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AOL, Inc. (NYSE:AOL)

Q2 2011 Earnings Call

August 9, 2011 8:00 AM ET

Executives

Eoin Ryan – Vice President, Investor Relations

Tim Armstrong – Chairman and CEO

Artie Minson – Chief Financial Officer

Analysts

Brian Pitz – UBS

Rory Maher – Hudson Square Research

Ross Sandler – RBC

Mark Mahaney – Citigroup

Ken Sena – Evercore Partners

Sachin Khattar – Jefferies

Ingrid Chung – Goldman Sachs

Tom White – Macquarie

Clay Moran – Benchmark

John Blackledge – Credit Suisse

Sameet Sinha – B. Riley

David Joyce-Miller – Tabak & Co.

Operator

Good day, ladies and gentlemen, and welcome to the AOL’s Second Quarter 2011 Earnings Conference Call. My name is [Chenille], and I’ll be your coordinator for today. At this time, all participants are in listen-only mode. Later, we will facilitate a question-and-answer session. As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to Mr. Eoin Ryan, Vice President of Investor Relations. Please proceed.

Eoin Ryan

Good morning. Thanks, Chenille, and everyone for joining us on our second quarter 2011 earnings call. You can find our Q2 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 CFO, Artie Minson. Tim and Artie will make some brief remarks on the quarter and our overall strategy and then we’ll open up the lines for Q&A.

But first I will remind you that during this call, we will 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. Reported results should not be indicative of future performance.

Some of these risks have been set forth in our quarterly report Form 10-Q for the three months ending June 30, 2011 and in our annual report Form 10-K for the year ended December 31, 2010 filed with the SEC. All information discussed in this conference call is as of today August 09, 2011, and we do not intend nor do we 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’ll refer you to the press release on the Investor Relations section of our website for all comparable GAAP measures and full reconciliation.

With that, I’ll turn it over to Tim.

Tim Armstrong

Yeah. Thanks Eoin. Good morning. And thanks for joining us on the Q2 AOL Call. AOL is singularly focused on becoming the next great media company for the digital age, being rich, engaging and easy to find content and experiences for consumers and best-in-class environment for advertisers.

Our focus on this call is to put us on a growth path. We have cleaned up and simplified our operations. We are witnessing encouraging metrics in key growth areas and we are seeing the beginning of this manifest in our reported numbers. AOL is a healthier company today than it was a year ago.

In Q1, we grew display revenue for the first time in four years. The Q2 display revenue continued to grow and for the first time in three years, AOL grew global advertising revenue. These are important steps in the come back of AOL and demonstrate the tough work we have done to fix the company and it is having an impact. Revenue growth will precede profit growth and we have revenue growth on the move.

Q2 results were solid and here are a few highlights. As I mentioned, we grew global advertising – the global advertising business for the first time since 2008, being up 5% year-over-year and beating larger competitors in growth, especially in the U.S.

For Advertising.com, Q2 was the first quarter of year-over-year growth since Q4 2009, continued a string of four consecutive quarters of sequential growth. We grew meaningful traffic against important areas of our stated goals in the content business. The Huffington Post traffic surpassed The New York Times during the quarter, nearing 10 million monthly unique users.

In mobile, we’re solid a number four in U.S. traffic. We are up 60% year-on-year on mobile downloads. In Project Devil, the number of impressions sold grew over 100% and engagement metrics continue to improve. Consumers are spending almost four times as long on a page with Project Devil on it as compared to the industry averages and spending almost 2.5 times longer watching video.

Today we have on our sites 11 different Devil campaigns running, including premium brands like Coca-Cola, Procter & Gamble, Johnson & Johnson, Kraft Foods and many more.

In Video, we grew viewers and views by over 100% year-over-year. In local, we advanced patch into 44 new accounts and have amassed almost 10 million uniques as I mentioned, the revenue here is small but it’s growing very quickly.

At the Huffington Post Media Group, we launched 17 sites including a new aol.com in Canada and the U.K. We launched AOL B2B with AOL Energy, AOL Defense and AOL Government. In the consumer side area, we launched AOL Healthy Living, Huffington Post Canada and Huffington Post U.K., Huffington Post Women, Huffington Post Celebrity, Huffington Post Parent, Huffington Post BlackVoices. We’ve been very busy in the content business.

In the access business, the churn rate continued to moderate at 2.2% and we launched 13 new paid services during the quarter. We’ve also been able to gain significant talent. During Q2 we reduced our workforce in total by about 500 but added back 300 new employs and team members across content, advertising, product and technology, all into jobs that are based on AOL’s future.

During Q2 we also kept up the innovation, there are number of products and services in the pipeline that our product and engineering teams are building that fit well inside of our strategy and I’m very excited about the developments we’re making there. One of the ones I would point out, we launched at the beginning of August was edition mobile content reader, but we have more products and services coming.

Let me switch gears, there is also some areas during Q2, which we made progress in, but we should have made more progress in, and we have set up rigorous operational metrics page reviews to make methodical progress over the next few quarters in these areas and I wanted to detail some of those for you.

First is domestic display, we have captured growth and I think you’re seeing some outstanding numbers from us in the growth sector for display, but we have the ability to capture more than we did and there are a number of initiatives we’re working on to increase those gains.

Inside of that Project Devil can be operational at a higher scale. Project Devil is successful for us but it’s not a feature, it’s a full product, and I want the company to run Project Devil as a full product and continue to scale our operations behind it.

The second piece is the Huffington Post Media Group. We trimmed our brand portfolio, we consolidated our content and technology platforms and overall, the integration has been a big success. But along with normal integrations of this scale, there was a few properties that we under optimized the traffic and revenue on. And now we have a process in place to quickly get the right attention and results and success and growth for those properties.

But I think there are a couple other areas that overall we saw a very good success, but key properties, one of them being AOL.com. We want to continue to work on it and we are seeing success coming from the work we are doing over the last few weeks.

In Patch, we continue to improve the services, we’re bringing to towns and I think we have seen tremendous traffic growth for consumers in Patch. We’re now turning our focus to the local businesses and how we actually continue to innovate on the business side and revenue side on Patch. Revenue is growing quickly on Patch, but we can do a much better job of servicing the local businesses.

On August 1st, we launched our new product for Patch, which is going to allow advertisers to help them drive traffic to their stores, drive leads to service businesses and sell products online. Patch has a very concise list of work to do and they are doing it.

On the video side, we spent a lot of time, energy and resources on video last year. Traffic has grown nicely across the video properties and network. We’ve done a nice job of getting scalable technology behind those. But we have not fully matched the scale on the consumer side with the revenue potential.

The revenue in the video marketplace is very hot right now and we can do a better job capturing that going forward. There’s a number of straight forward operational items that we need to work on in video and we’re currently working on them on the revenue side.

Many of you also noticed we’ve recently made a change to our advertising organization, providing sales and sales products under one organization. We have a big project to accomplish in the come back of AOL, but that’s not the ultimate goal of our team, of our company. We want to be one of the top three players in the media business, making the changes and decisions with our goal in mind. I asked Ned Brody to lead the global advertising and publishing sales because we will capture more demand in the marketplace over the coming quarters and years.

I wanted to put a very fine point on this next sentence, I’m about to say, because I think it’s really important is that, this is not a reorganization of our sales force and it’s not a resetting of the strategy. AOL’s strategy and sales force remain intact and are doing a very good job. This is about also improving the operations of our advertising business globally. So I just wanted to make sure you understand that clearly and I’m happy to talk more about it when we get into Q&A.

Ned Brody has been an excellent operator, I expect him to eliminate the needless operational friction that has prevented us from moving at the speed we want and driving more successful growth. AOL has a great sales team and we do not suffer demand problem in the marketplace. The operational changes we have made are built around maximizing demand, plain and simple.

As I look at the remainder of the year, my focus areas remain the same, growing traffic. We have a number of short-term and long-term projects that we’re working on both internally and also externally. We have one – number two is the scale of the ad offerings, we have a unique set of offerings to scale across our agency and clients, our businesses and products like Project Devil and our video products are very compelling, as well as local.

And Patch profitability, Patch has grown very nicely from the consumer side, we are in the right markets with the right size TAM and now we really want to turn our attention to turning our traffic into revenue. So, just highlight for me, growing traffic, growing scale in the ad offerings and Patch profitability.

We are at the heart of a once in a generation transition in media and we are leading the changes and our strategy remains consistent and unwavering. There is a clear opportunity in front of us and I believe we have lined up our products, people and focus in front of that opportunity.

Regardless of the short-term economic bump, we’re going to keep breaking through the challenges on a daily basis. As a shareholder and investor in AOL, the current valuation does not fit well with me and I can promise you, we’re on a mission to make this a great company and a great investment.

Let me turn the call over to Artie before we get back to you with questions and comments.

Artie Minson

Thanks, Tim, and thanks everybody for joining us this morning. Let me jump right into the results, so we can leave plenty of time for Q&A. As Tim noted, there were both positive and negative items in the quarter. So, let me start with the positive.

Revenue was strong with global advertising revenue growing for the first time since 2008 with overall 5% growth in ad revenue driven by 29% growth in the third-party network. That was a result of 15% organic growth in the third-party network plus the benefit of acquisitions.

As Tim noted, we’re really pleased how quickly the third-party operations have turned around under Ned’s leadership and we’re excited about the future prospects here as we enhanced our network offering through the integration of our recent acquisitions in this area.

Another positive was that advertising growth was also driven by continued display growth. Domestic display grew 16% on a reported basis or 18% excluding the impact of the DMS divestiture last year and 9% on a pro forma basis, which includes revenue from the Huffington Post and TechCrunch in both periods and excludes DMS revenue in 2010. Recall that Q1 was the first time since 2007 that we grew display revenue and Q2 marks the second consecutive quarter of year-over-year growth.

A third positive was that our subscription operations continued its trend of churn reduction with Q2 churn of 2.2% and the average tenure of our subscriber base is now roughly 10.5 years.

Another highlight for the quarter was strong conversion of OIBDA into free cash flow with $77 million of free cash flow representing an approximate 100% conversion rate. As we noted on the Q1 call, we expected to return to strong free cash flow generation in the last nine months of year and we’re pleased with our start in Q2.

We remain on very solid footing from a balance sheet perspective finishing the quarter with close to $460 million of cash on hand. Additionally, we’re still not paying federal cash taxes due to the worthless stock deduction we have taken and we have approximately $150 million of future cash tax savings from worthless stock deductions left to go.

We are very pleased with the positives of the quarter, but frankly there are few places when we entered the quarter expecting better performance. With respect to domestic display, our results were impacted by a slow month of June. Through the first two months of the quarter, our domestic display results were pacing well and we are up 25% on a reported basis quarter-to-date.

Given our reported growth of 16% for the quarter or again 18% excluding the impact of the DMS divestiture, you can clearly see that June was weaker than we had anticipated. As a result, our 9% pro forma growth in domestic display was slower than the pro forma growth we experienced in Q1.

Similarly, our search trends got a little bit weaker as we moved through the quarter due to softness in domestic CPC’s. We entered the month of June in search down 19% quarter-to-date and June again was a weaker month from a search perspective than we had been anticipating.

The softness we saw in CPC’s is obviously different from what our partner Google saw in their first – in their reported results and the issue appears to be related to advertising mix changes within the network during the quarter. The softness in domestic display and search in June flowed through to our OIBDA results and it was frankly too late in the quarter for any meaningful in-quarter expense remediation.

I also want to point out that our second quarter results were impacted by approximately $5 million of non-recurring expense items during the quarter, approximately $3 million of which we had not anticipated at the time of our Q1 call.

These non-recurring items included things like facilities costs to integrate some of the recent acquisitions, which were expensed for accounting purposes. Consulting costs related to M&A integration, doing cleanup and the transition of our operations in India.

On the last call, I said that in Q2 non-tax expenses will grow $5 to $10 million sequentially. We round up at the high end of the range due to the non-recurring items I just outlined, as well as having a full quarter’s expense to the Huffington Post and goviral.

As a reminder, we only have the Huffington Post and goviral expenses for one and two months respectively in our Q1 results. Having these businesses into our core quarter, including the associated retention compensation added approximately $10 million in expenses sequentially.

In addition, we made a few million dollars of organic investments in the Huffington Post, Patch and goviral in Q2, as we roll back new categories counts and made investments as we plan to rollout into new countries, all that adds up to approximately $18 million quarter-over-quarter expense increase, offset by an approximate $18 million quarter-over-quarter reduction in transaction costs related to M&A.

Majority of the Huffington Post, goviral and Patch expenses are recorded as cost of revenue and given that most are now ongoing expenses, we expect non-Patch cost of revenue expenses to remain in Q2 levels for the remainder of the year. I do expect to see a slight downtick in SG&A in the back half of the year.

I want to point out that we remain vigilant on expenses, after completing our India restructuring, our current headcount excluding Patch that are approximately 4,100, down from over 7,000 two years ago. We also continue to ship resources to areas where we see significant growth in the future.

For instance, during July we reduced staffing levels by approximately 150 people across different areas of our domestic operations and we will reinvest these savings in areas like video, mobile, Huffington Post expansion and Patch.

As we move to the back half of the year, we remain comfortable with our full year revenue estimates. However, the softness in this play and to a lesser expense search has lowered our internal adjusted OIBDA expectations. As such, we are now forecasting adjusted OIBDA in the range of $340 to $370 million. We expect Q3 to be the low adjusted OIBDA quarter for the year with adjusted OIBDA in the $65 to $75 million range.

Just one housekeeping item before I close. We had a very small recast in our historic results in the range of $1 to $2 million per quarter between third-party network revenue and domestic display. This did not impact total revenue or overall growth trends, but I wanted to point out the recast of our historic trending schedules.

Before I close, let me just say that while there are pockets of our performance that I wish was better, the takeaway for me is we are making progress in key areas. We are growing our advertising revenue again. Global advertising revenue growth will lead to the turnaround of AOL and we expect it will continue. We’ve a rock solid balance sheet and we are focused on executing against the opportunities we outlined for you at Investor Day.

With that, let me open it up for Q&A. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Brian Pitz of UBS.

Brian Pitz – UBS

Great. Thanks. Tim, some questions on Project Devil, how penetrate is the platform both on owned and third-party and what percent of impressions are Devil ads? And can you just talk about the timing to get the Devil ads up and running, is it longer than you expected, because it seems like the street is thinking that it’s taken a little longer than expected to get the penetration and I have a quick follow-up?

Tim Armstrong

Sure. So, let me just start with the last part of your question first, which is, the Project Devil on a operational basis, it’s important for us to have the smoothest, fastest operational process in place, because what we’re essentially doing is bring the new product to marketplace. So, it means in the channel that we sell through clients and agencies, those people have to be educated and have to understand what the benefits of that, products that takes time.

The second piece of the operational time is internally, how we have our internal operations, how the sales force is setup to sell it, how the compensation plans work, how we setup our technology systems to deliver Devil and the rest of the inventory we have those things.

So I think we have a mass scale project and we have since -- we launched it at the end of the last year to continue to see that process up. Again one of the changes with Ned is connecting Devil into the network and into – owned and operated properties are much higher scale.

I would say one of the more encouraging things and let me jump in the inventory for a minute, I spent a little bit of time down in Baltimore which is Advertising.com headquarters and we recently have launched the Devil network, which Hirsch and Wall Street Journal and other people are partners.

And I think one of the encouraging pieces of the data I saw in meeting with the management team down there and the teams running the campaign, was our ability not just on the operator properties from the network to drive Devil growth in terms of pricing and scale.

The owned and operated properties, Devil is continuing to increase, I think, we said we increased 100% quarter-over-quarter in terms of the amount of impression that ran and Devil performed very, very, very well on our owned and operated properties. I think the fact that even today right now we have 11 campaigns running from the largest advertisers.

I think, if you look across the properties today, you’re going to see Procter & Gamble, RIM, Sprint, Hewlett-Packard, AIR, Craft, Coke, Johnson & Johnson and I think the traction that they’re seeing on the product is going to lead to more inventory, higher percentage of our inventory were still know in the low double digits for inventory and I think we can make a very large improvement in terms of that, I expect that to happen.

Brian Pitz – UBS

Great. And then, in addition to the call option value on your ad business turnaround, it seems also I think you have a decent amount of value locked-up in cash deferred tax assets, patents buildings, datacenter, et cetera. At these levels maybe you could comment on how you view a buyback as an accretive strategy at this point? Thanks.

Artie Minson

Yeah. I mean, I would just say the same thing, I’ve always said on this front, which is we’re in a come back mode and which is a different mode than other company. So we have to be very opportunistic about how we focus and use the assets. So we’re very careful about how we use cash and very careful about the balance sheet, as you can see from how we’ve managed it.

At this point, a buyback is certainly would be in the consideration set for us along with other opportunities we have, but stack ranking of a buyback versus opportunistically having that cash available, we settle through the integrations we’ve done. I think we’ve been more focused on settling through the integrations growing products and services and focus on the future growth than we have been locked into any specific plans around buybacks.

So I would just say, we’ll -- we’re opportunistic, I believe, I’m a big personal investor in the company, I believe the stock is undervalued and I think our operational results are going to be fastest way for us to bring the value of the stock up.

Brian Pitz – UBS

Great. Thanks.

Operator

Your next question comes from the line of Rory Maher of Hudson Square Research.

Rory Maher – Hudson Square Research

Good morning. I think, in time you bring in a new head of sales, whether it’d be [Rio] or just replacing it with better candidate, as usually some kind of lag effect in terms of training the news -- training the staff on the new strategy and I’m wondering, if you’re going to expect to see this in third quarter with really coming in? And also related to that, I think, you’ve said 9% pro-forma domestic display in second quarter was worse than the first quarter. Can you just remind me what the first quarter was?

And then lastly, Tim, can you kind of go though in detail exactly what probably it brings to the table as you ahead of sales to that level but it didn’t?

Tim Armstrong

Hi. Well, I’ll handle the first and third questions and then, Artie, I don’t know if you want to talk a little bit about the short pro forma results. So, let me just be really crystal clear about this. One is Ned was already deeply integrated into the advertising business having -- running Advertising.com group.

The second piece is, I think probably when I noticed, Ned was acting as the COO function of the advertising group of last year as well. So, I think one is Ned works closely, we have a very, very strong set of leaders across our advertising is about six or seven really strong senior leaders in advertising, we’ve excellent sales and operational people. Ned worked very closely with all of them including Jeff, last year. They helped basically to get the results on track to where we are coming into today.

And second of all, is I would just, I really want to underlying this. There is no strategy change and I mean that. There is no -- we are not switching to our network only strategy. The AOL historically, before I got here a whole bunch of strategy shifts whether they would swing the pendulum back and forth. We are in the premium content business, in the premium advertising business and owned and operator properties and across the network. There is no strategy shift double underlying, double highlight, double yellow, no strategy shift. Ned is intermittently aware of the strategy, has helped drive the strategy and I think that will be a positive and I think Ned is an excellent operator.

What Ned brings to the table, which is I think what our company needs right now, is if you look at our overall portfolio of assets we have in the advertising and content business, we have very strong assets now. And what I would like to see happen here is the operational rigor behind those assets, grow at the same scale that we put into in the rest of the business.

So I think specifically, what Ned is going to be bring to the table, I’m not going to go into a detail, because you won’t understand our systems. I believe that within our inventory planning systems, within our data and insight system, within our reporting that we do for ad customers, there is a huge amount of incremental lift to be done there and I would expect Ned to really be able to focus on that.

And second of all, I would just say this is, on the sales side, the leaders that were promoted when Ned came in, we’re running the different regions for us or different verticals are very strong, we’re in very close tough with them and I think, I would doubt we’re going to see any major changes in the advertising results other than the economic results that are happening in the economy. I think we’re on a forward -- already plowing forward very quickly.

Artie Minson

I’d just answer to the pro forma question. If you look at it, apples-to-apples methodology, which is you include the acquisitions in both the years and you exclude DMS in 2010, pro forma domestic display was 12%.

Rory Maher – Hudson Square Research

Great. Thanks a lot, guys.

Operator

You next question comes from the line of Ross Sandler, RBC.

Ross Sandler – RBC

Thanks, guys. Just two questions. First, Tim, can you talk a little bit about the current environment you’re seeing in domestic display in 3Q, with July or these first few days of August any different then ending trajectory in June? And then the second question for Artie, so this new updated range of $340 to $370 for 2011, obviously below consensus expectation.

I’m just wondering what the disconnect is, is just because, you are expecting lower revenue from higher margin areas, are the Patch losses accelerating and then given the access and search secular declines, is there any comfort that this might be -- the trough run rate by which we can build on next year or are you expecting next year to be below this range?

Tim Armstrong

Well, I have just said the environment, I think, Artie is very close to this also and can comment on it. But, so let me just describe where I think industry level things are at right now is from the environment -- from the customer prospective, I believe there still remains a tremendous amount of planning of how customers are moving money to the digital space.

And I think, if you look at where the potential opportunities are even from our competitive set where people are talking about investing, I think a lot of that has to do in two different buckets. One is the ROI centric customer acquisition bucket. The second is in the displayed bucket and specifically to your question in the display bucket. I think there are number of sub-areas underneath that, which are really important. One of them is video. I think there is a tremendous amount of customers trying to move specific money on to the Internet and on the mobile for video.

The second area is in very competitive categories. Let’s take it to the telecom space for instance and also the financial services space. What we saw during Q2 was a shift from acquisition marketing into more brand marketing as pricing becomes more similar, what customers really start to focus on is the brand attributes and how their brands talk to customers.

So, I think in the categories, if you go down to each industry category of advertising, you’re seeing different mix shifts between customer acquisition and display, the areas where we saw growth in Q2 and I’m assuming we’re going to see in Q3 are from the spaces in display where it’s very important for those customers to built their brands, because they can’t build just commoditized pricing on acquisition and that’s a very important part of the marketplace.

And with our products and services, we are able to cover both, we are able to cover very detailed CPA-based campaigns with the Advertising.com group and we are able to cover the brand campaigns on our owned properties. And now with the project doubled, we have been able to mix the brand essence across the Advertising.com group and owned and operated properties.

So, I think, you’re going to see display growth on a go forward basis, I don’t know what the economic bumps are going to do and I think you’re going to see serious competition in certain industry categories around display there. And, I think, on the retail category, the retail category was softer in Q2 and in Q3, this is a critical quarter for us to get more traction in retail, but I’m not sure what our competitors are seeing in retail right now.

Artie Minson

Hey, it’s Artie. Let me answer a couple of your specific questions there. On the pro forma revenue growth, the June trend versus the July trend. June was essentially on a pro forma basis flat year-over-year and the July trend was similar to the June trend.

In terms of the takedown of the OIBDA range, you asked what was driving and it’s really a reduction from what had been our prior expectation on domestic display. And as I said and to a lesser extent search, specifically it is not due to any acceleration of the Patch expenses, which was a question you had asked that, those are -- those to be clear are not accelerating? On 2012, we are not going to give any forward look on 2012 as of yet. So, I think, I’ll just leave it at that.

Ross Sandler – RBC

Thanks guys.

Operator

Your next question comes from the line of Mark Mahaney with Citigroup.

Mark Mahaney – Citigroup

Thanks. Just to stay with the domestic display trends, to what extent Tim do you want to address the issue of whether premium display advertising is seeing growth undermined by your Ad Exchanges at network, you are obviously planning both sides of this. But looking at what happened with maybe with WebMD in this quarter with Yahoo results and seeing the strength you are having in your third-party network, at least opens the question as to whether the greater targeting of the Ad Exchanges to ad networks and then also the rise of social networking sites are really undermining premium ads sites. I’m over exaggerating, but you get the point, could you just address that? Thank you.

Tim Armstrong

Yeah. Let me be super real direct about this one. So I think last year there was a general sense, I would even say internally here, Mark, that the kind of the focus on Ad Exchanges was really going to be upsetting to Advertising.com and I think that was the general notion in the industry.

But I think once we got one level below that and really started to look on how -- what customers actually want, I mean it’s the same thing, a lot of people on the call work at value added service, banks where people try to drive higher growth and investments.

The Ad Exchanges worked the same way, which is you have to have the technology layer within those exchanges to actually drive the customer acquisition, pricing and results that people want and the very detailed way, we partner first of all with most of those exchanges, number one now. Number two is we have a set of products and features that are -- some of them are out, some of them we’re going to be rolling out, that enhance the inventory capability there.

So I would expect ad networks as long as they innovate and remain strong to be a vital piece actually within the Ad Exchanges, number one. And number two, is for us to continue innovate places outside of the Ad Exchanges. If you look at Project Devil, the premium network and some of those things, that’s really important. So, I’m happy with our results, we have a lot of work to keep doing there, but I think a lot of it comes down to what you’re actually delivering for customers.

The second piece is on social networking, so I think there is two questions I get from investors a lot, which are Google and Facebook and those companies basically eating up a lot of the display ad budgets and I think the reality is and I have said this all along and I’ve said this on the calls in the past.

We have to be able to compete at a level with the largest, fastest growing competitors in this space. Here is my honest assessment of the space is Google has done a nice job putting together a set of assets around display, I think that there is a big opening in the marketplace around premium display and around premium networks with the huge opening and that’s where we are focused on.

On the social networking site, I think some of the larger players in the social networking space are very hot from a client perspective, but I don’t think from our results targeting perspective, there is any advantage there. So, I think our goal is to connect premium content, premium experiences and premium services with the premium networks and premium products. Because every major brand in this country and all countries needs to keep promoting their brand, not just acquisition pricing and that’s why I think you’re seeing us having success here. I would expect us to have more success in the future, as we continue to innovate the products and services against those areas.

Mark Mahaney – Citigroup

Thanks a lot.

Operator

Your next question comes from the line of Ken Sena of Evercore Partners.

Ken Sena – Evercore Partners

Hi. So, I just have two questions regarding engagement. AOL grew its unique about 1% year-over-year with the contribution from acquisition such as Huffington Post and others, as well as the investments that you’re making with an aol.com, in terms of increased content and video.

Can you explain, sort of, what’s driving, sort of, that offset in some of those other contributions that might be keeping your traffic flat? And then secondly, in regarding the 15% or so organic growth in third-party, are you seeing more of a contribution from new advertisers coming in or you just monetizing them better? Thanks.

Tim Armstrong

Sure. On the traffic side, there are probably three important concepts in traffic. One is, I said this before, we’ve removed what I would consider unhealthy distribution deals. We had some fairly significant spending on buying traffic at AOL, one of those major deals just basically ran out within the last few months, but traffic wise, it’s tough to make our decisions, help with the company wise right decision to make.

Second area around it is, there are some core properties which we’ve seen down draft in traffic, which hit the overall UV number, one engagement number, one is AIM and I would say the second largest one is probably MapQuest to some degree.

And then, we -- the third area is really the access business, I mean, there is a smaller down draft in the access business, but I think all three of those things were known. We said publicly we are going to take down the bad distribution. Aim and MapQuest traffic has gone down a little bit, although MapQuest has improved the product a lot, so I’m hopefully they are.

And then on the access business, that’s the reason people aren’t buying or access anymore. I would just also specifically point to two very large initiatives internally that we’re working on to grow traffic. One is an internal project called Bridge and Tunnel, where we have a very, very robust set of analytics, the most robust set of analytics, I have seen at any company around traffic and around usage, that’s one.

The second thing is, we have a number of business opportunities on the table, not M&A opportunities but business opportunities with partnerships. And I think those will continue to drive traffic. So my look forward for the next year would be, I hope to see that we have an increased level of traffic. I would also point out that things like TechCrunch, Huffington Post, goviral, 5min, a lot of the acquisitions we did plus some of the core properties actually in the last month aol.com has started to grow again.

So, numbers wise, Huffington Post, I think heard about 36 or 40 million users when they acquired it, internally we are seeing that number closer to the 80 million now in terms of the amount of traffic internally. Patch went from roughly zero to 10 million users.

So I think you’re seeing a traffic shift and I would expect traffic to keep growing. As I said in my remarks, it’s the number one thing in my list focus wise. So, I’m not – I’m always concerned about it, but I think we have the right operational focus and plans behind it.

Ken Sena – Evercore Partners

Okay. Thank you. And can I just ask one follow-up. Is there any update to the $440 million or so OIBDA target for the end of the year that’s excluding the stock-based comp and restructuring?

Artie Minson

Yeah. Within my proactive remarks, so we are $340 to $370 million of OIBDA for a year.

Ken Sena – Evercore Partners

Okay. Thank you.

Operator

Your next question comes from the line of Youssef Squali from Jefferies.

Sachin Khattar – Jefferies

Hi, guys. This is Sachin sitting in for Youssef. One question, Artie, I don’t, maybe I’m asking the question different way. But on display, do you know what the sort of the organic level of growth for comparing to Q1, up 6% organically, for Q2 what was it sort of ex-acquisition vis-à-vis Q1?

Artie Minson

The reason we have given the pro forma number is due to -- which I think is far in a way the most appropriate way to look at it -- is we have as we move through Q2, we so integrated the properties that for example Huffington Post, as it became more and more integrated with AOL News and some of the AOL historic properties got re-branded and traffic moved over to Huffington Post, that to give that organic ex-Huffington Post became less and less meaningful. So, I think the real best way to look at it and the way we are looking at it internally is on the pro forma basis, which is the 9% in Q2.

Sachin Khattar – Jefferies

Okay. Got it. And then just a quick follow-up, did you guys see any, sort of, hits to or any changes to traffic, I guess, from Panda 2.2 towards the end of June going in the third quarter?

Tim Armstrong

Yeah. Just overall, Panda has been a positive experience for us as a whole. I think, we -- basically Panda seems to be focused on real-time and quality. So, we tend to focus on real-time and quality, also I would expect that to continue to grow.

I think, across the big properties we have talked about, I think it’s been positive and I would just also point out and I think Panda from a key focus for the industry, I think it’s a pretty large significant shift that’s going to be forced at over up at the Internet, companies with search engines or other types of networking products around content, which is one the largest player in the industry goes towards real-time and high quality. My guess is other people are not going to go towards lag time and low quality.

So, the investments we have been making in high quality and real-time, I think, over a longer period of time across all our distribution areas will probably do net positive.

Sachin Khattar – Jefferies

Got it. Thanks a lot, guys.

Operator

Your next question comes from the line of Ingrid Chung of Goldman Sachs.

Ingrid Chung – Goldman Sachs

Thanks. Good morning. So, I was wondering if you could approach the OIBDA question from the cost standpoint. I think you said COGs in 3Qs is going to be flat to 2Q. If July macro softness continues, how quickly can you reduce costs and how much of your cost structure is variable at this point? Thanks.

Artie Minson

Hey, Ingrid, it’s Artie. If you look at the difference pieces of the cost structure, take the asset cost structure, a good bit of that is variable, but far away the biggest component of our cost structure is frankly our headcount and what you’ve seen is us continue to prune that in areas where we think weak and reduce investment, but what we’ve done in areas where frankly we see growth and opportunities to earn really good returns in the future is we re-deploy those dollars.

So, for example as I’ve laid out we just -- in the last quarter we meaningfully reduced our India operations. We just went through in July about a 150% reduction in our domestic operations across the board, but we will redeploy those savings and our view has been look that there are meaningful opportunities to earn returns. We’ve laid those out at Investor Day and there -- you will see therefore the overall cost structure on the cost of goods sold side stay flattish.

But there is redeployment of dollars going on in that and so the takedown -- the growth in COGs as I also laid out is basically due to just the fact that we are now having some of these acquisitions that we are on in for the full quarter in Q1. We have had them in for fourth quarter and Q2. So, net takeaway is cost structure flat year-over-year, but investing in opportunities we see meaningful growth while we are basically pruning and taking out investments in areas where we think we can reduce costs.

Ingrid Chung – Goldman Sachs

Okay. Great. Thank you.

Operator

The next question comes from the line of Tom White of Macquarie.

Tom White – Macquarie

Thanks for taking my question. Quick question on patch, it sounds as if the sort of cost side of the equation is kind of in line, what milestones will you guys be looking at in order to judge that patches on a successful path to profitability, such as traffic, ad coverage.

And then just secondly should we expect any benefit to your ad business specifically how far from the political calendar next year and if so when will that start showing up the numbers?

Tim Armstrong

Yeah. I think to just quickly hit on it is, we measure every single individual Patch individually and I think the metrics that we look at there are traffic. So for instance, even the first three patches that we’ve started basically had double-digit growth during Q2 and if we look at the all of the individual Patch, I mean, one of the questions that we are constantly looking at is, is every Patch viable, should we be trimming patches, those things and the reality is we see strong growth across the Patch spectrum.

The second piece is on the revenue side of things, you have to remember we started this year with very few customers and very little revenue. By the time we exit, this year, we will have a meaningful amount of customers and a meaningful run rate on Patch.

