Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

AOL, Inc. (NYSE:AOL)

Q1 2012 Results Earnings Call

May 09, 2012 8:00 AM ET

Executives

Eoin Ryan – Vice President, Investor Relations

Tim Armstrong – Chairman and CEO

Artie Minson – Chief Financial Officer and President, AOL Services

Analysts

Ross Sandler – RBC Capital Markets

Ben Schachter – Macquarie

Laura Martin – Needham

Mark Mahaney – Citi

Peter Stabler – Wells Fargo Securities

John Blackledge – Credit Suisse

James Cakmak – Telsey Advisory Group

Anthony DiClemente – Barclays

Heath Terry – Goldman Sachs

Operator

Good day, ladies and gentlemen. And welcome to the AOL’s First Quarter 2012 Earnings Conference Call. My name is Diana, and I’ll be the 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, Diana. And everyone for joining us for our first quarter 2012 earnings call. You can find our Q1 earnings press release, 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 and on our overall strategy, and then we will open up the lines 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-K for the year ended September 31, 2011 filed with the SEC. All information discussed on this conference call is as of today, May 9, 2012, 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 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.

And with that, I will turn it over to Tim.

Tim Armstrong

Thanks, Eoin, and thanks to investors for joining the call. Here is the quick summary of our results. AOL had a strong financial performance in Q1. We had significant improvements in majority of our revenue trends. We reduced the expense base for the third consecutive quarter and are now operating at lower cost structure.

We saw strong operational improvements across almost all areas of the company. We made progress centering the company around technology and product development. We unlocked $1 billion to our patent transaction with Microsoft, representing approximately 60% of the market cap of the company on the day we announced that transaction. The value of the transaction appears not be fully reflected in our valuation, I’ll speak to that in a few moments.

As we discussed in our last call in February, there are five major areas of focus for AOL this year. I want to briefly update you on those areas. Number one is to grow our audience. In Q1, we grew total unique quarter-over-quarter.

Growth is coming from a number of areas, including the Huffington Post, Moviefone, DailyFinance, Patch, and AOL Autos. We also launched a number of new properties during Q1 that we expect to provide strong growth in the future.

In video we launched AOL On in beta our new curated video property. We are ranked number one in eight video categories including autos, finance, tech, fashion, travel and home. In Q1, video views were up 40% year-over-year.

In mobile we are focused on growing our mobile audience and we are making great progress. We now have over 60 million smartphone downloads and close to 40 million mobile unique users growing at 25% year-over-year. During Q1, we launched new mobile products for aol.com, Moviefone, Engadget, About.me, just to name a few.

During the quarter we continued to see strong consumer reach across our ad product and we reached 183 million people in the U.S. including 51 million women ages 25 to 54.

Second major area we’re focused on this year is to grow our revenue. Q1 was our fourth consecutive quarter of global advertising growth year-over-year. In video, we sold over 1 billion video ad impressions during the quarter, growing over 100% year-over-year resulting in 100% growth in video revenue year-over-year.

We just finished the video advertising upfront and our products were well-received. I would also point out that the video is at a watershed moment, where many clients and agencies are co-planning TV and web video together opening up the opportunity for significant budgets to move online.

With Devil, we grew the number of impressions and revenue over 80% year-over-year, Devil CPMs also grew year-over-year and Devil continues to meaningfully outperform industry averages for similar sized format.

In a study conducted with third-party measurement company Moat, Devil performed 12% better than similarly sized custom rich media format and 72% higher than similarly sized flash units.

Devil works our customers wanted and we will continue to scale it. Today, there are 54 Devil campaigns running on our properties with 36 unique advertisers, compared to 37 campaigns and 19 advertisers on our last call.

In local, we are gaining significant traction with Patch. We have now booked for 2012 115% of the revenue we recorded for the entirety of 2011. We expect revenue of $40 million to $50 million for 2012, and we also expect lower expenses year-over-year from 2011 to 2012.

The Advertising.com group had 23% growth in its fourth consecutive quarter of year-over-year revenue growth. The Ad.com group has seen very strong performance in multiple categories, as well as international.

Artie will review search and subscription revenue trends in more detail, but we are both very pleased with the performance of those areas. Search had its best performance in three years. The subscription theme at AOL has meaningfully reduced churn over the last two years.

Third area of focus is building great products and experiences. We have approximately 25 major brands now down from over 152 years ago. Operating under our 80/80/80 principle of local, women and influencers, AOL has built on the largest stables of brands in the content space.

In Q1, we redesigned DailyFinance and AOL Autos. The Huffington Post added seven new verticals and reached over 1 billion page views monthly during Q1. Huff Post also expanded internationally into France and Quebec, Canada.

We launched PawNation and Mandatory in conjunction with BermanBraun. We launched Makers in conjunction with PBS in February and have generated over 4 million users and over 8 million video views on that property. As I mentioned earlier, we launched AOL On in Beta our new video property and we now have a video hub plus an extensive video network.

One special note during Q1 is we won a Pulitzer prize with David Wood work on Beyond the Battlefield and it was an incredible honor for him, for Arianna Huffington and for the Huffington Post. It’s a great example of how powerful digital premium content has become on the internet.

Fourth area is to create technology-based platforms. In advertising, we are beginning to execute our long-term strategy of putting platforms into the daily workflow of our agency partners.

In Q1, we had the beta launches of AOP and Pictela Enterprise with multiple agency partners. Both of those products empower agencies to help their clients create and run media more effectively and efficiently.

We launched the first phase of our predictive segment advertising product, built on our large scale analytics platform, and we rolled out a number of extended platforms internationally, including real time bidding for advertising in the U.K. market.

We completed the migration of 70 million mailboxes, encompassing approximately 52 billion email messages onto one platform and we won the Uptime Institute Server Roundup decommissioning almost 10,000 servers and saving over $5 million annually.

