Description
Filed with the SEC from Mar 29 to April 04:
AOL (AOL)
Starboard Value sent a letter to the board reacting to media reports that AOL had retained an adviser to find a buyer for AOL's patent portfolio and to explore other strategic alternatives.
BUSINESS OVERVIEW
Business Overview
Our business operations are focused on the following:
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AOL Properties. We seek to be a leading online publisher of relevant and engaging online content and provider of engaging consumer products and services, by utilizing open and highly scalable publishing platforms and content management systems. In addition, we have extended and continue to extend the reach of our offerings to our consumer audience on multiple platforms and digital devices. AOL Properties include our owned and operated content, products and services in HPMG, AOL Services and Local and Mapping strategy areas in addition to our AOL Ventures offerings. 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.
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Advertising. We generate advertising revenues from AOL Properties through the sale of display advertising and search and contextual advertising. We also generate advertising revenues through the sale of advertising on third-party websites, which we refer to as the “Third Party Network.” Our mission is to provide an open and transparent advertising system that is easy-to-use and offers our publishers and advertisers unique and valuable insights. We seek to grow the number of publishers and advertisers utilizing the Third Party Network.
We market our offerings to advertisers on both AOL Properties and the Third Party Network under the brand “AOL Advertising.” We market our offerings to publishers on the Third Party Network under the brand “Advertising.com” and also market offerings as video advertisements distributed through goviral ApS (“goviral”, formerly goviral A/S) and 5 Minutes Ltd (“5Min”).
AOL Properties
HPMG
HPMG seeks to be a leading online publisher of relevant and engaging online content and provider of engaging consumer products and services, by utilizing scalable publishing platforms, social engagement platforms and content management systems. In addition, we have extended and continue to extend the reach of our offerings to our consumer audience on multiple platforms and digital devices. HPMG offerings include original content produced through our large network of content creators, which includes professional journalists from new and traditional media, freelance writers and bloggers, content we license from third parties and aggregations of user-generated content. Our content offerings are made available to broad audiences through sites such as The Huffington Post, as well as to niche audiences on highly-targeted, branded properties, such as The Huffington Post Women, The Huffington Post Parents and The Huffington Post Black Voices. Additionally, we seek to enter joint ventures and strategic partnerships with third parties with established brands in an effort to expand our content offerings. To facilitate the intake, creation, management and publication of original content, we utilize publishing platforms and content management systems that are designed to scale in a cost-effective manner in order to produce a large variety of relevant content for consumers.
We believe that our acquisition of The Huffington Post will solidify our strategy of creating a global content network while providing our consumers with an array of news, analysis, commentary, entertainment and community engagement. In 2011, we began expansion of The Huffington Post internationally and we aim to continue to expand The Huffington Post in order to provide relevant content and offerings to a wide array of consumers in new markets.
Search and Contextual
We offer AOL Search on AOL Properties. We provide our consumers with a general, internet-based search experience that utilizes the organic web search results of Google, Inc. (“Google”) and additional links on the search results page that showcase contextually relevant AOL and third-party content and information, as well as provide a variety of search-related features (such as suggesting related searches to help users further refine their search queries). We also provide our consumers with relevant paid text-based search advertising through our relationship with Google, in which we provide consumers sponsored link ads in response to their search queries. In addition, we offer vertical search services (i.e., search within a specific content category) and mobile search services on AOL Properties.
We also offer contextually relevant advertising from both Google and AOL’s proprietary products. These advertisements are placed on sites targeted by advertisers based on the content of the websites. In the second quarter of 2011, we launched a new search user interface and incorporated new web search features and advertisement formats that enhanced search results and streamlined the user experience.
Local and Mapping
We seek to be a leading provider of local content, platforms and services covering geographic levels ranging from neighborhoods to major metropolitan areas. We have developed and acquired platforms that are designed to facilitate the production, aggregation, distribution and consumption of local content. This local content includes professional editorial content, user-generated content and business listings. Our goal is to provide a compelling, accessible and comprehensive local experience on the internet.
AOL Services
AOL Services encompasses our paid services, search, the AOL.com homepage and mail operations, including mobile development and other offerings.
AOL Services includes our subscription access service, which provides a number of online services including narrow-band (telephone dial-up) access to the internet. We are developing, testing and marketing additional AOL and third-party products and services that are offered to internet consumers generally. Some products or services are offered to access subscribers for no additional charge or at a discounted rate in order to increase customer satisfaction and retention. Computer tools, maintenance and warranty services, online technical support, anti-virus software, identity theft protection, online and social media privacy and reputation monitoring services, diet and fitness services, online learning and other lifestyle services are currently offered and additional categories may be added in the future. Consumers will be able to manage their products and services through this platform, including adding or canceling a product or service. AOL continues to develop and offer other paid services as a way to attract, engage and serve consumers. Currently, the majority of the consumers for our paid services products are also access subscribers.
The revenue related to these products and services is recognized as subscription revenue in cases where we are responsible for providing the service to the end consumer. In instances when we are promoting a third-party product and receiving performance compensation on those services, but the third party is responsible for providing the service to the end consumer, we recognize the revenue as display advertising revenue.
We also offer an array of consumer applications, such as AOL Mail and AIM, which are leading e-mail and instant messaging services in the United States. We seek to enable consumers to access our content, products and services on mobile devices. In 2011, we made significant improvements to our mobile web portal and launched a number of innovative mobile applications that extend our desktop properties.
Distribution of AOL Properties
Content, products and services on AOL Properties are generally available to online consumers and we are focused on attracting greater numbers of consumers to our offerings. In addition, we utilize various distribution channels as described below which allow us to more directly reach online consumers.
Subscription Access Service
Our AOL-brand subscription access service, which we offer to consumers in the United States for a monthly fee, is a valuable distribution channel for AOL Properties. As of December 31, 2011, we had 3.3 million AOL-brand subscribers in the United States of which approximately 11% use our service for dial-up access. Our access service subscribers are important users of AOL Properties and engaging both present and former access service subscribers is an important component of our strategy. In addition, our subscription access service will remain an important source of revenue and cash flow for us in the near term.
In addition to our content, products and services that are available to all online consumers, an AOL-brand access subscription provides members with dial-up access to the internet and, depending on the applicable price plan, various degrees of enhanced safety and security features, technical support and other benefits. In addition, we continue to offer internet access services under the CompuServe and Netscape brands.
Our major access service partners are Verizon Communications Inc. (formerly MCI Communications Services, Inc.) and PAETEC iTel LLC (“PAETEC”), which provide us with modem networks and related services for a substantial portion of our subscription access service. We have agreed to commit a significant portion of our access service subscribers’ total dial-up network hours to the Verizon and PAETEC networks. More specifically, 50% of our total dial-up network hours are presently committed to Verizon, and 25% of our total dial-up network hours are presently committed to PAETEC. Through take or pay provisions in each agreement, we will incur penalty payments if we fail to dedicate the required percentage of dial-up hours to these service partners. As of December 31, 2011, we are meeting our volume commitments to each of these service providers. We have agreed to use both the Verizon and PAETEC networks until December 31, 2014. The agreement with Verizon may be renewed at our option until December 31, 2015, and the agreement with PAETEC may be renewed at our option for two twelve-month periods. Upon expiration of these agreements, we expect to continue our relationships with Verizon and PAETEC or enter into agreements with one or more other providers of modem networks and related services.
