ITEM 1. BUSINESS
Introduction
AOL Inc. (referred to herein as “AOL”, the “Company”, “we”, “our” or “us”) is a leading global web services brand company with a substantial worldwide audience and a suite of online content, products and services that we offer to consumers, advertisers, publishers and subscribers. We are focused on attracting and engaging consumers by creating and offering high quality branded online content, products and services and providing valuable online advertising services on both our owned and operated properties and third-party websites.
We are in the midst of executing a multi-year strategic plan to reinvigorate growth in our revenues and profits by taking advantage of the continuing migration of advertising, commerce and information to the internet and digital devices. Our strategy is to focus our resources on AOL’s core competitive strengths in content production, advertising and paid services while expanding the distribution of our premium content, product and service offerings on multiple platforms and digital devices, including on portable wireless devices such as smartphones and tablets. We continue to reinvigorate AOL’s culture and brand by prioritizing the consumer experience, making greater use of data-driven insights and encouraging innovation.
AOL was founded in 1985 and later merged with Time Warner Inc. (“Time Warner”) in 2001. In the fourth quarter of 2009, the board of directors of Time Warner approved the complete legal and structural separation of AOL Inc. from Time Warner (the “spin-off”), following which we became an independent, publicly-traded company. On November 2, 2009, the Company converted from AOL Holdings LLC, a limited liability company wholly owned by Time Warner, to AOL Inc., a Delaware corporation wholly owned by Time Warner. The spin-off occurred on December 9, 2009.
Segments
In the fourth quarter of 2012, our management changed the way in which they evaluate our business for the purpose of allocating resources and assessing performance. As a result, we have changed our reporting of business results from a single reportable segment to three reportable segments, which are determined based on how the business is evaluated by our chief operating decision maker (“CODM”) function. Our reportable segments are:
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The Brand Group, which consists of AOL’s portfolio of distinct and unique content brands as well as certain service brands. The results for this segment include the performance of our advertising offerings on a number of owned and operated sites, such as AOL.com, The Huffington Post, Patch, TechCrunch and MapQuest.
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The Membership Group, which consists of offerings that serve AOL’s registered account holders, both free and paid. The results for this segment include AOL’s subscription offerings and advertising offerings on Membership Group properties, including communications products such as AOL Mail and AIM, as well as from performance compensation for marketing third party products and services.
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AOL Networks (formerly the Advertising.com Group), which consists of AOL’s offerings to publishers and advertisers utilizing AOL’s third-party advertising network as well as Brand Group and Membership Group inventory sold by AOL Networks. The results for this segment include the performance of Advertising.com, ADTECH, sponsored listings, Pictela, goviral and AOL On.
In addition to the above reportable segments, we have a corporate and other category that includes activities that are not directly attributable or allocable to a specific segment. This category primarily consists of broad corporate functions including legal, human resources, accounting, finance and marketing as well as activities and
costs not directly attributable to a segment such as restructuring costs, tax settlements and other general business costs. In this category we also include investments and owned and operated offerings managed by AOL Ventures, which we formed to attract and develop innovative initiatives.
For financial information about our segments for the years ended December 31, 2012, 2011 and 2010, see “Note 13” in our accompanying consolidated financial statements and “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
The Brand Group
The Brand Group seeks to be a leading publisher of relevant and engaging online content and provider of engaging online consumer products and services, by utilizing highly scalable publishing platforms and content management systems. The Brand Group consists of AOL’s portfolio of distinct and unique content brands as well as certain service brands with a focus on news, local, women/lifestyle and technology. Through our diverse network of sites, we seek to reach a global audience on many platforms and devices. Additionally, we offer advertisers and agencies powerful, comprehensive and efficient online tools to effectively deliver advertising and reach targeted audiences across Brand Group properties.
Brand Group offerings include original content produced through our large network of content creators, which includes professional journalists from new and traditional media, politicians, celebrities, academics, policy experts, freelance writers and bloggers, aggregated content from third parties and user-generated content. Our content offerings are made available to broad audiences through sites such as AOL.com and The Huffington Post, as well as to niche audiences on highly-targeted, branded properties, such as StyleList and TechCrunch. Additionally, we seek to enter joint ventures and strategic partnerships with third parties with established brands in an effort to expand our content offerings. To facilitate the intake, creation, management and publication of original content, we utilize publishing platforms and content management systems that are designed to scale in a cost-effective manner in order to produce a large variety of relevant content for consumers. In some instances, we have entered into third party partnerships in certain content verticals, which typically provide that the Brand Group receives a share of advertising revenue sold on a co-branded property.
The Brand Group offers many highly engaging and relevant brands, including:
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AOL.com-our welcome screen and navigation hub for entering other Brand Group and Membership Group properties and the internet. AOL.com aggregates compelling and engaging content and provides easy access to important digital services such as AOL Search and AOL Mail.
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The Huffington Post-an influential news, opinion and lifestyle website with moderated user comments, which also includes many sections that offer news and perspectives on different subject areas including multicultural issues, healthy living and politics. We have continued our expansion of The Huffington Post internationally largely through our partnerships with established local media companies. In 2012, The Huffington Post expanded its operations into Italy, Spain and France and we seek to continue the expansion of The Huffington Post in 2013 and beyond. Also in 2012,we launched HP Live!, a live online streaming network which leverages The Huffington Post’s community and social platform and invites instantaneous viewer response by smart phones, tablets or webcam.
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Patch-a community-specific news and information platform dedicated to providing comprehensive and trusted local coverage for individual towns and communities. We have developed and acquired platforms that are designed to facilitate the production, aggregation, distribution and consumption of local content. This local content includes professional editorial content, user-generated content and business listings. We continue to focus on increasing operating efficiencies and on exploring alternative revenue streams. We had approximately 900 Patch towns as of December 31, 2012.
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MapQuest-a leading online mapping and directions service. We seek to continue to supplement our MapQuest offerings beyond navigation through the launch of original travel content and enhanced trip planning features. We plan on further refining our mobile products with features and enhancements that enable users to experience trips more efficiently. MapQuest also licenses its business-to-business services to third party customers.
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Entertainment brands-Moviefone, AOL Music and Cambio
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Technology and Marketplace brands-TechCrunch, Engadget, DailyFinance, AOL Autos and AOL Travel
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Lifestyle brands-including Games.com, StyleList, Kitchen Daily, Homesessive and Makers
Increasingly, consumers access the internet on devices other than a personal computer. We continue to develop and offer applications for our existing desktop products and services that are optimized for display on alternative devices, such as smartphones, tablets and internet-enabled televisions. In addition, we also continue to develop and offer applications specific to such devices. We plan to continue investing in mobile applications within the Brand Group, prioritizing launches of key brands, collaborating with other providers in order to have our mobile applications included in their offerings, and expanding our mobile advertising platform.
We offer AOL Search on the Brand Group properties. We provide our consumers with a general, internet-based search experience that utilizes the organic web search results of Google, Inc. (“Google”) and additional links on the search results page that showcase contextually relevant AOL and third-party content and information, as well as provide a variety of search-related features (such as suggesting related searches to help users further refine their search queries). We also provide our consumers with relevant paid text-based search advertising through our relationship with Google, in which we provide consumers sponsored link ads in response to their search queries. In 2012, we refined our search results to optimize the consumer experience by serving the appropriate number of advertisements by query type. In addition, we offer vertical search services (i.e., search within a specific content category) and mobile search services on Brand Group properties.
We also offer contextually relevant advertising from both Google and AOL’s proprietary products. These advertisements are placed on sites targeted by advertisers based on the content of the websites. We also market our search services through search engine marketing, working with marketing partners to drive traffic to, and maximize the utilization of, our search services.
While the majority of AOL search revenues are reflected within the Brand Group, there are also search revenues within the Membership Group and AOL Networks for search offerings provided in each of those segments.
Content, products and services on Brand Group properties are generally available to online consumers and we are focused on attracting greater numbers of consumers to our offerings. In addition, we utilize various distribution channels as described below which allow us to more directly reach online consumers.
Certain of our Brand Group properties, such as our portals AOL.com and HuffingtonPost.com, serve as valuable distribution channels for our content, products and services as does the AOL-brand subscription access service. We also use a variety of other distribution channels, including agreements with manufacturers of digital devices and other consumer electronics and mobile carriers. We also distribute our content, products and services directly to consumers on the open web and through the Apple App Store, the Google Play Store, the Amazon Appstore and the Android Market. Additional distribution channels include toolbars, widgets, co-branded portals and websites, mobile aggregators, third-party websites and social networks that link to AOL Properties. AOL seeks to make its content, products and services, available on social networks, whether offered directly or by
means of partnerships with social network operators. We also utilize search engine marketing and search engine optimization as distribution methods. In addition, we make available open standards and protocols for use by third-party developers to enhance, promote and distribute our properties.
The Membership Group
The Membership Group is focused on delivering world-class experiences to our consumers who rely on AOL products and properties every day. The Membership Group creates integrated experiences that allow AOL consumers to have access to useful content from important brands, communication tools and valuable services. As with the Brand Group, AOL Advertising offers advertisers and agencies tools to effectively deliver advertising and reach targeted audiences across Membership Group properties. AOL Search is also offered on Membership Group properties.
The Membership Group includes our subscription access service, which provides a number of online services including narrow-band (telephone dial-up) access to the internet. As of December 31, 2012, we had approximately 2.8 million AOL-brand access subscribers in the United States. Our access service subscribers are important users of Brand Group and Membership Group properties and engaging both present and former access service subscribers is an important component of our strategy. In addition to our content, products and services that are available to all online consumers, an AOL-brand access subscription provides members with dial-up access to the internet and, depending on the applicable price plan, various degrees of enhanced safety and security features, technical support along with other benefits and discounts. Beginning in late 2011, we began a process to simplify the price structure of our access subscription plans and continued to focus on the valuable bundles of useful products and services we offer consumers along with their access service. In addition, we continue to offer internet access services to consumers under the CompuServe and Netscape brands.
Our access service partners provide us with modem networks and related services for a substantial portion of our subscription access service. We have agreed to commit a significant portion of our access service subscribers’ total dial-up network hours to these networks. Upon expiration of these agreements, we expect to continue our relationships with our service partners or enter into agreements with one or more other providers of modem networks and related services.
We are developing, testing and marketing additional curated AOL and third-party products and services that we offer to internet consumers generally a la carte or on a bundled basis. Some products or services are offered to access subscribers for no additional charge or at a discounted rate in order to increase customer satisfaction and retention. Computer tools, maintenance and warranty services, online technical support, anti-virus software, identity theft protection, online and social media privacy and reputation monitoring services, diet and fitness services, online learning and other lifestyle services are currently offered and additional categories may be added in the future. Consumers are able to manage their products and services through an online tool that facilitates self-management of these products and services, including the ability to add or cancel a product or service. Currently, the majority of the consumers of our paid services products are also access subscribers.
We also offer free communications tools, such as AOL Mail and AIM, which are leading e-mail and instant messaging services in the United States. AOL Mail and AIM are significant sources of our consumer traffic and engagement.
We distribute Membership Group properties through channels similar to the Brand Group as described above.
AOL Networks
AOL Networks’ focus is to position AOL as a global partner for leading publishers, advertisers and agencies seeking to maximize the value of their online brands through premium formats, video, content, networks and platforms. AOL Networks provides services and solutions that focus on acquiring inventory and content from
online publishers, adding value to that inventory and content, and selling it to online advertisers. We acquire unsold advertising inventory on third party websites, which we refer to as the Third Party Network, in addition to Brand Group and Membership Group offerings and then use our proprietary optimization, targeting and delivery technology to best match advertisers with available inventory.
AOL Networks includes the following:
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Advertising.com-the foundation of AOL Networks which serves as the third party inventory acquisition, technology, data and insights arm of AOL’s advertising sales groups;
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goviral-a global online video distribution network;
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AOL On-a platform of AOL’s complete video offerings and a curated video hub for consumers that offers premium video across a variety of channels that can be experienced on desktops, tablets, mobile devices and connected TV devices;
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ADTECH-our own proprietary ad serving technology (i.e., technology that places advertisements on websites and digital devices) that is the primary vehicle for placements of advertisements on Brand Group and Membership Group properties; in addition, we license this ad serving technology to third parties through our ADTECH subsidiaries in the United States and Europe (“ADTECH”);
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Pictela-a provider of a global technology platform for serving and distributing high-definition branded content, including videos, photos and applications, across online advertising; and
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Sponsored Listings-allows advertisers to target text-based and text plus image-based ads on Brand Group and Membership Group properties and within the Third Party Network with a high degree of control over ad placement.
AOL Networks offers a display advertising interface that gives advertisers the ability to target and control the delivery of their advertisements and provides advertisers and agencies with relevant display analytics and measurement tools. Through AOL Networks, we can offer our advertising technology products and solutions to advertisers, publishers and other technology companies individually or on a bundled basis. We aim to develop our current relationships with publishers and advertisers and continue to expand the number of publishers and advertisers we serve through the products and services we offer on the Third Party Network. Currently, a significant portion of our revenues on the Third Party Network is generated from the advertising inventory acquired from a limited number of publishers.
We utilize AdLearn, a proprietary scheduling, optimization and delivery technology that employs a set of complex mathematical algorithms that seek to optimize advertisement placements across the Third Party Network and the available inventory on Brand Group and Membership Group properties. This optimization is based on expected user response, which is derived from previous user response plus factors such as user segmentation, creative performance and site performance. AdLearn allows performance to be analyzed quickly and advertisement placement to be frequently optimized based on specific objectives, including click-through rate, conversion rate, sales volume and other metrics. We also offer advertisers the ability to target advertisements to specific users using technology that utilizes non-personally identifiable information, such as geographic location, previous exposure to certain advertisements or user behavior online. In the fourth quarter of 2012, we acquired Buysight, Inc. (“Buysight”), a leading provider of retargeting and intent-based targeted advertising which uses data to dynamically render more tailored advertising experiences for advertisers and consumers.
During the fourth quarter of 2011, the Company, Yahoo! Inc. (“Yahoo”) and Microsoft Corporation (“Microsoft”) entered into nonexclusive agreements to allow advertising networks operated by each of the companies to offer each other’s premium non-reserved online display inventory to their respective customers. This partnership offers advertisers and agencies the efficiency of buying premium display at scale to reach customers and audiences.
In 2012, we launched AdLearn Open Platform, an extension of our AdLearn technology that allows advertisers and agencies to manage, optimize and analyze online marketing campaigns from one central platform. This platform provides advertisers and agencies with the ability to manage their advertising campaign via our AdLearn optimization technology, real-time bidding capabilities, massive reach and premium inventory on our Third Party Network and on Brand Group and Membership Group properties. Advertisers have the option to use AdLearn Open Platform through self-service or managed-service solutions.
In addition, we launched ADTECH Marketplace, a new global platform which enables premium publishers to optimize advertising revenue by allowing their inventory to be purchased by advertisers on a static or real-time bidding basis, using criteria set by such publishers to customize acceptable buying attributes and increase the value of their inventory.
We have continued to focus on innovation in premium branded display. Our premium advertising format, “Project Devil,” seeks to enhance the consumer experience by improving the aesthetic quality, impact and interactivity of online advertising, while also providing solutions for advertisers looking for innovative ways to showcase their products and services to consumers. AOL Networks has an international presence, primarily in Europe and Canada, with our Advertising.com, ADTECH and goviral offerings. We seek to continue to expand our advertising offerings in key markets. In this regard, in February 2012, we purchased an additional interest in our joint venture with Mitsui & Co., Ltd. (“Ad.com Japan”) in order to obtain control of the board and day-to-day operations of Ad.com Japan. We seek to expand our sales of mobile advertising by utilizing the AOL Networks publisher network to aggregate mobile inventory. We focus on offering advertisers and agencies valuable premium mobile inventory, targeting capabilities and real-time optimization on a cross-platform basis.
Revenues
Advertising Revenues
Across our segments and the corporate and other category, our advertising operations focus on the following:
AOL Properties. We sell advertising on AOL Properties, which include our owned and operated content, products and services in the Membership Group and Brand Group segments in addition to our AOL Ventures offerings. AOL Properties also include co-branded websites owned or operated by third parties for which certain criteria have been met, including that the internet traffic has been assigned to us.
Third Party Network. We also sell advertising on the Third Party Network and offer advertising services to the publishers of these sites.
We market our offerings to advertisers on both AOL Properties and the Third Party Network under the brand “AOL Advertising” and collectively we refer to our total advertising offerings as the AOL Advertising Network.
AOL Properties Advertising Revenue
We generate advertising revenues in our segments through the sale of display advertising and search advertising. We offer advertisers a wide range of capabilities and solutions to effectively deliver advertising and reach targeted audiences across AOL Properties through our dedicated advertising sales force. A significant area of our focus is on offering customized premium advertising. The substantial number of unique visitors on AOL Properties allows us to offer advertisers the capability of reaching a broad and diverse demographic and geographic audience without having to partner with multiple content providers. We seek to provide effective and efficient advertising solutions utilizing data-driven insights that help advertisers decide how best to engage consumers. We offer advertisers marketing and promotional opportunities to purchase specific placements of
advertising directly on AOL Properties (i.e., in particular locations and on specific dates). In addition, we offer advertisers the opportunity to bid on unreserved advertising inventory on AOL Properties utilizing our proprietary scheduling, optimization and delivery technology. Finally, advertising inventory on AOL Properties not sold directly to advertisers, as described above, may be included for sale to advertisers by AOL Networks with inventory purchased from third-party publishers. In addition, agreements with advertisers can include other advertising-related services such as content sponsorships, exclusivities or advertising effectiveness research.
