EX-99.1 38 dex991.htm INFORMATION STATEMENT INFORMATION STATEMENT
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EXHIBIT 99.1

LOGO

, 2009

Dear Time Warner Shareholder:

We are pleased to inform you that on             , 2009, the board of directors of Time Warner Inc. approved the spin-off of AOL Holdings LLC, a wholly owned subsidiary of Time Warner, which will be converted into a corporation and renamed AOL Inc. prior to the spin-off. Upon completion of the spin-off, Time Warner shareholders will own 100% of the outstanding shares of common stock of AOL. We believe that this separation into two independent, publicly-traded companies is in the best interests of both Time Warner and AOL.

The spin-off will be completed by way of a pro rata dividend of AOL shares held by Time Warner to our shareholders of record as of 5:00 p.m. on             , 2009, the spin-off record date. Time Warner shareholders will be entitled to receive              shares of AOL common stock for every              shares of Time Warner common stock they hold on the record date. The dividend will be issued in book-entry form only, which means that no physical stock certificates will be issued. No fractional shares of AOL common stock will be issued. If you would have been entitled to a fractional share of AOL common stock in the distribution, you will receive the net cash value of such fractional share instead.

The spin-off is subject to certain customary conditions. Shareholder approval of the spin-off is not required, and you will not need to take any action to receive shares of AOL common stock.

Immediately following the spin-off, you will own shares of common stock of both Time Warner and AOL. Time Warner common stock will continue to trade on the New York Stock Exchange under the symbol “TWX.” AOL intends to list its common stock on the New York Stock Exchange under the symbol “AOL.”

We expect the spin-off to be tax-free to the shareholders of Time Warner, except with respect to any cash received in lieu of fractional shares. The spin-off is conditioned on the receipt of an opinion of counsel confirming that the spin-off will not result in the recognition, for U.S. Federal income tax purposes, of gain or loss to Time Warner or its shareholders, except to the extent of cash received in lieu of fractional shares. Time Warner may waive receipt of the tax opinion as a condition to the spin-off.

The enclosed Information Statement, which is being mailed to the shareholders of Time Warner, describes the spin-off and contains important information about AOL, including its historical consolidated financial statements.

We look forward to your continued support.

Sincerely,

Jeff Bewkes

Chairman and Chief Executive Officer

LOGO


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LOGO

, 2009

Dear AOL Shareholder:

It is my pleasure to welcome you as a shareholder of our company, AOL Inc. We are a leading global web services company with a substantial worldwide audience, a suite of powerful web brands and industry-leading products, and the largest advertising network in the United States.

As an independent, publicly-traded company, we believe we can more effectively focus on our objectives and satisfy the strategic needs of our company. In connection with the distribution of our common stock by Time Warner, we intend to list our common stock on the New York Stock Exchange under the symbol “AOL.”

I invite you to learn more about AOL by reviewing the enclosed Information Statement. We look forward to your continued support as a holder of AOL common stock.

Sincerely,

Tim Armstrong

Chairman and Chief Executive Officer

 

 

770 Broadway    New York, NY     10003    USA


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Information contained herein is subject to completion or amendment. A Registration Statement on Form 10 relating to these securities has been filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended.

 

SUBJECT TO COMPLETION, DATED OCTOBER 26, 2009

INFORMATION STATEMENT

AOL Inc.

770 Broadway

New York, New York 10003

Common Stock

(par value $0.01)

This Information Statement is being sent to you in connection with Time Warner Inc.’s spin-off of its wholly-owned subsidiary, AOL Inc. To effect the spin-off, Time Warner will distribute all of the shares of AOL common stock on a pro rata basis to the holders of Time Warner common stock. It is expected that the spin-off will be tax-free to Time Warner shareholders for U.S. Federal income tax purposes, except to the extent of cash received in lieu of fractional shares.

Every                      shares of Time Warner common stock outstanding as of 5:00 p.m., New York City time, on                     , 2009, the record date for the spin-off, will entitle the holder thereof to receive                      shares of AOL common stock. The distribution of shares will be made in book-entry form. Time Warner will not distribute any fractional shares of AOL common stock. Instead, the distribution agent will aggregate fractional shares into whole shares, sell the whole shares in the open market at prevailing market prices and distribute the aggregate net cash proceeds from the sales pro rata to each holder who would otherwise have been entitled to receive a fractional share in the spin-off.

The spin-off will be effective as of                     , 2009. Immediately after the spin-off becomes effective, we will be an independent, publicly-traded company.

No vote or further action of Time Warner shareholders is required in connection with the spin-off. We are not asking you for a proxy and request that you do not send us a proxy. Time Warner shareholders will not be required to pay any consideration for the shares of AOL common stock they receive in the spin-off, and they will not be required to surrender or exchange shares of their Time Warner common stock or take any other action in connection with the spin-off.

All of the outstanding shares of AOL common stock are currently owned by Time Warner. Accordingly, there is no current trading market for AOL common stock. We expect, however, that a limited trading market for AOL common stock, commonly known as a “when-issued” trading market, will develop as early as two trading days prior to the record date for the spin-off, and we expect “regular way” trading of AOL common stock will begin the first trading day after the distribution date. We intend to list AOL common stock on the New York Stock Exchange under the symbol “AOL.”

In reviewing this Information Statement, you should carefully consider the matters described in the section entitled “Risk Factors” beginning on page 15 of this Information Statement.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved these securities or determined if this Information Statement is truthful or complete. Any representation to the contrary is a criminal offense.

This Information Statement is not an offer to sell, or a solicitation of an offer to buy, any securities.

The date of this Information Statement is                    , 2009.


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TABLE OF CONTENTS

 

     Page

SUMMARY

   1

RISK FACTORS

   15

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

   29

THE SPIN-OFF

   30

DIVIDEND POLICY

   38

CAPITALIZATION

   39

SELECTED HISTORICAL FINANCIAL DATA

   40

BUSINESS

   42

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   55

MANAGEMENT

   85

EXECUTIVE COMPENSATION

   91

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

   148

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

   150

DESCRIPTION OF OUR CAPITAL STOCK

   159

WHERE YOU CAN FIND MORE INFORMATION

   164

INDEX TO FINANCIAL STATEMENTS

   F-1

 

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SUMMARY

This summary highlights selected information from this Information Statement and provides an overview of our company, our separation from Time Warner and the distribution of our common stock by Time Warner to its shareholders. For a more complete understanding of our business and the separation and distribution, you should read the entire Information Statement carefully, particularly the discussion set forth under “Risk Factors” beginning on page 15 of this Information Statement, and our audited and unaudited historical consolidated financial statements and notes to those statements appearing elsewhere in this Information Statement.

Unless the context otherwise requires, references in this Information Statement to (i) “AOL,” the “Company,” “we,” “our” and “us” refer to AOL Inc. and its consolidated subsidiaries, after giving effect to the reorganization, separation and distribution, and (ii) “Time Warner” refer to Time Warner Inc. and its consolidated subsidiaries, other than AOL. The transaction in which Time Warner will distribute to its shareholders all of the shares of our common stock is referred to in this Information Statement as the “distribution.” The transaction in which we will be separated from Time Warner is sometimes referred to in this Information Statement as the “separation” or the “spin-off.”

Our Company

We are a leading global web services company with an extensive suite of brands and offerings and a substantial worldwide audience. Our business spans online content, products and services that we offer to consumers, publishers and advertisers. We are focused on attracting and engaging consumers and providing valuable online advertising services on both our owned and operated properties and third-party websites. We have the largest advertising network in terms of online consumer reach in the United States as of September 2009.

Our Strategic Initiatives

We have begun executing a multi-year strategic plan to reinvigorate growth in our revenues and profits by taking advantage of the migration of commerce, information and advertising to the Internet. Our strategy is to focus our resources on AOL’s core competitive strengths in web content production, local and mapping, communications and advertising networks while expanding the presence of our content, product and service offerings on multiple platforms and digital devices. We also aim to reorient AOL’s culture and reinvigorate the AOL brand by prioritizing the consumer experience, making greater use of data-driven insights and encouraging innovation. Particular areas of strategic emphasis include:

 

   

Expanding Our Owned Content Offerings. We will expand our offerings of relevant and engaging online consumer content by focusing on the creation and publication of our own original content. In addition, we will seek to provide premium global advertisers with effective and efficient means of reaching our consumers.

 

   

Pursuing Local and Mapping Opportunities. We believe that there are significant opportunities for growth in the area of local content, platforms and services, by providing comprehensive content covering all geographic areas from local neighborhoods to major metropolitan areas. By enhancing these local offerings, including through our flagship MapQuest brand, we seek to provide consumers with a comprehensive local experience.

 

   

Enhancing Our Established Communications Offerings. Our goal is to increase the reach and engagement of our established communications offerings (including our email products and instant messaging applications) on multiple platforms and digital devices.

 

 

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Growing the Third Party Network. We seek to significantly increase the number of publishers and advertisers utilizing our third-party advertising network by providing an open, transparent and easy-to-use advertising system that offers unique and valuable insights to our publishers and advertisers.

 

   

Encouraging Innovation through AOL Ventures. We believe that we can attract and develop innovative initiatives through AOL Ventures by creating an environment that encourages entrepreneurialism. We currently expect to invest significantly less capital in AOL Ventures than in our other strategic initiatives and we may seek outside capital where appropriate.

Business Overview

Our business operations are focused on the following:

 

   

AOL Media. We seek to be a global publisher of relevant and engaging online content by utilizing open and highly scalable publishing platforms and content management systems, as well as a leading online provider of consumer products and services. We refer to our owned and operated content, products and services as “AOL Media.”

We generate advertising revenues on AOL Media through the sale of display and search advertising. We seek to provide effective and efficient advertising solutions utilizing data-driven insights that help advertisers decide how best to engage consumers. Google is, except in certain limited circumstances, the exclusive web search provider for AOL Media.

We also generate revenues through our subscription access service. We view our subscription access service as a valuable distribution channel for AOL Media. Our access service subscribers are important users of AOL Media and engaging both present and former access service subscribers is an important component of our strategy. In addition, our subscription access service will remain an important source of revenue and cash flow for us in the near term.

Global consumers are increasingly accessing and using the Internet through devices other than personal computers, such as digital devices (e.g., smartphones). As a result, we seek to ensure that our content, products and services are compatible with such devices so that our consumers are able to access and use our content, products and services via these devices.

 

   

Third Party Network. We also generate advertising revenues through the sale of advertising on third-party websites and on digital devices, which we refer to as the “Third Party Network.” In order to effectively connect advertisers with online advertising inventory, we purchase advertising inventory from publishers and utilize proprietary optimization, targeting and delivery technology to best match advertisers with available advertising inventory. Our mission is to provide an open and transparent advertising system that is easy-to-use and offers our publishers and advertisers unique and valuable insights. We seek to significantly increase the number of publishers and advertisers utilizing the network.

We market our offerings to advertisers on both AOL Media and the Third Party Network under the brand “AOL Advertising.” We market our offerings to publishers on the Third Party Network under the brand “Advertising.com.”

 

 

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Other Information

In connection with the spin-off, we intend to enter into a new revolving credit facility. We intend to use the proceeds of this facility, as necessary, to support our working capital needs and the growth of our business and for other general corporate purposes. We describe this facility in greater detail under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Principal Debt Obligations” on page 77 of this Information Statement.

In connection with the reorganization that will occur prior to the spin-off, we will be converted into a Delaware corporation. Our principal executive offices are located at 770 Broadway, New York, New York 10003. Our telephone number is 1-877-AOL-1010. Our website address is www.corp.aol.com. Information contained on, or connected to, our website or Time Warner’s website does not and will not constitute part of this Information Statement or the Registration Statement on Form 10 of which this Information Statement is part.

The Spin-Off

Overview

On May 28, 2009, Time Warner announced plans for the complete legal and structural separation of AOL from Time Warner, following which AOL will be an independent, publicly-traded company.

Before our separation from Time Warner, we will enter into a Separation and Distribution Agreement and several other agreements with Time Warner related to the spin-off. These agreements will govern the relationship between AOL and Time Warner up to and subsequent to the completion of the separation and provide for the allocation between AOL and Time Warner of various assets, liabilities and obligations (including employee benefits, intellectual property, information technology and tax-related assets and liabilities). See “Certain Relationships and Related Party Transactions—Agreements with Time Warner” beginning on page 150 of this Information Statement for more detail.

The distribution of our common stock as described in this Information Statement is subject to the satisfaction or waiver of certain conditions. In addition, Time Warner has the right not to complete the spin-off if, at any time, the board of directors of Time Warner determines, in its sole discretion, that the spin-off is not in the best interests of Time Warner or its shareholders, or that market conditions are such that it is not advisable to separate AOL from Time Warner. See “The Spin-Off—Conditions to the Spin-Off” on page 36 of this Information Statement for more detail.

Questions and Answers about the Spin-Off

The following provides only a summary of the terms of the spin-off. You should read the section entitled “The Spin-Off” beginning on page 30 of this Information Statement for a more detailed description of the matters described below.

 

Q: What is the spin-off?

 

A: The spin-off is the method by which we will separate from Time Warner. In the spin-off, Time Warner will distribute to its shareholders all of the shares of our common stock that it owns. Following the spin-off, we will be a separate company from Time Warner, and Time Warner will not retain any ownership interest in us. The number of shares of Time Warner common stock you own will not change as a result of the spin-off.

 

 

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Q: Why is the separation of AOL structured as a spin-off?

 

A: Time Warner believes that a tax-free distribution of our shares is the most efficient way to separate our business from Time Warner in a manner that will improve flexibility and benefit both Time Warner and us, and create long-term value for Time Warner shareholders.

 

Q: What will I receive in the spin-off?

 

A: As a holder of Time Warner common stock, you will receive a dividend of                     shares of our common stock for every                     shares of Time Warner common stock held by you on the record date. Your proportionate interest in Time Warner will not change as a result of the spin-off. For a more detailed description, see “The Spin-Off” beginning on page 30 of this Information Statement.

 

Q: What is being distributed in the spin-off?

 

A: Approximately                     shares of our common stock will be distributed in the spin-off, based on the number of shares of Time Warner common stock outstanding as of                     , 2009. The actual number of shares of our common stock to be distributed will be calculated on                     , 2009, the record date. The shares of our common stock to be distributed by Time Warner will constitute all of the issued and outstanding shares of our common stock immediately prior to the distribution. For more information on the shares being distributed in the spin-off, see “Description of Our Capital Stock—Common Stock” beginning on page 159 of this Information Statement.

 

Q: What is the record date for the distribution?

 

A: Record ownership will be determined as of 5:00 p.m., New York City time, on                     , 2009, which we refer to as the record date.

 

Q: When will the distribution occur?

 

A: The distribution date of the spin-off is                     , 2009. We expect that it will take the distribution agent, acting on behalf of Time Warner, up to two weeks after the distribution date to fully distribute the shares of our common stock to Time Warner shareholders.

 

Q: What do I have to do to participate in the spin-off?

 

A: No action is required on your part. Shareholders of Time Warner entitled to receive our common stock are not required to pay any cash or deliver any other consideration, including any shares of Time Warner common stock, to receive the shares of our common stock distributable to them in the spin-off.

 

Q: If I sell, on or before the distribution date, shares of Time Warner common stock that I held on the record date, am I still entitled to receive shares of AOL common stock distributable with respect to the shares of Time Warner common stock I sold?

 

A: If you decide to sell any of your shares of Time Warner common stock on or before the distribution date, you should consult with your stockbroker, bank or other nominee and discuss whether you want to sell your Time Warner common stock or the AOL common stock you will receive in the spin-off, or both. See “The Spin-Off—Trading Prior to the Distribution Date” on page 36 of this Information Statement for more information.

 

 

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Q: How will Time Warner distribute shares of our common stock?

 

A: Holders of shares of Time Warner common stock on the record date will receive shares of our common stock in book-entry form. See “The Spin-Off—Manner of Effecting the Spin-Off” on page 31 of this Information Statement for a more detailed explanation.

 

Q: How will fractional shares be treated in the spin-off?

 

A: No fractional shares will be distributed in connection with the spin-off. Instead, the distribution agent will aggregate all fractional shares into whole shares and sell the whole shares in the open market at prevailing market prices. The distribution agent will then distribute the aggregate cash proceeds of the sales, net of brokerage fees and other costs, pro rata to each Time Warner shareholder who would otherwise have been entitled to receive a fractional share in the distribution. See “The Spin-Off—Treatment of Fractional Shares” on page 32 of this Information Statement for a more detailed explanation.

 

Q: What is the reason for the spin-off?

 

A: The board of directors of Time Warner considered the following potential benefits in making its determination to pursue the spin-off:

 

   

Strategic Focus and Flexibility. Following the spin-off, Time Warner and AOL will each have more focused businesses and be better able to dedicate financial resources to pursue appropriate growth opportunities and execute strategic plans best suited to its respective business. The spin-off will also allow each of Time Warner and AOL to enhance its strategic flexibility to respond to industry dynamics.

 

   

Focused Management. The spin-off will allow management of each company to devote its time and attention to the development and implementation of corporate strategies and policies that are based primarily on the specific business characteristics of the respective companies.

 

   

Management Incentives. The spin-off will enable AOL to create incentives for its management and employees that are more closely tied to its business performance and shareholder expectations. AOL equity-based compensation arrangements will more closely align the interests of AOL’s management and employees with the interests of its shareholders and should increase AOL’s ability to attract and retain personnel.

 

   

Investor Choice. The spin-off will allow investors to make independent investment decisions with respect to Time Warner and AOL. Investment in one or the other company may appeal to investors with different goals, interests and concerns.

 

Q: What are the U.S. Federal income tax consequences to me of the spin-off?

 

A: The spin-off is conditioned on the receipt by Time Warner, on or before the distribution date, of an opinion of Cravath, Swaine & Moore LLP confirming that the spin-off will not result in the recognition, for U.S. Federal income tax purposes, of gain or loss to Time Warner or its shareholders, except to the extent of cash received in lieu of fractional shares. The opinion will be based on the assumption that, among other things, the representations made, and information submitted, in connection with it are accurate. Time Warner may waive receipt of the tax opinion as a condition to the spin-off.

The aggregate tax basis of the Time Warner common stock and our common stock, received in a tax-free spin-off, in the hands of Time Warner’s shareholders immediately after the spin-off will be the same as the aggregate tax basis of the Time Warner common stock held by the holder immediately before the spin-off, allocated between the common stock of Time Warner and us in proportion to their relative fair market values on the date of the spin-off.

 

 

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See “The Spin-Off—Material U.S. Federal Income Tax Consequences of the Spin-Off” beginning on page 33 of this Information Statement and “Risk Factors—Risks Relating to the Spin-Off—The spin-off could result in significant tax liability to Time Warner shareholders” on page 25 of this Information Statement for more information regarding the potential tax consequences to you of the spin-off.

 

Q: Does AOL intend to pay cash dividends?

 

A: We intend to retain future earnings for use in the operation of our business and to fund future growth. We do not anticipate paying any dividends for the foreseeable future. See “Dividend Policy” on page 38 of this Information Statement for more information.

 

Q: How will AOL common stock trade?

 

A: Currently, there is no public market for our common stock. We intend to list our common stock on the New York Stock Exchange under the symbol “AOL.”

We anticipate that trading will commence on a “when-issued” basis as early as two trading days prior to the record date. When-issued trading in the context of a spin-off refers to a transaction effected on or before the distribution date and made conditionally because the securities of the spun-off entity have not yet been distributed. When-issued trades generally settle within three trading days after the distribution date. On the first trading day following the distribution date, any when-issued trading in respect of our common stock will end and regular-way trading will begin. Regular-way trading refers to trading after the security has been distributed and typically involves a trade that settles on the third full trading day following the date of the sale transaction. See “The Spin-Off—Trading Prior to the Distribution Date” on page 36 of this Information Statement for more information. We cannot predict the trading prices for our common stock before or after the distribution date.

 

Q: Will the spin-off affect the trading price of my Time Warner common stock?

 

A: Yes. We expect the trading price of shares of Time Warner common stock immediately following the distribution to be lower than immediately prior to the distribution because its trading price will no longer reflect the value of the AOL business. Furthermore, until the market has fully analyzed the value of Time Warner without the AOL business, the price of shares of Time Warner common stock may fluctuate.

 

Q: Do I have appraisal rights?

 

A: No. Holders of Time Warner common stock are not entitled to appraisal rights in connection with the spin-off.

 

Q: Who is the transfer agent for AOL common stock?

 

A: Computershare Trust Company, N.A.

 

Q: Are there risks associated with owning shares of AOL common stock?

 

A: Our business is subject to both general and specific risks and uncertainties relating to our business. Our business is also subject to risks relating to the spin-off. Following the spin-off, we will also be subject to risks relating to being an independent, publicly-traded company. Accordingly, you should read carefully the information set forth in the section entitled “Risk Factors” beginning on page 15 of this Information Statement.

 

 

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Q: Where can I get more information?

 

A: If you have any questions relating to the mechanics of the distribution, you should contact the distribution agent at:

Computershare Trust Company, N.A.

250 Royall Street

Canton, MA 02021

Phone:

Before the spin-off, if you have any questions relating to the separation, you should contact Time Warner at:

Investor Relations

Time Warner Inc.

One Time Warner Center

New York, NY 10019-8016

Phone: 1-866-INFO-TWX

After the spin-off, if you have any questions relating to AOL, you should contact us at:

Investor Relations

AOL Inc.

770 Broadway

New York, NY 10003-9522

Phone: 1-877-AOL-1010

 

 

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Summary of the Spin-Off

 

Distributing Company    Time Warner Inc., a Delaware corporation. After the distribution, Time Warner will not own any shares of our common stock.
Distributed Company    AOL Inc., a Delaware corporation and a wholly-owned subsidiary of Time Warner. After the spin-off, we will be an independent, publicly-traded company.
Distributed Securities    All of the shares of our common stock owned by Time Warner, which will be 100% of our common stock issued and outstanding immediately prior to the distribution.
Record Date    The record date is                     , 2009.
Distribution Date    The distribution date is                     , 2009.
Reorganization    On July 8, 2009, Time Warner completed the purchase of Google’s 5% interest in us. Following this purchase, we became a 100%-owned subsidiary of Time Warner. Prior to the spin-off, Time Warner will convert AOL Holdings LLC into a Delaware corporation to be named AOL Inc. Time Warner will then cause substantially all of the assets and liabilities of AOL LLC (other than AOL LLC’s guarantees of indebtedness of Time Warner and other non-AOL affiliates of Time Warner), our wholly-owned subsidiary that currently holds, directly or indirectly, all of the AOL business, to be transferred to and assumed by us. Following this transfer and assumption of AOL LLC’s assets and liabilities, ownership of AOL LLC will be transferred to, and retained by, Time Warner. For more information, see the description of the Internal Transactions in “Certain Relationships and Related Party Transactions—Agreements with Time Warner” beginning on page 150 of this Information Statement.
Distribution Ratio    Every                     shares of Time Warner common stock outstanding as of 5:00 p.m., New York City time, on the record date, will entitle the holder thereof to receive                     shares of our common stock. Please note that if you sell your shares of Time Warner common stock on or before the distribution date, the buyer of those shares may in certain circumstances be entitled to receive the shares of our common stock issuable in respect of the shares sold. See “The Spin-Off—Trading Prior to the Distribution Date” on page 36 of this Information Statement for more detail.
The Distribution    On the distribution date, Time Warner will release the shares of our common stock to the distribution agent to distribute to Time Warner shareholders. The distribution of shares will be made in book-entry form. It is expected that it will take the distribution agent up to two weeks to electronically issue shares of our common stock to you or your bank or brokerage firm on your behalf by way of direct registration in book-entry form. You will not be required to make any payment, surrender or exchange your shares of Time Warner common stock or take any other action to receive your shares of our common stock.

 

 

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Fractional Shares    The distribution agent will not distribute any fractional shares of our common stock to Time Warner shareholders. Instead, the distribution agent will aggregate fractional shares into whole shares, sell the whole shares in the open market at prevailing market prices and distribute the aggregate net cash proceeds from the sales pro rata to each holder who would otherwise have been entitled to receive a fractional share in the distribution. Recipients of cash in lieu of fractional shares will not be entitled to any interest on the amounts of payments made in lieu of fractional shares. The receipt of cash in lieu of fractional shares generally will be taxable to the recipient shareholders as described in “The Spin-Off—Material U.S. Federal Income Tax Consequences of the Spin-Off” beginning on page 33 of this Information Statement.
Conditions to the Spin-Off    The spin-off is subject to the satisfaction or waiver by Time Warner of the following conditions:
  

•   the board of directors of Time Warner shall have authorized and approved the separation and distribution and not withdrawn such authorization and approval, and shall have declared the dividend of AOL common stock to Time Warner shareholders;

  

•   each ancillary agreement contemplated by the Separation and Distribution Agreement shall have been executed by each party thereto;

  

•   the Securities and Exchange Commission shall have declared effective our Registration Statement on Form 10, of which this Information Statement is a part, under the Securities Exchange Act of 1934, as amended (which we refer to in this Information Statement as the Exchange Act), and no stop order suspending the effectiveness of the Registration Statement shall be in effect, and no proceedings for such purpose shall be pending before or threatened by the SEC;

  

•   our common stock shall have been accepted for listing on the New York Stock Exchange or another national securities exchange approved by Time Warner, subject to official notice of issuance;

  

•   the Internal Transactions (as described in “Certain Relationships and Related Party Transactions—Agreements with Time Warner—Separation and Distribution Agreement” beginning on page 150 of this Information Statement) shall have been completed;

  

•   Time Warner shall have received the written opinion of Cravath, Swaine & Moore LLP, which shall remain in full force and effect, that the spin-off will not result in the recognition, for U.S. Federal income tax purposes, of gain or loss to Time Warner or its shareholders, except to the extent of cash received in lieu of fractional shares;

 

•   Time Warner shall have received a certificate signed by our Chief Financial Officer, dated as of the distribution date, certifying that prior to the distribution we have made capital and other expenditures, and have operated our cash management, accounts payable and receivables collection systems, in the ordinary course consistent with prior

 

 

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practice, subject to an exception which permits us to cause any excess cash held by our foreign subsidiaries to be transferred to us or any of our other subsidiaries;

 

•   no order, injunction or decree issued by any governmental authority of competent jurisdiction or other legal restraint or prohibition preventing consummation of the distribution shall be in effect, and no other event outside the control of Time Warner shall have occurred or failed to occur that prevents the consummation of the distribution;

 

•   no other events or developments shall have occurred prior to the distribution date that, in the judgment of the board of directors of Time Warner, would result in the spin-off having a material adverse effect on Time Warner or its shareholders;

 

•   prior to the distribution date, this Information Statement shall have been mailed to the holders of Time Warner common stock as of the record date;

  

•   our current directors shall have duly elected the individuals listed as members of our post-distribution board of directors in this Information Statement, and such individuals shall be the members of our board of directors immediately after the distribution; provided, however, that our current directors shall appoint one independent director prior to the date on which when-issued trading of our common stock commences on the New York Stock Exchange and such director shall serve on our audit committee; and

 

•   immediately prior to the distribution date, our amended and restated certificate of incorporation and amended and restated by-laws, each in substantially the form filed as an exhibit to the Registration Statement on Form 10 of which this Information Statement is a part, shall be in effect.

   The fulfillment of the foregoing conditions will not create any obligation on the part of Time Warner to effect the spin-off. We are not aware of any material federal or state regulatory requirements that must be complied with or any material approvals that must be obtained, other than compliance with SEC rules and regulations and the declaration of effectiveness of the Registration Statement by the SEC, in connection with the distribution. Time Warner has the right not to complete the spin-off if, at any time, the board of directors of Time Warner determines, in its sole discretion, that the spin-off is not in the best interests of Time Warner or its shareholders, or that market conditions are such that it is not advisable to separate AOL from Time Warner.
Trading Market and Symbol    We intend to file an application to list shares of our common stock on the New York Stock Exchange under the symbol “AOL.” We anticipate that, as early as two trading days prior to the record date, trading of shares of AOL common stock will begin on a “when-issued” basis and will continue up to and including the distribution date, and we expect “regular-way” trading of our common stock will begin the first trading day after the distribution date. We also anticipate that, as early as two
   trading days prior to the record date, there will be two markets in Time Warner common stock: a “regular-way” market on which shares of Time Warner common stock will trade with an entitlement to shares of AOL

 

 

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   common stock to be distributed pursuant to the distribution, and an “ex-distribution” market on which shares of Time Warner common stock will trade without an entitlement to shares of AOL common stock. See “The Spin-Off—Trading Prior to the Distribution Date” on page 36 of this Information Statement for more information.
Tax Consequences to Time Warner Shareholders   

 

Time Warner shareholders are not expected to recognize any gain or loss for U.S. Federal income tax purposes as a result of the spin-off, except with respect to any cash received in lieu of fractional shares. See “The Spin-Off—Material U.S. Federal Income Tax Consequences of the Spin-Off” beginning on page 33 of this Information Statement for a more detailed description of the U.S. Federal income tax consequences of the spin-off.

   Each shareholder is urged to consult his, her or its tax advisor as to the specific tax consequences of the spin-off to that shareholder, including the effect of any U.S. Federal, state, local or foreign tax laws and of changes in applicable tax laws.
Relationship with Time Warner after the Spin-Off   

 

We will enter into a Separation and Distribution Agreement and other agreements with Time Warner related to the reorganization, separation and distribution. These agreements will govern the relationship between AOL and Time Warner up to and subsequent to the completion of the separation and provide for the allocation between AOL and Time Warner of various assets, liabilities and obligations (including employee benefits, intellectual property, information technology and tax-related assets and liabilities). The Separation and Distribution Agreement, in particular, will provide for the settlement or extinguishment of certain obligations between AOL and Time Warner. We will enter into a Transition Services Agreement with Time Warner pursuant to which certain services will be provided on an interim basis following the distribution. We will also enter into an Employee Matters Agreement that will set forth the agreements of Time Warner and AOL concerning certain employee compensation and benefit matters. Further, we will enter into an agreement with Time Warner regarding the sharing of taxes incurred before and after the spin-off, certain indemnification rights with respect to tax matters and certain restrictions to preserve the tax-free status of the spin-off. In addition, to facilitate the ongoing use of various intellectual property by each of AOL and Time Warner, we intend to enter into an Intellectual Property Cross-License Agreement with Time Warner that will provide for reciprocal licensing arrangements. We will also enter into an IT Applications Database Agreement that will provide for reciprocal access to software applications that have been developed internally, and a Master Services Agreement for ATDN and Hosting Services pursuant to which we will provide Time Warner with network access and hosting services. We also intend to enter into various other commercial agreements with Time Warner. We describe these arrangements in greater detail under “Certain Relationships and Related Party Transactions—Agreements with Time Warner” beginning on

 

 

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   page 150 of this Information Statement, and describe some of the risks of these arrangements under “Risk Factors—Risks Relating to the Spin-Off” beginning on page 25 of this Information Statement.
Dividend Policy    We intend to retain future earnings for use in the operation of our business to fund future growth. We do not anticipate paying any dividends for the foreseeable future. See “Dividend Policy” on page 38 of this Information Statement.
Transfer Agent    Computershare Trust Company, N.A.
Risk Factors    Our business is subject to both general and specific risks and uncertainties relating to our business. Our business is also subject to risks relating to the spin-off. Following the spin-off, we will also be subject to risks relating to being an independent, publicly-traded company. Accordingly, you should read carefully the information set forth under “Risk Factors” beginning on page 15 of this Information Statement.
Management and Strategy    In April 2009, Tim Armstrong was appointed our Chairman and Chief Executive Officer, and he commenced a review of AOL’s strategy and operations. As a result of this review, we have developed the next phase of our business strategy, which is to focus primarily on attracting and engaging Internet consumers and generating advertising revenues, with our subscription access service managed as a valuable distribution channel for our content, product and service offerings. For more information, see “Business” beginning on page 42 of this Information Statement. In order to execute this strategy, we have updated our organizational structure and hired certain members of senior management, including a new Chief Financial Officer. We will continue to evaluate our organizational structure and personnel requirements as part of the ongoing management of our business.

 

 

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Summary Historical Consolidated Financial Data

The following tables present certain summary historical financial information as of and for each of the years in the five-year period ended December 31, 2008, and as of June 30, 2009 and for the six months ended June 30, 2009 and 2008. The summary historical consolidated financial data as of December 31, 2008 and 2007 and for each of the fiscal years in the three-year period ended December 31, 2008, and as of June 30, 2009 and for the six months ended June 30, 2009 and 2008, are derived from our historical consolidated financial statements included elsewhere in this Information Statement. The summary historical consolidated financial data as of December 31, 2006 and as of and for the years ended December 31, 2005 and 2004 are derived from our unaudited consolidated financial statements that are not included in this Information Statement. The unaudited financial statements have been prepared on the same basis as the audited financial statements, and in the opinion of our management include all adjustments, consisting of only ordinary recurring adjustments, necessary for a fair presentation of the information set forth in this Information Statement.

The summary historical financial data presented below should be read in conjunction with our consolidated financial statements and accompanying notes thereto, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included elsewhere in this Information Statement. For each of the periods presented, we were a subsidiary of Time Warner. The financial information included herein may not necessarily reflect our financial position, results of operations and cash flows in the future or what our financial position, results of operations and cash flows would have been had we been an independent, publicly-traded company during the periods presented. In addition, our historical financial information does not reflect changes that we expect to experience in the future as a result of our separation from Time Warner, including changes in the financing, operations, cost structure and personnel needs of our business. Further, the historical financial information includes allocations of certain Time Warner corporate expenses. We believe the assumptions and methodologies underlying the allocation of general corporate expenses are reasonable. However, such expenses may not be indicative of the actual level of expense that would have been incurred by us if we had operated as an independent, publicly-traded company or of the costs to be incurred in the future.

 

     Years Ended December 31,    Six Months Ended
June 30,
     2008    2007    2006    2005    2004    2009    2008
($ in millions)                   (unaudited)    (unaudited)    (unaudited)
Statement of Operations Data:                     

Revenues:

                    

Advertising

   $ 2,096.4    $ 2,230.6    $ 1,886.1    $ 1,337.8    $ 1,005.0    $ 862.2    $ 1,082.2

Subscription

     1,929.3      2,787.9      5,783.6      6,754.9      7,476.9      749.2      1,029.8

Other

     140.1      162.2      117.0      109.4      139.7      59.6      73.0
                                                

Total revenues

   $ 4,165.8    $ 5,180.7    $ 7,786.7    $ 8,202.1    $ 8,621.6    $ 1,671.0    $ 2,185.0

Operating income (loss)(a)

     (1,167.7)      1,853.8      1,167.8      (1,817.8)      230.5      300.3      505.1

Income (loss) from continuing operations(b)

     (1,526.6)      1,213.3      716.5      (363.6)      477.0      173.2      286.2
                                                

Net income (loss) attributable to AOL Inc.(c)

   $ (1,525.8)    $ 1,396.1    $ 749.7    $ (334.1)    $ 564.4    $ 173.4    $ 286.6
                                                

 

(a)

2008 includes a $2,207.0 million non-cash impairment to reduce the carrying value of goodwill and $20.8 million in amounts incurred related to securities litigation and government investigations. 2007 includes a net pre-tax gain of $668.2 million on the sale of the German access service business and $171.4 million in amounts incurred related to securities litigation and government investigations. 2006 includes a $767.4 million gain on the sales of the French and United Kingdom access service businesses and $705.2 million in amounts incurred related to securities litigation and government investigations. 2005 includes $2,864.8 million in amounts incurred related to securities litigation and government investigations. 2004 includes $536.0 million in amounts incurred related to securities litigation and

 

 

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government investigations. The six months ended June 30, 2009 include $14.2 million in amounts incurred related to securities litigation and government investigations. The six months ended June 30, 2008 include $8.0 million in amounts incurred related to securities litigation and government investigations.

 

(b) Includes net gains of $944.4 million in 2005 and $293.6 million in 2004 related to the sale of primarily available-for-sale equity securities.

 

(c) Includes net income of $182.1 million in 2007, $18.9 million in 2006, $29.5 million in 2005 and $31.4 million in 2004 related to discontinued operations. 2006 also includes a non-cash benefit of $14.3 million as the cumulative effect of an accounting change upon the adoption of FAS 123R to recognize the effect of estimating the number of equity awards granted prior to January 1, 2006 that are ultimately not expected to vest. 2004 also includes a non-cash benefit of $34.0 million related to the cumulative effect of an accounting change in connection with the consolidation of America Online Latin America, Inc. in accordance with FIN 46R.