Our access service subscriber base has declined and is expected to continue to decline as a result of several factors, including the increased availability of high-speed broadband internet connections, the fact that a significant amount of online content, products and services has been optimized for use with broadband internet connections, the effects of our strategic shift which essentially eliminated our marketing efforts for our subscription access service and providing the vast majority of our content, products and services for free. See “Item 1A—Risk Factors—Risks Relating to Our Business—Our focus on our online advertising-supported business model involves significant risks”.
Other Distribution Channels
We also distribute AOL Properties through a variety of other channels, including agreements with manufacturers of digital devices and other consumer electronics and mobile carriers. AOL also distributes its content, products and services directly to consumers on the open web and through the Apple App Store. Additional distribution channels include toolbars, widgets, co-branded portals and websites, third-party websites and social networks that link to AOL Properties. We also utilize search engine marketing and search engine optimization as distribution methods. In addition, we make available open standards and protocols for use by third-party developers to enhance, promote and distribute AOL Properties.
AOL seeks to make its AOL Properties and original content as well as other products and services available on social networks, whether offered directly or by means of partnerships with social network operators.
AOL Properties Revenue Generation
We generate advertising revenues from AOL Properties through the sale of display advertising and search and contextual advertising. We offer advertisers a wide range of capabilities and solutions to effectively deliver advertising and reach targeted audiences across AOL Properties through our dedicated advertising sales force. The substantial number of unique visitors on AOL Properties allows us to offer advertisers the capability of reaching a broad and diverse demographic and geographic audience without having to partner with multiple content providers. We seek to provide effective and efficient advertising solutions utilizing data-driven insights that help advertisers decide how best to engage consumers. 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. 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.
For the years ended December 31, 2011, 2010 and 2009, our advertising revenues on AOL Properties were $930.5 million, $940.4 million and $1,207.3 million, respectively.
Display Advertising Revenues
Display advertising revenues are generated through the display of graphical advertisements as well as performance-based advertising. Agreements for advertising on AOL Properties typically take the following forms:
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impression-based contracts in which we provide “impressions” (an “impression” is delivered when an advertisement appears in web pages viewed by users) in exchange for a fixed fee (generally stated as cost-per-thousand impressions);
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time-based contracts in which we provide a minimum number of impressions over a specified time period for a fixed fee; or
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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.
We utilize our own proprietary “ad serving technology” ( i.e., technology that places advertisements on websites and digital devices) as the primary vehicle for placements of advertisements on AOL Properties through our subsidiary, ADTECH GmbH (“ADTECH”, formerly ADTECH AG). We also license this ad serving technology to third parties.
Search and Contextual Advertising
Search and contextual advertising revenues are generated when a consumer clicks on a text-based ad on their screen. These text-based ads are either generated from a consumer-initiated search query or generated based on the content of the webpage the consumer is viewing. Google is, except in certain limited circumstances, the exclusive web search provider for AOL Properties, based on our agreement that runs through December 31, 2015. In connection with these search services, Google provides us with a share of the revenue generated through paid text-based search advertising and contextual advertising on AOL Properties. For the year ended December 31, 2011, advertising revenues associated with the Google relationship (substantially all of which were search and contextual revenues generated on AOL Properties) were $335.3 million. In addition, we sell search-based keyword advertising directly to advertisers on AOL Properties through the use of a white-labeled, modified version of Google’s advertising platform, for which we provide a share of the revenue generated through such sales to Google. As part of our relationship with Google, we have expanded the alliance to include the provision of mobile search and mobile search advertising services to AOL. AOL and Google also have a video partnership that features AOL’s video content on YouTube. See “Item 1A—Risk Factors—Risks Relating to Our Business—We are dependent on a third-party search provider”.
Third Party Network Advertising Revenues
We also generate advertising revenues through the sale of advertising on third party websites. Our advertising offerings on the Third Party Network consist primarily of the sale of display advertising and also include search and contextual advertising. Advertising arrangements for the sale of Third Party Network inventory typically take the form of impression-based contracts or performance-based contracts. In order to generate advertising revenues on the Third Party Network, we historically incurred higher traffic acquisition costs (TAC) as compared to advertising on AOL Properties. We currently market our offerings to publishers on the Third Party Network under the brand “Advertising.com.”
We launched the Advertising.com Group during the second quarter of 2011. The Advertising.com Group’s focus is to position AOL as a global partner for leading publishers, advertisers and agencies seeking to maximize the value of their online brands through premium formats, video, content, networks, platforms and monetization. The Advertising.com Group includes Advertising.com, ADTECH, AOL Video, goviral, Pictela, Content Solutions (including StudioNow, Inc. (“StudioNow”) and SEED), 5Min and Sponsored Listings. During 2010, we launched a new advertising format, “Project Devil,” that seeks to enhance the consumer experience by improving the aesthetic quality, impact and interactivity of online advertising, while also providing solutions for advertisers looking for innovative ways to showcase their products and services to consumers. We acquired Pictela in December 2010 in order to scale our delivery of video, photos and applications, both within the new advertising format and generally across AOL Properties. We believe that the Pictela acquisition, combined with Project Devil, will help us improve our display advertising product offering and provide new premium format systems under the Advertising.com Group. Our acquisition of goviral during the first quarter of 2011, provides us with branded online video for media agencies, creative agencies and content producers. Additionally, our acquisition of 5Min in the third quarter of 2010 provides us with video content and a syndication platform for web-based videos that enhances our ability to distribute content. We aim to increase the use of video on our sites, including the use of video on our branded properties and digital devices.
In order to effectively connect advertisers with online advertising inventory, we purchase advertising inventory from publishers and utilize proprietary optimization, targeting and delivery technology to best match advertisers with available advertising inventory. A significant portion of our revenues on the Third Party Network is generated from the advertising inventory acquired from a limited number of publishers.
The Third Party Network includes a display advertising interface that gives advertisers the ability to target and control the delivery of their advertisements and provides advertisers and agencies with relevant display analytics and measurement tools. We intend to utilize self-service systems and tools in order to expand our relationships with advertisers. For our publishers, inclusion in the Third Party Network offers a comprehensive set of tools and technologies to manage and maximize their return. We aim to develop our current relationships with publishers and advertisers and continue to expand the number of publishers and advertisers we serve through the products and services we offer on the Third Party Network.
We utilize AdLearn, a proprietary scheduling, optimization and delivery technology that employs a set of complex mathematical algorithms that seek to optimize advertisement placements across the Third Party Network and the available inventory on AOL Properties. This optimization is based on expected user response, which is derived from previous user response plus factors such as user segmentation, creative performance and site performance. AdLearn allows performance to be analyzed quickly and advertisement placement to be frequently optimized based on specific objectives, including click-through rate, conversion rate, sales volume and other metrics. We also offer advertisers the ability to target advertisements to specific users using technology that utilizes non-personally identifiable information, such as geographic location, previous exposure to certain advertisements or user behavior online.
During the fourth quarter of 2011, the Company, Yahoo! Inc. and Microsoft Corporation entered into nonexclusive agreements to allow advertising networks operated by each of the companies to offer each other’s premium nonreserved online display inventory to their respective customers. We believe that this partnership will offer advertisers and agencies the efficiency of buying premium display at scale to reach customers and audiences.
For the years ended December 31, 2011, 2010 and 2009, our advertising revenues on the Third Party Network were $383.7 million, $343.7 million and $529.4 million, respectively.
