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AOL, Inc. (NYSE:AOL)

Q2 2012 Earnings Conference Call

July 25, 2012 08:00 AM ET

Executives

Timothy M. Armstrong - Chairman and CEO

Arthur Minson - CFO and COO

Eoin Ryan - VP, Investor Relations

Analysts

Anthony DiClemente - Barclays Capital

Ronald Josey - ThinkEquity LLC, Research Division

Laura Martin - Needham & Company

Mark Mahaney – Citigroup, Inc.

James Cakmak - Telsey Advisory Group

Peter Stabler - Wells Fargo Securities, LLC

Ken Sena - Evercore Partners, Inc.

James Lee – CLSA

Sean Kim - RBC Capital Markets

Victor Anthony - Topeka Capital Markets

Operator

Good day, ladies and gentlemen and welcome to AOL’s Second Quarter 2012 Earnings Conference Call. My name is Towanda, 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’d now like to turn the conference over to Mr. Eoin Ryan, Vice President of Investor Relations. Please proceed.

Eoin Ryan

Good morning. Thanks, Towanda, and everyone for joining us for our second quarter 2012 earnings call. You can find our Q2 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 Operating and Financial Officer, Artie Minson. Tim and Artie will make some brief remarks on the quarter and on our overall strategy, and then we will open the lines up for Q&A.

But first I will remind you that during this call, we may discuss our outlook for future financial and operating performance, corporate strategy, marketing and product plans, technology improvements, cost initiatives, planned investments, as well as our expectations for the economy and online advertising in general.

These forward-looking statements typically are preceded by words such as we will, we expect, we believe, we anticipate, or similar statements. These forward-looking statements are subject to risks and uncertainties, and our actual results could differ materially from the views expressed today. Our quarter results should not be indicative of future performance.

Some of these risks have been set 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, July 25, 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.

Timothy M. Armstrong

Thanks, Eoin, and thanks to everybody joining on the call. Overall, I’m very pleased with the results we’re posting today. While we walk through deeper results from Q2, there are three big items that you should take note of.

Number one is our revenue trends have significantly closed the gap to reaching our goal to becoming a revenue and profit growth Company. We have the lowest decline in revenue in seven years at only 2%. Adjusted OIBDA grew during Q2 for the first time in four years.

Number two, we managed cost down for the company for the fourth consecutive quarter, while still making strategic investments in key areas of our brands. Number three, we continue to grow our audience quarter-over-quarter and we’re up 5% in UVs for the first half of the year.

Our operating results also having number of important highlights. Our five areas of focus remain the same, audience, revenue and cost, products, technology, and talent. On the audience front, our consumer traffic grew to 112 million U.S. unique, up from a 108 million at Q1 and a 107 million in Q4, 2011. We saw a strong engagement on AOL.com with clicks to content up over 20%. Total page views grew year-over-year in the quarter. Video views are up a 100% year-over-year. Huff Post has shown strong growth since we acquired it has double-digit traffic growth year-over-year. We are also now in the cusp of serving that audience for a video version of the Huffington Post and we believe the Huff Post will continue to be the innovative leader in the information phase.

Ads Traffic is up year-over-year and quarter-over-quarter and our consumers came back 14% more Q2 and spend 19% more time on ads in Q2 than they did in Q1. Mobile usage grew 30% year-over-year. We are serving 40 million consumers on AOL mobile product and we’ve made a significant technological progress in our mobile CMS for tablets.

International consumer growth areas have been fueled by the expansion of Huffington Post, video platforms and other strong endemic brands. On the revenue side, advertising revenue has now grown year-over-year five quarters in a row. AOL search declined 1%, the lowest rate of decline in over three years and search on aol.com continues to grow strongly year-over-year that it has now for six consecutive quarters.

AOL subscription Services had a churn of 1.7%, the lowest in over a decade. Our reach in advertising also expanded on AOL and the Advertising.com business as we are now serving 186 million consumers with ads in the U.S. Advertising.com grew at double-digit rates year-over-year and it has done that now for five consecutive quarters.

Our video impressions continue to grow strongly, up a 100% year-over-year. Project Devil continues to expand and gain traction, excluding the home page which can skew comparison results. Devil impressions in revenue grew a 100% and we continue to show strong and solid traction in signing up third-party publishers on the network.

Goviral, our cost per video platform expanded its global platform to Italy, Holland, Netherlands, Japan and Korea. And our Patch revenue grew strongly and we continue to expect between $40 million and $50 million of revenue for Patch in 2012. We just signed one of our largest deals in the history of Patch from a national advertiser on their fourth renewal.

On the product side, Huff Post launched nine new or redesigned sections and entered same in a partnership with El Pais. Huff Post Live is up and running with a full launch scheduled in the coming month. The product is full of innovation that can only come from Huff Post and we will continue to keep Huff Post in the lead, in the most innovative and information brands on the web.

We launched a new weather site Sky and partnership with BermanBraun, the third such site we’ve launched in that partnership. We rolled out our Mail Refresh, a new mail product to 50% of our customers, and the response has been great with a growth in visits and email sent per visit versus the classic product.

On the advertising side and video we launched the ability to monetize video across screen sizes and devices. We also launched innovative video format. Goviral launched a very differentiated product called Canvas allowing advertisers to over relay social activity on top of the ad, fostering deep consumer engagement.

We launched Project Devil for mobile. Advertisers can now simultaneously plan and run Devil campaigns across desktop, tablet, and mobile devices. We started delivering our first campaigns on mobile devices on our publishing network and we’ve now offer true cost platform campaign delivery across tablets and smartphones that are optimized by Ad Learn. We are making great progress across the board in our mobile products, we launched the Huffington Period, the iPad weekly products. The product was launched to Toyota as the exclusive launch partner.

We launched an innovative TechCrunch app for the iPad with the Verizon Wireless as the exclusive launch partner. We launched new version of the Moviefone app in partnership with Fandango. And we launched the 3.0 version of Map Plus for the iPhone. Its the only free mapping app with voice navigation.

In technology, we launched our micro datacenter last month, as micro datacenter dramatically sets the footprint of our equipment power in full usage and it’s a game changer for us. We had two hack-a-thons driving cutting edge agile development via teams participating simultaneously across the globe and in our area of talent we’re continuing to recruit top notch talent to AOL. Year-to-date we added approximately 500 high quality new employees for the company, while reducing overall head count by 5%.