 

     

 

As of December 31,

  

 

As of June 30,
2009

   2008    2007    2006    2005    2004   
($ in millions)              (unaudited)    (unaudited)    (unaudited)    (unaudited)

Balance Sheet Data:

                 

Cash

   $ 134.7    $ 151.9    $ 401.5    $ 119.9    $ 256.9    $ 74.7

Total assets

   $ 4,861.3    $ 6,863.1    $ 6,786.4    $ 6,064.6    $ 7,803.0    $ 4,502.1
                                         

Long-term notes payable and obligations under capital leases

   $ 33.7    $ 24.7    $ 105.1    $ 110.4    $ 153.7    $ 40.8
                                         

Total equity

   $ 3,737.7    $ 5,269.5    $ 4,505.8    $ 3,530.8    $ 4,346.0    $ 3,284.9
                                         

 

 

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RISK FACTORS

The risks and uncertainties described below are those which we consider material and of which we are currently aware. In addition, this Information Statement contains forward-looking statements that involve risks and uncertainties. You should carefully read the section “Cautionary Statement Concerning Forward-Looking Statements” on page 29 of this Information Statement.

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 strategic shift to an online advertising-supported business model involves significant risks.

Following our strategic shift in 2006 from focusing primarily on generating subscription revenues to focusing primarily on attracting and engaging Internet consumers and generating advertising revenues, we have become increasingly dependent on advertising revenues as our subscription access service revenues continue to decline. We have not been able to generate sufficient growth in our advertising revenues to offset the loss of subscription access service revenues we have experienced in recent years. 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, including through our higher-priced channels, and to maintain or increase pricing for advertising. Our ability to generate positive cash flows will be adversely affected over the next several years by the continued decline of access subscribers unless we can successfully implement our strategic plan, grow our online advertising business and reduce our current cost structure. Adding to this risk is that advertising revenues are more unpredictable and variable than our subscription access service 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. In addition, because subscription revenues have relatively low direct costs, the expected decline in subscription revenues will likely result in declines in operating income and cash flows for the foreseeable future, even if we achieve significant growth in advertising revenues. If we are unable to successfully implement our strategic plan and grow the earnings generated by our online advertising services, we may not be able to support our business in the future.

Accordingly, we have recently implemented several restructuring plans to better align our organizational structure and costs with our strategy. We anticipate additional restructuring plans and expect to continue to actively manage our costs. Identifying and implementing additional cost reductions, however, is becoming increasingly difficult to do in an operationally effective manner. If we do not recognize the anticipated benefits of our restructuring plans and cost reduction initiatives, or if we fail to better align our cost structure in a timely manner, our business could be adversely affected.

If we do not continue to develop and offer compelling content, products and services, our ability to attract new consumers or maintain the engagement of our existing consumers could be adversely affected.

In order to attract consumers and generate increased engagement on AOL Media, we believe we must offer compelling content, products and services. However, 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 costs and time to develop. In addition, consumer tastes are difficult to predict and subject to rapid change. If we are unable to provide content, products and services that are sufficiently attractive and relevant to consumers (including subscribers to our subscription access service), we may not be able to attract new consumers or maintain or increase our existing consumers’ engagement. Even if we successfully develop and offer compelling content, products and services, we may not be able to attract new consumers and maintain or increase our existing consumers’ engagement.

 

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In general, subscribers to our subscription access service are among the most engaged consumers on AOL Media. As our subscriber base declines, we need to maintain the engagement of former subscribers similar to historical levels and increase the number and engagement of other consumers on AOL Media in order to successfully execute our business model. There can be no assurance that we will be able to maintain the engagement of former subscribers or attract and engage sufficient other consumers to sustain or increase historical engagement levels on AOL Media. If we cannot do so, our business could be adversely affected.

Even if we are able to attract new consumers to, and generate increased engagement on, AOL Media, we may not be able to maintain or increase our advertising revenues associated with AOL Media.

Different AOL Media properties generate varying volumes of advertising that are sold at a range of prices. To the extent our consumers are active on AOL Media properties where we do not deliver a high volume of advertisements or high-priced advertisements, we are limited in our ability to generate advertising revenues from such activity. Accordingly, if we are not able to attract and engage consumers to those AOL Media 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 Media properties increases and their aggregate engagement increases.

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. New and popular competitors, such as social networking sites, online advertising businesses and providers of communication tools, quickly emerge. Competition among companies offering advertising products, technology and services, and aggregators of third-party products and services, is intense. Internationally, we face intense competition from both global and local competitors. In addition, competition may generally cause us to incur unanticipated costs associated with research and product development.

The competition faced by our subscription access service, especially from broadband Internet access providers, could cause the number of our subscribers to decline at a faster rate than experienced in the past. 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. Many broadband providers, including cable companies, bundle their offerings with telephone, entertainment or other services, which may result in lower prices than stand-alone services. Based on customer survey information, the majority of our canceling access subscribers either already have broadband Internet connections or are leaving for broadband Internet connections. Broadband penetration of U.S. households increased from 28% in 2004 to 63% in 2008 and the number of U.S. households with dial-up access decreased from approximately 44 million in 2004 to 14 million in 2008. In addition to competition from broadband providers, competition among dial-up Internet access service providers is intense.

There can be no assurance that we will be able to compete successfully in the future with existing or potential competitors or that competition will not adversely affect our business.

Weak economic conditions could adversely affect our revenues.

The global economy is in a sustained and deep recession, and the future economic environment may continue to be less favorable than that of recent years. This recession could lead to further reduced advertising spending in the foreseeable future. Because we derive a substantial portion of our revenues from the sale of advertising, declines and delays in advertising spending could continue to reduce our revenues. Advertising spending by companies in certain sectors that have been significantly impacted by the downturn in the economy represents a significant portion of our advertising revenues, and any economic or other changes resulting in a significant reduction in the advertising spending of these or other sectors could further adversely affect our advertising revenues.

 

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Additionally, declines in consumer spending due to weak economic conditions may cause advertisers to reduce their spending if consumers are purchasing fewer of their products or services, ultimately resulting in downward pricing pressure on our advertising inventory. As a result, declines in consumer spending could indirectly adversely affect our advertising revenues.

While we do not believe that our subscription access service has been adversely affected by the current recession, there is a risk that existing subscribers may elect to cancel their subscriptions as a result of the weaker economic climate. Should this occur, we may experience an accelerated decline in our subscription revenues.

Demand and pricing for, and volume sold of, online advertising may face downward pressure which would adversely affect our advertising revenues.

During 2008 and the first half of 2009, we experienced lower demand from advertisers across a number of advertiser categories that have been significantly impacted by weak global economic conditions. In order for us to maintain or increase advertising revenues in the future, we believe it will be important to increase our overall volume of advertising sold, including sales of advertising through our higher-priced channels, and to maintain or increase pricing for advertising. If overall demand continues to decline or if overall pricing declines occur, our advertising revenues could be adversely affected.

We are dependent on a third-party search provider.

We do not own or control a general text-based web search service. Instead, Google is, except in certain limited circumstances, the exclusive web search provider for AOL Media. In 2008, search advertising revenues comprised approximately one-third of our total advertising revenues and was the only category of our advertising revenues that grew year-over-year. 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. Furthermore, except in certain limited circumstances, we have agreed to use Google’s algorithmic search and sponsored links on an exclusive basis in the United States through December 19, 2010. Upon expiration of this agreement, there can be no assurance that the agreement will be renewed, or, if the agreement is renewed, that we would receive the same or a higher revenue share as we do under the current agreement. In addition, there can be no assurance that if we enter into an arrangement with an alternative search provider the terms would be as favorable as those under the current Google agreement. Even if we were to enter into an arrangement with an alternative search provider with terms as or more favorable than those under the current Google agreement, such an arrangement might generate significantly lower search advertising revenues for us if the alternative search provider is not able to generate search advertising revenues as successfully as Google currently does.

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 Media. As search advertising represents a significant portion of online advertising spending, we believe that our lack of a proprietary search service could adversely affect our ability to maintain and increase advertising revenues.

We may need to raise additional capital, and we cannot be sure that additional financing will be available.

While subsequent to the separation we expect to fund our ongoing working capital, capital expenditure and financing requirements through cash flows from operations and a new 364-day senior secured revolving credit facility to be entered into in connection with the separation, we may require additional financing in the future. Our ability to obtain future financing will depend, among other things, on our financial condition and results of operations as well as on the condition of the capital markets or other credit markets at the time we seek financing. We expect that Time Warner will provide a guarantee of the proposed revolving credit facility in order to facilitate its arrangement in connection with the spin-off. However, Time Warner will not provide guarantees with respect to our future financings, and without the benefit of such guarantee we may not be able to obtain replacement or other future financing on terms acceptable to us in a timely manner, or at all. Our ability to fund

 

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our working capital, capital expenditure and financing requirements in the future may be adversely affected if we are unable to extend the credit facility beyond the anticipated 364-day term or obtain a new credit facility or other financing at the end of the anticipated one-year term 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.

The terms of our new revolving credit facility will contain restrictive covenants which may limit our business and financing activities.

The terms of our new revolving credit facility will include customary covenants which may impose restrictions on our business and financing activities, subject to certain exceptions or the consent of our lenders and Time Warner as guarantor, including, among other things, limits on our ability to incur additional debt, create liens, enter into merger and acquisition transactions, pay dividends and engage in transactions with affiliates. We also expect that the credit facility will contain certain customary affirmative covenants, including a requirement that we maintain a maximum consolidated leverage ratio and a minimum consolidated interest coverage ratio, and customary events of default. Our ability to comply with these covenants may be adversely affected by events beyond our control, including economic, financial and industry conditions. A breach of any of the credit facility covenants, including a failure to maintain a required ratio or meet a required test, may result in an event of default. This may allow our lenders to declare all amounts outstanding under the credit facility, together with accrued interest, to be immediately due and payable. If this occurs, we may not be able to refinance the accelerated indebtedness on acceptable terms, or at all, or otherwise repay the accelerated indebtedness. In addition, we will be restricted from extending, renewing or increasing our obligations under our new revolving credit facility, and the documentation entered into in connection with the facility may not be amended, modified, waived or released, in each case, without the consent of Time Warner, which may limit our ability to react to changes in financing needs or obtain relief from covenant restrictions in the event necessary.

If we cannot make our content, products and services available and attractive to consumers via devices other than personal computers, our ability to attract consumers and maintain or increase their engagement could be adversely affected.

Global consumers are increasingly accessing and using the Internet through devices other than personal computers, such as digital devices (e.g., smartphones). In order for consumers to access and use our content, products and services via these devices, we must ensure that our content, products and services are compatible with such devices. We also need to secure arrangements with device manufacturers and wireless carriers in order to have placement on these devices. We must also ensure that our licensing arrangements with third-party content providers allow us to make this content available on these devices. If we cannot effectively make our content, products and services available on these devices, fewer consumers may access and use our content, products and services. In addition, we must develop and offer effective advertising solutions on these devices in order to generate advertising revenues from the use of such devices by our consumers. If we are not able to attract and engage consumers via these devices or develop effective advertising solutions for such devices, our business could be adversely affected.

We rely on legacy technology infrastructure and a failure to update or replace this technology infrastructure could adversely affect our business.

Significant portions of our content, services and products are dependent on technology infrastructure that was developed a number of years ago. We expect to incur substantial ongoing costs to update and replace our legacy technology. 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. These delays or interruptions in service may cause our consumers, advertisers and publishers to become dissatisfied with our offerings and could adversely affect our business.

 

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Our dependence on legacy technology infrastructure may also put us in a weaker position relative to a number of our key web services competitors. Competitors with newer technology infrastructure may have greater flexibility and be in a position to respond more quickly than us to new opportunities, which may impact our competitive position in certain markets and adversely affect our business.

In addition, many of our employees with the necessary skills to maintain and repair our legacy technology infrastructure have either been reassigned within the Company or are no longer with the Company, creating a potential gap in our ability to service and support this legacy infrastructure.

If we are unable to hire, engage and retain key personnel, our business could be adversely affected.

We are dependent on our ability to hire, engage and retain talented, highly-skilled employees, including employees with specific areas of expertise. Accomplishing this may be difficult due to many factors, including the impact of our restructuring plans on employee morale, the geographic location of our main corporate and business offices, fluctuations in global economic and industry conditions, frequent changes in our management and leadership and the attractiveness of our compensation programs relative to those of our competitors. If we do not succeed in retaining and engaging our key employees and in attracting new key personnel, including personnel with specific areas of expertise, we may be unable to meet our strategic objectives and, as a result, our business could be adversely affected.

Further, due to past changes in our strategic direction, we may not have employees whose skills fully align with those required to achieve our strategic objectives. In some cases, we may need to hire suitably skilled employees to address strategic challenges we may encounter in the future.

A failure to scale and adapt our existing technology architecture to manage the expansion of our offerings could adversely affect our business.

We expect to continue to expand our offerings to consumers, advertisers and publishers. Expanding the amount and type of our offerings will require substantial expenditures to scale or adapt our technology infrastructure. The technology architectures 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. We may make additional changes to our architectures and systems to deliver our consumer offerings and services to advertisers and publishers, including moving to completely new technology architectures and systems. Such changes 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. These delays or interruptions in service may cause consumers, advertisers and publishers to become dissatisfied with our offerings and could adversely affect our business.

If we cannot effectively distribute our content, products and services, our ability to attract new consumers could be adversely affected.

As the Internet audience continues to fragment, distribution of our content, products and services via traditional methods (e.g., toolbars) may become less effective, and new distribution strategies may need to be developed. Even if we are able to distribute our content, products and services effectively, this does not assure that we will be able to attract new consumers.

Currently, an important distribution channel for AOL Media 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. If we are unable to grow organically by attracting new consumers to our content, products and services, we may need to rely on distribution channels that require us to pay significant fees to third parties. Furthermore, these fees have been increasing as Internet companies compete for a limited number of premium distribution channels. Any increased reliance on these third-party distribution channels could adversely affect our business.

 

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If we cannot continue to develop and offer effective advertising products and services, our advertising revenues could be adversely affected.

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 costs. If we cannot continue to develop and improve our advertising products and services, our advertising revenues could be adversely affected. Furthermore, if we cannot enhance our existing advertising offerings or develop new advertising offerings or technologies to keep pace with market trends, including new technologies that more effectively or efficiently plan, price or target advertising, our advertising revenues could be adversely affected.

We are dependent on third parties for our business in Europe.

In 2006 and 2007, we sold to third parties our subscription access service businesses, including our subscriber relationships, in the United Kingdom, France and Germany. We now depend on the current owners of these businesses to continue our relationships with our former subscribers and to generate advertising revenues in these countries. We provide the owners of our former subscription access service businesses varying levels of programming and advertising services and receive a portion of advertising revenues generated from certain activities. If one or more of these agreements is terminated by these third parties, or these parties take actions that affect the relationships with our former subscribers, our advertising revenues and business in Europe could be adversely affected.

Our access service subscriber base could decline faster than we currently anticipate.

Our access service subscriber base has declined and is expected to continue to decline. This decline is the result of several factors, including the increased availability of high-speed Internet broadband connections, the fact that a significant amount of online content, products and services has been optimized for use with broadband Internet connections and the effects of our strategic shift announced in 2006, which resulted in significantly reduced marketing efforts for our subscription access service and the free availability of the vast majority of our content, products and services. Also, a substantial number of the subscribers to our subscription access service do not use the service to access the Internet on a regular basis and may terminate their subscription at any time. In addition, we must maintain the current payment method information of our subscribers and, if we fail to do so, we may lose paid relationships with some of our access subscribers. If any of these factors result in our access subscriber base declining faster than we currently anticipate, our subscription revenues and business could be adversely affected.

If we do not present a clear message about our strategic focus to our commercial partners, our ability to attract and retain partners could be adversely affected.

We have had multiple changes in executive leadership and leadership direction and, accordingly, we have presented our commercial partners with numerous mixed messages about our goals and our strategy for achieving these goals. As a result, some of our commercial partners may become reluctant to continue to partner with us. If our advertising and publishing partners become reluctant to partner with us, our business 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, computer viruses, denial of service attacks, power outages, natural disasters, accidents, terrorism or other events within or outside our control could adversely affect us and our consumers, including through service disruption, damage to

 

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equipment and data and excessive call volume to call centers. Such an event could result in large expenditures necessary to repair or replace such networks or information systems or to protect them from similar events in the future. Significant incidents could result in a disruption of our business, consumer dissatisfaction and a loss of consumers or revenues.

We are dependent on third-party providers of telecommunications services.

Although we currently have agreements with several different third-party telecommunications service providers, there are only a limited number of such providers that are capable of providing our network services. To the extent that we cannot renew or extend our contracts with these providers on similar terms or to the extent that we cannot acquire similar network capacity from other providers on similar terms, the cost of obtaining network services may increase and our financial results could be adversely affected. In addition, because of the limited number of telecommunications services providers, in the event that a provider decides to exit the business of providing telecommunications services, our ability to maintain the geographic scope of these network services could be adversely affected. In such an event, certain consumers in the affected geographic areas would be unable to continue to use our subscription access service and our business could be adversely affected.

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, 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. 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 or otherwise adversely affect our business.

We have been, and may in the future be, subject to claims of intellectual property infringement that could adversely affect our business.

Periodically, third parties claim that we infringe their intellectual property rights. We expect to continue to be subject to claims and legal proceedings regarding alleged infringement by us of the intellectual property rights of others. These claims, whether meritorious or not, are 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, or could limit or reduce the number of our offerings to consumers, advertisers and publishers and otherwise adversely affect our business.

Some of our commercial agreements may require us to indemnify 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. 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. The occurrence of any of these events could adversely affect our business.

 

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The misappropriation, release, loss or misuse of AOL data or 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, computer hacking, natural disasters, terrorism 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.

Changes to federal, state or international laws or regulations applicable to our business could adversely affect our business.

Our business is subject to a variety of federal, state and international laws and regulations, including those with respect to advertising generally, consumer protection, content regulation, privacy, defamation, child protection, advertising to and collecting information from children, taxation and billing. 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. 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 be subject to significant liabilities which could adversely affect our business.

There are several federal laws that specifically affect our business, including the following:

 

   

The Children’s Online Privacy Protection Act of 1998 and the Federal Trade Commission’s related implementing regulations, which prohibit the collection of personal information from users under the age of 13 without parental consent. In addition, there has been an international movement to provide additional protections to minors who are online which, if enacted, could result in substantial compliance costs.

 

   

The Digital Millennium Copyright Act of 1998, parts of which limit the liability of certain eligible online service providers for listing or linking to third-party websites that include materials which infringe copyrights or other intellectual property rights of others.

 

   

The Communications Decency Act of 1996, sections of which provide certain statutory protections to online service providers who distribute third-party content.

 

   

The Protect Our Children Act of 2008, which requires online services to report and preserve evidence of violations of federal child pornography laws under certain circumstances.

 

   

The Electronic Communications Privacy Act of 1986, which sets forth the provisions for access, use, disclosure and interception and privacy protections of electronic communications.

In addition, many states have enacted legislation governing the breach of data security in which sensitive consumer information is released or accessed. If we fail to comply with these applicable laws or regulations we could 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 fail 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, our business could be adversely affected.

 

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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. 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 and advertisement and content delivery. In the Third Party Network, cookies or similar technologies help present, target and measure the effectiveness of advertisements. The regulation of these “cookies” and other current online advertising practices could adversely affect our business.

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 advertisements or delete cookies, or consumers may elect to manually delete cookies more frequently. Likewise, search services providers may adjust their algorithms and indexes, which may hinder the ability of consumers to reach and use our content, products and services. This risk is increased because there are a small number of search services providers and any change made by one or more of these providers could significantly affect our business. The widespread adoption of these products and technologies or changes to current products, technologies and services could adversely affect our business.

Acquisitions of other businesses could adversely affect our operations and result in unanticipated liabilities.

Since January 1, 2008, we have acquired 11 businesses and we are likely to make additional acquisitions and strategic investments in the future. The completion of acquisitions and strategic investments and the integration of acquired companies or assets involve a substantial commitment of resources. 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;

 

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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.

The failure to successfully address these risks or other problems encountered in connection with past or future acquisitions and strategic investments could cause us to fail to realize the anticipated benefits of such transactions and incur unanticipated liabilities that could harm our business.

We face risks relating to doing business internationally that could adversely affect our business.

Our business operates and serves consumers worldwide. There are certain risks inherent in doing business internationally, including:

 

   

economic volatility and the current global economic recession;

 

   

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 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;

 

   

potentially adverse tax developments;

 

   

longer payment cycles;

 

   

political or social unrest;

 

   

seasonal volatility in business activity;

 

   

risks related to government regulation;

 

   

the existence in some countries of statutory shareholder 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.

Also, we could be at a competitive disadvantage in the long term if we are not able to capitalize on international opportunities in growth economies. International expansion involves significant investment as well as risks associated with doing business abroad, as described above. Furthermore, investments in some regions can take a long period to generate an adequate return and in some cases there may not be a developed or an

 

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efficient legal system to protect foreign investment or intellectual property rights. In addition, if 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, or interpretations or application of these tax laws and regulations, could change. In addition, new international, federal, state and local tax laws and regulations affecting our business could be enacted or taxing authorities may disagree with our interpretation of tax laws and regulations. Our subscription access service is protected from taxation through the Federal Internet Tax Non-Discrimination Act, which is in effect until November 2014. However, faced with decreasing revenues, several states have sought to increase revenue by taxing advertising generally, Internet advertising specifically, or by increasing general business taxes. Imposing new taxes on advertising or Internet advertising would adversely affect us. An increase in general business taxes would adversely affect us if it occurred in a jurisdiction in which we operate. 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 could be required to record significant impairment charges in the future.

We are required under generally accepted accounting principles to test goodwill for impairment at least annually, and to review our identifiable intangible assets when events or changes in circumstances indicate the carrying value may not be recoverable. Factors that could lead to impairment of goodwill and identifiable intangible assets include significant adverse changes in the business climate and declines in the value of our business. We recorded a significant goodwill impairment charge in 2008 and may be required to record additional impairment charges (which would reduce our net income) in the future.

Risks Relating to the Spin-Off

The spin-off could result in significant tax liability to Time Warner shareholders.

The spin-off is conditioned on the receipt by Time Warner, on or before the distribution date, of an opinion of counsel confirming that the spin-off will not result in the recognition, for U.S. Federal income tax purposes, of gain or loss to Time Warner or its shareholders, except to the extent of cash received in lieu of fractional shares. Time Warner can waive receipt of the tax opinion as a condition to the spin-off. See “The Spin-Off—Material U.S. Federal Income Tax Consequences of the Spin-Off” beginning on page 33 of this Information Statement for more detail.

The opinion will be based on, among other things, certain assumptions and representations made by Time Warner and us, which if incorrect or inaccurate in any material respect would jeopardize the conclusions reached by counsel in its opinion. The opinion will not be binding on the Internal Revenue Service or the courts. Notwithstanding receipt by Time Warner of the opinion of counsel, the IRS could determine that the spin-off should be treated as a taxable transaction if it disagrees with the conclusions in the opinion.

If the IRS were to determine that the spin-off should be treated as a taxable transaction, then a U.S. holder receiving our shares in the spin-off will be treated as having received a distribution to the extent of the fair market value of the shares received on the distribution date. That distribution will be treated as taxable dividend income to the extent of such holder’s ratable share of the current and accumulated earnings and profits of Time Warner, if any. Any amount that exceeds such share of earnings and profits of Time Warner will be treated first as a tax-free return of capital to the extent of the U.S. holder’s adjusted tax basis in its shares of common stock of Time Warner (thus reducing such adjusted tax basis), with any remaining amounts being treated as capital gain. For a more detailed discussion, see “The Spin-Off—Material U.S. Federal Income Tax Consequences of the Spin-Off” beginning on page 33 of this Information Statement.

 

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We may be unable to achieve some or all of the benefits that we expect to achieve from our separation from Time Warner.

As an independent, publicly-traded company, we believe that our business will benefit from, among other things, allowing us to better focus our financial and operational resources on our specific business, allowing our management to design and implement corporate strategies and policies that are based primarily on the business characteristics and strategic decisions of our business, allowing us to more effectively respond to industry dynamics and allowing the creation of effective incentives for our management and employees that are more closely tied to our business performance. However, by separating from Time Warner, we may be more susceptible to market fluctuations and other adverse events than we would have been were we still a part of Time Warner. In addition, we may not be able to achieve some or all of the benefits that we expect to achieve as an independent company in the time we expect, if at all. For example, it is possible that investors and securities analysts will not place a greater value on our business as an independent company than on our business as a part of Time Warner.

We may be unable to make, on a timely or cost-effective basis, the changes necessary to operate as an independent company, and we may experience increased costs after the spin-off.

We have historically operated as part of Time Warner’s corporate organization, and Time Warner has assisted us by providing certain corporate functions. Following the spin-off, Time Warner will have no obligation to provide assistance to us other than the interim services to be provided as described in “Certain Relationships and Related Party Transactions—Agreements with Time Warner” beginning on page 150 of this Information Statement. Because our business has previously operated as part of the wider Time Warner organization, we cannot assure you that we will be able to successfully implement the changes necessary to operate independently or that we will not incur additional costs that could adversely affect our business.

Our historical financial information is not necessarily representative of the results we would have achieved as an independent, publicly-traded company and may not be a reliable indicator of our future results.

The historical financial information we have included in this Information Statement may not reflect what our results of operations, financial position and cash flows would have been had we been an independent, publicly-traded company during the periods presented, or what our results of operations, financial position and cash flows will be in the future when we are an independent company. This is primarily because:

 

   

we will enter into transactions with Time Warner that either have not existed historically or that are on different terms than the terms of arrangements or agreements that existed prior to the spin-off;

 

   

our historical financial information reflects allocations for certain services historically provided to us by Time Warner that may not reflect the costs we will incur for similar services in the future as an independent company; and

 

   

our historical financial information does not reflect changes that we expect to experience in the future as a result of our separation from Time Warner, including changes in the cost structure, personnel needs, financing and operations of our business.

Following the spin-off, we also will be responsible for the additional costs associated with being an independent, publicly-traded company, including costs related to corporate governance and public reporting. Therefore, our financial statements may not be indicative of our future performance as an independent company. For additional information about our past financial performance and the basis of presentation of our financial statements, see “Selected Historical Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and the notes thereto included elsewhere in this Information Statement.

 

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Certain of the contracts to be transferred or assigned to us contain provisions requiring the consent of a third party in connection with the transactions contemplated by the reorganization and distribution. If such consent is not given, we may not be entitled to the benefit of such contracts in the future.

Certain of the contracts to be transferred or assigned to us in connection with the reorganization contain provisions which require the consent of a third party to the reorganization, the distribution or both. If we are unable to obtain such consents on commercially reasonable and satisfactory terms, our ability to obtain the benefit of such contracts in the future may be impaired.

We may have been able to receive better terms from unaffiliated third parties than the terms we receive in our agreements with Time Warner.

The agreements related to our separation from Time Warner, including the Separation and Distribution Agreement, Transition Services Agreement, Second Tax Matters Agreement, Employee Matters Agreement, Intellectual Property Cross-License Agreement, IT Applications and Database Agreement, Master Services Agreement for ATDN and Hosting Services and any other agreements, will be negotiated in the context of our separation from Time Warner while we are still part of Time Warner. Accordingly, these agreements may not reflect terms that would have resulted from arm’s-length negotiations among unaffiliated third parties. The terms of the agreements being negotiated in the context of our separation are related to, among other things, allocations of assets, liabilities, rights, indemnifications and other obligations among Time Warner and us. We may have received better terms from third parties because third parties may have competed with each other to win our business. See “Certain Relationships and Related Party Transactions” beginning on page 150 of this Information Statement for more detail.

Risks Relating to our Common Stock and the Securities Market

There is no existing market for our common stock and we cannot be certain that an active trading market will develop or be sustained after the spin-off, and following the spin-off our stock price may fluctuate significantly.

There is currently no public market for our common stock. It is anticipated that before the distribution date for the spin-off, trading of shares of our common stock will begin on a “when-issued” basis and such trading will continue up to and including the distribution date. However, there can be no assurance that an active trading market for our common stock will develop as a result of the spin-off or be sustained in the future. The lack of an active market may make it more difficult for you to sell our shares and could lead to our share price being depressed or more volatile.

We cannot predict the prices at which our common stock may trade after the spin-off. The market price of our common stock may fluctuate widely, depending on many factors, some of which may be beyond our control, including:

 

   

our business profile and market capitalization may not fit the investment objectives of some Time Warner shareholders and, as a result, these Time Warner shareholders may sell our shares after the distribution;

 

   

actual or anticipated fluctuations in our operating results due to factors related to our business;

 

   

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;

 

   

the failure of securities analysts to cover our common stock after the spin-off;

 

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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. This has been particularly true in recent years for Internet services companies. These broad market fluctuations could adversely affect the trading price of our common stock.

Substantial sales of common stock may occur in connection with the spin-off, which could cause our stock price to decline.

The shares of our common stock that Time Warner distributes to its shareholders generally may be sold immediately in the public market. Although we have no actual knowledge of any plan or intention on the part of any significant shareholder to sell our common stock following the separation, it is possible that some Time Warner shareholders, possibly including some of our larger shareholders, will sell our common stock received in the distribution if, for reasons such as our business profile or market capitalization as an independent company, we do not fit their investment objectives. The sales of significant amounts of our common stock or the perception in the market that this will occur may result in the lowering of the market price of our common stock.

Your percentage ownership in AOL will be diluted in the future.

Your percentage ownership in AOL will be diluted in the future because of equity awards that have been granted to our Chairman and Chief Executive Officer that will be converted into AOL common stock-based equity awards, as well as any additional equity awards that are granted to our directors, officers and employees. We intend to establish equity incentive plans that will provide for the grant of common stock-based equity awards to our directors, officers and other employees. In addition, we may issue equity as all or part of the consideration paid for acquisitions and strategic investments we may make in the future.

Provisions in our amended and restated certificate of incorporation and by-laws and of Delaware law may prevent or delay an acquisition of our company, which could decrease the trading price of our common stock.

Our amended and restated certificate of incorporation and by-laws and Delaware law contain provisions that are intended to deter coercive takeover practices and inadequate takeover bids by making such practices or bids unacceptably expensive to the raider and to encourage prospective acquirors to negotiate with our board of directors rather than to attempt a hostile takeover.  These provisions include rules regarding how shareholders may present proposals or nominate directors for election at shareholder meetings and the right of our board to issue preferred stock without shareholder approval.

Delaware law also imposes some restrictions on mergers and other business combinations between any holder of 15% or more of our outstanding common stock and us.  For more information, see “Description of Our Capital Stock—Certain Provisions of Delaware Law, Our Amended and Restated Certificate of Incorporation and By-laws” beginning on page 160 of this Information Statement.

We believe these provisions protect our shareholders from coercive or otherwise unfair takeover tactics by requiring potential acquirors to negotiate with our board and by providing our board with more time to assess any acquisition proposal.  These provisions are not intended to make our company immune from takeovers. However, these provisions apply even if the offer may be considered beneficial by some shareholders and could delay or prevent an acquisition that our board determines is not in the best interests of our company and our shareholders.

 

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CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

This Information Statement contains certain “forward-looking statements” regarding business strategies, market potential, future financial performance and other matters. Words such as “anticipates,” “estimates,” “expects,” “projects,” “forecasts,” “intends,” “plans,” “believes” and words and terms of similar substance used in connection with any discussion of future operating or financial performance identify forward-looking statements. These forward-looking statements are based on management’s current expectations and beliefs about future events. As with any projection or forecast, they are inherently susceptible to uncertainty and changes in circumstances. Except for our ongoing obligations to disclose material information under the federal securities laws, neither we nor Time Warner are under any obligation to, and expressly disclaim any obligation to, update or alter any forward-looking statements whether as a result of such changes, new information, subsequent events or otherwise.

Various factors could adversely affect our operations, business or financial results in the future and cause our actual results to differ materially from those contained in the forward-looking statements, including those factors discussed in detail in “Risk Factors” beginning on page 15 of this Information Statement. In addition, we operate in a highly competitive, consumer and technology-driven and rapidly changing interactive services business. This business is affected by government regulation, economic, strategic, political and social conditions, consumer response to new and existing products and services, technological developments and, particularly in view of new technologies, the continued ability to protect intellectual property rights. Our actual results could differ materially from management’s expectations because of changes in such factors.

Further, lower than expected valuations associated with our cash flows and revenues may result in our inability to realize the value of recorded intangibles and goodwill. In addition, achieving our business and financial objectives, including growth in operations and maintenance of a strong balance sheet, could be adversely affected by the factors discussed or referenced under the section “Risk Factors” beginning on page 15 of this Information Statement as well as, among other things:

 

   

a longer than anticipated continuation of the current economic slowdown or further deterioration in the economy;

 

   

decreased liquidity in the capital markets, including any reduction in the ability to access the capital markets for debt securities or bank financings;

 

   

our borrowing capacity under the new revolving credit facility;

 

   

the impact of terrorist acts and hostilities;

 

   

changes in our plans, strategies and intentions;

 

   

the impact of significant acquisitions, dispositions and other similar transactions; and

 

   

the failure to meet earnings expectations.

 

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THE SPIN-OFF

Background

On May 28, 2009, Time Warner announced plans for the complete legal and structural separation of AOL from Time Warner. Prior to the spin-off, Time Warner will convert AOL Holdings LLC into a Delaware corporation to be named AOL Inc. Time Warner will then cause substantially all of the assets and liabilities of AOL LLC (other than AOL LLC’s guarantees of indebtedness of Time Warner and other non-AOL affiliates of Time Warner, certain leasehold interests and other assets and liabilities which are not material to the AOL business), our wholly-owned subsidiary that currently holds, directly or indirectly, all of the AOL business, to be transferred to and assumed by us. Following this transfer and assumption of AOL LLC’s assets and liabilities, ownership of AOL LLC will be transferred to, and retained by, Time Warner. We refer to these steps in this Information Statement as the reorganization. For more information, see the description of the Internal Transactions in “Certain Relationships and Related Party Transactions—Agreements with Time Warner” beginning on page 150 of this Information Statement.

The structure of the reorganization was determined by Time Warner in connection with the successful completion of a solicitation of consents, which we refer to as the Consent Solicitation, from the holders of certain outstanding public debt of Time Warner or its subsidiaries that is guaranteed by AOL LLC. The Consent Solicitation resulted in the adoption on April 16, 2009 of amendments to each indenture underlying such debt. As a result of the Consent Solicitation, certain covenant restrictions no longer apply to the conveyance or transfer by AOL LLC of its properties and assets substantially as an entirety (including the transfer to AOL contemplated by the reorganization), provided that Home Box Office, Inc. issues a guarantee of such debt, but AOL LLC was not released from its guarantee obligations as a result of the Consent Solicitation and will remain a guarantor following the spin-off. Accordingly, it is necessary for AOL LLC to remain a part of Time Warner following the distribution of substantially all of its assets and liabilities to AOL. Following the spin-off, AOL and its subsidiaries will not guarantee any debt issued by Time Warner or its subsidiaries. See Note 8 of the interim consolidated financial statements for more information regarding the Consent Solicitation.

As part of a broad strategic alliance with Google Inc., on April 13, 2006, Time Warner issued a 5% equity interest in us to Google for $1,000 million in cash. On July 8, 2009, Time Warner repurchased Google’s 5% interest in us. Following this purchase, we became a 100%-owned subsidiary of Time Warner. For a more detailed discussion of the strategic alliance, see Note 3 to the accompanying audited consolidated financial statements.

To accomplish the spin-off, Time Warner will, following the reorganization, distribute all of its equity interest in us, consisting of all of the outstanding shares of our common stock, to Time Warner shareholders on a pro rata basis. Following the spin-off, Time Warner will not own any equity interest in us, and we will operate independently from Time Warner. No vote of Time Warner’s shareholders is required or is being sought in connection with the spin-off, and Time Warner’s shareholders will not have any appraisal rights in connection with the spin-off.

The distribution of our common stock as described in this Information Statement is subject to the satisfaction or waiver of certain conditions. In addition, Time Warner has the right not to complete the spin-off if, at any time, the board of directors of Time Warner determines, in its sole discretion, that the spin-off is not in the best interests of Time Warner or its shareholders, or that market conditions are such that it is not advisable to separate AOL from Time Warner. For a more detailed description, see “—Conditions to the Spin-Off” on page 36 of this Information Statement.

