common stock. See “Note 6” in our accompanying consolidated financial statements for further discussion of our stock repurchase program. Included in the cash used by financing activities for the three months ended March 31, 2011 was $12.2 million of cash collateral posted to secure letters of credit related to certain of our lease agreements. Previously, our letters of credit were guaranteed by Time Warner.

 

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Free Cash Flow

We use Free Cash Flow as a supplemental measure of our performance. We define Free Cash Flow as cash provided by operating activities, less capital expenditures, product development costs and principal payments on capital leases. We consider Free Cash Flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated by the business that, after capital expenditures, capitalized product development costs and principal payments on capital leases, can be used for strategic opportunities, including investing in our business, making strategic acquisitions and strengthening the balance sheet. Analysis of Free Cash Flow also facilitates management’s comparisons of our operating results to competitors’ operating results. A limitation on the use of this metric is that Free Cash Flow does not represent the total increase or decrease in cash for the period because it excludes certain non-operating cash flows.

Free Cash Flow is a non-GAAP financial measure and may be different than similarly-titled non-GAAP financial measures used by other companies. The presentation of this financial information is not intended to be considered in isolation or as a substitute for the financial information prepared and presented in accordance with GAAP.

The following table presents our reconciliation of Free Cash Flow to cash provided by operating activities

(in millions):

 

    Three Months Ended
March 31,
 
        2012             2011      

Cash provided by operating activities

  $ 19.9      $ 4.0   

Less: Capital expenditures and product development costs

    15.0        34.2   

Less: Principal payments on capital leases

    14.4                  11.3   
 

 

 

   

 

 

 

Free Cash Flow

  $             (9.5)      $ (41.5)   
 

 

 

   

 

 

 

Free Cash Flow increased for the three months ended March 31, 2012 as compared to the three months ended March 31, 2011. This increase is due to the increase in cash provided by operating activities, discussed in “Summary Cash Flow Information—Operating Activities” above and due to reduced capital expenditures and product development costs. While we expect to generate significant positive free cash flows for the full year of 2012 as well as for the foreseeable future, free cash flow was negative for the three months ended March 31, 2012 and 2011 due primarily to annual employee bonus payments made in each of those quarters.

Customer Credit Risk

Customer credit risk represents the potential for financial loss if a customer is unwilling or unable to meet its agreed-upon contractual payment obligations. Credit risk originates from sales of advertising and subscription access service and is dispersed among many different counterparties. No single customer had a receivable balance at March 31, 2012 greater than 10% of total net receivables.

Customer credit risk is monitored on a company-wide basis. We maintain a comprehensive approval process prior to issuing credit to third-party customers. On an ongoing basis, we track customer exposure based on news reports, rating agency information and direct dialogue with customers. Counterparties that are determined to be of a higher risk are evaluated to assess whether the payment terms previously granted to them should be modified. We also continuously monitor payment levels from customers, and a provision for estimated

 

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uncollectible amounts is maintained based on historical experience and any specific customer collection issues that have been identified. While such uncollectible amounts have historically been within our expectations and related reserve balances, if there is a significant change in uncollectible amounts in the future or the financial condition of our counterparties across various industries or geographies deteriorates further, additional reserves may be required.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with GAAP, which require management to make estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements and the accompanying notes. Management considers an accounting policy to be critical if it is important to our financial condition and results of operations and if it requires significant judgment and estimates on the part of management in its application. The development and selection of these critical accounting policies have been determined by our management. Due to the significant judgment involved in selecting certain of the assumptions used in these areas, it is possible that different parties could choose different assumptions and reach different conclusions. We consider the policies related to the following matters to be critical accounting policies: (a) gross versus net revenue recognition; (b) impairment of goodwill; and (c) income taxes.

For additional information about our critical accounting policies and our significant accounting policies, see “Item 7—MD&A—Critical Accounting Policies” and “Note 1” to our audited consolidated financial statements in our Annual Report. There have been no significant changes to our critical accounting policies disclosed in our Annual Report for the year ended December 31, 2011.

 

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AOL INC.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in market risk from the information provided in Part II, Item 7A “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K for the year ended December 31, 2011.

 

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AOL INC.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that the information we are required to disclose in our financial reports is recorded, processed, summarized and reported within the time periods specified by the SEC rules and forms, and that such information is accumulated and communicated to senior management, as appropriate, to allow timely decisions regarding required disclosure. Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2012. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2012, at a reasonable assurance level.

Changes to Internal Control Over Financial Reporting

We have evaluated the changes in our internal control over financial reporting that occurred during the three months ended March 31, 2012 and concluded that there have not been any changes that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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AOL INC.

ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited; In millions, except per share amounts)

 

    Three Months Ended March 31,  
    2012      2011  

Revenues:

    

Advertising

  $ 330.1      $ 313.7   

Subscription

    182.1        215.4   

Other

    17.2        22.3   
 

 

 

    

 

 

 

Total revenues

    529.4        551.4   

Costs of revenues

    384.6        388.9   

General and administrative

    96.2        120.7   

Amortization of intangible assets

    9.8        24.2   

Restructuring costs

    7.4        27.8   

Loss on disposal of consolidated business

    -         1.6   
 

 

 

    

 

 

 

Operating income (loss)

    31.4        (11.8)   

Other income (loss), net

    8.4        0.6   
 

 

 

    

 

 

 

Income (loss) from operations before income taxes

    39.8        (11.2)   

Income tax provision (benefit)

    18.8        (15.9)   
 

 

 

    

 

 

 

Net income

  $ 21.0      $ 4.7   

Net (income) loss attributable to noncontrolling interests

    0.1          
 

 

 

    

 

 

 

Net income attributable to AOL Inc.

  $ 21.1      $ 4.7   
 

 

 

    

 

 

 

Per share information attributable to AOL Inc. common stockholders:

    

Basic net income per common share

  $ 0.22      $ 0.04   
 

 

 

    

 

 

 

Diluted net income per common share

  $ 0.22      $ 0.04   
 

 

 

    

 

 

 

Shares used in computing basic income per common share

    94.4        106.9   
 

 

 

    

 

 

 

Shares used in computing diluted income per common share

    95.0        107.9   
 

 

 

    

 

 

 

Comprehensive income attributable to AOL Inc.:

    

Comprehensive income

  $ 20.1      $ 12.0   

Comprehensive (income) loss attributable to noncontrolling interests

    0.8          
 

 

 

    

 

 

 

Comprehensive income attributable to AOL Inc.

  $ 20.9      $ 12.0   
 

 

 

    

 

 

 

See accompanying notes.

 

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AOL INC.

ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS

(In millions, except per share amounts)

 

     March 31,
2012
     December 31,
2011
 
     (unaudited)         
Assets      

Current assets:

     

Cash and equivalents

   $ 361.9       $ 407.5   

Accounts receivable, net of allowances of $7.8 and $8.3, respectively

     288.8         311.5   

Prepaid expenses and other current assets

     34.8         36.9   

Deferred income taxes

     93.3         53.7   
  

 

 

    

 

 

 

Total current assets

     778.8         809.6   

Property and equipment, net

     499.0         505.2   

Goodwill

     1,073.6         1,064.0   

Intangible assets, net

     143.5         135.2   

Long-term deferred income taxes

     211.3         259.2   

Other long-term assets

     51.1         51.8   
  

 

 

    

 

 

 

Total assets

   $ 2,757.3       $         2,825.0   
  

 

 

    

 

 

 
Liabilities and Equity      

Current liabilities:

     

Accounts payable

   $ 70.7       $ 74.9   

Accrued compensation and benefits

     74.6         152.8   

Accrued expenses and other current liabilities

     164.4         171.6   

Deferred revenue

     74.2         70.9   

Current portion of obligations under capital leases

     44.1         44.6   
  

 

 

    

 

 

 

Total current liabilities

     428.0         514.8   

Long-term portion of obligations under capital leases

     63.8         66.2   

Long-term deferred income taxes

     10.2         3.5   

Other long-term liabilities

     75.4         67.9   
  

 

 

    

 

 

 

Total liabilities

     577.4         652.4   
  

 

 

    

 

 

 

Commitments and contingencies (see Note 9)

     

Redeemable noncontrolling interest (see Note 1)

     13.7           

Stockholders’ equity:

     

Common stock, $0.01 par value, 107.9 million shares issued and 93.1 million shares outstanding as of March 31, 2012 and 107.0 million shares issued and 94.3 million shares outstanding as of December 31, 2011

     1.1         1.1   

Additional paid-in capital

     3,430.9         3,422.4   

Accumulated other comprehensive loss, net

     (287.7)         (287.5)   

Accumulated deficit

     (768.7)         (789.8)   

Treasury stock, at cost, 14.8 million shares at March 31, 2012 and 12.7 million shares at December 31, 2011

     (209.4)         (173.6)   
  

 

 

    

 

 

 

Total stockholders’ equity

     2,166.2         2,172.6   
  

 

 

    

 

 

 

Total liabilities, redeemable noncontrolling interest and stockholders’ equity

   $ 2,757.3       $ 2,825.0   
  

 

 

    

 

 

 

See accompanying notes.

 

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AOL INC.

ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited; In millions)

 

    Three Months Ended March 31,  
    2012      2011  

Operating Activities

    

Net income

  $ 21.0       $ 4.7   

Adjustments for non-cash and non-operating items:

    

Depreciation and amortization

    45.9         68.6   

Asset impairments and write-offs

    0.9         1.5   

(Gain) loss on investments and sale of consolidated businesses, net

    (10.8)         3.0   

Equity-based compensation

    8.6         10.4   

Other non-cash adjustments

            3.2   

Deferred income taxes

    8.6         (15.6)   

Changes in operating assets and liabilities, net of acquisitions

    (54.3)         (71.8)   
 

 

 

    

 

 

 

Cash provided by operating activities

    19.9         4.0   

Investing Activities

    

Investments and acquisitions, net of cash acquired

    4.3         (369.7)   

Capital expenditures and product development costs

    (15.0)         (34.2)   

Other investment proceeds

    0.3         0.2   
 

 

 

    

 

 

 

Cash used by investing activities

    (10.4)         (403.7)   

Financing Activities

    

Repurchase of common stock

    (35.8)           

Principal payments on capital leases

    (14.4)         (11.3)   

Tax withholdings related to net share settlements of restricted stock units

    (5.4)         (0.2)   

Decrease (increase) in cash collateral securing letters of credit

    0.2         (12.2)   

Other financing activities

    0.3         0.1   
 

 

 

    

 

 

 

Cash used by financing activities

    (55.1)         (23.6)   

Effect of exchange rate changes on cash and equivalents

            3.3   

Decrease in cash and equivalents

    (45.6)         (420.0)   

Cash and equivalents at beginning of period

    407.5         801.8   
 

 

 

    

 

 

 

Cash and equivalents at end of period

  $ 361.9       $ 381.8   
 

 

 

    

 

 

 

Supplemental disclosures of cash flow information

    

Cash paid for interest

  $ 1.5       $ 1.5   
 

 

 

    

 

 

 

Cash paid for income taxes

  $ 2.5       $ 4.1   
 

 

 

    

 

 

 

See accompanying notes.

 

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AOL INC.

ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited; In millions)

 

    Common Stock     Additional
Paid-In
Capital
    Accumulated
Other
Comprehensive
Loss
    Accumulated
Deficit
    Treasury
Stock,

at Cost
    Total
Stockholders’
Equity
 
    Shares     Amount            

Balance at December 31, 2010

    106.7      $ 1.1     $ 3,376.6     $ (287.9)      $ (802.9)      $      $ 2,286.9   

Net income attributable to AOL Inc.

           -        -               4.7               4.7   

Foreign currency translation adjustments

           -        -        7.3                       7.3   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

           -        -        7.3        4.7               12.0   

Amounts related to equity-based compensation, net of tax withholdings (See Note 6)

           -        18.0                            18.0   

Issuance of common stock

    0.2        -        0.1                            0.1   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2011

    106.9      $ 1.1     $ 3,394.7     $ (280.6)      $ (798.2)      $      $ 2,317.0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2011

    94.3      $ 1.1     $ 3,422.4     $ (287.5)      $ (789.8)      $ (173.6)      $ 2,172.6   

Net income attributable to AOL Inc.

           -        -               21.1               21.1   

Unrealized gain on equity method investments

           -        -        0.1                      0.1   

Foreign currency translation

adjustments

           -        -        (0.3)                      (0.3)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

           -        -        (0.2)        21.1               20.9   

Amounts related to equity-based

compensation, net of tax withholdings

           -        8.2                            8.2   

Issuance of common stock

    0.9        -        0.3                            0.3   

Repurchase of common stock

    (2.1)        -        -                      (35.8)        (35.8)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2012

    93.1      $ 1.1     $ 3,430.9     $ (287.7)      $ (768.7)      $ (209.4)      $ 2,166.2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

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AOL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1—DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of Business

For a description of the business of AOL Inc. (“AOL” or the “Company”), see “Note 1” to the Company’s audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 (the “Annual Report”).

Basis of Presentation

Basis of Consolidation

The consolidated financial statements include 100% of the assets, liabilities, revenues, expenses and cash flows of AOL and all voting interest entities in which AOL has a controlling voting interest (“subsidiaries”) in accordance with the consolidation accounting guidance. Intercompany accounts and transactions between consolidated companies have been eliminated in consolidation. As of March 31, 2012, the Company did not have any consolidated variable interest entities.

The financial position and operating results of substantially all foreign operations are consolidated using the local currency as the functional currency. Local currency assets and liabilities are translated at the rates of exchange on the balance sheet date, and local currency revenues and expenses are translated at average rates of exchange during the period. Resulting translation gains or losses are included in the consolidated balance sheet as a component of accumulated other comprehensive income (loss), net.

Redeemable Noncontrolling Interest

The noncontrolling interest in a joint venture between Mitsui & Company Ltd. (“Mitsui”) and AOL (“Ad.com Japan”) is classified outside of permanent equity in the Company’s consolidated balance sheet for the three months ended March 31, 2012, due to a redemption right available to the noncontrolling interest holder in the future. The noncontrolling interest holder’s right to redeem its stock is exercisable any time between July 1 and July 30 of any year, commencing with July 1, 2014, at a price that is below the fair value of the noncontrolling interest as of March 31, 2012. Net income in the consolidated statement of comprehensive income for the three months ended March 31, 2012 reflects 100 percent of the results of Ad.com Japan as the company has a controlling interest in the entity. Net income is subsequently adjusted to remove the noncontrolling interest to arrive at net income attributable to AOL Inc.

Changes in Basis of Presentation

The Company has changed the classification of certain amounts within the accompanying consolidated statement of cash flows for the three months ended March 31, 2011. The revisions related to accrued liabilities and capital expenditures do not have a material impact on the consolidated statement of cash flows.

Use of Estimates

The preparation of the financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements and footnotes thereto. Actual results could differ from those estimates.

 

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Table of Contents

AOL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

Significant estimates inherent in the preparation of the consolidated financial statements include asset impairments, reserves established for doubtful accounts, equity-based compensation, depreciation and amortization, business combinations, income taxes, litigation matters and contingencies.

Interim Financial Statements

The interim consolidated financial statements are unaudited; however, in the opinion of management, they contain all the adjustments (consisting of those of a normal recurring nature) considered necessary to present fairly the financial position, the results of operations and cash flows for the periods presented in conformity with GAAP applicable to interim periods. The interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements of AOL in the Annual Report.

Information about Geographical Areas

Revenues in different geographical areas are as follows (in millions):

 

     Three Months Ended March 31, (a)  
             2012                      2011           

United States

   $ 476.4      $ 506.5    

United Kingdom

     24.2        23.0    

Germany

     9.0        8.2    

Canada

     7.3         8.4    

Japan

     6.9         0.2    

Other international

                         5.6                            5.1    
  

 

 

    

 

 

 

Total international

     53.0        44.9    
  

 

 

    

 

 

 

Total

   $ 529.4      $ 551.4    
  

 

 

    

 

 

 

 

  (a)

Revenues are attributed to countries based on the location of customers.

Recent Accounting Standards

Goodwill Impairment

In September 2011, new guidance was issued related to assessing goodwill impairment. Under the new guidance, a company is permitted to make a qualitative assessment of whether goodwill impairment exists before applying the two-step goodwill impairment test. If the conclusion from the qualitative assessment is that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the company would be required to conduct the current two-step goodwill impairment test. Otherwise, it would not need to apply the two-step test.

This new guidance became effective for the Company in January 2012. Given the proximity of the book value and fair value of the Company’s sole reporting unit as of the date of its 2011 annual goodwill impairment test, this guidance is not expected to result in a material change to the way the Company performs its analysis for goodwill.

 

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Table of Contents

AOL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2—INCOME (LOSS) PER COMMON SHARE

Basic income per common share is calculated by dividing net income attributable to AOL Inc. common stockholders by the weighted average number of shares of common stock issued and outstanding during the reporting period. Diluted income per common share is calculated to give effect to all potentially dilutive common shares that were outstanding during the reporting period. The dilutive effect of outstanding equity-based compensation awards is reflected in diluted income per common share by application of the treasury stock method, only in periods in which such effect would have been dilutive for the period.

For the three months ended March 31, 2012, the Company had 9.0 million of weighted-average potentially dilutive common shares that were not included in the computation of diluted earnings per share because to do so would be anti-dilutive for that period. For the three months ended March 31, 2011, the Company had 7.1 million of weighted-average potentially dilutive common shares that were not included in the computation of diluted earnings per share because to do so would be anti-dilutive for that period.

The following table is a reconciliation of basic and diluted net income attributable to AOL Inc. common stockholders per common share (in millions, except per share amounts):

 

     Three Months Ended March 31,  
             2012                      2011          

Net income attributable to AOL Inc. common stockholders

   $ 21.1      $ 4.7  
  

 

 

    

 

 

 

Shares used in computing basic income per common share

     94.4        106.9  

Dilutive effect of equity-based awards

     0.6        1.0  
  

 

 

    

 

 

 

Shares used in computing diluted income per common share

     95.0        107.9  
  

 

 

    

 

 

 

Basic net income per common share

   $ 0.22      $ 0.04  
  

 

 

    

 

 

 

Diluted net income per common share

   $ 0.22      $ 0.04  
  

 

 

    

 

 

 

NOTE 3—GOODWILL

A summary of changes in the Company’s goodwill during the three months ended March 31, 2012 is as follows (in millions):

 

     Gross Goodwill      Impairments      Net Goodwill  

December 31, 2011

   $ 36,689.1       $ (35,625.1)       $ 1,064.0   

Acquisitions

     10.9                 10.9   

Translation adjustments

     (1.3)                 (1.3)   
  

 

 

    

 

 

    

 

 

 

March 31, 2012

   $ 36,698.7       $ (35,625.1)       $ 1,073.6   
  

 

 

    

 

 

    

 

 

 

The increase in goodwill for the three months ended March 31, 2012 was due primarily to AOL’s purchase of an additional 3% interest in Ad.com Japan. See “Note 4” for additional information on this acquisition.

 

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Table of Contents

AOL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 4—BUSINESS ACQUISITIONS, DISPOSITIONS AND OTHER SIGNIFICANT TRANSACTIONS

Ad.com Japan

On February 9, 2012, AOL entered into a share-purchase agreement with Mitsui to purchase an additional 3% interest in Ad.com Japan for approximately $1.2 million. Ad.com Japan, which operates a display advertising network business in Japan, was formed in 2006. Prior to the execution of the share purchase agreement, AOL and Mitsui each owned 50% interest in Ad.com Japan, and AOL accounted for its 50% interest using the equity method of accounting. As part of this transaction, AOL obtained control of the board and of the day-to-day operations of Ad.com Japan. AOL has accounted for the incremental 3% share purchase as a business combination achieved in stages (“step acquisition”) and consolidated Ad.com Japan beginning on February 9, 2012 (“the closing date”).

Under the accounting guidance for step acquisitions, AOL is required to record all assets acquired, liabilities assumed, and Mitsui’s noncontrolling interests at fair value, and recognize the entire goodwill of the acquired business. The step acquisition guidelines also require that AOL remeasure its preexisting investment in Ad.com Japan at fair value, and recognize any gains or losses from such remeasurement. The fair value of AOL’s interest immediately before the closing date was $15.4 million which resulted in the Company recognizing a noncash gain of approximately $10.8 million within other income (loss), net on the consolidated statement of comprehensive income in the first quarter of 2012. The Company used a combination of the market based approach (guideline public company) and an income approach (discounted cash flow analysis), both of which represent level 3 fair value measurements, to measure both the fair value of AOL’s preexisting investment and the fair value of Mitsui’s noncontrolling interest. As Mitsui has a right to put its interest to AOL based on a pre-established and determinable price in the future, the noncontrolling interest is presented as redeemable noncontrolling interest outside permanent equity in the Company’s consolidated balance sheet. The noncontrolling interest holder’s right to redeem its stock is exercisable any time between July 1 and July 30 of any year, commencing with July 1, 2014. The amount payable from AOL to Mitsui if Mitsui were to exercise its redemption right is determined by taking the sum of ¥2,000,000,000 (approximately $26.0 million as of the closing date) plus any incremental cash over the $7.8 million cash balance at December 31, 2011, and multiplying that total by Mitsui’s percentage ownership of Ad.com Japan (47% at closing). The Company has elected to recognize changes in the redemption value as they occur; however, this has no impact on the carrying value of Mitsui’s interest in Ad.com Japan because it exceeds the current redemption value. As of March 31, 2012 the undiscounted redemption value of the put option held by Mitsui was calculated to be approximately $11.7 million, which is below the $13.7 million carrying value of Mitsui’s interest in Ad.com Japan.

AOL recorded $9.7 million of goodwill (which is not deductible for tax purposes) and $19.2 million of intangible assets associated with this acquisition. The intangible assets associated with this acquisition consist primarily of trade names to be amortized on a straight-line basis over a period of ten years and advertiser relationships to be amortized over a period of five years. The fair value of the significant identified intangible assets was estimated by using relief from royalty, cost savings and multi-period excess earnings valuation methodologies, which represent level 3 fair value measurements. Inputs used in the methodologies primarily included projected future cash flows, discounted at a rate commensurate with the risk involved.

Unaudited pro forma results of operations assuming this acquisition had taken place at the beginning of each period are not provided because the historical operating results of the acquired company were not significant and pro forma results would not be significantly different from reported results for the periods presented.

 

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AOL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

Patent Portfolio Sale

On April 5, 2012, AOL entered into a definitive agreement (the “Purchase Agreement”) to sell approximately 800 of the Company’s patents and their related patent applications (the “Patent Portfolio”) to Microsoft Corporation, a Washington corporation (“Microsoft”), and to grant Microsoft a non-exclusive license to the Company’s retained patent portfolio, for aggregate proceeds of approximately $1.1 billion in cash (excluding transaction costs). Of this amount, $960 million is associated with the sale of the Patent Portfolio and $96 million is associated with non-exclusive license fees. The transaction is structured as a purchase of all of the outstanding shares of a wholly owned non-operating subsidiary of the Company and the direct acquisition of those patents in the Patent Portfolio not held by the subsidiary.

At the closing of the transaction, the Company and Microsoft will enter into an Intellectual Property Matters Agreement which provides for (i) a non-exclusive license to the Company for the use of all of the transferred patents in the Patent Portfolio and (ii) mutual releases with respect to claims arising from patents held by the other party prior to the closing. Additionally, the Company will grant Microsoft a non-exclusive license under all the patents retained by the Company after the closing and Microsoft will grant the Company certain defensive termination rights related to those retained patents.

Consummation of the transaction is subject to certain conditions, including, among others, the expiration or termination of any applicable Hart-Scott-Rodino waiting period, the absence of any injunction, statute, rule, regulation, order or decree that prohibits or makes illegal the consummation of the sale, and the representations and warranties of the other party, without giving effect to any materiality qualifications therein, shall be true and correct in all material respects (unless made as of a specific date), except in the case of the Company where such failures to be true and correct have not had a material adverse effect.

The Purchase Agreement may be terminated by mutual written consent, by either party (i) if a non-appealable statute, rule, regulation, order or decree prevents the transaction; (ii) if all of the closing conditions of the other party have been satisfied but the other party fails to consummate the sale within two business days; or (iii) if the closing shall not have occurred within six months of signing, provided that such date may be extended by either party by 180 days. If Microsoft elects to utilize the 180 day extension, a per day fee will apply. Microsoft would be required to pay the Company a termination fee of $211.2 million if the transaction is terminated pursuant to its terms for any of the above reasons other than by mutual written consent, if the Company’s failure to perform a covenant is the cause of the termination or if the conditions to the agreement are met and the Company fails to close the transaction within two business days.

Based on utilization of tax losses generated by the sale of the non-operating subsidiary and existing deferred tax assets, the Company does not expect the $1.1 billion proceeds to result in material cash taxes.

NOTE 5—INCOME TAXES

The Company’s pre-tax income from operations of $39.8 million and related income tax expense of $18.8 million resulted in an effective tax rate of 47.2% for the three months ended March 31, 2012, as compared to an effective tax rate of 142.0% for the three months ended March 31, 2011. The effective tax rate for the three months ended March 31, 2012 differed from the statutory U.S. federal income tax rate of 35.0% primarily due to foreign losses that did not produce a tax benefit and due to a change in state tax rates. The effective tax rate for three months ended March 31, 2011 differed from the statutory U.S. federal income tax rate of 35.0% primarily due to $7.1 million of income tax benefit associated with a worthless stock deduction related to the sale of a subsidiary in the first quarter of 2011 and favorable adjustments of $8.2 million related to escrow disbursements from prior acquisitions for which the Company concluded it will be able to recognize a tax benefit.

 

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AOL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 6—STOCKHOLDERS’ EQUITY

AOL is authorized to issue up to 660.0 million shares of all classes of stock, consisting of 60.0 million shares of preferred stock, par value $0.01 per share (“Preferred Stock”), and 600.0 million shares of common stock, par value $0.01 per share. Rights and privileges associated with shares of Preferred Stock are subject to authorization by the Company’s Board of Directors and may differ from those of any and all other series at any time outstanding. All shares of common stock will be identical and will entitle the holders thereof to the same rights and privileges.

As of March 31, 2012, 107,932,632 shares of common stock were issued and 93,105,844 shares of common stock were outstanding. No dividends were declared or paid for the three months ended March 31, 2012.

On August 10, 2011, the Company’s Board of Directors approved a stock repurchase program, which authorizes the Company to repurchase up to $250.0 million of its outstanding shares of common stock from time to time through August 2012. Repurchases are subject to market conditions, share price and other factors. Repurchases have been and will be made in accordance with applicable securities laws in the open market or in private transactions and may include derivative transactions, or pursuant to any trading plan adopted in accordance with Rule 10b5-1 of the Securities and Exchange Commission. For the three months ended March 31, 2012, the Company repurchased 2.1 million shares at a weighted average price of $17.29 per share as part of this program. Total consideration paid for the repurchase of common stock was $35.8 million for the three months ended March 31, 2012. As of March 31, 2012, the Company repurchased a total of 14.8 million shares at a weighted average price of $14.11 per share as part of this program, for total consideration of $209.4 million. Shares repurchased under the program are recorded as treasury stock on the Company’s consolidated balance sheet. The repurchase program may be suspended or discontinued at any time. The shares repurchased during the three months ended March 31, 2012 were not the result of an accelerated share repurchase agreement and did not result in any derivative transactions. Management has not made a decision on whether shares purchased under this program will be retired or reissued.

During the three months ended March 31, 2011, the Company recorded $18.0 million of equity-based compensation that resulted in an increase in additional paid-in capital. Included in this amount was $10.4 million related to expense incurred under AOL’s equity-based compensation plan, $3.9 million related to the fair value of unvested Huffington Post Plan options held by The Huffington Post employees that were converted into AOL stock options and related to pre-combination service, as well as $4.0 million related to the accelerated vesting of stock options related to terminated employees.

NOTE 7—EQUITY-BASED COMPENSATION

Pursuant to the Company’s Amended and Restated 2010 Stock Incentive Plan (“2010 SIP”) stock options are granted to employees, advisors and non-employee directors of AOL with exercise prices equal to the quoted market value of the common stock at the date of grant. Generally, the stock options vest ratably over a three to four year vesting period and expire ten years from the date of grant. Certain stock option awards provide for accelerated vesting upon an election to retire after reaching a specified age and years of service, as well as certain additional circumstances for non-employee directors.

Also pursuant to the 2010 SIP, AOL may also grant shares of common stock or restricted stock units (“RSUs”) to its employees, advisors and non-employee directors, which generally vest ratably over a three to four year period from the date of grant. Holders of restricted stock and RSU awards are generally entitled to receive regular cash dividends or dividend equivalents, respectively, at the discretion of the Board of Directors, if paid by the Company during the period of time that the restricted stock or RSU awards are unvested.

 

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AOL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

The Company is authorized to grant equity awards to employees, advisors and non-employee directors covering an aggregate of 16.6 million shares of AOL common stock under the 2010 SIP, of which up to 7.8 million awards may be issued in the form of full-value awards, such as restricted stock or RSUs. Amounts available for issuance pursuant to grants under the 2010 SIP will change over time based on such activities as the conversion of equity awards into common stock, the forfeiture of equity awards and the cancellation of equity awards, among other activities.

Upon the (i) exercise of a stock option award, (ii) vesting of a RSU or (iii) grant of restricted stock, shares of AOL common stock are issued from authorized but unissued shares or from treasury stock.

Equity-Based Compensation Expense

Compensation expense recognized by AOL related to its equity-based compensation plans is as follows (in millions):

 

     Three Months Ended
March 31,
 
         2012              2011      

Stock options

   $ 4.2      $ 4.9  

RSUs

     4.4        5.5  
  

 

 

    

 

 

 

Total equity-based compensation expense

   $           8.6      $         10.4  
  

 

 

    

 

 

 

Tax benefit recognized

   $ 3.4      $ 4.1  

As of March 31, 2012, the Company had 8.6 million stock options and 3.2 million RSUs outstanding to employees, advisors and non-employee directors. The weighted-average exercise price of the stock options and the weighted-average grant date fair value of the RSUs outstanding as of March 31, 2012 were $20.52 and $20.75, respectively.

As of March 31, 2012, total unrecognized compensation cost related to unvested AOL stock option awards was $35.1 million and is expected to be recognized over a weighted-average period of approximately 2.5 years. Total unrecognized compensation cost as of March 31, 2012 related to unvested RSUs was $52.5 million and is expected to be recognized over a weighted-average period of approximately 2.6 years. To the extent the actual forfeiture rate is different from what the Company has estimated, equity-based compensation expense related to these awards will be different from the Company’s expectations.

AOL Stock Options

The assumptions presented in the table below represent the weighted-average value of the applicable assumption used to value AOL stock options at their grant date:

 

    

Three Months Ended March 31,

    

        2012        

  

        2011        

Expected volatility

   39.9%    36.4%

Expected term to exercise from grant date

   5.16 years    5.49 years

Risk-free rate

   0.9%    2.5%

Expected dividend yield

   0.0%    0.0%

 

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AOL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

The assumptions above relate to AOL stock options granted during the period. The assumptions for 2011 do not include stock options that were converted in connection with the acquisition of The Huffington Post during the three months ended March 31, 2011.

NOTE 8—RESTRUCTURING COSTS

For the three months ended March 31, 2012, the Company incurred $7.4 million in restructuring costs related to organizational changes made in an effort to improve its ability to execute its strategy.

A summary of AOL’s restructuring activity for the three months ended March 31, 2012 is as follows (in millions):

 

     Employee
Terminations
     Other Exit
Costs
     Total  

Liability at December 31, 2011

    $ 5.6          $ 7.1         $ 12.7    

Restructuring expense

     7.3          0.1          7.4    

Foreign currency translation and other adjustments

     1.0          0.1          1.1    

Cash paid

     (4.6)          (1.9)          (6.5)    
  

 

 

    

 

 

    

 

 

 

Liability at March 31, 2012

    $                 9.3         $           5.4         $         14.7    
  

 

 

    

 

 

    

 

 

 

At March 31, 2012, of the remaining liability of $14.7 million, $14.1 million was classified as a current liability within accrued expenses and other current liabilities, with the remaining $0.6 million classified within other long-term liabilities in the consolidated balance sheet. Amounts classified as long-term are expected to be paid through 2014.

NOTE 9 – COMMITMENTS AND CONTINGENCIES

Commitments

For a description of AOL’s commitments see “Note 10” to the Company’s audited consolidated financial statements included in the Annual Report.

Contingencies

AOL is a party to a variety of claims, suits and proceedings that arise in the normal course of business, including actions with respect to intellectual property claims, tax matters, labor and unemployment claims, commercial claims, claims related to the Company’s business model for content creation and other matters. With respect to tax matters, AOL has received tax assessments in certain states related to sales and use taxes on its business operations. AOL has appealed these tax assessments and plans to vigorously contest these matters. In addition, AOL has received assessments in certain foreign countries related to income tax and transfer pricing, and plans to vigorously contest these matters as well. In certain instances, the Company was required to pay a portion of the tax assessment in order to proceed with the dispute of the assessment. While the results of such normal course claims, suits and proceedings cannot be predicted with certainty, management does not believe that, based on current knowledge and the likely timing of resolution of the various matters, any additional reasonably possible potential losses above the amount accrued for such matters would be material to the Company’s financial statements. Regardless of the outcome, legal proceedings can have an adverse effect on us because of defense costs, diversion of management resources and other factors.

 

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AOL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 10—SEGMENT INFORMATION

An operating segment is defined as a component of an enterprise that engages in business activities from which it may earn revenues and incur expenses and that has discrete financial information that is regularly reviewed by the chief operating decision maker in deciding how to allocate resources and in assessing performance.

The Company’s chief operating decision maker, its Chief Executive Officer, evaluates performance and makes operating decisions about allocating resources based on financial data presented on a consolidated basis. There are no managers who are held accountable by AOL’s chief operating decision maker, or anyone else, for an operating measure of profit or loss for any operating unit below the consolidated unit level. Accordingly, management has determined that the Company has one segment.

 

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AOL INC.

PART II. OTHER INFORMATION

 

ITEM 1.        LEGAL PROCEEDINGS

We are a party to a variety of claims, suits and proceedings that arise in the normal course of business, including actions with respect to intellectual property claims, tax matters, labor and unemployment claims, commercial claims, claims related to our business model for content creation and other matters. With respect to tax matters, we have received tax assessments in certain states related to sales and use taxes on our business operations. We have appealed these tax assessments and plan to vigorously contest these matters. In addition, we have received assessments in certain foreign countries related to income tax and transfer pricing, and plan to vigorously contest these matters as well. In certain instances, we were required to pay a portion of the tax assessment in order to proceed with the dispute of the assessment. While the results of such normal course claims, suits and proceedings cannot be predicted with certainty, management does not believe that, based on current knowledge and the likely timing of resolution of various matters, any additional reasonably possible potential losses above the amount accrued for such matters would be material to our financial statements. Regardless of the outcome, legal proceedings can have an adverse effect on us because of defense costs, diversion of management resources and other factors. See “Item 1A—Risk Factors—Risks Relating to Our Business—If we cannot continue to enforce and protect our intellectual property rights, our business could be adversely affected” and “Item 1A—Risk Factors—Risks Relating to Our Business—We have been, and may in the future be, subject to claims of intellectual property infringement or tort law violations that could adversely affect our business” included in our Annual Report.

 

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AOL INC.

PART II. OTHER INFORMATION

 

ITEM 1A. RISK FACTORS

There have been no material changes to the Company’s risk factors from those disclosed in Part I – Item 1A of our Annual Report for the year ended December 31, 2011.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following is a summary of common shares repurchased by the Company under its stock repurchase program:

 

Period

  Total Number
of Shares
Purchased
    Average
Price
Paid per
Share
    Total Number of
Shares Purchased as
Part of Publicly
announced Plans or
Programs (a)
    Approximate  Dollar
Value of Shares that
May Yet Be Purchased
Under the Plans or
Programs (a)
 

January 1, - January, 31, 2012

    279,301     $     14.99        279,301     $             72,300,000   

February 1, - February 29, 2012

    -        -        -      $ 72,300,000   

March 1, - March 31, 2012

    1,788,200     $ 17.65        1,788,200     $ 40,800,000   

Total

    2,067,501     $ 17.29        2,067,501     $ 40,800,000   

(a) On August 11, 2011 the Company announced that its Board of Directors approved a stock repurchase program effective August 10, 2011, which authorizes the Company to repurchase up to $250 million of its outstanding shares of common stock through August 2012. Repurchases have been and will be made in accordance with applicable securities laws in the open market or in private transactions and may include derivative transactions, or pursuant to any trading plan adopted in accordance with Rule 10b5-1 of the Securities and Exchange Commission. The repurchase program may be suspended or discontinued at any time. The approximate dollar value of shares that may yet be repurchased under the program disclosed above excludes commissions and other fees paid in relation to repurchases through March 31, 2012.

 

ITEM 6. EXHIBITS

The agreements and other documents filed as exhibits to this report are not intended to provide factual information or other disclosure, other than with respect to the terms of the agreements or other documents themselves, and you should not rely on them for that purpose. In particular, any representations and warranties made by us in these agreements or other documents were made solely within the specific context of the relevant agreement or document and may not describe the actual state of affairs as of the date they were made or at any other time.

See the Exhibit Index immediately following the signature page of this Quarterly Report.

 

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AOL INC.

SIGNATURES

Pursuant to the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on May 9, 2012.

 

AOL INC.
By  

/s/    ARTHUR MINSON

Name:   Arthur Minson
Title:   Executive Vice President and Chief Financial Officer

 

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AOL INC.

EXHIBIT INDEX

 

Exhibit
Number

  

Description

   
  10.1    Employment Agreement between AOL Inc. and Timothy M. Armstrong, dated March 28, 2012.*
   
  10.2    Employment Agreement between AOL Inc. and John Reid-Dodick, dated December 1, 2011.*
   
  10.3    Form of Performance Stock Option Agreement.*
   
  10.4    Form of Performance Share Award Agreement.*
   
  10.5    Form of Non-Qualified Stock Option Agreement (Version 3).*
   
  10.6    Form of Notice of Grant of Performance Stock Option.*
   
  10.7    Form of Notice of Grant of Performance Share Award (Revenue).*
   
  10.8    Form of Notice of Grant of Performance Share Award (Relative TSR).*
   
  10.9    Form of Notice of Grant of Non-Qualified Stock Option.*
   
  31.1    Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
  31.2    Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
   
  32.1    Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.†
   
101    Interactive Data Files Pursuant to Rule 405 of Regulation S-T: (i) Consolidated Statements of Comprehensive Income for the three months ended March 31, 2012 and 2011, (ii) Consolidated Balance Sheets as of March 31, 2012 and December 31, 2011, (iii) Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011, (iv) Consolidated Statements of Equity for the three months ended March 31, 2012 and 2011 and (v) Notes to Consolidated Financial Statements. ††

 

* Management contract or compensatory plan or arrangement.

 

This certification will not be deemed “filed” for purposes of Section 18 of the Exchange Act (15 U.S.C. 78r), or otherwise subject to the liability of that section. Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act or Exchange Act, except to the extent that the Registrant specifically incorporates it by reference.

 

†† In accordance with Rule 406T of Regulation S-T, the information in these exhibits is furnished and deemed not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Exchange Act of 1934, and otherwise is not subject to liability under these sections and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, except as expressly set forth by specific reference in such filing.

 

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