For the years ended December 31, 2012, 2011 and 2010, our advertising revenues on AOL Properties were $946.9 million, $930.5 million and $940.4 million, respectively.
Display Advertising Revenues
Display advertising revenues are generated through the display of graphical advertisements as well as performance-based advertising. Agreements for advertising on AOL Properties typically take the following forms:
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impression-based contracts in which we provide “impressions” (an “impression” is delivered when an advertisement appears in web pages viewed by users) in exchange for a fee (generally stated as cost-per-thousand impressions);
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time-based contracts in which we provide promotion over a specified time period for a fixed fee; or
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performance-based contracts in which performance is measured in terms of either “click-throughs” (when a user clicks on a company’s advertisement) or other user actions such as product/customer registrations, survey participation, sales leads, product purchases or other revenue sharing relationships.
Search Advertising Revenues
Search advertising revenues (formerly called search and contextual advertising revenues) are generated on AOL Properties when a consumer clicks on a text-based ad on their screen. These text-based ads are either generated from a consumer-initiated search query or generated based on the content of the webpage the consumer is viewing. Google is, except in certain limited circumstances, the exclusive web search provider for AOL Properties, based on our agreement that runs through December 31, 2015. In connection with these search services, Google provides us with a share of the revenue generated through paid text-based search advertising and contextual advertising on AOL Properties. For the year ended December 31, 2012, advertising revenues associated with the Google relationship were $350.9 million. Substantially all of these revenues were search revenues generated on AOL Properties, with a significant majority generated within the Brand Group and to a lesser extent within the Membership Group. In addition, we sell search-based keyword advertising directly to advertisers on AOL Properties through the use of a white-labeled, modified version of Google’s advertising platform, for which we provide a share of the revenue generated through such sales to Google. As part of our relationship with Google, in 2012 we expanded the alliance to include the provision of mobile search advertising services to AOL. AOL and Google also have a video partnership that features AOL’s video content on YouTube. See “Item 1A
ITEM 1A. RISK FACTORS
The risks and uncertainties described below are those which we consider material and of which we are currently aware. In addition, this Annual Report contains forward-looking statements that involve risks and uncertainties. You should carefully read the section “Cautionary Statement Concerning Forward-Looking Statements”.
If any of the following events occur, our business, financial condition or results of operations could be materially and adversely affected and the trading price of our common stock could materially decline.
Risks Relating to Our Business
Our focus on our online advertising-supported business model involves significant risks.
As our subscription revenues continue to decline, we have become increasingly dependent on advertising revenues. Until recently, we have not been able to generate sufficient growth in our advertising revenues to offset the loss of subscription revenues we have experienced in recent years and we may not be able to do so in the future on a consistent basis.
Growth in our advertising revenues depends on our ability to continue offering effective products and services for advertisers and publishers. Continuing to develop and improve these products and services may require significant time and investment. If we cannot continue to develop and improve our advertising products, services and technologies, our advertising revenues could be adversely affected.
In order for us to increase advertising revenues in the future, we believe it will be important to increase our overall volume of advertising sold and to maintain or increase pricing for advertising. If we are not able to attract consumers to, and engage consumers with, those AOL Properties that typically generate higher-priced and higher-volume advertising, our advertising revenues may not increase even if the aggregate number of consumers on AOL Properties increases and their aggregate engagement increases.
Additionally, there are different cost structures within our advertising business. In order to generate display advertising revenues on the Third Party Network, we incur TAC. While a majority of the costs associated with generating display advertising on the Third Party Network are variable, a majority of costs associated with generating display advertising revenue on AOL Properties are fixed. Therefore, even if we generate higher display advertising revenues on the Third Party Network, because there are lower incremental margins associated with these sales, the increase in our operating income will be less than it would with an equivalent increase in display revenues on AOL Properties.
Additionally, advertising revenues are more unpredictable and variable than our subscription revenues, and are more likely to be adversely affected during economic downturns, as spending by advertisers tends to be cyclical in line with general economic conditions.
We face intense competition in all aspects of our business.
The internet industry, with its low barriers to entry and rapidly shifting consumer tastes, is dynamic and rapidly evolving. Competition among internet companies offering online content, products and services, as well as with traditional offline content and advertising companies which are increasingly offering their own online content, products and services, is intense both domestically and globally and new competitors can quickly emerge. We could be at a competitive disadvantage in the long term if we are not able to capitalize on international opportunities, especially as compared to a number of our competitors who maintain an expansive global presence. If our competitors are more successful than we are in developing compelling content, products and services or in attracting and retaining consumers, advertisers, publishers and subscribers domestically and internationally, our business could be adversely affected.
If we do not continue to develop and offer compelling content, products and services and attract new consumers or maintain the engagement of our existing consumers, our advertising revenues could be adversely affected.
In order to attract consumers and maintain or increase engagement on AOL Properties, we believe we must offer compelling content, products and services. Acquiring, developing and offering new content, products and services, as well as new functionality, features and enhanced performance of our existing content, products and services, may require significant investment and time to develop. In addition, consumer tastes are difficult to predict and subject to rapid change.
In general, subscribers to our subscription access service are among the most engaged consumers on AOL Properties. As our subscriber base declines, it is advantageous to maintain the engagement of former access subscribers and increase the number and engagement of other consumers on AOL Properties in order to successfully execute our business model. Additionally, consumer engagement on certain of the AOL Properties, such as AOL.com, has been very significant to our operating results and we continue to focus on efforts to maintain or increase engagement on those properties. For example, we derive a significant portion of our search advertising revenue from search queries on AOL.com. If we are unable to develop online content, products and services that are attractive and relevant to AOL.com consumers, we may not be able to maintain or increase our existing consumers’ engagement on or attract new consumers to AOL.com and as a result our search advertising revenues may be adversely affected.
We are dependent on a third-party search provider.
We do not own or control a general web search service. Google is, except in certain limited circumstances, the exclusive United States provider of web search and sponsored links on AOL Properties through December 31, 2015. For the year ended December 31, 2012, search advertising revenues comprised approximately 26% of our total advertising revenues. Changes that Google has made and may unilaterally make in the future to its search service or advertising network, including changes in pricing, algorithms or advertising relationships, could adversely affect our advertising revenues, a decline or an unfavorable change in our relationship with Google could materially affect our advertising revenues. Because we do not own or control such a search service, we are not able to package and sell search advertising along with display advertising services outside of AOL Properties and we believe that this could adversely affect our ability to increase advertising revenues.
Changes to products, technology and services made by third parties and consumers could adversely affect our business.
We are dependent on many products, technologies and services provided by third parties, including browsers, data and search indexes, in order for consumers to use our content, products and services, as well as to deliver, measure, render and report advertising. Any changes made by these third parties or consumers to functionality, features or settings of these products, technologies and services could adversely affect our business. For example, third parties may develop, and consumers may install, software that is used to block display or search advertisements or delete cookies, or consumers may elect to manually delete cookies more frequently. The widespread adoption of products and technologies or changes to current products, technologies and services could adversely affect our business.
We rely on legacy technology infrastructure and a failure to update, scale or replace this technology infrastructure could adversely affect our business.
Significant portions of our content, products and services are dependent on technology infrastructure that was developed a number of years ago. The technology infrastructure utilized for our consumer offerings and advertising services are highly complex and may not provide satisfactory support as usage increases and products and services expand, change and become more complex in the future. In addition, we incur significant costs
operating our business with multiple and often contradictory technology platforms and infrastructure. Updating and replacing our technology infrastructure may be challenging to implement and manage, may take time to test and deploy, may cause us to incur substantial costs and may cause us to suffer data loss or delays or interruptions in service which could adversely affect our business. Competitors with newer technology infrastructure may have greater flexibility and be in a position to respond more quickly than us to new opportunities, which could impact our competitive position in certain markets and adversely affect our business.
If we are unable to hire, engage and retain key management and other personnel, our business could be adversely affected.
Our future success depends in large part upon the continued service of key members of our management team and other personnel. If we do not succeed in retaining and engaging our key employees and in attracting new key personnel, we may be unable to meet our strategic objectives, maintain or build our brands, and, as a result, our business could be adversely affected. In particular, Tim Armstrong, our CEO, is critical to AOL’s overall management, as well as the development of AOL’s strategic direction and culture. We do not maintain any key-person life insurance policies.
If we cannot effectively distribute our content, products and services, our ability to attract new customers and maintain the engagement of existing consumers could be adversely affected.
As the behavior of internet consumers continues to change, distribution of our content, products and services via traditional methods may become less effective, and new distribution strategies may need to be developed. Consumers are increasingly using social networking sites to communicate and to acquire and disseminate information rather than through instant messaging, electronic mail and portals. As consumers migrate towards social networks, we seek to build social elements into our content, products and services in order to make them available on social networks and to attract and engage consumers on our properties. There is no guarantee that we will be able to successfully integrate our content with such social networking or other new consumer trends. Even if we are able to distribute our content, products and services effectively through social networking or other new or developing distribution channels, this does not assure that we will be able to attract new consumers.
Currently, an important distribution channel for AOL Properties is through our subscription access service. However, our access service subscriber base has declined and is expected to continue to decline. This continued decline is likely to reduce the effectiveness of our subscription access service as a distribution channel. In addition, certain of our websites, including portals such as the AOL home page and the Huffington Post, act as valuable distribution channels for other AOL Properties. If we are unable to grow organically by attracting new consumers directly to our content, products and services or if traffic to our portals declines or our portals are less successful as a distribution vehicle for other AOL Properties, we may need to rely on distribution channels that require us to pay significant fees to third parties such as operators of third-party websites, online networks, software companies, device manufacturers, and others to promote or supply our services to their users.
Previously, we entered into distribution agreements with computer manufacturers to install our products and services on their personal computers and laptops. We no longer regularly enter into such agreements and as consumers upgrade their hardware, our products and services may not be as easily accessible. Additionally, our products and services may not be compatible on or supported by new hardware. A decline in the traffic and engagement from these consumers could adversely affect our advertising and subscription revenue.
Global consumers are increasingly accessing and using the internet through devices other than personal computers, such as smartphones, tablets and televisions. In order for consumers to access and use our content, products and services via these devices, we must continue to ensure that our content, products and services are compatible with such devices. We also need to continue to secure arrangements with device manufacturers and carriers to promote prominent and effective distribution of our content, products and services.
In addition to placement agreements with wireless carriers and manufacturers, currently we offer applications directly to consumers for download from AOL Properties, the Apple App Store, or through other distribution channels. To the extent that consumers are using our applications, content, products and services, we have opportunities to generate advertising revenues. However, the amount of revenues, including advertising revenues, earned from such arrangements is currently small relative to advertising revenues earned through other arrangements. Also, business models in the marketplace seem to be undergoing experimentation and rapid change. To the extent that we cannot generate consumer awareness and adoption of our applications, content, products and services, our business could be adversely impacted.
Our access service subscriber base could decline faster than we currently anticipate which could result in a decrease in our subscription and advertising revenues.
Our access service subscriber base has declined and is expected to continue to decline. This decline has been the result of several factors, including the increased availability of high-speed internet broadband connections and attractive bundled offerings by such broadband providers, the fact that a significant amount of online content, products and services has been optimized for use with broadband internet connections and the effects of our strategic shift to focus on generating advertising revenues, which resulted in us essentially eliminating our marketing efforts for our subscription access service and the free availability of the vast majority of our content, products and services. Dial-up internet access services do not compete favorably with broadband access services with respect to connection speed and do not have a significant, if any, price advantage over certain broadband services. A substantial number of our access service subscribers do not use our dial-up service to access the internet. Although we provide other online services in addition to dial-up access as part of our subscription access plans, there can be no assurance that our subscribers will value the bundle of services we offer and they may cancel their subscriptions at any time. If any of these factors result in our access subscriber base declining faster than we currently anticipate, our subscription and advertising revenues could be adversely affected.
A disruption or failure of our networks and information systems, the internet or other technology may disrupt our business.
Our business is heavily dependent on the availability of network and information systems, the internet and other technologies. Shutdowns or service disruptions caused by events such as criminal activity, sabotage or espionage, computer viruses, hacking and other cyber-security attacks, router disruption, automated attacks such as denial of service attacks, power outages, natural disasters, accidents, terrorism, equipment failure or other events within or outside our control could adversely affect us and our consumers, including loss or compromise of data, service disruption, damage to equipment and data and excessive call volume to call centers. Furthermore, such attacks are not always able to be immediately detected, which means that we may not be in a position to promptly address the attacks or to implement adequate preventative measures. Such events could result in large expenditures necessary to recover data, or repair or replace such networks or information systems or to protect them from similar events in the future. As not all of our systems are fully redundant, some data or systems might not be recoverable after such events. In addition, not all of our systems operate in the same data centers. Significant incidents could result in a disruption of parts of our business, consumer dissatisfaction, damage to our brands, legal costs or liability, and a loss of consumers or revenues.
If we cannot continue to enforce and protect our intellectual property rights, our business could be adversely affected.
We rely on patent, copyright, trademark, domain name and trade secret laws in the United States and similar laws in other countries, as well as licenses and other agreements with our employees, consumers, content providers, suppliers and other parties, to establish and maintain our intellectual property rights in the technology, content, products and services used in our operations. These laws and agreements may not guarantee that our
intellectual property rights will be protected and our intellectual property rights could be challenged or invalidated. Also, recent amendments to U.S. patent laws may adversely impact our ability to protect our new technologies, content, products and services and to defend against claims of patent infringement. In addition, such intellectual property rights may not be sufficient to permit us to take advantage of current industry trends or otherwise to provide competitive advantages, which could result in costly redesign efforts, discontinuance of offerings, decreased traffic and associated revenue or otherwise adversely affect our business. As we acquire and publish more original content, our intellectual property may be increasingly subject to misappropriation by others, and the costs to protect and enforce our intellectual property rights may increase.
We have been, and may in the future be, subject to claims of intellectual property infringement or tort law violations that could adversely affect our business.
Many companies (including patent holding companies) and individuals own patents, copyrights, trademarks, and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. We have recently experienced an increase in the number of intellectual property rights claims against us coinciding with the expansion of various parts of our business. We may continue to experience these increases as we develop and offer new products, services, and technologies through various distribution channels. These claims, whether meritorious or not, may result in litigation, may be time-consuming and costly to resolve, and may require expensive changes in our methods of doing business and/or our content, products and services. These intellectual property infringement claims may require us to enter into royalty or licensing agreements on unfavorable terms or to incur substantial monetary liability. Additionally, these claims may result in our being enjoined preliminarily or permanently from further use of certain intellectual property and/or our content, products and services, or may require us to cease or significantly alter certain of our operations. The occurrence of any of these events as a result of these claims could result in substantially increased costs, could limit or reduce the number of our offerings to consumers, advertisers, publishers and subscribers, could stifle innovation or otherwise adversely affect our business.
Some of our commercial agreements may require us to indemnify third parties against intellectual property infringement claims, which may require us to use substantial resources to defend against or settle such claims or, potentially, to pay damages. These third parties may also discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely impact our business. Additionally, we may be exposed to liability or substantially increased costs if a commercial partner does not honor its contractual obligation to indemnify us for intellectual property infringement claims made by third parties or if any amounts received are not adequate to cover our liabilities or the costs associated with defense of such claims. The occurrence of any of these events could adversely affect our business.
As a publisher of original content and aggregator of third party content, we also face risks of periodic tort claims such as defamation or improper use of publicity rights, as well as infringement claims such as plagiarism. Whether or not they have merit, these claims may be time-consuming or costly to resolve.
The misappropriation, release, loss or misuse of AOL, consumer or other data could adversely affect our business.
Our business utilizes significant amounts of data about our business, consumers and our advertising and publishing partners in order to deliver our content, products and services and our advertising solutions. The misappropriation, release, loss or misuse of this data, whether by accident, omission or as the result of criminal activity, sabotage or espionage, hacking, computer viruses, natural disasters, terrorism, equipment failure or other events, could lead to negative publicity, harm to our reputation, customer dissatisfaction, regulatory enforcement actions or individual or class-action lawsuits or significant expenditures to recover the data or protect data from similar releases in the future, and may otherwise adversely affect our business. Furthermore, as not all of our systems are fully redundant, some data or systems might not be recoverable in a catastrophic event or other significant service disruption.
New or existing federal, state or international laws or regulations applicable to our business could subject us to claims or otherwise adversely affect our business.
Our business is subject to a variety of federal, state and international laws and regulations, including those with respect to consumer privacy, advertising generally, consumer protection, content regulation, network neutrality, cyber security, data protection, intellectual property (including copyright, patent, trademark and trade secret laws), defamation, child protection, advertising to and collecting information from children, taxation, employment classification, billing, subpoena and warrant processes and others. These laws and regulations and the interpretation or application of these laws and regulations could change. In addition, new laws or regulations affecting our business could be enacted. Furthermore, many laws were adopted prior to the advent of the internet and related technologies or have an unsettled application or scope with respect to the internet and related technologies and therefore their application on our business is often uncertain. Additionally, as our business evolves, we may be subject to new laws and the application of existing laws to us might change. These laws and regulations are frequently costly to comply with and may divert a significant portion of management’s attention. If we fail to comply with these applicable laws or regulations, we could receive negative publicity and be subject to significant liabilities which could adversely affect our business.