Reasons for the Spin-Off

The Time Warner board of directors has regularly reviewed the businesses that comprise Time Warner to ensure that Time Warner’s resources are being put to use in a manner that is in the best interests of Time Warner and its shareholders. In reaching the decision to separate AOL and to pursue a spin-off of AOL, the Time Warner

 

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board considered a wide range of potential structural alternatives for AOL, such as retaining some or all of the AOL business as part of Time Warner, a sale or merger of some or all of the AOL business to or with third parties, and a variety of different approaches to separating some or all of the AOL business as a stand-alone entity or entities. Time Warner’s management retained Allen & Company LLC, BofA Merrill Lynch and Deutsche Bank Securities, Inc. to advise management and assist in the evaluation of a range of strategic alternatives with respect to Time Warner’s ownership of AOL. The board evaluated these alternatives with the goal of enhancing shareholder value with the input and advice of Time Warner and AOL management. As part of this evaluation, the board considered a number of factors, including the strategic focus and flexibility for Time Warner and AOL, the ability of Time Warner and AOL to compete and operate efficiently and effectively (including, but not limited to, AOL’s ability to retain and attract management talent), the financial profile of Time Warner and AOL, the potential reaction of investors and the probability of successful execution of the various structural alternatives and the risks associated with those alternatives.

As a result of this evaluation, the Time Warner board of directors determined that proceeding with a spin-off of AOL would be in the best interests of Time Warner and its shareholders. The board considered the following benefits of this approach:

 

   

Strategic Focus and Flexibility. Following the spin-off, Time Warner and AOL will each have more focused businesses and be better able to dedicate financial resources to pursue appropriate growth opportunities and execute strategic plans best suited to its respective business. The spin-off will also allow each of Time Warner and AOL to enhance its strategic flexibility to respond to industry dynamics.

 

   

Focused Management. The spin-off will allow management of each company to devote its time and attention to the development and implementation of corporate strategies and policies that are based primarily on the specific business characteristics of the respective companies.

 

   

Management Incentives. The spin-off will enable AOL to create incentives for its management and employees that are more closely tied to its business performance and shareholder expectations. AOL equity-based compensation arrangements will more closely align the interests of AOL’s management and employees with the interests of its shareholders and should increase AOL’s ability to attract and retain personnel.

 

   

Investor Choice. The spin-off will allow investors to make independent investment decisions with respect to Time Warner and AOL. Investment in one or the other company may appeal to investors with different goals, interests and concerns.

In determining whether to effect the spin-off, the board of directors of Time Warner also considered the costs and risks associated with the transaction, including those associated with preparing AOL to become an independent, publicly-traded company, the risk of volatility in our stock price that may occur immediately following the spin-off due to sales by Time Warner’s shareholders whose investment objectives may not be met by our common stock and the time that it may take for our Company to attract its optimal shareholder base. Notwithstanding these costs and risks, however, the board of directors of Time Warner determined that a spin-off was the best alternative to enhance shareholder value taking into account the factors discussed above.

Manner of Effecting the Spin-Off

Time Warner will effect the spin-off by distributing to its shareholders, as a pro rata dividend,                      shares of our common stock for every                      shares of Time Warner common stock outstanding as of                    , 2009, the record date of the distribution.

Prior to the spin-off, Time Warner will deliver all of the issued and outstanding shares of our common stock to the distribution agent. Following the distribution date, which is                     , 2009, the distribution agent will electronically deliver the shares of our common stock issuable in the spin-off to you or your bank or brokerage firm on your behalf by way of direct registration in book-entry form. Registration in book-entry form refers to a method of recording share ownership where no physical share certificates are issued to shareholders, as is the case in this distribution.

 

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Commencing on or shortly after the distribution date, if you are a registered holder of Time Warner shares entitled to shares of our common stock, the distribution agent will mail to you an account statement that indicates the number of shares of our common stock that have been registered in book-entry form in your name. We expect it will take the distribution agent up to two weeks after the distribution date to complete the distribution of the shares of our common stock and mail statements of holding to all Time Warner shareholders.

Please note that if you sell any of your shares of Time Warner common stock on or before the distribution date, the buyer of those shares, and not you, may in certain circumstances be entitled to receive the shares of our common stock issuable in respect of the shares sold. See “—Trading Prior to the Distribution Date” on page 36 of this Information Statement for more information.

A number of Time Warner shareholders hold their Time Warner common stock through a bank or brokerage firm. In such cases, the bank or brokerage firm would be said to hold the shares in “street name” and ownership would be recorded on the bank or brokerage firm’s books. If you hold your Time Warner common stock through a bank or brokerage firm, your bank or brokerage firm will credit your account for the common stock of our company that you are entitled to receive in the spin-off. If you have any questions concerning the mechanics of having shares held in street name, we encourage you to contact your bank or brokerage firm.

Shareholders of Time Warner are not being asked to take any action in connection with the spin-off. No shareholder approval of the spin-off is required or is being sought. We are not asking you for a proxy, and request that you not send us a proxy. You are also not being asked to surrender any of your shares of Time Warner common stock for shares of our common stock. The number of outstanding shares of Time Warner common stock will not change as a result of the spin-off.

We expect to incur approximately $13.0 million of costs associated with the separation, primarily related to consulting and audit fees, board search and recruiting costs and legal expenses. We expect to fund these costs through our cash flows from operations.

Treatment of Fractional Shares

The distribution agent will not distribute any fractional shares in connection with the spin-off. Instead, the distribution agent will aggregate all fractional shares into whole shares and sell the whole shares in the open market at prevailing market prices. The distribution agent will then distribute the aggregate cash proceeds of the sales, net of brokerage fees and other costs, pro rata to each Time Warner shareholder who would otherwise have been entitled to receive a fractional share in the distribution. The distribution agent will, in its sole discretion, without any influence by Time Warner or us, determine when, how, through which broker-dealer and at what price to sell the whole shares. The distribution agent and any broker-dealer used by the distribution agent will not be an affiliate of either Time Warner or us.

The distribution agent will send a check to each registered holder of Time Warner common stock who is entitled to a fractional share representing the cash amount deliverable in lieu of the shareholder’s fractional share interest as soon as practicable following the distribution date. If you hold your shares through a bank or brokerage firm, your bank or brokerage firm will receive, on your behalf, your pro rata share of the aggregate net cash proceeds from the sales. No interest will be paid on any cash distributed in lieu of fractional shares. The receipt of cash in lieu of fractional shares will generally be taxable to the recipient shareholders.
See “—Material U.S. Federal Income Tax Consequences of the Spin-Off” below for more information.

 

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Material U.S. Federal Income Tax Consequences of the Spin-Off

The following is a summary of the material U.S. Federal income tax consequences to the holders of Time Warner common stock in connection with the spin-off. This summary is based on the Internal Revenue Code, the Treasury Regulations promulgated thereunder and judicial and administrative interpretations thereof, in each case as in effect and available as of the date of this Information Statement and all of which are subject to change at any time, possibly with retroactive effect. Any such change could affect the tax consequences described below.

This summary is limited to holders of Time Warner common stock that are U.S. Holders, as defined immediately below. A U.S. Holder is a beneficial owner of Time Warner common stock that is, for U.S. Federal income tax purposes:

 

   

an individual who is a citizen or a resident of the United States;

 

   

a corporation, or other entity taxable as a corporation for U.S. Federal income tax purposes, created or organized under the laws of the United States or any state thereof or the District of Columbia;

 

   

an estate, the income of which is subject to U.S. Federal income taxation regardless of its source; or

 

   

a trust, if (i) a court within the United States is able to exercise primary jurisdiction over its administration and one or more United States persons have the authority to control all of its substantial decisions or (ii) in the case of a trust that was treated as a domestic trust under the law in effect before 1997, a valid election is in place under applicable Treasury Regulations.

This summary also does not discuss all tax considerations that may be relevant to shareholders in light of their particular circumstances, nor does it address the consequences to shareholders subject to special treatment under the U.S. Federal income tax laws, such as:

 

   

dealers or traders in securities or currencies;

 

   

tax-exempt entities;

 

   

banks, financial institutions or insurance companies;

 

   

real estate investment trusts, regulated investment companies or grantor trusts;

 

   

persons who acquired Time Warner common stock pursuant to the exercise of employee stock options or otherwise as compensation;

 

   

shareholders who own, or are deemed to own, at least 10% or more, by voting power or value, of Time Warner equity;

 

   

holders owning Time Warner common stock as part of a position in a straddle or as part of a hedging, conversion or other risk reduction transaction for U.S. Federal income tax purposes;

 

   

certain former citizens or long-term residents of the United States;

 

   

holders who are subject to the alternative minimum tax; or

 

   

persons that own Time Warner common stock through partnerships or other pass-through entities.

This summary does not address the U.S. Federal income tax consequences to Time Warner shareholders who do not hold Time Warner common stock as a capital asset. Moreover, this summary does not address any state, local or foreign tax consequences or any estate, gift or other non-income tax consequences.

If a partnership (or any other entity treated as a partnership for U.S. Federal income tax purposes) holds Time Warner common stock, the tax treatment of a partner in that partnership will generally depend on the status of the partner and the activities of the partnership. Such a partner or partnership should consult its own tax advisor as to its tax consequences.

 

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YOU SHOULD CONSULT YOUR OWN TAX ADVISOR WITH RESPECT TO THE U.S. FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES OF THE DISTRIBUTION.

The spin-off is conditioned on Time Warner’s receipt of a favorable opinion of Cravath, Swaine & Moore LLP confirming that the spin-off will not result in the recognition, for U.S. Federal income tax purposes, of gain or loss to Time Warner or its shareholders, except to the extent of cash received in lieu of fractional shares. The opinion will be based on the assumption that, among other things, the representations made, and information submitted, in connection with it are accurate. Assuming the spin-off qualifies as tax-free:

 

   

the spin-off will not result in any taxable income, gain or loss to Time Warner;

 

   

no gain or loss will be recognized by, or be includible in the income of, a shareholder of Time Warner common stock, except with respect to any cash received in lieu of fractional shares;

 

   

the aggregate tax basis of the Time Warner common stock and our common stock in the hands of Time Warner’s shareholders immediately after the spin-off will be the same as the aggregate tax basis of the Time Warner common stock held by the holder immediately before the spin-off, allocated between the common stock of Time Warner and us in proportion to their relative fair market values on the date of the spin-off; and

 

   

the holding period of our common stock received by Time Warner’s shareholders will include the holding period of their Time Warner common stock, provided that such Time Warner common stock is held as a capital asset on the date of the spin-off.

Time Warner’s shareholders that have acquired different blocks of Time Warner common stock at different times or at different prices should consult their tax advisors regarding the allocation of their aggregate adjusted basis among, and their holding period of, shares of our common stock distributed with respect to such blocks of Time Warner common stock.

The Spin-Off and Tax-Free Transaction Status

Time Warner has not requested, and does not intend to request, a private letter ruling from the IRS confirming that the spin-off will be tax-free to shareholders of Time Warner for U.S. Federal income tax purposes. Time Warner has made it a condition to the spin-off that Time Warner obtain an opinion of Cravath, Swaine & Moore LLP confirming that the spin-off will not result in the recognition, for U.S. Federal income tax purposes, of gain or loss to Time Warner or its shareholders, except to the extent of cash received in lieu of fractional shares. The opinion will be based on various factual representations and assumptions, as well as certain undertakings made by Time Warner and us. If any of those factual representations or assumptions were untrue or incomplete in any material respect, any undertaking was not complied with, or the facts upon which the opinion is based were materially different from the facts at the time of the spin-off, the spin-off may not qualify for tax-free treatment. Opinions of counsel are not binding on the IRS. As a result, the conclusions expressed in the opinion of counsel could be challenged by the IRS, and if the IRS prevails in such challenge, the tax consequences to you could be materially less favorable.

If the spin-off were not to qualify as a tax-free transaction, each shareholder who receives our common stock in the spin-off would generally be treated as receiving a distribution in an amount equal to the fair market value of our common stock received, which would generally result in:

 

   

a taxable dividend to the extent of the shareholder’s pro rata share of Time Warner’s current and accumulated earnings and profits;

 

   

a reduction in the shareholder’s basis (but not below zero) in Time Warner common stock to the extent the amount received exceeds the shareholder’s share of Time Warner’s earnings and profits; and

 

   

a taxable gain from the exchange of Time Warner common stock to the extent the amount received exceeds both the shareholder’s share of Time Warner’s earnings and profits and the basis in the shareholder’s Time Warner common stock.

 

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Information Statement

U.S. Treasury Regulations require each Time Warner shareholder that immediately before the spin-off owned 5% or more (by vote or value) of the total outstanding stock of Time Warner to attach to such shareholder’s U.S. Federal income tax return for the year in which such stock is received a statement setting forth certain information related to the spin-off.

Results of the Spin-Off

After the spin-off, we will be an independent, publicly-traded company. Immediately following the spin-off, we estimate we will have approximately                      million shares of our common stock issued and outstanding (based on the number of shares of Time Warner common stock outstanding as of                     , 2009). The actual number of shares of our common stock to be distributed in the spin-off will depend on the actual number of shares of Time Warner common stock outstanding on the record date, and will reflect any issuance of new shares pursuant to Time Warner’s equity plans, including from exercises of stock options and vestings of restricted stock units or performance stock units, and any shares repurchased by Time Warner under its common stock repurchase program, in each case on or prior to the record date. The spin-off will not affect the number of outstanding shares of Time Warner common stock or any rights of Time Warner shareholders, although we expect the trading price of shares of Time Warner common stock immediately following the distribution to be lower than immediately prior to the distribution because its trading price will no longer reflect the value of the AOL business. Furthermore, until the market has fully analyzed the value of Time Warner without the AOL business, the price of shares of Time Warner common stock may fluctuate.

Immediately following the spin-off, we expect to have approximately                      holders of record of shares of our common stock (based on the number of holders of record of Time Warner common stock on                     , 2009).

Before our separation from Time Warner, we will enter into a Separation and Distribution Agreement and several other agreements with Time Warner related to the spin-off. These agreements will govern the relationship between AOL and Time Warner up to and subsequent to the completion of the separation and provide for the allocation between AOL and Time Warner of various assets, liabilities and obligations (including employee benefits, intellectual property, information technology and tax-related assets and liabilities). We describe these arrangements in greater detail under “Certain Relationships and Related Party Transactions—Agreements with Time Warner” beginning on page 150 of this Information Statement.

Listing and Trading of our Common Stock

As of the date of this Information Statement, we are a wholly-owned subsidiary of Time Warner. Accordingly, there is currently no public market for our common stock, although a “when-issued” market in our common stock may develop prior to the distribution. See “—Trading Prior to the Distribution Date” below for an explanation of a “when-issued” market. We intend to list our shares of common stock on the New York Stock Exchange under the symbol “AOL.”   Following the spin-off, Time Warner common stock will continue to trade on the New York Stock Exchange under the symbol “TWX.”

Neither we nor Time Warner can assure you as to the trading price of Time Warner common stock or our common stock after the spin-off, or as to whether the combined trading prices of our common stock and the Time Warner common stock after the spin-off will be less than, equal to or greater than the trading prices of Time Warner common stock prior to the spin-off. The trading price of our common stock may fluctuate significantly following the spin-off. See “Risk Factors—Risks Relating to our Common Stock and the Securities Market” beginning on page 27 of this Information Statement for more detail.

The shares of our common stock distributed to Time Warner shareholders will be freely transferable, except for shares received by individuals who are our affiliates. Individuals who may be considered our affiliates after

 

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the spin-off include individuals who control, are controlled by or are under common control with us, as those terms generally are interpreted for federal securities law purposes. These individuals may include some or all of our directors and executive officers. Individuals who are our affiliates will be permitted to sell their shares of our common stock only pursuant to an effective registration statement under the Securities Act of 1933, as amended (which we refer to in this Information Statement as the Securities Act), or an exemption from the registration requirements of the Securities Act, such as the exemptions afforded by Section 4(1) of the Securities Act or Rule 144 thereunder.

Trading Prior to the Distribution Date

It is anticipated that, as early as two trading days prior to the record date and continuing up to and including the distribution date, there will be a “when-issued” market in our common stock. When-issued trading refers to a sale or purchase made conditionally because the security has been authorized but not yet issued. The when-issued trading market will be a market for shares of our common stock that will be distributed to Time Warner shareholders on the distribution date. If you own shares of Time Warner common stock at the close of business on the record date, you will be entitled to shares of our common stock distributed pursuant to the spin-off. You may trade this entitlement to shares of our common stock, without the shares of Time Warner common stock you own, on the when-issued market. On the first trading day following the distribution date, we expect when-issued trading with respect to our common stock will end and regular-way trading will begin.

Following the distribution date, we expect shares of our common stock to be listed on the New York Stock Exchange under the trading symbol “AOL.” We will announce our when-issued trading symbol when and if it becomes available.

It is also anticipated that, as early as two trading days prior to the record date and continuing up to and including the distribution date, there will be two markets in Time Warner common stock: a “regular-way” market and an “ex-distribution” market. Shares of Time Warner common stock that trade on the regular way market will trade with an entitlement to shares of our common stock distributed pursuant to the distribution. Shares that trade on the ex-distribution market will trade without an entitlement to shares of our common stock distributed pursuant to the distribution. Therefore, if you sell shares of Time Warner common stock in the regular-way market up to and including the distribution date, you will be selling your right to receive shares of our common stock in the distribution. However, if you own shares of Time Warner common stock at the close of business on the record date and sell those shares on the ex-distribution market up to and including the distribution date, you will still receive the shares of our common stock that you would otherwise be entitled to receive pursuant to the distribution.

Conditions to the Spin-Off

We expect that the separation will be effective on the distribution date, provided that the following conditions shall have been satisfied or waived by Time Warner:

 

   

the board of directors of Time Warner shall have authorized and approved the separation and distribution and not withdrawn such authorization and approval, and shall have declared the dividend of AOL common stock to Time Warner shareholders;

 

   

each ancillary agreement contemplated by the Separation and Distribution Agreement shall have been executed by each party thereto;

 

   

the SEC shall have declared effective our Registration Statement on Form 10, of which this Information Statement is a part, under the Exchange Act, and no stop order suspending the effectiveness of the Registration Statement shall be in effect, and no proceedings for such purpose shall be pending before or threatened by the SEC;

 

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our common stock shall have been accepted for listing on the New York Stock Exchange or another national securities exchange approved by Time Warner, subject to official notice of issuance;

 

   

the Internal Transactions (as described in “Certain Relationships and Related Party Transactions—Agreements with Time Warner—Separation and Distribution Agreement” beginning on page 150 of this Information Statement) shall have been completed;

 

   

Time Warner shall have received the written opinion of Cravath, Swaine & Moore LLP, which shall remain in full force and effect, that the spin-off will not result in the recognition, for U.S. Federal income tax purposes, of gain or loss to Time Warner or its shareholders, except to the extent of cash received in lieu of fractional shares;

 

   

Time Warner shall have received a certificate signed by our Chief Financial Officer, dated as of the distribution date, certifying that prior to the distribution we have made capital and other expenditures, and have operated our cash management, accounts payable and receivables collections systems, in the ordinary course consistent with prior practice, subject to an exception which permits us to cause any excess cash held by our foreign subsidiaries to be transferred to us or any of our other subsidiaries;

 

   

no order, injunction or decree issued by any governmental authority of competent jurisdiction or other legal restraint or prohibition preventing consummation of the distribution shall be in effect, and no other event outside the control of Time Warner shall have occurred or failed to occur that prevents the consummation of the distribution;

 

   

no other events or developments shall have occurred prior to the distribution date that, in the judgment of the board of directors of Time Warner, would result in the spin-off having a material adverse effect on Time Warner or its shareholders;

 

   

prior to the distribution date, this Information Statement shall have been mailed to the holders of Time Warner common stock as of the record date;

 

   

our current directors shall have duly elected the individuals listed as members of our post-distribution board of directors in this Information Statement, and such individuals shall be the members of our board of directors immediately after the distribution; provided, however, that our current directors shall appoint one independent director prior to the date on which when-issued trading of our common stock commences on the New York Stock Exchange and such director shall serve on our audit committee; and

 

   

immediately prior to the distribution date, our amended and restated certificate of incorporation and by-laws, each in substantially the form filed as an exhibit to the Registration Statement on Form 10 of which this Information Statement is a part, shall be in effect.

The fulfillment of the foregoing conditions will not create any obligation on the part of Time Warner to effect the spin-off. We are not aware of any material federal or state regulatory requirements that must be complied with or any material approvals that must be obtained, other than compliance with SEC rules and regulations and the declaration of effectiveness of the Registration Statement by the SEC, in connection with the distribution. Time Warner has the right not to complete the spin-off if, at any time, the board of directors of Time Warner determines, in its sole discretion, that the spin-off is not in the best interests of Time Warner or its shareholders, or that market conditions are such that it is not advisable to separate AOL from Time Warner.

Reasons for Furnishing this Information Statement

This Information Statement is being furnished solely to provide information to Time Warner shareholders who will receive shares of our common stock in the distribution. It is not to be construed as an inducement or encouragement to buy or sell any of our securities or any securities of Time Warner. We believe that the information contained in this Information Statement is accurate as of the date set forth on the cover. Changes to the information contained in this Information Statement may occur after that date, and neither we nor Time Warner undertakes any obligation to update the information except in the normal course of our respective public disclosure obligations and practices.

 

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DIVIDEND POLICY

We intend to retain future earnings for use in the operation of our business and to fund future growth. We do not anticipate paying any dividends for the foreseeable future. The decision whether to pay future dividends will be at the discretion of our board of directors and will depend on many factors, including our financial condition, earnings, capital requirements of our business, covenants associated with debt obligations, legal requirements, regulatory constraints, industry practice and other factors that our board of directors deems relevant. There can be no assurance that we will pay a dividend in the future or continue to pay any dividend if we do commence the payment of dividends.

 

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CAPITALIZATION

The following table sets forth the unaudited cash and capitalization of AOL as of June 30, 2009, on an historical basis and as adjusted for the spin-off. You should review the following table in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and accompanying notes included elsewhere in this Information Statement.

 

     June 30, 2009  
     Historical     As adjusted  
($ in millions)    (unaudited)     (unaudited)  

Cash(1)

   $ 74.7      $ 100.0   

Capitalization:

    

Indebtedness:

    

Senior secured revolving credit facility

   $ —        $ —     

Current portion of obligations under capital lease

     27.5        27.5   

Long-term obligations under capital lease

     40.8        40.8   

Equity:

    

Common stock, $.01 par value(2)

     —          1.0   

Additional paid-in capital(2)

     —          3,518.5   

Divisional equity(2)

     3,566.2        —     

Accumulated other comprehensive loss, net

     (282.6     (282.6

Noncontrolling interest

     1.3        1.3   
                

Total capitalization

   $ 3,353.2      $ 3,306.5   
                

 

(1) The “As adjusted” cash reflects a cash contribution to us from Time Warner in connection with the spin-off such that our total cash balance as of the effective date of the spin-off will be $100.0 million.

 

(2) Upon the effective date of the spin-off, our divisional equity will be reclassified and allocated between common stock and additional paid-in capital based on the number of shares of AOL common stock issued and outstanding. The “As adjusted” capitalization reflects an estimate of 100 million shares of our common stock assumed to be issued and outstanding upon the spin-off. In addition, the “As adjusted” capitalization reflects the effects of certain transactions between us and Time Warner which will be recorded as adjustments to equity prior to the spin-off. These adjustments primarily consist of the reversal of our liability to Time Warner for certain tax positions (an estimated increase to additional paid-in capital of $359.8 million based on the outstanding liability at June 30, 2009, which includes the related accrual for interest and penalties), and the reversal of certain equity-based compensation deferred tax assets (an estimated decrease to additional paid-in capital of $438.9 million, based on the deferred tax asset balance at June 30, 2009) which will be retained by Time Warner following the spin-off.

 

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SELECTED HISTORICAL FINANCIAL DATA

The following tables present certain selected historical financial information as of and for each of the years in the five-year period ended December 31, 2008, and as of June 30, 2009 and for the six months ended June 30, 2009 and 2008. The selected historical consolidated financial data as of December 31, 2008 and 2007 and for each of the fiscal years in the three-year period ended December 31, 2008, and as of June 30, 2009 and for the six months ended June 30, 2009 and 2008, are derived from our historical consolidated financial statements included elsewhere in this Information Statement. The selected historical consolidated financial data as of December 31, 2006 and as of and for the years ended December 31, 2005 and 2004 are derived from our unaudited consolidated financial statements that are not included in this Information Statement. The unaudited financial statements have been prepared on the same basis as the audited financial statements, and in the opinion of our management include all adjustments, consisting of only ordinary recurring adjustments, necessary for a fair presentation of the information set forth in this Information Statement.

The selected historical financial data presented below should be read in conjunction with our consolidated financial statements and the accompanying notes thereto, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included elsewhere in this Information Statement.  For each of the periods presented, we were a subsidiary of Time Warner. The financial information included herein may not necessarily reflect our financial position, results of operations and cash flows in the future or what our financial position, results of operations and cash flows would have been had we been an independent, publicly-traded company during the periods presented. In addition, our historical financial information does not reflect changes that we expect to experience in the future as a result of our separation from Time Warner, including changes in the financing, operations, cost structure and personnel needs of our business. Further, the historical financial information includes allocations of certain Time Warner corporate expenses. We believe the assumptions and methodologies underlying the allocation of general corporate expenses are reasonable. However, such expenses may not be indicative of the actual level of expense that would have been incurred by us if we had operated as an independent, publicly-traded company or of the costs to be incurred in the future.

 

     Years Ended December 31,    Six Months Ended
June 30,
     2008     2007    2006    2005     2004    2009    2008
($ in millions)                    (unaudited)     (unaudited)    (unaudited)

Statement of Operations Data:

                  

Revenues:

                  

Advertising

   $ 2,096.4      $ 2,230.6    $ 1,886.1    $ 1,337.8      $ 1,005.0    $ 862.2    $ 1,082.2

Subscription

     1,929.3        2,787.9      5,783.6      6,754.9        7,476.9      749.2      1,029.8

Other

     140.1        162.2      117.0      109.4        139.7      59.6      73.0
                                                  

Total revenues

   $ 4,165.8      $ 5,180.7    $ 7,786.7    $ 8,202.1      $ 8,621.6    $ 1,671.0    $ 2,185.0

Operating income (loss)(a)

   $ (1,167.7   $ 1,853.8    $ 1,167.8    $ (1,817.8   $ 230.5    $ 300.3    $ 505.1

Income (loss) from continuing operations(b)

   $ (1,526.6   $ 1,213.3    $ 716.5    $ (363.6   $ 477.0    $ 173.2    $ 286.2
                                                  

Net income (loss) attributable to AOL Inc.(c)

   $ (1,525.8   $ 1,396.1    $ 749.7    $ (334.1   $ 564.4    $ 173.4    $ 286.6
                                                  

 

(a)

2008 includes a $2,207.0 million non-cash impairment to reduce the carrying value of goodwill and $20.8 million in amounts incurred related to securities litigation and government investigations. 2007 includes a net pre-tax gain of $668.2 million on the sale of the German access service business and $171.4 million in amounts incurred related to securities litigation and government investigations. 2006 includes a $767.4 million gain on the sales of the French and United Kingdom access service businesses and $705.2 million in amounts incurred related to securities litigation and government investigations. 2005 includes $2,864.8 million in amounts incurred related to securities litigation and government investigations. 2004 includes

 

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$536.0 million in amounts incurred related to securities litigation and government investigations. The six months ended June 30, 2009 include $14.2 million in amounts incurred related to securities litigation and government investigations. The six months ended June 30, 2008 include $8.0 million in amounts incurred related to securities litigation and government investigations.

 

(b) Includes net gains of $944.4 million in 2005 and $293.6 million in 2004 related to the sale of primarily available-for-sale equity securities.

 

(c) Includes net income of $182.1 million in 2007, $18.9 million in 2006, $29.5 million in 2005 and $31.4 million in 2004 related to discontinued operations. 2006 also includes a non-cash benefit of $14.3 million as the cumulative effect of an accounting change upon the adoption of FAS 123R to recognize the effect of estimating the number of equity awards granted prior to January 1, 2006 that are ultimately not expected to vest. 2004 also includes a non-cash benefit of $34.0 million related to the cumulative effect of an accounting change in connection with the consolidation of America Online Latin America, Inc. in accordance with FIN 46R.

 

     As of December 31,    As of June 30,
2009
     2008    2007    2006    2005    2004   
($ in millions)              (unaudited)    (unaudited)    (unaudited)    (unaudited)

Balance Sheet Data:

                 

Cash

   $ 134.7    $ 151.9    $ 401.5    $ 119.9    $ 256.9    $ 74.7

Total assets

   $ 4,861.3    $ 6,863.1    $ 6,786.4    $ 6,064.6    $ 7,803.0    $ 4,502.1
                                         

Long-term notes payable and obligations under capital leases

   $ 33.7    $ 24.7    $ 105.1    $ 110.4    $ 153.7    $ 40.8
                                         

Total equity

   $ 3,737.7    $ 5,269.5    $ 4,505.8    $ 3,530.8    $ 4,346.0    $ 3,284.9
                                         

 

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BUSINESS

Introduction

We are a leading global web services company with an extensive suite of brands and offerings and a substantial worldwide audience. Our business spans online content, products and services that we offer to consumers, publishers and advertisers. We are focused on attracting and engaging consumers and providing valuable online advertising services on both our owned and operated properties and third-party websites. We have the largest advertising network in terms of online consumer reach in the United States as of September 2009. Our ability to broadly reach diverse demographic and geographic audiences is attractive to brand advertisers seeking to promote their brands to a variety of consumers without having to partner with multiple content providers.

Historically, our primary strategic focus was our dial-up Internet access services business which operated one of the largest Internet subscription access services in the United States. As broadband penetration in the United States increased, we experienced a decline, which we continue to experience, in subscribers to our access service. At the same time, online advertising experienced significant growth. In August 2006, we fundamentally shifted the primary strategic focus of our business from generating subscription revenues to attracting and engaging Internet consumers and generating advertising revenues. In connection with this shift, we began offering the vast majority of our content, products and services to consumers for free in an effort to attract and engage a broader group of consumers. While this strategic shift was announced in 2006, we are still in the process of completing this transition. Consequently, our subscription access service remains an important source of our total revenues and cash flows.

Time Warner has been evaluating potential transactions involving, and structural alternatives for, AOL for some time, including the possibility of separating the global web services and subscription access services businesses, which share infrastructure such as data centers and network operations centers. Historically, the global web services business had three units: the first focused on content published on a variety of websites with related applications and services; the second focused on social networking, community and instant communications products and services; and the third focused on providing advertising services on both our owned and operated properties and third-party websites. The subscription access services business included the AOL-branded Internet access service as well as CompuServe and Netscape Internet access services.

In April 2009, Tim Armstrong was appointed our Chairman and Chief Executive Officer, and he commenced a review of AOL’s strategy and operations while Time Warner continued its evaluation of structural alternatives. Time Warner’s evaluation resulted in the announcement on May 28, 2009 that it would move forward with plans for the complete legal and structural separation of AOL from Time Warner.

In connection with the strategic review conducted by Mr. Armstrong, which factored in Time Warner’s decision to spin off AOL, we have updated our organizational structure and developed the next phase in the strategic shift begun in 2006. Our strategy remains focused primarily on attracting and engaging Internet consumers and generating advertising revenues, with our subscription access service managed as a valuable distribution channel for our content, product and service offerings. As a result, we intend to continue to operate as a single integrated business rather than as two separate businesses.

Our Strategic Initiatives

Consistent with our strategic shift to a business focused primarily on generating advertising revenues, we have begun executing a multi-year strategic plan to reinvigorate growth in our revenues and profits by taking advantage of the migration of commerce, information and advertising to the Internet. Our strategy is to focus our resources on AOL’s core competitive strengths in web content production, local and mapping, communications and advertising networks while expanding the presence of our content, product and service offerings on multiple

 

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platforms and digital devices. We also aim to reorient AOL’s culture and reinvigorate the AOL brand by prioritizing the consumer experience, making greater use of data-driven insights and encouraging innovation. Particular areas of strategic emphasis include:

 

   

Expanding Our Owned Content Offerings. We will expand our offerings of relevant and engaging online consumer content by focusing on the creation and publication of our own original content. In addition, we will seek to provide premium global advertisers with effective and efficient means of reaching our consumers.

 

   

Pursuing Local and Mapping Opportunities. We believe that there are significant opportunities for growth in the area of local content, platforms and services, by providing comprehensive content covering all geographic areas from local neighborhoods to major metropolitan areas. By enhancing these local offerings, including through our flagship MapQuest brand, we seek to provide consumers with a comprehensive local experience.

 

   

Enhancing Our Established Communications Offerings. Our goal is to increase the reach of and engagement on our established communications offerings (including our email products and instant messaging applications) on multiple platforms and digital devices.

 

   

Growing the Third Party Network. We seek to significantly increase the number of publishers and advertisers utilizing our third-party advertising network by providing an open, transparent and easy-to-use advertising system that offers unique and valuable insights to our publishers and advertisers.

 

   

Encouraging Innovation through AOL Ventures. We believe that we can attract and develop innovative initiatives through AOL Ventures by creating an environment that encourages entrepreneurialism. We currently expect to invest significantly less capital in AOL Ventures than in our other strategic initiatives and we may seek outside capital where appropriate.

Business Overview

Our business operations are focused on the following:

 

   

AOL Media. We seek to be a global publisher of relevant and engaging online content by utilizing open and highly scalable publishing platforms and content management systems, as well as a leading online provider of consumer products and services. AOL Media includes our owned and operated content, products and services in the Content, Local and Mapping, Communications and AOL Ventures strategy areas.

We generate advertising revenues from our owned and operated content, products and services through the sale of display and search advertising. We seek to provide effective and efficient advertising solutions utilizing data-driven insights that help advertisers decide how best to engage consumers.

We also generate revenues through our subscription access service. We view our subscription access service as a valuable distribution channel for AOL Media. Our access service subscribers are important users of AOL Media and engaging both present and former access service subscribers is an important component of our strategy. In addition, our subscription access service will remain an important source of revenue and cash flow for us in the near term.

Global consumers are increasingly accessing and using the Internet through devices other than personal computers, such as digital devices (e.g., smartphones). As a result, we seek to ensure that our content, products and services are compatible with such devices so that our consumers are able to access and use our content, products and services via these devices.

 

   

Third Party Network. We also generate advertising revenues through the sale of advertising on third-party websites and on digital devices, which we refer to as the “Third Party Network.” Our mission is to provide an open and transparent advertising system that is easy-to-use and offers our publishers and advertisers unique and valuable insights. We seek to significantly increase the number of publishers and advertisers utilizing the network.

 

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We market our offerings to advertisers on both AOL Media and the Third Party Network under the brand “AOL Advertising.” We market our offerings to publishers on the Third Party Network under the brand “Advertising.com.”

AOL Media

Content Offerings

AOL Media content offerings include content we license from third parties, original content produced through our large network of content creators, which includes established journalists and other freelance writers, and aggregations of user-generated content. Our content offerings are made available to broad audiences through sites such as the AOL.com homepage, as well as to niche audiences on highly-targeted, branded properties, such as Asylum, Engadget and WalletPop. Over time, to increase the flexibility and revenue generation potential of our content, we intend to create more of our own original content and rely less on licensed third-party content. To facilitate the intake, management and publication of original content, we are moving toward utilizing 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.

AOL Media content offerings include the following:

 

   

News & Information (including Engadget, DailyFinance, WalletPop, AOL Autos, FanHouse and PoliticsDaily);

 

   

Women & Lifestyle (including StyleList, Lemondrop and ParentDish);

 

   

Entertainment (including Moviefone, AOL Music, AOL TV, PopEater and Games.com); and

 

   

Targeted Audiences (including Black Voices and AOL Latino).

Local and Mapping

We seek to be a leading provider of local content, platforms and services covering geographic levels ranging from neighborhoods to major metropolitan areas. We have developed and acquired a number of platforms that are designed to facilitate the aggregation, distribution and consumption of local content. This local content includes professional editorial content, user-generated content and business listings. Through our flagship MapQuest brand, we provide trusted maps and directions directly to consumers as well as through business-to-business licensing. By linking our local and mapping platforms, we anticipate providing one of the most compelling, accessible and comprehensive local experiences on the Internet.

Historically, local “city guide” and “directory-style” sites have focused on providing information and services to larger-scale metropolitan areas, while smaller communities and towns have been largely ignored. We believe that these smaller communities represent a significant opportunity. For small communities, local newspapers associated with nearby metropolitan regions have been a central resource for news and events. We believe these local print publications are currently facing significant economic challenges. In order to take advantage of these dynamics we intend to significantly invest in this area and establish online destinations that provide comprehensive news, events and directories at the community level.

Our local and mapping offerings include the following:

 

   

MapQuest, which is a leading online mapping and directions service;

 

   

Local Entertainment Guides (including AOL City Guide, City’s Best and Digital City);

 

   

Local Directories (including AOL Yellow Pages, AOL White Pages and AOL Classifieds);

 

   

Local Events (including Going.com and When.com); and

 

   

Local Sites (including Patch), which aggregate news, events and directories for small communities and towns.