Subscription Revenues
We generate subscription revenues through our subscription access service. As of December 31, 2011, our primary AOL-brand price plans were $25.90 and $14.95 per month. These plans include maintenance and warranty services, online technical support, anit-virus software and identity theft protection. We also offer consumers, among other things, enhanced online safety and security features and technical support for a monthly subscription fee. As noted above, our access service subscriber base has declined and is expected to continue to decline. This has resulted in year-over-year declines in our subscription revenues. The number of domestic AOL-brand access subscribers was 3.3 million, 3.9 million and 5.0 million at December 31, 2011, 2010 and 2009, respectively. For the years ended December 31, 2011, 2010 and 2009, our subscription revenues were $803.2 million, $1,023.6 million and $1,388.8 million, respectively.
Although our subscription revenues have declined and are expected to continue to decline, we believe that our subscription access service will continue to provide us with an important source of revenue and cash flow in the near term. The revenue and cash flow generated from our subscription access service will help us to pursue our strategic initiatives.
Other Revenues
In addition to advertising and subscription revenues, we also generate fee, license and other revenues. Through MapQuest’s business-to-business services, we generate licensing revenue from third-party customers. We also generate other revenues by licensing our proprietary ad serving technology to third parties, primarily through our subsidiary, ADTECH. We generate fees from our consumer applications associated with mobile e-mail and instant messaging functionality from mobile carriers.
AOL Ventures
Some of the initiatives described above may be classified as part of AOL Ventures. We formed AOL Ventures with the goal of creating an entrepreneurial environment to attract and develop innovative initiatives. AOL Ventures focuses on acquisitions that we have previously made which have start-up characteristics or which do not currently fit within our other areas of strategic focus, investments we intend to make in early-stage, externally-developed opportunities and employee-originated innovations that we believe would benefit from incubation and development within the AOL Ventures environment. The size of our investment and corresponding ownership interest varies depending on the opportunity, as does our level of involvement and control. We intend to attract top talent and source attractive opportunities by partnering with leading angel investors, venture capitalists and universities.
Product Development
We seek to develop new and enhanced versions of our products and services for our consumers, publishers and advertisers. While in the past we have relied primarily on our own proprietary technology to support our products and services, we have been steadily increasing our use of open source technologies and platforms with a view to diversifying our sources of technology, as well as for cost management. Research and development costs related to our software development efforts for 2011, 2010 and 2009 totaled $56.9 million, $63.2 million and $63.2 million, respectively. These costs consist primarily of personnel and related costs that are incurred related to the development of software and user-facing internet offerings that do not qualify for capitalization. At December 31, 2011 and 2010, the net book value of capitalized internal-use software was $43.2 million and $62.6 million, respectively. For the years ended December 31, 2011, 2010 and 2009, we capitalized $21.1 million, $22.7 million and $48.7 million, respectively, related to the development of internal-use software.
CEO BACKGROUND
Mr. Tim Armstrong has served as Chairman and Chief Executive Officer of AOL since April 7, 2009. Prior to that, Mr. Armstrong served as President, Americas Operations of Google Inc., an internet search engine company. Mr. Armstrong joined Google in 2000 as Vice President, Advertising Sales, and in 2004 was promoted to Vice President, Advertising and Commerce and then in 2007 was named President, Americas Operations and Senior Vice President. Before joining Google, Mr. Armstrong served as Vice President of Sales and Strategic Partnerships for Snowball.com from 1998 to 2000. Prior to that, he served as Director of Integrated Sales and Marketing at Starwave’s and Disney’s ABC/ESPN Internet Ventures. Mr. Armstrong started his career by co-founding and running a newspaper based in Boston, Massachusetts. Mr. Armstrong is a trustee of Lawrence Academy and is chair of the board of the Ad Council.
Mr. Armstrong brings to the Board extensive experience, expertise and background in internet marketing, sales and the interactive media industry gained from his former positions at Google Inc. He also possesses corporate leadership experience and extensive knowledge of our business gained from his position as Chief Executive Officer with responsibility for the day-to-day oversight of the Company’s business operations.
Mr. Richard Dalzell was Senior Vice President and Chief Information Officer of Amazon.com, Inc., an online retailer, until his retirement in 2007. Previously, Mr. Dalzell served in numerous other positions at Amazon.com, including Senior Vice President of Worldwide Architecture and Platform Software and Chief Information Officer from 2001 to 2007, Senior Vice President and Chief Information Officer from 2000 to 2001 and Vice President and Chief Information Officer from 1997 to 2000. Prior to Amazon.com, Mr. Dalzell was Vice President of the Information Systems Division at Wal-Mart Stores, Inc. from 1994 to 1997.
Mr. Dalzell brings to the Board extensive experience, expertise and background in internet information technology gained from his recent service as the Chief Information Officer of Amazon.com. He also brings corporate leadership experience gained from his service in various senior executive roles at Amazon.com.
Ms. Karen Dykstra is a former partner at Plainfield Asset Management LLC and was Chief Operating Officer and Chief Financial Officer of Plainfield Direct Inc. from 2006 to 2010. Plainfield Asset Management LLC manages investment capital for institutions and high net worth individuals in the United States and abroad. Plainfield Direct Inc., a direct lending and investment business of Plainfield Asset Management, is now known as Plainfield Direct LLC. Prior to joining Plainfield, Ms. Dykstra was the Chief Financial Officer of Automatic Data Processing, Inc., a company that provides business outsourcing solutions, from 2003 to 2006. Ms. Dykstra serves on the boards of directors of Gartner, Inc. and Crane Co.
Ms. Dykstra brings to the Board extensive experience, expertise and background with regard to accounting and financial matters gained from her previous position as the Chief Financial Officer and director of Plainfield Direct, Inc. and her previous service as the Chief Financial Officer of Automatic Data Processing, Inc., as well as her service on the Audit Committees of Gartner, Inc. and Crane Co. She also possesses public company board experience gained from her service on the boards of directors of Gartner, Inc. and Crane Co.
Mr. Alberto IbargĂĽen is the President and Chief Executive Officer of the John S. and James L. Knight Foundation, a private, independent foundation. Before joining the Foundation in 2005, Mr. IbargĂĽen served in various positions at Knight-Ridder, Inc. from 1995 to 2005, as Chairman & Publisher of The Miami Herald (1998) and as Vice President of International Operations, The Miami Herald and Publisher of El Nuevo Herald. Mr. IbargĂĽen serves on the boards of directors of AMR Corporation and PepsiCo, Inc.
Mr. IbargĂĽen brings to the Board extensive experience, expertise and background with regard to media, journalism, and financial matters gained from his current position as the Chairman and Chief Executive Officer of the John S. and James L. Knight Foundation and from his service in various positions at Knight-Ridder, in addition to his service on the Audit Committees of PepsiCo and AMR Corporation. He also brings public company board experience gained from his service on the boards of directors of PepsiCo and AMR Corporation.
Ms. Susan Lyne has served as the Chair of Gilt Groupe, Inc., an online fashion and luxury brand retailer, since September 2010. Previously, she was Gilt Groupe’s Chief Executive Officer from September 2008 to September 2010. Ms. Lyne served as President, Chief Executive Officer and director of Martha Stewart Living Omnimedia, Inc., an integrated media and merchandising company, from 2004 to 2008. Prior to joining Martha Stewart Living, Ms. Lyne served in various positions at The Walt Disney Company, including President, ABC Entertainment from 2002 to 2004, Executive Vice President, Movies & Miniseries, ABC Entertainment from 1998 to 2002, and Executive Vice President, Acquisition, Development & New Business, Walt Disney Motion Picture Group, from 1996 to 1998. Prior to joining Walt Disney, she worked for News Corporation Ltd. and K-111 Communications for approximately nine years as Founder, Editor-in-Chief & Publication Director, Premiere magazine. Previously, Ms. Lyne served on the board of directors of CIT Group Inc. from 2006 until 2009.