Many of our advertising partners are subject to industry specific laws and regulations or licensing requirements, including advertisers in the following industries: pharmaceuticals, online gaming, alcohol, adult content, tobacco, firearms, insurance, securities brokerage, real estate, sweepstakes, free trial offers, automatic renewal services and legal services. If any of our advertising partners fails to comply with any of these licensing requirements or other applicable laws or regulations, or if such laws and regulations or licensing requirements become more stringent or are otherwise expanded, we could receive negative publicity, incur significant penalties or our business could be otherwise adversely affected.
Failure to comply with federal, state or international privacy laws or regulations, or the expansion of current or the enactment of new privacy laws or regulations, could adversely affect our business.
A variety of federal, state and international laws and regulations govern the collection, use, retention, sharing and security of consumer data. In addition to the potentially differing interpretations of existing law, the present landscape of public policy and privacy creates uncertainty for business planning. In such an uncertain environment, it is difficult to make informed long-term business planning decisions about data use, notice, storage, access, retention or choice. The existing privacy-related laws and regulations are evolving and subject to potentially differing interpretations. In addition, various federal, state and foreign legislative and regulatory bodies may expand current or enact new laws regarding privacy matters. We have posted privacy policies and practices concerning the collection, use and disclosure of user data on our websites. Any failure, or perceived failure, by us to comply with our posted privacy policies or with any data-related consent orders, Federal Trade Commission requirements or orders or other federal, state or international privacy or consumer protection-related laws, regulations or industry self-regulatory principles could result in claims, proceedings or actions against us by governmental entities or others or other liabilities, which could adversely affect our business. In addition, a failure or perceived failure to comply with industry standards or with our own privacy policies and procedures could result in a loss of consumers or advertisers and adversely affect our business.
Federal, state and international governmental authorities continue to evaluate the privacy implications inherent in the use of third-party web “cookies” for behavioral advertising. We use cookies, which are small text files placed in a consumer’s browser, to facilitate authentication, preference management, research and measurement, personalization, targeting and advertisement and content delivery. The regulation of these “cookies” and other current online advertising practices could adversely affect our business.
Any restructuring actions and cost reduction initiatives that we undertake may not deliver the expected results and these actions may adversely affect our business operations.
We may undertake various restructuring activities and cost reduction initiatives in an effort to better align our organizational structure and costs with our strategy. In connection with such activities, we may experience a disruption in our ability to perform functions important to our strategy. While we strive to reduce the negative impact of such restructuring actions and cost reduction initiatives, such activities could result in significant disruptions to our operations, including adversely affecting the timeliness of product releases, the successful implementation and completion of our strategic objectives and the results of our operations. We expect to continue to actively manage our costs. However, if we do not fully realize or maintain the anticipated benefits of any restructuring plans and cost reduction initiatives, our business could be adversely affected.
We may need to raise additional capital, and we cannot be sure that additional financing will be available.
We have funded our ongoing working capital, capital expenditure and financing requirements through cash flows from operations and asset dispositions; however, we may require additional financing in the future. Our ability to obtain future financing will depend on, among other things, our financial condition and results of operations as well as the condition of the capital markets or other credit markets at the time we seek financing. We currently do not have any ratings from the credit rating agencies, so our access to capital markets may be limited. We may not be able to obtain future financing on terms acceptable to us in a timely manner, or at all. Our ability to fund our working capital, capital expenditure and financing requirements in the future may be adversely affected if we are unable to obtain financing on acceptable terms. If we are unable to enter into the necessary financing arrangements or sufficient funds are not available on acceptable terms when required, we may not have sufficient liquidity and our business may be adversely affected.
Acquisitions of other businesses could adversely affect our operations and result in unanticipated liabilities.
Since January 1, 2012, we acquired Buysight and other smaller businesses and we may make additional acquisitions and strategic investments in the future. The completion of acquisitions and strategic investments as well as the integration of acquired companies or assets involve a substantial commitment of resources and we may fail to realize the anticipated benefits of such transactions and incur unanticipated liabilities that could harm our business. In addition, past or future transactions may be accompanied by a number of risks, including:
•
the uncertainty of our returns on investment due to the new and developing industries in which some of the acquired companies operate;
•
the adverse effect of known potential liabilities or unknown liabilities, such as claims of patent or other intellectual property infringement, associated with the companies acquired or in which we invest;
•
the difficulty of integrating technology, administrative systems, personnel and operations of acquired companies into our services, systems and operations and unanticipated expenses related to such integration;
•
the potential loss or disengagement of key talent at acquired companies;
•
the potential disruption of our ongoing business and distraction of our management;
•
additional operating losses and expenses of the businesses we acquire or in which we invest and the failure of such businesses to perform as expected;
•
the failure to successfully further develop acquired technology, resulting in the impairment of amounts currently capitalized as intangible assets;
•
the difficulty of reconciling potentially conflicting or overlapping contractual rights and duties; and
•
the potential impairment of relationships with consumers, partners and employees as a result of the combination of acquired operations and new management personnel.
We face risks relating to doing business internationally that could adversely affect our business.
Our business operates and serves consumers globally. There are certain risks inherent in doing business internationally, including:
•
economic volatility and the current global economic uncertainty;
•
currency exchange rate fluctuations;
•
the requirements of local laws and customs relating to the publication and distribution of content and the display and sale of advertising;
•
uncertain protection and enforcement of our investment or intellectual property rights;
•
import or export restrictions and changes in trade regulations;
•
difficulties in developing, staffing and simultaneously managing a large number of foreign operations as a result of distance as well as language and cultural differences;
•
issues related to occupational safety and adherence to local labor laws and regulations;
•
political or social unrest;
•
risks related to government regulation;
•
the existence in some countries of statutory stockholder minority rights and restrictions on foreign direct ownership;
•
the presence of corruption in certain countries; and
•
higher than anticipated costs of entry.
One or more of these factors could adversely affect our business.
International expansion involves increased investment as well as risks associated with doing business abroad, as described above. In certain instances, we have expanded internationally through joint ventures, and our inability to control certain aspects of a joint venture partnership may impact the development and expansion of our offerings. Furthermore, investments in some regions can take a long period to generate an adequate return. In addition, as we expand into new international regions, we may have limited experience in operating and marketing our products and services in such regions and could be at a disadvantage compared to competitors with more experience.
We could be subject to additional tax liabilities which could adversely affect our business.
International, federal, state and local tax laws and regulations affecting our business are extremely complex and subject to varying interpretations. These tax laws and regulations, or interpretations or application of these tax laws and regulations, could change or new laws and regulations affecting our business could be enacted.
There can be no assurance that our tax positions will not be challenged by relevant tax authorities or that we would be successful in any such challenge. Our subscription access service is protected from taxation through the Federal Internet Tax Non-Discrimination Act, which is in effect until November 2014 and there is no guarantee that this exemption will continue past this date. Several taxing jurisdictions have sought to increase revenue by imposing new taxes on, advertising generally, and internet advertising specifically, or by increasing general business taxes. Imposing new taxes on advertising or internet advertising would adversely affect us. A tax on digital products in a particular state would require us to either pay the sales tax on all non-access paid services sold in that state or implement a system to collect the tax from our customers and remit it to that state which could be costly to put in place. Other states have sought to expand the definition of “nexus” for the purpose of taxing goods and services sold over the internet. If enacted, these new taxes would adversely affect our consumers and, as a result, could adversely affect our business.
We may not be able to utilize our tax attributes to offset future U.S. taxable income.
We believe that we have valuable tax attributes that are significant assets of the Company. Unless otherwise restricted, we can utilize these tax assets in certain circumstances to offset future U.S. taxable income, including in connection with capital gains that may be generated from a potential asset sale. Our ability to use the tax assets could be limited and the timing of the usage of the tax assets could be substantially delayed if we experience an “ownership change,” as defined in Section 382 of the Internal Revenue Code. A company generally experiences an “ownership change” for tax purposes if the percentage of stock owned by its 5% stockholders (as defined for tax purposes) increases by more than 50 percentage points over a rolling three-year period. To help protect shareholder value and preserve our ability to use the tax assets, our Board of Directors (the “Board”) recently adopted a Tax Asset Protection Plan (the “TAPP”) to act as a deterrent to any person acquiring beneficial ownership of 4.9% or more of our outstanding common stock without the approval of the Board. Notwithstanding the adoption of the TAPP, we cannot eliminate the possibility that an “ownership change” will occur. The amount by which our ownership may change in the future could, for example, be affected by purchases and sales of stock by stockholders and repurchases of stock by us, should we choose to do so. Additionally, if our shareholders do not approve the adoption of the TAPP at our next annual meeting, the TAPP will terminate in August 2013. If the TAPP is not effective in preventing an ownership change our ability to use the tax assets to offset taxable income may be reduced or eliminated. Even if the TAPP is effective in preventing an ownership change, we will only be able to utilize these tax assets to the extent we generate taxable income and the taxing authorities do not challenge the amount of our tax assets or otherwise make an adverse determination regarding our ability to use these assets, and therefore we are not able to guarantee that the tax assets will be valuable to us in the future.
Risks Relating to our Common Stock and the Securities Market
Our stock price may fluctuate significantly.
Our stock price has fluctuated significantly over the last two years and may fluctuate significantly depending on many factors, some of which may be beyond our control, including:
•
actual or anticipated fluctuations in our operating results due to factors related to our business;
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success or failure of our business strategy;
•
our quarterly or annual earnings, or those of other companies in our industry;
•
our ability to obtain financing as needed;
•
announcements by us or our competitors of significant acquisitions or dispositions;
•
changes in accounting standards, policies, guidance, interpretations or principles;
•
changes in earnings estimates by securities analysts or our ability to meet those estimates;
•
the operating and stock price performance of other comparable companies;
•
overall market fluctuations;
•
changes in laws and regulations affecting our business; and
•
general economic conditions and other external factors.
Stock markets in general have experienced volatility that has often been unrelated to the operating performance of a particular company. These broad market fluctuations could adversely affect the trading price of our common stock. When the market price of a company’s stock fluctuates significantly, shareholders may institute securities class action litigation against that company. Any litigation against us could cause us to incur substantial costs, divert the time and attention of our management and other resources or otherwise harm our business.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Our headquarters, located in New York City, is a leased property consisting of approximately 230 thousand square feet. We own a corporate campus in Dulles, Virginia comprising office buildings, a data center, child care and support facilities of approximately 840 thousand square feet. We lease or own additional office, data center and warehouse space located in California and Virginia totaling approximately 620 thousand square feet. In addition to these properties, we lease approximately 480 thousand square feet in over 50 facilities for use as corporate offices, sales offices, development centers, data centers and other operations in other locations in the United States and internationally. Our larger leased sites are located in Colorado, Illinois, Maryland and Massachusetts and in the countries of Canada, Germany, India, Ireland, Israel and the United Kingdom. We sublease to third parties approximately 225 thousand square feet of our leased properties. Due to the nature of the Company’s operations, most of the properties described above are used by more than one of our segments.
We believe that our facilities are sufficient to meet our current and projected needs. We also have an ongoing process to review and update our real estate portfolio to meet changing business needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
During the second quarter of 2012, we paid $13.5 million to settle a sales tax matter with the Virginia Department of Taxation covering the period from February 1995 through December 2011. In connection with the resolution of this matter, we recorded incremental sales and use tax expense within general and administrative expense of $9.6 million for the year ended December 31, 2012.
In addition to the matter described above, we are a party to a variety of claims, suits and proceedings that arise in the normal course of business, including actions with respect to intellectual property claims, tax matters, labor and unemployment claims, commercial claims, claims related to our business model for content creation and other matters. We reached various settlements on certain intellectual property and other legal matters during the year ended December 31, 2012. Collectively, the amounts incurred and paid related to these matters were not material to our financial statements.
With respect to tax matters, we have received tax assessments in certain states related to sales and use taxes on our business operations. We have appealed these tax assessments and plan to vigorously contest these matters. In addition, we have received assessments in certain foreign countries related to income tax and transfer pricing, and plan to vigorously contest these matters as well. In certain instances, we were required to pay a portion of the tax assessment in order to proceed with the dispute of the assessment.
In February 2013, we received notice that the Attorney General for the State of Florida is investigating a number of advertising companies, including Advertising.com, regarding the placement of allegedly deceptive third-party advertising on their online advertising networks. We are cooperating with the investigation and have responded to initial information requests. While the results of such claims, suits, and proceedings and investigations cannot be predicted with certainty, management does not believe that, based on current knowledge and the likely timing of resolution of various matters, any additional reasonably possible potential losses above the amount accrued for such matters would be material to our financial statements. Regardless of the outcome, legal proceedings can have an adverse effect on us because of defense costs, diversion of management resources and other factors. See “Item 1A - Risk Factors-Risks Relating to Our Business-If we cannot continue to enforce and protect our intellectual property rights, our business could be adversely affected” and “Item 1A - Risk Factors-Risks Relating to Our Business-We have been, and may in the future be, subject to claims of intellectual property infringement or tort law violations that could adversely affect our business” included in this Annual Report.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
AOL’s common stock is listed on the New York Stock Exchange (NYSE) under the symbol “AOL.” The following table presents the quarterly high and low sales prices for the common stock on the NYSE as reported for each period indicated:
As of February 22, 2013 there were approximately 16,560 holders of record of our common stock. Because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. The closing price of the common stock on the NYSE on February 22, 2013 was $37.79.
Stock Repurchases
The following is a summary of common shares repurchased by the Company under its stock repurchase program during the three months ended December 31, 2012:
(a) On August 26, 2012, we entered into a fixed dollar collared accelerated stock repurchase agreement with Barclay’s Capital Inc. (“Barclays”), as agent for Barclays Bank PLC, effective August 27, 2012 (the “ASR Agreement”). The average price paid per share reflects the average price for all shares delivered by Barclays under the ASR Agreement as of December 31, 2012.
(b) Under the ASR Agreement, on August 30, 2012, we paid $654.1 million from cash on hand to Barclays to repurchase outstanding shares of common stock. The approximate dollar value of shares that may yet be repurchased under the program disclosed above excludes commissions and other fees paid in relation to repurchases through December 31, 2012. We currently anticipate that the ASR Agreement will be completed during the second quarter of 2013.
Dividend Policy
On August 26, 2012, we declared the payment of a special, one-time, cash dividend of $5.15 per share to shareholders of record at the close of business on December 5, 2012 (the “Special Cash Dividend”), which was paid on December 14, 2012. This dividend was part of the process of returning 100% of the $1,056 million of patent transaction proceeds to shareholders. We do not currently anticipate additional declarations of cash dividends on our common stock in the immediate future. The declaration of additional cash dividends on our common stock could impact existing stock repurchase agreements.
Performance Graph
The graph below matches AOL Inc.’s cumulative 36-Month total shareholder return on common stock with the cumulative total returns of the S&P Midcap 400 index and the Morgan Stanley High-Technology index. The graph tracks the performance of a $100 investment in our common stock and in each of the indexes (with the reinvestment of all dividends) from December 10, 2009 (the first trading day after our spin-off from Time Warner) to December 31, 2012.
* $ 100 invested on 12/10/09 in stock or index, including reinvestment of dividends.
Fiscal year ending December 31.
Copyright© 2013 S&P, a division of The McGraw - Hill Companies Inc. All rights reserved.
The stock price performance included in this graph is not necessarily indicative of future stock price performance.
This performance graph shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 (the “Exchange Act”) or incorporated by reference into any of our filings under the Securities Act of 1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following financial information for each of the five years ended December 31, 2012 has been derived from the Company’s consolidated financial statements. The selected consolidated financial data as of December 31, 2012 and 2011 and for the years ended December 31, 2012, 2011 and 2010 is derived from our audited consolidated financial statements included elsewhere in this Annual Report. The selected consolidated financial data as of December 31, 2010, 2009 and 2008 and for the years ended December 31, 2009 and 2008 is derived from audited financial statements not included herein.
The selected historical financial data presented below should be read in conjunction with our consolidated financial statements and the accompanying notes thereto, and “Item 7
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the potential gain or loss arising from changes in market rates and prices, which historically for us, has been associated primarily with changes in foreign currency exchange rates. We transact business in various foreign currencies which exposes us to the risk of fluctuations in foreign currency exchange rates. Foreign currency exchange gains and losses are not material to the Company’s earnings in 2012, 2011 and 2010. At December 31, 2012, while the majority of our cash balance was denominated in U.S. dollars, cash denominated in foreign currencies made up approximately 19% of total cash, including 6% in British pounds, 6% in Euros, 3% in Indian rupees, 2% in Japanese yen and 1% in Canadian dollars.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of AOL Inc.
We have audited the accompanying consolidated balance sheets of AOL Inc. as of December 31, 2012 and 2011, and the related consolidated statements of comprehensive income (loss), equity and cash flows for each of the three years in the period ended December 31, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of AOL Inc. at December 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), AOL Inc.’s internal control over financial reporting as of December 31, 2012 based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2013 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
McLean, Virginia
February 28, 2013
AOL INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In millions, except per share amounts)
See accompanying notes.
AOL INC.
CONSOLIDATED BALANCE SHEETS
(In millions, except per share amounts)
See accompanying notes.
AOL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
See accompanying notes.
AOL INC.
CONSOLIDATED STATEMENTS OF EQUITY
(In millions)
(a) Under the terms of the Company’s tax matters agreement with Time Warner, amounts payable or receivable to Time Warner prior to the spin-off were reflected as adjustments to divisional equity. During the year ended December 31, 2010, the Company adjusted its deferred tax assets and estimated amount payable to Time Warner for income taxes prior to the spin-off and these adjustments resulted in a $27.0 million reduction to additional paid-in capital (“APIC”).
See accompanying notes.