 

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Communications

We offer a powerful global suite of communications products and services. Our email and instant messaging products and services provide us with the ability to reach millions of consumers and we seek to continue to develop and enhance the functionality of these communications offerings. Our goal is to increase the reach and engagement of our communications offerings on multiple platforms and digital devices.

Our communications offerings include the following:

 

   

AOL Mail, which is one of the most popular e-mail services in the United States;

 

   

AIM, which is a leading instant messaging service in the United States;

 

   

ICQ, which is an instant messaging service that has a strong international presence; and

 

   

Communications solutions for third parties (including co-branded, white-labeled and AOL-branded solutions).

We believe there are long-term opportunities to distribute content, products and advertising through our communications offerings, enabling us to generate increased advertising revenue.

Search

We offer AOL Search on AOL Media. We provide our consumers with a general, Internet-based search experience that utilizes Google’s organic web search results and additional links on the search results page that showcase contextually relevant AOL and third-party content and information (adjacent to the search results), 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 search-based, sponsored link ads in response to their search queries.

We also offer our own proprietary video (Truveo) and news (Relegence) search services. Truveo is one of the most comprehensive video search engines in the world. Truveo’s functionality enables consumers to enter search terms to discover publicly available online videos and receive search results that include links to each video’s host site and thumbnails to help consumers refine their search queries for relevant videos. The Relegence news search service acquires information on a real-time basis from public and private information sources, including news wires, websites, regulatory feeds and corporate sources, and indexes this information on a proprietary platform to enable use of relevant, targeted news feeds throughout AOL Media. In addition, we offer vertical search services (i.e., search within a specific content category) and mobile search services on AOL Media.

Distribution of AOL Media

AOL Media content, products and services 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 which allow us to more directly reach online consumers.

Subscription Access Service

Our AOL-brand subscription access service, which we offer consumers in the United States for a monthly fee, is a valuable distribution channel for AOL Media. As of June 30, 2009, we had 5.8 million AOL-brand access subscribers in the United States.

 

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In addition to our content, products and services that are available to all online consumers, an AOL access subscription provides members with dial-up access to the Internet and, depending on the applicable price plan, various degrees of enhanced safety and security features, technical support and other benefits. In addition, we continue to offer Internet access services under the CompuServe and Netscape brands.

Our major access service partners are Level 3 Communications, LLC and MCI Communications Services, Inc., who provide us with modem networks and related services for a substantial portion of our subscription access service. We have agreed to commit a significant portion of our access service subscribers’ total dial-up network hours to the Level 3 and MCI networks, and will incur penalty payments if we fail to dedicate the required percentage of dial-up hours to these service partners. As of June 30, 2009, we are meeting our volume commitments to each of these service partners. We have agreed to use the Level 3 and MCI networks until March 31, 2011 and December 31, 2009, respectively. The agreement with MCI may be renewed at our option until December 31, 2010. Upon expiration of these agreements, we expect to continue our relationships with Level 3 and MCI or enter into agreements with one or more other providers of modem networks and related services.

Our access service subscriber base has declined and is expected to continue to decline as a result of several factors, including the increased availability of high-speed broadband Internet connections, the fact that a significant amount of online content, products and services has been optimized for use with broadband Internet connections and the effects of our strategic shift announced in 2006, which resulted in significantly reduced marketing efforts for our subscription access service and the free availability of the vast majority of our content, products and services. See “Risk Factors—Risks Relating to Our Business—Our strategic shift to an online advertising-supported business model involves significant risks” on page 15 of this Information Statement.

Other Distribution Channels

We also distribute AOL Media through a variety of other channels, including agreements with original equipment manufacturers of computers, digital devices and other consumer electronics, broadband access providers and mobile carriers. Additional distribution channels include toolbars, widgets, co-branded portals and websites, and third-party websites and social networks that link to AOL Media. We also utilize search engine marketing and search engine optimization as distribution methods. In addition, we make available open standards and protocols for use by third-party developers to enhance, promote and distribute AOL Media.

AOL Media Revenue Generation

Advertising Revenues

We generate advertising revenues from AOL Media through the sale of display and search advertising. We offer advertisers a wide range of capabilities and solutions to effectively deliver advertising and reach targeted audiences across AOL Media through our dedicated sales force. The substantial number of unique visitors on AOL Media 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 Media (i.e., in particular locations and on specific dates). In addition, we offer advertisers the opportunity to bid on unsold advertising inventory on AOL Media utilizing our proprietary scheduling, optimization and delivery technology. Finally, advertising inventory on AOL Media not sold directly to advertisers, as described above, may be included for sale to advertisers with inventory purchased from third-party publishers in the Third Party Network.

We offer numerous types of advertising, including text and banner advertising, mobile, search-sponsored links, video and rich media advertising, sponsorship of content offerings, local and classified advertising, contextual and audience targeting opportunities, lead generation and affiliate marketing solutions. Advertising revenues are generated through the display of graphical advertisements, the display of sponsored links to an

 

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advertiser’s website that are associated with search results, the display of contextual links to an advertiser’s website as well as other performance-based advertising. Agreements for advertising on AOL Media typically take the following forms:

 

   

impression-based contracts in which we provide “impressions” (an “impression” is delivered when an advertisement appears in web pages viewed by users) in exchange for a fixed fee (generally stated as cost-per-thousand impressions);

 

   

time-based contracts in which we provide a minimum number of impressions over a specified time period for a fixed fee; or

 

   

performance-based contracts in which performance is measured in terms of either “click-throughs” (when a user clicks on a company’s advertisement) or other user actions such as product/customer registrations, survey participation, sales leads or product purchases.

We utilize our own proprietary “ad serving technology” (i.e., technology that places advertisements on websites and digital devices) as the primary vehicle for placements of advertisements on AOL Media through our subsidiary, ADTECH AG. We also license this ad serving technology to third parties.

Google is, except in certain limited circumstances, the exclusive web search provider for AOL Media. In connection with these search services, Google provides us with a share of the revenue generated through paid text-based search advertising on AOL Media. For the year ended December 31, 2008, advertising revenues associated with the Google relationship (substantially all of which were generated on AOL Media) were $678 million. In addition, we sell search-based keyword advertising directly to advertisers on AOL Media 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. Domestically, we have agreed, except in certain limited circumstances, to use Google’s search services on an exclusive basis through December 19, 2010. Upon expiration of this agreement, we expect to continue to generate advertising revenues by providing paid-search advertising on AOL Media, either through the continuation of our relationship with Google or an agreement with another search provider. See “Risk Factors—Risks Relating to Our Business—We are dependent on a third-party search provider” on page 17 of this Information Statement.

Subscription Revenues

We generate subscription revenues through our subscription access service. As of September 2009, our primary AOL-brand price plans were $25.90 and $11.99 per month. We also offer consumers, among other things, enhanced online safety and security features and technical support for a monthly subscription fee. As noted above, our access service subscriber base has declined and is expected to continue to decline, and this has resulted in year-over-year declines in our subscription revenues. The number of domestic AOL-brand access subscribers was 6.9 million, 9.3 million and 13.2 million at December 31, 2008, 2007 and 2006, respectively. For the years ended December 31, 2008, 2007 and 2006, our subscription revenues were $1,929 million, $2,788 million and $5,784 million, respectively.

Although our subscription revenues have declined and are expected to continue to decline, we believe that our subscription access service will continue to provide us with an important source of revenue and cash flow in the near term. The revenue and cash flow generated from our subscription access service will help us to pursue our strategic initiatives and continue the transition of our business toward attracting and engaging Internet consumers and generating advertising revenues in accordance with the 2006 strategy shift.

Third Party Network

We also generate advertising revenues through the sale of advertising on the Third Party Network. In order to effectively connect advertisers with online advertising inventory, we purchase advertising inventory from publishers and utilize proprietary optimization, targeting and delivery technology to best match advertisers with available advertising inventory.

 

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The Third Party Network includes a display advertising interface that gives advertisers the ability to target and control the delivery of their advertisements and provides advertisers and agencies with relevant display analytics and measurement tools. For our publishers, inclusion in the Third Party Network offers a comprehensive set of tools and technologies to manage and maximize their return.

We utilize a proprietary scheduling, optimization and delivery technology, called AdLearn, which employs a set of complex mathematical algorithms that seek to optimize advertisement placements across the Third Party Network and the available inventory on AOL Media. 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.

Advertising arrangements for the sale of Third Party Network inventory typically take the form of impression-based contracts or performance-based contracts.

Other Revenues

In addition to advertising and subscription revenues, we also generate fee, license and other revenues. From our communications offerings, we generate fees associated with mobile email and instant messaging functionality from mobile carriers. Through MapQuest’s business-to-business services, we generate licensing revenue from third-party customers. We also generate revenues by licensing our proprietary ad serving technology to third parties, primarily through our subsidiary, ADTECH AG.

AOL Ventures

Some of the initiatives described above may be classified as part of AOL Ventures. We formed AOL Ventures with the goal of creating an entrepreneurial environment to attract and develop innovative initiatives. AOL Ventures will focus on acquisitions that we have previously made which have start-up characteristics or which do not currently fit within our other areas of strategic focus, investments we intend to make in early-stage, externally-developed opportunities and employee-originated innovations that we believe would benefit from incubation and development within the AOL Ventures environment.

For initiatives included within AOL Ventures, our goal is to create an improved environment for fostering sustained long-term growth. For future initiatives and investments – whether externally-developed or employee-originated – AOL Ventures will focus on early-stage opportunities that are aligned with our long-term strategy. The size of our investment and corresponding ownership interest will vary depending on the opportunity, as will our level of involvement and control. We intend to attract top talent and source attractive opportunities by partnering with leading angel investors, venture capitalists and universities. We currently expect to invest significantly less capital in AOL Ventures than in our other operations. In addition to capitalizing the initiatives and investments included within AOL Ventures ourselves, we may seek outside capital where appropriate.

Product Development

We seek to develop new and enhanced versions of our products and services for our consumers, publishers and advertisers. While in the past we have relied primarily on our own proprietary technology to support our products and services, we have been steadily increasing our use of open source technologies and platforms with a view to diversifying our sources of technology, as well as for cost management. Research and development costs related to our software development efforts for 2008, 2007 and 2006 totaled $68.8 million, $74.2 million and $114.4 million, respectively. These costs consist primarily of personnel and related costs that are incurred related to the development of software and user-facing Internet offerings that do not qualify for capitalization.

 

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Intellectual Property

Our intellectual property assets include copyrights, trademarks and trademark applications, patents and patent applications, domain names, trade secrets and licenses of intellectual property rights of various kinds. These intellectual property assets, both in the United States and in other countries around the world, are, collectively, among our most valuable assets. We rely on a combination of copyright, trademark, patent, trade secret and unfair competition laws as well as contractual provisions to protect these assets. The duration and scope of the protection afforded to our intellectual property depend on the type of property in question and the laws and regulations of the relevant jurisdiction. In the case of licenses, they also depend on contractual provisions. We consider the “AOL” brand and our other brands to be some of our most valuable assets and these assets are protected by numerous trademark registrations in the United States and globally. These registrations may generally be maintained in effect for as long as the brand is in use in the respective jurisdictions.

Google Alliance

In April 2006, AOL, Google and Time Warner completed the issuance to Google of a 5% equity interest in us and entered into agreements in March 2006 which expanded their existing strategic alliance. Under the expanded alliance, Google provides our consumers with a general, Internet-based search experience that utilizes Google’s organic web search results and additional links on the search results page that showcase contextually relevant AOL and third-party content and information (adjacent to the search results), as well as 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 search-based sponsored link ads in response to their search queries. In addition, Google provides us with the use of a white-labeled, modified version of its advertising platform to enable us to sell search-based keyword advertising directly to advertisers on AOL Media, provides us with advertising credits for promotion of AOL Media on Google’s network, provides other promotional opportunities for our content and collaborates with us on a number of other areas.

On July 8, 2009, Time Warner completed the purchase of Google’s 5% interest in us. See Note 3 to the accompanying audited consolidated financial statements for additional information on this purchase.

Competition

We compete for the time and attention of consumers with a wide range of Internet companies, including Yahoo! Inc., Google, Microsoft Corporation’s MSN, IAC/Interactive Corp. and social networking sites such as Facebook, Inc. and Fox Interactive Media Inc.’s MySpace, as well as traditional media companies which are increasingly offering their own Internet products and services.

We compete for advertisers and publishers with a wide range of companies offering competing advertising products, technology and services, aggregators of such advertising products, technology and services and aggregators of third-party advertising inventory. In addition to those companies listed above, competitors include WPP Group plc (24/7 Real Media) and ValueClick, Inc. Competition among these companies has been intensifying and may lead to continuing decreases in prices for certain advertising inventory, particularly in light of current economic conditions where advertisers in certain categories are lowering their marketing expenditures.

Our subscription access service competes with other Internet access providers, especially broadband providers.

Internationally, our primary competitors are global enterprises such as Yahoo!, Google, MSN, IAC, Facebook, MySpace and other social networking sites, as well as a large number of local enterprises.

The Internet industry is dynamic and rapidly evolving, and new and popular competitors, such as social networking sites, providers of communications tools and providers of advertising services, frequently emerge.

 

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Government Regulation and Other Regulatory Matters

Our business is subject to various federal and state laws and regulations, particularly in the areas of privacy, data security and consumer protection.

Laws and regulations applicable to our business include the following:

 

   

The Children’s Online Privacy Protection Act of 1998 and the Federal Trade Commission’s related implementing regulations, which prohibit the collection of personal information from users under the age of 13 without parental consent. In addition, there has been an international movement to provide additional protections to minors who are online which, if enacted, could result in substantial compliance costs.

 

   

The Digital Millennium Copyright Act of 1998, parts of which limit the liability of certain eligible online service providers for listing or linking to third-party websites that include materials which infringe copyrights or other intellectual property rights of others.

 

   

The Communications Decency Act of 1996, sections of which provide certain statutory protections to online service providers who distribute third-party content.

 

   

The Protect Our Children Act of 2008, which requires online services to report and preserve evidence of violations of federal child pornography laws under certain circumstances.

 

   

The Electronic Communications Privacy Act of 1986, which sets forth the provisions for access, use, disclosure and interception and privacy protections of electronic communications.

 

   

The Controlling the Assault of Non-Solicited Pornography And Marketing Act of 2003, which establishes requirements for those who send commercial email, sets forth penalties for email “spammers” and companies whose products are advertised in spam if they violate the law and gives consumers the right to ask emailers to stop spamming them.

Our marketing and billing activities are subject to regulation by the Federal Trade Commission and each of the states and the District of Columbia under both general consumer protection laws and regulations prohibiting unfair or deceptive acts or practices as well as various laws and regulations mandating disclosures, authorizations, opt-out procedures and record-keeping for particular sorts of marketing and billing transactions. These laws and regulations include, for example, the Telemarketing Sales Rule, federal and state “Do Not Call” statutes, the Electronic Funds Transfer Act, Regulation E, anti-cramming regulations promulgated by state Public Utilities Commissions and other regulatory bodies. Moreover, our ability to bill under certain payment methods is subject to commercial agreements including, for example, the Credit Card Association Rules and agreements between our payment aggregator and telephone carriers.

We regularly receive and resolve inquiries relating to marketing and billing issues from state Attorneys General, the Federal Trade Commission and the Federal Communications Commission and, over the course of more than 20 years of operations, we have entered into several Consent Orders, Assurances of Voluntary Compliance/Discontinuance and settlements pursuant to which we have implemented a series of consumer protection safeguards. Examples include the prohibition of consumer retention-related compensation to call center personnel based either on non-third-party verified retention transactions or minimum retention thresholds; implementing tools that mandate adherence to various consumer protection procedural safeguards around marketing, sales, registration, cancellation, retention and reactivation transactions; recordation and retention of particular call types; enabling and requiring full customer support for disabled consumers; and implementing regular training programs and monitoring mechanisms to ensure compliance with these obligations.

In the United States, Internet access services are generally classified as “information services” which are not subject to regulation by the Federal Communications Commission.

 

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Various international laws and regulations also affect our growth and operations. In addition, various legislative and regulatory proposals under consideration from time to time by the United States Congress and various federal, state and international authorities have in the past, and may in the future, materially affect us. In particular, 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 and advertisement and content delivery. In the Third Party Network, cookies or similar technologies help present, target and measure the effectiveness of advertisements. More sophisticated targeting and measurement facilitate enhanced revenue opportunities. The regulation of these “cookies” and other current online advertising practices could adversely affect our business.

Employees

We employ approximately 7,000 people, based in 18 countries around the world, including the United States, India, the United Kingdom, Germany, Ireland, Israel, Canada and France. The countries outside of the United States where we have the largest employee populations are India, with over 1,000, and the United Kingdom, with approximately 500. A significant number of our international employees support our domestic operations. In general, we consider our relationship with employees to be good.

Global Presence

We have AOL-branded and co-branded portals and websites in North and South America, Europe and the Asia Pacific region. In addition, we continue to offer Internet access service under the AOL-brand in the United States and Canada. We sold our AOL-brand access service businesses in the United Kingdom and France in the fourth quarter of 2006 and sold our German access service business in the first quarter of 2007. We have advertising operations in the United States, Canada and nine countries across Europe, as well as in Japan through a joint venture with Mitsui & Co., Ltd. We are currently evaluating the countries in which we operate as a part of the effort to align our cost structure. As part of this evaluation, we may decide to cease or reduce operations in certain countries. For geographic area data for the years ended December 31, 2008, 2007 and 2006, see Note 12 to the accompanying audited consolidated financial statements.

Seasonality

In the fourth quarter, we have historically seen a sequential increase in advertising revenues associated with holiday advertising; however, this fluctuation can be offset by adverse economic conditions.

 

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Property and Equipment

The following table sets forth certain information concerning our principal properties:

 

Description/Use/Location

  

Approximate
Square Footage

  

Leased or
Owned

  

Expiration Date,
if Leased

Corporate Headquarters,

770 Broadway,

New York, New York

   228,000    Leased    2023

Corporate Campus,

22000 AOL Way,

Dulles, Virginia

   1,573,000(a)    Owned    N/A

Corporate Offices,

75 Rockefeller Plaza,

New York, New York

   178,000(b)    Leased    2014

Dulles Technology Center,

22080 Pacific Boulevard,

Dulles, Virginia

   180,000    Owned    N/A

Manassas Technology Center,

777 Infantry Ridge Road,

Manassas, Virginia

   228,000    Owned    N/A

Netscape Technology Center,

Executive, Administrative and Business Offices,

401, 464, 468 and 475 Ellis,

Mountain View, California

      363,000(c)    Leased    2010-2014

Development Center,

RMZ EcoSpace Campus 1A

Outer Ring Road,

Bellandur, Bangalore, India

  

262,000

   Leased    2012

 

(a) Approximately 663,000 square feet are leased to third-party tenants.

 

(b) This space is currently sublet from Time Warner, with all but 2,435 square feet being sub-sublet to a third party through the end of the AOL sublease, and this space will remain with Time Warner following the spin-off.

 

(c) Approximately 195,000 square feet are subleased to third-party tenants.

In addition to the properties above, we own and lease over 100 facilities for use as corporate offices, sales offices, development centers, technology centers and other operations in other locations in California, Colorado, the District of Columbia, Florida, Georgia, Illinois, Maryland, Massachusetts, Michigan, New York, Ohio, Pennsylvania, Texas, Virginia and Washington and in the countries of Australia, Canada, China, Denmark, Finland, France, Germany, India, Ireland, Israel, Japan, Luxembourg, Mexico, The Netherlands, Norway, Spain, Sweden and the United Kingdom.

We believe that our facilities are well maintained and are sufficient to meet our current and projected needs. We also have an ongoing process to continually review and update our real estate portfolio to meet changing business needs.

Legal Proceedings

On May 24, 1999, two former AOL Community Leader volunteers brought a putative class action, Hallissey et al. v. America Online, Inc., in the U.S. District Court for the Southern District of New York alleging violations of the Fair Labor Standards Act (“FLSA”) and New York State law. The plaintiffs allege that, in serving as AOL

 

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Community Leader volunteers, they were acting as employees rather than volunteers for purposes of the FLSA and New York State law and are entitled to minimum wages. The court denied the Company’s motion to dismiss in 2006 and ordered the issuance of notice to the putative class in 2008. In February 2009, plaintiffs filed a motion to file an amended complaint, the briefing for which was completed in May 2009, and which the court denied on July 17, 2009. In 2001, four of the named plaintiffs in the Hallissey case filed a related lawsuit alleging retaliation as a result of filing the FLSA suit in Williams, et al. v. America Online, Inc., et al. A related case was filed by several of the Hallissey plaintiffs in the U.S. District Court for the Southern District of New York alleging violations of the retaliation provisions of the FLSA. This case was stayed pending the outcome of the Company’s motion to dismiss in the Hallissey matter discussed above, but has not yet been activated. Also in 2001, two related class actions were filed in state courts in New Jersey (Superior Court of New Jersey, Bergen County Law Division) and Ohio (Court of Common Pleas, Montgomery County, Ohio), alleging violations of the FLSA and/or the respective state laws. These cases were removed to federal court and subsequently transferred to the U.S. District Court for the Southern District of New York for consolidated pretrial proceedings with Hallissey.

On January 17, 2002, AOL Community Leader volunteers filed a class action lawsuit in the U.S. District Court for the Southern District of New York, Hallissey et al. v. AOL Time Warner, Inc., et al., against AOL LLC alleging ERISA violations. Plaintiffs allege that they are entitled to pension and/or welfare benefits and/or other employee benefits subject to ERISA. In March 2003, plaintiffs filed and served a second amended complaint, adding as defendants the AOL Time Warner Administrative Committee and the AOL Administrative Committee. On May 19, 2003, AOL filed a motion to dismiss and the Administrative Committees filed a motion for judgment on the pleadings. Both of these motions are pending. The Company intends to defend against all these lawsuits vigorously.

On August 1, 2005, Thomas Dreiling, a shareholder of Infospace Inc., filed a derivative suit in the U.S. District Court for the Western District of Washington against AOL LLC and Infospace Inc. as nominal defendant. The complaint, brought in the name of Infospace, asserts violations of Section 16(b) of the Exchange Act. The plaintiff alleges that certain AOL LLC executives and the founder of Infospace, Naveen Jain, entered into an agreement to manipulate Infospace’s stock price through the exercise of warrants that AOL LLC received in connection with a commercial agreement with Infospace. The complaint seeks disgorgement of profits, interest and attorneys’ fees. On January 3, 2008, the court granted AOL LLC’s motion and dismissed the complaint with prejudice. Plaintiff filed a notice of appeal with the U.S. Court of Appeals for the Ninth Circuit, and the oral argument occurred on May 7, 2009. On August 19, 2009, the Ninth Circuit issued its opinion affirming the District Court’s opinion on all issues. The petitioners’ September 2, 2009 motion for rehearing en banc before the Ninth Circuit was denied on October 13, 2009. The Company intends to defend against this lawsuit vigorously.

On September 22, 2006, Salvadore Ramkissoon and two unnamed plaintiffs filed a putative class action against AOL LLC in the U.S. District Court for the Northern District of California based on AOL LLC’s public posting of AOL LLC member search queries in late July 2006. Among other things, the complaint alleges violations of the Electronic Communications Privacy Act and California statutes relating to privacy, data protection and false advertising. The complaint seeks class certification and damages, as well as injunctive relief that would oblige AOL LLC to alter its search query retention practices. In February 2007, the District Court dismissed the action without prejudice. The plaintiffs then appealed this decision to the Ninth Circuit. On January 16, 2009, the Ninth Circuit held that AOL LLC’s Terms of Service violated California public policy as to any California plaintiffs in the putative class, as it did not allow for them to fully exercise their rights. The Ninth Circuit reversed and remanded to the District Court for further proceedings. On April 24, 2009, AOL LLC filed a motion to stay discovery as well as a motion to implement the Ninth Circuit’s mandate; the former motion was denied on June 22, 2009. AOL LLC filed its answer on June 29, 2009. On July 6, 2009, the District Court found that the plaintiffs’ claims for unjust enrichment and public disclosure of private facts were subject to the forum selection clause in the Terms of Service and thus could not be pursued in that court. Further, the District Court ordered additional briefing on whether the District Court may compel plaintiffs to litigate their claims for alleged violations of the Electronic Communications Privacy Act in a state court. The briefing has been filed by both sides and the Company awaits a ruling from the District Court. The Company intends to defend against this lawsuit vigorously.

 

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Between December 27, 2006 and July 6, 2009, AOL Europe Services SARL (which we refer to as “AOL Luxembourg”), a wholly-owned subsidiary of AOL organized under the laws of Luxembourg, received four assessments from the French tax authority for French value added tax related to AOL Luxembourg’s subscription revenues from French subscribers earned during the period from July 1, 2003 through October 31, 2006. The assessments, including interest accrued through the respective assessment dates, total €187.1 million (approximately $262.8 million based on the euro to dollar exchange rate as of June 30, 2009). The Company disputes these assessments and has recorded an incremental expense of $14.7 million related to this matter in the third quarter of 2009.

In addition to the matters listed above, we are a party to a variety of legal proceedings that arise in the normal course of our business. While the results of such normal course legal proceedings cannot be predicted with certainty, management believes that, based on current knowledge, the final outcome of the current pending matters will not have a material adverse effect on our financial position, results of operations or cash flows. 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 “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 “Risk Factors—Risks Relating to Our Business—We have been, and may in the future be, subject to claims of intellectual property infringement that could adversely affect our business” included elsewhere in this Information Statement.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our results of operations and financial condition together with our audited and unaudited historical consolidated financial statements and the notes thereto included elsewhere in this Information Statement as well as the discussion in the section of this Information Statement entitled “Business” beginning on page 42 of this Information Statement. This discussion contains forward-looking statements that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including those discussed in the sections of this Information Statement entitled “Risk Factors” beginning on page 15 of this Information Statement and “Cautionary Statement Concerning Forward-Looking Statements” on page 29 of this Information Statement.

Introduction

Management’s discussion and analysis of financial condition and results of operations is a supplement to the accompanying consolidated financial statements and provides additional information on AOL’s business, recent developments, financial condition, liquidity and capital resources, cash flows and results of operations. MD&A is organized as follows:

 

   

Overview. This section provides a general description of our business, as well as recent developments we believe are important in understanding the results of operations and financial condition or in understanding anticipated future trends.

 

   

Results of operations. This section provides an analysis of our results of operations for the three years ended December 31, 2008 and the three and six months ended June 30, 2009 and June 30, 2008.

 

   

Liquidity and capital resources. This section provides a discussion of our current financial condition and an analysis of our cash flows for the three years ended December 31, 2008 and the six months ended June 30, 2009 and June 30, 2008. This section also provides a discussion of our contractual obligations and commitments, off-balance sheet arrangements and customer credit risk that existed at December 31, 2008. Included in this section is a discussion of the amount of financial capacity available to fund our future commitments and ongoing operating activities.

 

   

Market risk management. This section discusses how we monitor and manage exposure to potential gains and losses arising from changes in market rates and prices, which, for us, is primarily associated with changes in foreign currency exchange rates.

 

   

Critical accounting policies. This section identifies and summarizes those accounting policies that are considered important to our results of operations and financial condition, require significant judgment and require estimates on the part of management in application.

Overview

The Spin-Off

On May 28, 2009, Time Warner announced plans for the complete legal and structural separation of AOL from Time Warner. The spin-off will be completed by way of a pro rata dividend of AOL shares held by Time Warner to its shareholders as of the record date. Immediately following completion of the spin-off, Time Warner shareholders will own 100% of the outstanding shares of common stock of AOL. After the spin-off, we will operate as an independent, publicly-traded company.

 

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Prior to the spin-off, Time Warner will complete the Internal Transactions as described in “Certain Relationships and Related Party Transactions—Agreements with Time Warner” beginning on page 150 of this Information Statement. Additionally, AOL and Time Warner expect to enter into a series of agreements, including the Separation and Distribution Agreement, Transition Services Agreement, Employee Matters Agreement, Second Tax Matters Agreement, Intellectual Property Cross-License Agreement, IT Applications and Database Agreement, Master Services Agreement for ATDN and Hosting Services and continue various other commercial arrangements which are also described in “Certain Relationships and Related Party Transactions—Agreements with Time Warner.” Consummation of the separation is subject to certain conditions, as described in “The Spin-Off—Conditions to the Spin-Off” on page 36 of this Information Statement.

Our Business

As described further in the section entitled “Business” beginning on page 42 of this Information Statement, our business operations are focused on AOL Media and the Third Party Network. We market our offerings to advertisers on both AOL Media and the Third Party Network under the brand “AOL Advertising.”

AOL Media

We seek to be a global publisher of relevant and engaging online content by utilizing open and highly scalable publishing platforms and content management systems, as well as a leading online provider of consumer products and services. In addition, we plan to extend the reach of our offerings to a consumer audience on multiple platforms and digital devices.

We generate advertising revenues from AOL Media through the sale of display and search advertising. We offer advertisers a wide range of capabilities and solutions to effectively deliver advertising and reach targeted audiences across AOL Media through our dedicated sales force. 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 Media (i.e., in particular locations and on specific dates). In addition, we offer advertisers the opportunity to bid on unsold advertising inventory on AOL Media utilizing our proprietary scheduling, optimization and delivery technology. Finally, advertising inventory on AOL Media not sold directly to advertisers, as described above, may be included for sale to advertisers with inventory purchased from third-party publishers in the Third Party Network.

Growth of our advertising revenues depends on our ability to attract consumers and increase engagement on AOL Media by offering compelling content, products and services, as well as on our ability to monetize such engagement by offering effective advertising solutions. In order to attract consumers and generate increased engagement, we have developed and acquired, and in the future will continue to develop and acquire, content, products and services designed to attract and engage consumers in various ways.

We have made and are exploring making additional changes to our content, products and services designed to enhance the consumer experience (e.g., fewer advertisements on certain AOL Media properties). These changes have involved and may continue to involve the elimination or modification of advertising practices that historically have been a source of revenues. These enhancements to the consumer experience are intended to ultimately increase our revenues by increasing the attractiveness of our content, product and service offerings to consumers and therefore their value to advertisers, but these enhancements may have a negative impact on revenues in the near term.

Google is, except in certain limited circumstances, the exclusive web search provider for AOL Media. In connection with these search services, Google provides us with a share of the revenue generated through paid text-based search advertising on AOL Media. For the year ended December 31, 2008, advertising revenues associated with the Google relationship (substantially all of which were generated on AOL Media) were $678 million. Domestically, we have agreed, except in certain limited circumstances, to use Google’s search services on an exclusive basis through December 19, 2010. Upon expiration of this agreement, we expect to continue to generate advertising revenues by providing paid-search advertising on AOL Media, either through the continuation of our relationship with Google or an agreement with another search provider.

 

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We view our subscription access service, which we offer consumers in the United States for a monthly fee, as a valuable distribution channel for AOL Media. In general, subscribers to our subscription access service are among the most engaged consumers on AOL Media. However, our access service subscriber base has declined and is expected to continue to decline. This decline is the result of several factors, including the increased availability of high-speed broadband Internet connections, the fact that a significant amount of online content, products and services has been optimized for use with broadband Internet connections and the effects of our strategic shift announced in 2006, which resulted in significantly reduced marketing efforts for our subscription access service and the free availability of the vast majority of our content, products and services. See “Risk Factors—Risks Relating to Our Business—Our strategic shift to an online advertising-supported business model involves significant risks” on page 15 of this Information Statement. As our subscriber base declines, we need to maintain the engagement of former subscribers similar to historical levels and increase the number and engagement of other consumers on AOL Media. We seek to do this by developing and offering engaging content, products and services. Further, we will continue to seek to transition those access subscribers who are terminating their paid access subscriptions to free AOL Media offerings.

For the years ended December 31, 2008, 2007 and 2006, our subscription revenues were $1,929.3 million, $2,787.9 million and $5,783.6 million, respectively. Although our subscription revenues have declined and are expected to continue to decline, we believe that our subscription access service will continue to provide us with an important source of revenue and cash flow in the near term. The revenue and cash flow generated from our subscription access service will help us to pursue our strategic initiatives and continue the transition of our business toward attracting and engaging Internet consumers and generating advertising revenues in accordance with the 2006 strategy shift. Even if our strategy is successful and we are able to grow our advertising revenues, we will be challenged to grow our operating income in the near term because of the continuing decline in our subscriber base. In particular, because subscription revenues have relatively low direct costs, the expected decline in subscription revenues will result in declines in operating income and cash flows for the foreseeable future, even if we achieve significant growth in advertising revenues.

Some of the initiatives described above may be classified as part of AOL Ventures.

Third Party Network

We also generate advertising revenues through the sale of advertising on the Third Party Network. Our advertising offerings on the Third Party Network consist primarily of the sale of display advertising. In order to generate advertising revenues on the Third Party Network, we have historically had to incur higher traffic acquisition costs as compared to advertising on AOL Media.

We plan to expand the Third Party Network in order to allow us to serve many more publishers and advertisers than at present. We currently market our offerings to publishers under the brand “Advertising.com.” A significant portion of our revenues on the Third Party Network are generated from the advertising inventory acquired from a limited number of publishers. Accordingly, we intend to make strategic investments in order to expand the Third Party Network and related advertising solutions.

Trends, Demands and Uncertainties Impacting Our Business

The web services industry is highly competitive and rapidly changing. Trends, challenges and uncertainties that may have a significant impact on our business, our opportunities and our ability to execute our strategy include the following:

 

   

Commerce, information and advertising continue to migrate to the Internet and away from traditional media outlets. We believe this continuing trend will create strategic growth opportunities for us to attract new consumers and develop new and effective advertising solutions.

 

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We believe that effectively aligning our organizational structure and costs to our strategy is an important challenge to the successful implementation of our strategic plan. We anticipate additional restructuring plans, and expect to continue to actively manage our costs, in order to realize the desired benefits of our strategic plan.

 

   

As the amount of content that is available online continues to expand, consumers are increasingly fragmenting across the Internet away from portals such as AOL.com. While this fragmentation may result in fewer consumers utilizing portals for their information consumption, we own a large variety of niche sites (e.g., Engadget, Lemondrop and PoliticsDaily) that we expect to continue to drive consumer engagement. Furthermore, the Third Party Network, which reaches thousands of websites, will allow us to continue to provide advertising solutions across a fragmenting Internet environment.

 

   

In recent years, there has been a significant shift in the method of Internet access away from dial-up access. This is due to a number of factors, including the increased availability of high-speed broadband Internet connections and the fact that a significant amount of online content, products and services has been optimized for use with broadband Internet connections. This trend, combined with the effects of our strategic shift announced in 2006, has contributed to the continuing decline in the number of our access subscribers.

In addition to the trends, challenges and uncertainties listed above, we have historically operated as part of Time Warner’s corporate organization, and Time Warner has assisted us by providing certain corporate functions. Following the spin-off, Time Warner will have no obligation to provide assistance to us other than the interim services to be provided as described in “Certain Relationships and Related Party Transactions—Agreements with Time Warner” beginning on page 150 of this Information Statement. Because our business has previously operated as part of the Time Warner organization, we cannot assure you that we will be able to efficiently implement the changes necessary to operate independently or that we will not incur additional costs that could adversely affect our business. Further, implementing these changes may require a significant portion of our management’s attention.

Audience Metrics

We utilize unique visitor numbers to evaluate the performance of AOL Media. In addition, we utilize unique visitor numbers to evaluate the reach of our total advertising network, which includes both AOL Media and the Third Party Network. Unique visitor numbers provide an indication of our consumer reach. Although our consumer reach does not correlate directly to advertising revenue, we believe that our ability to broadly reach diverse demographic and geographic audiences is attractive to brand advertisers seeking to promote their brands to a variety of consumers without having to partner with multiple content providers.

The source for our unique visitor information is a third party (comScore Media Metrix, or Media Metrix). Media Metrix estimates unique visitors based on a sample of Internet users in various countries. While we are familiar with the general methodologies and processes that Media Metrix uses in estimating unique visitors, we have not performed independent testing or validation of Media Metrix’s data collection systems or proprietary statistical models, and therefore we can provide no assurance as to the accuracy of the information that Media Metrix provides.

Our average monthly domestic unique visitors to AOL Media, as reported by Media Metrix, for the six months ended June 30, 2009 and the years ended December 31, 2008, 2007 and 2006 were 106 million, 110 million, 112 million and 111 million, respectively. Our average monthly global unique visitors to AOL Media, as reported by Media Metrix, for the six months ended June 30, 2009 and the years ended December 31, 2008, 2007 and 2006 were 282 million, 260 million, 235 million and 193 million, respectively. Our average monthly domestic unique visitors to our total advertising network, which includes both AOL Media and the Third Party Network, as reported by Media Metrix, for the six months ended June 30, 2009 and the years ended December 31, 2008, 2007 and 2006 were 175 million, 171 million, 156 million and 143 million, respectively. AOL’s unique visitor numbers also include unique visitors attributable to co-branded websites owned by third parties for which certain criteria have been met, including that the Internet traffic has been assigned to us.