We are also investing heavily in improvement in education services for our employees and we have run 100 classes so far this year with approximately 1,300 employees attending and participating. As we look forward to the second half of the year, there are some precise things we would like to accomplish. Number one, is we continue to execute aggressively on our consumer and commercial roadmap. We have a number of new and enhanced products in the pipeline, we got lots of product launching in Q3, such as the full version of Huff Post Live, the new patch products, new products for advertising stack and the continued build out of the subscription platform.

Number two, is the continued improvement of our revenue strength to a deeper set of segmented approaches to our customers, both ad customers and direct consumer revenue. We completed a more segmented and verticalized approach to our sales organization in Q2 and we’re going to continue to add in Q3 and Q4.

Number three, we continued – we want to have continued reduction in AOL’s cost phase, it’s an important part of the ongoing focus for the company. We’re currently working with our operating executives to methodically prioritize our investments with the outlook being a focus on fewer and better investments of the company. Now – four is the finish return of the $1.1 billion proceeds from a patent sale and a patent licensing, although we have started that process we’re intent no finishing that process by the end of 2012.

Number five, is to improve the transparency our revenue and cost through a more finally segmented approach to our reporting. We’re making progress towards segment reporting and we will continue to expect to have it done by the end of 2012. We’re very clear on what we want to accomplish in Q3 and the second half of the year and we’re driving hard this summer to accomplish those goals.

The global AOL team delivered a solid Q2 and it did so in the wake of a very public and distracting proxy concept. Our team played through Q2 short handed and we’ve managed this to our multiple wins for shareholders, consumers and customers. But I’m most pleased with our team, including our Board of Directors and our lead director Fed Reynolds. The AOL team stayed focused and we chose fight over flight and we’re stronger now than we were last year at this time. This is the total credit to our team and I’m very proud of the work and efforts done and shown across all the employees at AOL.

As I turn the call over to Artie, I also wanted to highlight the new operating structure of the company. Artie has done a great job as CFO and one of the most difficult CFO jobs in our industry. During his time as CFO, he has also taken on a series of meaningful operational roles including the running of AOL Services and he has a proven track record of improving those areas as a leader. Our new structure with Artie becoming COO should continue to help us propel the company forward. Artie will be overseeing the three operating units, I will be focusing on product development, sales and our technology platform. We will also have the opportunity to expand the executive team by adding a CFO.

And with that, I’m going to turn it over to Artie. Artie?

Arthur Minson

Thanks, Tim and, thanks everybody for joining us this morning. Today’s results are relatively straightforward and marked continued progress in improving our revenue trends and reducing our expenses. In Q2, continued advertising revenue growth and significantly improved search and contextual and subscription revenue trends resulted in our first quarter of adjusted OIBDA growth in four year.

To be clear we grow adjusted OIBDA both including and excluding the impact of the unusual items during the quarter, which is something we’re extremely proud of. Our aspirations are sustained top and bottom line growth and our Q2 results mark another large and important step towards that goal.

Another thing we’re proud of is that since AOL became public in December 2009, we’ve been on operating on dual tracks. One improving our product offerings and operations and two creating and unlocking value for shareholders. In addition to the improved results in Q2, closed the patent transaction with Microsoft and including the approximately 40 million left on our share repurchase authorizations. We intend to return approximately $1.1 billion in cash to our shareholders in 2012. This will bring AOL’s total return of capital to shareholders to approximately $1.3 billion in 18 months.

Turning now to the results in the individual revenue streams in a little more detail. Global advertising revenue continues to grow, up 6% year-over-year. And this growth has fueled this quarter by growth in third-party network and global display revenue, which combined grew 9% and offset by lower search revenue. Search and contextual revenue declined only 1%, its lowest rate in over three years.

Global display revenue grew 2% year-over-year. This was the first full quarter when the result from the Huffington Post were included in both quarters. The reported results are now apples-to-apples compared to three year-ago. Domestic display revenue was flat year-over-year in Q2, improved from the 5% decline on a pro forma basis in Q1. As a decline in the number of reserve impressions sold during the quarter was offset by continued improved reserve pricing.

Advertisers remained willing to pay premium prices for premium placement and formats besides premium content, which is obviously very encouraging. Third-party network revenue grew 19% year-over-year in Q2. Underlying this is a 11% organic growth in Advertising.com, due mainly to continued growth in the number of publishers we work with as well as the number of impressions there.

During the quarter we continue to expand our capabilities in real time bidding to access an increased supply of impressions on all major ad exchanges. As I mentioned in the past, we’ve significantly expanded the ad.com product offering to include premium products and services. This has both attracted new clients and has allowed us to do more with a current client base. Additionally and encouragingly Studio Now, Five Men, Goviral and Pictela, all acquisitions we made in 2010 and early 2011, which are now fully anniversaried or in aggregate contributing meaningfully to results. We see strong growth on the network accelerated by the addition of these products and services.

Another point to make before I move on is that we’re growing third-party network revenue more profitably with traffic acquisition costs as a percentage of total third-party revenue decreasing year-over-year. This is a credit to Ned Brody, the CEO of the Advertising.com Group and his team who have a long history of optimizing campaigns for advertisers at scale offering premium products, targeting and reporting, while maximizing revenue for its publisher partners.

There is significant value in this particular area of AOL and it is backed by a robust text back which will soon offer a full end-to-end solution for advertisers and publishers. An integral part of this text back is our ad server ADTECH, which I would say is in the top tier of ad service in the world. We recognize ADTECH revenue and other revenue and expect to grow at nicely this year through its expansion into new markets and the role out of new products such as mobile and ADTECH canvas, an advanced rich media creative tool allowing agencies and advertisers to build their own creative.

Turning now to search and contextual revenue and subscription revenue trends, which continue to improve meaningfully during the quarter as they’ve done for the past 2.5 years. Search and contextual revenue declined only 1% year-over-year in Q2, which is outstanding when viewed in the context of its roughly 30% and 20% year-over-year declines in 2010 and 2011 respectively. Pealing the onion a little to discuss three main areas of search, I typically speak about.