AOL INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1-DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
AOL Inc. (“AOL” or the “Company”) is a leading global web services brand company with a substantial worldwide audience and a suite of online content, products and services that it offers to consumers, advertisers, publishers and subscribers. AOL is focused on attracting and engaging internet consumers by creating and offering high quality branded content, products and services and providing valuable online advertising services on both its owned and operated properties and third-party websites.
AOL is in the midst of executing a multi-year strategic plan to reinvigorate growth in the Company’s revenues and profits by taking advantage of the continuing migration of advertising, commerce and information to the internet and digital devices. The Company’s strategy is to focus its resources on AOL’s core competitive strengths in content production, advertising and paid services while expanding the distribution of its premium content, product and service offerings on multiple platforms and digital devices, including on portable wireless devices such as smartphones and tablets. AOL continues to reinvigorate its culture and brand by prioritizing the consumer experience, making greater use of data-driven insights and encouraging innovation.
AOL was founded in 1985 and later merged with Time Warner Inc. (“Time Warner”) in 2001. In the fourth quarter of 2009, the board of directors of Time Warner approved the complete legal and structural separation of AOL Inc. from Time Warner (the “spin-off”), following which the Company became an independent, publicly-traded company. On November 2, 2009, the Company converted from AOL Holdings LLC, a limited liability company wholly owned by Time Warner, to AOL Inc., a Delaware corporation wholly owned by Time Warner. The spin-off occurred on December 9, 2009.
In the fourth quarter of 2012, AOL’s management changed the way in which they evaluate their business for the purpose of allocating resources and assessing performance. As a result, AOL has changed its reporting of business results from a single reportable segment to three reportable segments, which are determined based on how the business is evaluated by the Company’s chief operating decision maker (“CODM”) function. AOL revised its financial information and disclosures for prior periods to reflect the segment disclosures as if the current operating structure had been in effect throughout all periods presented. AOL’s reportable segments are the Brand Group, the Membership Group and AOL Networks. In addition to the above reportable segments, AOL has a corporate and other category that includes activities that are not directly attributable to or allocable to a specific segment.
Brand Group
The Brand Group consists of AOL’s portfolio of distinct and unique content as well as certain service brands. The results for this segment include the performance of AOL’s advertising offerings on a number of owned and operated sites, such as AOL.com, The Huffington Post, Patch, TechCrunch and MapQuest.
Membership Group
The Membership Group consists of offerings that serve AOL’s registered account holders, both free and paid. The results for this segment include AOL’s subscription offerings and advertising offerings on Membership Group properties, including communications products such as AOL Mail and AIM, as well as from performance compensation for marketing third party products and services.
AOL INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
AOL Networks
AOL Networks (formerly the Advertising.com Group) consists of AOL’s offerings to publishers and advertisers utilizing AOL’s third-party advertising network as well as AOL Properties inventory sold by AOL Networks. The results for this segment include the performance of Advertising.com, ADTECH, sponsored listings, Pictela, goviral and AOL On.
Corporate and Other
Corporate and other primarily consists of broad corporate functions including legal, human resources, accounting, finance, marketing and activities and costs not directly attributable or allocable to a specific segment such as restructuring costs, tax settlements and other general business costs. In this category, AOL also includes investments and owned and operated offerings managed by AOL Ventures, which it formed to attract and develop innovative initiatives.
Basis of Presentation
Basis of Consolidation
The consolidated financial statements include 100% of the assets, liabilities, revenues, expenses and cash flows of AOL and all voting interest entities in which AOL has a controlling voting interest (“subsidiaries”) and variable interest entities in which AOL is the primary beneficiary in accordance with the consolidation accounting guidance. Intercompany accounts and transactions between consolidated companies have been eliminated in consolidation. The consolidated balances of the Company’s variable interest entities are not material to the Company’s consolidated financial statements for the periods presented.
The financial position and operating results of the majority of AOL’s foreign operations are consolidated using the local currency as the functional currency. Local currency assets and liabilities are translated at the rates of exchange on the balance sheet date, and local currency revenues and expenses are translated at average rates of exchange during the period. Resulting translation gains or losses are included in the consolidated balance sheet as a component of accumulated other comprehensive income (loss), net and in the consolidated statement of comprehensive income (loss) as a component of other comprehensive income (loss), net of tax.
Redeemable Noncontrolling Interest
The noncontrolling interest in a joint venture between Mitsui & Company Ltd. (“Mitsui”) and AOL (“Ad.com Japan”) is classified outside of permanent equity in the Company’s consolidated balance sheet as of December 31, 2012, due to a redemption right available to the noncontrolling interest holder in the future. The noncontrolling interest holder’s right to redeem its stock is exercisable any time between July 1 and July 30 of any year, commencing with July 1, 2014. Net income in the consolidated statement of comprehensive income (loss) for the year ended December 31, 2012 reflects 100% of the results of Ad.com Japan as the Company has a controlling financial interest in the entity. Net income is subsequently adjusted to exclude AOL’s noncontrolling interests to arrive at net income attributable to AOL Inc.
Use of Estimates
The preparation of the financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements and footnotes thereto. Actual results could differ from those estimates. Significant estimates inherent in the preparation of the consolidated financial statements include asset impairments, reserves established for doubtful accounts, equity-based compensation, depreciation and amortization, business combinations, income taxes, litigation matters and contingencies.
AOL INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Summary of Significant Accounting Policies
Revenues
The Company generates revenue primarily from advertising and from its subscription access service. Revenue is recognized when persuasive evidence of an arrangement exists, performance under the contract has begun, the contract price is fixed or determinable and collectability of the related fee is reasonably assured.
Advertising Revenues
Advertising revenues are generated on AOL Properties through display advertising and search advertising. Display advertising revenue is generated by the display of graphical advertisements and other performance-based advertising. Agreements for advertising on AOL Properties typically take the forms of impression-based contracts, time-based contracts or performance-based contracts. Search advertising revenue is generated when a consumer clicks on a text-based advertisement on their screen. These text-based advertisements are either generated from a consumer-initiated search query or generated based on the content of the webpage the consumer is viewing. In addition to advertising revenues generated on AOL Properties, the Company also generates revenue from its advertising offerings on its Third Party Network, which consist primarily of the sale of display advertising and also include search advertising. Advertising arrangements for the sale of Third Party Network inventory typically take the form of impression-based contracts or performance-based contracts.
Advertising revenues derived from impression-based contracts, in which AOL provides impressions in exchange for a fixed fee (generally stated as cost-per-thousand impressions), are generally recognized as the impressions are delivered. An “impression” is delivered when an advertisement appears in web pages viewed by users. Revenues derived from time-based contracts, in which AOL provides promotion over a specified time period for a fixed fee, are recognized on a straight-line basis over the term of the contract, provided that AOL is meeting and will continue to meet its obligations under the contract (e.g., delivery of impressions over the term of the contract). Advertising revenues derived from contracts where AOL is compensated based on certain performance criteria are recognized as AOL completes the contractually specified performance. Performance is measured in terms of either “click-throughs” when a user clicks on a company’s advertisement or other user actions such as product/customer registrations, survey participation, sales leads, product purchases or other revenue sharing relationships.
Gross versus Net Revenue Recognition
In the normal course of business, the Company sometimes acts as or uses an intermediary or agent in executing transactions with third parties. The determination of whether revenue should be reported gross or net is based on an assessment of whether the Company is acting as the principal or an agent in the transaction. If the Company is acting as a principal in a transaction, the Company reports revenue on a gross basis. If the Company is acting as an agent in a transaction, the Company reports revenue on a net basis. In determining whether the Company acts as the principal or an agent, the Company follows the accounting guidance for principal-agent considerations and the Company places the most weight on whether or not the Company is the primary obligor in the arrangement.
Multiple-Element Transactions
Management analyzes contracts with multiple elements under the accounting guidance for multiple-element arrangements. The guidance requires that revenue arrangements with multiple deliverables should be divided into separate units of accounting if the deliverables in the arrangement have value to the customer on a standalone basis, and if the delivery of the undelivered items in the arrangement is considered probable and substantially in
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the control of the vendor. If these criteria are met, then the arrangement consideration is allocated among the separate units of accounting based on their relative estimated selling prices. In such circumstances, the Company uses a selling price hierarchy to determine the selling price to be used for allocating revenue to the deliverables: (i) vendor-specific objective evidence of fair value (“VSOE”), (ii) third-party evidence of selling price, and (iii) best estimate of the selling price (“ESP”). VSOE generally exists only when the Company sells the deliverable separately and VSOE is the price actually charged by the Company for that deliverable. ESPs reflect the Company’s best estimates of what the selling prices of deliverables would be if they were sold regularly on a stand-alone basis.
If the deliverables cannot be separated into multiple units of accounting, then the arrangement is accounted for as a combined unit of accounting and recognized into revenue based on the lower of (i) performance or (ii) straight-line as calculated in aggregate for the entire deal. Straight-line revenue recognition is determined by taking the total sold value of all deal components and recognizing that value evenly over the entire deal term.
Revenue arrangements where the Company applies the accounting guidance for multiple-element arrangements generally consist of arrangements where the Company is providing online advertising as well as non-advertising elements (i.e., production of a “micro-site”). However, there are not a significant number of these arrangements as the substantial majority of the Company’s revenue arrangements solely involve the provision of online advertising which is accounted for based on performance.
Subscription Revenues
The Company earns revenue from its subscription services in the form of monthly or annual fees paid by subscribers to its service offerings, and such revenues are recognized on a straight-line basis as the service is provided.
Traffic Acquisition Costs
AOL incurs costs through arrangements in which it acquires online advertising inventory from publishers for resale to advertisers and arrangements whereby partners distribute AOL’s free products or services or otherwise direct traffic to AOL Properties. AOL considers these costs to be traffic acquisition costs (“TAC”). TAC arrangements have a number of different economic structures, the most common of which are: (i) payments based on a cost-per-thousand impressions or based on a percentage of the ultimate advertising revenues generated from the advertising inventory acquired for resale, (ii) payments for direct traffic delivered to AOL Properties priced on a per-click basis (e.g., search engine marketing fees) and (iii) payments to partners in exchange for distributing AOL products to their users (e.g., agreements with computer manufacturers to distribute the AOL toolbar or a co-branded web portal on computers shipped to end users). These arrangements can be on a fixed-fee basis (which often carry reciprocal performance guarantees by the counterparty), on a variable basis or, in some cases, a combination of the two. TAC agreements with fixed payments are typically expensed ratably over the term of the agreement. TAC agreements with variable payments are typically expensed based on the volume of the underlying activity at the specified contractual rates. TAC agreements with a combination of a fixed fee for a minimum amount of traffic delivered or other underlying activity and variable payments for delivery or performance in excess of the minimum are typically recognized into expense at the greater of straight-line or actual performance, taking into account counterparty performance to date and the projected counterparty performance over the term of the agreement.
Restructuring Costs
Restructuring costs consist primarily of employee termination benefits and contract termination costs, including lease exit costs. One-time involuntary termination benefits are recognized as a liability at estimated fair value when the plan of termination has been communicated to employees and certain other criteria are met. With
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respect to certain contractual termination benefits or employee terminations in certain foreign countries operating under ongoing benefit arrangements, a liability for termination benefits is recognized at estimated fair value when it is probable that amounts will be paid to employees and such amounts are reasonably estimable. Contract termination costs are recognized as a liability at fair value when a contract is terminated in accordance with its terms, or when AOL has otherwise executed a written termination of the contract. When AOL ceases using a facility but does not intend to or is unable to terminate the operating lease, AOL records a liability for the present value of the remaining lease payments, net of estimated sublease income, if any, that could be reasonably obtained for the property (even if the Company does not intend to sublease the facility for the remaining term of the lease). Costs associated with exit or disposal activities are reflected as restructuring costs in the consolidated statements of comprehensive income. See “Note 9” for additional information about the Company’s restructuring activities.
Equity-Based Compensation
AOL records compensation expense under AOL’s equity-based compensation incentive plans based on the equity awards granted to employees.
In accounting for equity-based compensation awards, the Company follows the accounting guidance for equity-based compensation, which requires that a company measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost associated with stock options is estimated using the Black-Scholes option-pricing model. The cost of equity instruments granted to employees is recognized in the consolidated statements of comprehensive income on a straight-line basis (net of estimated forfeitures) over the period during which an employee is required to provide service in exchange for the award. See “Note 8” for additional information on equity-based compensation.
Asset Impairments
Goodwill
Goodwill is tested annually for impairment during the fourth quarter or earlier upon the occurrence of certain events or substantive changes in circumstances that indicate goodwill is more likely than not impaired. These indicators include a sustained, significant decline in the Company’s stock price; a decline in its expected future cash flows; significant disposition activity; a significant adverse change in the economic or business environment; and the testing for recoverability of a significant asset group, among others. The occurrence of these indicators could have a significant impact on the recoverability of goodwill and could have a material impact on the Company’s consolidated financial statements.
The testing of goodwill for impairment is required to be performed at the level referred to as the reporting unit. As discussed above, during the fourth quarter of 2012, AOL’s management changed the way in which AOL evaluates its business for the purpose of allocating resources and assessing performance, and based on this change, the Company concluded that it has four reporting units for purposes of the goodwill impairment test; the Brand Group, the Membership Group, AOL Networks and Patch.
Goodwill impairment is determined using a two-step process. The first step involves a comparison of the estimated fair value of a reporting unit to its carrying amount, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired and the second step of the impairment test is not necessary. If the carrying amount of a reporting unit exceeds its estimated fair value, then the second step of the goodwill impairment test must be performed. To measure the amount of impairment loss, if any, AOL determines the implied fair value of goodwill in the same manner as the amount of goodwill
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recognized in a business combination. Specifically, the estimated fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.
Long-lived Assets
Long-lived assets, including finite-lived intangible assets (e.g., acquired technology and customer relationships), do not require that an annual impairment test be performed; instead, long-lived assets are tested for impairment upon the occurrence of an indicator of potential impairment. Once an indicator of potential impairment has occurred, the impairment test is based on whether the intent is to hold the asset for continued use or to hold the asset for sale. If the intent is to hold the asset for continued use, the impairment test first requires a comparison of estimated undiscounted future cash flows generated by the asset group against the carrying value of the asset group. The Company groups long-lived assets for purposes of recognition and measurement of an impairment loss at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. If the carrying value of the asset group exceeds the estimated undiscounted future cash flows, the asset group would be deemed to be potentially impaired. Impairment, if any, would then be measured as the difference between the estimated fair value of the asset and its carrying value. Fair value is generally determined by discounting the future cash flows associated with that asset group. If the intent is to hold the asset group for sale and certain other criteria are met (i.e., the asset group can be disposed of currently, appropriate levels of authority have approved the sale and there is an active program to locate a buyer), the impairment test involves comparing the asset group’s carrying value to its estimated fair value less estimated costs of disposal. To the extent the carrying value is greater than the asset group’s estimated fair value less estimated costs of disposal, an impairment loss is recognized for the difference.
AOL recorded non-cash asset impairments and write-offs related to long-lived assets held and used and held for sale of $4.9 million, $7.6 million and $12.1 million in 2012, 2011 and 2010, respectively, included in costs of revenues and general and administrative costs in the consolidated statements of comprehensive income (loss). The charges recorded in 2012 and 2011 related primarily to asset write-offs in connection with facility consolidation, computer retirements and capitalized internal-use software project terminations. The charge recorded in 2010 included a $6.2 million impairment charge related to the sale of Pacific Corporate Park.
Income Taxes
Income taxes are presented in the consolidated financial statements using the asset and liability method prescribed by the accounting guidance for income taxes. Income taxes (e.g., deferred tax assets, deferred tax liabilities, taxes currently payable/refunds receivable and tax expense) are recorded based on amounts refundable or payable in the current year and include the deferred income tax effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases, stated at enacted tax rates expected to be in effect when the taxes are actually paid or recovered. Deferred income taxes reflect expected future tax benefits (i.e., assets) and future tax costs (i.e., liabilities). The tax effect of net operating loss, capital loss and general business credit carryovers result in deferred tax assets. Valuation allowances are established when management determines it is “more likely than not” that some portion or all of the deferred tax asset may not be realized. The Company considers all positive and negative evidence in evaluating its ability to realize its deferred income tax assets, including its historical operating results, ongoing tax planning, and forecast of future taxable income, on a jurisdiction by jurisdiction basis.
With respect to uncertain tax positions, AOL recognizes in the consolidated financial statements those tax positions determined to be “more likely than not” of being sustained upon examination, based on the technical
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merits of the positions. AOL records a liability for the difference between the benefit recognized and measured pursuant to the accounting guidance for income taxes and the tax position taken on its tax return. The Company adjusts its estimated liabilities for uncertain tax positions periodically because of ongoing examinations by, and settlements with, the various taxing authorities, as well as changes in tax laws, regulations and interpretations. The consolidated tax provision for any given year includes adjustments to prior year income tax accruals that are considered appropriate and any related estimated interest. The Company’s policy is to recognize, when applicable, interest and penalties on uncertain tax positions as part of income tax expense.
Certain Risks and Concentrations
The Company’s financial instruments include primarily cash and equivalents, accounts receivable, accounts payable, accrued expenses and other current liabilities. Due to the short-term nature of these assets and liabilities, their carrying amounts approximate their fair value. Financial instruments that potentially subject the Company to concentrations of credit risk are primarily cash and accounts receivable.
The Company maintains its cash and equivalents balances in the form of money market accounts, Treasury bills and time deposits. The Company maintains cash deposits with banks that at times exceed applicable insurance limits. The Company reduces its exposure to credit risk by maintaining such deposits with high quality financial institutions that management believes are creditworthy.