 

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Recent Developments

Impact of the Current Economic Environment

The current global economic recession adversely impacted our advertising revenues in 2008 and the first half of 2009. During the three and six months ended June 30, 2009, our advertising revenues declined 21% and 20%, respectively, as compared to the corresponding periods in 2008. While our ability to forecast future advertising revenues is limited, we expect that the global economic recession will continue to adversely impact our advertising revenues at least through the remainder of 2009. We do not believe that the current global economic recession has had a material impact on our subscription revenues.

AOL-Google Alliance

On July 8, 2009, Time Warner repurchased Google’s 5% interest in us for $283.0 million, which amount included a payment in respect of Google’s pro rata share of cash distributions to Time Warner by AOL attributable to the period of Google’s investment in us. Following this purchase, we became a 100%-owned subsidiary of Time Warner.

Goodwill Impairment Charge

In connection with the annual goodwill impairment analysis performed during the fourth quarter of 2008, we determined that the carrying value of our goodwill was impaired and, accordingly, recorded a goodwill impairment charge of $2,207.0 million to write goodwill down to its implied fair value. This impairment was partially attributable to lower cash flow expectations associated with the significant economic downturn in 2008. See Notes 1 and 2 to the accompanying audited consolidated financial statements for more information on this goodwill impairment charge.

Restructuring Actions

We undertook various restructuring activities in the first half of 2009 in an effort to better align our cost structure with our revenues. As a result, for the three and six months ended June 30, 2009, we incurred restructuring charges of $14.4 million and $72.7 million, respectively, related to involuntary employee terminations and facility closures. We currently expect to incur $10 to $20 million of additional restructuring charges through the spin-off, which is anticipated to occur in the fourth quarter of 2009. Shortly after the spin-off, we plan to undertake additional restructuring activities to more effectively align our organizational structure and costs to our strategy. Additionally, we are evaluating the countries in which we operate as part of the effort to align our cost structure. As part of this evaluation, we may decide to cease or reduce operations in certain countries. Although we are not yet in a position to quantify specific amounts, we expect to incur significant additional restructuring charges.

Acquisition of Patch Media Corporation

On June 10, 2009, we purchased Patch Media Corporation (“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 is being held in an indemnity escrow account until the first anniversary of the closing.

At the time of closing, Tim Armstrong, our Chairman and Chief Executive Officer, held, indirectly, through Polar Capital Group, LLC (“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 connection with the transaction, Mr. Armstrong, through Polar Capital, waived his right to

 

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receive any transaction consideration in excess of his original $4.5 million investment, opting to accept only the return of his initial investment. In addition, Mr. Armstrong elected to return the $4.5 million (approximately $450,000 of which is being held in the indemnity escrow account for a year) that he was entitled to receive in connection with the transaction to us, to be held by us until after our separation from Time Warner. As soon as legally permissible, following the separation, we will cause to be issued to Polar Capital an amount of AOL Inc. common stock equivalent to $4.5 million (minus any amounts held in the indemnity escrow account) based on an average of the high and low market prices on the relevant trading day. The issuance of shares of AOL Inc. common stock to Polar Capital will be exempt from registration under Section 4(2) of the Securities Act of 1933, as a transaction by an issuer not involving a public offering. The payment to Polar Capital of the $4.5 million of consideration is not contingent on the continued employment of Mr. Armstrong with us.

In evaluating the fair market value of Patch, Time Warner engaged the services of a financial advisory firm, which reviewed certain information, including recent financial performance and financial forecasts relating to Patch’s earnings and cash flow and performed valuation analyses including: a discounted cash flow analysis of Patch’s expected earnings, a comparison of the multiple being paid for Patch to the trading multiples of comparable public companies, and a comparison of the multiple being paid for Patch to the multiples paid in comparable merger and acquisition transactions. The discounted cash flow analysis was based on terminal multiples of revenue of 2.0 to 4.0x, terminal multiples of EBITDA of 8.0 to 12.0x and discount rates of 20 to 40%. Comparable public companies were trading at 0.2 to 3.2x 2010 revenue and 0.01 to 0.20x revenue on a growth adjusted basis. In comparable mergers and acquisitions, acquirors paid a multiple of 0.7 to 29.4x revenue for the last 12 months prior to the transaction, 0.8 to 8.6x forward revenue and 1.6 to 10.6x invested capital. The purchase price of $7.0 million for Patch was within the range implied by the discounted cash flow analysis and the implied valuation multiples were below or within the range of multiples for the comparable public companies and comparable merger and acquisition transactions.

In connection with its analysis, the financial advisory firm assumed and relied upon the accuracy and completeness of the financial and other information that was available to it from public sources, that was provided to it by Time Warner or its representatives, or that was otherwise available to it, without independent verification of such information. With respect to the financial forecasts, the financial advisory firm assumed no responsibility for such forecasts or the assumptions on which they were based and assumed that such forecasts had been reasonably prepared on a basis reflecting the best currently available estimates and judgments of the management of Time Warner as to the future financial performance of Patch, and that such financial information was materially complete.

Based on the analyses undertaken, and subject to the above assumptions and qualifications, the financial advisory firm confirmed that the $7.0 million value ascribed by us was within the range of estimated fair market values for Patch as of the transaction date.

The Patch acquisition did not significantly affect our consolidated financial results for the three and six months ended June 30, 2009.

Results of Operations

Basis of Presentation

The consolidated financial statements included elsewhere in this Information Statement, which are discussed below, include 100% of our assets, liabilities, revenues, expenses and cash flows as well as those of our subsidiaries. While the consolidated financial statements have been derived from the historical results of AOL Holdings LLC, we have presented the consolidated financial statements as those of AOL Inc., which AOL Holdings LLC will be converted into prior to the spin-off and the stock of which will be distributed in the distribution. Intercompany accounts and transactions between consolidated companies have been eliminated in consolidation. For each of the periods presented, we were a subsidiary of Time Warner. The financial information included herein may not necessarily reflect our financial position, results of operations and cash flows in the future or what our financial position, results of operations and cash flows would have been had we

 

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been an independent, publicly-traded company during the periods presented. We expect to incur additional costs to be able to function as an independent, publicly-traded company, including additional costs related to corporate finance, governance and public reporting.

In connection with the spin-off, we will enter into transactions with Time Warner that either have not existed historically or that are on terms different from the terms of arrangements or agreements that existed prior to the spin-off. See “Certain Relationships and Related Party Transactions—Agreements with Time Warner” beginning on page 150 of this Information Statement for more detail. In addition, our historical financial information does not reflect changes that we expect to experience in the future as a result of our separation from Time Warner, including changes in the financing, operations, cost structure and personnel needs of our business. Further, the historical financial statements include allocations of certain Time Warner corporate expenses. We believe the assumptions and methodologies underlying the allocation of general corporate expenses are reasonable. However, such expenses may not be indicative of the actual level of expense that would have been incurred by us if we had operated as an independent, publicly-traded company or of the costs expected to be incurred in the future. These allocated expenses relate to various services that have historically been provided to us by Time Warner, including cash management and other treasury services, administrative services (such as government relations, tax, employee benefit administration, internal audit, accounting and human resources), equity-based compensation plan administration, aviation services, insurance coverage and the licensing of certain third-party patents. During the years ended December 31, 2008, 2007 and 2006, we incurred $23.3 million, $28.4 million and $35.8 million, respectively, of expenses related to charges for services performed by Time Warner, and for the three and six months ended June 30, 2009, we incurred $5.4 million and $10.7 million, respectively, of such expenses.

Consolidated Results

2008, 2007 and 2006

The following table presents our historical operating results as a percentage of revenues for the periods presented, and should be read in conjunction with the accompanying consolidated statements of operations:

 

     Years Ended December 31,  
     2008     2007     2006  

Revenues

   100   100   100

Costs and expenses:

      

Costs of revenues

   55      51      53   

Selling, general and administrative

   16      19      28   

Amortization of intangible assets

   4      2      2   

Amounts related to securities litigation and government investigations, net of recoveries

   —        3      9   

Restructuring costs

   —        2      3   

Goodwill impairment charge

   53      —          

Gain on disposal of assets and consolidated businesses, net

   —        (13)      (10)   
                  

Total costs and expenses

   128      64      85   
                  

Operating income (loss)

   (28)      36      15   
                  

Income (loss) from continuing operations before income taxes

   (28 )%    36   15
                  

 

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The following table presents our revenues, by revenue type, for the periods presented ($ in millions):

 

     Years Ended December 31,  
     2008    2007    % Change
from 2007
to 2008
    2006    % Change
from 2006
to 2007
 

Revenues:

             

Advertising

   $ 2,096.4    $ 2,230.6    (6 )%    $ 1,886.1    18

Subscription

     1,929.3      2,787.9    (31 )%      5,783.6    (52 )% 

Other

     140.1      162.2    (14 )%      117.0    39
                         

Total revenues

   $ 4,165.8    $ 5,180.7    (20 )%    $ 7,786.7    (33 )% 
                         

The following table presents our revenues, by revenue type, as a percentage of total revenues for the periods presented:

 

     Years Ended December 31,  
     2008     2007     2006  

Revenues:

      

Advertising

   50   43   24

Subscription

   46      54      74   

Other

   4      3      2   
                  

Total revenues

   100   100   100
                  

Advertising Revenues

Advertising revenues are generated through the display of graphical advertisements, the display of sponsored links to an advertiser’s website that are associated with search results (also referred to as paid-search), the display of contextual links to an advertiser’s website, as well as other performance-based advertising. Agreements for advertising on AOL Media typically take the form of impression-based contracts in which we provide impressions in exchange for a fixed fee (generally stated as cost-per-thousand impressions), time-based contracts in which we provide a minimum number of impressions over a specified time period for a fixed fee or performance-based contracts in which performance is measured in terms of either “click-throughs” when a user clicks on a company’s advertisement or other user actions such as product/customer registrations, survey participation, sales leads or product purchases. In addition, agreements with advertisers can include other advertising-related elements such as content sponsorships, exclusivities or advertising effectiveness research.

In addition to advertising revenues generated on AOL Media, we also generate revenues from our advertising offerings on the Third Party Network. To generate revenues on the Third Party Network, we purchase advertising inventory from publishers (both large and small) in the Third Party Network using proprietary optimization, targeting and delivery technology to best match advertisers with available advertising inventory. Advertising arrangements for the sale of Third Party Network inventory typically take the form of impression-based contracts or performance-based contracts.

Advertising revenues on AOL Media and the Third Party Network for the years ended December 31, 2008, 2007 and 2006 are as follows ($ in millions):

 

     Years Ended December 31,
     2008    2007    % Change
from 2007 to
2008
  2006    % Change
from 2006 to
2007

AOL Media

   $ 1,450.4    $ 1,553.1    (7)%   $ 1,405.1    11%

Third Party Network

     646.0      677.5    (5)%     481.0    41%
                         

Total advertising revenues

   $ 2,096.4    $ 2,230.6    (6)%   $ 1,886.1    18%
                         

 

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Advertising revenues generated on AOL Media decreased 7%, or $102.7 million, for the year ended December 31, 2008, as compared to the year ended December 31, 2007. The decrease was due in part to a benefit to revenue for the year ended December 31, 2007 of approximately $19 million related to a change in an accounting estimate as a result of more timely impression delivery data. The remaining decrease included a decline of approximately $115 million due to weak economic conditions which resulted in lower advertising demand, as well as the challenges of integrating businesses acquired in late 2007 and early 2008, partially offset by an increase of $31 million in paid-search revenues from the Google relationship. The increase in paid-search revenues was driven by higher revenues per search query on certain AOL Media properties and broader distribution of paid-search through AOL Media, which contributed $76 million and $30 million, respectively, to the increase, partially offset by a $75 million decrease due to a decline in search query volume on certain AOL Media properties.

Advertising revenues generated on AOL Media increased 11%, or $148.0 million, for the year ended December 31, 2007, as compared to the year ended December 31, 2006. The increase was due in part to a $66 million increase in paid-search revenues from the Google relationship driven by higher revenues per search query on certain AOL Media properties, the $19 million benefit related to the change in an accounting estimate discussed above and an increase of approximately $63 million due to an increase in volume of sold inventory.

For all periods presented in this Information Statement, we have had a contractual relationship with Google whereby Google provides paid text-based search advertising on AOL Media. For all of the periods presented in this Information Statement, revenues under the Google arrangement represented a significant percentage of the advertising revenues generated by AOL Media. For the years ended December 31, 2008, 2007 and 2006, the revenues associated with the Google relationship (substantially all of which were generated on AOL Media) were $678 million, $642 million and $573 million, respectively.

The 5% decrease in advertising revenues generated on the Third Party Network for the year ended December 31, 2008, as compared to the year ended December 31, 2007, was due to a decrease of $189 million resulting from the wind-down of a contract with a major customer, which was partially offset by increased revenues of $131 million attributable to acquisitions completed in 2007 and other advertising growth of $27 million. Since January 1, 2008, the major customer noted above has been under no contractual obligation to do business with us, and our advertising revenues from this customer declined to $26 million in 2008 from $215 million in 2007.

The 41% increase in advertising revenues generated on the Third Party Network for the year ended December 31, 2007, as compared to the year ended December 31, 2006, is attributable to organic growth and, to a lesser extent, the effect of acquisitions completed in 2007, which contributed revenues of $27 million in 2007. Our revenues on the Third Party Network benefited from the expansion of the relationship with the major customer referred to in the paragraph above in the second quarter of 2006. The revenues associated with this relationship increased $58 million to $215 million in 2007, as compared to 2006.

Subscription Revenues

The 31% decline in subscription revenues for the year ended December 31, 2008, as compared to the year ended December 31, 2007, was due to a 26% decrease in the number of domestic AOL-brand access subscribers (which is discussed further below), the sale of our German access service business in the first quarter of 2007, which resulted in a decrease of $88 million for the year ended December 31, 2008, and a decrease of $51 million related to a decline in non-AOL-brand access subscribers (i.e., CompuServe and Netscape brand access subscribers). The 52% decline in subscription revenues for the year ended December 31, 2007, as compared to the year ended December 31, 2006, was driven by the 30% decrease in the number of domestic AOL-brand access subscribers as well as the sales of the access service businesses in the United Kingdom and France in the fourth quarter of 2006 and the sale of the German access service business in the first quarter of 2007 (which we collectively refer to as the European access service businesses). As a result of the sales of the European access service businesses, subscription revenues declined by $1,465 million in 2007.

 

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The number of domestic AOL-brand access subscribers was 6.9 million, 9.3 million and 13.2 million at December 31, 2008, 2007 and 2006, respectively. The average monthly revenue per domestic AOL-brand access subscriber (which we refer to in this Information Statement as ARPU) was $18.38, $18.66 and $19.18 for the years ended December 31, 2008, 2007 and 2006, respectively. We include in our subscriber numbers individuals, households and entities that have provided billing information and completed the registration process sufficiently to allow for an initial log-on to the AOL access service. Domestic AOL-brand access subscribers include subscribers participating in introductory free-trial periods and subscribers that are paying no monthly fees or reduced monthly fees through member service and retention programs, which together represented 2% or less of our total subscribers at December 31, 2008 and 2007 and 6% of our total subscribers at December 31, 2006. Individuals who have registered for our free offerings, including subscribers who have migrated from paid subscription plans, are not included in the AOL-brand access subscriber numbers presented above. Subscribers to our subscription access service contribute to our ability to generate advertising revenues.

The continued decline in domestic AOL-brand access subscribers is the result of several factors, including the increased availability of high-speed broadband Internet connections, the fact that a significant amount of online content, products and services has been optimized for use with broadband Internet connections and the effects of our strategic shift announced in 2006, which resulted in significantly reduced marketing efforts for our subscription access service and the free availability of the vast majority of our content, products and services. The decrease in ARPU of $0.28 for the year ended December 31, 2008, as compared to the year ended December 31, 2007, was due to a shift in the subscriber mix to lower-priced plans, which reduced ARPU by $1.35, and a decrease in premium services revenues, which reduced ARPU by $0.30. These decreases were partially offset by an increase in the percentage of revenue-generating customers, which increased ARPU by $0.43, and price increases for lower-priced plans, which increased ARPU by $1.11. The decrease in ARPU of $0.52 for the year ended December 31, 2007, as compared to the year ended December 31, 2006, was due to a shift in the subscriber mix to lower-priced plans, which reduced ARPU by $1.63, partially offset by an increase in the percentage of revenue-generating customers, which increased ARPU by $1.11.

Other Revenues

Other revenues consist primarily of fees associated with our mobile email and instant messaging functionality from mobile carriers, licensing revenues from third-party customers through MapQuest’s business-to-business services and licensing revenues from licensing our proprietary ad serving technology to third parties through our subsidiary, ADTECH AG.

Other revenues decreased 14% for the year ended December 31, 2008, as compared to the year ended December 31, 2007, due to declines in the revenues associated with the transition support services agreements with the purchasers of our European access service businesses (which ended in 2008), which contributed $23 million in revenue for the year ended December 31, 2008, as compared to $51 million for the year ended December 31, 2007, partially offset by increases in mobile email and instant messaging revenues of $14 million. Other revenues increased 39% for the year ended December 31, 2007, as compared to the year ended December 31, 2006, due to the commencement of the agreements to provide transition support services to the purchasers of the European access service businesses in late 2006 and early 2007, which contributed $51 million in other revenues for the year ended December 31, 2007, partially offset by a decline in modem sales of $18 million. These modems were sold as part of a bundled broadband offering to European access subscribers, and are no longer part of our subscription access service offerings due to the sales of the European access service businesses.

Geographical Concentration of Revenues

Since the sales of the European access service businesses, a significant majority of our revenues have been generated in the United States. In 2008 and 2007, 87% and 88%, respectively, of our revenues were generated in the United States, whereas in 2006, only 73% of our revenues were generated in the United States. This change

 

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was due to the significance of the international revenues associated with the European access service businesses in 2006. Substantially all of the non-United States revenues in 2008, 2007 and 2006 were generated by our European operations (primarily in the United Kingdom, France and Germany). We expect the significant majority of our revenues to continue to be generated in the United States for the foreseeable future.

Operating Costs and Expenses

The following table presents our operating costs and expenses for the periods presented ($ in millions):

 

     Years Ended December 31,
     2008    2007    % Change
from 2007

to 2008
   2006    % Change
from 2006

to 2007

Costs of revenues

   $   2,278.4       $   2,652.6         (14)%    $   4,129.0         (36)%

Selling, general and administrative

     644.8         964.2         (33)%      2,199.6         (56)%

Amortization of intangible assets

     166.2         95.9          73%      133.5          (28)%

Amounts related to securities litigation and government investigations, net of recoveries

     20.8         171.4         (88)%      705.2         (76)%

Restructuring costs

     16.6         125.4         (87)%      222.2         (44)%

Goodwill impairment charge

     2,207.0         —               NA          —           —  

Gain on disposal of assets and consolidated businesses, net

     (0.3)        (682.6)        (100)%      (770.6)        (11)%

The following categories of costs are generally included in costs of revenues: network-related costs, traffic acquisition costs (which we refer to in this Information Statement as TAC), product development costs and other costs of revenues. For the year ended December 31, 2008, the largest component of costs of revenues was TAC. TAC consists of costs incurred through arrangements in which we acquire third-party online advertising inventory for resale and arrangements whereby partners distribute our free products or services or otherwise direct traffic to AOL Media. TAC arrangements have a number of different economic structures, the most common of which are: 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, payments for direct traffic delivered to AOL Media priced on a per click basis (e.g., search engine marketing fees) and payments to partners in exchange for distributing our products to their users (e.g., agreements with computer manufacturers to distribute our 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. Network-related costs include narrowband access costs, hardware and software maintenance expense, high-speed data circuits, personnel and related overhead costs incurred in supporting the network and depreciation of network-related assets. Product development costs include software maintenance costs, research and development costs and other expenses incurred in the development of software and user-facing Internet offerings, including personnel and related overhead support costs. Other costs of revenues include content royalties and customer service costs, which include outsourced customer service costs and, historically, employee and related costs for our operated customer support call centers, as well as costs associated with customer billing and collections, personnel and related overhead costs, depreciation and amortization of certain capitalized software and certain asset impairments.

Our costs of revenues and selling, general and administrative expenses declined significantly for the periods presented, driven by two factors. First, our cost structure in Europe is significantly lower than it was prior to the sales of our European access service businesses, as such sales led to significant cost decreases for the year ended December 31, 2007 and, to a lesser extent, for the year ended December 31, 2008. Second, we have undertaken a number of cost reduction initiatives as a result of the strategic shift announced in 2006. The decisions made in connection with these cost reduction initiatives included ceasing to actively market our subscription access

 

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service, closing and outsourcing our customer support and call center functions, entering into variable network cost agreements as opposed to fixed cost agreements to reduce costs in response to the declining access subscriber base, reducing headcount through restructuring actions taken during the periods presented and leveraging non-United States personnel in a cost-effective manner.

More specifically, costs of revenues decreased 14% to $2,278.4 million for the year ended December 31, 2008, as compared to $2,652.6 million for the year ended December 31, 2007. The sale of our German access service business in the first quarter of 2007 contributed $78 million of the decrease. Excluding that decline, the primary drivers of the decrease in costs of revenues were a decrease in network-related costs, product development and certain other costs of revenues. Network-related costs declined by $149 million, which included declines in narrowband network costs of $56 million due to the decline in access service subscribers, a decrease in personnel and related overhead costs to support the network of $43 million resulting from reduced headcount, declines in depreciation expense associated with network equipment of $29 million and other declines of $26 million related to the decline in access service subscribers. Product development expenses declined $32 million due to a decrease in personnel-related costs as a result of reduced headcount. Other costs of revenues included a decrease in other personnel and related overhead costs of $97 million as a result of reduced headcount, declines in non-network depreciation and amortization of $47 million, declines in costs associated with customer billing and collections of $24 million due to the decline in subscribers and lower content royalties of $21 million. Also contributing to the decline in personnel-related costs described above was our decision not to pay bonuses for 2008. Partially offsetting these declines were increases in TAC. TAC increased 14% to $687 million for the year ended December 31, 2008, as compared to $604 million for the year ended December 31, 2007, due to a new product distribution agreement resulting in TAC of $106 million, additional TAC of $92 million related to revenues generated by the acquisitions completed in 2007 and other increases in TAC consistent with the other Third Party Network advertising growth of $27 million previously discussed, partially offset by the wind-down of the contract with the major customer described above, which resulted in a decline of $160 million.

Costs of revenues as a percentage of revenues were 55% and 51% in the years ended December 31, 2008 and 2007, respectively. The increase in costs of revenues as a percentage of revenues for the year ended December 31, 2008, as compared to the year ended December 31, 2007, was a result of declines in our subscription revenues and advertising revenues exceeding the decline in costs to deliver such revenues.

Costs of revenues decreased 36% to $2,652.6 million for the year ended December 31, 2007, as compared to $4,129.0 million the year ended December 31, 2006. The decline reflects a decrease of $1,020 million attributable to the sales of our European access service businesses. Excluding that decline, the primary drivers of the decrease in costs of revenues were decreases in network-related costs, product development costs and certain other costs of revenues. Network-related costs declined by $251 million, which included declines in narrowband network costs of $147 million due to the decline in access service subscribers, declines in broadband costs of $36 million and declines in depreciation expense associated with network equipment of $18 million. Product development expenses declined $54 million due to a decrease in personnel and consulting costs as a result of significantly reduced development efforts and the use of lower-cost, non-United States personnel in connection with the strategic shift announced in 2006. Other declines in costs of revenues in 2007 included a decline of $237 million as a result of reduced headcount and lower outside services costs due primarily to call center closures, a $69 million decrease in content royalties and a decline in costs associated with customer billing and collections of $37 million. Partially offsetting these declines were increases in TAC. TAC increased 57% to $604 million for the year ended December 31, 2007, as compared to $384 million for the year ended December 31, 2006, due to increases in Third Party Network TAC, driven by the Third Party Network advertising growth previously discussed. Also contributing to this increase was approximately $50 million in TAC incurred in 2007 related to revenue share payments made to the buyers of the European access service businesses. Since we sold these businesses in late 2006 and early 2007, the TAC incurred in 2006 related to these arrangements was not significant.

 

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Costs of revenues as a percentage of revenues were 51% and 53% in the years ended December 31, 2007 and 2006, respectively. This decrease in costs of revenues as a percentage of revenues for the year ended December 31, 2007, as compared to the year ended December 31, 2006, was driven by our cost management initiatives that we implemented as part of the strategic shift announced in 2006. These cost management initiatives included a restructuring action in 2006 to reduce headcount and terminate certain contracts.

Selling, general and administrative expenses consist primarily of marketing costs associated with subscriber acquisition marketing efforts and payments to marketing partners for domestic AOL-brand access subscribers, personnel costs and facility costs related to our corporate and business support functions, depreciation on property and equipment used in our corporate and business support functions, consulting fees, bad debt expense and legal fees.

Selling, general and administrative expenses decreased to $644.8 million for the year ended December 31, 2008, a 33% decline as compared to the year ended December 31, 2007, of which $34 million was attributable to the sale of our German access service business. The remaining decrease was due to a decline in marketing costs of $127 million, which was related to reduced subscriber acquisition marketing efforts as part of the strategic shift announced in 2006, and a reduction in personnel and related overhead costs of $88 million, due partially to reduced headcount and our decision not to pay annual bonuses for 2008. Selling, general and administrative expenses for the year ended December 31, 2008 also included $22 million of external costs incurred in connection with Time Warner’s evaluation of various strategic alternatives related to us, including the previously contemplated separation of AOL into separate businesses, which more than offset a $20 million decline in other outside consulting expenses.

Selling, general and administrative expenses decreased to $964.2 million for the year ended December 31, 2007, a 56% decline as compared to the year ended December 31, 2006, of which $361 million was attributable to the sales of our European access service businesses. The remaining decrease was due to a decline in marketing costs of $593 million resulting from the strategic shift announced in 2006, a decline in subscriber bad debt expense of $99 million due to lower subscriber membership, a decline in personnel-related costs of $76 million, a decline in depreciation expense of $60 million and a decline in outside consulting expenses of $48 million.

Amortization of intangible assets results primarily from acquired intangible assets including technology, customer relationships and trade names. Amortization of intangible assets increased $70.3 million for the year ended December 31, 2008, a 73% increase as compared to the year ended December 31, 2007, due primarily to a significant increase in our acquired intangible assets resulting from the acquisitions of Bebo, Inc. in early 2008 and the acquisitions of Quigo Technologies Inc. and TACODA, Inc. in late 2007. Amortization of intangible assets decreased $37.6 million for the year ended December 31, 2007, a 28% decrease as compared to the year ended December 31, 2006, due primarily to $45 million of amortization expense in 2006 that did not recur in 2007, as this expense was associated with intangible assets that were included in the sales of our European access service businesses.

Amounts related to securities litigation and government investigations, net of recoveries consist of legal settlement costs and legal and other professional fees incurred by Time Warner related to the defense of various securities lawsuits involving us or our former officers and employees. While these amounts were historically incurred by Time Warner and reflected in Time Warner’s financial results, they have been reflected as an expense and a corresponding additional capital contribution by Time Warner in our consolidated financial statements because they involve us. We recognized $20.8 million, $171.4 million and $705.2 million of expense related to these matters for the years ended December 31, 2008, 2007 and 2006, respectively. Following the spin-off, these costs will continue to be incurred by Time Warner to the extent that proceeds from a settlement with insurers are available to pay those costs, and thereafter will be borne by AOL or Time Warner to the extent either entity is obligated by its bylaws or otherwise to pay such costs. See Note 9 to the accompanying audited consolidated financial statements for more information.

 

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As a result of the strategic shift announced in 2006 and continuing efforts to better position and optimize our business, we undertook restructurings in 2008, 2007 and 2006. Our 2008 results included net restructuring charges of $16.6 million related to costs incurred associated with involuntary employee terminations and facility closures. Our 2007 results included restructuring charges of $125.4 million, reflecting costs incurred associated with involuntary employee terminations, asset write-offs and facility closures. The 2007 charges also included a reversal of $15 million of restructuring costs associated with a change in estimate for 2006 and prior restructuring activity. Our 2006 results included $222.2 million in restructuring charges, related to costs incurred associated with involuntary employee terminations, contract terminations, asset write-offs and facility closures.

The goodwill impairment charge in 2008 was incurred as a result of the annual goodwill impairment analysis performed during the fourth quarter of 2008. In that analysis, we determined that the carrying value of our goodwill was impaired and, accordingly, recorded a goodwill impairment charge of $2,207.0 million to write goodwill down to its implied fair value. See Notes 1 and 2 to the accompanying audited consolidated financial statements for more information.

The gain on disposal of assets and consolidated businesses for the years ended December 31, 2007 and 2006 consisted primarily of the $668.2 million gain on the sale of our German access service business in 2007 and the $767.4 million in gains on the sales of our French and United Kingdom access service businesses in 2006.

Operating Income (Loss)

Our operating loss was $1,167.7 million for the year ended December 31, 2008, as compared to operating income of $1,853.8 million for the year ended December 31, 2007. The decline was due primarily to the goodwill impairment charge in 2008, a significant decrease in revenues in 2008 and a gain on the disposal of our German access service business in 2007, partially offset by decreases in costs of revenues, selling, general and administrative expenses and restructuring costs.

Operating income was $1,853.8 million for the year ended December 31, 2007, as compared to operating income of $1,167.8 million for the year ended December 31, 2006. The increase was due primarily to decreases in costs of revenues, selling, general and administrative expenses, a decrease in costs related to securities litigation and government investigations, a decrease in restructuring costs and an increase in advertising revenues, partially offset by a decrease in subscription revenues.

Other Income Statement Amounts

The following table presents our other income amounts from continuing operations for the periods presented ($ in millions):

 

     Years Ended December 31,
     2008    2007    % Change
from 2007
to 2008
   2006    % Change
from 2006
to 2007

Other income (loss), net

   $ (3.8)      $ 1.2      (417)%      $     29.4      (96)%

Income tax provision

     355.1         641.7      (45)%        480.7      33%

Other income (loss), net was essentially flat for the year ended December 31, 2008, as compared to the year ended December 31, 2007, as there were no significant changes in other income activity in those periods. Other income (loss), net decreased $28.2 million to $1.2 million for the year ended December 31, 2007, as compared to the year ended December 31, 2006, due primarily to $17 million of net gains in 2006 associated with foreign currency transactions.

The provision for income taxes for the year ended December 31, 2008 differs from the amount computed by applying the U.S. Federal statutory income tax rate due to state taxes and a non-deductible goodwill impairment charge.

 

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Our effective tax rate for the year ended December 31, 2008 was (30.3)%, which included the effect of the $2,207.0 million goodwill impairment charge, the majority of which was non-deductible for income tax purposes. Excluding the effect of this charge, our effective tax rate for the year ended December 31, 2008 was 43.4%, as compared to 34.6% for the year ended December 31, 2007. The increase in the effective tax rate (after excluding the effect of the goodwill impairment charge) was due to tax benefits realized in 2007 associated with the utilization of tax loss carryforwards on the sale of our German access service business. Our effective tax rate for the year ended December 31, 2007 was 34.6%, compared to 40.2% in 2006. The higher effective tax rate in 2006 was due to uncertainties associated with certain foreign intangible assets.

Three and Six Months Ended June 30, 2009 and 2008

The following table presents our operating results as a percentage of revenues for the periods presented, and should be read in conjunction with the accompanying consolidated statements of operations:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
       2009         2008         2009         2008    

Revenues:

   100   100   100   100

Costs and expenses:

        

Costs of revenues

   58      57      57      56   

Selling, general and administrative

   15      18      16      16   

Amortization of intangible assets

   4      4      4      4   

Amounts related to securities litigation and government investigations, net of recoveries

   1      —        1      —     

Restructuring costs

   2      —        4      1   
                        

Total costs and expenses

   80      79      82      77   
                        

Operating income

   20      21      18      23   

Other income (loss), net

   —        —        —        —     
                        

Income before income taxes

   20   21   18   23
                        

The following table presents our revenues, by revenue type, for the three and six months ended June 30, 2009 and 2008 ($ in millions):

 

     Three Months Ended
June 30,
   % Change     Six Months Ended
June 30,
   % Change  
       2009        2008          2009        2008     

Revenues:

                

Advertising

   $ 419.2    $ 530.3    (21 )%    $ 862.2    $ 1,082.2    (20 )% 

Subscription

     355.7      491.0    (28 )%      749.2      1,029.8    (27 )% 

Other

     28.9      35.4    (18 )%      59.6      73.0    (18 )% 
                                

Total revenues

   $ 803.8    $ 1,056.7    (24 )%    $ 1,671.0    $ 2,185.0    (24 )% 
                                

The following table presents our revenues, by revenue type, as a percentage of total revenues for the three and six months ended June 30, 2009 and 2008:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
       2009         2008         2009         2008    

Revenues:

        

Advertising

   52   50   52   50

Subscription

   44      46      45      47   

Other

   4      4      3      3   
                        

Total revenues

   100   100   100   100
                        

 

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The strengthening of the U.S. dollar relative to significant foreign currencies to which we are exposed negatively affected our revenues by approximately $24 million and $47 million for the three and six months ended June 30, 2009, respectively, as compared to the three and six months ended June 30, 2008. However, due to an offsetting positive impact on expenses, the impact of exchange rate differences on operating income and net income in comparing these periods was not material. If exchange rates remain at levels similar to those in the first half of 2009, we expect similar impacts on revenues, operating income and net income during the remainder of 2009.

Advertising Revenues

Advertising revenues on AOL Media and the Third Party Network for the three and six months ended June 30, 2009 and 2008 are as follows ($ in millions):

 

     Three Months Ended
June 30,
       % Change        Six Months Ended
June 30,
       % Change    
     2009    2008       2009    2008   

AOL Media

   $ 294.7      $ 363.2      (19)%    $ 604.8      $ 726.9      (17)%

Third Party Network

     124.5        167.1      (26)%      257.4        355.3      (28)%
                                 

Total advertising revenues

   $     419.2      $     530.3      (21)%    $     862.2      $     1,082.2      (20)%
                                 

Advertising revenues generated on AOL Media decreased 19%, or $69 million, and 17%, or $122 million, for the three and six months ended June 30, 2009, as compared to the three and six months ended June 30, 2008, respectively. The decrease was due in part to a decline in paid-search revenues from the Google relationship of $29 million and $50 million for the three and six months ended June 30, 2009, as compared to the three and six months ended June 30, 2008, respectively, due to decreases in search query volume on certain AOL Media properties which contributed $18 million and $47 million to the decline, respectively, and, for the three months ended June 30, 2009, as compared to the three months ended June 30, 2008, lower revenues per search query on certain AOL Media properties which contributed $11 million to the decline. The remaining decrease of approximately $40 million and $72 million for the three and six months ended June 30, 2009, as compared to the three and six months ended June 30, 2008, was due to weak economic conditions that resulted in lower advertising demand. For the three months ended June 30, 2009 and 2008, the revenues associated with our arrangement with Google (substantially all of which were generated on AOL Media) were $139 million and $168 million, respectively, and were $285 million and $336 million, respectively, for the six months ended June 30, 2009 and 2008.

The decrease in advertising revenues on the Third Party Network for the three and six months ended June 30, 2009, as compared to the three and six months ended June 30, 2008, was 26% and 28%, respectively, and was also due to weakening global economic conditions that resulted in lower advertising demand. In addition, the decline in advertising revenues on the Third Party Network included a decrease of $4 million and $20 million for the three and six months ended June 30, 2009, respectively, due to the wind-down of the contract with the major customer previously discussed. Revenues associated with this major customer were $1 million and $2 million for the three and six months ended June 30, 2009, respectively, compared to $5 million and $22 million for the three and six months ended June 30, 2008, respectively.

While our ability to forecast future advertising revenue is limited, we expect that our advertising revenues will be negatively impacted by weak global economic conditions at least through the remainder of 2009. Our advertising revenues will also continue to be negatively impacted by the decline in our domestic AOL-brand access subscribers. In addition, we also expect that the changes to our content, products and services designed to enhance the consumer experience which are discussed in “—Overview—AOL Media” above may have a negative impact on our advertising revenues in the near term.