First, co-branded portals, international markets, which are declining due primarily to our exit in 2010 from unprofitable distribution deals and markets and contextual which is largely flat.

Second, the AOL client, which has been declining as subscribers churn and third AOL.com where search has been growing at double-digit pace for over a year now. Revenue from search and co-branded portals, international markets and contextual revenue declined by approximately 15% in Q2 and now represents approximately 30% of total search revenue.

Search revenue on the AOL client declined by approximately 15% in Q2 and represented approximately 30% of total search revenue. Meanwhile these declines will largely offset in the quarter by continued strong growth in search revenue from AOL.com, which continue to grow at double-digit rates and now represents approximately 40% of total search and contextual revenue compared to approximately 30% a year-ago.

Our improved search trends are being driven by hard work and real time attention to the products with the team constantly testing new ways to both optimize, monetization of the product, while ensuring a consistency of consumer experience. Francis Lobo and the search team constantly test and monitor all metric related to users engagement and monetization, constantly tweak and manage the product based on that data.

Attention like this is what led with significant increase in click through rates and revenue for search during the quarter. Our hands are at ten and two here and with an improved overall consumer experience at AOL.com, we’re making real progress which is meaningfully impacting results.

Ending the revenue discussion with our subscription services, where revenue declined 13% year-over-year compared with 23% decline in Q2, 2011. We no longer think about this area of business as an internet access business, but instead as a subscription services business offering subscribers curated premium subscription offerings. Part of this transformation we have layered an additional value add products and services for our subscribers bundled at a very low incremental cost to AOL. The metrics like churn, retention, saves rate and reactivated users, up all improved meaningfully.

Subscribers now receive PC support and protection products like LifeLock, McAfee, SugarSync as well as value added services like PRIVATE Wi-Fi, password manager, PC insurance, and discounts on products such as Sprint. This is just a sub step of what is included and more products and services and subscription bundles are on the way. There is a science in running a great subscriber business that requires a lot of blocking and tackling, direct and constant interaction with your subscribers and an intense use of data to measure your efforts and adjust accordingly.

Our head of subscription services Bud Rosenthal and his team are mastering the science and have over the past 18 months implemented a rolling thunder of roughly 200 different initiatives, which have had a direct and materially positive impact on our subscription metrics.

I cannot over state how important even the slightest improvement the subscription metrics have on the business for years out and our improvements have been far from slight. Churn for the quarter was 1.7% versus 2.2% in Q2 last year and 2% in Q1 this year. As we engage more with our subscribers and drive awareness and adoption of incremental products and services, churn drops even further. The subscribers who have adopted two or more products turning over 80% licensed subscribers who have not adopted their products.

Day breaks at the call center have also improved meaningfully, growing 25% year-over-year, and importantly a retention of those saved is also over 80%, 90 days out. So we are clearly happy with our progress here.

Turning now to expenses. Our focus is on doing more with less, while we continue to invest in certain areas for growth. We’re mindful to reduce expenses or stop activity in areas outside of our core strategy or where we have not gotten traction we’ve once hoped. During the quarter, adjusted OIBDA expenses excluding traffic acquisition cost and expenses related to the patent sale proxy contest and a tax settlement due to 2012 and non-recurring expenses in Q2 2011, which I will talk about in a minute, about 8% year-over-year and by a $200,000 sequentially.

I will note that even as we continue to pull expenses out of the business, we continue to invest in areas that are growing rapidly, like ad.com and initiatives like we are excited about such as HuffPost Live, HuffPost International and in other endemic grounds attracting audiences. We know advertisers are interested in reaching. Managing expenses is the way of life at AOL and we know there are huge benefits of scale here and when coupled with growth in our revenue streams with high incremental margins.

Q2 was the first quarter in four years when AOL grew adjusted OIBDA which is meaningful milestone to the company. Clearly we are benefited from the inclusion of the licensing income from our patent transaction with Microsoft. But as I noted, even excluding that benefit as well as the impact of $14.4 million of buying expenses in Q2 related to our patent transaction and proxy contest $7.6 million negative impact to adjusted OIBDA to settle outstanding tax claims covering 15 years in Virginia which is the largest state in which we do business.

Adjusted OIBDA was approximately $95 million up approximately 16% year-over-year when you take into consideration the roughly $5 million of non-recurring expenses Q2, 2011. This growth was driven by strong across the Board performance including strong expenses result, continued advertising revenue growth and continued declines the rate of search and contextual and subscription revenue.

Let me spend another minute on our adjusted OIBDA and what this quarters better than expected performance means to the full-year and particularly how its rates relates to the $350 million target I guided to last quarter. As I noted at that time, the $350 million was an organic number and excluded the impact of any expenses in fees related to our proxy contest and patent sale and it did not contemplate the receipt of the licensing income upfront or our recent tax settlement. The $350 million did include reinvestment for growth in HuffPost Live, HuffPost International and then our third party network operation.

The net impact of the receipt of the licensing income and the negative impact of the patent transaction and proxy expenses and tax settlement with a positive $74 million to Q2, full-year of 2012 adjusted OIBDA. This was the outperformance this quarter its likely to result in reported adjusted OIBDA for approximately $450 million which when you back out the items from Q2 I just mentioned gives you adjusted OIBDA for the full-year of approximately $375 million versus the previous $350 million target I guided to last quarter. So to be clear, we are taking up our full year adjusted OIBDA guidance like $25 million on an organic basis.

Turning now to the balance sheet. We had approximately $1.5 billion of cash on hand at the end of the quarter. Free cash flow for the quarter was $135 million reflecting both the licensing income and profit growth. Free cash flow excluding the benefit of a licensing income and the negative impact of the transaction related expenses declined year-over-year reflecting a cash payment of $13.5 million tax settlement in Virginia in Q2 and a slight increase in accounts receivable days outstanding as compared to the prior year which we expect will turn around and benefit us in the back-half of the year.

We continue to efficiently convert adjusted OIBDA to free cash flow and expect to remain disciplined in this regard. Finally we did not buyback stock during the quarter as we finalized the closing of the patent transaction prepared for the launch of the Dutch tender offered to repurchase $400 million of stock. As we have mentioned this is the first step in AOL returning $1.1 billion in cash to shareholders in 2012. Rating at roughly three and half times current years adjusted OIBDA our preference is to meet the repurchasing stock at these levels.