Our fifth focus area is gain, retain and grow talent. We added approximately 300 high quality new employees to the company, while keeping headcount roughly flat. We hired more engineers in Q1 than any other position at the company. We are rolling out a new talent program that was designed and built in Q1, and targeted at growing AOL’s internal talent pool and leadership.

Over the course of 2012 and 2013, we’ll continue to drive towards profitability in all areas of the business and remain focused on improving our operating results. I can assure you the team is hard at work, making AOL a better company on a daily basis.

While we continue to focus on operations, we have also made progress in terms of increasing shareholder value. We began by unlocking value late last summer by announcing a $250 million share repurchase authorization and by quickly pulling in approximately 14% of our outstanding shares.

We recently took another major step in value creation with $1 billion patent transaction, as a fellow shareholder who works with many other shareholders, we are all interested in improving the value of AOL, both in the short-term and the long-term.

We regularly spend time with many shareholders and after listening to their feedback and ideas we’re announcing the following today. Number one, we will increase our adjusted OIBDA outlook for 2012 and note that we continue to expect adjusted OIBDA growth in 2013.

Number two, we will bring Patch to run rate profitability by the end of 2013 through revenue and cost improvements.

Number three, as I mentioned earlier, the $1 billion patent sale is not fully reflected in our valuation. To clear up any doubt about the value we will be returning to shareholders, once we receive the patent proceeds we intend to distribute 100% of those proceeds back to our shareholders in the most efficient and expedient way possible.

Number four, we will move to a segmented approach to managing AOL’s operations in a segmented public reporting format, which will further increase transparency into AOL’s business segment.

Number five, we have an active search for independent Board member and we will target to add two independent directors within the next six to 12 months. We have and will continue to solicit the best candidates from our shareholders.

In summary, we have simplified our product offering and our organizational structure. We have divested non-core assets including the patent transaction. We have unlocked over $1.7 billion of value for our shareholders since spinning-off. We have reduced the outstanding shares by 14% in just eight months and we will continue to reduce it.

AOL is a much stronger company today than it was before we spun it off of Time Warner and we’re on a path of becoming significantly stronger both in the short-term and the long-term. Q1 was a -- in a great way to start off the year and I’m very pleased with our products and proud of our teams work across the company.

As we progress through Q2, we will also be promoting key leaders and important brand roles in expanding the talent we have in the management of AOL. We are not only excited about the business but excited to make sure the key talent is in the key position to propel the company forward.

With that, I’ll turn it over to Artie Minson. Artie?

Artie Minson

Thanks, Tim, and thanks everybody for joining us this morning. We’ve been busy and accomplished a lot since our last call. We have improved the trends in almost all of our revenue streams and continue to reduce expenses. We have returned cash to shareholders through the continued repurchase of our stock.

We have now cumulatively repurchased approximately 14.8 million shares at an average price of $14.11, which obviously compares very well to where the stock is currently trading and most recently, we unlocked over $1 billion of asset value through the sale and licensing of a portfolio patent assets that most described very little value to. As such, I’m very pleased with our progress.

Before we get into Q1 results, I want to spend a minute talking about the patent sale, which was a big win for AOL and our shareholders. For me this transaction had three very important attributes.

First, we monetized the portfolio at a very attractive price. Second, we bifurcated the transaction into a sale and licensing arrangement and doing so, highlighted clearly the value of the remaining portfolio of 300 current and pending patents. And third, the deal was structured in a tax efficient manner and as a result, we do not expect to pay any material cash taxes in connection with the transaction.

At close, the proceeds from this transaction will add over $10 per share in cash to our balance sheet and as Tim mentioned, we are announcing today that all appropriate Board discussion have been had and we intend to return 100% of the proceeds to our shareholders in an expedited manner upon receipt of the proceeds. However, we are still working through the most appropriate tax efficient manner to return the proceeds to shareholders.

From day one, our goal has been to do two things at AOL, create great consumer and advertising experiences and create unlocked meaningful value for our shareholders. We accomplished both of those goals over the last three months.

Turning now to the results. In Q1, we made continued improvements to most of our main revenue streams, which resulted in a total revenue decline of 4%. Our goal is sustainable growth and our trajectory is in the right direction, and compares very favorably to the 17% decline we experienced in Q1 last year.

Looking through the individual revenue streams in a little bit more detail, global advertising revenue grew 5% year-over-year, the fourth consecutive quarter of year-over-year growth.

Fueled this quarter by growth in third-party network and global display revenue, which combined grew 10% and offset lower search revenue, which declined as Tim noted, at its lowest rate in three years.

Looking at the combined O&O and third-party network view puts AOL on an apples-to-apples footing with some of our competitors who report O&O and network together.

Global display revenue grew 1% year-over-year on a reported basis, a decline in the number of reserved impressions sold during the quarter resulted in a 5% decline in domestic display revenue on a pro forma basis, which includes revenue from the Huffington Post in both periods.

The decline in reserved impressions was due in part to discrete client related issues were in at least one instance, a large partner temporarily suspended digital ad spend during the quarter and in part due to an increasing demand for performance-based advertising through Ad.com.

Encouragingly, reserve pricing continued to grow in Q1, with advertisers remaining willing to pay premium prices for premium placement and formats besides premium client. We also witnessed rapid expansion in three very high growth areas, video, premium formats and local with Patch growing revenue strongly.

We currently expect improved trends in Q2 as compared to Q1 and we expect to return to year-over-year growth for domestic display in Q3 and Q4 for which the pipeline already looks encouraging.

Keep in mind that had we grown pro forma domestic display this quarter at the rate we grew it in Q4 that total company adjusted OIBDA would have grown year-over-year. So we are very close to getting all things right at AOL.

Third-party network revenue grew 23% year-over-year in Q1, its fourth consecutive quarter of growth year-over-year. Underlying this 14% year-over-year growth in Advertising.com, due namely to growth in the number of advertisers and publishers we work with, as well as the number of impressions we serve.

Over the past year we have significantly expanded our premium solutions to advertisers and publishers, and we have invested in our sales team, which has allowed for deeper penetration with key clients.