The Company’s exposure to customer credit risk relates primarily to advertising customers and individual subscribers to AOL’s subscription access service, and is dispersed among many different counterparties, with no single customer having a receivable balance in excess of 10% of total net receivables at December 31, 2012 or 2011.
For each of the periods presented herein, the Company has had a contractual relationship with Google whereby Google provides paid text-based search advertising on AOL Properties. For the years ended December 31, 2012, 2011 and 2010, the revenues associated with the Google relationship (substantially all of which were search revenues generated on AOL Properties), were $350.9 million, $335.3 million and $398.4 million, respectively.
Cash and Equivalents
Cash equivalents primarily consist of highly liquid short-term investments with an original maturity of three months or less, which include money market accounts, Treasury bills and time deposits that are readily convertible into cash. Cash equivalents are carried at cost plus accrued interest, which approximates fair value. These are included within cash and cash equivalents as level one measurements.
Restricted Cash
In the first quarter of 2011, the Company posted cash collateral for letters of credit related to certain of the Company’s lease agreements. The collateral amounts are legally restricted as to withdrawal and use for a period in excess of twelve months. Accordingly, the collateral balances have been classified as restricted cash within other long-term assets and are omitted from cash and equivalents on the consolidated balance sheets. Also included in restricted cash are security deposits held by the Company from lessees that are restricted as to use. The Company had $12.3 million of restricted cash included in other long-term assets on the consolidated balance sheet as of December 31, 2012.
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Allowance for Doubtful Accounts
AOL’s receivables consist primarily of two components, receivables from individual subscribers to AOL’s subscription services and receivables from advertising customers. Management performs separate evaluations of these components to determine if the balances will ultimately be fully collected considering management’s views on trends in the overall aging of receivables as well as past collection experience. In addition, for certain advertising receivables, management prepares an analysis of specific risks on a customer-by-customer basis. Using this information, management reserves an amount that is expected to be uncollectible. Receivables are written off when amounts are deemed to be uncollectible and internal collection efforts are closed.
Property and Equipment
Property and equipment are stated at cost. Depreciation, which includes amortization of capitalized software costs and amortization of assets under capital leases, is provided on a straight-line basis over the estimated useful lives of the assets. AOL evaluates the depreciation periods of property and equipment to determine whether events or circumstances warrant revised estimates of useful lives. Depreciation expense, recorded in costs of revenues and general and administrative expense, totaled $138.7 million, $160.9 million and $196.3 million for the years ended December 31, 2012, 2011 and 2010, respectively. Costs related to leasehold improvements are capitalized and amortized on a straight-line basis over the shorter of the economic useful life of the improvements or the remaining lease term.
Property and equipment, including assets under capital lease, consist of ($ in millions):
(a) Land is not depreciated.
Capitalized Internal-Use Software Development Costs
AOL capitalizes certain costs incurred for the development of internal-use software. These costs, which include the costs associated with coding, software configuration, major upgrades and enhancements and are related to both AOL’s internal systems (such as billing and accounting) and AOL’s user-facing internet offerings, are included in property and equipment, net in the consolidated balance sheet. For the years ended December 31, 2012, 2011, and 2010, AOL capitalized $30.8 million, $21.1 million and $22.7 million, respectively, related to the development of internal-use software.
Research and Development
Research and development costs, which are expensed as incurred, are included in costs of revenues and totaled $44.8 million, $56.9 million and $63.2 million for the years ended December 31, 2012, 2011, and 2010,
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respectively. These costs consist primarily of personnel and related costs that are incurred related to the development of software and user-facing internet offerings that do not qualify for capitalization.
Leases
The Company leases operating equipment and office space in various locations worldwide. Lease obligations are classified as operating leases or capital leases, as appropriate. Leased property that meets the capital lease criteria is capitalized and the present value of the future minimum lease payments is recorded as an asset under capital lease with a related capital lease obligation in the consolidated balance sheets.
Rent expense under operating leases is recognized on a straight-line basis over the lease term taking into consideration scheduled rent increases and any lease incentives.
Intangible Assets
AOL has a significant number of intangible assets, including acquired technology, trademarks and customer relationships. AOL does not recognize the fair value of internally generated intangible assets. Intangible assets acquired in business combinations are recorded at fair value on the Company’s consolidated balance sheets and are amortized over estimated useful lives on a straight-line basis. Intangible assets subject to amortization are tested for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. AOL does not have any indefinite lived intangible assets other than goodwill.
Advertising Costs
The Company expenses advertising costs as they are incurred. Advertising expense was $85.8 million, $76.9 million and $79.3 million for the years ended December 31, 2012, 2011, and 2010, respectively.
Loss Contingencies
In the normal course of business, the Company is involved in legal proceedings, tax audits (other than income taxes) and other matters that give rise to potential loss contingencies. The Company accrues a liability for such matters when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. In situations where the Company can determine a best estimate within the range of potential loss, the Company records the best estimate of the potential loss as a liability. In situations where the Company has determined a range of loss, but no amount within the range is a better estimate than any other amount within the range, the Company records the minimum amount of the range of loss as a liability.
Other Comprehensive Income (Loss)
Other comprehensive income (loss) is included within comprehensive income (loss) in the consolidated statements of comprehensive income (loss) and stockholders’ equity in the consolidated balance sheets and consists of net income (loss) and other gains and losses affecting equity that, under GAAP, are excluded from net income (loss). For AOL, such items consist primarily of foreign currency translation gains (losses).
Recent Accounting Standards
Goodwill Impairment
In September 2011, new guidance was issued related to assessing goodwill impairment. Under the new guidance, a company is permitted to first make a qualitative assessment to determine whether it is more likely
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than not that the fair value of a reporting unit is less than its carrying amount before applying the two-step goodwill impairment test. If the conclusion from the qualitative assessment is that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the company would be required to perform two-step goodwill impairment test. Otherwise, it would not need to apply the two-step test.
This new guidance became effective for the Company in January 2012. The Company did not perform the qualitative assessment during its goodwill impairment analysis, as it had a change in its reporting units during the year. As a result of the change in reporting units, the Company is required to perform a goodwill impairment analysis immediately before and after its change in the reporting units. See “Note 3” for a further description of the annual goodwill impairment test.
NOTE 2-INCOME (LOSS) PER COMMON SHARE
Basic income (loss) per common share is calculated by dividing net income (loss) attributable to AOL Inc. common stockholders by the weighted average number of shares of common stock outstanding during the reporting period. Diluted income (loss) per common share is calculated to give effect to all potentially dilutive common shares that were outstanding during the reporting period. The dilutive effect of outstanding equity-based compensation awards is reflected in diluted income (loss) per common share by application of the treasury stock method, only in periods in which such effect would have been dilutive for the period.
For the years ended December 31, 2012, 2011 and 2010, the Company had 2.9 million, 9.0 million and 5.8 million, respectively, of weighted-average potentially dilutive common shares that were not included in the computation of diluted income (loss) per common share, because to do so would be anti-dilutive for those periods.
The following table is a reconciliation of basic and diluted net income (loss) attributable to AOL Inc. common stockholders per common share (in millions, except per share amounts):
NOTE 3-GOODWILL AND INTANGIBLE ASSETS
A summary of changes in the Company’s consolidated goodwill during the year ended December 31, 2011 is as follows (in millions):
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A summary of changes in the Company’s goodwill during the years ended December 31, 2012 as well as goodwill allocated to the Company’s reporting units as of December 1, 2012, were as follows (in millions):
Impairment Testing of Goodwill
Goodwill is tested annually for impairment during the fourth quarter or earlier upon the occurrence of certain events or substantive changes in circumstances that indicate goodwill is more likely than not impaired.
Following the change in management structure described in “Note 1”, the Company concluded that it had four reporting units; the Brand Group, the Membership Group, AOL Networks and Patch. There are no components below these four reporting units for which discrete financial information is available and regularly reviewed by the CODM.
As a result of the change in management structure in the fourth quarter of 2012, the Company is required to perform a goodwill impairment analysis immediately before its change in reporting units and immediately after such change. As a result, as of December 1, 2012, the Company performed both a consolidated goodwill impairment analysis (prior to the change in reporting units, the company had a single consolidated reporting unit for goodwill impairment testing) and a goodwill impairment analysis for each of the four reporting units subsequently.
In performing the consolidated goodwill impairment analysis, the Company used a market-based approach. The primary input in this approach was a quoted market price in an active market. To determine the estimated fair value of the Company’s consolidated reporting unit, the Company calculated its market capitalization based on its stock price and adjusted it by a control premium of 30%, which resulted in an estimated fair value of $3,139.6 million. The premium used to arrive at a controlling interest equity value was determined based on values observed in recent market transactions.
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In performing the goodwill impairment analysis for the Company’s four reporting units following the change in segments, the Company allocated goodwill to each reporting unit based on the fair value of each reporting unit relative to the total consolidated fair value of the company. The estimated fair value of each of the four reporting units was determined utilizing an income approach or discounted cash flow (“DCF”) method. The reasonableness of the DCF approach was assessed by reference to a market-based approach by reporting unit, and the fair value determined under the market-based approach corroborated the fair values determined by the DCF approach. As a corroborative step, the Company also reconciled the sum of the fair values of the reporting units to its total market capitalization plus the 30% control premium used in the consolidated test described above.
Based on the goodwill impairment tests performed above, the estimated fair value exceeded the carrying value for AOL as a single reporting unit and for each reporting unit, and therefore, the second step of the goodwill impairment test was not required on a consolidated basis or for any of the Company’s four reporting units. On a consolidated basis and for each of the Membership Group, Brands and AOL Networks, the estimated fair value of the reporting units exceeded its respective book value by in excess of 20%. If the estimated fair value of the Patch reporting unit had been hypothetically lower by 10% as of the date of the impairment test, the carrying value would have exceeded fair value and the second step of the goodwill impairment test would have been required to be performed to determine the implied fair value of goodwill, and would likely have resulted in an impairment of all or a portion of the $17.5 million of goodwill assigned to the Patch reporting unit.
2011 and 2010 Goodwill Impairment Analysis
The Company performed a goodwill impairment analysis based on certain triggering events occurring during the third quarter of 2011. As a result, it was determined that the fair value of AOL exceeded its carrying value. Therefore, the second step of the goodwill impairment test did not need to be performed and no impairment charge was recorded.
Based on the Company’s annual impairment analysis as of December 1, 2011, the estimated fair value of the Company’s sole reporting unit exceeded its book value and therefore the second step of the goodwill impairment test did not need to be performed. As such, no impairment charge was recorded during the fourth quarter of 2011.
The Company performed a goodwill impairment analysis based on certain triggering events occurring during the second quarter of 2010. As a result, the Company recorded an impairment charge of $1,414.4 million for the three months ended June 30, 2010. In connection with the annual goodwill impairment analysis performed during the fourth quarter of 2010, the Company determined that the fair value of its sole reporting unit exceeded its book value. As a result, the second step of the goodwill impairment test did not need to be performed; and therefore no additional charge was incurred during 2010.
Intangible Assets
The Company’s intangible assets and related accumulated amortization at December 31, 2012 and 2011 consisted of the following (in millions):
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(a) Amortization of intangible assets is provided on a straight-line basis over their respective useful lives, which generally range from one to ten years. The Company evaluates the useful lives of its finite-lived intangible assets each reporting period to determine whether events or circumstances warrant revised estimates of useful lives.
The Company recorded amortization expense of $38.2 million, $92.0 million and $145.3 million for the years ended December 31, 2012, 2011 and 2010, respectively. Based on the amount of intangible assets as of December 31, 2012, the estimated amortization expense for each of the succeeding five years ending December 31 is as follows (in millions):
The amounts above may vary as acquisitions and dispositions occur in the future.
NOTE 4-BUSINESS ACQUISITIONS, DISPOSITIONS AND OTHER SIGNIFICANT TRANSACTIONS
Patent Portfolio Sale and License
On June 15, 2012, the Company sold approximately 800 patents and their related patent applications (the “Sold Patents”) to Microsoft Corporation (“Microsoft”), and granted Microsoft a non-exclusive license to the Company’s retained patent portfolio, for aggregate proceeds of $1,056 million in cash (excluding transaction costs). The transaction was structured as a sale of all of the outstanding shares of a wholly owned non-operating subsidiary and the direct sale of certain other patents not held by the subsidiary. The Company concluded that immediate recognition of all of the proceeds was appropriate as the Company has no ongoing performance obligations with respect to the sold or licensed patents.
The disposed assets had a carrying value of $3.2 million on the Company’s balance sheet and accordingly, the Company recorded a gain on the disposition of the Sold Patents of $946.5 million (which represents the consideration allocated to the sale less the carrying value of the disposed assets and transaction costs that were contingent on closing). With respect to the licensing portion of the transaction, the Company recognized income from licensing its retained patent portfolio of $96.0 million during the year ended December 31, 2012.
Based on the anticipated utilization of existing deferred tax assets and the fact that the disposition of the Sold Patents generated a capital loss (which is subject to a full valuation allowance), the Company does not expect the $1,056 million in proceeds to result in material cash taxes.
Acquisitions
The businesses acquired by the Company during the periods presented herein were all in their early stages of development. This fact, along with market conditions at the time of acquisition, contributed to purchase prices that resulted in the allocation of a significant portion of such purchase prices to goodwill.
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2012 Acquisitions
Ad.com Japan
On February 9, 2012, AOL entered into a share-purchase agreement with Mitsui to purchase an additional 3% interest in Ad.com Japan for approximately $1.2 million. Ad.com Japan, which operates a display advertising network business in Japan, was formed in 2006. Prior to the execution of the share purchase agreement, AOL and Mitsui each owned a 50% interest in Ad.com Japan, and AOL accounted for its 50% interest using the equity method of accounting. As part of this transaction, AOL obtained control of the board and of the day-to-day operations of Ad.com Japan. AOL has accounted for the incremental 3% share purchase as a business combination achieved in stages (“step acquisition”) and consolidated Ad.com Japan beginning on February 9, 2012 (“the closing date”).
Under the accounting guidance for step acquisitions, AOL is required to record all assets acquired, liabilities assumed, and Mitsui’s noncontrolling interests at fair value, and recognize the entire goodwill of the acquired business. The step acquisition guidelines also require that AOL remeasure its preexisting investment in Ad.com Japan at fair value, and recognize any gains or losses from such remeasurement. The fair value of AOL’s interest immediately before the closing date was $15.4 million, which resulted in the Company recognizing a non-cash gain of approximately $10.8 million within other income (loss), net on the consolidated statement of comprehensive income in the first quarter of 2012. The Company used a combination of the market based approach (guideline public company) and an income approach (discounted cash flow analysis), both of which represent level 3 fair value measurements, to measure both the fair value of AOL’s preexisting investment and the fair value of Mitsui’s noncontrolling interest. As Mitsui has a right to put its interest to AOL based on a pre-established and determinable price in the future, the noncontrolling interest is presented as redeemable noncontrolling interest outside permanent equity in the Company’s consolidated balance sheet. The noncontrolling interest holder’s right to redeem its stock is exercisable any time between July 1 and July 30 of any year, commencing with July 1, 2014. The amount payable from AOL to Mitsui if Mitsui were to exercise its redemption right is determined by taking the sum of 2 billion Japanese yen (approximately $26.0 million as of the closing date) plus any incremental cash over the $7.8 million cash balance at December 31, 2011, and multiplying that total by Mitsui’s percentage ownership of Ad.com Japan (47% at closing). The Company has elected to recognize changes in the redemption value as they occur; however, this has no impact on the carrying value of Mitsui’s interest in Ad.com Japan because it exceeds the current redemption value. As of December 31, 2012 the undiscounted redemption value of the put option held by Mitsui was calculated to be approximately $12.3 million, which is below the $13.4 million carrying value of Mitsui’s interest in Ad.com Japan.
AOL recorded $9.7 million of goodwill (which is not deductible for tax purposes) and $19.2 million of intangible assets associated with this acquisition. The intangible assets associated with this acquisition consist primarily of trade names to be amortized on a straight-line basis over a period of ten years and advertiser relationships to be amortized on a straight-line basis over a period of five years. The weighted average amortization period for all intangible assets is approximately eight years. The fair value of the significant identified intangible assets was estimated by using relief from royalty, cost savings and multi-period excess earnings valuation methodologies, which represent level 3 fair value measurements. Inputs used in the methodologies primarily included projected future cash flows, discounted at a rate commensurate with the risk involved.
Unaudited pro forma results of operations assuming this acquisition had taken place at the beginning of each period are not provided because the historical operating results of the acquired company were not significant and pro forma results would not be significantly different from reported results for the periods presented.
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Other 2012 Acquisitions
The Company also completed the following acquisitions during the year ended December 31, 2012:
•
During the third quarter of 2012, the Company completed the acquisition of the following: a 49% interest that the Company did not already own in AJM Productions, LLC (“Cambio”), a company that operates a leading online content and lifestyle platform for pre-teen and teen audiences, and; StyleMePretty, LLC (“StyleMePretty”), a company which operates a leading online provider of style-savvy wedding resources devoted to the modern bride.
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During the fourth quarter of 2012, the Company completed the acquisition of Everlater, Inc., a company that produces software to simplify the creation and sharing of web content and Buysight, Inc. (“Buysight”), a company that operates a targeted advertising platform which uses machine learning technology to allow for real time optimization of advertising campaigns.
The aggregate purchase price of these acquisitions was $27.8 million, net of cash acquired. AOL recorded $12.5 million of goodwill, of which $6.6 million is deductible for tax purposes, and $16.4 million of intangible assets related to these acquisitions. With respect to the Buysight acquisition, during negotiations the Company agreed to pay a bonus to certain employees of Buysight immediately after the closing, and the $4.7 million paid was recognized as compensation expense during the fourth quarter of 2012.