However, due to the size of the intended capital return of $1.1 billion relative to our current market capitalization and our desire to preserve our large tax attributes which could be diminished should we trigger a change of control as defined by the IRS. We need quite carefully and potentially through several methods. Don’t expect us to act cautiously but decisively through the remainder of the year to return 100% of the proceeds plus the approximately $40 million remaining on our share repurchase authorization by yearend 2012 without affecting our value book tax attributes.

So to conclude, our result today represents another meaningful step forward in the turnaround of AOL. I am very pleased with our progress and I look forward to your questions.

With that let me turn it over to the operator.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Anthony DiClemente with Barclays. Please proceed.

Anthony DiClemente - Barclays Capital

Thanks very much. Good morning guys. The new guidance, so the ex one-time items $375 million in EBITDA i.e. that you just articulated. I am wondering what does that imply for trending in display advertising and just to be specific about the question, the metric that you include in your release would you take a display and add in third party the one that got to plus 9 I think it was plus 10 last quarter. What is your guidance imply for those trends or that trend third party plus display for the back-half?

Arthur Minson

Hey Anthony, it’s Artie.

Anthony DiClemente - Barclays Capital

Hey.

Arthur Minson

Right now where I would like to leave it is just we’re going to go with the guidance of $375 million. There’s obviously a lot of pieces to the guidance, our subscription trends, our search trends, our expenses trends, growth in AOL.com are all a meaningful piece of that. I think what you saw in the display side was improvements as we move from Q1 to Q2, as we previously have discussed we expect that improvement trends to continue to the back-half of the year and while we have limited visibility at this point that’s something we’re working very hard on to improve that trends as we move to the back-half of the year, but we’re not going to get into sort of any specific guidance on any particular line. We’re just going to leave it at the adjusted OIBDA number total.

Anthony DiClemente - Barclays Capital

More broadly is there a way that you can give us a little bit more context as to what's going on in the market place with respect to pricing in volume maybe Tim can chime in on what the market is showing you guys and certainly you’re doing your own -- your specific efforts are to continue to try to improve your share, but can you give us how kind of trending in the market place throughout the quarter and what you expect for the back-half there?

Timothy M. Armstrong

So just let me hit on three big bullets in display advertising. One is the overall industry which was different than a year-ago it has gotten more rational and what I mean by more rational is, I saw a fairly large advertiser CEO last night. Again this was a consistent trend I am hearing across the board from our customers, both clients and agencies is, people are starting to look across a spectrum of how properties convert.

So I think last year there were a lot of hot spaces, quote unquote in display and now basically people are really kind of zeroed in on the places they’re getting results from and I think those places are very thrilled around premium formats, video and also they’re starting to be as people look into the audiences that actually perform, so where you put your ads and what the ads look like matter a lot. So I think from that standpoint that’s the macro trend is customers are looking at the full spectrum more rationally, looking at the audiences rationally and specifically I think we see even in this economy that people are customers and agencies are drilled towards spending more digitally overall mobile video those things.

Second area is specifically looking at AOL, you basically under the surface at AOL you see kind of a shifting in the trends in terms of where we’re focused and where we expect revenue to go and I think one of the things we’ve smartly done is, continue to push the company more into things like Project Devil and video and those things are growing very nicely and I think when you look at the Advertising.com group as a whole and as a network the targeting and the rationalization in terms of the results customers get, that’s an area that’s growing very well.

And then the third area which is the area I mentioned on the call last time was really, I think you’re seeing the improvement in our display business right now, but specifically we have a very kind of precise way we want to go to market which are the improvements we wanted to make, which is data driven, verticalized meaning by industry and then the verticalization on our product and services and I’ll give you a quick example of that.

The auto category for instance with a vertical has more new product launches this year and next year than they’ve had in the last few years ago for a lot of different economic and things like Japan, tsunami issue, but that essentially moves the auto category budgets are moving towards 60%, 70%, 80% launch based budgets. And in that area we actually have a very good opportunity to have specific auto based advertising products that can work across the board. So the improvements you saw in Q2 in our advertising business, I would expect them to continue in the second half of the year overall but the market remains strong, it’s getting more rational and I think as we get more verticalized and data driven we’ll have a better outcome.

Anthony DiClemente - Barclays Capital

Thank you guys.

Operator

Your next question comes from the line of Ron Josey with ThinkEquity. Please proceed.

Ronald Josey - ThinkEquity LLC, Research Division

Hi. Thanks and good morning everyone. So maybe more of a high-level question for you Tim, and its more just talking about display and the longer term opportunity here at AOL. So I think over last year we have seen AOL report display results. And it was in decent mid singles pro forma basis we saw on a year-over-year results this quarter sort of flat year-over-year. But what do you think needs to happen to consistently grow in line with the market or at least sort of high single maybe low double-digit rate? Thank you.

Timothy M. Armstrong

After the proxy contest and I am actually spending a significant amount of time on this but I’ll go into probably one more level of detail than I normally do here. So when you look across the opportunity for display, there’s two important things that we have to be diligent about. Number one is, what are we serving and what you put on a screen matters a lot and what the results are. So Project Devil is an example of a product that it works very well for consumers, it has a deep engagement for advertisers and lots of metrics can follow through in terms of conversion, those things. So we've to move very quickly on a differentiated approach in display overall as a business, number one.

And also I would just get into video and mobile. They’re doing cross screen products where people, I think, I said last summer 75% of the IOs coming in had – probably had mobile and video on them. I think it’s probably almost 100% now, but where is the 100% overall and I think from the standpoint of growth from us as a business underneath the trend line you’re seeing in display although it looks like its flat. We have very strong growth going in video, mobile, ad networks, display premium format. So the areas where I think the market is growing towards were having a lot of growth and opportunity there.

The second piece which I hit on in Anthony’s question. The first question and again I’ll just be super directly about it. Our approach to the market place last year got basically into a non-data centric approach to the market place and non-verticalized approach and we have shifted that back overall and I spend a lot of time with ad customers, clients and agencies and the holding companies and my rule internally here is you cannot leave the building without data now and that data has to be transformational in terms of how it goes across our products and services.