Encouragingly here we are seeing very strong organic growth from the acquisitions we have made to augment our network offering. Particularly with video, with well north of 50% revenue growth coming from 5min and goviral, both of which have a higher margin profile than a typical network business.

5min was fully anniversaried in Q3 last year and we had goviral for two months of this Q1 last year. We are very pleased with the contribution from these acquisitions and they’re off to a good start, and they are part of the reason that the third-party network revenue net of TAC increased by approximately one-third year-over-year.

In fact, you will note that despite the sequential increases in third-party network revenue, TAC declined sequentially. So in addition to overall revenue growth we are seeing margin benefits from the mix shift.

Search and contextual revenue, and subscription revenue trends continue to improve meaningfully during the quarter. Search and contextual revenue declined only 6% year-over-year in Q1, and actually grew sequentially for the second consecutive quarter.

This is especially encouraging given the typical seasonal strength of the fourth quarter and the current declining CPC environment. As you know, we have made significant improvements to our search product and experience over the past year, which have resulted in meaningful improvement to our search revenue trends.

Dissecting the individual components of our search revenue, as has been the trend, this quarter’s declines were led by fewer queries from co-branded portals and international markets, due primarily to our exit in 2010 from unprofitable distribution deals and markets. This group now represents approximately 30% of our search revenue and declined by approximately 20% in Q1.

We also had fewer queries from the AOL client reflecting the subscriber decline. This group also represents 30% of our total search and contextual revenue, and declined also by approximately 20% in Q1.

Notwithstanding, these declines, total search and contextual revenue trend improvements were driven by continued growth in search revenue from AOL.com, which now represents approximately 40% of total search and contextual revenue, compared to only 30% a year ago. So clearly we’re seeing some strong growth there.

Ending the revenue dissection with the subscription service operations, subscription revenue declined 15% year-over-year, which compares to a 24% decline in Q1 of 2011 and continues a now well-established trend of improvement.

Over the last year we’ve been working very hard to reinvent our subscription service away from internet access as a value proposition to much more of a premium subscription offering.

Value-add products and services our subscribers now receive as part of their subscription package, include product such as PC support and protection like LifeLock, McAfee and SugarSync, as well as value-added services such as Private WiFi, Password Manager, PC insurance and discounts on products such as Sprint. The result is the total value far in excess of what our subscribers pay for their package.

Our actions have significantly improved their subscriber metrics. When we spun-off from Time Warner in December 2009, we had a subscription operation which we’re selling dial-up access with subscribers declining 27% year-over-year, churning at a monthly average rate of 3% and with ARPU declining.

In Q1 of 2012, subscribers declined 14%, monthly churn was 2% and importantly, ARPU was flat both sequentially and year-over-year. We are incredibly pleased with our progress here and we continue to see improvement.

Churns for both March and April was in the 1.8% range, each basis point of improvement in these metrics has a meaningful impact on profitability and we are working really hard here to continue to improve results.

Turning now to expenses. During the quarter, we continued to reduce our expense base and even did so sequentially despite the seasonal uptick in Q1 expenses that we traditionally see in employee expenses.

Q1 adjusted OIBDA expenses excluding TAC and a legal settlement in Q4 2011 declined by 7% year-over-year and $6 million sequentially. This is the third consecutive quarter of sequential declines in adjusted OIBDA expenses, excluding TAC and the Q4 2011 legal settlements.

This in addition to advertising revenue growth and improved subscription, and search trends resulted in our lowest OIBDA decline in four years.

Taking a step back, you can see that Q2 -- since Q2 of last year, we have cut $35 million of adjusted OIBDA expenses less TAC on approximate $140 million in yearly run rate. We have reduced expenses, while still investing for future growth and we will continue to look at ways to operate more efficiently.

With EPS growing again, our next goal is adjusted OIBDA growth and our trajectory is pointed towards that goal. We have now put together a string of quarters of improved revenue trends and meaningful cost reductions, which will positively impact this year and next.

As a result, while I said on the last call that we are comfortable with analyst full year adjusted OIBDA estimates, which were at that time and remain today approximately $310 million.

I’m now comfortable saying that adjusted OIBDA for the full year will be approximately $350 million, excluding the impact of any expenses and fees related to our proxy contest and our release recent patent sale.

This guidance contemplates reinvestment for growth in the Huffington Post streaming network and in our third-party network operations, primarily 5min and goviral given the substantial opportunities we are seeing in video. These are investments that we expect will payoff in 2013 and beyond.

I will also note that it is still our expectation to grow full year adjusted OIBDA year-over-year in 2013. We have spoken often of our five pillars to grow, combined display growth, Patch revenue growth, contributions from acquisitions, moderation in search and subscription declines, and finally, strong expense control. We have made progress in each of these pillars and we expect to continue to improve.

Turning now to the balance sheet, we had $361 million of cash on hand at the end of the quarter. As expected and as was the case in Q1 2011, free cash flow was negative reflecting the payments during the quarter of employee bonuses for 2011.

However, you will note that this quarter’s free cash flow decline meaningfully improved versus Q1 of the prior year, aided in part by lower capital expenditures. Going forward, we expect a healthy conversion of adjusted OIBDA to free cash flow at a rate similar to what we saw in 2011.

We continue to repurchase stock during the quarter, taking in 1.8 million shares at an average price of $17.65. We have now spent $209 million to repurchase 14.8 million shares at an average price of $14.11.

As I noted earlier, it’s more than $10 lower than where the stock trades today. As we noted in the earnings release, during the quarter, we temporarily suspended our repurchase program.

Before I close, I wanted to elaborate a bit on Tim’s point on how we will manage the business and its impact it will have on financial results going forward. Now two full years as a public company, we’ve gotten to the point where we have addressed many of the major structural issues that needed to be addressed to position the company for success.

The next step we’ll begin to move to a more segmented approach to operating the company, which will provide individuals running their businesses with more operating and financial control over their results.