Ms. Lyne brings to the Board extensive experience, expertise and background in interactive media, and internet marketing gained from her current position as the Chair of Gilt Groupe, her former role as Chief Executive Officer of Gilt Groupe, and her previous service as President and Chief Executive Officer of Martha Stewart Living and as President of ABC Entertainment. In addition, she brings corporate leadership experience gained from her former service as Chief Executive Officer of Gilt Groupe and Martha Stewart Living.
Ms. Patricia Mitchell has served as President and Chief Executive Officer of The Paley Center for Media, a global non-profit cultural institution, since 2006. Before that, Ms. Mitchell was President and Chief Executive Officer of the Public Broadcasting Service, a non-profit public broadcasting television service, from 2000 to 2006. For more than two decades, Ms. Mitchell was a journalist and producer, serving as reporter, anchor, talk show host, producer and executive for three broadcast networks and several cable channels. Ms. Mitchell previously served on the board of directors of Sun Microsystems, Inc. from 2005 to 2010 and of Bank of America Corporation from 2001 to 2009.
Ms. Mitchell brings to the Board extensive experience, expertise and background in media, telecommunications and broadcasting gained from her current service as the President and Chief Executive Officer of The Paley Center for Media, as well as her former role as President and Chief Executive Officer of the Public Broadcasting Service. In addition, she brings public company board experience gained from her service on the boards of Sun Microsystems and Bank of America.
Mr. Fredric Reynolds was with CBS Corporation, a media company, and its predecessor companies from 1994 until he retired in August 2009. Mr. Reynolds was Executive Vice President and Chief Financial Officer of CBS Corporation from 2005 to 2009. He also served as President and Chief Executive Officer of the Viacom Television Stations Group of Viacom Inc., and President of the CBS Television Stations Division of CBS, Inc. Before that, he served as Executive Vice President and Chief Financial Officer of Viacom Inc. and its predecessor CBS Corporation which was formerly Westinghouse Electric Corporation. Mr. Reynolds joined Westinghouse from PepsiCo Inc. Mr. Reynolds serves on the boards of directors of Kraft Foods Inc., The Readers Digest Association, Inc. and Metro-Goldwyn-Mayer Studios Inc.
Mr. Reynolds brings to the Board extensive experience, expertise and background in media, telecommunications, accounting and financial matters gained from his service as the Chief Financial Officer of CBS Corporation, as well as his service on the Audit Committees of Kraft Foods Inc. and The Readers Digest Association, Inc. He also brings corporate leadership experience gained from his service in various senior executive positions at CBS and Viacom.
Mr. James Stengel has been President and Chief Executive Officer of The Jim Stengel Company, LLC, a marketing think tank and consulting firm, since 2008. Mr. Stengel is also currently an adjunct marketing professor at UCLA’s Anderson School of Management. Mr. Stengel worked at The Procter & Gamble Company, a global consumer products company, from 1983 to 2008, holding a variety of positions including Global Marketing Officer from 2001 to 2008. Mr. Stengel serves on the board of directors of Motorola Mobility, Inc. and served on the board of directors of Motorola, Inc. prior to the spin-off of Motorola Mobility, Inc. in January 2011.
Mr. Stengel brings to the Board extensive experience, expertise and background in branding and marketing, having served as the Global Marketing Officer of Procter & Gamble. He also brings public company board experience and leadership development experience gained from his service as a board member and as a member of the Compensation and Leadership Committee of Motorola Mobility, Inc. and of Motorola, Inc. prior to the spin-off of Motorola Mobility, Inc. in January 2011.
MANAGEMENT DISCUSSION FROM LATEST 10K
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 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.
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 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 our acquisition of The Huffington Post on March 4, 2011 and the creation of 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. To facilitate this, in the first quarter of 2011, we launched the next phase of a single consumer-facing platform that allows us to manage and distribute these additional products to internet consumers. We offer these products to our current and former access subscribers as well as other internet consumers.
During the first quarter of 2012, we expect that our total revenues will continue to decline as compared to the same period in 2011, but at a lower rate of decline than we experienced in the first quarter of 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. 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 first quarter of 2011 and to be partially offset by growth in global advertising revenue.
Recent Developments
2012 Acquisition
On February 9, 2012, AOL 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 for approximately $1.2 million. The joint venture, 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 the joint venture, 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 the joint venture. AOL will therefore account for the incremental 3% share purchase as a business combination achieved in stages (“step acquisition”) in the first quarter of 2012, and will consolidate the joint venture beginning on February 9, 2012.
Under the step acquisition accounting requirements, AOL is required to record both its controlling interest and Mitsui’s non-controlling interests at fair value, and recognize the entire goodwill of the acquired business. The step acquisition guidelines also require that AOL recognize any gains or losses on its pre-existing investment. As a result of this step acquisition, AOL expects to record a noncash gain of approximately $10-$15 million in the first quarter of 2012.
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 February 1, 2012, we repurchased a total of 13.0 million shares at a weighted average price of $13.62 per share (approximately $178 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 year ended December 31, 2011, approximately 6% 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. Approximately two-thirds of the traffic assigned to AOL for the year ended December 31, 2011 relates to an agreement with a counterparty which expired on December 31, 2011. We did not have significant monetization of this traffic, and as a result, we do not expect a significant impact on our advertising revenues as a result of the expiration of this agreement.
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.
2011 vs. 2010
Advertising revenues increased $30.1 million for the year ended December 31, 2011 as compared to the year ended December 31, 2010, reflecting an $88.6 million increase in our core product offerings (including the impact of recent acquisitions), partially offset by a $58.5 million decline related to initiatives implemented by AOL in late 2009 and early 2010 in connection with restructuring our business.
Excluding the impact from the AOL-implemented initiatives discussed further below, advertising revenue for the year ended December 31, 2011 as compared to the year ended December 31, 2010 reflects increases in display revenue and Third Party Network revenue, partially offset by declines in search and contextual revenue. Display revenue increased $74.5 million primarily due to increased revenue from premium display advertising, a portion of which is attributable to our acquisitions of TechCrunch, Inc. (“TechCrunch”) and The Huffington Post. The increase in display revenue also includes the impact of improved yield management across our properties, an increase in Patch revenues and an increase in performance-based fees related to marketing of third party products and services. The Third Party Network revenue increase of $70.1 million relates primarily to an increase in advertisers and publishers on the network and the acquisitions of goviral and 5Min. Domestic search and contextual revenue declined $40.3 million primarily related to fewer domestic queries, due in large part to a decline in queries from legacy cobranded portals and a 15% year-over-year decrease in domestic AOL-brand access subscribers. International search and contextual revenue declines of $15.7 million were due to fewer queries primarily in the United Kingdom. These declines in search and contextual revenue include an offsetting impact related to growth in search revenue on AOL.com.
Apart from the increase in our core product offerings, advertising revenue reflects declines of $58.5 million related to AOL-implemented initiatives to wind down or shut down certain products and shut down or reduce operations internationally. The impact of these initiatives included declines in Third Party Network revenue of $30.1 million associated with European shutdowns and de-emphasis of the typically low margin search engine campaign management and lead generation affiliate products. In addition, we experienced declines in search and contextual revenue of $15.0 million primarily due to declines of $12.2 million from ICQ which we sold in the third quarter of 2010. Display revenues declined $13.4 million due to the sale of ICQ, Digital Marketing Services, Inc. and Bebo, Inc. (“Bebo”) in 2010, and due to our reduced operations in Germany and France.