So on the consumer side of things where HuffPost is up double-digits in traffic and growing really nicely. We have new products coming on that area. The patch stuff is working well and a lot of our other endemic brands are working well. The Advertising.com network is working well. We still need to go out to the market place with a segmented approach meaning the vast majority of our sales people and services are targeted as the top customers. We have taken industry specific verticalized data, verticalized products out to the market place and then three of the analytics and follow through we have basically it shows the power of AOL’s audience.

AOL has one of the best converting audiences on the internet. When you go to talk to the big car companies so you talk to a lot of our big partners, conversions matter a lot and AOL is good moving horizontal parking lot, CPD products off the shell, getting people on airlines and at the more world class in data centric approach to both how we show things to consumers and how we optimize the backend of our business. I said this at the Q1 earnings call; we should be a growth company in display advertising. We have the right product, the right level of staffing and it’s really about getting a hyper organized around this and something I know a lot about and we should be doing a better job at it and we're still working on it.

Ronald Josey - ThinkEquity LLC, Research Division

That’s great, thank you. One quick follow-up and I appreciate the shift at data driven approach, but given the shift in sales force, do you think that’s what's limiting potentially visibility in the second half, I think Artie might have just said that in the last answer?

Timothy M. Armstrong

Yeah, I think overall we have a very large budget going on that we started in Q2 right now which is really pushing the sales force, but we have very good relationships and a very good sales team into this approach and I think from that standpoint I think we are just being cautious because we want to make the improvements here and I think setting expectations, because I used to think about expectations as an investor we are precisely laser focused on this, our hands are tending to give multiple meetings per week and we have a large set of projects going on internally to improve this very quickly due to I personally think the outcome is going to be positive for investors in display advertising, yeah.

Are we willing to put up the numbers right now to show that I think we feel that we will see those numbers but we’re not sure exactly what the range is going to be, so I think that’s why we decided not to give guidance on that, but I can assure you with 100% we are -- that is a massive focus of the company right now.

Ronald Josey - ThinkEquity LLC, Research Division

Great. Thank you very much.

Operator

Your next question comes from the line of Laura Martin with Needham & Company. Please proceed.

Laura Martin - Needham & Company

Good morning. Excellent numbers you guys. Two quick questions, one on subscription, so this number down 13% is just excellent and last quarter I think it was down 15%. So you’re kind of in three short months improving the decline if you will by 200 basis points. So if I think about modeling that over the next 12 months is that -- should I assume that, that 200 to 300 basis point improvement can continue and therefore that kind of get to a breakeven level at subscription four quarters from now. So I am interested in and how to think about that or does that mitigate over time because these certain numbers are excellent that you’re reporting.

And then a housekeeping question Artie on, when the current $400 million of share repurchase closes on August 2, how quickly do you think you can get back in the market with the next charge of the $700 million you guys have committed to returning by yearend? Thanks.

Arthur Minson

Hi Laura, it’s Artie. Let me hit the subscription and then I can hit the buyback stuff and may want to jump in as well. On the subscription stuff, like you know there’s two pieces really to the revenue decline, it’s how much can we slowdown churn and what can we do on the rate side and what you’re seeing the benefit this quarter is we’re both reducing churn pretty meaningfully both sequentially year-over-year and at the same time we’ve been able to increase ARPU. And let me hit the churn pieces first and then I'll hit the ARPU piece.

And on the churn piece we have that significantly improved the product that helps existing customers plus those who call in with the potential cancel intent. We have been able to articulate to them the new value we put in the product and what that has done is a couple of things, it improved sales rate, it had them signup for new services and when we’ve done that we’ve a drastic reduction in churn.

One of the questions, frankly, the team and I spent a lot of time about is there probably is some amount of structural churn in the business along which it’s going to get difficult to get to, what that number is, we’re not exactly sure, but I think you’re always going to see some churn in the business and it’s a little bit unclear, guys, how much lower we can push it.

On the rate side, what we’ve done is we’ve rationalized pricing from basically down from over 60 price points to where we’re basically at about 84 price points now. We actually added a premium level of service this quarter at 2799 where you get a significant number of product and services. And that helped a little bit on the rate side.

The net-net in getting back to your core question is I think we continue -- and our goal is to continue to moderate on the churn side. I think on the rate side, it might get a little bit lumpy with some quarter improved better than others, just given we’re not going to be constantly doing pricing rational. That’s probably something we’ll look to do targeted year-over-year.

So it’s a little bit unclear to me how much lower we can drive the overall decline. I think when you said 200 basis improvement quarter-over-quarter, that’s pretty aggressive and that is not something we’ve model then, I think frankly I’m incredibly pleased with getting down to 13%, would -- might there be opportunities to do a little bit better, yes, but I wouldn’t model that in right now.

Laura Martin - Needham & Company

Very helpful, that’s very helpful. Thank you.

Arthur Minson

On the $400 million that you know, the plan is to basically close the tender on the 2nd of August. And our expectation is shortly thereafter we’d hopefully be able to articulate what the plan is for the next piece for returning the -- its $1.1 billion.

Laura Martin - Needham & Company

Okay, so within weeks, not months, right?

Arthur Minson

Yeah. I’d expect it to be within weeks.

Laura Martin - Needham & Company

Okay. Great, thanks so much. Congratulations, great numbers guys.

Arthur Minson

Okay.

Operator

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

Mark Mahaney – Citigroup, Inc.

Hi, guys. Going back to the display advertising ,is there something, is there any macro uncertainty there, are you seeing any greater than normal interpretation on the part of advertisers to spent just in the U.S. on display advertising? And could you also just again touch on the issue of industry-wide pricing and to the extent to which from networks in Facebook you’re seeing overall pricing deflationary pressures?

Timothy M. Armstrong

Yes, Mark. So let me give you more detail on those, I think from a customer basis we feel pretty active in terms of planning, overall. So, I -- although Europe I think is an economy -- we were doing well in Europe in terms of growth, but Europe overall as an economy is seeing weak, we’re just over there and we’re going back over. And U.S. market though remains pretty energetic, and I think overall when you look at kind of the macro trends that are happening, I think one is in terms of social spending on advertiser, people spent a lot last year, this year they’re kind of getting into a point where they’re going to really look at how do you actually connect content with social and add more value to the social buying they did last year. So I think it’s a positive trend for us.