As a result of these operating exchanges, we would expect to move to segment reporting by year end. At that time, we will of course provide you with all the necessary historical numbers and metrics, so that you can update your models with ease. We hope this more granular look into our financials will more clearly highlight our progress to date and the inherent value of the company.

So to conclude, our results today represent another meaningful step forward in the turnaround of AOL. I’m very pleased with our progress and I look forward to your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Ross Sandler, RBC Capital Markets.

Ross Sandler – RBC Capital Markets

Great. Thanks, guys. Just two quick questions. First, free cash flow and then second on the search business. So Artie, you guys have mentioned here that you turn the corner on OIBDA in 2012, you expect OIBDA to grow in 2013.

So your free cash flow conversion in the first quarter here looks a lot better than it did in first quarter of 2011. So any reason to believe that free cash flow won’t also turn the corner this year and grow in 2013?

And then on the search side, the declines continue to moderate. So can you give us some color on how you’re doing this? So if you look at third-party traffic stats it would suggest that queries are still declining and I know you mentioned that AOL.com is actually growing double digits? Are you monetizing AOL.com better or you are driving more queries or both? Thank you.

Artie Minson

Sure. Let me hit the free cash flow question first. As you pointed out, the first quarter free cash flow when you compare to last year was a meaningful improvement. As you move through the back half of the year what we expect to see is continued healthy conversion of OIBDA into free cash flow, so you should expect to see meaningful free cash flow generation in the back half of 2012.

As you move to 2013, what I would expect is a healthy conversion again of OIBDA into free cash flows to the extent that you can grow your OIBDA in 2013. I wouldn’t expect any difference really going forward the OIBDA to free cash flow conversion. So therefore you should expect to see a free cash flow improvement as well.

Let me turn to search, we’re obviously really pleased with the direction of the search trends and it’s something, we’ve been talking about for a while now that you should expect to see as we work on getting the overall company back to OIBDA growth.

Growth in AOL.com as you pointed out has been particular strong and I do want to give a shout out to Chris Grosso who runs the AOL homepage and Francis Lobo who among other responsibilities here run search, as well as their respective teams who work so well with the team to really operationalize the number of features that have improved the search experience and ultimately lead to improved financial performance here.

We’re also focused, which I want to point out is just we are not satisfied with some of the areas in search that are declining in the 20% range. For example, 6 million people still use the AOL client every month. And we’ve put a small team together to do a project cleanup of that product, and our view is basically look if you can get the user experience right that’s going to ultimately lead to financial results.

As we lookout on search, I think to point out the obvious, there are some items we control and there are some items like the current CPC pricing environment, which is down that we can’t control.

So that makes the search area little bit harder to predict if we can get the declines low in that, when you’ve seen in the last two quarters but we’re very pleased with, the results of the last two quarters and it continues to be vary volume is strong as what you’re seeing is click-throughs are strong given the improved product.

Tim Armstrong

I’ll also just add I think little bit to search deal that we did. That’s what Chris and Francis worked on overall and we have partnership with Google remains strong. And also Ross, Artie and I just want to wish you well. I know you’re about to have a baby. So thanks for the question and good luck with you and your wife.

Ross Sandler – RBC Capital Markets

Thanks, Tim, and nice job this quarter, guys.

Operator

The next question comes from the line of Ben Schachter, Macquarie.

Ben Schachter – Macquarie

Hey, guys. Congratulations on all the successes here so far. And looking at other assets that you have, how could you rank sort of assets that you think are unappreciated by the street or undervalued and that you could potentially monetized?

And then can you talk about investment areas that you may not currently be in? Tim, you use the reference of being on offense. What are the areas that you might want to get into more in the future, let me know?

Artie Minson

Hey. It’s Artie. I will hit on valuation a little bit, I mean, look -- if you look at the stock today and you sort of back out the cash. The stock is trading not much differently than where it was frankly trading in August, despite what I would say meaningful operational improvement.

So really other than what we’ve really historically I think been primarily valued around the subscription business. There is not much valuation as best I can see it from a lot of other pieces of the business. So, we will point that out. I’m not going to comment anything specifically with respect to future asset sales that we may do and why don’t I turn it over to Tim for a second.

Tim Armstrong

So investment areas, Ben, there is a, let me just hit a few of them and we’re pretty focused about what we are looking at in terms of other investment areas. One is mobile. One of the things that we really tasked our team with this year is a concept we call Mobile First, which is basically designing products from mobile back to the web, instead of the web to mobile.

We just did a product review this week of our first property that was really designed from a mobile backwards standpoint and I think it’s really impressive, and the general gist of that investment is, we -- if our content is like Coca Cola, we are going to serve it in different size servings, 8-ounce, 16-ounce, 36-ounce whatever.

We basically believe that designing our products and services for the smallest unit possible and making that great, will translate even better to the bigger units over time. So, I think you should expect to see us come out with a number of mobile first investments.

I’d also say, there is a product with Huffington Post we’re coming out where that we’ve talked about a little publicly around mobile. That we are excited that the tablet based product, we are excited about. And then we have a number of different investments in mobile advertising.

The other area that I think we’ve been looking at is investments in Advertising.com group overall, which continues to do well and I think we’ve seen some really good progress there and things like the 5min and goviral, as well as the traditional Ad.com business. So we have an investment area there to basically put platforms into our customers and scale up video and some of the targeting in big scale beta projects there.

And then the last area I would basically say is around what I would say are differentiated, profitable and scaled content opportunities. Patch is working on new product right now, which we’re excited about.

We launched Makers was a great example of a video product we did, profitable out of the gauge very, very good experience overall. So we have a number of things that we’re working on in kind of the experienced content area that are also very commercially viable in terms of profitability and those things.

But we’re really targeted that we run the entire company off a top box metric, where we measure every single thing we’re doing as a company and what we’re investing in and more importantly what we’re not investing in. So I think we’re really clear in our future investments overall.

Ben Schachter – Macquarie

Okay. Thanks and good luck.

Tim Armstrong

Thanks.