2010 vs. 2009
Advertising revenues decreased $452.6 million for the year ended December 31, 2010 as compared to the year ended December 31, 2009. Of this decline, $268.2 million was related to AOL-implemented initiatives and the remaining $184.4 million decline was related to our core product offerings.
AOL-implemented initiatives to wind down or shut down certain products and shut down or reduce operations internationally resulted in declines of $268.2 million for the year ended December 31, 2010 as compared to the year ended December 31, 2009. The most significant impact from these initiatives drove declines in Third Party Network revenue of $177.1 million associated with European shutdowns and de-emphasis of the typically low margin search engine campaign management and lead generation affiliate products. In addition, we experienced declines in search and contextual revenue of $54.2 million, primarily due to the de-emphasis of our contextual products, fewer queries in Germany and France where we have reduced operations and declines of $14.3 million from ICQ which we sold in the third quarter of 2010. International display revenues declined by $36.9 million related to our reduced operations in Germany and France and the sale of Bebo and ICQ in 2010.
Apart from the impacts of the AOL-implemented initiatives, advertising revenue reflects further declines in search and contextual, display and Third Party Network revenue. Search and contextual revenue for the year ended December 31, 2010 declined $127.6 million as compared to the year ended December 31, 2009. Of this decline, $93.7 million reflects the impact of fewer domestic search queries on AOL Properties, related primarily to a 23% year-over-year decrease in domestic AOL-brand access subscribers as well as lower traffic on AOL Properties. The search and contextual revenue declines also include international declines of $33.9 million due to fewer queries primarily in the United Kingdom. Domestic display revenue declines of $45.1 million reflect a slight decline in premium inventory sales as well as the impact of less inventory from AOL Properties being monetized through the Third Party Network, resulting primarily from our efforts to improve the user experience. Premium inventory sales declines reflect the impact on sales of a salesforce reorganization in the first quarter of 2010, which resulted in subsequent quarters beginning with a significantly smaller sales pipeline. Domestic display revenue declines were partially offset by approximately $2.0 million related to acquisitions made in 2010. Third Party Network declines of $10.9 million reflect a reduction in sales due to increased competition at Ad.com and a reduction in contextual advertising. These Third Party Network declines were partially offset by an increase of $2.3 million related to acquisitions made in 2010.
Revenues Associated with Google
For all periods presented in this Annual Report, we have had a contractual relationship with 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 years ended December 31, 2011, 2010 and 2009, the revenues associated with the Google relationship (substantially all of which were search and contextual revenues generated on AOL Properties) were $335.3 million, $398.4 million and $556.7 million, respectively.
Subscription Revenues
Subscription revenues declined 22% for the year ended December 31, 2011 as compared to the year ended December 31, 2010. The decline was due to an approximate 15% decrease in the number of domestic AOL-brand access subscribers between December 31, 2010 and December 31, 2011. Excluding the migration of customers to an access subscription plan in the third quarter of 2011 discussed further below, our domestic AOL-brand access subscribers declined by 20% between December 31, 2010 and December 31, 2011. To a lesser extent, the decline in subscription revenues was due to a $0.45 decline in domestic average monthly revenue per AOL-brand access subscriber (“ARPU”) including the nominal impacts of both the migration of customers to an access subscription plan and the simplified pricing structure discussed further below. In 2011, we resolved the final open dispute with the counterparty to whom we sold our German access business in 2007, resulting in a $3.1 million favorable impact, which compared to a $5.4 million favorable impact in prior year.
Subscription revenues declined 26% for the year ended December 31, 2010 as compared to the year ended December 31, 2009. The decline was due to an approximate 23% decrease in the number of domestic AOL-brand access subscribers between December 31, 2009 and December 31, 2010. Also contributing to the decline in subscription revenues was a $0.30 decline in ARPU. Partially offsetting these declines was $5.4 million related to the favorable resolution of a portion of a dispute with the counterparty to whom we sold our German access business in 2007.
The number of domestic AOL-brand access subscribers was 3.3 million, 3.9 million and 5.0 million at December 31, 2011, 2010 and 2009, respectively. ARPU was $17.71, $18.16 and $18.46 for the years ended December 31, 2011, 2010 and 2009, 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 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.
During the third quarter of 2011, certain individuals who were not previously customers of an access subscription plan (and therefore not previously included in our count of AOL-brand access subscribers) were migrated to a higher priced plan that includes a number of additional features including access services. As a result, our domestic AOL-brand access subscribers at December 31, 2011 include approximately 200,000 subscribers related to this migration. Late in the third quarter of 2011, AOL began a process to simplify the number of price plans and service packages available to AOL-brand access subscribers. As a result, we provided additional features and services to approximately 1.4 million subscribers with a simplified pricing structure.
Other Revenues
Other revenues consist primarily of fees associated with our mobile e-mail and instant messaging functionality from mobile carriers, licensing revenues from third-party customers of MapQuest’s business-to-business services and licensing revenues from licensing our proprietary ad serving technology to third parties through our subsidiary, ADTECH. In addition, other revenue also includes revenue from ticket sales related to technology events hosted by TechCrunch.
Other revenues decreased 22% for the year ended December 31, 2011, as compared to the year ended December 31, 2010, due primarily to a decrease in revenues from our mobile messaging services of $21.3 million as mobile carriers continue to move away from paying on a per message basis, a decline in third party web hosting revenues of $4.1 million, a decline in licensing revenues from MapQuest’s business-to-business services of $2.1 million and a decrease in transition services revenue of $2.0 million. These declines were partially offset by increases in TechCrunch revenue of $3.4 million and an increase in ADTECH and other licensing revenues of $2.4 million.
Other revenues decreased 9% for the year ended December 31, 2010, as compared to the year ended December 31, 2009, due primarily to lower revenues from our mobile messaging services of $17.3 million as mobile carriers began to move away from paying on a per message basis and a decline in licensing revenues from MapQuest’s business-to-business services of $6.9 million. These declines were partially offset by increases in third party web hosting revenues of $8.8 million, increases in ADTECH and other licensing revenues of $2.7 million and increases in transition services revenue of $2.9 million.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
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 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.
AOL Properties include our owned and operated content, products and services in the Content, Local, Paid Services and Applications and Commerce strategy areas, in addition to our AOL Ventures offerings. AOL Properties also include co-branded websites owned 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.
Visibility into advertising revenue is limited due to the fact that many advertising agreements are executed during the quarter that the advertising is displayed. During the remainder of 2011, we expect that our search and contextual revenues will continue to decline as compared to the same period in 2010, driven by a decline in domestic search queries, primarily due to the decline in our domestic AOL-brand access subscribers.
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 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 our acquisition of TheHuffingtonPost.com, Inc. (“The Huffington Post”) on March 4, 2011 and the creation of the AOL Huffington Post Media Group (“HPMG”), we have accelerated our strategy to deliver a scaled and differentiated array of premium news, analysis, commentary and entertainment.
Our current access service subscriber base, excluding the one-time migration of certain individuals into paid subscription plans during the third quarter, has declined and is expected to continue to decline as a result of several factors, including the increased availability of high-speed broadband internet connections, the fact that a significant amount of online content, products and services has been optimized for use with broadband internet connections and the effects of our strategic shift to a Company focused on generating advertising revenues. As part of our strategic shift, we have essentially eliminated our marketing efforts for our subscription access service and we have made available for free the vast majority of our content, products and services. As our access subscriber base declines, we need to maintain the engagement of former subscribers and increase the number and engagement of other consumers on AOL Properties. In addition to developing and offering engaging content, products and services, we seek to retain our access subscribers by including additional products and services in their paid subscription plans for no additional charge or at a discounted rate. Further, we have transitioned and will continue to seek to transition a substantial percentage of those access subscribers who are terminating their paid access subscriptions to free AOL Properties offerings.
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. To facilitate this, in the first quarter of 2011 we launched the next phase of a single consumer-facing platform that allows us to manage and distribute these additional products to internet consumers. We offer these products to our current and former access subscribers as well as other internet consumers.
Our subscription revenues have relatively low direct costs, and accordingly, our subscription access service has a significant positive impact on our operating income (loss). Although our subscription revenues have declined and are expected to continue to decline, we believe that our subscription access service will continue to provide us with an important source of revenue and cash flow for the foreseeable future. The revenue and cash flow generated from our subscription access service will help us pursue our strategic initiatives and continue the transition of our business toward attracting and engaging internet consumers and generating advertising revenues. We expect our total revenues and operating income as compared to the same prior year period to decline in the fourth quarter of 2011, primarily due to declines in subscription revenue and search and contextual revenue as a result of the continuing decline in our current access subscriber base.
Recent Developments
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 will depend on 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 November 2, 2011, we repurchased a total of 9.7 million shares at a weighted average price of $13.39 per share under this program.
Key Metrics
Audience Metrics
We utilize unique visitor numbers to evaluate the performance of AOL Properties. Following the acquisition of The Huffington Post on March 4, 2011, AOL aligned all of its content under the newly formed HPMG, which is a subset of AOL Properties and excludes Mail, Instant Messaging and AOL Ventures. As a result of this realignment and to reflect how management views the business, we are disclosing domestic average monthly unique visitors to HPMG for all periods presented and will no longer disclose domestic average monthly unique visitors to AOL Media. The primary differences between HPMG and AOL Media are that HPMG includes The Huffington Post, AOL Search and Local.
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 September 30, 2011, approximately 6% 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.
Apart from the impacts of the AOL-implemented initiatives, advertising revenue reflects increases in Third Party Network revenue and display revenue, partially offset by further declines in search and contextual revenue. The Third Party Network revenue increase of $21.9 million and $51.8 million for the three and nine months ended September 30, 2011, respectively, related primarily to increases in Retail, Auto, Telecom and Personal Finance and the acquisitions of 5Min and goviral. For the three and nine months ended September 30, 2011, display revenue increased $18.5 million and $51.8 million, respectively, primarily due to increased revenue from premium display advertising, a portion of which is attributable to our acquisitions of The Huffington Post and TechCrunch, Inc. The increase in display revenue also includes the impact of improved yield management, an increase in Patch revenues and performance-based fees related to marketing of third party products and services. Domestic search and contextual revenue for the three and nine months ended September 30, 2011, declined $11.8 million and $35.2 million, respectively, as compared to the same periods in 2010, primarily due to lower domestic search queries, the majority of which resulted from the 15% year-over-year decrease in domestic AOL-brand access subscribers. International search and contextual revenue declines of $2.0 million and $13.4 million for the three and nine months ended September 30, 2011, respectively, were due to fewer queries primarily in the United Kingdom. These declines in search and contextual revenue were slightly offset by growth in search revenue on AOL.com.
Revenues Associated with Google and Advertising Revenue Expectations
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 and nine months ended September 30, 2011, the revenues associated with the Google relationship (substantially all of which were search and contextual revenues generated on AOL Properties) were $80.7 million and $252.0 million, respectively. For the three and nine months ended September 30, 2010, the revenues associated with the Google relationship (substantially all of which were search and contextual revenues generated on AOL Properties) were $92.3 million and $308.9 million, respectively.
Visibility into advertising revenue is limited due to the fact that many advertising agreements are executed during the quarter that the advertising is displayed. During the remainder of 2011, we expect that our search and contextual revenues will continue to decline as compared to the same period in 2010, driven by a decline in domestic search queries, primarily due to the decline in our domestic AOL-brand access subscribers.
Subscription Revenues
During the three months ended September 30, 2011, certain individuals who were not previously customers of an access subscription plan (and therefore not previously included in our count of AOL-brand access subscribers) were migrated to a higher priced plan that includes a number of additional features including access services. As a result, our AOL-brand access subscribers at September 30, 2011 include approximately 200,000 subscribers related to this migration. The monthly fee billed to these subscribers is lower than our average monthly fees to other subscribers, and as a result, domestic average monthly revenue per AOL-brand access subscriber (“ARPU”) for the three and nine months ended September 30, 2011 was negatively impacted by this migration.
Subscription revenues declined 22% and 23% for the three and nine months ended September 30, 2011, respectively, as compared to the same periods in 2010. The decline was due to an approximate 15% decrease in the number of domestic AOL-brand access subscribers between September 30, 2010 and September 30, 2011, which is net of the 5% increase discussed above related to customers migrated to an access subscription plan. The decrease in the number of access subscribers is discussed further in “Overview – Our Business” herein. To a lesser extent, the decline in subscription revenues for the three and nine months ended September 30, 2011 was due to a $0.61 and $0.51 decline in ARPU, respectively, including the impact of the migration of customers to an access subscription plan which led to a slightly higher rate of decline in ARPU than in recent periods.
The number of domestic AOL-brand access subscribers was 3.5 million and 4.1 million at September 30, 2011 and 2010, respectively. ARPU was $17.49 and $17.66 for the three and nine months ended September 30, 2011, respectively, compared to $18.10 and $18.17 for the three and nine months ended September 30, 2010, 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 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.
As noted previously, our current access service subscriber base (excluding the one-time migration of certain individuals into paid subscription plans during the third quarter) has declined and is expected to continue to decline. While we expect that our subscription revenues will continue to decline for the foreseeable future, we believe they will continue to provide us with an important source of revenue.
Other Revenues
Other revenues consist primarily of fees associated with our mobile e-mail and instant messaging functionality from mobile carriers, licensing revenues from third-party customers of MapQuest’s business-to-business services and licensing revenues from licensing our proprietary ad serving technology to third parties through our subsidiary, ADTECH AG. In addition, other revenues include amounts associated with hosting certain Time Warner, Inc. (“Time Warner”) websites on our servers as part of the transition services provided in connection with our spin-off from Time Warner, the majority of which occurred in 2010.
Other revenues decreased 15% and 18% for the three and nine months ended September 30, 2011, respectively, as compared to the three and nine months ended September 30, 2010, due primarily to a decrease in revenues from our mobile messaging services.
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.
CONF CALL
Eoin Ryan
Good morning. Thanks, Gary, and everyone for joining us for our fourth quarter 2011 earnings call. You can find our Q4 earnings press release and accompanying slides, and trending schedules on our website.
On the call with me today is our Chairman and CEO, Tim Armstrong; and our Chief Financial Officer and President of AOL Services, Artie Minson. Tim and Artie will make some brief remarks on the quarter on our overall strategy and then we will open the lines up for Q&A.
But first, I will remind you that during this call, we may discuss our outlook for future financial and operating performance, corporate strategy, marketing and product plans, technology improvements, cost initiatives, planned investments, as well as our expectations for the economy and online advertising in general.
These forward-looking statements typically are preceded by words such as we will, we expect, we believe, we anticipate or similar statements. These forward-looking statements are subject to risks and uncertainties and our actual results could differ materially from the views expressed today.
Our quarter results should not be indicative of future performance. Some of these risks have been set forth in our annual report Form 10-Q for the year ended December 31, 2010, filed with the SEC. All information discussed on this conference call is as of today February 1, 2012. We do not intend and do not undertake any duty to update this information to reflect future events or circumstances.