Video is a huge trend, I think we’re seeing a lot of stuff from branded entertainment and just on the network side, video overall and I think there is a strong propensity on just the overall targeting technology front, overall big advantage we’ve in that space is a technology fact that the advertising.com group has been able to build, which allows us to leverage and we just think that business grow so strongly.

And then what I’d say with pricing is, pricing is dependant on products and that sounds pretty simple, but we continue to see very, very strong pricing for Project Devil. I think overall video pricing has remained high, I think there has been more supply for video in the marketplace, so pricing isn’t growing like it did last year overall. And I didn’t expect video to remain a fairly strong marketplace overall replacing -- I don’t know if it’s going to go up dramatically, but it’s probably not going to go down dramatically either and I think people are paying for quality overall.

And let me add, network side I think one of the things that customers get smart about when lots of inventory comes on the marketplace and it’s really low price there maybe an initial attraction to it, but then over time what happens is people really start to get more specific about the measurement of ROI and what the value they’re getting. So the reason in the marketplace, you can have network pricing on one side and then you can have Project Devil pricing on the other side is because there is a spectrum of pricing people will pay for different levels, engagement or analytic. And I think our recipe as a company has been focused on having high price, high engagement, high metrics driven around brand conversions overall as a business in locals and other area with high pricing.

And then on the network side is for us to basically keep our pricing up on the network by enhancing a targeting capabilities and access to more premium inventory, things like the Devil Network and those things. So I’m positive on the overall advertising business in terms of digital planning and spending overall. I’m positive on pricing as long as you’ve the right product and services in the marketplace, I think if you get caught in the vortex of tonnage, that’s may or may not be positive.

And then I’m possibly free to disclose from last year to where we sit today in terms of the fact that the world has gotten more rational in terms of understanding what audiences convert at what levels and we have an incredibly powerful audience in terms of performance for advertising.

Mark Mahaney – Citigroup, Inc.

Thank you, Tim.

Operator

Your next question comes from the line of Tom Forte with Telsey Advisory Group. Please proceed.

James Cakmak - Telsey Advisory Group

Hi, good morning. This is James actually calling in for Tom. Two questions, please. First, on your latest initiatives, you talked a little bit around mobile with the launch of Devil, new applications and previously some preference around board members with mobile experience, so can you provide us with a little bit more detail on your efforts around that, what kind of opportunity you see, kind of demand you’re seeing from the advertisers and is this something that potentially moves the needle?

And then, Artie, you provided some clarity on what’s going on with the subscriber segment, but -- and just given the fact that you’ve been able to reduce trend as much and ARPU has held relatively steady and even up this quarter, but I understand it’s going to lumpy, is there something where we could potentially think about where you actually invest to grow the subscriber count because of the margin profile of the business or should we think about it more managing for the decline?

Timothy M. Armstrong

On the mobile side, starting off, we’ve some pretty clear initiatives. Number one is building our product mobile first. So we’ve a number of products coming out that we’re shipping the development as a company that basically optimize for the smaller screen network seamlessly up to larger screens, it sounds pretty basic, but the results, our consumers are really good and we’ve really interesting products are coming up that we’ve been building in that front shortly.

The second piece is kind of CMS and services, underneath there, one of the things we spent a lot of time our last seven or eight months building is a mobile content management system that basically is seamless in terms of being on the front multiple brand and scale them really quickly. If you look at things like the new Moviefone app or the Huff Post in the period, or the new TechCrunch app those things that you can see basically are work on the kind of content management side of mobile.

On the advertising side, we’ve a very specific, precise focus there, which is, one insertion order all screens and then two, there is just like we’ve on the offline, that on the desktop side of things with the advertising.com network with great targeting and things like Project Devil would do a great job of brand preference for advertisers. We’ve now mimic that on our mobile devices across our technology stack. And I think the results that we’re seeing both in the early days of the Project Devil launch, Pictela launch for premium format from mobile we’re seeing very, very high engagements from customers and consumers. And on the Advertising.com network, which I think is a technological feat for us on the targeting side because those are – cookieless based targeting for the most part. We’re seeing great results there as well.

So, I -- internally, some of the things we talk about in terms of the mobile space and in terms of format space with desktop and mobile is the consumers are there, the engagement can be there and I think just as – something like the computer hardware have gotten commoditized before Apple really innovated and had a non-commodity product there at scale, our focus as a company is non-commodity product that add network level and applet things like Project Devil and Pictela level overall.

So, yeah, I think it can be needle moving for us and we’re pushing really hard on it.

Arthur Minson

And on the subscription side, actually to your point, given, frankly, how stronger response we’ve gotten from our subscription, our existing subscription base on offering them a curated bundle services, we’re in internal and external conversations about extensionally re-launching some subscription products, it’s probably going to be a 2013 initiative, but there is definitely an appetite for curated bundles in this space, people are looking for expertise which is something AOL has and telling them what exactly it is they should be buying across the spectrum of areas. So I think it is something you’ll see out in the ’13.

James Cakmak - Telsey Advisory Group

Okay, thank you. And then just lastly for modeling purposes, the $22 million non-recurring impact from the patent and proceeds related expenses, can you spread a little bit more detail on the distribution from the allocation of those expenses among the expense line?

Arthur Minson

Sure. There was basically -- as I said, there is $22 million. The biggest piece of it for the patent sale and that’s principally related and they were, just cost getting that done. There were also the proxy cost which were slightly less than that and then were about 7 plus million dollars related to a tax settlement related to about a 15-year period where -- in Virginia which is the largest state we do business. So, that was roughly the breakdown of the three.

Operator

Your next question comes from the line of Peter Stabler with Wells Fargo Securities. Please proceed.

Peter Stabler - Wells Fargo Securities, LLC

Hi, good morning. Thanks for taking the question. So, a couple on Patch, Tim, you’ve talked in the past about Patch being a platform, not just an advertising sales platform, but also potentially a commerce platform and you alluded in your comments too, new products being rolled out, I’m wondering if you could give us any more color on what’s going on in Patch in terms of product development and when -- and the kind of nature of products when we can see those in the market? Thanks very much.