 

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Subscription Revenues

The decline in subscription revenues for the three and six months ended June 30, 2009, as compared to the three and six months ended June 30, 2008, was 28% and 27%, respectively, due to a 28% decrease in the number of domestic AOL-brand access subscribers between June 30, 2008 and June 30, 2009.

The number of domestic AOL-brand access subscribers was 5.8 million, 6.3 million and 8.1 million as of June 30, 2009, March 31, 2009 and June 30, 2008, respectively. ARPU was $18.27 and $17.99 for the three months ended June 30, 2009 and 2008, respectively, and $18.38 and $18.14 for the six months ended June 30, 2009 and 2008, respectively. The increase in ARPU for the three and six months ended June 30, 2009, as compared to the three and six months ended June 30, 2008, was due to price increases for lower-priced plans, which increased ARPU by $2.17 and $2.07, respectively, partially offset by a shift in the subscriber mix to lower-priced plans, which decreased ARPU by $1.41 and $1.45, respectively.

The continued decline in domestic AOL-brand access subscribers is the result of several factors, including the increased availability of high-speed broadband Internet connections, the fact that a significant amount of online content, products and services has been optimized for use with broadband Internet connections and the effects of our strategic shift announced in 2006, which resulted in significantly reduced marketing efforts for our subscription access service and the free availability of the vast majority of our content, products and services. As a result of these factors, we expect subscription revenues to decline for the foreseeable future.

Other Revenues

Other revenues decreased 18% for both the three and six months ended June 30, 2009, as compared to the three and six months ended June 30, 2008, due to declines in the revenues associated with the transition support services agreements with the purchasers of the European access service businesses. These agreements ended in 2008, and contributed $6 million and $15 million in revenue for the three and six months ended June 30, 2008, respectively. The decline in revenue from these agreements was partially offset by an increase in mobile email and instant messaging revenues of $1 million and $5 million for the three and six months ended June 30, 2009, respectively, as compared to the three and six months ended June 30, 2008.

We expect other revenues for the remainder of 2009 to be essentially flat as compared to the corresponding period of 2008.

Operating Costs and Expenses

The following table presents our operating costs and expenses for the periods presented ($ in millions):

 

     Three Months Ended
June 30,
   % Change   Six Months Ended
June 30,
   % Change
       2009        2008          2009        2008     

Costs of revenues

   $ 464.3    $ 601.6    (23)%   $ 949.4    $ 1,225.1    (23)%

Selling, general and administrative

     124.8      180.1    (31)%     263.1      354.1    (26)%

Amortization of intangible assets

     34.8      42.1    (17)%     71.3      79.4    (10)%

Amounts related to securities litigation and government investigations, net of recoveries

     6.8      4.1    66%     14.2      8.0    78%

Restructuring costs

     14.4      3.8    279%     72.7      13.3    447%

Costs of revenues decreased 23% to $464.3 million for the three months ended June 30, 2009, as compared to $601.6 million for the three months ended June 30, 2008, and decreased 23% to $949.4 million for the six months ended June 30, 2009, as compared to $1,225.1 million for the six months ended June 30, 2008. The primary drivers of the decrease in costs of revenues were a decrease in TAC, network-related costs, product

 

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development and certain other costs of revenues. TAC decreased 27% to $130 million for the three months ended June 30, 2009, as compared to $179 million for the three months ended June 30, 2008, and decreased 29% to $263 million for the six months ended June 30, 2009 from $370 million for the six months ended June 30, 2008, due to the decrease in advertising revenues on the Third Party Network and, to a lesser extent, declines in product distribution costs related to an amendment to a product distribution agreement in the third quarter of 2008. Network-related costs declined by $15 million and $33 million, respectively, for the three and six months ended June 30, 2009 due to declines in narrowband network costs resulting from the decline in access service subscribers and declines in other network related costs. Further contributing to the declines in costs of revenues for the three and six months ended June 30, 2009 were decreases in product development costs of $14 million and $33 million, respectively, due to a decrease in personnel and consulting costs as a result of reduced headcount and reduced development efforts and decreases in other outside services costs of $12 million and $25 million, respectively, as a result of reduced consulting and lower outsourced call center expenses. Other costs of revenues declines for the three and six months ended June 30, 2009 were due to cost savings initiatives, including declines in personnel costs, content royalties and ad serving expenses.

Costs of revenues as a percentage of revenues were essentially flat at 58% and 57% for the three months ended June 30, 2009 and 2008, respectively, and 57% and 56% for the six months ended June 30, 2009 and 2008, respectively.

Selling, general and administrative expenses decreased 31% to $124.8 million for the three months ended June 30, 2009, as compared to $180.1 million for the three months ended June 30, 2008, and decreased 26% to $263.1 million for the six months ended June 30, 2009, as compared to $354.1 million for the six months ended June 30, 2008. These decreases were due to declines in direct marketing costs of $21 million and $44 million, respectively, for the three and six months ended June 30, 2009, reflecting reduced subscriber acquisition marketing and reduced spending due to cost savings initiatives. Further contributing to the decline in selling, general and administrative expenses for the three and six months ended June 30, 2009 were decreases in consulting costs of $12 million and $32 million, respectively, partially due to the costs incurred in 2008 associated with Time Warner’s evaluation of various strategic alternatives related to our business.

Amortization of intangibles declined 17% to $34.8 million for the three months ended June 30, 2009, as compared to $42.1 million for the three months ended June 30, 2008, and declined 10% to $71.3 million for the six months ended June 30, 2009, as compared to $79.4 million for the six months ended June 30, 2008, due to certain intangible assets becoming fully amortized at the end of 2008, partially offset by an increase in our acquired intangible assets resulting from the acquisition of Bebo, Inc. in early 2008.

We undertook various restructuring activities in the first half of 2009 in an effort to better align our cost structure with our revenues. As a result, for the three and six months ended June 30, 2009, we incurred restructuring charges of $14.4 million and $72.7 million, respectively, related to involuntary employee terminations and facility closures. We currently expect to incur $10 to $20 million of additional restructuring charges through the spin-off, which is anticipated to occur in the fourth quarter of 2009. Shortly after the spin-off, we plan to undertake additional restructuring activities to more effectively align our organizational structure and costs to our strategy. Although we are not yet in a position to quantify specific amounts, we expect to incur significant additional restructuring charges. The results for the three and six months ended June 30, 2008 included restructuring charges of $3.8 million and $13.3 million, respectively, related to involuntary employee terminations and facility closures.

Operating Income

Operating income was $158.7 million for the three months ended June 30, 2009, as compared to operating income of $225.0 million for the three months ended June 30, 2008, and was $300.3 million for the six months ended June 30, 2009, as compared to $505.1 million for the six months ended June 30, 2008. These decreases were due to the decline in revenues and an increase in restructuring costs, offset by decreases in costs of revenues and selling, general and administrative expenses.

 

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Other Income Statement Amounts

The following table presents our other income statement amounts impacting our income from continuing operations for the periods presented ($ in millions):

 

     Three Months Ended
June 30,
   % Change    Six Months Ended
June 30,
   % Change
     2009    2008       2009    2008   

Other income (loss) net

   $5.3      ($1.5)    453%    $2.2      $0.2    N/A  

Income tax provision

   73.3      96.9     (24)%    129.3      219.1    (41)%  

Other income (loss), net increased to $5.3 million for the three months ended June 30, 2009, as compared to a $1.5 million loss for the three months ended June 30, 2008, and increased to $2.2 million for the six months ended June 30, 2009, as compared to $0.2 million for the six months ended June 30, 2008, due to net gains in 2009 associated with foreign currency transactions.

Our effective tax rates were 44.7% and 42.7% for the three and six months ended June 30, 2009, as compared to 43.4% for both the three and six months ended June 30, 2008. The effective tax rates for the three and six months ended June 30, 2009, as compared to the same period in 2008, were essentially flat as there were no significant changes in activity in those periods. The effective tax rates for the three and six months ended June 30, 2009 differ from the statutory U.S. Federal income tax rate of 35.0% due to state income taxes, net of the income tax benefit.

Liquidity and Capital Resources

Current Financial Condition

Historically, the cash we generate has been sufficient to fund our working capital, capital expenditure and financing requirements. Subsequent to the separation, while our ability to forecast future cash flows is limited, we expect to fund our ongoing working capital, capital expenditure and financing requirements through cash flows from operations and a new revolving credit facility to be entered into in connection with the separation. While we expect to continue to generate positive cash flows from operations, we believe that our cash flows from operations will decline over the next several years due to the continued decline in the number of domestic AOL-brand access subscribers. Growth in cash flows from operations will only be achieved when, and if, the growth in earnings from our online advertising services more than offsets the continued decline in domestic AOL-brand access subscribers. In order for us to achieve such increase in earnings from advertising services, we believe it will be important to increase our overall volume of advertising sold, including through our higher-priced channels, and to maintain or increase pricing for advertising. Advertising revenues, however, 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. If we are unable to successfully implement our strategic plan and grow the earnings generated by our online advertising services, we would reassess our cost structure or seek other financing alternatives to fund our business.

At June 30, 2009, our cash totaled $74.7 million, as compared to $134.7 million at December 31, 2008. Until the separation is consummated, Time Warner will provide cash management and other treasury services to us. As part of these services, we sweep the majority of our domestic cash balances to Time Warner on a daily basis and receive funding from Time Warner for any domestic cash needs. Accordingly, our cash balances presented herein consist primarily of cash held at international locations for international cash needs.

 

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In connection with the separation, we intend to enter into a new revolving credit facility. We intend to use the proceeds of this facility, as necessary, to support our working capital needs and the growth of our business and for other general corporate purposes. We describe the anticipated terms of this facility in greater detail under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Principal Debt Obligations” on page 77 of this Information Statement.

Summary Cash Flow Information

Our cash flows from operations are driven by net income adjusted for non-cash items such as depreciation, amortization, goodwill impairment, equity-based compensation expense and other activities impacting net income such as the gains and losses on the sale of assets or operating subsidiaries. Cash flows from investing activities consist primarily of the cash used in the acquisitions of various businesses as part of our strategy, proceeds received from the sale of assets or operating subsidiaries and cash used for capital expenditures. Cash flows from financing activities relate primarily to our distributions of cash to Time Warner as part of our historical cash management and treasury operations, as well as payments made on debt and capital lease obligations.

Operating Activities

The following table presents cash provided by operations for the periods presented ($ in millions):

 

     Years Ended December 31,     Six Months Ended
June 30,
 
     2008     2007     2006     2009    2008  

Net income (loss)

   $ (1,526.6   $ 1,395.4      $ 749.7      $ 173.2    $ 286.2   

Adjustments for non-cash and nonoperating items:

           

Non-cash cumulative effects of accounting change, net of tax

     —          —          (14.3     —        —     

Depreciation and amortization

     477.2        498.6        634.3        212.3      240.3   

Non-cash asset impairments

     2,240.0        16.2        52.2        6.6      4.1   

Gain on disposal of assets and consolidated businesses, net

     (0.3     (682.6     (770.6     —        —     

Non-cash equity-based compensation

     19.6        32.3        41.2        7.8      4.8   

Amounts related to securities litigation and government investigations, net of recoveries

     20.8        171.4        705.2        14.2      8.0   

Deferred income taxes

     (49.5     102.2        (14.7     9.7      —     

Adjustments relating to discontinued operations

     —          (186.7     12.6        —        —     

All other, net, including working capital changes

     (247.6     (330.2     (253.4     174.6      (75.7
                                       

Cash provided by operations

   $ 933.6      $ 1,016.6      $ 1,142.2      $ 598.4    $ 467.7   
                                       

Cash provided by operations decreased by $83.0 million to $933.6 million for the year ended December 31, 2008 as compared to the year ended December 31, 2007 driven by our decline in operating income. Our operating loss was $1,167.7 million for the year ended December 31, 2008, a decline of $3,021.5 million as compared to the year ended December 31, 2007. Excluding the declines in operating income related to the $2,207.0 million non-cash goodwill impairment charge in 2008 and the $668.2 million gain on the sale of our German access service business in 2007 (which is related to an investing cash flow), and excluding the $150.6 million increase in operating income related to securities litigation and government investigations (which were non-cash to us as Time Warner paid these amounts), operating income declined by $296.9 million, driving the decrease in cash provided by operations. This decline was mostly offset by changes in working capital, driven by a number of factors. First, a portion of our $222.2 million restructuring charge incurred in 2006 was paid in 2007, and the majority of our restructuring charge incurred in 2007 was also paid in 2007, reducing cash provided by operations in 2007. Second, the continued decline in domestic access subscribers and our strategic

 

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shift announced in 2006 led to a significant decline in deferred revenues (as we typically collect cash in advance of providing service to customers) from December 31, 2006 to December 31, 2007, resulting in lower cash from operations in 2007. Third, our advertising receivables increased in 2007 as our advertising business grew, and our advertising receivables declined in 2008 as a result of the weak economic conditions. As a result, our cash from operations in 2008 benefited from sales of advertising in 2007.

Cash provided by operations decreased by $125.6 million to $1,016.6 million for the year ended December 31, 2007, as compared to the year ended December 31, 2006. This decrease was due primarily to changes in working capital. As discussed above, a portion of the restructuring charges incurred in 2006 were paid in 2007 and the majority of our restructuring charge incurred in 2007 was also paid in 2007, reducing cash provided by operations in 2007. Further, our higher subscriber base in 2006 led to a larger amount of cash collected in 2006 for which the related revenue was recognized in 2007, which benefited cash from operations in 2006. While our operating income increased in 2007 as compared to 2006, the increase was due primarily to the amounts incurred in 2006 related to securities litigation and government investigations (which were non-cash to us as Time Warner paid these amounts), and excluding the effects of this non-cash charge, operating income was not a significant driver of the change in operating cash flows.

Cash provided by operations increased by $130.7 million to $598.4 million for the six months ended June 30, 2009, as compared to the six months ended June 30, 2008, due primarily to an increase in cash provided by working capital, which was partially offset by a decrease in net income and non-cash adjustments. The increase in cash provided by working capital was driven mainly by the change in accrued compensation and benefits and the change in our restructuring liability. Our decision not to pay annual bonuses to employees related to 2008 performance led to a significant increase in cash provided by operations for the six months ended June 30, 2009, as we paid such bonuses to employees related to 2007 performance in the first quarter of 2008. The increase in cash provided by working capital as a result of the restructuring liability activity was primarily due to payments made in the first half of 2008 for restructuring charges incurred in 2007 exceeding payments made for the comparable period in 2009 and the restructuring charges incurred in the first half of 2009 that have not yet been paid.

The components of working capital are subject to fluctuations based on the timing of cash transactions. The changes in working capital between periods primarily reflect changes in cash collected from subscribers and advertising customers and the timing of payments for accrued expenses and other liabilities.

Our cash paid for taxes (substantially all of which was paid to Time Warner under the tax matters agreement) was $516.6 million, $741.9 million and $312.6 million for the years ended December 31, 2008, 2007 and 2006, respectively, and $132.3 million and $387.5 million for the six months ended June 30, 2009 and 2008, respectively. The fluctuations in cash paid for taxes for the years ended December 31, 2008, 2007 and 2006 and the six months ended June 30, 2009 and 2008 were commensurate with the fluctuations in operating income for those periods (after excluding the effect of the non-deductible goodwill impairment charge in the fourth quarter of 2008).

 

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Investing Activities

The following table presents cash provided (used) by investing activities for the periods presented ($ in millions):

 

     Years Ended December 31,     Six Months Ended
June 30,
 
     2008     2007     2006     2009     2008  

Investments and acquisitions, net of cash acquired:

          

Bebo

   $ (852.0     —          —        $ (7.8   $ (849.1

buy.at

     (125.2     —          —          —          (125.2

Quigo

     —          (346.4     —          —          —     

TACODA

     —          (273.9     —          —          —     

ADTECH AG

     —          (105.9     —          —          —     

Third Screen Media

     —          (105.4     —          —          —     

All other

     (58.2     (49.8     (134.0     (7.9     (50.5

Capital expenditures and product development costs

     (172.2     (280.2     (387.1     (67.6     (100.3

Proceeds from disposal of assets and consolidated businesses, net:

          

German access service business

     —          849.6        —          —          —     

French access service business

     —          —          360.5        —          —     

United Kingdom access service business

     126.9        118.7        476.2        —          126.9   

All other

     —          66.5        —          —          —     

Investment activities from discontinued operations:

          

Proceeds from the sale of Tegic

     —          265.0        —          —          —     

All other

     —          (4.0     —          —          —     

Other investment proceeds

     8.4        8.0        5.1        0.7        6.8   
                                        

Cash provided (used) by investing activities

   $ (1,072.3   $ 142.2      $ 320.7      $ (82.6   $ (991.4
                                        

Cash used by investing activities for the year ended December 31, 2008 was $1,072.3 million, a decrease of $1,214.5 million as compared to cash provided by investing activities of $142.2 million for the year ended December 31, 2007. This decrease was due to a decrease in proceeds received from sold businesses and an increase in cash used for acquisitions, partially offset by reduced capital expenditures and product development costs. Cash provided by investing activities decreased by $178.5 million for the year ended December 31, 2007, as compared to the year ended December 31, 2006, due to an increase in cash used for acquisitions, partially offset by a $396.6 million increase in proceeds received from sold businesses and a decrease in capital expenditures and product development costs.

Cash used by investing activities decreased by $908.8 million to $82.6 million for the six months ended June 30, 2009, as compared to the six months ended June 30, 2008, due to a decrease in cash used for acquisitions and reduced capital expenditures and product development costs, partially offset by a decrease related to proceeds received in the first half of 2008 from the sale of our United Kingdom access service business.

Capital expenditures and product development costs are mainly for the purchase of computer hardware, software, network equipment, furniture, fixtures and other office equipment.

 

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Financing Activities

The following table presents cash provided (used) by financing activities for the periods presented ($ in millions):

 

     Years Ended December 31,     Six Months Ended
June 30,
 
     2008     2007     2006     2009     2008  

Debt repayments

   $ (54.0   $ (25.9   $ (502.2   $ —        $ (0.7

Principal payments on capital leases

     (25.1     (36.1     (66.3     (14.8     (11.3

Proceeds from sale of member interests

     —          —          1,000.0        —          —     

Excess tax benefits on stock options

     2.1        34.4        47.6        —          1.8   

Net contribution from (distribution to) Time Warner

     210.4        (1,390.3     (1,670.2     (554.6     695.5   

Other

     1.5        (7.4     (9.7     (10.3     5.4   
                                        

Cash provided (used) by financing activities

   $ 134.9      $ (1,425.3   $ (1,200.8   $ (579.7   $ 690.7   
                                        

Cash provided by financing activities for the year ended December 31, 2008 was $134.9 million, compared to cash used by financing activities of $1,425.3 million for the year ended December 31, 2007. This change was due to the $210.4 million of cash contributed by Time Warner in 2008, compared to $1,390.3 million of cash distributed to Time Warner in 2007. Cash was contributed by Time Warner in 2008 as a result of our significant acquisitions in 2008, which required cash in excess of the amount generated by operations. In 2007, we also spent cash on acquisitions in excess of the cash provided by operations; however, we received proceeds from the sales of Tegic and the German and United Kingdom access service businesses in that year, which allowed us to distribute cash to Time Warner. Cash used by financing activities was $1,425.3 million for the year ended December 31, 2007, compared to $1,200.8 million for the year ended December 31, 2006. The increase in cash used in financing activities in 2007 reflects the absence of the $1,000 million of proceeds from the sale of a 5% membership interest in AOL to Google in 2006.

Cash used by financing activities was $579.7 million for the six months ended June 30, 2009, compared to $690.7 million of cash provided by financing activities in the six months ended June 30, 2008, due to an increase in the amount distributed to Time Warner in the first six months of 2009 consistent with the increase in operating cash flows and reduction in cash used in investing activities.

Principal Debt Obligations

In connection with the separation, we intend to enter into a new senior secured revolving credit facility (which we refer to as the “Facility”). We intend to use the proceeds of the Facility, as necessary, to support our working capital needs and the growth of our business and for other general corporate purposes.

We currently expect to receive commitments from a syndicate of banks and financial institutions for a 364-day senior secured revolving credit facility with borrowing capacity of up to $250 million. The material terms of the Facility will include:

 

   

financial covenants which will require us to maintain a maximum consolidated leverage ratio (the ratio of total debt to EBITDA as defined in the agreement governing the Facility) of not greater than 1.5 to 1.0, and a minimum consolidated interest coverage ratio (the ratio of EBITDA as defined in the agreement governing the Facility to consolidated cash interest expense) of at least 4.0 to 1.0;

 

   

restrictive covenants which will limit our ability to, among other things: incur indebtedness (excluding, among other things, purchase money indebtedness and capital leases of up to $50 million, other indebtedness of up to $50 million of restricted subsidiaries that are not guarantors of the Facility, indebtedness of up to $100 million incurred to finance, or assumed in connection with, acquisitions and other indebtedness of up to $50 million incurred by us and the subsidiary guarantors of the Facility), create liens, dispose of assets outside of the ordinary course of business, pay dividends and similar

 

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restricted payments, engage in investments, make loans, advances, acquisitions and guarantees, engage in transactions with affiliates, enter into mergers and change our business, in each case subject to certain customary exceptions and baskets;

 

   

customary events of default, the occurrence of which will, among other things, give Time Warner the option to purchase all outstanding loans and commitments under the Facility;

 

   

collateral provisions providing that obligations under the Facility will be secured by a perfected first-priority security interest in substantially all of our assets and the assets of our material wholly owned domestic subsidiaries (excluding cash and real property, but including 100% of the stock of our domestic subsidiaries and 65% of the stock of our first-tier foreign subsidiaries); and

 

   

the option for us to prepay, terminate or reduce the commitments under the Facility at any time without penalty in minimum amounts of $5.0 million.

The effectiveness of the Facility will be conditioned upon, among other things, arrangements satisfactory to Bank of America, N.A. (in its capacity as the administrative agent) having been made for the completion of the spin-off within a reasonable period of time following the closing date of the Facility, the execution of definitive documentation with respect to the Facility and other customary conditions.

Our obligations under the Facility will be guaranteed by each of our material wholly owned domestic subsidiaries. In addition, we expect that Time Warner will guarantee our obligations under the Facility. As consideration for Time Warner providing a guarantee of the Facility, we expect to pay Time Warner an initial fee equal to             % of the aggregate principal amount of the commitments under the Facility, and an ongoing guarantee fee which will vary with the amount of undrawn commitments and the principal amount of our obligations outstanding under the Facility, as well as changes in Time Warner’s senior unsecured long-term debt credit ratings. The guarantee fee will be subject to prescribed periodic increases over the term of the Facility.

We will be restricted from extending, renewing or increasing our obligations under the Facility, and the documentation entered into in connection with the Facility may not be amended, modified, waived or released, in each case, without Time Warner’s prior consent. We do not anticipate that Time Warner will renew its guarantee of the Facility should the Facility be renewed or extended beyond its initial 364-day term.

We expect to enter into the Facility following the date on which the Registration Statement of which this Information Statement is a part is declared effective by the SEC, but prior to the spin-off. There can be no assurance that the actual terms of the Facility will not differ materially from those described above.

Contractual Obligations and Commitments

We have obligations under certain contractual arrangements to make future payments for goods and services. These contractual obligations secure the future rights to various assets and services to be used in the normal course of operations. For example, we are contractually committed to make certain minimum lease payments for the use of property under operating lease agreements. In accordance with applicable accounting rules, the future rights and obligations pertaining to firm commitments, such as operating lease obligations and certain purchase obligations under contracts, are not reflected as assets or liabilities in the accompanying consolidated balance sheets.

The following table presents certain payments due under contractual obligations with minimum firm commitments as of December 31, 2008 ($ in millions):

 

     Total    2009    2010-2011    2012-2013    Thereafter

Capital lease obligations

   $ 63.3    $ 27.6    $ 32.6    $ 3.1    $ —  

Operating lease obligations

     487.1      67.2      123.1      81.7      215.1

Long-term obligations to Time Warner

     377.0      —        —        —        377.0

Purchase obligations(a)

     292.9      243.7      33.4      10.2      5.6
                                  

Total contractual obligations

   $ 1,220.3    $ 338.5    $ 189.1    $ 95.0    $ 597.7
                                  

 

(a) Purchase obligations include certain significant contractual relationships involving TAC payments that expire according to their terms in 2009, including $99 million related to a product distribution arrangement and $53 million related to arrangements requiring minimum guaranteed revenue share payments to the respective counterparties.

 

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The following is a description of our material contractual obligations at December 31, 2008:

 

   

Capital lease obligations represent the minimum lease payments under non-cancelable capital leases, primarily for network equipment financed under capital leases. See Note 4 to the accompanying audited consolidated financial statements for more information.

 

   

Operating lease obligations represent the minimum lease payments under non-cancelable operating leases, primarily for our real estate and operating equipment in various locations around the world. See Note 9 to the accompanying audited consolidated financial statements for more information.

 

   

Long-term obligations to Time Warner represent our reserve for uncertain tax positions which is reflected in the consolidated balance sheet and at December 31, 2008 totaled $377.0 million (which includes related accrued interest and penalties). The specific timing of any cash payments relating to these obligations cannot be projected with reasonable certainty. Upon the effectiveness of the Second Tax Matters Agreement, Time Warner will assume the obligation for certain tax positions taken by Time Warner in its consolidated, combined, unitary or similar tax returns with respect to AOL up to the date of the spin-off. As a result, at the date of the spin-off, AOL expects to reverse the recorded liability to Time Warner related to these tax positions, with an offsetting adjustment to equity. See Note 5 to the accompanying audited consolidated financial statements for more information.

 

   

Purchase obligations, as used herein, refer to a purchase obligation representing an agreement to purchase goods or services that is enforceable and legally binding on us and that specifies all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. We expect to receive consideration (i.e., products or services) for these purchase obligations. The purchase obligation amounts do not represent the entire anticipated purchases in the future, but represent only those items for which we are contractually obligated. Examples of the types of obligations included within purchase obligations include narrowband network agreements, guaranteed royalty payments and toolbar and product distribution arrangements. Additionally, we also purchase products and services as needed with no firm commitment. For this reason, the amounts presented in the table above do not provide a reliable indicator of our expected future cash outflows. For purposes of identifying and accumulating purchase obligations, we have included all material contracts meeting the definition of a purchase obligation (e.g., legally binding for a fixed or minimum amount or quantity). For those contracts involving a fixed or minimum quantity but with variable pricing terms, we have estimated the contractual obligation based on our best estimate of the pricing that will be in effect at the time the obligation is incurred. Additionally, we have included only the obligations represented by those contracts as they existed at December 31, 2008, and did not assume renewal or replacement of the contracts at the end of their respective terms. See Note 9 to the accompanying audited consolidated financial statements.

Off-Balance Sheet Arrangements

As of December 31, 2008, we did not have any relationships with unconsolidated special purpose entities or financial partnerships for the purpose of facilitating off-balance sheet arrangements.

Indemnification Obligations

Currently, we indemnify Time Warner for certain tax positions related to AOL taken by Time Warner from April 13, 2006 up to the date of the spin-off in its consolidated tax return. In connection with the transactions entered into between AOL and Time Warner prior to the AOL-Google alliance, Time Warner retained the obligation with respect to tax positions related to AOL prior to April 13, 2006 in Time Warner’s consolidated tax return. In the event Time Warner makes payments to a taxing authority with respect to AOL-related tax positions taken from April 13, 2006 through the date of the spin-off, we would be required to make an equivalent payment to Time Warner. The aggregate amount of the reserve for uncertain tax positions underlying this indemnification obligation to Time Warner was $359.8 million (which includes estimated related accrued interest and penalties) at June 30, 2009. This liability is recorded as a long-term obligation to Time Warner in the consolidated balance sheet. This indemnification obligation relates to tax positions taken on Time Warner’s consolidated tax returns

 

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that are subject to U.S. Federal, state, local or foreign income tax examinations by taxing authorities. Upon the effectiveness of the Second Tax Matters Agreement, Time Warner will assume the obligation for certain tax positions taken by Time Warner in its consolidated, combined, unitary or similar tax returns with respect to AOL up to the date of the spin-off. As a result, at the date of the spin-off, AOL expects to reverse the recorded liability to Time Warner related to these tax positions, with an offsetting adjustment to equity.

In the ordinary course of business, we incur indemnification obligations of varying scope and terms to third parties, which could include customers, vendors, lessors, purchasers of assets or operating subsidiaries and other parties related to certain matters, including losses arising out of our breach of agreements or representations and warranties made by us, services to be provided by us, intellectual property infringement claims made by third parties or, with respect to the divestiture of assets or operating subsidiaries, matters related to our conduct of the business and tax matters prior to the sale. It is not possible to determine the aggregate maximum potential loss under such indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, we have not incurred material costs as a result of claims made in connection with indemnifications provided and, as of December 31, 2008, management concluded that the likelihood of any material amounts being paid by us under such indemnifications is not probable. As of December 31, 2008, amounts accrued in our financial statements related to indemnification obligations are not material.

Customer Credit Risk

Customer credit risk represents the potential for financial loss if a customer is unwilling or unable to meet its agreed-upon contractual payment obligations. Credit risk originates from sales of advertising and subscription access service and is dispersed among many different counterparties.

We had gross accounts receivable of approximately $540 million and maintained reserves, including an allowance for uncollectible accounts, of $39.8 million at December 31, 2008. Our exposure to customer credit risk relates primarily to our advertising customers and individual subscribers to our access service, which represent $449 million and $47 million, respectively, of the outstanding accounts receivable balance at December 31, 2008. No single customer had a receivable balance at December 31, 2008 greater than 10% of total net receivables.

Customer credit risk is monitored on a company-wide basis. We maintain a comprehensive approval process prior to issuing credit to third-party customers. On an ongoing basis, we track customer exposure based on news reports, ratings agency information and direct dialogue with customers. Counterparties that are determined to be of a higher risk are evaluated to assess whether the payment terms previously granted to them should be modified. We also continuously monitor payment levels from customers, and a provision for estimated uncollectible amounts is maintained based on historical experience and any specific customer collection issues that have been identified. While such uncollectible amounts have historically been within our expectations and related reserve balances, if there is a significant change in uncollectible amounts in the future or the financial condition of our counterparties across various industries or geographies deteriorates further, additional reserves may be required.

Market Risk Management

Market risk is the potential gain or loss arising from changes in market rates and prices, which, for us, is associated primarily with changes in foreign currency exchange rates.

We use derivative instruments (principally foreign exchange forward contracts), which historically have been entered into by Time Warner on our behalf, to manage the risk associated with exchange rate volatility.

We use these derivative instruments to hedge various foreign exchange exposures, including variability in foreign-currency-denominated cash flows (such as foreign currency expenses expected to be incurred in the future) and currency risk associated with foreign-currency-denominated operating assets and liabilities (i.e., fair

 

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value hedges). As part of our overall strategy to manage the level of exposure to the risk of foreign currency exchange rate fluctuations, we have historically hedged a portion of our foreign currency exposures anticipated over the calendar year. At December 31, 2008 and 2007, we had contracts for the sale of $91.4 million and $28.4 million, respectively, and the purchase of $210.2 million and $74.2 million, respectively, of foreign currencies at fixed rates. These contracts are primarily for the purchase and sale of the British Pound and Euro.

Based on the foreign exchange contracts outstanding at December 31, 2008, a 10% devaluation of the U.S. dollar as compared to the level of foreign exchange rates for currencies under contract at December 31, 2008 would result in approximately $12 million of net unrealized gains. Conversely, a 10% appreciation of the U.S. dollar would result in approximately $12 million of net unrealized losses. Such unrealized gains or losses largely would be offset by corresponding decreases or increases, respectively, in the dollar value of future cash expenditures within the hedging period.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States, which require management to make estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements and the accompanying notes. Management considers an accounting policy to be critical if it is important to our financial condition and results of operations, and if it requires significant judgment and estimates on the part of management in its application. The development and selection of these critical accounting policies have been determined by our management. Due to the significant judgment involved in selecting certain of the assumptions used in these areas, it is possible that different parties could choose different assumptions and reach different conclusions. We consider the policies relating to the following matters to be critical accounting policies:

 

   

Gross versus net revenue recognition;

 

   

Impairment of goodwill; and

 

   

Income taxes.

Gross Versus Net Revenue Recognition

We generate a significant portion of our advertising revenues from our advertising offerings on the Third Party Network, which consist of sales of display advertising. In connection with our advertising offerings on the Third Party Network, we typically act as or use an intermediary or agent in executing transactions with third parties. The significant judgments made in accounting for these arrangements relate to determining whether we should report revenue based on the gross amount billed to the customer or on the net amount received from the customer after commissions and other payments to third parties. To the extent revenues are recorded on a gross basis, any commissions or other payments to third parties are recorded as expense so that the net amount (gross revenues less expense) is reflected in operating income. Accordingly, the impact on operating income is the same whether we record revenue on a gross or net basis.

The determination of whether revenue should be reported gross or net is based on an assessment of whether we are acting as the principal or an agent in the transaction. If we are acting as a principal in a transaction, we report revenue on a gross basis. If we are acting as an agent in a transaction, we report revenue on a net basis.  The determination of whether we are acting as a principal or an agent in a transaction involves judgment and is based on an evaluation of the terms of an arrangement. In determining whether we act as the principal or an agent, we follow the guidance in EITF Issue No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent (“EITF 99-19”). Pursuant to EITF 99-19, we recognize revenue on a gross basis in situations in which we believe we are the principal in transactions considering the indicators set forth in EITF 99-19. We consider all of the indicators in EITF 99-19 in making this determination. While none of the indicators individually are considered presumptive or determinative, in reaching our conclusions on gross versus net revenue recognition, we place the most weight on the analysis of whether or not we are the primary obligor in the arrangement.

 

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As an example of the judgments relating to recognizing revenue on a gross or net basis, we sell advertising on behalf of third parties on the Third Party Network. The determination of whether we should report our revenue based on the gross amount billed to our advertising customers, with the amounts paid to the Third Party Network website owner (for the advertising inventory acquired) reported as costs of revenues, requires a significant amount of judgment based on an analysis of several factors. In these arrangements, we are generally responsible for (i) identifying and contracting with third-party advertisers, (ii) establishing the selling prices of the inventory sold, (iii) serving the advertisements at our cost and expense, (iv) performing all billing and collection activities including retaining credit risk and (v) bearing sole liability for fulfillment of the advertising. Accordingly, in these arrangements, we generally believe we are the primary obligor and therefore report revenues earned and costs incurred related to these transactions on a gross basis. During 2008, we earned and reported gross advertising revenues of $646.0 million and incurred costs of revenues of $478.3 million related to providing advertising services on the Third Party Network.

Impairment 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. FASB Statement No. 142, Goodwill and Intangible Assets (“FAS 142”), requires the testing of goodwill for impairment to be performed at the level referred to as the reporting unit. A reporting unit is either the “operating segment level” or one level below, which is referred to as a “component.” The level at which the impairment test is performed requires judgment as to whether the operations below the operating segment constitute a self-sustaining business. If the operations below the operating segment level are determined to be a self-sustaining business, testing is generally required to be performed at this level; however, if multiple self-sustaining business units exist within an operating segment, an evaluation would be performed to determine if the multiple business units share resources that support the overall goodwill balance. For purposes of our goodwill impairment test, we consider ourselves to be a single reporting unit. Different judgments relating to the determination of reporting units could significantly affect the testing of goodwill for impairment and the amount of any impairment recognized.

In accordance with FAS 142, 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. In performing the first step, we determine the fair value of our single reporting unit using a discounted cash flow (“DCF”) analysis and, in certain cases, a combination of a DCF analysis and a market-based approach. Determining fair value requires the exercise of significant judgment, including judgments about appropriate discount rates, perpetual growth rates, the amount and timing of expected future cash flows, as well as relevant comparable company earnings multiples for the market-based approach. The cash flows employed in the DCF analyses are based on our most recent budgets, forecasts and business plans as well as various growth rate assumptions for years beyond the current business plan period. Discount rate assumptions are based on an assessment of the risk inherent in the future cash flows of the reporting unit. In addition, when a DCF analysis is used as the primary method for determining fair value, we assess the reasonableness of its determined fair value by reference to other fair value indicators such as comparable company public trading values, research analyst estimates and, where available, values observed in private market transactions. As an example of the judgments made by us, in our 2008 goodwill impairment analysis, we increased the discount rates utilized in the DCF analysis to a range of 13% to 15% in 2008 from 12% in 2007, while the terminal growth rates for our advertising revenues were decreased to a range of 2.5% to 3% in 2008 from 4.5% in 2007.

If the estimated fair value of the 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. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with its goodwill carrying amount to measure the amount of impairment loss, if any. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. In other words, the estimated fair value of the reporting unit is allocated to all of the assets and liabilities of that unit

 

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(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 purchase price paid. 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. Significant changes in the estimates and assumptions described above could materially affect the determination of fair value for our reporting unit which could trigger future impairment.