The intangible assets associated with these acquisitions consist of acquired technology and trademarks to be amortized on a straight-line basis over a weighted average period of five years, non-compete agreements to be amortized on a straight-line basis over a weighted average period of three years and customer relationships to be amortized on a straight-line basis over a weighted average period of four years. The weighted average amortization period for all intangible assets is approximately five years.
2011 Acquisitions
goviral
On January 31, 2011, the Company completed the acquisition of goviral ApS (“goviral”, formerly goviral A/S), a company that distributes branded online video for media agencies, creative agencies and content producers, for a purchase price of $69.1 million, net of cash acquired.
AOL recorded $58.3 million of goodwill (which is not deductible for tax purposes) and $18.4 million of intangible assets related to this acquisition. The intangible assets associated with this acquisition consist primarily of customer relationships and acquired technology to be amortized on a straight-line basis over a weighted average period of approximately four years.
In addition to the purchase price paid for this business, the Company agreed to pay up to $22.6 million to certain employees of goviral over the expected future service period of two years contingent on their future service to AOL. The payments of up to $22.6 million are being recognized as compensation expense on an accelerated basis over the expected service period of two years from the acquisition date. For tax purposes, a significant majority of the incentive compensation being treated as additional basis in goviral and a tax deduction will only be obtained upon disposition of goviral.
The Huffington Post
On March 4, 2011, the Company acquired The Huffington Post.com, Inc. (“The Huffington Post”) for a purchase price of $295.5 million, net of cash acquired. The Huffington Post is an innovative internet source of
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online news, analysis, commentary, entertainment and community engagement. In addition to the market conditions at the time of acquisition and the early stage of development of The Huffington Post, the Company’s expectation that the acquisition would enhance the Company’s ability to serve audiences across several platforms contributed to the allocation of a significant portion of the purchase price to goodwill.
In addition to the purchase price of $295.5 million disclosed above, the Company incurred $8.7 million of restructuring charges associated with payments made for stock options that vested on or shortly after the closing date as a result of the termination of certain The Huffington Post employees. In connection with the acquisition, the Company assumed The Huffington Post Long-Term Incentive Plan (the “Huffington Post Plan”). The fair value of unvested Huffington Post Plan options held by The Huffington Post employees that were converted into unvested AOL stock options was $12.1 million. Of the fair value of The Huffington Post options that were converted, $3.6 million was included in the purchase price, $8.1 million is being recognized as equity-based compensation expense over the remaining award vesting periods (subject to adjustments for actual forfeitures), which for most employees is 24 months from the acquisition date, and the remaining $0.4 million was recorded as a restructuring charge.
AOL recorded $192.4 million of goodwill (which is not deductible for tax purposes) and $108.2 million of intangible assets associated with this acquisition. The intangible assets associated with this acquisition consist primarily of trade names to be amortized on a straight-line basis over a period of ten years and customer relationships to be amortized over a period of four years.
2010 Acquisitions
StudioNow
On January 22, 2010, the Company completed the acquisition of StudioNow, Inc. (“StudioNow”), a provider of a proprietary digital platform that allows clients to create, produce, manage and distribute professional quality videos at scale, for a purchase price of $32.1 million. Of the total consideration, $14.1 million was paid through the issuance of 0.6 million shares of AOL common stock valued as of the closing date. Of the remaining $18.0 million, $14.0 million was paid in cash at the closing date and $4.0 million reflects the present value of the cash consideration due two years after the closing date (which was paid in January 2012).
This business was acquired to attract and engage more internet users and drive high volumes of video content production through StudioNow’s platform, which, along with market conditions at the time of acquisition, contributed to a purchase price that resulted in the allocation of a significant portion of the purchase price to goodwill. AOL recognized $26.7 million of goodwill (which is not deductible for tax purposes) and $4.3 million of intangible assets related to this acquisition. The intangible assets related to this acquisition consist of technology acquired, customer relationships, trade names and other assets to be amortized on a straight-line basis over a period of three years.
5Min
On September 28, 2010, the Company completed the acquisition of 5 Minutes Ltd. (“5Min”), a company that provides a syndication platform for web-based videos, for a purchase price of $64.7 million, net of cash acquired. The acquisition offers AOL and partners significant web distribution, which, along with market conditions at the time of acquisition, contributed to a purchase price that resulted in the allocation of a significant portion of the purchase price to goodwill. The Company recorded $49.6 million of goodwill (which is not deductible for tax purposes) and $20.0 million of intangible assets related to this acquisition. The intangible assets associated with this acquisition consist of technology, advertiser relationships and a trade name to be amortized on a straight-line basis over a weighted average period of approximately five years.
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Other 2010 Acquisitions
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On September 28, 2010, the Company completed the acquisition of Thing Labs, Inc., a company that produces software to simplify the creation and sharing of web content. This acquisition will allow the Company to continue its initiative to provide consumers with the best venues to discover and share content.
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On September 29, 2010, the Company completed the acquisition of TechCrunch, Inc. (“TechCrunch”), a company that owns and operates a network of websites dedicated to technology news, information and analysis. This business was acquired to enhance AOL’s offerings of high-quality, technology-oriented content.
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On December 15, 2010, the Company completed the acquisition of Pictela, Inc. (“Pictela”), a provider of rich media advertising formats used by agencies and publishers. This business was acquired to further the Company’s ability to provide high quality advertising content.
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On December 20, 2010, the Company completed the acquisition of about.me, Inc. (“about.me”), a company that provides a web service product that empowers people to create a single personal profile page that presents their online identities together in one place, simplifying the social experience across the web. This business was acquired to enhance the Company’s ability to provide relevant and meaningful content to consumers.
The aggregate purchase price of these acquisitions was $63.8 million, net of cash acquired. AOL recorded $55.7 million of goodwill (which is not deductible for tax purposes) and $10.1 million of intangible assets related to these acquisitions.
The intangible assets associated with these acquisitions consist of acquired technology, trademarks, non-compete agreements and customer relationships to be amortized on a straight-line basis over a weighted average period of approximately three years.
In 2013, the Company disposed of a controlling interest in both StudioNow and about.me in two separate transactions. The proceeds received and gain recorded on each of these transactions was immaterial to the Company’s consolidated financial statements. The retained interests held by the Company in StudioNow and about.me are being accounted for under the cost method as the Company does not exercise significant influence over either business.
Additional Information on Acquisitions
For the years ended December 31, 2012, 2011 and 2010, the Company incurred $1.0 million, $9.9 million and $3.3 million, respectively, of third-party transaction expenses primarily related to the acquisitions discussed above. These transaction costs were recorded within general and administrative costs in the consolidated financial statements.
The amounts assigned to intangible assets were based on the Company’s best estimate of the fair value of such assets. The Company used an independent valuation specialist to assist in determining the fair value of the identified intangible assets in significant acquisitions. In most instances, the fair value of the significant identified intangible assets was estimated by performing a discounted cash flow analysis using the “income” approach, which represents a level 3 fair value measurement. The income approach includes a forecast of direct revenues and costs associated with the respective intangible assets and charges for economic returns on tangible
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and intangible assets utilized in cash flow generation. Net cash flows attributable to the identified intangible assets are discounted to their present value at a rate commensurate with the perceived risk. The projected cash flow assumptions considered contractual relationships, customer attrition, eventual development of new technologies and market competition.
The useful lives of trade names were estimated based on the Company’s evaluation of the useful lives of comparable intangible assets purchased under similar circumstances. The useful lives of customer relationships were estimated based upon the length of the contracts currently in place, probability-based estimates of contract renewals in the future and natural growth and diversification of the customer base.
In connection with incentive cash compensation arrangements made in connection with acquisitions made in 2012, 2011 and 2010, the Company recorded $12.3 million, $35.2 million and $6.2 million in retention compensation expense for the years ended December 31, 2012, 2011 and 2010, respectively.
Unaudited pro forma results of operations assuming these acquisitions had taken place at the beginning of each period are not provided because the historical operating results of the acquired companies were not significant and pro forma results would not be significantly different from reported results for the periods presented.
Summary of Discontinued Operations
There were no discontinued operations in 2012 and 2011. Discontinued operations for the year ended December 31, 2010 reflect the financial condition, results of operations and cash flows of buy.at. The consolidated statement of operations for the year ended December 31, 2010 includes the results of operations of buy.at for the period from January 1, 2010 through the sale date of February 26, 2010, the pre-tax loss on the sale of buy.at and the income tax benefit associated with the capital loss generated by the buy.at sale. Financial data for discontinued operations for the year ended December 31, 2010 is as follows (in millions):
NOTE 5-LONG-TERM DEBT AND OTHER FINANCING ARRANGEMENTS
Capital Leases
Capital lease obligations consist of ($ in millions):
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Assets recorded under capital lease obligations totaled $209.1 million and $182.2 million at December 31, 2012 and 2011, respectively. Related accumulated amortization totaled $106.2 million and $77.4 million at December 31, 2012 and 2011, respectively.
Future minimum capital lease payments at December 31, 2012 are as follows (in millions):
Interest Expense
Interest expense was $5.9 million, $6.5 million and $11.2 million for the years ended December 31, 2012, 2011 and 2010, respectively, and is included in “Other income (loss), net” on the consolidated statements of comprehensive income (loss). Interest expense for 2010 includes $6.9 million related to credit facility fees paid to Time Warner. The weighted-average interest rate on AOL’s capital lease obligations was 5.35% and 5.64% at December 31, 2012 and 2011, respectively. The weighted-average rate on capital lease obligations due within one year was 5.39% at December 31, 2012.
NOTE 6-INCOME TAXES
The components of income (loss) from continuing operations before income taxes were as follows (in millions):
The components of the provision for income tax expense (benefit) provided on income from continuing operations were as follows (in millions):
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The items accounting for the difference between income tax expense (benefit) computed at the federal statutory rate of 35% and the provision for income taxes were as follows:
(a) The effective tax rate for state and local taxes, net of U.S. federal benefit, was lower in 2012 as a result of the treatment of gain/loss on sale of assets, which was primarily related to the disposition of the Sold Patents. Due to the size of the foreign losses relative to pre-tax income, the effective tax rate for state and local taxes, net of U.S. federal benefit, increased in 2011.
The significant components of AOL’s deferred tax assets and liabilities were as follows (in millions):
(a) As of December 31, 2011, $0.2 million of deferred tax liabilities were included in accrued expenses and other current liabilities on the consolidated balance sheet.
AOL had net operating losses from various foreign jurisdictions of $4,175.7 million and $4,187.8 million as of December 31, 2012 and 2011, respectively. Many of these foreign losses are attributable to specific operations and may not be utilized to offset taxable income of other operations of AOL. The expiration period of the foreign net operating losses ranges from 2014 to indefinite.
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AOL had $284.0 million and $566.9 million of U.S. federal net operating loss carryforwards as of December 31, 2012 and 2011, respectively. Certain of these federal net operating loss carryforwards are subject to statutory annual use limitations. AOL had approximately $773.5 million and $1,018.0 million of net operating loss carryforwards in various state and local jurisdictions as of December 31, 2012 and 2011, respectively. Certain of these state tax losses are subject to a valuation allowance because they are attributable to specific operations and may not be utilized against taxable income of other operations of AOL. These federal, state and local net operating loss carryforwards will expire between 2013 and 2032.
AOL has a capital loss carryforward of $1,254.6 million as of December 31, 2012, which will begin to expire in 2015, but the majority will expire at the end of 2017. Significant uncertainty exists regarding the future realization of the $497.9 million deferred tax asset related to this capital loss carryforward and as a result, AOL has recorded a full valuation allowance on this deferred tax asset.
AOL has credit carryforwards of $23.4 million as of December 31, 2012, which will expire ranging from 2014 to indefinite. Certain of these credit carryforwards are subject to a valuation allowance.
During the year ended December 31, 2012, AOL increased its valuation allowance by $456.4 million primarily related to capital losses realized on the sale of a U.S. subsidiary.
As of December 31, 2012, the total valuation allowance of $1,616.6 million included $1,102.1 million of deferred tax assets on net operating loss carryforwards and $497.9 million of deferred tax assets on capital loss carryforwards. The total valuation allowance was established based on management’s determination that the deferred tax assets are not more likely than not to be realized. Management believes that the remaining deferred tax assets are more likely than not to be realized based upon consideration of all positive and negative evidence, including AOL’s operating results and forecast of future taxable income, on a jurisdiction by jurisdiction basis.
U.S. federal income taxes are provided on the portion of AOL’s income from certain foreign subsidiaries that is expected to be remitted to the United States. The Company has recorded deferred income taxes and foreign withholding taxes on unremitted earnings from foreign subsidiaries in the amount of $8.2 million and $7.4 million, as of December 31, 2012 and 2011, respectively. For AOL’s other foreign subsidiaries, the Company has not provided for U.S. income and foreign withholding taxes on approximately $11.1 million of certain foreign subsidiaries’ undistributed earnings as of December 31, 2012, because such earnings have been retained and are intended to be indefinitely reinvested outside of the United States. It is not practical to estimate the amount of taxes that would be payable upon remittance of these earnings because such tax, if any, is dependent on circumstances existing if and when remittance occurs.
Accounting for Uncertainty in Income Taxes
Changes in unrecognized tax benefits, excluding the related accrual for interest and penalties, from January 1 to December 31 are set forth below (in millions):
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AOL entered into a Second Tax Matters Agreement with Time Warner, effective December 9, 2009, that governs the respective post spin-off rights, responsibilities and obligations of Time Warner and AOL with respect to tax matters for the pre spin-off tax periods. As a member of Time Warner’s consolidated U.S. federal income tax group, AOL has (and continues to have following the spin-off) joint and several liability with Time Warner to the IRS for the consolidated U.S. federal income taxes of the Time Warner group relating to the taxable periods in which AOL was part of the group. Under the Second Tax Matters Agreement, however, Time Warner agreed to assume this liability and any similar liability for U.S. federal, state or local income taxes, including liability for uncertain income tax positions taken by Time Warner with respect to AOL, that are determined on a consolidated, combined, unitary or similar basis for each taxable period in which AOL was included in such consolidated, combined, unitary or similar group with Time Warner. As a result, at the date of the spin-off, AOL reversed the recorded liability (including accrued interest) to Time Warner related to these uncertain tax positions, with an offsetting $368.1 million adjustment to equity. AOL remains responsible for any foreign income taxes and any other income taxes (primarily state taxes) that are not determined on a consolidated, combined, unitary or similar basis with Time Warner.
The Company accrues interest and penalties where there is an underpayment of taxes, based on management’s best estimate of the amount ultimately to be paid, in the same period that 1) the interest would begin accruing or 2) the penalties would first be assessed. The Company’s policy on the classification of interest and penalties is to record both as part of income tax expense. Interest expense recorded through the income tax provision (benefit) related to uncertain tax positions was $0.7 million, $0.1 million, and $0.4 million for the years ended December 31, 2012, 2011 and 2010, respectively. As of December 31, 2012 and 2011, the amount of accrued interest in the consolidated balance sheet associated with uncertain tax positions was $1.3 million and $0.6 million, respectively. As of December 31, 2012, $0.2 million of penalties were accrued.
The statute of limitations of certain foreign jurisdictions in which AOL filed separately from Time Warner have not expired and therefore, the periods from 2003 through the current period remain open to examination by the taxing authorities. For the periods following the spin-off, the examination periods in all significant jurisdictions, including U.S., New York, Virginia, Canada, Germany, India, Ireland, Luxembourg and United Kingdom, remain open and subject to examination by the taxing authorities.
The Company’s liabilities for unrecognized tax benefits, which include interest and penalties, were $21.7 million and $0.6 million as of December 31, 2012 and 2011, respectively. The remainder, if recognized, would affect deferred taxes. As of December 31, 2012, the amount of unrecognized tax benefits, net of the federal tax benefit of state tax deductions, which, if recognized, would affect the Company’s effective tax rate, is $144.3 million. A number of years may elapse before an uncertain tax position is finally resolved. It is difficult to predict the final outcome or the timing of resolution of any particular uncertain tax position. The Company reevaluates and adjusts its reserves for income taxes, as well as the related interest, in light of changing facts and circumstances. Settlement of any particular position would usually require the use of cash and result in the reduction of the related liability. The resolution of a matter would be recognized as an adjustment to the provision for income taxes and the effective tax rate in the period of resolution. The Company does not expect its unrecognized tax benefits to significantly change in the next twelve months.
NOTE 7-STOCKHOLDERS’ EQUITY
AOL is authorized to issue up to 660.0 million shares of all classes of stock, consisting of 60.0 million shares of preferred stock, par value $0.01 per share (“Preferred Stock”), and 600.0 million shares of common stock, par value $0.01 per share. In August 2012, in connection with the Tax Asset Protection Plan discussed further below, AOL filed a Certificate of Designation to its Amended and Restated Certificate of Incorporation creating a series of approximately 0.1 million shares of Preferred Stock designated as Series A Junior
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Participating Preferred Stock, par value $0.01 per share (the “Series A Preferred Stock”). The Series A Preferred Stock has the voting and such other rights as provided for in the Certificate of Designation. Rights and privileges associated with shares of Preferred Stock are subject to authorization by the Company’s Board of Directors (the “Board”) and may differ from those of any and all other series at any time outstanding. As of December 31, 2012, there was no Series A Preferred Stock outstanding. All shares of common stock are identical and will entitle the holders thereof to the same rights and privileges.
On January 22, 2010, the Company issued 0.6 million shares of AOL common stock as partial consideration for the acquisition of StudioNow. During 2010, the Company also issued 0.2 million shares of AOL common stock to Polar Capital Group, LLC (“Polar Capital”), in satisfaction of its contractual obligation to return its CEO’s initial investment of approximately $4.5 million in Patch Media Corporation (“Patch”), which arose from the acquisition of Patch on June 10, 2009.
During the first quarter of 2010, the Company adjusted its deferred tax assets and estimated amount payable to Time Warner for income taxes prior to the spin-off from Time Warner and these adjustments resulted in a $27.0 million reduction to APIC.
2011 Stock Repurchase Program
On August 10, 2011, the Company’s Board approved a stock repurchase program, which authorized the Company to repurchase up to $250.0 million of its outstanding shares of common stock from time to time through August 2012. Repurchases were subject to market conditions, share price and other factors. Repurchases were made in accordance with applicable securities laws in the open market or in private transactions and may have included derivative transactions, or pursuant to any trading plan adopted in accordance with Rule 10b5-1 of the Securities and Exchange Commission. For the year ended December 31, 2012, the Company paid $35.8 million to repurchase 2.1 million shares at a weighted average price of $17.29 per share as part of this program. From the inception of the program through December 31, 2012, the Company repurchased a total of 14.8 million shares at a weighted average price of $14.11 per share as part of this program, for total consideration of $209.4 million. Shares repurchased under the program were recorded as treasury stock on the Company’s consolidated balance sheet. The shares repurchased under this program during the year ended December 31, 2012 were not the result of an accelerated share repurchase agreement and did not result in any derivative transactions. Management has not made a decision on whether shares purchased under this program will be retired or reissued. The Company’s Board re-authorized the purchase of the remaining shares under the stock repurchase program to be purchased as part of the accelerated stock repurchase agreement entered into on August 26, 2012 as defined below.
Dutch Auction Tender Offer
On June 28, 2012, AOL announced a $400.0 million modified Dutch auction tender offer. The tender offer began on the date of the announcement, June 28, 2012, and expired on August 2, 2012. Through the Dutch tender offer, AOL’s shareholders had the opportunity to tender some or all of their shares at a price within the range of $27.00 to $30.00 per share. Upon expiration, approximately 0.3 million shares were tendered through the offer at a final purchase price of $30.00 per share, for a total purchase price of approximately $8.8 million. AOL accounted for the repurchase of these shares as treasury stock on the Company’s consolidated balance sheet during the third quarter of 2012.
Accelerated Stock Repurchase Agreement
On August 26, 2012, the Company entered into a fixed dollar collared accelerated stock repurchase agreement with Barclays Capital Inc. (“Barclays”), as agent for Barclays Bank PLC, effective August 27, 2012
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(the “ASR Agreement”). Under the ASR Agreement, on August 30, 2012, AOL paid $654.1 million from cash on hand to Barclays to repurchase outstanding shares of common stock. The consideration paid to Barclays to repurchase shares included $54.1 million in contemplation of a cash dividend announced by the Company on August 27, 2012 (the “Special Cash Dividend”) and discussed further below, which was calculated as the present value of the special cash dividend with respect to those shares deliverable under the ASR Agreement prior to the ex-dividend date of December 3, 2012. Since the ASR Agreement is indexed to the Company’s stock and the Company has the option to settle in cash or shares at the Company’s discretion, the Company has accounted for shares repurchased under the ASR Agreement within equity in its consolidated balance sheet. As such, the $654.1 million payment to Barclays was initially recorded as a reduction to APIC prior to the shares being delivered. As the shares are delivered by Barclays, AOL transfers an amount equal to the estimated value of the shares delivered from APIC to treasury stock, such that upon completion of the ASR Agreement, the entire $654.1 million will be recorded as treasury stock.
The specific number of shares that AOL ultimately will repurchase under the ASR Agreement will be based on the share price of AOL common stock over a valuation period in accordance with the terms of the ASR Agreement, subject to a floor and cap provision that establishes a minimum and maximum number of repurchased shares, and subject to the agreed adjustment for the value of the special cash dividend. Upon the termination of the hedging period on October 19, 2012, the cap price and the floor price under the ASR Agreement were established at $32.69 and $26.68, respectively. The cap and floor prices establish the expected minimum and maximum shares to be delivered in total upon completion of the ASR Agreement of 18.4 million to 22.5 million shares, respectively. During the year ended December 31, 2012 and to date, Barclays delivered 18.4 million shares to AOL, and in connection with this delivery of shares, AOL reclassified $620.2 million of the $654.1 million paid to Barclays from APIC to treasury stock. On final settlement of the ASR Agreement, AOL may be entitled to receive additional shares of common stock, or if AOL elects, cash, from Barclays, or under certain circumstances specified in the ASR Agreement, AOL may be required to deliver shares or make a cash payment, at its option, to Barclays. In connection with this transaction, Barclays has purchased and is expected to continue to purchase common stock in the open market. The specific number of shares that the Company will ultimately receive under the ASR Agreement will be based on the volume weighted average price of AOL’s shares from October 22, 2012 (the first trading day following the termination of the hedging period) through the completion of the transaction as compared to the established cap and floor prices. Upon delivery of the final shares to AOL, if any, the Company will reclassify the remaining $33.9 million under the ASR Agreement from APIC to treasury stock. The Company currently anticipates that the ASR Agreement will be completed in the second quarter of 2013.
Special Cash Dividend
On August 26, 2012, AOL declared the Special Cash Dividend of $5.15 per share to be paid to shareholders of record at the close of business on December 5, 2012. The total amount of the Special Cash Dividend paid to shareholders on December 14, 2012 was $434.4 million with an offsetting reduction to retained earnings in the Company’s consolidated balance sheet. In connection with the payment of the Special Cash Dividend and in accordance with and pursuant to the Company’s Amended and Restated 2010 Stock Incentive Plan (“2010 SIP”), the Company made an equitable adjustment to outstanding stock options, such that both the fair value and intrinsic value of employee awards immediately following the Special Cash Dividend are essentially unchanged from the fair value and intrinsic value prior to the Special Cash Dividend. This dividend will be treated as a return of capital for tax purposes. In addition to the amount paid on December 14, 2012, individuals who hold restricted stock units (“RSUs”) and performance stock units (“PSUs”) will be paid out dividend equivalents in cash as the respective RSUs and PSUs vest. The Company did not record any incremental compensation expense in connection with the adjustment of stock options or payment of dividend equivalents on RSUs and PSUs given that the adjustments were made pursuant to an existing anti-dilution provision included in the Company’s 2010
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SIP, and the adjustments were made so that the holders of the awards were in the same economic position after the equity restructuring as before. As of December 31, 2012, the estimated liability recorded for dividend equivalents to be paid to holders of RSUs and PSUs, net of estimated forfeitures, was $12.2 million, of which $6.1 million was recorded in accrued expenses and other current liabilities and the remainder was recorded in other long-term liabilities.
Tax Asset Protection Plan
As of December 31, 2012, AOL had significant domestic tax attributes, including both net operating loss deferred tax assets and capital loss carry forward deferred tax assets. Unless otherwise restricted, AOL can utilize these tax attributes in certain circumstances to offset future U.S. taxable income, including in connection with capital gains that may be generated from a potential asset sale. Should a “change of control” be triggered under Section 382 of the Internal Revenue Code of 1986, as amended, the Company may not be able to utilize these tax attributes to offset future U.S. taxable income, or such utilization could be significantly delayed. As a result, during the third quarter of 2012, the Company adopted a Tax Asset Protection Plan (the “TAPP”) that is intended to act as a deterrent to any individual, individual fund or family of funds with common dispositive power acquiring 4.9% or more of the Company’s outstanding shares without the approval of the Company’s Board.
Pursuant to the TAPP, the Company declared a dividend of one right on each outstanding share of common stock held of record as of the close of business on September 7, 2012. One right will also be issued together with each share of common stock issued after September 7, 2012 but before the date the rights are exercisable and, in certain circumstances, after such date. Subject to the terms, provisions and conditions of the TAPP, if the rights become exercisable, each right would initially represent the right to purchase from the Company one ten-thousandth of a share of Series A Preferred Stock for a purchase price of $100. If issued, each fractional share of Series A Preferred Stock would give the stockholder approximately the same dividend, voting and liquidation rights as one share of common stock. However, prior to exercise, a right does not give its holder any rights as a stockholder of the Company, including, without limitation, any dividend, voting or liquidation rights.
The rights will expire on August 27, 2015, or such earlier time as the Company’s Board determines that the Company has no remaining designated tax attributes as of the beginning of a taxable year. The Company intends to submit the TAPP for stockholder approval at its next annual meeting of stockholders. As of December 31, 2012, no event occurred that caused the Company to believe it was appropriate to invoke an action under the TAPP. Thus, the adoption of the TAPP did not have a material impact on the Company’s financial statements as of and for the year ended December 31, 2012.
2013 Stock Repurchase Program
On February 8, 2013, AOL announced that the Company’s Board approved a stock repurchase program, which authorizes AOL to repurchase up to $100.0 million of its outstanding shares of common stock from time to time over the next twelve months. Repurchases are subject to market conditions, share price and other factors. Repurchases will be made in accordance with applicable securities laws in the open market, in block trades, pursuant to pre-arranged trading plans, private transactions, and may include derivative transactions. The repurchase program may be suspended or discontinued at any time and is subject to the terms and conditions of the ASR Agreement.
NOTE 8-EQUITY-BASED COMPENSATION AND EMPLOYEE BENEFIT PLANS
Defined Contribution Plans
AOL employees participate in domestic and international defined contribution plans, primarily consisting of AOL’s domestic savings plan. AOL’s contributions to these plans are based on a percentage of the employees’ elected contributions and are subject to plan provisions.
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Expenses related to AOL’s contribution to plans amounted to $14.5 million, $13.2 million and $11.5 million for the years ended December 31, 2012, 2011 and 2010, respectively.
Equity-Based Compensation
AOL Equity Plan
Pursuant to the Company’s 2010 SIP stock options are granted to employees, advisors and non-employee directors of AOL with exercise prices equal to the quoted market value of the common stock at the date of grant. Performance stock options are also granted to certain senior level executives. Generally, the stock options vest ratably over a three to four year vesting period and expire ten years from the date of grant. Certain stock option awards provide for accelerated vesting upon an election to retire after reaching a specified age and years of service, as well as certain additional circumstances for non-employee directors.
Also pursuant to the 2010 SIP, AOL may also grant shares of common stock, RSUs or PSUs to its employees, advisors and non-employee directors, which generally vest ratably over a three to four year period from the date of grant. Holders of restricted stock, RSU and PSU awards are generally entitled to receive regular cash dividends or dividend equivalents, respectively, at the discretion of the Board, if paid by the Company during the period of time that the restricted stock or RSU awards are unvested. Certain of the Company’s PSU awards are subject to quarterly remeasurement of expense with corresponding adjustments to cumulative recognized compensation expense, as the service inception date precedes the grant date for these awards.
The Company is authorized to grant equity awards to employees, advisors and non-employee directors covering an aggregate of 24.6 million shares of AOL common stock under the 2010 SIP. Shares that are subject to Restricted Stock Awards or Other Stock-Based Awards (as such terms are defined in the 2010 SIP) shall be counted against the share authorization limit and the per participant limit as 1.61 shares for every share granted. Amounts available for issuance pursuant to grants under the 2010 SIP will change over time based on such activities as the conversion of equity awards into common stock, the forfeiture of equity awards and the cancellation of equity awards, among other activities.
Upon the (i) exercise of a stock option award, (ii) vesting of a RSU or (iii) grant of restricted stock, shares of AOL common stock are issued from authorized but unissued shares or from treasury stock.
AOL Employee Stock Purchase Plan
Pursuant to the Company’s 2012 Employee Stock Purchase Plan (the “ESPP”), eligible employees who elect to participate are granted the opportunity to purchase AOL’s common stock at a discount. Eligible employees voluntarily elect whether or not to enroll in the ESPP. There are two offering periods each calendar year, one commencing May 16 of the calendar year and ending on November 15 of the same calendar year, and the other commencing on November 16 of the same calendar year and ending on May 15 of the following calendar year. The first offering period under the ESPP commenced on November 16, 2012. An employee may cancel his or her enrollment at any time, subject to the ESPP rules. Employees contribute to the ESPP through payroll deductions. Participating employees may contribute not less than 1% and up to 15% of their eligible compensation through after-tax payroll deductions. After an offering period has begun, an employee may decrease, but not increase, his or her contribution percentage, subject to the ESPP rules.
On the last business day of each offering period, each participating employee’s payroll deductions are used to purchase shares for the employee. The purchase price for the shares so purchased will be the lower of (i) 85%
AOL INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
of the fair market value of the Company’s common stock on the first day of the offering period, or (ii) 85% of the fair market value of the Company’s common stock on the last day of the offering period. During any single year, no employee may purchase more than $25,000 worth of shares under the ESPP (based on market value on the applicable enrollment date(s)) pro-rated equally to each offering period. The Company has accounted for the ESPP as compensatory given the presence of a look-back feature, a 15% stock purchase discount from market price which is significant and incremental, and the fact that plan terms are not available to all common stock holders.
A maximum of 9.4 million shares is available for issuance pursuant to the ESPP. Shares issued under the ESPP may be unissued shares, treasury shares or shares bought in the market. In the event there is any change in the shares of the Company through the declaration of stock dividends or a stock split-up, or through recapitalization resulting in share split-ups, or combinations or exchanges of shares, or otherwise, the Compensation Committee will make appropriate adjustments in the number of shares available for purchase under the ESPP, and the purchase price and the number of shares subject to any purchase rights which have not yet been exercised, and will take any further action that it determines in its discretion may be necessary or appropriate.
Acquisition of The Huffington Post
In connection with the acquisition of The Huffington Post in March 2011, the Company assumed the Huffington Post Plan and, as discussed above, agreed to consideration valued at $12.1 million related to the fair value of unvested stock options held by The Huffington Post employees that were generally converted into unvested AOL stock options. Specifically, as of closing: (1) the Company converted 706,881 outstanding shares that were subject to The Huffington Post stock options into 664,075 Company stock options; (2) the remainder of the shares subject to outstanding The Huffington Post stock options were cashed out pursuant to the merger agreement (all of the cashed-out shares were canceled and will not be returned to the share pool as Company shares under the Huffington Post Plan); and (3) a small number of shares subject to The Huffington Post stock options held by previously terminated employees had been either exercised or forfeited (the forfeited shares were returned to the share pool, and converted into Company shares under the Huffington Post Plan). Of the fair value of The Huffington Post options that were converted, $8.1 million is being recognized as equity-based compensation expense over the remaining award vesting periods (subject to adjustments for actual forfeitures), which for most employees is 24 months from the acquisition date. See “Note 4” for additional information on the acquisition of The Huffington Post and related stock conversion.
Equity-Based Compensation Expense
Compensation expense recognized by AOL related to its equity-based compensation plans is as follows (in millions):
AOL INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
AOL Stock Options
The assumptions presented in the table below represent the weighted-average value of the applicable assumption used to value AOL stock options at their grant date:
Because AOL’s common stock has a limited trading history, the volatility assumption was determined for 2012 and 2011 awards based on a blend of AOL’s implied volatility and the historical and implied volatilities of a comparable peer group of publicly traded companies. The expected term, which represents the period of time that options granted are expected to be outstanding, is estimated based on the historical exercise experience of AOL employees that held similar options to acquire Time Warner common stock. The risk-free rate assumed in valuing the options is based on the U.S. Treasury yield curve in effect at the time of grant for the expected term of the option. As the Company does not currently intend to pay dividends, the expected dividend yield is zero for all AOL equity awards granted.
The following table summarizes information about AOL stock options that were outstanding at December 31, 2012:
AOL INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(a) Represents The Huffington Post options converted at the time of acquisition.
(b) Represents a one-time equitable adjustment to holders of outstanding stock options as of November 30, 2012, in consideration for the decrease in value of options due to the $5.15 one-time special dividend that option holders were not entitled to receive.
As of December 31, 2012, 9.7 million shares of AOL common stock were available for future grants of stock options. As of December 31, 2012, there was $23.4 million of unrecognized compensation cost related to outstanding employee stock options expected to vest. The Company expects to recognize this amount over a weighted-average period of 2.3 years. To the extent the actual forfeiture rate is different from what the Company has estimated, equity-based compensation expense related to these awards will be different from the Company’s expectations.
The weighted-average grant date fair value of an AOL stock option granted during the years ended December 31, 2012, 2011 and 2010 was $6.93, $7.77 and $9.41, respectively.
AOL Restricted Stock Units and Performance Stock Units
The following table summarizes information about unvested AOL RSUs and PSUs at December 31, 2012:
At December 31, 2012, the intrinsic value of unvested AOL RSUs and PSUs was $83.5 million. As of December 31, 2012, there was $43.7 million of unrecognized compensation cost related to outstanding RSUs and PSUs expected to vest. The Company expects to recognize this amount over a weighted-average period of 2.1 years. To the extent the actual forfeiture rate is different from what the Company has estimated, equity-based compensation expense related to these awards will be different from the Company’s expectations. Total fair value of shares vested during the years ended December 31, 2012, 2011 and 2010 was $15.5 million, $24.7 million and $8.5 million, respectively
NOTE 9-RESTRUCTURING COSTS
2012 Restructuring Costs
In connection with the Company’s restructuring initiatives, the Company incurred $10.1 million in restructuring costs for the year ended December 31, 2012 related to organizational changes made in an effort to improve its ability to execute its strategy. These restructuring costs were primarily related to involuntary employee terminations.