Timothy M. Armstrong

So just some quick macro level, Patch, we basically want to have an ongoing multi-decade relationship with consumers in those marketplaces. They don’t move and we don’t want to move either. People saying, it accounts for long time, they spent a lot of money there and time.

So, the initial side of Patch was basically the launch in the market, digitize all of the assets in the town, basically create data cubes for everything in the town, then put journalists in to basically capture the audience on an ongoing basis.

The second phase of Patch, which I just saw yesterday live on our servers attached for the first time with a new Patch product, and essentially I’m not going to go into a lot of detail on it, but it allows us to continue to do news and the kind of directory listings that continue at a high scale, but also add stability for the community on much higher levels community involvement in a very precise way on the Patch platform.

So in essence, if you take the town as a campus where people don’t move, they’ve a specific interest, they like news and information, they like the directory listings. There is also an ability for us to mimic the way that people in town basically live their lives including commerce.

And as you think about the revenue model for Patch, first of all, I think the cost and revenue model, overall, revenue is growing quickly, cost is coming down at Patch. I think that’s a very positive thing for us. Overall, the model is getting more efficient.

And then two is we’ve had one sort of revenue line now put in different channels, which is advertising between national, regional and local. There is still significant opportunity across those three channels.

Commerce, there is two different initiatives we’ve. On commerce that will be coming out, one is basically in terms of being able to interact with businesses in a much more high scale way. The second one is a little bit more on the direct commerce front. And we’ll have more to say and announce about that later this year. But there has been a significant amount of work going into the Patch product on the engineering side over the last six or seven months and what I saw yesterday holds up, I think I think it will be a very, very interesting next couple of years for Patch.

Peter Stabler - Wells Fargo Securities, LLC

And one quick follow-up if I could, you mentioned in your comments that you were just secured at the AOL with the large national advertiser on Patch, I was wondering if you could give us, just not the name, but a little bit more color around that type of deal, and whether this is a long-term deal? Thanks very much.

Timothy M. Armstrong

Yeah, let me just describe it. The types, I’m not going to go into detail on that specific deal, but I’ll just give you quickly, if you look at national advertisers overall, you can pretty much take almost any national company that spends a lot of money on advertising. First of all, their ad budgets are typically split, not always, but I will just give you a rough (indiscernible). 50% is run nationally or globally and 50% is tried to be targeted locally.

If you look at some of the big bank customers to auto customers in the United States, a huge amount of their investment, so you can take like a -- really large bank in the United States, and if you look at their investments in the town, they typically have physical locations, they’ve financial advisers and they may have other things like insurance or other businesses in the town on account-by-account basis.

The national advertiser may have between a $1 million and $10 million actually physically invested in account and what we’re doing with Patch, I’d say, like a lot is able to leverage and introduce the people in the town directly to the assets they’ve in a town. So the deal I talked about on this call and a lot of the deals we’re doing which are large deals of national advertisers typically take their assets as a whole, national whole and break them down to specifically what’s happening in the town, I mean you can see great examples on Patch of national advertisers, and some of the banks do this. They’ll actually put their local customers in their ad. So as a consumer you’re on Patch to see big national brands with the video inside the ad happens to be a local business that you may shop at, maybe a bakery or a bike store or something like that. And I think the large deals we’re doing on Patch are essentially for the hometown partners with these national people and a partner locally in town.

Peter Stabler - Wells Fargo Securities, LLC

Thanks very much for the color.

Operator

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

Ken Sena - Evercore Partners, Inc.

Hi, thank you. Can you just please expand a little bit on the ad networking strategy? And maybe walk us through how your ad text doc potentially differentiates from a Google or other? And also if you can maybe – you mentioned real-time bidding on the advertiser side, but I think what you’re doing on the publisher side to gain traction? Thank you.

Timothy M. Armstrong

Sure. So, basically the differentiation for AOL specifically what we’re doing is focused on the format side, so one of the benefits that we’ve that other large players in the marketplace don’t have is the ability to essentially take some of the innovative products we’ve had from Patch and launch them at Dell without having to unwind a lot of other stuff we’re doing. So there’s been a very clear focus on how do we build formats that work for AOL properties plus the networks overall and how do we fill those things up.

The second piece is essentially how do you fit into the ecosystem of the ad network space overall, and if you look at the ad network space, essentially Google has an end-to-end platform they’ve built. I think we probably have the second largest end-to-end platform in the marketplace right now, and once you drop below that you start to see what essentially looks like a massive checker board of individual companies and properties. Some of them are still in some areas, but in essence there is very few people still across the board.

So from a differentiation standpoint at AOL, we bring to the table very large scale in terms of the size of the network. We bring very large scale in terms of the different technological ways that you can plan and target advertising overall. We bring a differentiation in the format that we provide and then we’re bringing a differentiation essentially to the overall other people’s exchanges as well. So we not only have our own network business with format, ad serving technology targeting and analytics. We’re also now able for advertisers to go into other exchanges and provide that as well.

So I think when you think about it, DSP, SSP, Mobile, Rich Media across the board, we’ve a very significant stack, Google does as well, but I think we’ve probably the most -- the second largest stack right now and it’s growing.

And then, I think your second -- can you just clarify the second question, it was around -- did I hit that?

Ken Sena - Evercore Partners, Inc.

Yeah.

Timothy M. Armstrong

Okay. Next question please?

Operator

And your next question comes from the line of James Lee with CLSA. Please proceed.

James Lee – CLSA

Thanks for taking my questions. Just a quick follow-up on Patch, can you guys give some clarification regarding revenue contribution and also spending level for the quarter? And also, the spending plan for the remainder of year, and help us understand how does that compare versus last year? Thank you.

Arthur Minson

Hi, James, this is Artie. So, a couple of things to point out, expenses on Patch are actually down a little bit sequentially as you know, one of the things we’ve been trying to do is optimize the operating structure in Patch and I think we’ve continued to find ways to operate Patch more efficiently, so you actually did see a little bit of a sequential decrease in expenses.

At the same time, we continued to see really, really strong revenue growth from Patch. We haven’t broken it out, but we feel very confident on the $40 million to $50 million full-year revenue guidance we’ve given. So, your existing leverage in the model where revenue continues to accelerate at the same time we’re continuing to be more efficient on the expense side.