As a result of the goodwill impairment charge recorded in 2008, the carrying value of our goodwill was reset to its estimated fair value as of December 31, 2008. To illustrate the magnitude of future potential goodwill impairment charges if the fair value of our reporting unit had been hypothetically lower by 30% as of December 31, 2008, the reporting unit’s book value would have exceeded fair value by $210 million. If this were to occur, the second step of the goodwill impairment test would be required to be performed to determine the ultimate amount of the goodwill impairment charge.

Income Taxes

Time Warner and its domestic subsidiaries, including AOL prior to the spin-off, file a consolidated U.S. Federal income tax return. Income taxes as presented in the consolidated financial statements attribute current and deferred income taxes of Time Warner to us in a manner that is systematic, rational and consistent with the asset and liability method prescribed by FASB Statement No. 109, Accounting for Income Taxes (“FAS 109”). AOL’s income tax provision is prepared under the “separate return method.” The separate return method applies FAS 109 to the standalone financial statements as if AOL were a separate taxpayer and a standalone enterprise. Income taxes (i.e., 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 results of any difference between GAAP and tax reporting. Deferred income taxes reflect the tax effect of net operating loss, capital loss and general business credit carryforwards and the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial statement and income tax purposes, as determined under enacted tax laws and rates. Valuation allowances are established when management determines it is more likely than not that some portion or all of the deferred tax asset will not be realized. Significant judgment is required with respect to the determination of whether or not a valuation allowance is required for certain of our deferred tax assets.

We analyze uncertain tax positions under the provisions of FIN 48. This interpretation requires us to recognize in the consolidated financial statements those tax positions determined to be “more likely than not” of being sustained upon examination, based on the technical merits of the positions.

From time to time, we engage in transactions in which the tax consequences may be subject to uncertainty. Examples of such transactions include business acquisitions and dispositions, including dispositions designed to be tax-free, issues related to consideration paid or received and certain financing transactions. Significant judgment is required in assessing and estimating the tax consequences of these transactions. We prepare and file tax returns based on interpretation of tax laws and regulations. In the normal course of business, our tax returns are subject to examination by various taxing authorities. Such examinations may result in future tax and interest assessments by these taxing authorities. In determining our tax provision for financial reporting purposes, we establish a reserve for uncertain tax positions unless such positions are determined to be “more likely than not” of being sustained upon examination, based on their technical merits. That is, for financial reporting purposes, we only recognize tax benefits taken on the tax return that we believe are “more likely than not” of being sustained. There is considerable judgment involved in determining whether positions taken on the tax return are “more likely than not” of being sustained. Actual results could differ from the judgments and estimates made, and we may be exposed to losses or gains that could be material. Further, to the extent we prevail in matters for which a liability has been established, or are required to pay amounts in excess of the liability established, our effective income tax rate in a given financial statement period could be materially affected.

 

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Currently, we indemnify Time Warner for certain tax positions related to AOL taken by Time Warner from April 13, 2006 up to the date of the spin-off in its consolidated tax return. In connection with the transactions entered into between AOL and Time Warner prior to the AOL-Google alliance, Time Warner retained the obligation with respect to tax positions related to AOL prior to April 13, 2006 in Time Warner’s consolidated tax return. In the event Time Warner makes payments to a taxing authority with respect to AOL-related tax positions taken from April 13, 2006 through the date of the spin-off, we would be required to make an equivalent payment to Time Warner. The aggregate amount of the reserve for uncertain tax positions underlying this indemnification obligation to Time Warner was $359.8 million (which includes estimated related accrued interest and penalties) at June 30, 2009. This liability is recorded as a long-term obligation to Time Warner in the consolidated balance sheet. This indemnification obligation relates to tax positions taken on Time Warner’s consolidated tax returns that are subject to U.S. Federal, state, local or foreign income tax examinations by taxing authorities. Upon the effectiveness of the Second Tax Matters Agreement, Time Warner will assume the obligation for certain tax positions taken by Time Warner in its consolidated, combined, unitary or similar tax returns with respect to AOL up to the date of the spin-off. As a result, at the date of the spin-off, AOL expects to reverse the recorded liability to Time Warner related to these tax positions, with an offsetting adjustment to equity.

 

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MANAGEMENT

The following table sets forth certain information, as of October 22, 2009, concerning our directors and executive officers following the spin-off, including a five-year employment history and any directorships held in public companies.

 

Name

       Age       

Position with AOL

Mr. Tim Armstrong

   38    Chairman and Chief Executive Officer

Mr. Richard Dalzell

   52    Director

Ms. Karen Dykstra

   50    Director

Mr. William Hambrecht

   74    Director

Ms. Patricia Mitchell

   66    Director

Mr. Michael Powell

   46    Director

Mr. Fredric Reynolds

   59    Director

Mr. James Stengel

   54    Director

Mr. James Wiatt

   63    Director

Mr. Arthur Minson

   38    Executive Vice President and Chief Financial Officer

Mr. Ted Cahall

   50    Executive Vice President and Chief Technology Officer

Mr. Ira Parker

   52    Executive Vice President, Corporate Secretary and General Counsel

Ms. Tricia Primrose

   45    Executive Vice President, Corporate Communications

Mr. Tim Armstrong

Mr. Armstrong has served as Chairman and Chief Executive Officer of AOL since April 7, 2009. Prior to that, Mr. Armstrong was Google’s President of The Americas Operations. Mr. Armstrong joined Google in 2000 as Vice President, Advertising Sales, and in 2004 was promoted to Vice President, Advertising and Commerce and then in 2007 he was named President, Americas Operations and SVP Google, Inc. Before joining Google, Mr. Armstrong served as Vice President of Sales and Strategic Partnerships for Snowball.com from 1998 to 2000. Prior to that, he served as Director of Integrated Sales and Marketing at Starwave’s and Disney’s ABC/ESPN Internet Ventures. Mr. Armstrong started his career by co-founding and running a newspaper based in Boston, Massachusetts.

Mr. Richard L. Dalzell

Mr. Richard Dalzell was Senior Vice President and Chief Information Officer of Amazon.com, Inc. until 2007. Previously, Mr. Dalzell served in numerous other positions at Amazon, including Senior Vice President of Worldwide Architecture and Platform Software and Chief Information Officer from 2001 to 2007, Senior Vice President and Chief Information Officer from 2000 to 2001 and Vice President and Chief Information Officer from 1997 to 2000. Prior to Amazon, Mr. Dalzell was Vice President of the Information Systems Division at Wal-Mart from 1994 to 1997.

Ms. Karen E. Dykstra

Ms. Karen Dykstra is a partner at Plainfield Asset Management LLC, and has been Chief Operating Officer and Chief Financial Officer of Plainfield Direct Inc. since 2006. Plainfield Asset Management LLC manages investment capital for institutions and high net worth individuals based in the United States and abroad. Plainfield Direct Inc. is a business development company managed by Plainfield Asset Management. Prior to joining Plainfield, Ms. Dykstra was the Chief Financial Officer of Automatic Data Processing, Inc. from 2003 to 2006. Ms. Dykstra serves on the boards of Gartner, Inc. and Crane Co.

 

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Mr. William R. Hambrecht

Mr. William Hambrecht founded and has been Chairman and Chief Executive Officer of WR Hambrecht + Co since 1998. WR Hambrecht + Co is a financial services firm. Before that, Mr. Hambrecht co-founded Hambrecht & Quist. In 2007, Mr. Hambrecht co-founded the United Football League. Mr. Hambrecht serves on the board of Motorola, Inc.

Ms. Patricia E. Mitchell

Ms. Patricia Mitchell has served as President and Chief Executive Officer of The Paley Center for Media, a global non-profit cultural institution, since 2006. Before that, Ms. Mitchell was President and CEO of the Public Broadcasting Service from 2000 to 2006. For more than two decades, Ms. Mitchell was a journalist and producer, serving as reporter, anchor, talk show host, producer and executive for three broadcast networks and several cable channels. Ms. Mitchell serves on the board of Sun Microsystems, Inc.

Mr. Michael K. Powell

Mr. Michael Powell has served as a Senior Advisor to Providence Equity Partners, a private equity firm since 2005. Mr. Powell is also Chairman of the MK Powell Group, which focuses on strategic advice in the areas of technology, media and communications. Previously, Mr. Powell served as Chairman of the Federal Communications Commission from 2001 to 2005. He also served as the Chief of Staff of the Department of Justice’s Antitrust Division and was an associate with the law firm of O’Melveny & Myers LLP. Mr. Powell serves on the boards of Cisco Systems, Inc. and Education Management Corporation. He was also named Chairman of NTT DoCoMo’s 5th U.S. Advisory Board.

Mr. Fredric G. Reynolds

Mr. Fredric Reynolds was with CBS Corporation and its predecessor companies from 1994 until he retired in August 2009. Mr. Reynolds was Executive Vice President and Chief Financial Officer of CBS Corporation from 2005 to 2009. He also served as President and Chief Executive Officer of the Viacom Television Stations Group of Viacom, Inc., and President of the CBS Television Stations Division of CBS, Inc. Before that, he was Executive Vice President and Chief Financial Officer of Viacom, Inc., CBS Corporation and Westinghouse Electric Corporation. Mr. Reynolds joined Westinghouse from PepsiCo Inc. Mr. Reynolds serves on the board of Kraft Foods Inc.

Mr. James R. Stengel

Mr. James Stengel has been President and Chief Executive Officer of The Jim Stengel Company, LLC, a think tank and consulting firm, since 2008. Mr. Stengel is also currently an adjunct marketing professor at UCLA’s Anderson School of Management. Mr. Stengel worked at Procter & Gamble from 1983 to 2008, holding a variety of positions including Global Marketing Officer from 2001 to 2008. Mr. Stengel serves on the board of Motorola, Inc.

Mr. James A. Wiatt

Mr. Jim Wiatt has been an independent consultant since June 2009. Mr. Wiatt served as Chairman and Chief Executive Officer of the William Morris Agency from 1999 until 2009, overseeing all areas of the entertainment company. Before joining WMA, Mr. Wiatt was Co-Chairman and Co-CEO of International Creative Management, a talent management company.

Mr. Arthur Minson

Mr. Minson has served as Executive Vice President and Chief Financial Officer of AOL since September 8, 2009. Prior to that, Mr. Minson served as Executive Vice President and Deputy Chief Financial Officer at Time

 

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Warner Cable Inc. Prior to joining Time Warner Cable in February 2006, Mr. Minson was Senior Vice President, Corporate Finance and Development at AOL from December 2004 to February 2006. Prior to that, Mr. Minson was Senior Vice President, Finance for AOL’s Broadband and Premium Services division from April 2004 to December 2004. Mr. Minson has also held senior finance positions at Rainbow Media Holdings, Inc. and Time Warner Inc. Mr. Minson began his career in the audit practice of Ernst and Young LLP.

Mr. Ted Cahall

Mr. Cahall has served as Executive Vice President and Chief Technology Officer of AOL since July 2009. Prior to that, Mr. Cahall served as President, AOL Products & Technologies from January 2009. Mr. Cahall joined AOL in January 2007 as Executive Vice President, Platforms division and, beginning in August 2007, Mr. Cahall also served as Executive Vice President, Technologies division. Before joining AOL, Mr. Cahall was Executive Vice President and Chief Operating Officer of United Online Inc.’s Internet properties from August 2005 to January 2007. Prior to that, Mr. Cahall was Chief Information Officer and Senior Vice President of Engineering for CNET Networks from January 2000 to August 2005. Before that, Mr. Cahall served as a Vice President at Bank of America for six years. Mr. Cahall spent the first six years of his career at AT&T Bell Laboratories.

Mr. Ira Parker

Mr. Parker has served as Executive Vice President, General Counsel and Corporate Secretary of AOL since 2006. Mr. Parker has also served as Executive Vice President, Corporate Development from February 2009 to September 2009 and also, from January 2008 to June 2009, served as Executive Vice President, Business Development. Prior to joining AOL, Mr. Parker served as Vice President and General Counsel, Corporate Secretary, and Chief Compliance Officer at Polaroid Corp. Prior to joining Polaroid in February 2004, Mr. Parker served as President and Chief Executive Officer at Genuity, Inc. from February 2003 to December 2003. Prior to that, he was Executive Vice President, General Counsel, Corporate Secretary, and Chief Compliance Officer of Genuity. Prior to joining Genuity in June 2000, Mr. Parker was a Vice President and Deputy General Counsel at GTE Corp. for two years and was a partner in the Washington, D.C. law firm Alston & Bird for three years. Before that, Mr. Parker spent nearly 10 years with the Federal Deposit Insurance Corp. in Washington, D.C. in various legal positions including Vice President and Deputy General Counsel of the FDIC’s Resolution Trust Corporation.

Ms. Tricia Primrose

Ms. Primrose has served as Executive Vice President, Corporate Communications of AOL since January 2007. Prior to that, Ms. Primrose was Vice President, Corporate Communications at AOL from March 2005. Ms. Primrose joined AOL in 1999 and from 2001 to March 2005, Ms. Primrose was Vice President, Corporate Communications at Time Warner Inc. Prior to that, she served as an Executive Vice President for the strategic communications firm Robinson Lerer & Montgomery from January 1997 to October 1999.

 

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The Board of Directors Following the Separation and Director Independence

Immediately following the separation, our board of directors will be comprised of nine directors. New York Stock Exchange rules require that the board be comprised of a majority of independent directors. We expect that our board of directors will determine, in accordance with the listing standards of the New York Stock Exchange, that all of our directors (with the exception of Mr. Armstrong, Mr. Hambrecht and Mr. Powell) are independent.

Committees of the Board

Effective upon the completion of the separation, our board of directors will have the following committees, each of which will operate under a written charter that will be posted to our website prior to the separation.

Audit Committee

The Audit Committee will be established in accordance with Section 3(a)(58)(A) and Rule 10A-3 under the Exchange Act. The Audit Committee will, among other things:

 

   

oversee the integrity of regular financial reports and other financial information we provide to the SEC or the public;

 

   

select an independent registered public accounting firm, such selection to be ratified by shareholders at our annual meeting;

 

   

preapprove all services to be provided to us by our independent registered public accounting firm;

 

   

confer with our independent registered public accounting firm to review the plan and scope of their proposed audit as well as their findings and recommendations upon the completion of the audit;

 

   

review the independence of the registered public accounting firm;

 

   

meet with the independent registered public accounting firm and with our appropriate financial personnel and internal financial controllers regarding our internal controls, practices and procedures; and

 

   

oversee all of our compliance, internal controls and risk management policies.

The Audit Committee will be comprised of members such that it meets the independence requirements set forth in the listing standards of the New York Stock Exchange and in accordance with the Audit Committee charter. Each of the members of the Audit Committee will be financially literate and have accounting or related financial management expertise as such terms are interpreted by the board of directors in its business judgment. None of our Audit Committee members will simultaneously serve on more than two other public company audit committees unless the board of directors specifically determines that it would not impair the ability of an existing or prospective member to serve effectively on the Audit Committee. The initial members of the Audit Committee will be determined prior to the spin-off.

Compensation Committee

The Compensation Committee will, among other things, be responsible for:

 

   

setting and reviewing our general policy regarding executive compensation;

 

   

determining the compensation (including salary, bonus, equity-based grants and any other long-term cash compensation) of our Chief Executive Officer and other senior executives;

 

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overseeing our disclosure regarding executive compensation, including approving the report to be included in our annual proxy statement on Schedule 14A and included or incorporated by reference in our annual report on Form 10-K; and

 

   

approving any employment agreements for our Chief Executive Officer and other senior executives.

The Compensation Committee will be comprised of members such that it meets the independence requirements set forth in the listing standards of the New York Stock Exchange and in accordance with the Compensation Committee charter. The members of the Compensation Committee will be “non-employee directors” (within the meaning of Rule 16b-3 of the Exchange Act) and “outside directors” (within the meaning of Section 162(m) of the Internal Revenue Code). The initial members of the Compensation Committee will be determined prior to the spin-off.

Nominating and Governance Committee

The Nominating and Governance Committee will, among other things, be responsible for:

 

   

reviewing and recommending to our board of directors amendments to our by-laws, certificate of incorporation, committee charters and other governance policies;

 

   

identifying, reviewing and recommending to our board of directors individuals for election to the board;

 

   

overseeing the Chief Executive Officer succession planning process, including an emergency succession plan;

 

   

reviewing the compensation for non-employee directors and making recommendations to our board of directors;

 

   

overseeing the board of directors’ annual self-evaluation; and

 

   

overseeing and monitoring general governance matters including communications with shareholders, regulatory developments relating to corporate governance and our corporate social responsibility activities.

The Nominating and Governance Committee will be comprised of members such that it meets the independence requirements set forth in the listing standards of the New York Stock Exchange and in accordance with the Nominating and Governance Committee charter. The initial members of the Nominating and Governance Committee will be determined prior to the spin-off.

Code of Ethics

Prior to the completion of the separation, we will adopt a written code of ethics that is designed to deter wrongdoing and to promote:

 

   

honest and ethical conduct;

 

   

full, fair, accurate, timely and understandable disclosure in reports and documents that we file with the SEC and in our other public communications;

 

   

compliance with applicable laws, rules and regulations, including insider trading compliance; and

 

   

accountability for adherence to the code and prompt internal reporting of violations of the code, including illegal or unethical behavior regarding accounting or auditing practices.

A copy of our code of ethics will be posted on our website immediately prior to the separation.

 

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Director Nomination Process

We retained an outside executive search firm, Spencer Stuart, to assist in the process of identifying and recruiting individuals to serve on our board of directors. The process involved, among other steps: developing criteria for selecting members of the board; identifying potential candidates; reviewing the potential candidates against the relevant criteria; interviewing the potential candidates; and exchanging relevant information between us and the potential candidates. The search process also involved senior management at both AOL and Time Warner, including executives involved in the areas of human resources, law, finance, governance and investor relations. The initial directors who will serve after the spin-off will be elected by our current directors prior to the separation, and will begin their terms at the time of the distribution, with the exception of one independent director who shall serve on our Audit Committee and begin his or her term prior to the date on which when-issued trading of our common stock commences on the New York Stock Exchange.

With regard to the criteria for our board members, we and Time Warner have sought to ensure that each director has the personal characteristics (such as integrity, business judgment, intellectual ability and capacity to work as part of a team), as well as the time and commitment, to serve effectively and contribute meaningfully as a director. In addition, we and Time Warner endeavored to provide that the board of directors, overall, has the appropriate set of professional skills, industry experience and diversity of perspectives to fulfill roles of the board and its committees. These include skills in the areas of finance, accounting, law, technology, marketing and general executive management, as well as experience in the areas of advertising, technology, media and government. Finally, we and Time Warner have sought to ensure that a majority of the board members are independent under applicable regulatory requirements and our governance documents, and that a majority of the board members have prior experience working closely with, or serving on, the board of a public company.

We intend to adopt corporate governance policies that will contain information concerning the responsibilities of the Nominating and Governance Committee with respect to identifying and evaluating future director candidates.

The Nominating and Governance Committee will evaluate future director candidates in accordance with the director membership criteria described in our corporate governance policies. The Nominating and Governance Committee will evaluate a candidate’s qualifications to serve as a member of our board of directors based on the skills and characteristics of individual directors as well as the composition of our board of directors as a whole. In addition, the Nominating and Governance Committee will evaluate a candidate’s professional skills and background, experience in relevant industries, age, diversity, geographic background, the number of other directorships, along with qualities expected of all directors, including integrity, judgment, acumen and the time and ability to make a constructive contribution to our board.

The Nominating and Governance Committee will consider director candidate recommendations by shareholders. Our amended and restated by-laws will provide that any shareholder of record entitled to vote for the election of directors at the applicable meeting of shareholders may nominate persons for election to our board of directors, if such shareholder complies with the applicable notice procedures.

Communications with Non-Management Members of the Board of Directors

Generally, it is the responsibility of management to speak for the Company in communications with outside parties, but we intend to adopt a Policy Statement Regarding Stockholder Communications with the Board of Directors, which sets forth the processes whereby shareholders and other interested third parties may communicate with non-management members of our board of directors.

 

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EXECUTIVE COMPENSATION

Compensation Discussion and Analysis

Prior to the spin-off, the Company has been a subsidiary of Time Warner, and therefore, its historical compensation strategy has been primarily determined by the Company’s senior management, acting in consultation with Time Warner’s senior management and the Time Warner Compensation and Human Development Committee (the “TW Committee”) of the Time Warner Board of Directors (the “TW Board”). Since the information presented in the compensation tables of this Information Statement relates to the Company’s 2008 fiscal year, which ended on December 31, 2008, this Compensation Discussion and Analysis (“CD&A”) focuses primarily on the Company’s compensation programs and decisions with respect to 2008 and the processes for determining 2008 compensation. In connection with the spin-off, the board of directors of the Company (the “AOL Board”) will form its own compensation committee (the “AOL Committee”). Following the spin-off, the AOL Committee will determine the Company’s executive compensation.

The Company experienced significant changes to its senior management during 2009, including the departure of its former Chairman and Chief Executive Officer (the “Former CEO”), Randy Falco, its former President and Chief Operating Officer (the “Former President”), Ron Grant, and its former Executive Vice President and Chief Financial Officer (the “Former CFO”), Nisha Kumar, and the hiring of its current Chairman and Chief Executive Officer (the “Current CEO”), Timothy Armstrong, who was formerly a Senior Vice President of Google Inc., and its current Chief Financial Officer (the “Current CFO”), Arthur Minson. Mr. Armstrong was hired and commenced a review of the Company’s strategy, structure and operations at a time when Time Warner was evaluating structural alternatives for the Company, culminating in the ultimate decision to proceed with the separation of the Company from Time Warner, and Mr. Minson was hired in anticipation of the Company’s separation from Time Warner. In light of these recent changes, this CD&A includes a detailed discussion of the terms of Mr. Armstrong’s and Mr. Minson’s employment agreements, and this CD&A and the related compensation tables also include information about the 2008 compensation of the Former CEO, the Former President and the Former CFO, as well as the Company’s two other most highly compensated executive officers during 2008 who are still employed by the Company, Ira Parker and Tricia Primrose. For purposes of this CD&A, the Company refers to the Former CEO, the Former President, the Former CFO, Mr. Parker and Ms. Primrose as the Company’s Named Executive Officers. The Company expects Mr. Parker and Ms. Primrose to remain employed with the Company following the spin-off. The following table lists the name of each Named Executive Officer, each such executive’s position with the Company during 2008 and the executive’s years of service with the Company and its affiliates as of December 31, 2008:

 

Name

  

Position with the Company during 2008

   Years of Service at the Company
and/or its Affiliates

Randy Falco

   Chairman and Chief Executive Officer    Over 2 years

Ron Grant

   President and Chief Operating Officer    Over 12 years

Nisha Kumar

   Executive Vice President and Chief Financial Officer    Over 7 years

Ira Parker

   Executive Vice President, Business Development, Corporate Secretary and General Counsel    Over 2 years

Tricia Primrose

   Executive Vice President, Corporate Communications    Over 9 years

This CD&A first describes how the Company’s compensation program was structured in 2008 and the roles of the TW Committee, Time Warner’s management and the Company’s management with respect to the

 

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Company’s 2008 compensation program. This CD&A then explains the Company’s current executive compensation philosophy and describes the main elements of the Company’s compensation program applicable to the Named Executive Officers, with a focus on determinations regarding their 2008 compensation. Finally, this CD&A describes actions taken in 2009 in light of the global economic downturn and discussions regarding potential transactions involving the Company, including the employment agreements with Mr. Armstrong and Mr. Minson and the separation agreements with Mr. Falco, Mr. Grant and Ms. Kumar.

Executive Compensation Program Design

Role of the TW Committee

In 2008, the TW Committee, acting pursuant to authority delegated to it by the TW Board, was responsible for (i) reviewing and approving the compensation of the Former CEO and the Former President, (ii) reviewing the succession plan for the Company’s Chief Executive Officer and (iii) approving the annual grant pool and grant guidelines for long-term incentive awards, including stock options, restricted stock units (“RSUs”) and performance stock units (“PSUs”).

Grants of long-term incentive awards made to employees of Time Warner and the Time Warner divisions (other than executive officers of Time Warner and Chief Executive Officers of the Time Warner divisions, as well as the Company’s Former President) that are within the annual grant guidelines established by the TW Committee are approved in the manner described under “—Role of Time Warner’s Management” below. Grants that exceed such guidelines are approved by the TW Committee.

In 2006, the TW Committee approved the entry into an employment agreement with Mr. Falco, because the TW Committee is responsible for approving all agreements with Chief Executive Officers of the Time Warner divisions. In 2008, the TW Committee approved an amended and restated employment agreement with Mr. Falco, described under “—Agreements with Named Executive Officers” below. In 2006, the TW Committee approved Mr. Grant’s employment agreement, described under “—Agreements with Named Executive Officers” below, because the TW Committee is responsible for approving all agreements that provide for annual compensation in excess of a designated threshold. In 2009, the TW Committee approved the terms of the employment agreement with Mr. Armstrong, which is described under “—Actions Taken in 2009—Employment Agreement with Current Chairman and Chief Executive Officer” below.

In addition, in 2009, the TW Committee approved the terms of the separation agreements with Mr. Falco and Mr. Grant, which are described under “—Agreements with Named Executive Officers” below, and granted authority to Time Warner’s Chief Executive Officer, Time Warner’s Executive Vice President, Administration (“EVP, Administration”) and Time Warner’s Senior Vice President, Global Compensation and Benefits (“SVP, Global Compensation and Benefits”) to negotiate and approve those separation agreements within the guidelines established by the TW Committee.

Role of Time Warner’s Management

During 2008, Time Warner’s Chief Executive Officer, Chief Financial Officer and EVP, Administration (i) approved the financial performance measures for the Company, which the Company included in its 2008 Annual Incentive Plan (the “2008 AIP”), (ii) approved a retention program established by the Company in 2008 for certain Executive Vice Presidents and (iii) generally reviewed the other aspects of the Company’s compensation program for its executive officers. Time Warner’s Chief Executive Officer, along with the TW Committee, reviewed the individual performance of Mr. Falco and Mr. Grant in connection with the annual review process as described under “—Annual Performance Review Process” below.

Time Warner’s Management Option Committee (the “TW Management Option Committee”), which consists of Time Warner’s Chief Executive Officer, Chief Financial Officer and EVP, Administration, approves stock option grants to Company employees, and Time Warner’s Chief Executive Officer, in his capacity as a

 

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member of the TW Board, approves awards of RSUs and PSUs to Company employees, in both cases, provided that the grants and awards are within annual guidelines established by the TW Committee, as described under “—Role of the TW Committee” above. However, the grants to Mr. Falco and Mr. Grant were approved by the TW Committee rather than the TW Management Option Committee, as described under “—Role of the TW Committee” above.

In addition, in connection with entering into the separation agreements with Mr. Falco and Mr. Grant in 2009, Time Warner’s Chief Executive Officer, EVP, Administration and SVP, Global Compensation and Benefits met with the TW Committee to review the obligations of the Company to these former executives under their existing employment agreements, propose terms of the separation agreements and request authority to negotiate and approve the separation agreements. Time Warner’s EVP, Administration and SVP, Global Compensation and Benefits also negotiated and approved the separation agreement with Ms. Kumar in 2009.

In 2009, Time Warner’s Chief Executive Officer, Chief Financial Officer, EVP, Administration, General Counsel and SVP, Global Compensation and Benefits consulted with and made recommendations to the TW Committee in connection with the hiring of, and entry into an employment agreement with, Mr. Armstrong to serve as the Current CEO. In addition, during 2009, Time Warner’s EVP, Administration and Time Warner’s SVP, Global Compensation and Benefits consulted with and made recommendations to Mr. Armstrong in connection with the hiring of Mr. Minson to serve as the Current CFO and the entry into an employment agreement with Mr. Minson, which is described under “—Actions Taken in 2009—Employment Agreement with Current Chief Financial Officer” below.

Role of the Company’s Management

Other than on matters relating to Mr. Falco’s and Mr. Grant’s compensation, for which the TW Committee was responsible, the Company’s Chief Executive Officer has primary responsibility for determining the compensation of the Company’s executive officers, including Ms. Kumar, Mr. Parker and Ms. Primrose. In connection with reviewing their compensation, the Company’s Chief Executive Officer frequently consults with David Harmon, the Company’s Executive Vice President, Human Resources (“EVP, HR”). The Company’s Chief Executive Officer also consults with the Company’s Chief Financial Officer on matters such as establishing financial performance metrics for incentive compensation and determining how executive pay fits within the Company’s budget parameters. Furthermore, as noted above, the Company’s Chief Executive Officer also consults with Time Warner management on certain matters, including events that are outside the ordinary course of business, such as executive promotions and the establishment of retention programs for executives. In the case of ordinary course compensation decisions regarding Ms. Kumar, Mr. Parker and Ms. Primrose, such as their regular base salary merit increases and the assessment of their individual performance for purposes of determining annual bonuses, the Company’s Chief Executive Officer is generally the principal decision-maker. In 2009, the Current CEO approved the separation agreement with Ms. Kumar that had been recommended, negotiated and approved by Time Warner’s management.

Annual Performance Review Process

The Company determines regular base salary merit increases and annual bonuses through an annual review of all employees, including the Named Executive Officers (other than Mr. Falco and Mr. Grant), to measure individual performance over the course of the performance year against pre-set financial, operational and individual goals. The system assists in ensuring that each employee’s compensation is tied to the financial and operating performance of the Company, the employee’s individual achievement and the employee’s demonstration of the Company’s strategic initiatives and values. The annual performance review process is generally conducted in the fourth quarter of the relevant performance year and continues into the first quarter of the following year. As part of the annual performance review process, each employee prepares a self-assessment of his or her performance against pre-set individual goals. Then, the employee’s manager conducts a performance assessment of the employee and makes recommendations concerning base salary merit increases and annual bonuses. The Company’s Chief Executive Officer, in consultation with the Company’s EVP, HR,

 

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conducts the performance assessment of each executive officer who reports directly to him, including Ms. Kumar, Mr. Parker and Ms. Primrose, with respect to their base salary merit increases, as described under “—Base Salary” below, and annual bonuses, as described under “—Annual Incentive Compensation” below.

In 2008, Time Warner’s Chief Executive Officer and the TW Committee conducted the performance assessments of Mr. Falco and Mr. Grant.

Philosophy, Review of Market Practices and Elements of Executive Compensation

Philosophy

In 2008, the Company was guided by the following philosophy in determining the compensation of the Named Executive Officers:

 

   

Competition. Compensation should reflect the competitive marketplace to enable the Company to attract, retain and motivate talented executive officers over the long term.

 

   

Accountability for Business Performance. Compensation should be tied in part to the Company’s financial and operating performance, so that executive officers are held accountable through their compensation for the performance of the business operations for which they are responsible.

 

   

Accountability for Individual Performance. Compensation should be tied in part to the executive officer’s individual performance to encourage and reflect individual contributions to the Company’s performance.

 

   

Retention. Compensation should be used to retain, motivate and eliminate distractions to executive officers during critical times of transition of the Company.

Use of Compensation Surveys and Other Comparative Data

In connection with the Company’s compensation planning process, it utilizes internal and external sources of information to determine appropriate levels and mixes of compensation. These sources include internal comparisons prepared by Time Warner reflecting information from its many subsidiaries and the Time Warner divisions. In addition, Time Warner has available extensive information on competitive market practices based on numerous compensation surveys of public and private technology companies and other multinational companies prepared by a variety of different compensation firms, including Radford Consulting, Mercer, SCHips, EmpSight, Towers Perrin, ICR, Altman Weil and Croner. In reviewing the external data, the Company typically focuses on companies in the technology industry and other multinational companies with annual revenues similar to the Company’s annual revenue. However, the Company generally does not focus on a specific peer group of companies. The Company believes that the internal data from other Time Warner divisions and the external survey data provide valuable information about the current market practices of a broad spectrum of companies.

When it determined the compensation for Mr. Falco, in addition to consulting internal sources of information from its other divisions, the TW Committee reviewed market data for compensation of Chief Executive Officers of six technology companies: Amazon.com, Inc., eBay, Inc., Google Inc., IAC/InterActive Corp., Microsoft Online Services and Yahoo! Inc., as well as Chief Executive Officers of companies in the Company’s general industry. The TW Committee reviewed similar market data for Chief Operating Officers in connection with entering into Mr. Grant’s employment agreement.

The Company typically targets total direct compensation, which is comprised of an executive officer’s base salary, annual cash bonus target and the estimated value of equity-based awards, at approximately the 75th percentile of the blended data from the internal and external sources it reviews in connection with the compensation planning process. In addition, the Company typically targets base salary at approximately the 50th percentile of the blended data. Although the Company has targeted the 75th percentile for total direct compensation, actual total direct compensation has been between the 50th and 75th percentiles for some

 

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executives due to the amount and value of Time Warner equity-based awards. For 2008, Ms. Kumar’s total direct compensation was between the 50th and 75th percentiles of the blended data, Mr. Parker’s total direct compensation was between the 50th and 75th percentiles of the blended data and Ms. Primrose’s total direct compensation was above the 75th percentile of the blended data. For 2008, Mr. Falco’s total direct compensation was between the 75th and 90th percentile of the compensation paid to Chief Executive Officers of companies in the Company’s general industry and also between the 75th and 90th percentiles of the compensation paid to Chief Executive Officers of the six technology companies listed above. At the time the Company entered into an employment agreement with Mr. Grant, Mr. Grant’s target total direct compensation was set at between the 75th and 90th percentiles of the compensation paid to Chief Operating Officers of companies in the Company’s general industry and between the 50th and 75th percentiles of the compensation paid to Chief Operating Officers of the six technology companies listed above. Mr. Grant’s annual compensation was not reviewed against market data for 2008.

Elements of Compensation for Executive Officers

The Company’s compensation philosophy is reflected in the elements of the Company’s executive compensation program, which includes the following key components:

 

   

annual base salary;

 

   

annual incentive compensation, including performance-based cash incentive compensation (i.e., bonus), based on the achievement of Company financial and operational goals and individual goals;

 

   

long-term equity incentive compensation, prior to the spin-off, in the form of Time Warner stock options, RSUs and PSUs;

 

   

cash retention bonuses provided to certain executives of the Company; and

 

   

retirement, health and welfare and other benefit programs provided generally to employees and some additional executive benefits, including post-termination compensation in the event of an involuntary termination of employment without cause.

In general, the elements of compensation reflect a focus on performance-driven compensation, a balance between short-term and long-term compensation and a combination of cash and equity-based compensation. All elements of executive compensation are generally reviewed by the Company’s Chief Executive Officer, Chief Financial Officer and EVP, HR, as well as Time Warner’s Chief Executive Officer, Chief Financial Officer and EVP, Administration, to maintain the amount and type of compensation within appropriate competitive parameters so that the program design encourages long-term growth in the Company’s value and an executive officer’s demonstration of the core values of the Company. However, the elements of Mr. Falco’s and Mr. Grant’s compensation were determined, reviewed and approved by the TW Committee. Each element of the Company’s 2008 executive compensation and the rationale for each element are described below.

Base Salary

The Company believes that including a competitive base salary in each executive officer’s compensation package is appropriate in order to attract, retain and motivate executive officers capable of leading its business in the complex and competitive business environment in which the Company operates. In reviewing annual base salary, the Company considers the nature and scope of each executive officer’s responsibilities, the executive officer’s prior compensation and performance in his or her job, the pay levels of similarly situated executive officers within the Company and the Time Warner divisions, the terms of employment letter agreements and published market survey data on compensation levels.

2008 Base Salaries. In 2008, the TW Committee approved the entry into an amended and restated employment agreement with Mr. Falco, described under “—Agreements with Named Executive Officers” below, and in 2006, the TW Committee approved the entry into Mr. Grant’s employment agreement, described under

 

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“—Agreements with Named Executive Officers” below. The base salaries for Mr. Falco and Mr. Grant were set forth in their employment agreements and did not change for 2008. Between December 2007 and February 2008, AOL LLC entered into a new employment letter agreement with each of Ms. Kumar, Mr. Parker and Ms. Primrose, which superseded the terms of their prior employment letter agreements and established their base salaries for 2008. These agreements are described in more detail under “—Agreements with Named Executive Officers” below. The base salaries for Ms. Kumar, Mr. Parker and Ms. Primrose were set by the Former CEO in consultation with the Company’s EVP, HR.