Operator

The next question comes from the line of Laura Martin, Needham.

Laura Martin – Needham

I have one for Tim and one for Artie. Tim, can you update us on Starboard, we are getting rumors in the press that you may saw. Could you talk about what’s going on with your discussions with them?

And then Artie on timing, it sounds like you guys have committed today to pay back all of the patent tax sale proceeds, we’re using AOL tax rate of under 5%. Could you confirm that that’s looking like you are tax experts, that’s about the right number or better? And what’s the timing on getting that money back out to shareholders, please? Thanks.

Tim Armstrong

Thank you, Laura. On the Starboard front, just to give people an update, so we’ve been in regular contact with them and have put offers on the table for settlement. Starboard folks haven’t -- have declined to see what we were going to announce on the earnings call today overall due to whatever their process is.

But we believe fairly strongly I think that with Starboard and AOL. I think there is absolute alignment on increasing shareholder value and short-term, long-term, I think there is probably disconnect in terms of, their focus is probably more on short-term, ours is on short-term and long-term, overall.

But I think as me and myself personally being a major shareholder and having spoken to all of our major shareholders at this point, we feel confident in the position that even the things that we announced today are really unlocked step alignment with what we hope to accomplish short-term and long-term. So barring any other changes, I think we’ll be going to a proxy contest and we feel good about our position in that and what we’re going to do moving forward.

So obviously, it’s in everybody’s best interest because it’s really expensive. And it’s also has not been helpful for us during the upfront advertising process to have lot of noise around our content business because major customers basically don’t put major investments in when they think things are unstable. And there has been a lot of press about the situation.

So I think from Starboard’s standpoint and our standpoint, resolution would be great. I don’t see any resolution on the horizon right now. So I think we’re kind of planning on heading towards the proxy contest and working with our shareholders and the announcements we’re making, I think will help us in that regard.

Artie Minson

And Laura, on timing of the patent sale proceeds, no change to what we announced when we announced the deal, which was we expect to do it by year end. I think there’s a chance it could happen earlier, but I think right now we’ll stick with that original timing.

With respect to taxes on the deal, we don’t expect any material cash taxes in connection with the deal. As you know, there was basically a sale piece of it and then for the patents we kept, there’s effectively a license on that given the fact that we effectively triggered a net capital loss in connection with the deal of approximately $1 billion, which is something we have flexibility if we chose to sell assets in the future.

We have that, that carries forward for five years, but there’s no cash taxes expected on the sale. And with respect to income taxes on the license, those will be sheltered by existing deferred tax assets. Our plan this morning is we will be sending 100% of the gross proceeds back to shareholders.

Laura Martin – Needham

Very helpful. Thanks.

Operator

The next question comes from the line of Mark Mahaney, Citi.

Mark Mahaney – Citi

Great. I want to ask two questions please. One on Patch and one on domestic display advertising. On Patch, I think Tim, you said that you expect about $40 million in revenue with expenses down year-over-year for Patch. Could you just help us understand the second part of that, I think Patch, I think is still in growth mode?

I don’t know that there’s a lot of start up cost, but maybe I misunderstand that to the business. I could see you get leverage and profitability out of -- due to growth, but not due to actually declining expenses. How do you do that and still grow the overall Patch business?

And on the domestic display side, you talked about seeing a return to your year-over-year growth for the domestic display on a pro forma basis in the back half of this year. Any more color as to why the confidence in that 5% decline in the March quarter obviously was disappointing, I think to you, I’m sure it was. That’s -- given the overall growth in this domestic display, advertising, that’s a significant outlier. So what do you need to do in order to improve that or was that really due to, kind of, one time-ish events during the quarter? Thanks a lot.

Tim Armstrong

Sure Mark. So basically on Patch, the range we gave was $50 million. I hope we can get over $40 million this year in Patch. On the cost structure side, I think one of the things that we continue to do since day one of Patch is we basically look at Patch as an operating model, on a per count sort of cost basis, revenue basis.

And then we have regionalized those into buckets and the Patch team basically over Q1, more smartly organized basically, the editorial process and the revenue process together and did something they called the OTOG structure, which is One Team One Goal, where basically everybody is transparently aligned on, how do you continue to run talent more efficiently, how do you get content more efficiently, how do you get advertising more efficiently.

So we’ve done a really good job of basically bringing our cost structure in line and down over time and my guess is, there is more cost improvements that can be done over time. And I would just highlight a couple of things on Patch overall. And there is a lot of noise about Patch is -- at a very base level, the economics in the individual talent, which we have talked about on these calls before, remains a really core value proposition for us, long-term profitability wise for that business.

And number two is, we’ve just started ramping up sales last March. So to basically be on $40 million, $50 million run rate after really starting to hire salespeople last March. There’s not too many businesses that have been on that type of trajectory overall.

So I think the fact that we’re focused on operational cost improvements, which we have done. And then on the revenue improvements and then we have a whole bunch of products that’s coming out in a pipeline, coming up which will help out the cost structure over time as well.

So I just -- there’s a general sense, Patch is kind of this giant uber number and spend. But in actuality, we look at it at a very piece by piece basis.

On display, let me hit this one really directly. And I’m not going to beat around the bush on this one. I think that company did an excellent job and our team did an excellent job on basically four out of the five or 4.5 out of five revenue streams. I think we’re one of the only companies that breaks out domestic display as a number and we’re happy to do it.

I was not happy with the domestic display over the course of Q1. We have a great sales team. We’ve very strong relationships in the marketplace. And I think that’s kind of precise color on that display number and why we think it’s going to go up in the back half of the year.

And Artie mentioned, one is we see the pipeline improving, two is we have a more structured approach to go-to-market strategy, which is more data centric, more ROI centric, most of the display customers at this point are very KPI focused. And I think a couple of significant changes have happened over the last few years but fact of the matter is search and some of the ROI types of advertising drove the marketplace with very few metrics.