We will also discuss certain non-GAAP financial measures including adjusted OIBDA and free cash flow. I will refer you to the press release on the Investor Relations section of our website for all comparable GAAP measures and full reconciliations.
Finally from time to time, we post information about AOL on our Investor Relations website at ir.aol.com and on our official corporate blog at blog.aol.com.
With that, I’ll turn it over to Tim
Tim Armstrong
Thanks, Eoin, and thanks all the investors joining today’s call. Artie and I will be making brief comments and remarks, and leaving a lot of time for questions and comments from you. AOL had a strong Q4, our global team has been working very hard and you are seeing improvements for three main reasons.
Number one, the operational and structural changes we have made to the company over the last two years are becoming visible on our numbers.
Number two, our strategy so simple and can face problems for consumers and customers and is synchronized with the landscape changes we see in our industry. Consumers won brands that provide information, deterioration and services, and have a defined brand proposition.
As the internet grows, brands become even more important. Human beings need brands that help them limit their choices. We have built and invested in a number of brands that are attracted to consumers including AOL the original brand of the internet.
One important note in our Q4 earnings is the improvements in the AOL services over the last year are really starting to payoff. The advertisers want to spend money with fewer and bigger partners, and that trend is accelerating. AOL has a very attractive set of brands and attractive network for advertisers to provide both scale and clearly define propositions for advertisers, and I just wanted to summarize them for you.
For advertisers we provide three simple things, one, is brand preference. How do we help use ads to help consumers choose one brand over another brand. Project Devil turns advertising into content and we help advertisers increase brand preference with consumers.
Number two, real-time targeting. How do capture in-market shoppers, being very strong at machine-based learning and real-time targeting, Advertising.com and our video network have key advantages for our advertisers to find in-market consumers.
Number three, pay just to parking lot, helping advertisers get consumers into their offline channels matters a lot. 2012 is already shaping up to be a year where many industries faced channels feeling economic challenges. Patch and our broader local strategy put us in the unique positions to help advertisers get people to offline locations.
And the last piece of why I think you’re seeing success in Q4 is, AOL has built our brands and services to work inside the changing landscape of our industry. There is an explosion of devices, bandwidth and closed cloud networks.
We have both owned and operated strategy of must carry brands and a series of publisher services that can cut through the devices networks and cloud. Owned and operated strategy and network also works on a global basis.
As a company we are focused on improving the things that we can control and the more we do that the better outcomes we’re seeing as a business. Q4 had a number of specific highlights I wanted to walk through.
Number one, AOL continued the improvement and returned to topline growth as a business. Number two, AOL continued tight cost controls and we had the second sequential quarter of lower expenses. Three, we have the third consecutive quarter of global advertising growth year-over-year. We had the third consecutive quarter on the acceleration of year-over-year advertising growth. Global, domestic and international display all grew at double-digit rates year-over-year. Our ad network had its third consecutive quarter of year-over-year growth and sixth consecutive quarter of sequential growth. The AOL publisher network had 30,000 partners in it receiving ads, content or video from AOL and we signed up 80,000 new video assets to run across the network.
AOL grew revenue from the top 100 advertisers and largest holding companies both year-over-year and quarter-over-quarter. Project Devil, video and mobile all grew by more all grew by more than 50% quarter-over-quarter and year-over-year. Web search revenue had its first sequential growth in revenue in over three years. Subscription revenue had its first sequential growth since 2006.
AOL had its second sequential growth in OIBDA for the first time in three years. Free cash flow grew year-over-year for the first time since Q1 2009. Headcount was down 4% year-over-year, if you exclude Patch it was down 10% year-over-year and over the last two years headcount is down close to 50%. AOL has also put ourselves in the position leading Q4 to potentially grow revenue in 2012 for the first time in a long time.
Matching their success we had on the business side, there are a number of consumer areas in Q4 that were successful. AOL ended Q4 is the fifth largest property on the web. AOL mobile ended the year at number four and crossed 50 million app downloads. Four entities were ranked number one in the vertical categories for consumer usage and 14 entities ranked in the top three of their category.
We ended Q4 with over 30 million social interactions for quarter. We ended Q4 with Huffington Post having 44 sections with five new sections launched in Q4. We then also in the Huffington Post weekly insertion rates for video reached 70%, meaning 70% of the pages on Huffington Post had videos on them by the end of Q4.
We crossed the 1 billion page view threshold monthly on Huffington Post during Q4 and AOL video is the number one video provider in the health, home, food, fashion and beauty, autos, travel and tech content areas. AOL video reaches over 42 million monthly views and AOL videos currently number seven on the web, but we hope to improve that during 2012.
One topic that gets a lot of discussion from investors is Patch and I wanted to give a deeper dive into the product. We believe this is a great investment for our shareholders and we remain very excited about the Patch opportunity. We also wanted to personally thank Patch team who is being killing themselves to roll the platform out across the country and to gain consumer and advertiser usage.
Patch ended Q4 in 863 pounds and had roughly 10 million unique users, publicly although we see much higher number internally. The average Patch found is 13.9 months old. Patch ended Q4 as a number four local property on the web and then the vintage usage case for Patch users, Patch has launched over years ago, grew at 182%. Patches that were launched in the past year have grown at 768%. We now have 14,000 bloggers, signed up to the Patch platform.
User comments, registered users, newsletters are all up 500% year-over-year. Patch ended Q4 with roughly 6,500 advertisers. Patch’s sales force in Q4 at 230 people with the average 10-year being about eight months and Patch’s revenue vintage in consideration with the consumer vintage is important.
Ending Q1 2011, there were 33 Patches that had about $2,000 per month in revenue. Ending Q4 2011, there were 401 Patches about $2,000 per month in revenue and we will continue to give more transparent patch information over time in terms of revenue and usage.
The average add-by grew close to 40% quarter-over-quarter and the duration of an add-by grew close to 20% quarter-over-quarter. So, we’re seeing meaningful changes and improvements in Patch monetization.
To-date in 2012, we have already sold 50% of the total revenue we did in 2011. So, we’re off to a very fast start on Patch sales for 2012.
Now, Patch is a highly scrutinized investment by a management team on our Board. Patch is not a pet project. Patch is a business that means deep consumers needs and advertising needs. We are serving the highest GDP towns in United States with high quality information and services, and we’re expecting to make a lot of progress on revenue in 2012. 2011 should also be the high watermark for our Patch investment and I would expect to see meaningful improvements on the economics of Patch during the year.
As we look forward to 2012 as a business just five areas of focus for our team. Number one is to grow unique visitors and we’re spending a lot of time and energy on that as a business.
Number two is to grow revenue through Project Devil, video, mobile, local and international.
Number three is to build better products and dramatically improve our services overall. We have a very big focus internally going through all of our products and brands right now to make organic improvement.
Number four is to put technology back at the center of the company. We have a very strong media business and advertising business, and we are continuing to grow our technology and technological progress in terms of the platforms we’re building and how they connect, not only with our own properties but also inside the industry.
Number five is to retain and gain talent. We want AOL to be the home for people who care about content, advertising and tech, excuse me, technology for the digital age.
In the first four weeks of this year, I’ve spent a lot of time internationally and domestically with our customers both ad agencies and clients, as well as with a lot of our product teams and I believe AOL has a great opportunity in 2012.
And with that, I’m going to turn the call over to Artie Minson. Artie?
Artie Minson
Thanks, Tim, and thanks everybody for joining us this morning. Overall, I’m very pleased with this quarter’s results. Well, for me, the headline is simply that we continue to significantly improve our revenue trends, while excluding a onetime legal settlement, continue to reduce expenses sequentially and return cash to shareholders in the form of a share buyback.