And so I think, overall we are – very carefully, we measure everything individually. I think a lot of people cover Patch and what we are doing on Patch and like to point out what we are investing in Patch, but I wouldn’t say as an investor myself, if we have the metrics, I think, we are going to have at the end of this year, leaving this year, I think, Patch will look like a very smart investment on the AOL side.

And then I would just a second, there is two areas where there is upside in the advertising for Patch, one you mentioned political, every candidate that I have talked to, I talked to Cory Booker, I talked to Governor Christie, we have got notes all the times from Senators and governors about Patch, I mean I think Patch is one of the most watched things in the political landscape outside of DC for how communities are doing.

So, I would expect us to have political upside there. We have a very robust plan actually for how we use all of our properties on the elections front and gain market share and adverting from that front. I think we are happy with our plans and we have to hustle to get the dollars, but there is a good opportunity there.

The second area I would just say that we have a company, Hewlett-Packard is running on Patch right now with the Project Devil ad and there is a very significant interest from national advertisers, specially the big box retailers and their OEM partners, their channel partners for Patch and most of the patches are within a 10-mile radius of the most of where all the big box retailers are.

So, we continue to see interest there. I would say the product we just launched on Patch for August 1st we just launched is a meaningful improvement to what we bring into the marketplace. Again, this is the same thing I talked about on the national or global side of advertising. This requires extreme operational diligence to push this stuff out and that’s really what we’re focused on.

Tom White – Macquarie

Great. Thanks.

Operator

The next question comes from the line of Clay Moran of Benchmark.

Clay Moran – Benchmark

Thanks, good morning. Should we assume that your second half domestic display business is not going to grow with the industry now or are you thinking that the industry growth rate has probably lower than originally expected and when you make that comparison, are you comparing against reported growth or organic growth -- sorry pro forma growth?

Tim Armstrong

I would just say -- we certainly understand how much work we have to do here in the future and what I’m about to say has nothing to do with the level of hustle or sweat that’s going to come out of this company. But I do think the fact that we deliver the results we did in Q2 on a global advertising display front, I would say are above the industry average when you look at the some of the larger players in the display space. So -- I -- whether or not other people change their benchmarks on industry growth, I think we kept our North Star goals and getting double-digit growth and really that’s what we did and I think we’re proud of that fact.

I do think the display industry benchmarks probably have changed, that’s not going to change our benchmark. I think we see the opportunity to continue to grow. I don’t know if we will be able to do it, but just, we don’t want to end up as the – we don’t want to end up aiming our sites at the lowest possible star. We want to aim our sites at the highest star and I think that’s what we’re continuing focus on.

And then -- I think when you think about pro forma versus organic, we did the single largest, fastest integration of the sites we do with The Huffington Post I have ever seen at other companies and I integrated DoubleClick into Google and did a whole bunch of other big integrations.

So, I think pro forma is probably the best way to look at -- I’ll let Artie comment on that, but guys, we’re not -- what I said here, we are not shooting at the come back of AOL it’s not the goal of this company, the goal is to be one of the top three players and I think if you set your sights on what the industry averages are, you’re probably not going to maximize the opportunities that I talked about.

Artie Minson

Yeah. No. I agree with him that the best way to look at it is basically our pro forma results. Frankly, again, some of the pro forma results of some of our peers was obviously, some of them are benefiting from acquisitions as well and I’ll just reiterate, what Tim said in that, our pro forma domestic display results this quarter, again some of our larger peers were compared against, we took share. So, we’re pleased with that.

Clay Moran – Benchmark

Okay. And then what percentage of revenue is from Europe now, I mean you’ve sold assets, you’ve launched some new international sites. I’m also just wondering what the international strategy is now?

Artie Minson

Yeah. I mean Europe is, it’s under 10% of the -- less than that of the revenue base at this point and we have a couple of initiatives in Europe, one is what you will see is goviral, which is doing really, really well, is looking at expansion plans across Europe. We are also looking, as we have discussed expansion plans for The Huffington Post across Europe, but in terms of its percentage of the overall business at this point, it’s still pretty small.

Tim Armstrong

I would just say there is -- we have 12 countries who are interested in. We are going to be going to three additional more out of the gates and what we have said to you guys, I think a year or year and a half ago was we pulled out Europe because we didn’t have scale platforms and scale technology. We are now going in with The Huffington Post combined platform which is a huge opportunity and the second piece is we have very scalable platforms with goviral and also with Devil. And I think if you look at the launch of the HuffPost UK, you’ll start to see -- or in Canada also we have meaningful traffics -- meaningful traction and interest from advertisers and I think you are going to see that across the different countries we go to.

Clay Moran – Benchmark

Okay. Thank you.

Operator

Your next question comes from the line of John Blackledge, Credit Suisse.

John Blackledge – Credit Suisse

Thanks. Two questions, first Tim earlier in the call you mentioned that some properties were under optimized and you are looking to particularly optimize those traffic and revenue. If you can just maybe give some detail on those properties and what you plan to do?

And then secondly on Patch in terms of monetization, just wondering how many sites are actually generating revenue now and how many will be by the end of the year and what that revenue run rate will be by the end of the year? Thank you.

Tim Armstrong

Sure. So let me just give you two quick examples -- two quick examples of under optimized properties and again, a lot of this was just due to the focus on integration but one was AOL.com. We made a tremendous amount of progress last year on improving aol.com and again aol.com, if you look it, roughly a year ago, it looks like a completely different property than what’s up there today.

So, we during integration probably spent less time on it than we should have. We are back to spending time on it. We put a new navigation area in Arianna and on the editorial side. It has done a nice job of putting a team in place there. So, I think we are starting to see in the last 30 days a re-tickup of that traffic which I think is important.

Another area would be in the space where we are -- in women’s content area which we have been historically very strong and I think we will be strong in a go-forward basis. In there, we really focused on launching new properties and changing some of the properties but, StyleList is the number one women’s brand for style and fashion. I think there were at bumps in the roads in the integration around that type of property, but again, I think we’ve come out of the gauge really quickly fixing those and I think those are the types of things.

I think -- the other thing actually, Moviefone is a very good brand and very good property and this has probably less to do with the integration and more to do with just a maniacal focus on products, but we probably took up put off a gap a little bit but we’ve gotten in Moviefone and improved that property there.

So, I think we watch every single property very closely. On the Patch side of things, we’ve a board meeting over the next day and half after the earnings call. If there is a board metric around revenue or profitability for the patches, I believe what we’re presenting is above track for what the goals are there.

So, I don’t think we are breaking out revenue individually per patches or how many patches have revenue, but a lot of patches have revenue. It’s growing quickly. We can do a better job of growing revenue on patches and that’s what we are focused on, but I don’t think we are releasing any individual numbers on Patch.

John Blackledge – Credit Suisse

Thank you.

Operator

Your next question comes from the line of Sameet Sinha of B. Riley.

Sameet Sinha – B. Riley

Yeah. Thank you. So I think most of us are familiar with the editorials such as Patch. Please remind us how the sales structure works, I mean, again, do you have feet-on-the-street kind of sales people or do you handle it on a national level or even at the network level?

Tim Armstrong

There are four ways Patch makes money right now from advertising. One is our national sales force, which is the small part of it, but the national sales force sells to big customers like Hewlett Packard, I mentioned. The second piece is that Patch has a feet-on-the-street sales force, which is regionally based in market and I’m not going to go into detail on how it’s structured, but it’s structured on a relative talent basis there.

The third way is an inside sales force which we’ve ramped up and has great results and then the fourth way is basically partnerships with other companies that have localized revenue -- for advertisement and not a very small part of what we are doing as well, but I think the main kind of focus areas have been the patch sales force and also we are focused on the inside sales force and the new products that we are rolling out.

Sameet Sinha – B. Riley

Thank you.

Tim Armstrong

And we probably have time for one more question, if possible. I don’t know if there is another question or not…

Operator

Yeah. It comes from the line of David Joyce-Miller from Tabak & Co.

David Joyce-Miller – Tabak & Co.

Thank you. You mentioned a shift in your headcount -- focus you bring in -- people to focus more on video and content. Are -- what’s the projects are they involved in and what sort of timeframe are you expecting there to be a return on them or they for -- aspects that you are currently selling on?

Tim Armstrong

They are -- a lot of them in aspects we are currently selling on, but let me just talk about some of the investments we have made in headcount. If you look at a lot of launches, that we did, if you look at HuffPost with TNO or Black Voices or our investments in the mobile team, those things -- if you are going to straight content properties, I think there is a fairly quick return on investment for that headcount. When you look at places like some of the services we are doing or the mobile team, I think we and our consumer applications group, we have a really talented group of products and engineering people there that are building stuff for the future.

I think, us being a solid number four in mobile and launching products like Editions there, I would expect us to have fairly quick return on investment for most of the head count that we are bringing in. I don’t think there is – I’m trying to think -- there is any projects that are like a multi-year return on headcount. I don’t think that’s the case. I think most of the headcount we brought into the company, we are expecting quicker results on.

So, I think the way to think about our cost structure or headcount is we have shifted pretty dynamically. If you look at, couple of years ago when we had between 8,000 and 10,000 employees to where we are today, we have -- how roughly half the number of employees, but even within that half, the mix shift underneath that has pretty dramatically changed also with their focus and all the areas we are focused on, we want a fast return on investment for that headcount.

Artie Minson

David, just to put a finer point on that, I mean, the 150 people (inaudible) left the organization, they tended to be in more support areas and what we have been incredibly focused on is investing in areas that basically, as Tim says, they either drive UVs or they the drive the monetization of those UBs. So those are the areas where dollars are going in and they are shifting out and so forth.

David Joyce-Miller – Tabak & Co.

Great. Thank you.

Tim Armstrong

So, just a total ramp up, I just wanted to highlight a couple of things. One is, I’m going to start with the people of this company. I think we’ve extracted more amongst any other company then we’ve from our team members here. I think we have done some very big changes as a company over the last couple of years and I’ve realized change drives a lot of different dynamics.

So, I want to say huge thank you to the employees of AOL for stepping up and having a global growth in advertising, our sales team, the product teams, technology team behind that.

And second of all, is really to the focus energy and efforts of the folks in the content group who’ve really continued to -- everyday be obsessed about what we deliver to the consumers and then lastly I would say that areas that we focused, that we are going to focus on traffic, revenue growth and Patch, we are running this company in a very maniacally focused metrics based way and making a very tough changes we need to make and we continue to improve the company.

And the last thing I’m dead serious about, we are not aiming this company to just have a struggling come back of AOL. We believe very strongly in our strategy, very strongly in the people and products and services that we are building and have and we are going to be unwavering and undeterred in our focus on that. I don’t care what the press says about this company.

I don’t care what the perception is other than the perception from our consumers and customers and I think that is our focus. We are competing in the media space. I doubt we are going to have lot of friends over time in media, we have some great partners there, but don’t mistake a lot of stuff you hear about this company from what’s actually happening and what the results we are shooting are for.

We are going to be a leadership based company and regardless of the economy and regardless of the other things, we believe we are on the right path. So, thanks for joining the call and I appreciate everything that the investors have said with us and we will see on the next call.

Operator

Ladies and gentlemen, that concludes the presentation. Thank you for your participation. You may now disconnect. Have a great day.

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