Those metrics have now come into more of the display marketplace. Our teams where I think if you think about why display was not where we want to be in Q1, a lot of it was because we had a sort of sales strategy that was probably off tuned a little bit. And we’ve now tuned it back up and the product portfolio simplified the data structures and we’re much more kind of KPI focused now with customers.

I’ve spent tremendous amount of time in the last four weeks with customers and with agencies. I just had another agency CEO meeting yesterday. I have two over the next two days. And I can tell you, there’s a lot of interest in our display products.

The pipeline is growing. And then we’re also focusing on not the old display market, but the new display market. And I think the video and things like Project Devil and Pictela, those things are growing quickly.

So we fully expect display to recover this year and just as we’ve seen the recovery in the ad network and the work we have done on churn and search, we have the same level of intensity on display. So I don’t want any investors get off this call thinking we’re not laser focused on display. It’s a big opportunity. There is a lot of money coming into that marketplace.

Mark Mahaney – Citi

Thanks Tim. One quick follow-up question, you made a comment earlier about the TV advertising, video advertising that may be something of a tipping point. When you think about the obstacles that are set up there to -- there is significant moats around I guess TV ad budgets and TV ad spending, but there is significant potential for that to migrate online. What do you think the timing is like? What do you think of that, two or three things that really have to happen for those budgets to meaningfully move online?

Tim Armstrong

They have -- went through a couple of meaningful movement in the past. I think basically it has to start with the will. The will is there. I’ve met with some of largest TV buyers in the country in the last four weeks, five weeks and all of them are trying to move single to double-digit percentages of the TV budgets towards online video overall.

But the will part is there, the way part is what I think will be the hurdles you talked about which is -- that is like this is a first year and many are the cases the large agencies and TV clients have mix web video with their TV upfront together. And it was kind of clunky process to watch just because it’s the first time all these bodies have tried to be good on the same process.

Second hurdle, which I think is actually going to be a benefit for web video is just making sure the TV buyer and a company that spent money on TV that you understand the translation between impression on TV and impression to the web.

And this is probably the most encouraging part for me being able to talk to our customers, it’s -- the end relation I’m hearing in the marketplace is that there’s actually a multiple benefit if you measure one TV impression versus a web video impression because the consumers tend to be more engaged.

I think over time that metric will happen. And then the third thing is just actually continuing to build up a piping to take that large-scale amount of money. So my guess is the will is there to spend single to double-digit increase from TV to web.

And I think the way it’s going to require basically the body is getting more organized, the metrics getting a little bit more organized and then the kind of infrastructure to take that money. But there’s no doubt in my mind, it’s going to happen. This year I don’t know what it’ll be, but over the next couple years I think you’re going to see dramatic increase.

Mark Mahaney – Citi

Thank you, Tim.

Operator

The next question comes from the line of Peter Stabler, Wells Fargo Securities.

Peter Stabler – Wells Fargo Securities

Good morning. Thanks. Wanted to go back to mobile. Could you give us a little bit more color on what you think the complexion of monetization will look there. Obviously, it’s become a focus for every major content producer on the web, but there seems to be a level of concern about monetization rates when you talk about the ROI and potential ROI drive off of clicks on mobile inventory. So are there possibilities for other monetization streams via mobile perhaps transactions or something else besides banners in length? Thanks very much.

Tim Armstrong

This is Tim. One of the things we just launched actually, which I -- so you just hit the nail on the head, which I think is mobile monetization is going to rely on a creativity of mobile advertising formats and more commercially viable ad models for mobile. One of the things we just launched was the Click-to-Call. So users can basically, instantaneously click to call and interact with the advertisers overall.

And I think those are the type of products in the market that are actually doing well now, and will continue to do well. There is a number of other things. There is a lot of investment and focus here in the startup community, as well as in places like AOL and probably some of our competitors, which is -- in a couple of different buckets.

One of the formats around mobile, what do you put on a screen and what attributes does it have, which is important. And I think there is a lot of innovation. We’re spending a lot of time on it. The most exciting thing happening at AOL, which I’m really excited about, and Greg Rogers and his team at Pictela has been leading.

Pictela just came up with a Project Devil for Mobile basically, which we have out and is really exciting. And I think will grow quickly. And then things like the mobile call to connect.

The second thing is just, kind of, what I just said about the TV buying also is, there is a lot of interest in mobiles. There is a lot of customers that want to spend on it. I would say it’s in the testing phase right now for clients overall, but if you look at usage trends and statistics, some of our properties have double-digit traffic on a daily basis now in Mobile. And I have talked to a lot of our competitors, and their customers who have the same thing.

So my guess is, you are going to see a very significant amount of innovation in mobile advertising. And we are working on Project Devil to mobile, with kind of things like Click to Call, then I’m not going to go into detail on it. But we actually have been working on a fairly unique ad network product, because mobile doesn’t have a lot of cookies attached to it, which is different than traditional Ad.com, where we have some innovation there that we have been working on and looks promising.

Peter Stabler – Wells Fargo Securities

Okay. And can we assume that 5min and goviral could potentially be extended into mobile as well?

Tim Armstrong

I think actually one of the reasons we invested so heavily in video, because video is mobile as well. So I think one of the clear-cut cases, which maybe we have described enough is our video investment is also a mobile investment. And we are really interested in it.

I would also go back. I won’t go into detail on it, but we had our first real significant product this week in terms of mobile first build out and the mobile first build out is actually targeted at not just the content, but also the monetization. So, I think I would expect mobile to improve at AOL and in the industry over the course of this year. But I think it’s on everybody’s radar screen because it’s an important topic.

Peter Stabler – Wells Fargo Securities

Thank you.

Operator

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

John Blackledge – Credit Suisse

Great. Thanks. Two questions. The first one is with the majority of the advertising growth coming from Ad.com in the first quarter, which includes obviously the contributions from goviral and 5min. If you could comment on the impact to the margin profile given the changing top line mix shift there at the third-party advertising line item?

And then Artie, if you could just maybe give us a sense of how the proceeds from the patents will be returned as one-time dividend or share buyback or a mix? Thank you.