AOL INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
2011 Restructuring Costs
In connection with the Company’s restructuring initiatives, the Company incurred $38.3 million in restructuring costs for the year ended December 31, 2011 related to organizational changes made in an effort to improve its ability to execute its strategy. These restructuring costs related to the Company’s acquisition of The Huffington Post, a reassessment of its operations in India and actions in the United States to align the Company’s costs with its strategy, and were primarily related to involuntary terminations of employees ranging from executives to line personnel.
2010 Restructuring Costs
For the year ended December 31, 2010, the Company incurred $33.8 million in restructuring costs to better align its organizational structure and costs with its strategy. These restructuring costs included $29.2 million related to employee terminations, facility closures and contract termination costs in 2010 and $4.6 million in restructuring costs associated with actions taken in 2009 and prior years (which includes adjustments to previous estimates). Employee termination costs were attributable to terminations of employees ranging from senior executives to line personnel.
A summary of AOL’s restructuring activity for the years ended December 31, 2012, 2011 and 2010 is as follows (in millions):
At December 31, 2012, of the remaining liability of $4.0 million, $3.3 million was classified as a current liability within accrued expenses and other current liabilities, with the remaining $0.7 million classified as a long-term liability in the consolidated balance sheet. Amounts classified as long-term are expected to be paid through 2016.
NOTE 10- COMMITMENTS AND CONTINGENCIES
Commitments
AOL’s total rent expense of continuing operations amounted to $35.2 million, $39.6 million and $34.8 million for the years ended December 31, 2012, 2011 and 2010, respectively. The Company has long-term lease
AOL INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
commitments for office space in various locations around the world, a number of which have renewal options at market rates to be determined prior to the renewal option being exercised. In addition, certain leases have rent escalation clauses with either fixed scheduled rent increases or rent increases based on the Consumer Price Index. The minimum rental commitments under long-term operating leases during the next five years and thereafter are as follows (in millions):
(a) Included in the above table are approximately $181.3 million of payments associated with the lease of the Company’s corporate headquarters in New York. AOL has leased its corporate headquarters for an initial lease term that ends in February 2023, with the option to extend the lease for an additional five years. Monthly rental payments to the landlord under this lease escalate by 7% after the end of the fifth year and tenth year of the lease term. Included in the above table are approximately $45.1 million of payments associated with a leased building in California. AOL has leased this space for an initial lease term that ends in June 2017 with no renewal options. Rent was abated for the first nine months of the lease term, with partial rent abatement for an additional three months. Only operating expenses were paid during the rent abatement period. Also included in the above table are payments for ongoing leases associated with AOL’s restructuring activities. AOL has recorded a liability on the balance sheet of $2.6 million related to these payments.
AOL has commitments under certain royalty, software licensing, TAC, deferred compensation and other agreements aggregating approximately $105.6 million at December 31, 2012, which are payable principally over a three-year period, as follows (in millions):
The Company also has certain contractual arrangements that would require it to make payments or provide funding if certain circumstances occur (“contingent commitments”). At December 31, 2012, these arrangements related primarily to letters of credit and totaled $11.8 million. The Company does not expect that these contingent commitments will result in any material amounts being paid by the Company in the foreseeable future.
Contingencies
During the second quarter of 2012, the Company paid $13.5 million to settle a sales tax matter with the Virginia Department of Taxation covering the period from February 1995 through December 2011. In connection with the resolution of this matter, the Company recorded incremental sales and use tax expense within general and administrative expense of $9.6 million for the year ended December 31, 2012.
AOL INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
In addition to the matter described above, AOL is a party to a variety of claims, suits and proceedings that arise in the normal course of business, including actions with respect to intellectual property claims, tax matters, labor and unemployment claims, commercial claims, claims related to the Company’s business model for content creation and other matters. The Company reached various settlements on certain intellectual property and other legal matters during the year ended December 31, 2012. Collectively, the amounts incurred and paid related to these matters were not material to the Company’s financial statements.
With respect to tax matters, AOL has received tax assessments in certain states related to sales and use taxes on its business operations. AOL has appealed these tax assessments and plans to vigorously contest these matters. In addition, AOL has received assessments in certain foreign countries related to income tax and transfer pricing, and plans to vigorously contest these matters as well. In certain instances, the Company was required to pay a portion of the tax assessment in order to proceed with the dispute of the assessment. In February 2013, we received notice that the Attorney General for the State of Florida is investigating a number of advertising companies, including Advertising.com, regarding the placement of allegedly deceptive third-party advertising on their online advertising networks. We are cooperating with the investigation and have responded to initial information requests. While the results of such claims, suits, proceedings and investigations cannot be predicted with certainty, management does not believe that, based on current knowledge and the likely timing of resolution of the various matters, any additional reasonably possible potential losses above the amount accrued for such matters would be material to the Company’s financial statements. Regardless of the outcome, legal proceedings can have an adverse effect on us because of defense costs, diversion of management resources and other factors.
NOTE 11-ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consist of (in millions):
NOTE 12-RELATED PARTY TRANSACTIONS
Acquisition of Patch Media Corporation
On June 10, 2009, AOL purchased Patch, a news, information and community platform business dedicated to providing comprehensive local information and services for individual towns and communities, for approximately $7.0 million in cash. Approximately $700,000 of the consideration was held in an indemnity escrow account until the first anniversary of the closing.
At the time of closing, Timothy M. Armstrong, AOL’s Chairman and Chief Executive Officer, held, indirectly, through Polar Capital (a private investment company which he founded), economic interests in Patch that entitled him to receive approximately 75% of the transaction consideration. Mr. Armstrong’s original investment in Patch, made in December 2007 through Polar Capital, was approximately $4.5 million. In
AOL INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
connection with the transaction, Mr. Armstrong, through Polar Capital, waived his right to receive any transaction consideration in excess of his original $4.5 million investment, opting to accept only the return of his initial investment in AOL common stock. In addition, Mr. Armstrong elected to return the $4.5 million (approximately $450,000 of which was held in the indemnity escrow account for a year) that he was entitled to receive in connection with the transaction to AOL, to be held by AOL until after the Company’s spin-off from Time Warner in exchange for the subsequent issuance of AOL common stock. In exchange for the $4.5 million he was entitled to receive, during 2010, AOL issued to Polar Capital 194,857 shares of AOL common stock.
Transactions with Time Warner
In connection with the spin-off from Time Warner in 2009, AOL entered into a separation agreement and several other related agreements which govern the ongoing relationship between the two companies. As part of these agreements, the Company entered into a Second Tax Matters Agreement with Time Warner that governs the respective rights, responsibilities and obligations of Time Warner and AOL after the spin-off with respect to all tax matters. The Company does not consider Time Warner to be a related party subsequent to the spin-off.
NOTE 13-SEGMENT INFORMATION
During the fourth quarter of 2012, the CODM function was comprised of the Company’s chief executive officer and chief operating officer. Effective in the fourth quarter of 2012, the Company made changes to its operating structure as a result of changes in how the CODM function views the business. Accordingly, the Company determined it no longer operates in a single segment. Prior to the fourth quarter of 2012, AOL reported as a single operating and reportable segment. The Company has revised its financial information and disclosures for prior periods to reflect the segment disclosures as if the current operating structure had been in effect throughout all periods presented.
The Company’s segments are determined based on the products and services it provides and how the CODM evaluates the business. The Company has the following operating segments:
•
Brand Group, which consists of AOL’s portfolio of distinct and unique content as well as certain service brands. The results for this segment include advertising offerings on a number of owned and operated sites, such as AOL.com, the Huffington Post, TechCrunch and MapQuest.
•
Membership Group, which consists of offerings that serve AOL’s registered account holders, both free and paid, and are focused on delivering world-class experiences to AOL’s loyal users who rely on these AOL products and properties every day. The results for this segment include AOL’s subscription offerings and advertising offerings on Membership Group properties, including communications products such as AOL Mail and AIM, as well as from performance compensation for marketing third party products and services.
•
AOL Networks, which consists of AOL’s offerings to publishers and advertisers utilizing AOL’s Third Party Network as well as AOL Properties inventory sold by AOL Networks. The results for this segment include Advertising.com, ADTECH, sponsored listings, Pictela, goviral and AOL On.
•
Patch, which is a community-specific news and information platform dedicated to providing comprehensive and trusted local coverage for individual towns and communities.
Both Patch and the Brand Group have similar characteristics in that both segments are focused on providing high quality content to internet users by creating original content, aggregating third party content and encouraging user content, and the primary source of revenue for both segments is online display and search
AOL INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
advertising presented along with the content. The Company believes that these segments perform very similar functions and that the business activities and economic environments (including long-term margins and sales trends) for these segments are similar as well. As a result, Patch and the Brand Group are aggregated into one reportable segment referred to herein as the Brand Group.
In addition to the above reportable segments, the Company has a corporate and other category that includes activities that are not directly attributable or allocable to a specific segment. This category primarily consists of costs associated with broad corporate functions including legal, human resources, marketing, finance and accounting, and activities not directly attributable to a segment such as AOL Ventures and other general business costs. In 2010, this category includes the results of operations for product lines the Company disposed of in 2010 (Bebo and ICQ).
AOL Networks sells advertising to third parties that is displayed on web properties managed within the Membership and Brand Groups. The revenues associated with these transactions are included in the revenues from external customers for AOL Networks. An intersegment TAC expense is included in the expenses recorded for AOL Networks, with a corresponding amount of intersegment revenues included in the respective segment results for the Membership and Brand Groups. The intersegment revenues and TAC expense are determined based on similar transactions that AOL Networks has with large third-party publishers.
The CODM function uses Adjusted OIBDA to evaluate the performance of the segments and allocate resources. Management considers Adjusted OIBDA to be the appropriate metric to evaluate and compare the ongoing operating performance of the Company’s business on a consistent basis across reporting periods, as it eliminates the effect of noncash items which the Company does not believe are indicative of its core operating performance. This measure of profit or loss is considered to be a non-GAAP measure, and may be different than similarly-titled non-GAAP financial measures used by other companies.
The Company views Adjusted OIBDA as the segment measure of profit or loss that is most useful to investors since it is indicative of a segment’s performance and is representative of the method management uses to evaluate performance and make decisions about allocating resources. The Company defines Adjusted OIBDA as operating income before depreciation and amortization excluding the impact of restructuring costs, non-cash equity-based compensation, gains and losses on all disposals of assets, non-cash asset impairments and special items that management does not believe are indicative of the Company’s core operating performance. Segment Adjusted OIBDA includes revenue from external customers and intersegment revenues, costs and expenses directly attributable to the segment and allocations of shared corporate and technology costs which are determined to be directly related to a particular segment.
AOL INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Segment information for the years 2012, 2011 and 2010 is as follows (in millions):
The following table presents the Company’s reconciliation of Adjusted OIBDA to operating income (loss) (in millions):
AOL INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Special items for the year ended December 31, 2012 include patent licensing income of $96.0 million and costs related to the patent sale of $15.7 million, as well as proxy contest costs of $8.9 million, the Virginia tax settlement of $7.6 million and acquisition-related costs of $5.1 million. Special items for the year ended December 31, 2011 include acquisition-related costs of $12.0 million and $8.5 million of legal settlement expenses.
Due to the nature of the Company’s operations, a majority of its assets are utilized by multiple products and services within all segments. In addition, segment assets are not reported to, or used by, the CODM function to allocate resources or assess performance of the Company’s segments. Accordingly, the Company has not disclosed asset information by segment.
Information about Geographical Areas
The following table presents revenues in different geographical locations (in millions):
(a) Revenues are attributed to countries based on the location of customers.
Net property and equipment located outside the United States, which represent 3% of total assets, are not material.
AOL INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 -SELECTED QUARTERLY FINANCIAL DATA (Unaudited)
(a) Operating income for the year ended December 31, 2012 includes the gain of $946.5 million (net of transaction costs) on the disposition of the Sold Patents and income of $96.0 million from licensing of intellectual property both related to the second quarter of 2012.
(b) Operating loss for the quarter ended March 31, 2011 includes restructuring costs of $27.8 million mainly as a result of the Company’s acquisition of The Huffington Post and costs incurred as a result of the reassessment of its operations in India.
(c) For the year ended December 31, 2012, the sum of the Company’s quarterly earnings per share does not equal its annual earnings per share due to timing impacts of the patent transaction and the repurchases of common stock on net income and quarterly and annual weighted-average shares outstanding, respectively.
AOL INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15-SUBSEQUENT EVENTS
Arthur Minson, Executive Vice President and Chief Operating Officer, has stepped down from his position effective February 26, 2013. Mr. Minson will remain with the Company for a transition period. The Company currently expects to record an immaterial charge during the first quarter of 2013 in connection with Mr. Minson’s departure.
The Company has appointed Susan Lyne as its new Executive Vice President and Chief Executive Officer of its Brand Group effective February 27, 2013. In addition, Ms. Lyne notified the Company of her decision to resign from the Board of Directors of the Company effective immediately following the commencement of her employment.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that the information we are required to disclose in our financial reports is recorded, processed, summarized and reported within the time periods specified by the SEC rules and forms, and that such information is accumulated and communicated to senior management, as appropriate, to allow timely decisions regarding required disclosure. Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Exchange Act, as amended. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2012. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2012, at a reasonable assurance level.
Changes to Internal Control Over Financial Reporting
We have evaluated the changes in our internal control over financial reporting that occurred during the three months ended December 31, 2012 and concluded that there have not been any changes that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer and effected by the Board, management and other personnel to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.
Internal control over financial reporting includes control self-assessments, which are audited by the internal audit function. Because of its inherent limitations, internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives. It is a process that involves human diligence and compliance and is therefore subject to lapses in judgment and breakdowns resulting from human error. It also can be circumvented by collusion or improper override. Because of its limitations, there is a risk that internal control over financial reporting may not prevent or detect on a timely basis errors or fraud that could cause a material misstatement of the financial statements. Additionally, changes in conditions may impact the effectiveness of controls subsequent to the date of the evaluation of the effectiveness of internal control over financial reporting.
Management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2012, using the criteria established in Internal Control-Integrated Framework issued by COSO. Based on this evaluation, management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2012.
Ernst & Young LLP, an independent registered public accounting firm, has audited the effectiveness of our internal control over financial reporting as of December 31, 2012, as stated in their report included in Item 9A.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of AOL Inc.
We have audited AOL Inc.’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). AOL Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, AOL Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of AOL Inc. as of December 31, 2012 and 2011, and the related consolidated statements of comprehensive income (loss), equity, and cash flows for each of the three years in the period ended December 31, 2012 of AOL Inc. and our report dated February 28, 2013 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
McLean, Virginia
February 28, 2013
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
AOL Inc.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item is incorporated by reference to our Proxy Statement to be filed in connection with the 2013 Annual Meeting of Stockholders.
We have adopted a Code of Ethics for Our Senior Executive and Senior Financial Officers. A copy of the Code is publicly available on our website at http://corp.aol.com/. Amendments to the Code or any grant of a waiver from a provision of the Code requiring disclosure under applicable SEC rules will also be disclosed on our website.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this item is hereby incorporated by reference to our Proxy Statement to be filed in connection with the 2013 Annual Meeting of Stockholders.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information called for by this item is hereby incorporated by reference to our Proxy Statement to be filed in connection with the 2013 Annual Meeting of Stockholders.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information called for by this item is hereby incorporated by reference to our Proxy Statement to be filed in connection with the 2013 Annual Meeting of Stockholders.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information called for by this item is hereby incorporated by reference to our Proxy Statement to be filed in connection with the 2013 Annual Meeting of Stockholders.
AOL Inc.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements
The Financial Statements listed in the Index to Consolidated Financial Statements and Supplementary Data, filed as part of this Annual Report.
(a)(2) Financial Statement Schedules
All financial statement schedules are omitted as the required information is not applicable or the information is presented in the consolidated financial statements or related notes.
(a)(3) Exhibits
See Item 15(b) below.
(b) Exhibits
The agreements and other documents filed as exhibits to this report are not intended to provide factual information or other disclosure other than with respect to the terms of the agreements or other documents themselves, and you should not rely on them for that purpose. In particular, any representations and warranties made by us in these agreements or other documents were made solely within the specific context of the relevant agreement or document and may not describe the actual state of affairs as of the date they were made or at any other time.
See the Exhibit Index immediately following the signature page of this Annual Report.
AOL INC.
SIGNATURES
Pursuant to the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on February 28, 2013.
AOL INC.
By
/s/ Karen Dykstra
Name:
Karen Dykstra
Title:
Chief Financial Officer
(Principal Financial Officer)
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Timothy M. Armstrong and Karen Dykstra, jointly and severally, his or her attorney-in-fact, each with the power of substitution, for him or her in any and all capacities, to sign any amendments to this Annual Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or substitute or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
AOL INC.
SIGNATURES
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EXHIBIT INDEX
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AOL INC.
EXHIBIT INDEX
* Portions of this agreement have been omitted pursuant to a request for confidential treatment.
** Management contract or compensatory plan or arrangement.
 This certification will not be deemed “filed” for purposes of Section 18 of the Exchange Act (15 U.S.C. 78r), or otherwise subject to the liability of that section. Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act or Exchange Act, except to the extent that the Registrant specifically incorporates it by reference.
 In accordance with Rule 406T of Regulation S-T, the information in these exhibits is furnished and deemed not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Exchange Act of 1934, and otherwise is not subject to liability under these sections and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, except as expressly set forth by specific reference in such filing.