Timothy M. Armstrong

Well, I’ll also just say from a platform perspective on Patch, Artie and I’ve spent a lot of time with Jon Brod at the leadership team at Patch, who is doing a great job. We’re continuing to innovate the models around the panels overall. So I think we’re -- we want revenue grow up and cost to go down over time, and that’s some interesting things that we’re working on.

James Lee – CLSA

Great. And Tim, can you just remind us when is the change from timing perspective to more segment-oriented and more data-oriented type of product that you put out? And I was wondering with this kind of thinking, are you kind of ahead of the industry in terms of doing this thinking or are you kind of point catching up versus your competitors?

Timothy M. Armstrong

Yeah. We -- so, one is you should expect this fall for us to be rolling out the new Patch product and I think when you see it you’ll understand why it’s different and what it looks like overall. So I think our expectation is fall, depending on what your definition of fall is, but its likely September to November timeframe.

And then I’d actually say, I – look, I think Patch is a very closely watched investment and obviously its a bold step for us as a company. I think we’re ahead of the market place. I think if you make the basic assumption that people want local information where they live which I think they do, overall and you look at the scale that we have done I think we’re ahead of the market place in terms of scale and doing in a very differentiated way.

The second piece is, we’ve learned a lot in the last couple of years on TAC about what will work and what communities need. If you look at the investments going into local community space right now, you’re seeing a lot of investments being made into the new local newspaper business with them trying to basically separate the newspapers from their pension issues and those things and I think I’ll say that, when I look out across the traditional landscape and versus our innovation we know very clearly what it’s like to start a turnaround a company, almost every company in our space on a local basis is in a turnaround of their own. And I think we’re starting with a very innovative high scale product. So I think we have a leadership position now and we plan on keeping it and we have been making very large investments in the technology overall and I think the stuff we’re going to be working on and coming out with is disruptive.

James Lee – CLSA

Great. Thank you.

Arthur Minson

Now we’re running a little bit over but people still have questions, I think we have time for two more of the questions.

Operator

Your next question comes from the line of Sean Kim with RBC Capital Markets. Please proceed.

Sean Kim - RBC Capital Markets

Hi, thanks. Just one question. Beyond this year, how should we think about your kind of longer term capital allocation strategy? Should we expect buybacks to continue at the pace or prior to the patent deal? Any sort of color there would be helpful. Thanks.

Arthur Minson

Hey Sean. On the capital allocation fees, I think the most important thing we’re focused right now on is, the return of the $1 billion of proceeds and that there’s some tax implications which we are working through with guys basically how much we’re able to buyback without having any impact on our significant tax attributes. So we’ll know more frankly as we make our way through this process in the various steps as we make our way through this process so it’s difficult to say now past $1.1 billion exactly how we will be returning capital to shareholders. And let me just take one more question.

Operator

Your next question comes from the line of Victor Anthony with Topeka Capital Markets. Please proceed.

Victor Anthony - Topeka Capital Markets

Yeah, thanks for putting me on and congrats on the operational improvement. Just to take you back on the last question; are there areas where you need to invest incrementally outside of Patch? Second, what has been the incremental contribution from the Microsoft, Yahoo, AOL advertising partnership? And the third quick question I had was just some of them was stretched but, any interest in going down the route of making a significant investment in original programming along the path what Netflix is doing or what Amazon is about to do in an effort to drive engagement across your properties? Thanks.

Timothy M. Armstrong

Just me hit those quickly, investments outside Patch I think we have been putting investments into Advertising.com group because I think they have done a tremendous job of turning that business around globally. The second area is on the international front, both Huffington Post and Advertising.com group we're looking internationally on the growth side of things and then there’s products like Huffington Post Live that are very disruptive and I think from that standpoint we’re trying to invest in things that we think have just lots of capabilities but also very strong revenue opportunities.

On the advertising partnership with Microsoft and Yahoo, I have had it up and running. We basically have increased the amount of impressions that are going into that exchange, the partnership grew by 67% quarter-over-quarter overall, but I think that partnership still has a lot more to go. It’s growing and we’re going to continue to partner Microsoft with Yahoo or big partners with us plus a bunch of lot of different properties and also on Advertising.com group overall.

And then the investment in original program, I think what you’ve seen us do is we have been investing in content that we’ve been building on things like Huffington Post and Patch and things like Makers and programs like that and also doing branded entertainment deals and partnerships with BermanBraun. As of right now we don’t have any announcements to make in the original programming phase, but I’d remind you that we have a subscription platform and we have other areas of our business like AOL on the new video area we launched where we’re number one in about seven different categories in streaming video right now. So we opportunistically we look at our original programming and those things seriously and we have more to say on that over the coming years. I think overall.

So why don’t we pull off there I think one – I just wanted to hit a couple of things on the way out. I think one is as a company right now there is a kind of ruthless prioritization of what we’re doing as a business. I think we’ve done a very good job of it, very difficult to have a company reduce cost, improve revenue lines, also while investing in new projects and I think we’ve done a good job of balancing those things and I think overall we would like to see revenue grow in the areas where you expected to grow, we expected to grow and I think we want to see cost come down, continue to come down over time.

Second thing is that we believe we’re investing in disruptive and differentiated platforms. Overall, I think when you look the results from Ad.com I think when you look at the things that Arianna and their team has been able to do at Huffington Post, they have been game changing. They continue to think about innovation, you look at products like Patch, you look at Pictela, and the video network we’ve done, Project Devil. The areas that we’re investing in are differentiated and not me to products and they’re not features. We are investing in real products in those areas.

And then the third thing I will just not under cut is from where we were a year-ago to today, I think we have a stronger more focused team. I think we have a better area around technology and innovation. And I think you’re seeing basically the results of having a very functional Board of Directors, very functional ,management team and very, very functional group of folks who are at the company around what we are investing in.

So, I think, I will speak for Artie and I and the rest of the management team. I think we’re very pleased with these results. We want to get better over time and I think this is – the adjusted OIBDA growth is just a start of what we want to accomplish in the future.

So thank you for joining the call. And please follow-up if any questions or concerns you have.

Operator

Thank you for joining today’s conference. That concludes the presentation. You may now disconnect and have a wonderful day.

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