Turning to the results, first our total revenue decline was the lowest rate of decline in five years and at 3% represents clear progress from a 6% decline in Q3 and a 26% decline in Q4 2010. Importantly, growth has been driven by trend improvements in everyone of key revenue streams.
Taking through those revenue streams in a little bit more detail, global advertising revenue grew 10% year-over-year, the third consecutive quarter of year-over-year growth and a significant improvement over a 29% decline in Q4 last year. The driver here continues to be growth in global display and third-party network revenue offsetting search revenue declines, which themselves are moderate.
Global display revenue grew 15% year-over-year on a reported basis and 4% on a pro forma basis, which includes revenue from the Huffington post in both periods, driven largely by continued improved yield management of our properties.
Growth also reflects increased sales of premium formats and video, which whilst still small, a good representations of our accomplishments over the past two years and of our future growth potential. We are finding that advertisers continue to be willing to pay premium prices for premium content and formats.
Third-party network revenue grew 20% year-over-year in Q4, its third consecutive quarter of growth year-over-year, compared to 42% decline in Q4 2010. In Q4, we once again grew the number of advertisers and publishers we worked with, as well as the number of impressions serve resulting in a growth we reported today.
It is important to note that growth is coming primarily from two areas. First, Advertising.com grew 10% year-over-year in Q4 and has been growing at double-digit rates for three stratight quarters. Second, goviral, which we acquired in January 2011 added $9 million to revenue during this quarter. Since acquisition, goviral has grown revenue over 100%.
We have also made meaningful progress as we told you we would in stemming the declines in search and contextual revenue, and subscription revenue. Search and contextual revenue declined only 8% year-over-over in Q4 and actually grew sequentially for the first time in three years. The decline year-over-year is the lowest rate of decline in three years and compares favorably to Q3’s 15% decline and Q4 2010’s 34% decline.
The main components of our search and contextual revenue are aol.com, the AOL clients and international search, legacy cobranded portals and other. Once again this quarter the decline by driven by lower revenue from the cobranded portals, international markets, and other due primarily to our exit in 2010 from unprofitable distribution deals and markets.
Cobranded international and other search revenue together represent approximately 30% of total search in Q4 and they declined by approximately 30% in Q4 of 2011. The client side represents approximately 33% of total searching’s actual revenue in Q4 and as we have said, continuous decline at a slower rate in the rate of subscription decline.
Total search and contextual revenue declines were partially offset by growth in search revenue from AOL.com, which now represents approximately 37% of total searching contextual revenue and grew year-over-year and every quarter in 2011, benefiting from improvements we have made to the consumer experience on AOL.com coupled with a better overall search product and experience.
And in the revenue discussion with our subscription services operations, which declined 18% year-over-year in the quarter were 17% excluding the impact in both Q4 2011 and 2010 of the resolution of a dispute related to the sale of our German access business in 2007. This represents the best results in five years for our subscription service operations.
In recent quarters, we have spent a good deal of time consolidating and simplifying our subscription offering. And we have reduced the number of price points from 60 to 6, which allows us to more clearly define and sustain time to enhance the value of our products offering for our subscribers.
Our subscription services are no longer about dialup, with only 11% of our subscription base currently using us exclusively for access, instead it is more about creating a premium subscription service where our subscription -- where our subscribers receive a bundle of valuable products and services. With the result being that they are getting a value proposition far in excess of what our subscribers are paying us.
We maintain a frequent and open dialogue with our subscribers and they are seeing the value, which has a very positive impact and churn, in fact, in recent months as we improved the product and work through price rationalizations, we’ve seen a 10% increase in the retention rate of subscribers calling of our call centers. We remain in the early days here but I think there are number of additional offerings we can rollout to offer high rated subscription packages to current and new subscribers.
Let me spend a little bit of time on Patch. 2011 for us was a period of continued focus on product and audience growth, followed mid-year by a build out of our sales force and testing of our ad products. As we said we would, we spend approximately $40 million per quarter on Patch.
As Tim indicated, we ended 2011 with over 850 Patch founds and our focus now was on improving the product experience and monetization of existing Patch founds, as well as streamlining, the operating and cost structure Patch across the country.
From an operational standpoint, we have now grew Patches into approximately 30 clusters of towns, were towns with natural connections will benefit from a more localized management and a more efficient allocation of resources to areas that will have the maximum impact in each particular cluster.
The clusters also form natural sales territories and will ensure we are appropriately assigning sales coverage across the country. As Tim mentioned, in 2011 only 22% of our Patches had dedicated sales persons. In 2012 each Patch will be fully covered from a sales perspective.
On the content and product side of Patch, we will continue to make investments in the product that in a very cost efficient manner allow us to increase the amounts and timeliness of the content on every Patch.
From an overall cost perspective, the net-net of this is, given some of the efficiencies we have gained, we are allowed to invest more in product and more in sales on an essentially flat year-over-year expense base.
Our initial business plan, assume we would get individual Patches to breakeven between three and four years with healthy margins thereafter. That continues to be our assumption, but as I’ve said, we will adjust accordingly to the extent we don’t achieve our financial expectations.
Turning now to overall AOL expenses. Although, cost containment was obscured in the first half of the year due to increased operating expenses from our acquisitions, we have a clear track record of reducing expenses over time.
2010 we took out $500 million of expenses before reinvestment. Q3 of this year non- TAC adjusted OIBDA expenses decline sequentially by approximately $25 million. In this quarter excluding the impact of the legal settlement, those expenses dropped to further $8 million sequentially.
The focus on expenses, of course, highly important to the turnaround of AOL, as we seek to grow the bottom line through revenue growth and through expense control, and we are really pleased with the 100% conversion of revenue increase to profit from Q3 to Q4.
I will point out that Q4 2011 adjusted OIBDA expenses including TAC and the $8.5 million of legal settlement were $360 million, which is the same level of expense we had in Q4 of 2010. This illustrates our ability to appropriately balance investment with expense where in just two quarters we were able to integrate to highly strategic assets Huffington Post and Goviral without an increase in overall ongoing expenses.
We should not always expect sequential decreases in expenses because at times it will be impacted by investment and seasonality. For example, in Q1 we do annual merit increases and we restart the cock on items such as 5-K and other employer contributions. But over time, we will continue to look to do things more efficiently.
Turning now to the balance sheet, we continue to repurchase stock during the quarter at very attractive prices. We bought back 3.3 million shares since our last call and over 12% of our shares outstanding since our Board authorized to repurchase of stock in August.
As a reminder, we have approximately $72 million left in the original authorization. Pro forma for our most recent stock purchases at the end of January, we had approximately $400 million of cash on hand, and as you saw from our report this morning, we continue to efficiently convert adjusted OIBDA into free cash flow.
I do want to remind you that in Q1 we payout bonuses for the prior year, which of course impacts free cash flow and while we manage our cash position very closely, as was the case in Q1 2011 and Q1 2012, free cash flow will be negative for the quarter.
I will touch briefly on taxes and remind people that we continue to benefit from a meaningful tax shield, and we save approximately $200 million of net cash tax savings left to go and that the high effective tax rate you saw in Q4 is due to bookkeeping related to lower deductions on RSUs divests due to the decline in our stock price and non-deductible foreign losses.
So to conclude, I’m very pleased with our results. In Q4, we improved every one of our key revenue streams, we reduced expenses sequentially excluding the legal settlement, and we continue to return cash to shareholders. We’re happy with the progress we have made and while we are fully aware that there is more work to do, we are happy with the momentum we are carrying into 2012.
With that, let me open it up to Q&A. Operator?
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