Artie Minson

Hey, John, let me take both those. What we saw in the third-party business is while we had 23% growth in the top line, the growth of sort of net of TAC was more in the 33% range. And what we’re seeing effectively is 5min and goviral have sort of higher margin characteristics than the traditional business.

So the OIBDA growth outpaces the revenue growth. And actually if you look at it what you’ll see is from fourth quarter, the first quarter you saw sequential uptick in the revenue line, but you actually saw a sequential reduction in the TAC line. So that’s probably just the most obvious place to see that you’re seeing just an overall margin shift mix within the third-party network business, which is obviously providing a benefit.

And so you combined to sort of the 50% plus of revenue growth we’re seeing in those acquisitions plus the margin benefits they are providing, they’re really proving out to be great acquisitions.

On the proceeds front, we have not made the final decision between buyback and special dividend. It’s something we’re working through with the Board. As I mentioned, there are some tax simplifications, just given the fact that we have frankly bought back 15 million shares. There is a cap and frankly, which we’re working through of how much you can buyback before you effectively figure a change in control of the company which could have an impact on our very valuable tax attributes that we have as a company.

So one of the things we want to make sure we do is make sure we don’t trip that caps. So we’re working with our tax advisers on that. We certainly have room to buyback more. But doing the whole thing in terms of buyback would be probably difficult to do, although we do certainly like buybacks given where the stock is currently trading.

John Blackledge – Credit Suisse

That’s great. Thanks. Thanks, Artie.

Operator

The next question comes from the line of Tom Forte, Telsey Advisory Group.

James Cakmak – Telsey Advisory Group

Good morning. This is James actually, calling in for Tom. Can you talk about the thought process behind returning a 100% of the cash to shareholders versus special M&A activity as you did with Huff Post. Do you feel that your current cash balance and cash that you can generate is sufficient to continue with the long-term mission for the company?

Tim Armstrong

James, on-premise basically on the operating in the companying and our strategy, we have a pretty significant strategy, which gets a lot of attention. And I think over time, we basically have, really changed almost $2 billion in assets as a company and really set ourselves up with pretty significant platform for growth.

And from this standpoint right now on M&A activity, we don’t have anything on our radar screen at the price level or focus areas that would require that type of capital. And I think one of the things that we’ve done a good job of is continuing to make operations more efficient and generate a lot of cash overall.

So as the stock price improves, as our cash position improves, we don’t feel the need to basically hold onto that level of cash. And I think the best investment we’ve been making recently has been in ourselves.

So you will see us continue to be aggressive on our strategy. And I do not want also the investors to think that by returning 100% of the cash that we’re changing the strategy of the company, we’re not. And we’re very excited about the things that we’ve been working on and innovating on. But at this point, if we had a good reason to hang onto the $1 billion, we probably do it.

We -- our cash flow going to add cash over the course of the year. And we have a significant amount of cash now. And I think the operations will get better. We just will raise guidance, those types of things. So that’s the thought process behind it overall.

And as far as what you should expect out of this year and as I said earlier, I think very solid focus on technology and product. And we’ll be making more announcements about that coming up. But we felt like it was in the right best interest of all our shareholders to return the capital.

I think we smartly and our Board very smartly took the time and energy to kind of focus on how to do it appropriately. And we are going to continue to work on that. And the first step number one is close the transaction.

James Cakmak – Telsey Advisory Group

Okay. Got it.

Artie Minson

The only thing I would add is, just if you take the current cash position, you project out sort of the balance of the year, when the patent sale will close, exclude the patent proceeds, I mean you are looking upwards of $0.5 billion of cash that we will have on the balance sheet, which we certainly think allows us financial flexibility to run the company. So we are very comfortable with that position.

James Cakmak – Telsey Advisory Group

Got it. And secondly, the growth on the video side was very impressive in the quarter. Can you just -- the questions that have surfaced are on the display side of the business ex-Patch, Patch the questions on the profitability there. Can you talk about investments that are necessary to make to continue to grow that video business, original content and so forth? And how can we expect continued growth and scale and the profitability within that business as we go forward?

Tim Armstrong

I will just make two comments on that. One is that the video platforms that we have and have invested in, one of the reasons we did the acquisitions and have built out some of the video platforms is because they are very-very scalable.

And from the standpoint of investments, I think there is incremental investments we are making into both technology and people on video. But the opportunity in video far outstrips the investments -- the incremental investments we are making on a go forward basis.

And then, second of all is, things like AOL On, which we just launched. We see significant gaps in the video marketplace that we plan on being aggressive about in terms of filling. So, if you look at our video investment, you basically have AOL On, which we just launched. You have goviral and 5min networks, which are really significant and have been growing nicely.

You see our owned and operated video process and then you see the investment that we’ve been putting into HPSN, which is the streaming network Huffington Post is launching on video. So, in terms of robust video strategy and the money we spent on video, we’re in a good position to scale it up very quickly but also at an incremental cost, not at a balance cost structure and that’s something we’re excited about.

James Cakmak – Telsey Advisory Group

Great. Thank you very much.

Operator

The next question comes from the line of Anthony DiClemente, Barclays.

Anthony DiClemente – Barclays

Good morning. Thank you. Continuing along on the video questions, I want to ask more about your On network, the video network and how it differentiates itself from the other video networks in the space. And then, just given all your efforts in video, Tim, I think we should hear about where you think ad format is evolving longer term. Wondering on the longer term split in video between performance based ads and impression based following along an earlier question about the TV dollars migrating to video.

And then on display, I think in the past, Tim, you’ve differentiated between pricing trends on different classes of display inventory that would be helpful for us if you could just give us your thoughts on where premium versus non-premium in the different classes and how pricing is trending? Thanks a lot for question.

Tim Armstrong

So just quickly on the competitive front, the video marketplace, AOL On fits into basically what we would call curated video channels. And I think from that standpoint when we announced it, we announced a whole bunch of different partners across 12 to 14 different video channels.