Pursuant to Mr. Falco’s and Mr. Grant’s employment agreements, their base salaries for 2008 were $1.0 million and $750,000, respectively. Mr. Falco’s and Mr. Grant’s base salaries were determined at the time their employment agreements were entered into based on the market data reviewed by the TW Committee described under “—Use of Compensation Surveys and Other Comparative Data” above. Ms. Kumar received a new employment letter agreement on January 9, 2008. After reviewing published market survey data along with internal comparisons across Time Warner and the Time Warner divisions, the Company increased Ms. Kumar’s base salary to $550,000, reflecting a 16% increase based on her performance. Mr. Parker received a new employment letter agreement on January 7, 2008, in connection with his promotion to include the position of the Company’s Executive Vice President, Business Development (“EVP, Business Development”). After reviewing published market survey data along with internal comparisons across Time Warner and the Time Warner divisions, the Company increased Mr. Parker’s base salary to $550,000 retroactive to the date of his promotion in 2007, reflecting a 22% increase based on his additional responsibilities and title and his performance. Ms. Primrose received a new employment letter agreement on December 7, 2007, with a base salary of $425,000, reflecting a 10.4% increase based on her performance. As a result of the global economic downturn and declining revenue and profits at the Company, Time Warner and the Former CEO, the Former CFO and the Company’s EVP, HR decided that none of the Company’s executive officers would receive a salary increase in 2009.

Annual Incentive Compensation

Mr. Falco and Mr. Grant Annual Bonuses. Mr. Falco’s and Mr. Grant’s employment agreements contained annual bonus provisions that were intended to provide each of Mr. Falco and Mr. Grant with a competitive level of compensation in the event that both the Company and the individual achieved satisfactory performance. Mr. Falco’s and Mr. Grant’s annual bonus awards for 2008 were designed to reward each individual for achieving financial and operational goals with respect to the Company and to reward individual performance. Mr. Falco and Mr. Grant did not participate in the 2008 AIP. The following is a description of the factors that were taken into account in determining 2008 annual bonuses under Mr. Falco’s and Mr. Grant’s employment agreements.

 

   

Bonus Targets. Mr. Falco’s and Mr. Grant’s bonus targets were expressed as stated dollar amounts in their employment agreements. As with the base salary, the bonus targets for Mr. Falco and Mr. Grant were set by the TW Committee. The bonus targets were determined taking into consideration the nature and scope of Mr. Falco’s and Mr. Grant’s responsibilities and were determined at the time their employment agreements were entered into based on the market data reviewed by the TW Committee described under “—Use of Compensation Surveys and Other Comparative Data” above.

 

   

Company Performance Goals. At the outset of the year, the TW Committee established goals for Mr. Falco and Mr. Grant based on the Company’s Adjusted OIBDA and Free Cash Flow. The calculation of the Company’s Adjusted OIBDA and Free Cash Flow for purposes of the annual bonus provisions of Mr. Falco’s and Mr. Grant’s employment agreements is described under “—Annual Incentive Compensation—Adjusted OIBDA and Free Cash Flow” below.

 

   

Individual Performance Goals. Mr. Falco and Mr. Grant worked together to formulate their proposed individual performance goals and then submitted them to Time Warner’s Chief Executive Officer for review. The TW Committee subsequently approved the individual goals for Mr. Falco. The individual goals were intended not only to guide Mr. Falco’s and Mr. Grant’s actions, but also to assist the TW Committee at the end of the year in exercising discretion in determining the bonuses to be paid to Mr. Falco and Mr. Grant.

 

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Evaluation Against Goals and Determination of Bonuses. At the end of the year, the Company’s performance was evaluated by the Company’s Chief Executive Officer, Chief Financial Officer and EVP, HR, in consultation with Time Warner’s Chief Executive Officer, Chief Financial Officer and EVP, Administration, with respect to the Company’s achievement of its pre-set financial criteria. Time Warner’s Chief Executive Officer conducted individual performance evaluations of Mr. Falco and Mr. Grant and conferred with the TW Committee regarding such evaluations. Time Warner’s Chief Executive Officer then recommended to the TW Committee the amounts of Mr. Falco’s and Mr. Grant’s bonuses based on Company and individual performance, and the TW Committee approved such amounts.

The following is a description of the 2008 bonus targets, performance goals and the evaluation process for purposes of Mr. Falco’s and Mr. Grant’s annual bonuses under their employment agreements.

 

   

2008 Bonus Targets. For 2008, Mr. Falco’s annual bonus target was $3.0 million, and Mr. Grant’s annual bonus target was $1.5 million, as determined by the TW Committee and set forth in their employment agreements.

 

   

2008 Performance Goals. For Mr. Grant and Mr. Falco, 70% of their 2008 annual bonuses was based on Company financial metrics, which are set forth in the tables below, and 30% was based on their individual performance versus certain strategic metrics, which are described below. At the beginning of 2008, the TW Committee approved the 70% financial goal and 30% personal goal weighting for Mr. Falco and Mr. Grant because it emphasizes the importance of the Company’s financial performance and reinforces Mr. Falco’s and Mr. Grant’s accountability for the achievement of their individual goals for the year. The relative weighting of these goals advances the components of the Company’s compensation philosophy that individual executive officers be held accountable for both the performance of the business operations for which they are responsible and their personal performance.

 

   

2008 Company Performance Goals. Within the Company financial measures, the TW Committee assigned a weighting of 70% to Adjusted OIBDA and a weighting of 30% to Free Cash Flow, based on its view of the relative importance of these measures as indicators of the Company’s operating performance over both the short and long term. The financial measures were selected not only because they are important measures of the Company’s financial performance, but also because they are consistent with the measures Time Warner used through 2008 to provide its business outlook to its investors.

For 2008, the TW Committee approved the actual financial performance targets for the Company in the table below with respect to Mr. Falco’s and Mr. Grant’s annual bonuses. The financial criteria and the performance rating for 2008 associated with the Adjusted OIBDA and Free Cash Flow metrics for the Company are shown in the table below.

 

Financial Criteria

($ in millions)

   % of Financial
Component
    25%    50%    Target
100%
   Maximum
150%
   2008
Actual
   2008
Actual
Performance
Rating (%)
 

Adjusted OIBDA

   70   $ 1,300    $ 1,600    $ 1,900    $ 2,000    $ 1,558    47

Free Cash Flow

   30   $ 750    $ 1,000    $ 1,250    $ 1,440    $ 1,169    84

 

   

2008 Individual Goals. The individual goals established for Mr. Falco and Mr. Grant at the beginning of 2008 were tailored to their positions and focused on supporting the Company’s overall strategic initiatives and values, which included operating with integrity, working collaboratively, creating an inclusive work place, being outwardly focused and driving performance and innovation (the “Global AOL Values”). Mr. Falco and Mr. Grant had the same individual goals because Time Warner viewed them as working together to achieve common goals with respect to the Company. Their individual goals were proposed by Mr. Falco to Time Warner’s Chief Executive Officer, who then submitted the individual goals for approval by the TW Committee. The individual goals for 2008 for Mr. Falco and Mr. Grant are described immediately below.

 

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Separate the Company’s business operations into Platform-A (i.e., the Company division that integrated advertising sales for all of the Company’s websites), Publishing (i.e., the Company’s content business) and Access (i.e., the Company’s legacy subscription business).

 

   

Expand the Platform-A brand, including through acquisitions, and position it with advertisers as the leading display network.

 

   

Expand the Publishing business while reducing costs and increasing advertising revenue.

 

   

Continue to transition paid Access subscribers to the Company’s free offerings and evaluate divestiture opportunities.

 

   

Improve operating margins and reduce corporate costs.

 

   

Expand international advertising under Platform-A, social networking services, content on the Company’s website and the Company’s technological infrastructure.

 

   

Evaluation Against 2008 Goals and Determination of 2008 Bonuses. Mr. Falco and Mr. Grant either met or exceeded each of their personal objectives for 2008, which accounted for 30% of their bonuses. In determining bonuses for 2008, Time Warner’s Chief Executive Officer and the TW Committee considered the Company’s performance ratings (47% for Adjusted OIBDA and 84% for Free Cash Flow, or a blended rate of 58%) and the individual performance ratings for Mr. Grant and Mr. Falco (125% each). Accordingly, Mr. Falco received a bonus of $2.25 million and Mr. Grant received a bonus of $1.125 million. These amounts are reflected in the “Non-Equity Incentive Plan Compensation” column in the Summary Compensation Table for Fiscal Year 2008.

2008 AIP. The annual bonuses for 2008 under the 2008 AIP were intended to provide each of Ms. Kumar, Mr. Parker and Ms. Primrose with a competitive level of compensation in the event that both the Company and the executive officer achieved satisfactory performance. As discussed above, Mr. Falco and Mr. Grant did not participate in the 2008 AIP. Annual bonus awards under the 2008 AIP were designed to reward participating executive officers for achieving financial and operational goals with respect to the Company and to reward individual performance, consistent with the Company’s pay-for-performance philosophy. The following is a description of the factors that were taken into account in determining 2008 annual bonuses for Ms. Kumar, Mr. Parker and Ms. Primrose.

 

   

2008 Bonus Targets. Each executive officer has a bonus target that represents the amount the Company expects to pay the executive officer for the year if both the Company and the individual achieve satisfactory performance. The pool for annual bonuses is based on the aggregate number of participants and the sum of each participant’s bonus target. An executive’s annual bonus target opportunity is generally expressed as a percentage of the executive officer’s base salary, and the bonus target is contained in the executive’s employment letter agreement and subject to the terms of the 2008 AIP. As with the base salary, the bonus targets for Ms. Kumar, Mr. Parker and Ms. Primrose were set by the Former CEO in consultation with the Company’s EVP, HR. Bonus targets were determined taking into consideration the nature and scope of each executive officer’s responsibilities, the bonus targets of similarly situated executives within the Company and the Time Warner divisions and data on market compensation levels based on published market surveys.

 

   

2008 Company Performance Goals. At the outset of each year, the Company’s Chief Executive Officer, Chief Financial Officer and EVP, HR, in consultation with Time Warner’s Chief Executive Officer, Chief Financial Officer and EVP, Administration, establish goals based on the Company’s Adjusted OIBDA and Free Cash Flow. The calculation of the Company’s Adjusted OIBDA and Free Cash Flow for purposes of the 2008 AIP is described under “—Annual Incentive Compensation—Adjusted OIBDA and Free Cash Flow” below. Over the course of the year, the level of funding of the bonus pool is adjusted based on the Company’s performance against the pre-set goals. Determination of the final funding under the annual bonus plan is at the discretion of the Company’s Chief Executive Officer, and must be approved by Time Warner.

 

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2008 Individual Performance Goals. The Company’s Chief Executive Officer and EVP, HR establish parameters for Ms. Kumar, Mr. Parker and Ms. Primrose to propose their own individual performance goals and then review the individual performance goals submitted by each executive to be used in determining the bonuses in connection with the Company’s annual performance review process. The individual goals are intended not only to guide the executive officers’ actions, but also to assist the Company and its Chief Executive Officer at the end of the year in exercising discretion in determining the bonuses to be paid to the executives, if the Company performance goals are met.

 

   

Evaluation Against Goals and Determination of Bonuses. At the end of the year, the Company’s performance is evaluated by the Company’s Chief Executive Officer, Chief Financial Officer and EVP, HR, in consultation with Time Warner’s Chief Executive Officer, Chief Financial Officer and EVP, Administration, with respect to the Company’s achievement of its pre-set financial criteria. The Company’s Chief Executive Officer conducts an individual performance evaluation of each executive officer who reports directly to him (other than the Former President), including Ms. Kumar, Mr. Parker and Ms. Primrose, and then determines in consultation with the Company’s EVP, HR whether annual bonuses should be paid to those executive officers based on Company and individual performance. Subject to the terms of the plan, if the Company performance goals are met, the Company’s Chief Executive Officer can exercise discretion in determining actual bonus amounts (if any) to executive officers.

The following is a description of the 2008 bonus targets, performance goals and the evaluation process for purposes of the 2008 AIP.

 

   

2008 Bonus Targets. In 2008, each of Ms. Kumar’s and Mr. Parker’s annual bonus target was 100% of the executive officer’s annual base salary, consistent with published market survey data on compensation levels for executives in comparable positions. Ms. Primrose’s annual bonus target was 75% of her annual base salary, consistent with published market survey data on compensation levels for executives in comparable positions.

 

   

2008 Performance Goals. For the executive officers of the Company, 70% of their 2008 annual bonus was based on Company financial metrics, which are set forth in the table below, and 30% was based on their individual performance versus certain strategic metrics, which are described below. At the beginning of 2008, the Former CEO, in consultation with the Former CFO and the Company’s EVP, HR and Time Warner’s Chief Executive Officer, Chief Financial Officer and EVP, Administration, approved the 70% financial goal and 30% personal goal weighting for Ms. Kumar, Mr. Parker and Ms. Primrose because it emphasizes the importance of the Company’s financial performance and reinforces individual accountability for the achievement of an executive officer’s goals for the year. The use of these goals advances the components of the Company’s compensation philosophy that individual executive officers be held accountable for both the performance of the business operations for which they are responsible and their personal performance.

 

   

2008 Company Performance Goals. Within the Company financial measures, the Former CEO, the Former CFO and the Company’s EVP, HR, in consultation with Time Warner’s Chief Executive Officer, Chief Financial Officer and EVP, Administration, assigned a weighting of 70% to Adjusted OIBDA and a weighting of 30% to Free Cash Flow, based on their views of the relative importance of these measures as indicators of the Company’s operating performance over both the short and long term. The financial measures were selected not only because they are important measures of the Company’s financial performance, but also because they are consistent with the measures Time Warner used through 2008 to provide its business outlook to its investors. Additionally, the Former CEO, the Former CFO and the Company’s EVP, HR and Time Warner’s Chief Executive Officer, Chief Financial Officer and EVP, Administration also considered whether the goals and targets that were set supported sustained growth in the Company’s financial performance over the long term, without encouraging excessive risk-taking. In order to fund the bonus pool under the 2008 AIP, achievement at 90% of the performance target goal for each of Adjusted OIBDA and Free Cash Flow was required.

 

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After the financial criteria for the Company were approved, the Former CEO, the Former CFO and the Company’s EVP, HR approved the actual financial performance targets for the Company in the table below for Ms. Kumar, Mr. Parker and Ms. Primrose. The financial criteria and the performance rating associated with the Adjusted OIBDA and Free Cash Flow metrics for the Company are shown in the table below.

 

Financial Criteria

($ in millions)

  

% of Financial
Component

  

Threshold

50%

  

Target

100%

  

Maximum
150%

  

2008
Actual

  

2008

Actual
Performance
Rating (%)

 

Adjusted OIBDA

   70%    $ 1,700    $ 1,800    $ 2,000    $ 1,558    0

Free Cash Flow

   30%    $ 1,050    $ 1,150    $ 1,350    $ 1,169    102

 

   

2008 Individual Goals. The individual goals established for Ms. Kumar, Mr. Parker and Ms. Primrose at the beginning of 2008 were tailored to each individual’s position and focused on supporting the Global AOL Values. The individual goals for 2008 for each of Ms. Kumar, Mr. Parker and Ms. Primrose are described immediately below.

Ms. Kumar

 

   

Improve management reporting, analysis and forecasting and prepare detailed benchmarks for the 2009 budget process.

 

   

Implement global technology solutions for financial accounting, planning and forecasting to ensure consistency and efficiency with respect to preparation of the Company’s financial reports.

 

   

Maintain compliance with Sarbanes-Oxley requirements and reduce audit findings that require executive review.

 

   

Manage and achieve expense targets across the Company’s businesses to achieve the Company’s overall budget target.

Mr. Parker

 

   

Develop and execute overall cost reduction strategies, including decreasing costs incurred by using outside counsel, while continuing to provide superior client service.

 

   

Expand the Business Development Group with measurable goals in terms of value added to the Company, both in transactions consummated and costs saved.

Ms. Primrose

 

   

Continue to strengthen the communications team.

 

   

Effectively communicate both internally and externally through People Networks, the Company’s new social and media networking initiatives.

 

   

Support key product initiatives that highlight the Company’s web strategy and maximize revenue potential for the Company.

 

   

Evaluation Against 2008 Goals and Determination of 2008 Bonuses. Ms. Kumar, Mr. Parker and Ms. Primrose either met or exceeded each of their personal objectives for 2008, which would have accounted for 30% of their bonuses in the event that the financial thresholds of the 2008 AIP had been met. However, the Company did not meet the threshold performance level for 2008 under the terms of the 2008 AIP of at least 90% of target for each of Adjusted OIBDA and Free Cash Flow, which was a requirement for payments under the 2008 AIP. The threshold performance level for the Adjusted OIBDA metric was $1.70 billion for 2008, and the threshold performance level for the Free Cash Flow metric was $1.05 billion. The results for 2008 were Adjusted OIBDA of $1.558 billion and Free Cash Flow of $1.169 billion. Since the Company did not achieve the Adjusted OIBDA threshold target for 2008, pursuant to

 

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the terms of the 2008 AIP, no bonuses were paid under the 2008 AIP to Ms. Kumar, Mr. Parker and Ms. Primrose. Accordingly, the bonus amounts for 2008 in the “Non-Equity Incentive Plan Compensation” column in the Summary Compensation Table for Fiscal Year 2008 are zero for Ms. Kumar, Mr. Parker and Ms. Primrose.

Transition Plan. Pursuant to their employment agreements, Mr. Falco and Mr. Grant participated in a special 2007 Transitional Cash Long-Term Incentive Program (the “Transition Plan”). The purpose of the Transition Plan was to motivate Mr. Falco and Mr. Grant based on the financial metrics that determined the Company’s performance over the two-year period that commenced on January 1, 2007. Mr. Falco’s annualized target under the Transition Plan was $2.0 million, and his maximum annualized amount under the Transition Plan was $4.0 million, as determined by the TW Committee. Mr. Grant’s annualized target was $1.5 million, and his maximum annualized amount under the Transition Plan was $3.0 million, as determined by the TW Committee. Although targets and maximum amounts were annualized, payments under the Transition Plan were not made until March 13, 2009, following the end of the 2007-2008 performance period. The entire amount of the bonuses under the Transition Plan was based on Company performance during this period relative to cumulative Adjusted OIBDA goals. The calculation of the Company’s Adjusted OIBDA for purposes of the Transition Plan is described under “—Annual Incentive Compensation—Adjusted OIBDA and Free Cash Flow” below. The cumulative Adjusted OIBDA measure was selected because it is an important measure of the Company’s financial performance that Time Warner used to gauge the executives’ performance during the transition period following their assumption of the roles as the Company’s Chief Executive Officer and President, respectively. In the beginning of 2008, the cumulative Adjusted OIBDA goals were adjusted to better reflect revised budget expectations for 2008. The revised financial criteria and the performance rating associated with the cumulative Adjusted OIBDA metric for the Company are shown in the table below.

 

Financial Criteria    Threshold         Target
   Budget
        Maximum
   2007-2008
   Performance  

($ in millions)

  

      0%      

  

50%

  

 100% 

  

 125% 

  

150%

  

    200%    

  

  Actual  

  

  Rating (%)  

 

2007-2008 Cumulative Adjusted OIBDA

   $ 3,515    $ 3,600    $ 3,695    $ 3,790    $ 3,837    $ 3,932    $ 3,520    3.2

The Company’s actual cumulative Adjusted OIBDA for the 2007-2008 period was $3.520 billion, which slightly exceeded the Threshold performance level and resulted in a performance rating of 3.2%. Accordingly, on March 13, 2009, the payout under the Transition Plan to Mr. Falco was $127,822 and to Mr. Grant was $95,866, which are reflected in the “Non-Equity Incentive Plan Compensation” column in the Summary Compensation Table for Fiscal Year 2008.

Adjusted OIBDA and Free Cash Flow. For purposes of the annual bonus provisions of Mr. Falco’s and Mr. Grant’s employment agreements, the 2008 AIP and the Transition Plan, “Adjusted OIBDA” is calculated based on the following formula: operating income (loss) before depreciation and amortization excluding the impact of non-cash impairments of goodwill, intangible and fixed assets, as well as gains and losses on sales of assets and consolidated businesses, certain restructuring costs incurred in 2007 and amounts related to securities litigation and government investigations. For purposes of the annual bonus provisions of Mr. Falco’s and Mr. Grant’s employment agreements and the 2008 AIP, “Free Cash Flow” is calculated based on the following formula: cash provided by operations plus the cash flow attributable to transactions with Time Warner (principally cash paid to Time Warner for taxes) less cash flow attributable to capital expenditures, product development costs and principal payments on capital leases.

Adjusted OIBDA and Free Cash Flow are non-GAAP financial measures. Below are reconciliations of these non-GAAP financial measures to the most comparable GAAP measures from the Company’s audited consolidated financial statements.

 

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Reconciliation of 2008 Adjusted OIBDA to 2008 operating loss for purposes of the annual bonus provisions of Mr. Falco’s and Mr. Grant’s employment agreements, the 2008 AIP and the Transition Plan, and reconciliation of 2007 Adjusted OIBDA to 2007 operating income for purposes of the Transition Plan ($ in millions) are as follows:

 

     Fiscal Year
Ended
December 31,
2008
    Fiscal Year
Ended
December 31,
2007
 

Adjusted OIBDA (1)

   $ 1,558.0      $ 1,962.0   

Asset impairments (2)

     (2,227.7     —     

Depreciation expense

     (311.0     (402.7

Amortization of intangible assets

     (166.2     (95.9

Gains on sale of assets and consolidated businesses (3)

     —          682.6   

Restructuring costs (4)

     —          (120.8

Amounts related to securities litigation and government investigations (5)

     (20.8     (171.4
                

Operating income (loss)

   $ (1,167.7   $ 1,853.8   
                

 

(1) Cumulative Adjusted OIBDA for the 2007-2008 performance period under the Transition Plan was $3,520.0 million.

 

(2) For the year ended December 31, 2008, the Company’s operating loss includes a $2,207.0 million non-cash impairment to reduce the carrying value of goodwill and $20.7 million of non-cash impairments related to asset writedowns in connection with facility consolidations. These amounts are excluded from cumulative Adjusted OIBDA.

 

(3) For the year ended December 31, 2007, the Company’s operating income includes gains on the sale of assets and consolidated businesses of $682.6 million (primarily related to the Company’s sale of its German access service business) which are excluded from Adjusted OIBDA.

 

(4) Certain of the Company’s restructuring costs incurred in 2007 are excluded from Adjusted OIBDA.

 

(5) For the year ended December 31, 2008 and 2007, the Company’s operating income (loss) includes $20.8 million and $171.4, respectively, of legal and other professional fees incurred and paid by Time Warner related to the defense of various securities lawsuits involving the Company or former officers and employees but reflected as an expense in the Company’s consolidated financial statements. These amounts are excluded from Adjusted OIBDA.

Reconciliation of Free Cash Flow to 2008 cash provided by operations for purposes of the annual bonus provisions of Mr. Falco’s and Mr. Grant’s employment agreements and the 2008 AIP ($ in millions):

 

     Fiscal Year
Ended
December 31,
2008
 

Cash provided by operations

   $ 933.6   

Add net transactions with Time Warner

     432.7   

Less capital expenditures and product development costs

     (172.2

Less principal payments on capital leases

     (25.1
        

Free Cash Flow

   $ 1,169.0   
        

Long-Term Incentives

In 2008, the long-term incentive awards provided to the Company’s Named Executive Officers were in the form of Time Warner equity-based awards. Long-term incentive awards are designed not only to provide

 

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executive officers with an opportunity to earn a competitive level of compensation, but also to advance the principle of pay-for-performance, to align the executive officers’ interests with those of Time Warner’s shareholders and to provide a significant retention tool. In 2008, executive officers were granted a combination of stock options, RSUs and PSUs. Stock options are granted to executive officers as an incentive to create and increase incremental shareholder value. RSUs are intended to reward and retain key talent, as well as to align executive officers’ interests with those of Time Warner’s shareholders even during periods of stock market fluctuations. PSUs are designed to reward executive officers based on the achievement of Time Warner’s total shareholder return (“TSR”) as compared to the TSR of other companies in the S&P 500 Index.

In connection with the spin-off, long-term incentive awards held by the Company’s Named Executive Officers who are employed by the Company at the time of the spin-off will be treated as provided in the equity compensation plan under which such awards were granted and the award agreements governing such awards, which will generally result in forfeiture of unvested stock options, vesting of a pro rata amount of RSUs that are scheduled to vest on the next vesting date and vesting of PSUs based on (i) the actual performance level achieved from the award date through the date of the spin-off and (ii) the target level of performance from the date of the spin-off through the last day of the performance period, plus all retained distributions relating thereto, as described under “—Potential Payments Upon a Termination of Employment or Change in Control—Termination without Cause” below and “—Potential Payments Upon a Termination of Employment or Change in Control—Change in Control or Spin-Off of the Company” below. However, the treatment of certain Time Warner equity awards granted to Mr. Armstrong will be treated as described under “—Actions Taken in 2009—Employment Agreement with Current Chairman and Chief Executive Officer” below, the treatment of certain Time Warner equity awards granted to Mr. Falco will be treated as described under “—Actions Taken in 2009—Separation Agreement with Former Chairman and Chief Executive Officer” below and the treatment of certain Time Warner equity awards granted to Mr. Grant will be treated as described under “—Actions Taken in 2009—Separation Agreement with Former President and Chief Operating Officer” below.

2008 Long-Term Incentives. During early 2008, the TW Committee determined the total estimated target value of annual compensation for Mr. Falco and Mr. Grant and the manner in which that total estimated target value would be delivered (including annual base salary, annual bonus and equity-based awards), and approved the equity-based awards to Mr. Falco and Mr. Grant.

In addition, the TW Committee approved the annual grant pool and grant guidelines for long-term incentive awards to be granted to employees of Time Warner and the Time Warner divisions, including stock options, RSUs and PSUs. The Former CEO and the Company’s EVP, HR determined the total estimated target value of annual compensation for Ms. Kumar, Mr. Parker and Ms. Primrose and the manner in which that total estimated target value would be delivered. Based on that review, the Former CEO then made recommendations to the TW Management Option Committee regarding the proposed 2008 stock option grants to Ms. Kumar, Mr. Parker and Ms. Primrose and to Time Warner’s Chief Executive Officer regarding their proposed 2008 RSU and PSU awards. All 2008 grants and awards to the Named Executive Officers were within the TW Committee’s grant guidelines. The TW Management Option Committee reviewed and approved the stock option grants to Ms. Kumar, Mr. Parker and Ms. Primrose, and Time Warner’s Chief Executive Officer, in his capacity as a member of the TW Board, reviewed and approved their awards of RSUs and PSUs. The value of equity-based awards granted to the Named Executive Officers for 2008 was intended to provide each executive with a competitive target level of compensation and to have a substantial portion of the executive’s compensation be performance-based and tied directly to Time Warner’s stock price.

The mix of equity awards (including stock options, RSUs and PSUs) granted to Mr. Falco and Mr. Grant was intended to deliver 40% of the aggregate award value through stock options and 60% of the aggregate award value through an equal amount of RSUs and PSUs. This mix reflected the determination by the TW Committee and Time Warner’s Chief Executive Officer and EVP, Administration of an appropriate mix of equity awards. The mix of equity awards granted to Ms. Kumar, Mr. Parker and Ms. Primrose in 2008 was intended to deliver one-third of the aggregate award value through each of stock options, RSUs and PSUs. This mix reflected market

 

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practices based on the published market surveys. All of the grants and awards took into account the relative retention value of each type of award and the dilutive impact of the awards. The Grants of Plan-Based Awards During 2008 table, below, reflects each Named Executive Officer’s 2008 equity awards.

Stock Options. Stock options represent the right to purchase shares of Time Warner common stock in the future at an exercise price determined on the grant date. Pursuant to provisions in Time Warner’s equity plans, stock options have exercise prices at fair market value, which, since October 2008, has been defined as the closing price of Time Warner’s common stock on the grant date as reported on the New York Stock Exchange Composite Tape. From January 2001 through September 2008, fair market value under Time Warner’s equity plans was defined as the average of the high and low sale prices of Time Warner’s common stock on the New York Stock Exchange on the grant date. The change to the current fair market value definition was approved in July 2008 and went into effect October 1, 2008 to bring Time Warner’s fair market value calculation in line with market practice and to make it easier to verify the fair market value. In a small number of countries other than the United States, the exercise price is established pursuant to local law requirements using another methodology, but the exercise price under that methodology will not be lower than what would be determined using the average of the high and low sale prices on the New York Stock Exchange on the grant date or the closing price of Time Warner’s common stock on the grant date, as applicable. The stock options vest in four equal installments on each of the first four anniversaries of the grant date.

Restricted Stock Units. The RSUs, which represent the right to receive a specified number of shares of Time Warner common stock upon vesting, vest in two equal installments on the third and fourth anniversaries of the award date.

Performance Stock Units. The PSUs awarded to the executive officers in 2008 have a performance measure of TSR of Time Warner’s common stock relative to that of the common stock of the companies in the S&P 500 Index (subject to certain adjustments) over the three-year period from January 1, 2008 through December 31, 2010. This performance measure is intended to align the participants’ interests with those of Time Warner’s shareholders. The PSUs provide for payment in shares of Time Warner common stock based on the performance achieved in amounts ranging from 0% to 200% of the target amounts awarded to the participants, with no payout if the relative TSR of Time Warner is below the 25th percentile of the comparison group and payout at 200% of the target amounts if the relative TSR of Time Warner is at the 100th percentile of the comparison group. The PSUs awarded on March 7, 2008 vest on the third anniversary of the award date based on achievement of the applicable performance measure.

Timing of Grants and Awards. The TW Committee approved the stock option grants and RSU and PSU awards for Mr. Falco on January 30, 2008 and for Mr. Grant on February 20, 2008, and the grants and awards were made on March 7, 2008, which was after (i) Time Warner’s earnings release was issued on February 6, 2008 and (ii) Time Warner’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007 was filed on February 22, 2008. The TW Committee approved Mr. Falco’s stock option grants and RSU and PSU awards on the same date it approved grants and awards to other Chief Executive Officers of the Time Warner divisions, and it approved Mr. Grant’s stock option grants and RSU and PSU awards on the same date it approved grants to other senior executives of the Time Warner divisions. Pursuant to the TW Committee’s delegation of authority, on March 5, 2008, the TW Management Option Committee approved the stock option grants and Time Warner’s Chief Executive Officer approved the RSU and PSU awards made to Ms. Kumar, Mr. Parker and Ms. Primrose, and the grants and awards were made on March 7, 2008. This timing is consistent with Time Warner’s historic practice for equity grants and awards made to executive officers of Time Warner in connection with the TW Committee’s annual review of compensation matters. The TW Committee’s practice has been to approve grants and awards to Time Warner’s executive officers and other recipients whose proposed grants and awards are subject to its approval under the grant and award guidelines established by the TW Committee at a meeting early in the year and to establish a subsequent grant or award date at that time that (a) provides sufficient time for Time Warner to prepare communication materials for employees throughout Time Warner who receive equity-based grants or awards at the same time as Time Warner’s executive officers, and

 

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(b) is after the issuance of the earnings release for the prior fiscal year and the filing of Time Warner’s Annual Report on Form 10-K for the prior fiscal year.

2008 Retention Program

Due to the uncertainty of the future of the Company’s business in early 2008 in light of potential transactions involving the Company, the need for continuity of the Company’s business and the Company’s desire to retain certain executive officers and ensure that they remained focused on their job responsibilities, the Company adopted a one-year retention program covering certain Executive Vice Presidents of the Company, including Ms. Kumar, Mr. Parker and Ms. Primrose. Mr. Falco and Mr. Grant did not participate in the 2008 retention program because their employment agreements provided for other retention compensation. Time Warner’s Chief Executive Officer and EVP, Administration approved the retention program, and the Former CEO and the Company’s EVP, HR determined which executive officers, including Ms. Kumar, Mr. Parker and Ms. Primrose, would participate in the retention program. The potential retention payments were equal to Ms. Kumar’s, Mr. Parker’s and Ms. Primrose’s respective 2008 base salaries. The retention payments would be paid if the executive officer was performing at a satisfactory level and was still an active employee on April 30, 2009, or prior to that date, if as a result of a “change of control transaction” (defined to include a change in the ownership of the Company such that its financial statements were no longer consolidated with those of Time Warner), the Named Executive Officer no longer had a position with the Company or his or her job functions and responsibilities were substantially or materially diminished from what they had been immediately prior to the change of control transaction. Since each of these Named Executive Officers was an employee of the Company on April 30, 2009 and performed satisfactorily, the Company paid Ms. Kumar, Mr. Parker and Ms. Primrose their retention payments in the amount of $550,000, $550,000 and $425,000, respectively, on May 15, 2009.

Agreements with Named Executive Officers

Consistent with the Company’s goal of attracting and retaining executive officers in a competitive environment, AOL LLC has entered into employment arrangements with each of the Company’s Named Executive Officers. In late 2007 and early 2008, AOL LLC entered into new employment arrangements with each of the Company’s Named Executive Officers, other than Mr. Grant. Time Warner and AOL LLC entered into the new employment agreement with Mr. Falco to (i) provide that the vesting of future grants of stock options and RSUs would accelerate on termination of Mr. Falco’s employment without cause and (ii) address the requirements of Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”). The Company entered into the new arrangements with Ms. Kumar, Mr. Parker and Ms. Primrose in order to (i) standardize the terms of their employment, including severance eligibility, (ii) address the requirements of Section 409A of the Code and (iii) in the cases of Ms. Kumar and Mr. Parker, reflect their promotions. Each of the employment letter agreements with the Company’s Named Executive Officers is described below.

Randy Falco (amended and restated agreement with Time Warner and AOL LLC to continue to serve as Chairman and CEO of the Company, effective March 7, 2008). The employment agreement’s term began on March 7, 2008 and, but for Mr. Falco’s separation from service, would have remained in effect through December 31, 2010, and then would have continued on a month-to-month basis until either party provided the other party with 60-days’ written notice of termination. The TW Committee set Mr. Falco’s total target compensation at a level appropriate for his position as Chairman and Chief Executive Officer of the Company, including a minimum base salary of $1.0 million and a discretionary annual cash bonus with a target amount of $3 million and a maximum amount of $4.5 million. Mr. Falco’s agreement provided for annual long-term incentive compensation with a target value of approximately $4.5 million, consisting of a combination of stock options, RSUs or other equity-based awards, cash-based plans, including the Transition Plan, or other components, as determined by the TW Committee. In addition, Mr. Falco’s agreement provided for participation in the Company’s savings and welfare benefit plans and perquisite programs, including $50,000 of group life insurance. Mr. Falco’s agreement also provided for an annual cash payment to him equal to twice the premium he would have to pay under the Group Universal Life insurance program made available by the Company to

 

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obtain life insurance in an amount equal to $4 million, regardless of whether Mr. Falco actually purchased life insurance. During the first year of the agreement, the Company provided Mr. Falco with transition housing in the Dulles, Virginia metropolitan area. The Company also paid Mr. Falco a monthly automobile allowance of $2,000 during the term of his employment agreement. In addition, Mr. Falco’s agreement provided for participation in the Transition Plan as well as the establishment of a deferred compensation arrangement on his behalf and the credit of $7,325,000 to the arrangement on the effective date of his employment agreement (as described under “—Non-Qualified Deferred Compensation for Fiscal Year 2008” below).

Ron Grant (agreement to serve as President and Chief Operating Officer of the Company, effective November 27, 2006, amended February 18, 2009). The employment agreement’s term began on November 27, 2006 and, but for Mr. Grant’s separation from service, would have remained in effect through December 31, 2010, and then would have continued on a month-to-month basis until either party provided the other party with 60-days’ written notice of termination. The TW Committee set Mr. Grant’s total target compensation at a level appropriate for his position as President and Chief Operating Officer of the Company, including a minimum base salary of $750,000 and a discretionary annual cash bonus with a target amount of $1.5 million and a maximum amount of $2.25 million. Mr. Grant’s agreement provided for annual long-term incentive compensation with a target value of approximately $2.75 million, consisting of a combination of stock options, restricted stock or other equity-based awards, cash-based plans, including the Transition Plan, or other components, as determined by the TW Committee. In addition, Mr. Grant’s agreement provided for participation in the Company’s savings and welfare benefit plans and perquisite programs, including $50,000 of group life insurance. Mr. Grant’s agreement also provided for an annual cash payment to him equal to twice the premium he would have to pay under the Group Universal Life insurance program made available by the Company to obtain life insurance in an amount equal to $3.0 million, regardless of whether Mr. Grant actually purchased life insurance. During the first year of the agreement, the Company provided Mr. Grant with transition housing in the Dulles, Virginia metropolitan area. The Company also paid Mr. Grant a monthly automobile allowance of $2,000 during the term of his employment agreement. In addition, Mr. Grant’s agreement provided for participation in the Transition Plan.