And we kind of look at the marketplace as having YouTube, which has been really successful on one end and a lot of investment in content going into YouTube probably less curated than we’re thinking about. On the other end, you have things like Hulu, which have done a great job. It would kind of, sort of TV -- yesterday’s TV type content and then you have the premium players like Netflix on the subscription side.

We’ve been really watching closely and consider it over the fact that we have 300,000 plus premium video assets both at AOL plus our other partnerships. And we believe that there is a very programmatic approach, very low cost of programmatic approach to curated video and deep interest verticals, which is what we’re pursuing.

And I think we fit nicely into the marketplace compared to the other video properties and I’d expect us to announce more curated areas and more curated people over time. But very heavily programmed overall which we’re excited about and it’s a great opportunity for our partners.

On the video advertising marketplace, I think you’re seeing the kind of start of the different formats that are coming out in video. And we think about video advertising in the future, I think there is a couple of different areas that are important. One is on the performance side, which there are performance video ads out now, there is a lot of work going into basically clickable format. And also we are having not just on the surface for consumers but a very high level of targeting underneath the surface for the video.

So, what videos to show to what consumers at what time, very similar to the big data projects we run on the ad networks. And we’re starting to mix both Project Devil and Pictela Ad.com and then the goviral, 5min technologies together to leverage that on ROI side.

On the secondary side, on the brand the TV Dollar moving into the video space, I think there is a lot of interest from our partners in terms of what I would call well lit and high scale platforms around content and brand advertising, the Makers side and I would just -- let me sideline for one note. If you are a mother or a father or related to anyone who is a woman in the world, you should go to makers.com and look at the content there, because it’s really impactful and the type of content.

I hope we continue to do in the future. It also is a very good video experience. And I think with a brand that we partner with Unilever’s simple brand. That’s the type of experience, I think is a big opportunity on the display marketplace overall.

So I would expect there to be a bifurcation ROI versus brand. I will also just certainly point out I think all advertising is getting out more customers and more revenue. So you’re going to see massive analytic in the video space on both areas.

And on display pricing trends, I think Artie mentioned, and we’ve seen this overall as our display pricing trend have been positive overall. And I think you see basically customers paying premium price for premium opportunities and something that we’re focused on. And then on a ROI side of things, I think the customers were doing and our ourselves also for the customers in the trends in the ROI space over time have been strong and again very verticalized by industry or by category.

So the auto channel is much different than the ROI pricing pharmaceuticals versus CPG. Customers are getting very smart about CPA’s. They’re willing to pay CRM prices for CPA, those type of things. I think it’s important to note that -- I think it is a perception that there is a flood of inventory and pricing is going to go down over time. But I think what’s going to happen is premium pricing is going to remain stable.

And I think you will see the CPA pricing basically get more and more differentiated by category overall.

Anthony DiClemente – Barclays

I think we have time for one more question.

Operator

The next question comes from the line of Heath Terry, Goldman Sachs.

Heath Terry – Goldman Sachs

Great. Thanks. Tim, I was wondering if you could just give us a sense, when looking at the growth that you’ve seen in display and the acceleration in growth that I think you are expecting. When you look at it across the components of mix and volume and pricing, what are you really relying on and where should we expect to see kind of the most progress early on?

Tim Armstrong

Let me again hit this in a couple of different spots. One is, if I look through our industry verticals for advertising, the network was up substantially across just about all of the major industries for advertising, whereas O&O and that’s kind of traditional O&O was not up.

And so when you start to dig in and I have been through this data, just to let you know, we have our full attention on this issue now. So having been through a lot of data and a lot of customer meetings, I think you should expect us to improve on a category-by-category basis.

The overall owned and operated in each of the specific verticals and we recently broke all of our data and information out into those verticals. So I think number one is, when we get on these calls going forward, you should expect me to say or Artie to say you can ask us, have you seen recovery in the industry verticals for owned and operated display. I would expect us to show improvement there.

Second thing is, I would expect improvement in terms of continuing to grow out the formats in video and some of those things where, traditional display is not necessarily a growth marketplace online now and we are changing a lot of our inventory into the other segments. And I think you will see us continue to grow those areas.

And then I think as we kind of continue to align our sales force and process, and structure against the best opportunities. I think we will have more information to talk about, just in terms of how do we unlock and unleash a lot of the brands in the salesforce in a much more open way to more customers to grow revenue.

And finally, the agency community is a big opportunity and we have very significant programs going on with agencies. So I expect the agency revenue to continue to improve over the course of the year. So, those are the types of things that you ask us about.

And then just wrapping up the call, I would just say in summary, operations are better. Last year, we had four to five areas of major red alerts around revenue that we’re continuing to fix and the comeback of AOL. Display is the one thing we’re focused on, but you’ve seen meaningful improvements in the other areas.

Now, display is getting our full attention. I think we’ve very, very clear alignment with our shareholders. I think you can expect a lot of noise between now and the proxy contest overall. I would not mistake that noise for what actually we’re focused on and doing. And I think the announcements we’re making today in earnings calls as well as the earnings themselves. The value of the company should go up overall.

And I would just finally end on something that’s important is the AOL team and leadership, I just want to say thank you to them, where we’ve been operating in an environment that’s been difficult to come back. We have the occupy AOL folks happening. And I think we’ve been really focused on continuing to operate through all of the areas that we are focused on.

And then overall as a leadership and management team, we’ve been playing, what we call internally our down situation, where we’ve navigated through these major things like the patent sale and some of the other shareholder issues while we’ve been continuing to operate the business.

And I think you’re going to see us continue to expand the leadership structure and a huge thanks to people like Artie and Julie Jacobs, our GC and some of the other management team members we have. I think they’ve done an exceptional job and we’re going to continue to do an exceptional job as we go forward. But thanks for joining the call today and we’ll talk to you soon. Thanks.

Operator

And thank you, again ladies and gentlemen. This concludes today’s conference. You may now disconnect and have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: AOL's CEO Discusses Q1 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts