10-K 1 d666245d10k.htm 10-K 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2013

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number 001-34419

 

 

AOL INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   20-4268793

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

770 Broadway

New York, NY

  10003
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: 212-652-6400

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, $0.01 par value

Rights to Purchase Series A Junior Participating Preferred Stock

 

New York Stock Exchange

New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

None

 

 

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  x

   Accelerated filer  ¨

Non-accelerated filer  ¨

   Smaller reporting company  ¨

(Do not check if a smaller reporting company)

  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant (based upon the closing price of such shares on the New York Stock Exchange on June 30, 2013) was approximately $2.7 billion. As of February 14, 2014, the number of shares of the Registrant’s common stock, par value $0.01 per share, outstanding was 79,453,253.

DOCUMENTS INCORPORATED BY REFERENCE

Certain information required by Part III of this report is incorporated by reference from the Registrant’s proxy statement to be filed pursuant to Regulation 14A with respect to the Registrant’s 2014 Annual Meeting of Stockholders.

 

 

 


Table of Contents

AOL INC.

TABLE OF CONTENTS

 

               Page
Number
 

Part I.

        
      Cautionary Statement Concerning Forward-Looking Statements      1   
   Item 1.    Business      2   
   Item 1A.    Risk Factors      17   
   Item 1B.    Unresolved Staff Comments      27   
   Item 2.    Properties      27   
   Item 3.    Legal Proceedings      27   
   Item 4.    Mine Safety Disclosures      27   

Part II.

        
   Item 5.   

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     28   
   Item 6.    Selected Financial Data      30   
   Item 7.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     33   
   Item 7A.    Quantitative and Qualitative Disclosures About Market Risk      60   
   Item 8.    Financial Statements and Supplementary Data      61   
   Item 9.   

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     103   
   Item 9A.    Controls and Procedures      104   
   Item 9B.    Other Information      106   

Part III.

        
   Item 10.    Directors, Executive Officers and Corporate Governance      107   
   Item 11.    Executive Compensation      107   
   Item 12.   

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     107   
   Item 13.    Certain Relationships and Related Transactions, and Director Independence      107   
   Item 14.    Principal Accounting Fees and Services      107   

Part IV.

        
   Item 15.    Exhibits, Financial Statement Schedules      108   

Signatures

     109   

Exhibit Index

     111   

 

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AOL INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

     Page
Number
 

Report of Independent Registered Public Accounting Firm

     62   

Consolidated Statements of Comprehensive Income (Loss) for the years ended December  31, 2013, 2012 and 2011

     63   

Consolidated Balance Sheets as of December 31, 2013 and 2012

     64   

Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2012 and 2011

     65   

Consolidated Statements of Equity for the years ended December 31, 2013, 2012 and 2011

     66   

Note 1: Description of Business, Basis of Presentation and Summary of Significant Accounting Policies

     67   

Note 2: Income (Loss) Per Common Share

     76   

Note 3: Goodwill and Intangible Assets

     77   

Note 4: Business Acquisitions, Dispositions and Other Significant Transactions

     80   

Note 5: Long-term Debt and Other Financing Arrangements

     84   

Note 6: Income Taxes

     86   

Note 7: Stockholders’ Equity

     90   

Note 8: Equity-Based Compensation and Employee Benefit Plans

     92   

Note 9: Restructuring Costs

     96   

Note 10: Commitments and Contingencies

     97   

Note 11: Accrued Expenses and Other Current Liabilities

     98   

Note 12: Segment Information

     99   

Note 13: Selected Quarterly Financial Data (unaudited)

     102   

 

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CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K (“Annual Report”) contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 regarding business strategies, market potential, future financial and operational performance and other matters. Words such as “anticipates,” “estimates,” “expects,” “projects,” “forecasts,” “intends,” “plans,” “will,” “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 as required by law, we are under no 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 “Item 1ARisk Factors.” In addition, we operate a web services company in a highly competitive, rapidly changing and consumer- and technology-driven industry. This industry 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.

Achieving our business and financial objectives, including improved financial results and maintenance of a strong balance sheet and liquidity position, could be adversely affected by the factors discussed or referenced in “Item 1ARisk Factors” as well as, among other things:

 

   

changes in our plans, strategies and intentions;

 

   

stock price volatility;

 

   

future borrowing and restrictive covenants under the new revolving credit facility;

 

   

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

 

   

our ability to attract and retain key employees;

 

   

any negative unintended consequences of cost reductions, restructuring actions or similar efforts, including with respect to any associated savings, charges or other amounts;

 

   

adoption of new products and services;

 

   

our ability to attract and retain unique visitors to our properties;

 

   

asset impairments; and

 

   

the impact of “cyber attacks.”

References in this Annual Report to “we,” “us,” the “Company,” and “AOL” refer to AOL Inc., a Delaware corporation.

 

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ITEM 1. BUSINESS

Introduction

AOL Inc. (referred to herein as “AOL”, the “Company”, “we”, “our” or “us”) is a leading global media and technology company with a substantial worldwide audience and a suite of digital brands, products and services that we offer to consumers, advertisers, publishers and subscribers. We are focused on attracting and engaging consumers by creating and offering high quality branded digital content, products and services and providing valuable advertising services on both our owned and operated properties and third-party websites.

We are in the midst of executing a multi-year strategic plan to reinvigorate growth in our revenues and profits by taking advantage of the continuing migration of advertising, commerce and information to the internet and digital devices. Our strategy is to focus our resources on AOL’s core competitive strengths in content, advertising, technology platforms, video and paid services while expanding the distribution of our premium content, product and service offerings on multiple platforms and digital devices, including on internet-enabled televisions, smartphones and tablets. We continue to reinvigorate AOL’s culture and brand by prioritizing the consumer experience, making greater use of data-driven insights and encouraging innovation.

AOL was founded in 1985 and later merged with Time Warner Inc. (“Time Warner”) in 2001. In the fourth quarter of 2009, the board of directors of Time Warner approved the complete legal and structural separation of the Company from Time Warner (the “spin-off”), following which we became an independent, publicly-traded company. On November 2, 2009, the Company converted from AOL Holdings LLC, a limited liability company wholly owned by Time Warner, to AOL Inc., a Delaware corporation wholly owned by Time Warner. The spin-off occurred on December 9, 2009.

Segments

Our business is organized into the following three reportable segments:

 

   

The Brand Group, which consists of our portfolio of distinct and unique content brands as well as certain service brands. The results for this segment include the performance of our advertising offerings on a number of owned and operated sites, such as AOL.com, The Huffington Post, TechCrunch and MapQuest. The Brand Group also includes co-branded websites owned or operated by third parties for which certain criteria have been met, including that the internet traffic has been assigned to us.

 

   

The Membership Group, which consists of offerings that serve our registered account holders, both free and paid. The results for this segment include the performance of our subscription offerings and advertising offerings on Membership Group properties, including communications products such as AOL Mail, as well as from performance compensation received for marketing third party products and services.

 

   

AOL Networks which consists of interconnected programmatic and premium advertising offerings that advertisers and publishers use to reach consumers across all devices (i.e., desktop, mobile, tablet and internet-enabled television) and includes offerings in formats such as display, video and social. The results for this segment include the performance of Advertising.com, AdLearn Open Platform (“AOP”), Adap.tv, Marketplace by ADTECH (“Marketplace”), The AOL On Network, Be On, ADTECH and Pictela.

In addition to the above reportable segments, we have a corporate and other category that includes activities that are not directly attributable or allocable to a specific segment. This category primarily consists of broad corporate functions and includes legal, human resources, accounting, finance and marketing as well as activities

 

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and costs not directly attributable to a particular segment such as restructuring costs, tax settlements and other general business costs.

For financial information about our segments for the years ended December 31, 2013, 2012, and 2011, see “Note 12” in our accompanying consolidated financial statements and “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

The Brand Group

The Brand Group seeks to be a leading publisher of relevant and engaging online content and a provider of engaging online consumer products and services, by utilizing highly scalable publishing platforms and content management systems. The Brand Group consists of our portfolio of distinct and unique content brands as well as certain service brands with a focus on news, local, women/lifestyle and technology. Through our diverse network of sites, we seek to reach a global audience on many platforms and devices. Additionally, we offer advertisers and agencies powerful, comprehensive and efficient online tools to effectively deliver advertising and reach targeted audiences across Brand Group properties.

Brand Group offerings include original content produced by professional journalists from new and traditional media, politicians, celebrities, academics, policy experts, freelance writers and bloggers, our curated content and curated and aggregated content from third parties and user-generated content. Our content offerings are made available to broad audiences through sites such as AOL.com and The Huffington Post, and related applications, as well as to specialized audiences on highly-targeted, branded properties, such as Engadget, StyleList and TechCrunch. Additionally, we have entered into joint ventures and strategic partnerships with third parties with established brands in an effort to expand our content offerings. To facilitate the intake, creation, management and publication of original content, we utilize publishing platforms and content management systems that are designed to scale in a cost-effective manner in order to produce a large variety of relevant content for consumers. In some instances, we have entered into third party partnerships in certain content verticals, which typically provide that the Brand Group receives a share of advertising revenue sold on a co-branded property.

The Brand Group offers many highly engaging and relevant brands, including:

 

   

AOL.com—AOL.com curates and aggregates compelling and engaging content and provides easy access to important services such as AOL Search and AOL Mail. We seek to continuously develop and refine our home page by offering enhanced features and functionality and user interface improvements.

 

   

The Huffington Post—an influential news, opinion and lifestyle website with moderated user comments, which also includes many sections that offer news and perspectives on different subject areas, such as multicultural issues, healthy living and politics. We have expanded The Huffington Post internationally and it is now in 10 countries, largely through partnerships with established local media companies. In 2014 and beyond we seek to continue the expansion of The Huffington Post. Additionally, HP Live! is a live online streaming video network which leverages The Huffington Post’s community and social platform and invites real-time viewer engagement and interaction by smartphone, tablet or webcams.

 

   

MapQuest—a leading online mapping and directions service. We seek to continue to supplement our MapQuest offerings beyond navigation through the launch of original travel content and enhanced trip planning features. We plan on further refining our mobile products with features and enhancements that enable users to experience trips more efficiently. MapQuest also licenses its business-to-business services to third party customers.

 

   

Entertainment brands—Moviefone and Games.com

 

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Technology and Marketplace brands—TechCrunch, Engadget and Daily Finance

 

   

Lifestyle brands—StyleList, Kitchen Daily, StyleMePretty and Makers

In January 2014, we acquired Project Rover, Inc., dba Gravity (“Gravity”), a leading company in multi-screen content optimization and personalization. Gravity’s patented technology creates interest graphs based on individuals’ interests, preferences and habits and allows publishers to offer a tailored and relevant selection of editorial and advertising content to readers. We believe Gravity’s technology will act as an accelerator in virtually all areas of our strategy to create more engaging, relevant and valuable experiences for its consumers, advertisers and publisher partners.

Increasingly, consumers access the internet on devices other than a personal computer. We continue to develop and offer applications for our existing desktop products and services that are optimized for display on portable devices, such as smartphones, tablets and on internet-enabled televisions. In addition, we also continue to develop and offer applications specific to such devices. We plan to continue investing in mobile applications within the Brand Group, prioritizing launches of key brands, collaborating with other providers in order to have our mobile applications included in their offerings, and expanding our mobile advertising platform.

We offer AOL Search on the Brand Group properties. We provide our consumers with a general, internet-based search experience that utilizes the organic web search results of Google Inc. (“Google”), presents additional links on the search results page that showcase contextually relevant AOL and third-party content and information and provides a variety of search-related features (such as suggesting related searches to help users further refine their search queries). We also provide our consumers with relevant paid text-based search advertising through our relationship with Google, in which we provide consumers sponsored link ads in response to their search queries. In addition, we offer vertical search services (i.e., search within a specific content category) and mobile search services on Brand Group properties.

We also offer contextually relevant advertising from both Google and AOL’s proprietary products. These advertisements are placed on sites targeted by advertisers based on the content of the websites. We also market our search services through search engine marketing, working with marketing partners to drive traffic to, and maximize the utilization of, our search services.

While the majority of our search revenues are reflected within the results of the Brand Group, search-related revenues are also included within the results of the Membership Group for search offerings provided in that segment.

Content, products and services on Brand Group properties are generally available to consumers and we are focused on attracting greater numbers of consumers to our offerings. In addition, we utilize various distribution channels as described below which allow us to more directly reach online consumers.

Certain of our Brand Group properties, such as our AOL.com portal and HuffingtonPost.com, serve as valuable distribution channels for our content, products and services as do our subscription services. We utilize our premium video platform as a means of distributing content and increasing engagement across our Brand Group properties. We use a variety of other distribution channels as well, including agreements with manufacturers of devices and other consumer electronics and mobile carriers. We distribute our content, products and services directly to consumers on the open web and through the Apple App Store, the Google Play Store, the Amazon Appstore and the Android Market. Additional distribution channels include toolbars, widgets, co-branded portals and websites, mobile aggregators, third-party websites and social networks (whether offered directly or by means of partnerships with social network operators) that link to AOL Properties. We also utilize search engine marketing and search engine optimization as distribution methods. We make available open standards and protocols for use by third-party developers to enhance, promote and distribute our properties.

 

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The Membership Group

The Membership Group is focused on delivering world-class experiences to our consumers who rely on our products and properties every day. The Membership Group creates integrated experiences that allow our consumers to have access to useful content from important brands, communication tools and valuable services. We offer advertisers and agencies tools to effectively deliver advertising and reach targeted audiences across Membership Group properties. AOL Search is also offered on Membership Group properties.

As of December 31, 2013, we had approximately 2.5 million domestic AOL subscribers. Our subscribers are important users of Brand Group and Membership Group properties and engaging our subscribers, as well as former AOL subscribers who continue to utilize our free service plan, is an important component of our strategy. Our paid subscription plans provide bundles of products and services ranging from online storage, privacy and security solutions to technical support, back-up and unlimited dial-up internet access options, computer protection and partner discounts.

As part of our ongoing efforts to increase customer satisfaction and retention, we continue to develop, test and market additional new products, services and bundles. AOL subscribers are able to manage their subscriptions through an online self-service portal as well as through telephone and chat-based customer support options.

We also offer a wide range of a la carte products and services, including computer tools, maintenance services, online technical support, anti-virus software, identity theft protection, online and social media privacy and reputation monitoring services, online learning and other lifestyle services. Consumers are likewise able to manage these products and services through an online self-service portal as well as through telephone and chat-based customer support options.

We also offer free communications tools, such as AOL Mail, which is a leading e-mail service in the United States. AOL Mail is a significant source of our consumer traffic and engagement.

We distribute Membership Group properties through channels similar to the Brand Group as described above.

AOL Networks

AOL Networks aims to help advertisers and publishers solve fundamental challenges presented by the digital marketing landscape by making available programmatic platforms, video offerings and advertising solutions. AOL Networks offers our advertising technology products and services to advertisers, publishers and other technology companies individually or on a bundled basis. We aim to develop our current relationships with publishers and advertisers and continue to drive increased global advertiser investment and publisher growth.

AOL Networks provides services and solutions that focus on acquiring inventory and content from online publishers, adding value to that inventory and content, and selling it to online advertisers. We acquire unsold advertising inventory from third party websites, which we refer to as the Third Party Network, in addition to Brand Group and Membership Group properties and then use our proprietary optimization, targeting and delivery technology to best match advertisers and their objectives with available inventory.

We expect cross-screen digital media advertising to increase as consumer habits shift towards digital media. Additionally, the number of video ads shown online continues to rise, and we believe that this is driven by premium formats and their ability to drive increased consumer engagement. The number of advertisers reaching consumers across multiple devices, such as desktop, mobile, tablets and internet-enabled televisions is also on the rise, and as consumer habits continue to shift towards digital media, we believe that AOL Networks is positioned to address these market and consumer trends through its platforms, offerings and solutions.

 

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Programmatic platforms

AOL Networks’ programmatic technology automates ad planning and buying by using technologies that match advertisers seeking to purchase advertising inventory that meets specific criteria and publishers seeking to sell advertising inventory that meets such criteria, across all screens and advertising formats. AOL Networks properties—including Advertising.com, AOP, Adap.tv, Marketplace and ADTECH are all vital components of our end-to-end programmatic platform. With this platform, we help our publishers and advertisers solve what we believe are critical marketing industry challenges of business inefficiency and data loss.

We believe that companies will integrate into larger, more comprehensive programmatic platforms rather than operating independently as the use of programmatic advertising increases. We also expect that advertisers will use programmatic platforms that can absorb, utilize and protect multiple data sets across screens, formats and inventory types. Our programmatic platform consists of the following offerings that advertisers and publishers use independently or in combination with one another on a managed-service basis:

AOP

AOP is our global demand side platform that utilizes AdLearn, our proprietary scheduling, optimization and delivery technology that employs a set of algorithms that seek to optimize advertisement placements across the Third Party Network and the available inventory on Brand Group and Membership Group properties. AOP is used by global advertisers and agencies to programmatically plan, buy and measure online advertising across all screens and advertising formats. Advertisers have access to premium non-reserved inventory on our Third Party Network, Advertising.com, and premium reserved and non-reserved inventory on Brand Group and Membership Group properties. Advertisers have the option to use AOP through self-service or managed services solutions.

Advertising.com (Ad.com)

Advertising.com is our global third-party advertising network that, similar to AOP, is powered by Ad Learn, that gets smarter at matching and optimizing media the more it is used. Ad.com inventory is comprised of non-reserved premium display and video inventory from third-party publishers as well as inventory from Brand Group and Membership Group properties. Advertisers can conduct campaigns across desktop, mobile, tablet and social formats and either access Ad.com inventory through AOP or via managed services for both brand and direct response marketing. We also offer advertisers the ability to target advertisements to specific users using technology that utilizes non-personally identifiable information, such as geographic location, previous exposure to certain advertisements and/or user behavior online.

The Company, Yahoo! Inc. (“Yahoo”) and Microsoft Corporation (“Microsoft”) are parties to nonexclusive agreements that allow advertising networks operated by each of the companies to offer each other’s premium non-reserved online display inventory to their respective customers. This partnership offers advertisers and agencies the efficiency of buying premium display at scale to reach customers and audiences. The Company and Yahoo expanded this partnership into the United Kingdom in January 2014.

Adap.tv

Advertisers, agencies and publishers use Adap.tv globally to buy and sell video advertising inventory both programmatically and on a managed-services basis across all screens. Through Adap.tv’s video platform we are able to offer advertisers, publishers and agencies a means of planning, buying and measuring video advertising programmatically across the internet, television and mobile video. We acquired adap.tv, Inc. (“Adap.tv”) in September of 2013.

 

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Marketplace

Marketplace is our global sell-side platform that enables premium publishers to programmatically sell their display, mobile and tablet inventory via exchange and private marketplace environments. Marketplace is available as a standalone publisher offering or as a part of the ADTECH ad serving platform. Marketplace is also available as a self-service tool or managed-service solution.

ADTECH

ADTECH is our own proprietary ad serving technology that is the primary ad server that our Brand Group and Membership Group properties use. In addition, we license this ad serving technology to third parties through our ADTECH subsidiaries in the United States and Europe. ADTECH supports premium display and video advertising across desktop, mobile and tablets.

Gravity

We recently acquired Gravity, a content personalization company. We intend to extend this offering to the third-party publishers that use our programmatic suite whether it is via Adap.tv, Marketplace, Advertising.com and/or ADTECH.

Premium Formats and Ad Experiences—Video

Our premium video platform includes the necessary content, technology platforms and distribution channels for advertisers and publishers to access video advertisements at scale.

Content

 

 

The AOL On Network

The AOL On Network is our premium video library with 15 curated content channels that can be accessed through and experienced across all devices including desktop, mobile, tablet and internet-enabled television. The AOL On Network includes original programming and video content from a large number of syndication partners.

 

 

Be On

Advertisers use Be On to create, syndicate and measure branded video content at scale across all internet-enabled devices. Our Be On offering provides a platform for long-form branded content across all internet-enabled devices and we seek to provide brands with the tools to create, syndicate at scale and measure premium content that consumers desire to watch and share.

Distribution

The AOL On Network distributes video advertising and content across a vast network of publishers and includes our Brand and Membership Group properties.

Technology

Our video technology platform is designed to meet a variety of video-related needs of our customers and partners including those related to content creation, distribution, monetization and measurement across all devices and video formats. In addition to the AOL On Network and Be On technology platforms, Adap.tv is also a critical platform that our advertisers and publishers use to buy and sell video advertising inventory.

 

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Other Premium Formats and Ad Experiences

We have upgraded and consolidated our creative platforms to improve the premium ad experiences we can offer advertisers and publishers across all devices. Advertisers and publishers use the Pictela platform globally on a self-service or managed services basis to achieve aesthetic quality, impact and interactivity of online advertising while showcasing their products and services. Through our Pictela platform we aim to drive higher quality ad experiences and deeper consumer engagement.

We have invested heavily in HTML5 integration to support the most innovative and flexible category-driven ad experiences. Similar to our other AOL Networks offerings, we support premium ad experiences across all formats and screens and encourage advertisers and publishers to use our sophisticated ad targeting strategies to drive improved results by delivering ads to the most interested consumers in relevant context.

As part of AOL Networks’ full technology platform, advertisers and publishers can use our premium formats and ad experiences in conjunction with our programmatic display offerings including AOP, Marketplace and Advertising.com.

AOL Networks has an international presence, primarily in Europe and Canada, with an additional international presence in Australia, India, Singapore, Tokyo and the United Kingdom through its Adap.tv offering. We seek to continue to expand our advertising offerings in key markets.

Revenues

Advertising Revenues

Across our segments, our advertising operations focus on the following:

AOL Properties. We sell advertising on AOL Properties, which include owned and operated content, products and services included in the Membership Group and Brand Group segments. AOL Properties also include co-branded websites owned or operated by third parties for which certain criteria have been met, including that the internet traffic has been assigned to us.

Third Party Network. We also sell advertising on the Third Party Network and offer advertising services to the publishers of these sites.

We market our offerings to advertisers on both AOL Properties and the Third Party Network under the brand “AOL Advertising” and collectively we refer to our total advertising offerings as the AOL Advertising Network.

AOL Properties Advertising Revenue

We generate advertising revenues in our segments through the sale of display advertising and search advertising. We offer advertisers a wide range of capabilities and solutions to effectively deliver advertising and reach targeted audiences across AOL Properties through our dedicated advertising sales force. A significant area of our focus is on offering customized premium advertising. The substantial number of unique visitors on AOL Properties allows us to offer advertisers the capability of reaching a broad and diverse demographic and geographic audience without having to partner with multiple content providers. We seek to provide effective and efficient advertising solutions utilizing data-driven insights that help advertisers decide how best to engage consumers. We offer advertisers marketing and promotional opportunities to purchase specific placements of advertising directly on AOL Properties (i.e., in particular locations and on specific dates). In addition, we offer advertisers the opportunity to bid on unreserved advertising inventory on AOL Properties utilizing our proprietary scheduling, optimization and delivery technology. Finally, advertising inventory on AOL Properties not sold directly to advertisers, as described above, may be included for sale to advertisers by AOL Networks

 

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with inventory purchased from third-party publishers. In addition, agreements with advertisers can include other advertising-related services such as content sponsorships, exclusivities or advertising effectiveness research.

For the years ended December 31, 2013, 2012 and 2011, our advertising revenues on AOL Properties were $998.7 million, $946.9 million and $930.5 million, respectively.

Display Advertising Revenues

Display advertising revenues are generated through the display of graphical advertisements as well as performance-based advertising. Agreements for advertising on AOL Properties typically take the following forms:

 

   

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

 

   

time-based contracts in which we provide promotion 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, product purchases or other revenue sharing relationships.

Search Advertising Revenues

Search advertising revenues are generated on AOL Properties when a consumer clicks on a text-based ad on their screen. These text-based ads are either generated from a consumer-initiated search query or generated based on the content of the webpage the consumer is viewing. Google is, except in certain limited circumstances, the exclusive web search and search-based advertising provider for AOL Properties, based on our agreement that runs through December 31, 2015. In connection with these search services, Google provides us with a share of the revenue generated through paid text-based search advertising and contextual advertising on AOL Properties. For the year ended December 31, 2013, advertising revenues associated with the Google relationship were $373.3 million. Substantially all of these revenues were search revenues generated on AOL Properties, with a significant majority generated within the Brand Group and to a lesser extent within the Membership Group. AOL and Google also have a video partnership that features AOL’s video content on YouTube. See “Item 1A—Risk Factors—Risks Relating to Our Business—We are dependent on a third-party search provider.”

Third Party Network Advertising Services

Our AOL Networks segment generates 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 and also include search advertising. Advertising arrangements for the sale of Third Party Network inventory typically take the form of impression-based contracts or performance-based contracts. In order to generate advertising revenues on the Third Party Network, we incur higher traffic acquisition costs (“TAC”) as compared to advertising on AOL Properties.

For the years ended December 31, 2013, 2012 and 2011, our advertising revenues on the Third Party Network were $614.7 million, $471.6 million and $383.7 million, respectively.

Subscription Revenues

The Membership Group generates subscription revenues principally through our subscription services products we offer to consumers. As of December 31, 2013, we offered price plans ranging from $30.99 to $4.99.

 

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These plans include a variety of features such as maintenance services, online technical support, anti-virus software and identity theft protection. We also offer consumers, among other things, enhanced online safety and security features and technical support for a monthly subscription fee. Our subscriber base has declined and is expected to continue to decline. This has resulted in year-over-year declines in our subscription revenues. The number of domestic AOL subscribers was 2.5 million, 2.8 million and 3.3 million at December 31, 2013, 2012 and 2011, respectively. For the years ended December 31, 2013, 2012 and 2011, our subscription revenues were $650.1 million, $705.3 million and $803.2 million, respectively.

Although our subscription revenues have declined and are expected to continue to decline, we believe that our subscription revenues generated by the Membership Group will continue to remain an important source of revenue, operating income and cash flow in the near term. The revenue and cash flow generated from our subscription services will help us to pursue our strategic initiatives.

The revenue related to our other bundled and subscription products and services is recognized as subscription revenue in cases where we are responsible for providing the service to the end consumer. In instances when we are promoting a third-party product and receiving performance compensation on those services, but the third party is responsible for providing the service to the end consumer, we recognize the net amount retained within the Membership Group as display advertising revenue.

Other Revenues

In addition to advertising and subscription revenues, we also generate fee, license and other revenues. The Brand Group generates licensing revenues from third-party customers through MapQuest’s business-to-business services and online travel services as well as revenue from ticket sales related to technology events hosted by TechCrunch. The Membership Group generates licensing revenues from third parties through its AIM enterprise. AOL Networks also generates other revenues by licensing our proprietary ad serving technology to third parties, primarily through ADTECH. Subsequent to the acquisition of Adap.tv, other revenues also includes fees generated from publishers and advertisers using Adap.tv’s platform technology and features, as well as services such as ad serving and hosting.

Product Development

We seek to develop new and enhanced versions of our products and services for our consumers, advertisers, publishers and subscribers. 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, third-party providers 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 2013, 2012 and 2011 totaled $40.6 million, $44.8 million and $56.9 million, respectively. These costs consist primarily of personnel and related costs that are incurred in relation to the development of software and user-facing internet offerings that do not qualify for capitalization. Certain costs related to the development of internal-use software are capitalized and included in property and equipment, net in the consolidated balance sheet. These costs include the costs associated with coding, software configuration, major upgrades and enhancements. At December 31, 2013 and 2012, the net book value of capitalized internal-use software development was $60.7 million and $46.0 million, respectively. For the years ended December 31, 2013, 2012 and 2011, we capitalized $38.1 million, $30.8 million and $17.2 million, respectively, related to the development of internal-use software.

Intellectual Property and Other Proprietary Rights

Our intellectual property and other proprietary assets include copyrights, trademarks and trademark applications, patents and patent applications, domain names, trade secrets, other proprietary rights and licenses of intellectual property rights of various kinds. These assets and rights, 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

 

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these assets. The duration and scope of the protection afforded to our intellectual property and other assets depends 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 jurisdiction.

Competition

The Brand Group and the Membership Group compete for the time and attention of consumers with a wide range of internet companies, including Yahoo, Google , Microsoft’s MSN, IAC/InteractiveCorp., specialized digital content companies like Business Insider, Buzzfeed, The Verge and CNET; and social networking companies such as Facebook, Inc. and Twitter, Inc., as well as traditional media companies which are increasingly offering their own internet products and services.

The AOL Networks technology platform competes with other end-to-end platform offerings such as Google and Yahoo, and AppNexus also aims to be in this competitive set. With respect to programmatic advertising, AOL Networks competes with companies that have one or more of our offerings such as Media Math, Rocket Fuel Inc., Pubmatic, Inc. and Turn Inc. that aim to service automation needs for advertisers and publishers. AOL Networks also competes with companies such as Videology, Inc. in video, Millennial Media, Inc. with respect to mobile and Conversant, Inc. and Criteo S.A. with respect to our Third Party Network. AOL Networks also competes with large video aggregators such as Hulu and YouTube. In premium formats, AOL Networks competes with companies such as Media Mind and Undertone that specialize in ad experiences.

Our subscription services compete with other providers of bundled subscription services.

Internationally, our primary competitors are global enterprises such as Yahoo, Google, MSN, IAC, Facebook 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 products and services, frequently emerge. We also compete with the companies listed above for talent in, among other areas, technology skills and content creation.

Government Regulation and Other Regulatory Matters

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

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 and Regulation E. 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 Attorney Generals, 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

 

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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; recording and retaining 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.

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 materially affected us in the past and may materially affect us in the future. In particular, federal, state and international governmental authorities continue to evaluate the privacy implications inherent in the use of mobile platforms, advertising networks and third-party web “cookies” for behavioral advertising. We use cookies, which are small text files placed in a consumer’s browser, to facilitate authentication, preference management, research and measurement, personalization, targeting and advertisement and content delivery. 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.

Marketing

Our marketing efforts continue to support our mission to inform, entertain and connect the world. We believe the most effective type of marketing in the near term will be our ability to deliver compelling content, products and services to the millions of consumers who visit us each day. We intend to continue to promote and support the AOL brand while we increase our focus on our family of individual content, product and service brands. We look for strategic opportunities to integrate our brands into high value sponsorships and targeted promotions aimed at defining our core value proposition to consumers. We also engage in meaningful marketing partnerships that allow us to grow our audience.

Employees

As of December 31, 2013, we employed approximately 5,100 people. Our employees are based in 20 countries around the world, including the United States, the United Kingdom, Ireland, Canada, Germany, Israel and India. At that time, the country outside of the United States where we had the largest employee population was the United Kingdom, with approximately 300 employees.

As of February 18, 2014, we employed approximately 4,600 people.

In general, we consider our relationship with employees to be good.

Global Presence

As of December 31, 2013, AOL Networks had advertising operations in the United States, Canada and Europe, as well as in Japan through a joint venture with Mitsui & Co., Ltd. (“Mitsui”). Our AOL Networks segment also has an expanded global presence through its Be On operations, primarily in Europe, and its Adap.tv operations in Australia, India, Singapore, Tokyo and the United Kingdom. As of December 31, 2013, the Brand Group had AOL-branded and co-branded portals and websites in North America and Europe. The Brand Group has also expanded its international operations through the launch of The Huffington Post in the United Kingdom, Canada, France, Spain, Japan, Germany, Tunisia, Morocco, Algeria and Italy, in certain instances in partnership with established local media companies, and we intend to continue this expansion process in 2014. We offer our subscription services through the Membership Group under the AOL brand in the United States, Puerto Rico,

 

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Canada and the United Kingdom. Our foreign operations may expose us to risks such as those described in “Item 1A—Risk Factors—Risks Relating to Our Business—We face risks relating to doing business internationally that could adversely affect our business.” For geographic area data for the years ended December 31, 2013, 2012 and 2011, see “Note 12” in our accompanying consolidated financial statements.

Seasonality

In the fourth quarter, we have historically seen a sequential increase in advertising revenues across our segments associated with holiday advertising.

 

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WHERE YOU CAN FIND MORE INFORMATION

We are required to file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission. Unless otherwise stated herein, these filings are not deemed to be incorporated by reference in this report. You may read and copy any documents filed by us at the Public Reference Room of the SEC, 100 F Street, N.E., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Our filings with the SEC are also available to the public through the SEC’s website at http://www.sec.gov. Our common stock is listed on the New York Stock Exchange (NYSE) under the symbol “AOL.” You can inspect and copy reports, proxy statements and other information about us at the NYSE’s offices at 20 Broad Street, New York, New York 10005. We also maintain an internet web site at www.corp.aol.com. We use our website as a channel of distribution of material company information. Financial and other information regarding AOL is routinely posted on and accessible at http://ir.aol.com and http://blog.aol.com. In addition, you may automatically receive e-mail alerts and other information about AOL by visiting the “e-mail alerts” section at http://ir.aol.com and enrolling your e-mail address. We make available on our internet website free of charge our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and any amendments to those reports as soon as practicable after we electronically file such reports with the SEC. In addition, copies of our (i) Corporate Governance Policy, (ii) charters for the Audit and Finance Committee, Compensation and Leadership Committee, Executive Committee and Nominating and Governance Committee and (iii) Standards of Business Conduct and Code of Ethics for Our Senior Executive and Senior Financial Officers are available through our internet website at http://ir.aol.com. References to our website are intended to be inactive textual references only and the information posted on, accessed through or otherwise connected to it shall not be deemed to be incorporated by reference into this report.

Executive Officers of the Registrant

Pursuant to General Instruction G of Form 10-K, the following is included in Part I of this Annual Report and sets forth certain information as of February 14, 2014 concerning our executive officers.

Mr. Tim Armstrong

Mr. Armstrong, age 43, has served as Chairman and Chief Executive Officer of AOL since April 2009. Prior to that, Mr. Armstrong was President, Americas Operations of Google Inc. Mr. Armstrong joined Google Inc. 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 Senior Vice President. 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. Armstrong is a trustee of Lawrence Academy and on the board of trustees of The Paley Center for Media. Mr. Armstrong currently serves on the board of directors of priceline.com Incorporated and on the board of advisors of Action America, Inc. Mr. Armstrong is a Chair Emeritus of the Ad Council, a non-profit organization.

Mr. Curtis Brown

Mr. Brown, age 50, has served as Executive Vice President and Chief Technology Officer of AOL since May 2012. Prior to that, Mr. Brown served as Senior Vice President of Engineering and Chief Technology Officer of AOL’s global advertising business, Advertising.com from November 2010 to May 2012. Prior to joining AOL in 2010, Mr. Brown served from June 2008 to November 2010 as Senior Vice President and Chief Technology Officer of Kaplan Test Prep, a multi-national educational services provider and as an independent technical consultant from January 2008 to June 2008, with clients that included the Metropolitan Museum of Art and digital brand agency, Katzenbach Partners. He has also previously held the title of Chief Technology Officer

 

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with Skymall, Oxygen Media, The Princeton Review and CTB/McGraw-Hill. Mr. Brown has served as a member of the IT Technology Advisory Board at the New School and the CTO Advisory Council for InfoWorld magazine and is a founding member of the New York City CTO Club.

Ms. Karen Dykstra

Ms. Dykstra, age 55, has served as Executive Vice President and Chief Financial and Administrative Officer of AOL since November 2013 and served as Executive Vice President and Chief Financial Officer from September 2012 until November 2013. Prior to that, Ms. Dykstra was a partner at Plainfield Asset Management LLC and held leadership positions with Plainfield from 2006 to 2010, including Chief Operating Officer and Chief Financial Officer of Plainfield Direct Inc. At that time, Plainfield Asset Management LLC managed investment capital for institutions and high net worth individuals in the United States and abroad. Plainfield Direct Inc., a direct lending and investment business of Plainfield Asset Management, is now known as Plainfield Direct LLC. Prior to joining Plainfield, she was the Chief Financial Officer of Automatic Data Processing, Inc. from 2003 to 2006 and acted as the Principal Financial Officer from 2001 to 2003. Her career spanned 25 years with Automatic Data Processing. Ms. Dykstra currently serves on the board of directors of Gartner Inc. She previously served on the AOL Board of Directors from 2009 until September 2012 and on the board of directors of Crane Co. from 2004 until 2012.

Ms. Julie Jacobs

Ms. Jacobs, age 47, has served as Executive Vice President, General Counsel and Corporate Secretary since May 2010. Prior to that, Ms. Jacobs served as Senior Vice President, Deputy General Counsel and Assistant Corporate Secretary, a role she held from March 2006 until May 2010. Ms. Jacobs joined AOL in 2000 as Assistant General Counsel. Prior to joining AOL, Ms. Jacobs was an attorney at Milbank Tweed Hadley & McCloy LLP, where her practice focused on a wide variety of international development and telecommunications projects.

Mr. Bob Lord

Mr. Lord, age 50, has served as Executive Vice President and Chief Executive Officer of AOL Networks since August 2013. Prior to that, Mr. Lord served as Razorfish Global CEO from February 2009 to August 2013 and CEO of Publicis Groupe’s Digital Technology Division from February 2013 to August 2013, which includes Razorfish, the Digitas LBi Network, Denuo, Fluent and CRM365 and CEO of VivaKi Interactive from December 2011 to January 2013. Prior to his CEO roles, Mr. Lord held various positions at Razorfish, including as East Region President from August 2004 to January 2009, as Executive Vice President SBI-Razorfish from March 2003 to July 2004 and as Chief Operating Officer from January 2002 to February 2003. Prior to Razorfish, Mr. Lord held various positions in technology consulting and engineering. Mr. Lord currently serves as a member of the Saint Luke’s Technology Advisory Committee and the Nantucket Project Advisory Board.

Ms. Susan Lyne

Ms. Lyne, age 63, has served as Executive Vice President and Chief Executive Officer of AOL’s Brand Group since February 2013. Prior to that, Ms. Lyne served as the Chair of Gilt Groupe, Inc., an online fashion and luxury brand retailer, since September 2010. Previously, she was Gilt Groupe’s Chief Executive Officer from September 2008 to September 2010. From 2004 to 2008, Ms. Lyne served as President, Chief Executive Officer and director of Martha Stewart Living Omnimedia, Inc., an integrated media and merchandising company. From 1996 to 2004, Ms. Lyne held various positions at the Walt Disney Company, including Executive Vice President Acquisition, Development and New Business, Walt Disney Motion Picture Group from 1996 to 1998, Executive Vice President, Movies and Miniseries, ABC Entertainment from 1998 to 2002 and President, ABC Entertainment from 2002 to 2004. Prior to joining Walt Disney, she worked for News Corporation Ltd. and K-111 Communications. Ms. Lyne currently serves on the board of directors of Starz, LLC and as Vice

 

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Chairman on the board of directors of Gilt Groupe, Inc. Ms. Lyne is currently a Trustee of The Rockefeller University and The New School. Ms. Lyne previously served on the AOL Board of Directors from 2009 until March 1, 2013 and on the board of directors of CIT Group Inc. from 2006 until 2009.

Mr. Bud Rosenthal

Mr. Rosenthal, age 47, has served as Senior Vice President and Chief Executive Officer of the AOL Membership Group since July 2013. Prior to that, Mr. Rosenthal served in several capacities at AOL, including Senior Vice President of Membership, Paid Services and President, Paid Services from June 2010 to June 2013. Prior to joining AOL, Mr. Rosenthal served as President and CEO of TurnHere from June 2008 to March 2010 and was Interim President and CEO of WorkMetro from July 2007 to February 2008. Mr. Rosenthal also served as Entrepreneur in Residence at Charles River Ventures from March 2006 to December 2006 and prior to that held the position of Vice President/General Manager at Rhapsody music subscription service at RealNetworks, Inc. from May 2005 to March 2006. Mr. Rosenthal also served as Vice President at Yahoo! Inc. from August 2001 to May 2005. Mr. Rosenthal was a co-founder of BigStep.

 

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ITEM 1A. RISK FACTORS

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

If any of the following events occur, our business, financial condition or results of operations could be materially and adversely affected and the trading price of our common stock could materially decline.

Risks Relating to Our Business

Our focus on our online advertising-supported business model involves significant risks.

Growth in our advertising revenues depends on our ability to maintain and expand our existing relationships with advertisers and publishers and our ability to develop new relationships with other advertisers and publishers. Growth in our advertising revenues also depends on our ability to continue offering effective products and services for advertisers and publishers. As the advertising market generates and develops new concepts and technology, we may incur additional costs to implement more effective products and services. As programmatic advertising gains traction with more advertisers and publishers, we continue to invest in and focus on our end-to-end technology and programmatic platforms. Continuing to develop and improve these products and services may require significant time and additional investment. If we cannot continue to develop and improve our advertising products, services and technologies in a timely fashion, our advertising revenues could be adversely affected.

The commercial attractiveness of the programmatic advertising solutions that we offer to publishers and advertisers depends on a variety of complex and evolving factors, among them the continued effective functioning and improvement of our proprietary learning algorithms, the continued ability to access and utilize relevant data about consumers and their consumption habits and, with respect to programmatic advertising exchange-related activities, continued automated access to the advertising inventory and application programming interfaces of publishers as well as continued robust relationships with brand advertisers and agencies.

Our programmatic advertising solutions may become less attractive, and our results of operations may suffer, as a result of changes in laws and regulations and changes in industry standards generally. In addition, the following factors may further diminish the appeal of our programmatic advertising solutions and thereby negatively affect our results of operations: with respect to the availability of consumer data, changes in consumer choices; with respect to the functioning of our algorithms, the failure or inability to access, collect or analyze relevant data (for technological reasons or otherwise); and with respect to programmatic exchange activities, access to publisher inventory and relationships with advertisers and agencies, technological limitations or restrictions imposed by advertisers and publishers themselves.

In order for us to increase advertising revenues in the future, we believe it will be important to increase our overall volume of advertising sold and to maintain or increase pricing for advertising. If we are not able to attract consumers to, and engage consumers with, those AOL Properties that typically generate higher-priced and higher-volume advertising, our advertising revenues may not increase even if the aggregate number of consumers on AOL Properties increases and their aggregate engagement increases.

Additionally, there are different cost structures within our advertising business. In order to generate display advertising revenues on the Third Party Network, we incur TAC. While a majority of the costs associated with generating display advertising on the Third Party Network are variable, a majority of costs associated with generating display advertising revenue on AOL Properties are fixed. Therefore, even if we generate higher

 

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display advertising revenues on the Third Party Network, because there are lower incremental margins associated with these sales, the increase in our operating income will be less than it would with an equivalent increase in display revenues on AOL Properties.

Additionally, advertising revenues are more unpredictable and variable than our subscription revenues, and are more likely to be adversely affected during economic downturns, as spending by advertisers tends to be cyclical in line with general economic conditions.

We face intense competition in all aspects of our business.

The internet industry, with its low barriers to entry and rapidly shifting consumer tastes, is dynamic and rapidly evolving. Competition among internet companies offering online content, products and services, as well as with traditional offline content and advertising companies which are increasingly offering their own online content, products and services, is intense both domestically and globally and new competitors can quickly emerge. Additionally, as the use of programmatic advertising continues to increase, we compete with companies that have also invested in programmatic platform offerings. As companies integrate into larger, more comprehensive programmatic platforms, new competitors may arise and our business could be adversely affected if we do not continue to invest in, develop and improve our programmatic products and services. We could be at a competitive disadvantage in the long term if we are not able to capitalize on international opportunities, especially as compared to a number of our competitors who maintain an expansive global presence. If our competitors are more successful than we are in developing compelling content, products and services or in attracting and retaining consumers, advertisers, publishers and subscribers domestically and internationally, our business could be adversely affected.

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

In order to attract consumers and maintain or increase engagement on AOL Properties, we believe we must offer compelling content, products and services. Acquiring, developing and offering new content, products and services, as well as new functionality, features and enhanced performance of our existing content, products and services, may require significant investment and time to develop. In addition, consumer tastes are difficult to predict and subject to rapid change.

In general, our subscribers are among the most engaged consumers on AOL Properties. As our subscriber base declines, it is advantageous to maintain the engagement of former AOL subscribers and increase the number and engagement of other consumers on AOL Properties in order to successfully execute our business model. Additionally, consumer engagement on certain of the AOL Properties, such as AOL.com, has been very significant to our operating results and we continue to focus on efforts to maintain or increase engagement on those properties. For example, we derive a significant portion of our search advertising revenue from search queries on AOL.com. If we are unable to develop online content, products and services that are attractive and relevant to AOL.com consumers, we may not be able to maintain or increase our existing consumers’ engagement on or attract new consumers to AOL.com and as a result our search advertising revenues may be adversely affected.

We are dependent on a third-party search provider.

We do not own or control a general web search service. Google is, except in certain limited circumstances, the exclusive provider of web search and search sponsored links on AOL Properties through December 31, 2015. For the year ended December 31, 2013, search advertising revenues comprised approximately 24.1% of our total advertising revenues. Changes that Google has made and may unilaterally make in the future to its search service or advertising network, including changes in its policies and guidelines, pricing, algorithms or advertising

 

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relationships, could adversely affect our advertising revenues. Additionally, a decline or an unfavorable change in our relationship with Google could materially affect our advertising revenues. Because we do not own or control such a search service, we are not able to package, sell or syndicate search advertising along with display advertising services outside of AOL Properties and we believe that this could adversely affect our ability to increase advertising revenues. In addition, if Google fails to perform its obligations under the search agreement or terminates the terms of the search agreement, it may have an adverse effect on 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 display or search advertisements or delete cookies, or consumers may elect to manually delete cookies more frequently. The widespread adoption of products and technologies or changes to current products, technologies and services could adversely affect our business.

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

Significant portions of our content, products and services are dependent on technology infrastructure that was developed a number of years ago. The technology infrastructure utilized for our consumer offerings and advertising services is highly complex and may not provide satisfactory support as usage increases and products and services expand, change and become more complex in the future. In addition, we incur significant costs operating our business with multiple and often contradictory technology platforms and infrastructure. Updating and replacing our technology infrastructure may be challenging to implement and manage, may take time to test and deploy, may cause us to incur substantial costs and may cause us to suffer data loss or delays or interruptions in service which could adversely affect our business. Competitors with newer technology infrastructure may have greater flexibility and be in a position to respond more quickly than us to new opportunities, which could impact our competitive position in certain markets and adversely affect our business.

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

Our future success depends in large part upon the continued service of key members of our management team and other personnel. If we do not succeed in retaining and engaging our key employees and in attracting new key personnel, we may be unable to meet our strategic objectives, maintain or build our brands, and, as a result, our business could be adversely affected. In particular, Tim Armstrong, our CEO, is critical to our overall management, as well as the development of our strategic direction and culture. We do not maintain any key-person life insurance policies.

If we cannot effectively distribute our content, products and services, our ability to attract new customers and maintain the engagement of existing consumers could be adversely affected.

As the behavior of internet consumers continues to change, distribution of our content, products and services via traditional methods may become less effective, and new distribution strategies may need to be developed. Consumers are increasingly using social networking sites to communicate and to acquire and disseminate information rather than through instant messaging, electronic mail and portals. As consumers migrate towards social networks, we continue to build social elements into our content, products and services in order to make them available on social networks and to attract and engage consumers on our properties. There is no guarantee

 

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that we will be able to successfully integrate our content with such social networking or other new consumer trends. Even if we are able to distribute our content, products and services effectively through social networking or other new or developing distribution channels, this does not assure that we will be able to attract new consumers.

Currently, an important distribution channel for AOL Properties is through our subscription services. However, our subscriber base has declined and is expected to continue to decline. This continued decline is likely to reduce the effectiveness of our subscription services as a distribution channel. In addition, certain of our websites, including the AOL home page portal and The Huffington Post, act as valuable distribution channels for other AOL Properties. If we are unable to grow organically by attracting new consumers directly to our content, products and services or if traffic to our portals declines or our portals are less successful as a distribution vehicle for other AOL Properties, we may need to rely on distribution channels that require us to pay significant fees to third parties such as operators of third-party websites, online networks, software companies, device manufacturers, and others to promote or supply our services to their users.

Previously, we entered into distribution agreements with computer manufacturers to install our products and services on their personal computers and laptops. We no longer regularly enter into such agreements and as consumers upgrade their hardware, our products and services may not be as easily accessible. Additionally, our products and services may not be compatible on or supported by new hardware. A decline in the traffic and engagement from these consumers could adversely affect our advertising and subscription revenue.

Global consumers are increasingly accessing and using the internet through devices other than personal computers, such as smartphones, tablets and televisions. In order for consumers to access and use our content, products and services via these devices, we must continue to ensure that our content, products and services are compatible with such devices. We also need to continue to secure arrangements with device manufacturers and carriers to promote prominent and effective distribution of our content, products and services. In addition to placement agreements with wireless carriers and manufacturers, currently we offer applications directly to consumers for download from AOL Properties, the Apple App Store, or through other distribution channels. To the extent that consumers are using our applications, content, products and services, we have opportunities to generate advertising revenues. However, the amount of revenues, including advertising revenues, earned from such arrangements is currently small relative to advertising revenues earned through other arrangements. Also, business models in the marketplace seem to be undergoing experimentation and rapid change. To the extent that we cannot generate consumer awareness and adoption of our applications, content, products and services, our business could be adversely impacted.

Our subscriber base could decline faster than we currently anticipate which could result in a decrease in our subscription and advertising revenues.

Our subscriber base has declined and is expected to continue to decline. This decline has been the result of several factors, including the increased availability of high-speed internet broadband connections and attractive bundled offerings by such broadband providers, the fact that a significant amount of online content, products and services has been optimized for use with broadband internet connections and the effects of our strategic shift to focus on generating advertising revenues, which resulted in us essentially eliminating our marketing efforts for our subscription access services and the free availability of the vast majority of our content, products and services. Although we provide many additional products and services as part of our subscription plans, there can be no assurance that our subscribers will value the bundle of services we offer and they may cancel their subscriptions at any time. If any of these factors result in our Subscriber base declining faster than we currently anticipate, our subscription and advertising revenues could be adversely affected.

 

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A disruption or failure of our networks and information systems, the internet or other technology may disrupt our business.

Our business is heavily dependent on the availability of network and information systems, the internet and other technologies. Shutdowns or service disruptions caused by events such as criminal activity, sabotage or espionage, computer viruses, hacking and other cyber-security attacks, router disruption, automated attacks such as denial of service attacks, power outages, natural disasters, accidents, terrorism, equipment failure or other events within or outside our control could adversely affect us and our consumers, including loss or compromise of data, service disruption, damage to equipment and data and excessive call volume to call centers. Furthermore, such attacks are not always able to be immediately detected, which means that we may not be in a position to promptly address the attacks or to implement adequate preventative measures. Such events could result in large expenditures necessary to recover data, or repair or replace such networks or information systems or to protect them from similar events in the future. As not all of our systems are fully redundant, some data or systems might not be recoverable after such events. In addition, not all of our systems operate in the same data centers. Significant incidents could result in a disruption of parts of our business, consumer dissatisfaction, damage to our brands, legal costs or liability, and a loss of consumers or revenues.

If we cannot continue to enforce and protect our intellectual property rights, our business could be adversely affected.

We rely on patent, copyright, trademark, domain name and trade secret laws in the United States and similar laws in other countries, as well as licenses and other agreements with our employees, consumers, content providers, suppliers and other parties, to establish and maintain our intellectual property rights in the technology, content, products and services used in our operations. These laws and agreements may not guarantee that our intellectual property rights will be protected and our intellectual property rights could be challenged or invalidated. Also, recent amendments to U.S. patent laws may adversely impact our ability to protect our new technologies, content, products and services and to defend against claims of patent infringement. In addition, such intellectual property rights may not be sufficient to permit us to take advantage of current industry trends or otherwise to provide competitive advantages, which could result in costly redesign efforts, discontinuance of offerings, decreased traffic and associated revenue or otherwise adversely affect our business. As we acquire and publish more original content, our intellectual property may be increasingly subject to misappropriation by others, and the costs to protect and enforce our intellectual property rights may increase. Additionally, as new generic top-level domains launch, we will likely register a significant number of domain names and initiate more enforcement actions in order to protect and defend the trademark rights in our brands, and we may incur significant costs as a result.

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

Many companies (including patent holding companies) and individuals own patents, copyrights, trademarks, and trade secrets and frequently enter into litigation based on allegations of infringement or other violations of intellectual property rights. As we develop and offer new products, services, and technologies through various distribution channels we may experience an increase in the number of intellectual property claims against us. These claims, whether meritorious or not, may result in litigation, may be time-consuming and costly to resolve, and may require expensive changes in our methods of doing business and/or our content, products and services. These intellectual property infringement claims may require us to enter into royalty or licensing agreements on unfavorable terms or to incur substantial monetary liability. Additionally, these claims may result in our being enjoined preliminarily or permanently from further use of certain intellectual property and/or our content, products and services, or may require us to cease or significantly alter certain of our operations. The occurrence of any of these events as a result of these claims could result in substantially increased costs, could limit or reduce the number of our offerings to consumers, advertisers, publishers and AOL subscribers, could stifle innovation or otherwise adversely affect our business.

 

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Some of our commercial agreements may require us to indemnify third parties against intellectual property infringement claims, which may require us to use substantial resources to defend against or settle such claims or, potentially, to pay damages. These third parties may also discontinue the use of our products, services, and technologies, as a result of injunctions or otherwise, which could result in loss of revenues and adversely impact our business. Additionally, we may be exposed to liability or substantially increased costs if a commercial partner does not honor its contractual obligation to indemnify us for intellectual property infringement claims made by third parties or if any amounts received are not adequate to cover our liabilities or the costs associated with defense of such claims. The occurrence of any of these events could adversely affect our business.

As a publisher of original content and aggregator of third party content, we also face risks of periodic tort claims such as defamation or improper use of publicity rights, as well as infringement claims such as plagiarism. Whether or not they have merit, these claims may be time-consuming or costly to resolve.

The misappropriation, release, loss or misuse of AOL, consumer or other data could adversely affect our business.

Our operations utilize significant amounts of data about our business, consumers, AOL subscribers and our advertising and publishing partners in order to deliver our content, products and services and our advertising solutions. Although we take measures to protect against unauthorized intrusion into such data, the misappropriation, release, loss or misuse of this data, whether by accident, omission or as the result of criminal activity, sabotage or espionage, hacking, computer viruses, natural disasters, terrorism, equipment failure or other events, could lead to negative publicity, harm to our reputation, customer dissatisfaction, regulatory enforcement actions or individual or class-action lawsuits or significant expenditures to recover the data or protect data from similar releases in the future, and may otherwise adversely affect our business. With respect to our AOL subscribers, if we experience any unauthorized intrusion into our subscribers’ data, our subscribers may not be willing to provide the information necessary for them to continue their subscription, and our business could be adversely affected. Furthermore, as not all of our systems are fully redundant, some data or systems might not be recoverable in a catastrophic event or other significant service disruption.

New or existing federal, state or international laws or regulations applicable to our business could subject us to claims or otherwise adversely affect our business.

Our business is subject to a variety of federal, state and international laws and regulations, including those with respect to consumer privacy, advertising generally, consumer protection, content regulation, network neutrality, cyber security, data protection, intellectual property (including copyright, patent, trademark and trade secret laws), defamation, child protection, advertising to and collecting information from children, taxation, employment classification, billing, subpoena and warrant processes and others. These laws and regulations and the interpretation or application of these laws and regulations could change. In addition, new laws or regulations affecting our business could be enacted. Furthermore, many laws were adopted prior to the advent of the internet and related technologies or have an unsettled application or scope with respect to the internet and related technologies and therefore their application on our business is often uncertain. Additionally, as our business evolves, we may be subject to new laws and the application of existing laws to us might change. These laws and regulations are frequently costly to comply with and may divert a significant portion of management’s attention. If we fail to comply with these applicable laws or regulations, we could receive negative publicity and be subject to significant liabilities which could adversely affect our business.

Many of our advertising partners are subject to industry specific laws and regulations or licensing requirements, including advertisers in the following industries: pharmaceuticals, online gaming, alcohol, adult content, tobacco, firearms, insurance, securities brokerage, real estate, sweepstakes, free trial offers, automatic renewal services and legal services. If any of our advertising partners fails to comply with any of these licensing requirements or other applicable laws or regulations, or if such laws and regulations or licensing requirements become more stringent or are otherwise expanded, we could receive negative publicity, incur significant penalties or our business could be otherwise adversely affected.

 

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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. In addition to the potentially differing interpretations of existing law, the present landscape of public policy and privacy creates uncertainty for business planning. In such an uncertain environment, it is difficult to make informed long-term business planning decisions about data use, notice, storage, access, retention or choice. The existing privacy-related laws and regulations are evolving and subject to potentially differing interpretations. There is a possibility that these laws may be interpreted in a way that is inconsistent with our practices. In addition, various federal, state and foreign legislative and regulatory bodies may expand current or enact new laws regarding data protection and 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, or could result in us having to change our data collection practices, which could adversely affect our business. In addition, a failure or perceived failure to comply with industry standards or with our own privacy policies and procedures could result in a loss of consumers or advertisers and adversely affect our business.

Federal, state and international governmental authorities continue to evaluate the privacy implications inherent in the use of third-party web “cookies” for behavioral advertising. We use cookies, which are small text files placed in a consumer’s browser, to facilitate authentication, preference management, research and measurement, personalization, targeting and advertisement and content delivery. The regulation of these “cookies” and other current online advertising practices could adversely affect our business.

Any restructuring actions and cost reduction initiatives that we undertake may not deliver the expected results and these actions may adversely affect our business operations.

We have undertaken various restructuring activities and cost reduction initiatives in an effort to better align our organizational structure and costs with our strategy. In connection with such activities, we may experience a disruption in our ability to perform functions important to our strategy. Such activities could result in significant disruptions to our operations, including adversely affecting the timeliness of product releases, the successful implementation and completion of our strategic objectives and the results of our operations. If we do not fully realize or maintain the anticipated benefits of any restructuring plans and cost reduction initiatives, our business could be adversely affected.

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

The terms of our new revolving credit facility include customary covenants which impose restrictions on our business and financing activities, subject to certain exceptions or the consent of our lenders including, among other things, limits on our ability to incur additional debt, create liens, enter into merger, acquisition and divestiture transactions, pay dividends and engage in transactions with affiliates. The credit facility contains 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 terminate the commitments under the credit facility, declare all amounts outstanding under the credit facility (if any), together with accrued interest, to be immediately due and payable and exercise other rights and remedies. 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.

 

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

We have funded our ongoing working capital, capital expenditure and financing requirements through cash flows from operations and asset dispositions; however, we may require additional financing in the future. Our ability to obtain future financing will depend on, among other things, our financial condition and results of operations as well as the condition of the capital markets or other credit markets at the time we seek financing. Our ability to fund our working capital, capital expenditure and financing requirements in the future may be adversely affected if we are unable to obtain financing on acceptable terms. If we are unable to enter into the necessary financing arrangements or sufficient funds are not available on acceptable terms when required, we may not have sufficient liquidity and our business may be adversely affected.

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

Since January 1, 2013, we acquired companies such as Adap.tv and Gravity and we may make additional acquisitions and strategic investments in the future. The completion of acquisitions and strategic investments as well as the integration of acquired companies or assets involve a substantial commitment of resources and we may fail to realize the anticipated benefits of such transactions and incur unanticipated liabilities that could harm our business. In addition, past or future transactions may be accompanied by a number of risks, including:

 

   

the uncertainty of our returns on investment due to the new and developing industries in which some of the acquired companies operate;

 

   

the adverse effect of known potential liabilities or unknown liabilities, such as claims of patent or other intellectual property infringement, associated with the companies acquired or in which we invest;

 

   

the difficulty of integrating technology, administrative systems, personnel and operations of acquired companies into our services, systems and operations and unanticipated expenses related to such integration;

 

   

the potential loss or disengagement of key talent at acquired companies;

 

   

the potential disruption of our ongoing business and distraction of our management;

 

   

additional operating losses and expenses of the businesses we acquire or in which we invest and the failure of such businesses to perform as expected;

 

   

the failure to successfully further develop acquired technology, resulting in the impairment of amounts currently capitalized as intangible assets;

 

   

the difficulty of reconciling potentially conflicting or overlapping contractual rights and duties; and

 

   

the potential impairment of relationships with consumers, partners and employees as a result of the combination of acquired operations and new management personnel.

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

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

 

   

economic volatility and the current global economic uncertainty;

 

   

currency exchange rate fluctuations;

 

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the requirements of local laws and customs relating to the publication and distribution of content and the display and sale of advertising;

 

   

uncertain protection and enforcement of our investment or intellectual property rights;

 

   

import or export restrictions and changes in trade regulations;

 

   

difficulties in developing, staffing and simultaneously managing a large number of foreign operations as a result of distance as well as language and cultural differences;

 

   

issues related to occupational safety and adherence to local labor laws and regulations;

 

   

political or social unrest;

 

   

risks related to government regulation;

 

   

the existence in some countries of statutory stockholder minority rights and restrictions on foreign direct ownership;

 

   

the presence of corruption in certain countries; and

 

   

higher than anticipated costs of entry.

One or more of these factors could adversely affect our business.

International expansion involves increased investment as well as risks associated with doing business abroad, as described above. In certain instances, we have expanded internationally through joint ventures, and our inability to control certain aspects of a joint venture partnership may impact the development and expansion of our offerings. Furthermore, investments in some regions can take a long period to generate an adequate return. In addition, as we expand into new international regions, we may have limited experience in operating and marketing our products and services in such regions and could be at a disadvantage compared to competitors with more experience.

We could be subject to additional tax liabilities which could adversely affect our business.

International, federal, state and local tax laws and regulations affecting our business are extremely complex and subject to varying interpretations. These tax laws and regulations, or interpretations or application of these tax laws and regulations, could change or new laws and regulations affecting our business could be enacted. There can be no assurance that our tax positions will not be challenged by relevant tax authorities or that we would be successful in any such challenge. Our subscription services are protected from taxation through the Federal internet Tax Non-Discrimination Act, which is in effect until November 2014 and there is no guarantee that this exemption will continue past this date. Several taxing jurisdictions have sought to increase revenue by imposing new taxes on, advertising generally, and internet advertising specifically, or by increasing general business taxes. Imposing new taxes on advertising or internet advertising would adversely affect us. Other states have sought to expand the definition of “nexus” for the purpose of taxing goods and services sold over the internet. If enacted, these new taxes would adversely affect our consumers and, as a result, could adversely affect our business.

We may not be able to utilize our tax attributes to offset future U.S. taxable income.

We believe that we have valuable tax attributes that are significant assets of the Company. Unless otherwise restricted, we can utilize these tax assets in certain circumstances to offset future U.S. taxable income, including

 

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in connection with capital gains that may be generated from a potential asset sale. Our ability to use the tax assets could be limited and the timing of the usage of the tax assets could be substantially delayed if we experience an “ownership change,” as defined in Section 382 of the Internal Revenue Code. A company generally experiences an “ownership change” for tax purposes if the percentage of stock owned by its 5% stockholders (as defined for tax purposes) increases by more than 50 percentage points over a rolling three-year period. To help protect shareholder value and preserve our ability to use the tax assets, our Board of Directors (the “Board”) adopted a Tax Asset Protection Plan (the “TAPP”) to act as a deterrent to any person acquiring beneficial ownership of 4.9% or more of our outstanding common stock without the approval of the Board. Notwithstanding the adoption of the TAPP, we cannot eliminate the possibility that an “ownership change” will occur. The amount by which our ownership may change in the future could, for example, be affected by purchases and sales of stock by stockholders and repurchases of stock by us, should we choose to do so. If the TAPP is not effective in preventing an ownership change our ability to use the tax assets to offset taxable income may be reduced or eliminated. Even if the TAPP is effective in preventing an ownership change, we will only be able to utilize these tax assets to the extent we generate taxable income and the taxing authorities do not challenge the amount of our tax assets or otherwise make an adverse determination regarding our ability to use these assets, and therefore we are not able to guarantee that the tax assets will be valuable to us in the future.

Risks Relating to our Common Stock and the Securities Market

Our stock price may fluctuate significantly.

Our stock price has fluctuated significantly over the last two years and may fluctuate significantly depending on many factors, some of which may be beyond our control, including:

 

   

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

 

   

success or failure of our business strategy;

 

   

our quarterly or annual earnings, or those of other companies in our industry;

 

   

our ability to obtain financing as needed;

 

   

announcements by us or our competitors of significant acquisitions or dispositions;

 

   

changes in accounting standards, policies, guidance, interpretations or principles;

 

   

changes in earnings estimates by securities analysts or our ability to meet those estimates;

 

   

the operating and stock price performance of other comparable companies;

 

   

overall market fluctuations;

 

   

changes in laws and regulations affecting our business; and

 

   

general economic conditions and other external factors.

Stock markets in general have experienced volatility that has often been unrelated to the operating performance of a particular company. These broad market fluctuations could adversely affect the trading price of our common stock. When the market price of a company’s stock fluctuates significantly, shareholders may institute securities class action litigation against that company. Any litigation against us could cause us to incur substantial costs, divert the time and attention of our management and other resources or otherwise harm our business.

 

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ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

Our headquarters, located in New York City, is a leased property consisting of approximately 230 thousand square feet. We own a corporate campus in Dulles, Virginia comprised of office buildings, a data center, child care and support facilities of approximately 825 thousand square feet. We lease or own additional office, data center and warehouse space located in California and Virginia totaling approximately 690 thousand square feet. In addition to these properties, we lease approximately 410 thousand square feet in over 50 facilities for use as corporate offices, sales offices, development centers, data centers and other operations in other locations in the United States and internationally. Our larger leased sites are located in California, Colorado, District of Columbia, Illinois, Maryland, Massachusetts, New York and Virginia and in the countries of Canada, Germany, India, Ireland, and the United Kingdom. We sublease to third parties approximately 190 thousand square feet of our leased properties. Due to the nature of our operations, most of the properties described above are used by more than one of our segments.

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

 

ITEM 3. LEGAL PROCEEDINGS

We are a party to a variety of claims, suits and proceedings that arise in the normal course of business, including actions with respect to intellectual property claims, tax matters, labor and unemployment claims, commercial claims, claims related to our business model for content creation and other matters. While the results of such normal course claims, suits and proceedings cannot be predicted with certainty, management does not believe that, based on current knowledge and the likely timing of resolution of various matters, any additional reasonably possible potential losses above the amount accrued for such matters would be material to our financial statements. Regardless of the outcome, legal proceedings can have an adverse effect on us because of defense costs, diversion of management resources and other factors. See “Item 1A—Risk Factors—Risks Relating to Our Business—If we cannot continue to enforce and protect our intellectual property rights, our business could be adversely affected” and “Item 1A—Risk Factors—Risks Relating to Our Business—We have been, and may in the future be, subject to claims of intellectual property infringement or tort law violations that could adversely affect our business” included in this Annual Report.

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

AOL’s common stock is listed on the New York Stock Exchange (NYSE) under the symbol “AOL.” The following table presents the quarterly high and low sales prices for the common stock on the NYSE as reported for each period indicated:

 

     High      Low  

2012 Quarters Ended:

     

March 31, 2012

   $ 19.48      $ 14.84  

June 30, 2012

     28.36        18.12  

September 30, 2012

     35.35        27.14  

December 31, 2012

     43.93        29.25  

2013 Quarters Ended:

     

March 31, 2013

   $ 39.75      $ 29.16  

June 30, 2013

     42.12        33.46  

September 30, 2013

     38.48        32.21  

December 31, 2013

     46.98        32.19  

As of February 14, 2014 there were approximately 15,563 holders of record of our common stock. Because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders. The closing price of the common stock on the NYSE on February 14, 2014 was $44.63.

Repurchases of Equity Securities

The following is a summary of common shares repurchased by the Company under its stock repurchase program during the three months ended December 31, 2013:

 

Period

   Total Number
of Shares
Purchased
     Average
Price Paid
per Share
     Total Number of
Shares Purchased as
Part of Publicly
announced Plans or
Programs (a) (b)
     Approximate Dollar
Value of Shares that
May Yet Be  Purchased
Under the Plans or
Programs (a) (b)
 

October 1,—October 31, 2013

     941,276      $ 34.60        941,276      $ 115,300,000  

November 1,—November 30, 2013

     —          —          —        $ 115,300,000  

December 1,—December 31. 2013

     —          —          —        $ 115,300,000  

Total

     941,276      $ 34.60        941,276      $ 115,300,000  

 

(a) On February 8, 2013, we announced that the Board approved a stock repurchase program (the “Original Repurchase Program”), which authorized us to repurchase up to $100 million of our outstanding shares of common stock through February 8, 2014. Repurchases were subject to market conditions, share price and other factors, and were made in accordance with applicable securities laws.
(b) Concurrent with the closing of the $250 million senior secured revolving credit facility agreement (the “Credit Facility Agreement”), on July 8, 2013, we announced that the Board approved a new stock repurchase program (the “New Repurchase Program”). Under the New Repurchase Program, the Board approved a new $150 million stock repurchase authorization. The repurchases may be made from time to time over the twelve months following the announcement of the New Repurchase Program, depending on market conditions, share price and other factors. The repurchases may be made in accordance with applicable securities laws in the open market, in block trades, pursuant to pre-arranged trading plans or otherwise and may include derivative transactions. The New Repurchase Program may be suspended or discontinued at any time. The New Repurchase Program does not affect in any way the terms of the Original Repurchase Program.

 

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The approximate dollar value of shares that may yet be repurchased under these programs disclosed in the tables above excludes commissions and other fees paid in relation to purchases through December 31, 2013.

Dividend Policy

On August 26, 2012, we declared the payment of a special, one-time, cash dividend of $5.15 per share to shareholders of record at the close of business on December 5, 2012 (the “Special Cash Dividend”), which was paid on December 14, 2012. We do not currently anticipate additional declarations of cash dividends on our common stock in the immediate future. The declaration of additional cash dividends on our common stock could impact existing stock repurchase agreements.

Performance Graph

The graph below matches AOL Inc.’s cumulative 48-Month total shareholder return on common stock with the cumulative total returns of the S&P Midcap 400 index and the Morgan Stanley High-Technology index. The graph tracks the performance of a $100 investment in our common stock and in each of the indexes (with the reinvestment of all dividends) from December 1, 2009 to December 31, 2013.

 

LOGO

 

* $ 100 invested on 12/10/09 in stock or index, including reinvestment of dividends.
   Fiscal year ending December 31.

Copyright© 2014 S&P, a division of The McGraw – Hill Companies Inc. All rights reserved.

 

     12/10/09      12/31/09      3/31/10      6/30/10      9/30/10      12/31/10      3/31/11      6/30/11      9/30/11  

AOL Inc.

     100.00         98.98         107.48         88.39         105.23         100.81         83.04         84.44         51.02   

S&P Midcap 400

     100.00         103.84         113.28         102.42         115.85         131.50         143.81         142.76         114.37   

Morgan Stanley High-Technology Index

     100.00         103.01         105.29         92.33         103.82         114.47         119.08         119.44         112.47   

 

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     12/31/11      3/31/12      6/30/12      9/30/12      12/31/12      3/31/13      6/30/13      9/30/13      12/31/13  

AOL Inc.

     64.20         80.65         119.39         149.79         146.22         190.07         180.14         170.76         230.21   

S&P Midcap 400

     129.22         146.66         139.43         147.01         152.32         172.81         174.54         187.71         203.35   

Morgan Stanley High-Technology Index

     119.35         147.01         138.80         150.29         141.80         147.07         148.73         161.02         183.36   

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

This performance graph shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 (the “Exchange Act”) or incorporated by reference into any of our filings under the Securities Act of 1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

 

ITEM 6. SELECTED FINANCIAL DATA

The following financial information for each of the five years ended December 31, 2013 has been derived from our consolidated financial statements. The selected consolidated financial data as of December 31, 2013 and 2012 and for the years ended December 31, 2013, 2012 and 2011 is derived from our audited consolidated financial statements included elsewhere in this Annual Report. The selected consolidated financial data as of December 31, 2011, 2010 and 2009 and for the years ended December 31, 2010 and 2009 is derived from audited financial statements not included herein.

The selected historical financial data presented below should be read in conjunction with our consolidated financial statements and the accompanying notes thereto, and “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included elsewhere in this Annual Report. Prior to December 9, 2009, the effective date of the spin-off, we were a subsidiary of Time Warner. Our historical financial information included herein may not necessarily be indicative of our future financial condition, results of operations and cash flows. In addition, for the period prior to December 9, 2009, the financial information included herein may not necessarily indicate 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.

 

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     Years Ended December 31,  
     2013      2012      2011      2010      2009  
($ in millions, except per share amounts)                                   

Statement of Comprehensive Income (Loss) Data:

              

Revenues:

              

Advertising

   $   1,613.4      $   1,418.5      $   1,314.2      $   1,284.1       $   1,736.7   

Subscription

     650.1        705.3        803.2        1,023.6         1,388.8   

Other

     56.4        67.9        84.7        109.0         120.3   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total revenues

   $   2,319.9      $   2,191.7      $ 2,202.1      $ 2,416.7       $ 3,245.8   

Costs of revenues

   $ 1,706.2      $   1,587.2      $ 1,584.4      $ 1,420.6       $ 1,893.2   

Operating income (loss) (a)

   $ 190.3      $ 1,201.9      $ 45.8      $ (982.6)       $ 462.6   

Income (loss) from continuing operations

   $ 90.6      $ 1,047.7      $ 13.1      $ (790.7)       $ 251.4   

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

   $ 92.4      $ 1,048.4      $ 13.1      $ (782.5)       $ 248.8   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Per share information attributable to AOL Inc. common stockholders: (c)

              

Basic income (loss) per common share from continuing operations

   $ 1.19      $ 11.51      $ 0.13      $ (7.42)       $ 2.38   

Discontinued operations

     —          —          —          0.08         (0.03)  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Basic net income (loss) per common share

   $ 1.19      $ 11.51      $ 0.13      $ (7.34)       $ 2.35   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Shares used in computing basic income (loss) per share (in millions)

     77.6        91.1        104.2        106.6         105.8   

Diluted income (loss) per common share from continuing operations

   $ 1.13      $ 11.21      $ 0.12      $ (7.42)       $ 2.38   

Discontinued operations

     —          —          —          0.08         (0.03)  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Diluted net income (loss) per common share

   $ 1.13      $ 11.21      $ 0.12      $ (7.34)       $ 2.35   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Shares used in computing diluted income (loss) per share (in millions)

     82.0        93.5        106.0        106.6         105.8   

Cash dividends paid per common share

   $ —        $ 5.15      $ —        $ —         $ —     

 

(a) 2013 includes a non-cash goodwill impairment charge of $17.5 million related to Patch. 2012 includes the sale of approximately 800 of our patents and their related patent applications (the “Sold Patents”) to Microsoft, and the grant to Microsoft of a non-exclusive license to our retained patent portfolio. As a result of this transaction, 2012 includes a gain of $946.5 million (net of transaction costs) on the disposition of the Sold Patents and income of $96.0 million from licensing our retained patent portfolio to Microsoft during the second quarter of 2012. Also included in 2012 is the release of a $16.4 million value added tax (“VAT”) indemnification reserve that was established upon the sale of the legacy German and United Kingdom access businesses in 2006 and 2007. 2011 includes $35.2 million in retention compensation expense related to acquired companies. 2010 includes a $1,414.4 million non-cash impairment charge to reduce the carrying value of goodwill and a $106.0 million gain on the sale of our ICQ operations. 2009 includes $27.9 million in amounts incurred related to securities litigation and government investigations.
(b) Includes net income (loss) related to discontinued operations of $8.2 million in 2010 and ($2.9) million in 2009.
(c)

On November 2, 2009, the Company converted from AOL Holdings LLC, a limited liability company wholly owned by Time Warner, to AOL Inc., a corporation wholly owned by Time Warner. On December 9, 2009, the date of our spin-off, 105.8 million shares of $0.01 par value AOL common stock were distributed to Time Warner shareholders of record as of 5 p.m. on November 27, 2009. For the year ended December 31, 2009, in determining the weighted average number of common shares outstanding for basic income (loss) per common share, we used 105.8 million shares for the period from January 1, 2009 through December 9, 2009, and the actual number of shares outstanding for the period from December 10,

 

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  2009 through December 31, 2009. Diluted income (loss) per common share subsequent to the distribution date of December 9, 2009 reflects the potential dilution of outstanding equity-based compensation awards by application of the treasury stock method.

 

     As of December 31,  
     2013      2012      2011      2010      2009  
(in millions)                                   

Balance Sheet Data:

              

Cash and equivalents

   $ 207.3       $ 466.6       $ 407.5       $ 801.8      $ 146.1  

Goodwill

   $ 1,361.7       $ 1,084.1       $ 1,064.0       $ 810.9      $ 2,171.6  

Total assets

   $   2,983.4       $   2,797.3       $   2,825.0       $   2,962.3      $   3,963.1  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Long-term portion of obligations under capital leases

   $ 56.2       $ 56.3       $ 66.2       $ 50.9      $ 41.5  

Treasury stock, at cost

   $ (942.9)       $ (838.4)       $ (173.6)       $ —        $ —    

Total equity

   $ 2,267.5       $ 2,137.8       $ 2,172.6       $ 2,286.9      $ 3,062.9  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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PART II—ITEM 7. 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 consolidated financial statements and the notes thereto included elsewhere in this Annual Report as well as the discussion in the “Item 1—Business” section. 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 “Item 1A—Risk Factors” and “Cautionary Statement Concerning Forward-Looking Statements.”

Introduction

Management’s discussion and analysis of financial condition and results of operations (“MD&A”) is a supplement to the accompanying consolidated financial statements and provides additional information on our business, recent developments, results of operations, liquidity and capital resources and critical accounting policies. MD&A is organized as follows:

 

   

Overview. This section provides a general description of our business and outlook for 2014, as well as recent developments we believe are important in understanding our 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 each of the three years in the period ended December 31, 2013.

 

   

Liquidity and capital resources. This section provides a discussion of our current financial condition and an analysis of our cash flows for each of the three years in the period ended December 31, 2013. This section also provides a discussion of our contractual obligations and commitments, off-balance sheet arrangements, indemnification obligations, principal debt obligations and customer credit risk that existed at December 31, 2013.

 

   

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

Overview

Our Business

We are a leading global media and technology company with a substantial worldwide audience and a suite of digital brands, products and services that we offer to consumers, advertisers, publishers and subscribers. We are focused on attracting and engaging consumers by creating and offering high quality branded online content, products and services and providing valuable advertising services on both our owned and operated properties and third-party websites. We market our offerings to advertisers on both AOL Properties and the Third Party Network. Through AOL Networks, we provide third party publishers with premium products and services intended to make their websites attractive to brand advertisers, such as video and custom content production, in addition to offering ad serving and sales of third party advertising inventory. Our AOL subscription service, which we offer consumers in the United States for a monthly fee, is a valuable distribution channel for AOL Properties.

 

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Our business is organized into three reportable segments: the Brand Group, the Membership Group, and AOL Networks. In addition to these reportable segments, we have a corporate and other category that includes activities that are not directly attributable or allocable to a specific segment.

Brand Group

The Brand Group consists of our portfolio of distinct and unique content and certain service brands. The results for this segment include the performance of our advertising offerings on a number of owned and operated sites, such as AOL.com, The Huffington Post, TechCrunch and MapQuest. The Brand Group also includes co-branded websites owned or operated by third parties for which certain criteria have been met, including that the internet traffic has been assigned to us.

We generate advertising revenues from the Brand Group through the sale of display and search advertising. Display advertising revenue is generated by the display of graphical advertisements and other performance-based advertising. We offer advertisers marketing and promotional opportunities to purchase specific placements of advertising directly on sites within the Brand Group (i.e., in particular locations and on specific dates). In addition, we offer advertisers the opportunity to bid on unreserved advertising inventory on Brand Group sites utilizing our proprietary scheduling, optimization and delivery technology. We collectively refer to revenue associated with these offerings as premium display advertising revenue. Finally, advertising inventory on Brand Group sites not sold directly to advertisers, as described above, may be included for sale to advertisers with inventory purchased from third-party publishers through AOL Networks. Amounts received from external customers for inventory sold through AOL Networks are recognized in AOL Networks with a corresponding intersegment TAC charge. An amount equal to the TAC charge for these transactions, reflecting the revenue net of the margin retained by AOL Networks, is then reflected as intersegment revenue within the Brand Group. Search advertising revenue is generated when a consumer clicks on a text-based advertisement on Brand Group sites. These text-based advertisements are either generated from a consumer-initiated search query or placed on sites targeted by advertisers based on the content of the websites. While the majority of our search revenues are reflected within the Brand Group, there are also search revenues within the Membership Group and AOL Networks for search offerings provided in each of those segments.

Membership Group

The Membership Group consists of offerings that serve our registered account holders, both free and paid. The results for this segment include our subscription offerings and advertising offerings on Membership Group properties, including communication products such as AOL Mail.

In addition, we offer new products and services that are either third party or AOL-developed products. We earn performance-based fees in relation to marketing third party products and services. We offer these products to our current and former subscribers as well as other internet consumers. As with the Brand Group, advertising inventory on Membership Group sites not sold directly to advertisers may be included for sale to advertisers through AOL Networks and is reflected as intersegment revenue within the Membership Group. AOL Search is also offered on Membership Group properties.

AOL Networks

AOL Networks consists of interconnected programmatic, video and premium advertising offerings that advertisers and publishers use to reach consumers across all devices (i.e., desktop, mobile, tablet and internet-enabled television) and includes formats such as display, video and social. AOL Networks’ offerings enable

 

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publishers and advertisers to utilize AOL’s third-party advertising network as well as AOL’s inventory within the Brand Group and Membership Group sold by AOL Networks. The results for this segment include the performance of Advertising.com, AOP, Adap.tv, Marketplace, The AOL On Network, Be On, ADTECH and Pictela. We generate advertising revenues on AOL Networks through the sale of advertising on third party websites and from advertising inventory on AOL Properties not sold directly to advertisers, as described above. Our advertising offerings on AOL Networks consist primarily of the sale of display advertising and also include search advertising through sponsored listings.

Recently, the online display advertising market has experienced an increase in programmatic buying of advertising inventory. We have addressed this trend by acquiring Adap.tv, a leading global programmatic video advertising platform. We also continue to invest in programmatic technology, such as our demand side and supply side platforms, in order for advertisers and agencies to better manage their advertising campaigns through the use of our optimization technology. We believe there is a significant opportunity to attract advertisers through the increased sale of premium formats and video through AOL Networks. We believe our scale, ability to target premium audiences and investments in technology and premium formats will allow us to increase the number of advertisers we work with and enable us to capitalize on the increase in programmatic buying. We believe our investments in premium formats and targeting will enable us to maximize yield for our advertisers. Revenues from the sale of our programmatic offerings are primarily reflected in AOL Networks results.

We have different cost structures within our advertising operations. In order to generate advertising revenues on AOL Networks, we have historically had to incur higher TAC as compared to advertising revenues generated on Brand Group or Membership Group properties. While a majority of the costs associated with generating advertising revenues on AOL Networks are variable, a majority of costs associated with generating advertising revenues on Brand Group and Membership Group properties are fixed. Therefore, to the extent we can generate higher revenues on Brand Group and Membership Group properties where we expect higher incremental margins, the increase in adjusted operating income before depreciation and amortization (“Adjusted OIBDA”) will be greater than it would be with an equivalent increase in advertising revenues on AOL Networks.

We believe that video enhancements across our owned and operated properties and third party websites can enhance our advertising product offerings and increase monetization and distribution of our content. We seek to launch new format enhancements, increase advertiser adoption of these formats and attract additional publishers. We aim to create products that will deepen our relationships with existing advertisers and attract new advertisers by providing them with effective and efficient means of reaching targeted audiences through premium video experiences. We remain focused on the continued expansion of our video platform for both our properties and our partners. As part of this strategy, we acquired Adap.tv in September of 2013. Advertisers, agencies and publishers use Adap.tv globally to buy and sell video advertising inventory both programmatically and on a managed-services basis across desktop, mobile and internet-enabled televisions. Through Adap.tv’s video platform we can offer advertisers, publishers and agencies a means of planning, buying and measuring video advertising programmatically across the internet, television and mobile video. We are rapidly integrating Adap.tv into AOL Networks, in order to maximize the strength and efficiency of our advertising solutions to advertisers, publishers and agencies.

Recent Developments

2013 Stock Repurchase Programs

On February 8, 2013, we announced that the Board approved the Original Repurchase Program, which authorized us to repurchase up to $100 million of our outstanding shares of common stock from time to time through February 8, 2014.

 

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Concurrent with the closing of the Credit Facility Agreement, on July 8, 2013, we announced that the Board approved the New Repurchase Program, which authorizes us to repurchase up to $150 million of outstanding shares of AOL common stock from time to time over the twelve months following the announcements of the New Repurchase Program. The New Repurchase Program may be suspended or discontinued at any time. The New Repurchase Program does not affect in any way the terms of the Original Repurchase Program.

Repurchases are subject to market conditions, share price and other factors. The repurchases may be made in accordance with applicable securities laws in the open market, in block trades, pursuant to pre-arranged trading plans or otherwise and may include derivative transactions.

As of this filing, we have repurchased a total of 3.9 million shares at a weighted-average price of $34.75 per share (approximately $134.8 million in aggregate), bringing our remaining repurchase authorization under the New Repurchase Program to approximately $115 million.

Restructuring Actions

As part of our continuing effort to reduce our expenses and invest in areas of strategic focus, we incurred restructuring costs of $41.3 million for the year ended December 31, 2013. The 2013 restructuring costs primarily related to our efforts to align our organizational structure with our strategy, including the restructuring of our Patch operations.

Acquisition of Gravity

On January 23, 2014, we acquired Gravity, a company incorporated and registered in Delaware, for approximately $82.4 million in cash. An additional $7.6 million of cash consideration will be deferred and paid over a two-year service period to certain Gravity employees. As part of the transaction, we will acquire approximately $12 million of net operating losses, which is expected to result in a future cash tax benefit to us of approximately $5 million. Gravity provides content personalization technology and publisher solutions to create relevant consumer and advertiser experiences.

Patch

On January 29, 2014, we entered into a joint venture with DMEP Corp. dba Hale Global (“Hale Global”) whereby we contributed Patch into a new limited liability company which will be operated and majority owned by Hale Global. The loss on disposition will be determined based on the difference between the fair value of our retained interest less the value of the deconsolidated net assets and our cash contribution into the joint venture. Our retained interest will be accounted for as an equity method investment.

Key Metrics

Key indicators to understanding our operating results include:

 

   

Growth of advertising revenues, net of traffic acquisition costs;

 

   

Unique visitors to AOL Properties;

 

   

Moderation of subscription revenue declines; and

 

   

Our ability to manage our cost structure.

 

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Audience Metrics

We utilize unique visitor numbers to evaluate the performance of AOL Properties. In addition, we utilize unique visitor numbers to evaluate the reach of our total advertising offerings, which we call the AOL Advertising Network and which includes both AOL Properties 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. Our 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 through a traffic assignment letter. For the year ended December 31, 2013, approximately 8% of our unique visitors to AOL Properties were attributable to co-branded websites owned by third parties where the internet traffic was assigned to us, compared to approximately 7% for the year ended December 31, 2012.

The source for our unique visitor information is a third party (comScore Media Metrix, or “Media Metrix”).

The following table presents our unique visitor metrics for the periods presented (in millions):

 

     Years Ended December 31,  
     2013      2012      2011  

Domestic average monthly unique visitors to AOL Properties

     116        111        110  

Domestic average monthly unique visitors to AOL Advertising Network

     194        186        184  

Subscriber Metrics

The number of domestic AOL subscribers was 2.5 million, 2.8 million and 3.3 million at December 31, 2013, 2012 and 2011, respectively. ARPU was $19.85, $18.39 and $17.71 for the years ended December 31, 2013, 2012 and 2011, 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. Our subscriber numbers 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. Individuals who have only registered for our free offerings, including subscribers who have migrated from paid subscription plans, are not included in the AOL subscriber numbers. Additionally, only those individuals whose subscription includes AOL-brand dial-up access service are included in the AOL subscriber numbers. Subscribers to our subscription access service also contribute to our ability to generate advertising revenues.

The primary non-financial metrics we monitor for our subscription service are monthly average churn and average paid tenure. Monthly average churn represents on average the percentage of AOL subscribers that are either terminated or cancel our services each month, factoring in new and reactivated subscribers. The domestic AOL subscriber monthly average churn was 1.5%, 1.8% and 2.3% for the years ended December 31, 2013, 2012 and 2011, respectively. Average paid tenure represents the average period of time individuals have been AOL subscribers. The average paid tenure of the remaining domestic AOL subscribers has been increasing, and was approximately 12.9 years, 11.8 years and 10.6 years for the years ended December 31, 2013, 2012 and 2011, respectively.

 

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Consolidated Results of Operations

Revenues

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

 

     Years Ended December 31,  
     2013      2012      % Change
from 2012
to 2013
     2011      % Change
from 2011
to 2012
 

Revenues:

              

Advertising

   $   1,613.4      $ 1,418.5        14%       $ 1,314.2        8%   

Subscription

     650.1        705.3        (8)%         803.2        (12)%   

Other

     56.4        67.9        (17)%         84.7        (20)%   
  

 

 

    

 

 

       

 

 

    

Total revenues

   $ 2,319.9      $   2,191.7        6%       $   2,202.1        (0)%   
  

 

 

    

 

 

       

 

 

    

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

 

     Years Ended December 31,  
         2013          2012      2011  

Revenues:

        

Advertising

     70%         65%         60%   

Subscription

     28           32           36     

Other

     2           3           4     
  

 

 

    

 

 

    

 

 

 

Total revenues

     100%         100%         100%   
  

 

 

    

 

 

    

 

 

 

Advertising Revenues

Advertising revenues are generated on AOL Properties through display advertising and search advertising, as described in “Overview – Our Business” herein. Agreements for advertising on AOL Properties 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 promotion 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, product purchases or other revenue sharing relationships. In addition, agreements with advertisers can include other advertising-related services such as content sponsorships, exclusivities or advertising effectiveness research.

In addition to advertising revenues generated on AOL Properties, 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 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.

 

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Advertising revenues on AOL Properties and the Third Party Network for the years ended December 31, 2013, 2012 and 2011 are as follows (in millions):

 

     Years Ended December 31,  
     2013      2012      % Change
from 2012
to 2013
     2011      % Change
from 2011
to 2012
 

AOL Properties:

              

Display

   $ 610.2      $ 575.4        6%       $ 573.4        0%   

Search

     388.5        371.5        5%         357.1        4%   
  

 

 

    

 

 

       

 

 

    

Total AOL Properties

     998.7        946.9        5%         930.5        2%   

Third Party Network

     614.7        471.6        30%         383.7        23%   
  

 

 

    

 

 

       

 

 

    

Total advertising revenues

   $   1,613.4      $   1,418.5        14%       $   1,314.2        8%   
  

 

 

    

 

 

       

 

 

    

2013 vs. 2012

Total advertising revenues increased $194.9 million, reflecting an increase in all lines of advertising revenue. The increase in Third Party Network revenue of $143.1 million is primarily due to growth in the sale of premium formats across our programmatic platform and by the inclusion of revenue from Adap.tv. Third Party Network revenue includes $76.1 million related to Adap.tv, which was acquired in September 2013 (Adap.tv also contributed $2.3 million in other revenues during 2013, as discussed below). Display revenue increased $34.8 million primarily due to increased impressions sold on AOL Properties. Search revenue increased $17.0 million primarily due to an increase in revenue per search.

2012 vs. 2011

Advertising revenues increased $104.3 million, primarily reflecting an increase in Third Party Network revenue and search revenue. The increase in Third Party Network revenue of $87.9 million relates in part to an increase in publishers on the network and increased sales of premium packages and products, including video. In addition, Third Party Network revenue increased by $32.7 million as a result of the consolidation of a joint venture between Mitsui and AOL (“Ad.com Japan”) beginning in the first quarter of 2012. Search revenue increased $14.4 million, driven primarily by continued increases in search revenue on AOL.com of $34.5 million through the optimization of the consumer experience and due to increased queries from marketing related efforts. This increase was partially offset by declines in search revenue resulting from our 15% decline in domestic AOL subscribers and declines in search on co-branded portals of $10.6 million. International display revenue increased by $10.5 million, primarily due to improved performance in the United Kingdom and Canada. Domestic display revenue declined $8.5 million due to the decline in the sale of reserved inventory with more impressions being sold through the Third Party Network at lower prices. The decrease in domestic display revenue was partially offset by growth in reserved pricing due to the increased sales of premium formats and video and by revenue growth from Patch.

Revenues Associated with Google

For all periods presented in this Annual Report, we have had a contractual relationship with Google whereby we generate significant revenues through paid text-based search and contextual advertising on AOL Properties provided by Google. For the years ended December 31, 2013, 2012 and 2011, the revenues associated with the Google relationship (substantially all of which were search revenues generated on AOL Properties) were $373.3 million, $350.9 million and $335.3 million, respectively.

 

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Subscription Revenues

Subscription revenues declined 8% for the year ended December 31, 2013 as compared to the same period in 2012. The decline was due to a 10% decrease in the number of domestic AOL subscribers between December 31, 2012 and December 31, 2013, which resulted in a decline in subscription revenue of $99.8 million. This decline was partially offset by an 8% increase in domestic average monthly subscription revenue per AOL subscriber (“ARPU”) for the year ended December 31, 2013 as compared to the same period in 2012. The increase in ARPU for the year ended December 31, 2013, which resulted in an increase in subscription revenue of $53.0 million, is primarily due to price increases related to our value plan strategy that provides additional features and services to subscribers.

Subscription revenues declined 12% for the year ended December 31, 2012 as compared to the same period in 2011. The decline was due to a 15% decrease in the number of domestic AOL subscribers between December 31, 2011 and December 31, 2012. Subscription revenue for the year ended December 31, 2012 as compared to the same period in 2011 also includes a favorable impact related to the simplified pricing structure process initiated in late 2011 and continued in 2012, which resulted in an increase in ARPU.

Other Revenues

Other revenues consist of revenues from licensing our proprietary ad serving technology to third parties through ADTECH, licensing revenues from third-party customers of MapQuest’s business-to-business and online travel services and fees from mobile carriers associated with our mobile e-mail and instant messaging functionality. Subsequent to the acquisition of Adap.tv, other revenues also includes fees generated from publishers and advertisers using Adap.tv’s platform technology and features, as well as services such as ad serving and hosting.

Other revenues decreased 17% for the year ended December 31, 2013 as compared to the same period in 2012, due primarily to the absence of revenue from StudioNow related to the divestiture in January 2013. StudioNow contributed $7.5 million in 2012 to other revenues. Additionally, there was a decrease in revenues from our mobile messaging services of $4.7 million and a decline in ADTECH licensing revenues of $2.1 million, partially offset by an increase in platform fees of $2.3 million related to Adap.tv, which was acquired in September 2013.

Other revenues decreased 20% for the year ended December 31, 2012 as compared to the same period in 2011, due primarily to a decrease in revenues from our mobile messaging services of $13.8 million and a decline in third party web hosting revenues of $5.7 million, partially offset by an increase in StudioNow production fees of $4.6 million.

Geographical Concentration of Revenues

For the periods presented herein, a significant majority of our revenues have been generated in the United States. The majority of the non-United States revenues for these periods were generated by our European operations (primarily in the United Kingdom and Germany). We expect the significant majority of our revenues to continue to be generated in the United States for the foreseeable future. See “Note 12” in our accompanying consolidated financial statements for further information regarding the revenues generated in the countries in which we operate.

 

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Operating Costs and Expenses

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

 

     Years Ended December 31,  
     2013      2012      % Change
from 2012
to 2013
     2011      % Change
from 2011
to 2012
 

Costs of revenues

   $   1,706.2       $   1,587.2         7%       $   1,584.4         0%   

General and administrative

     322.0         413.2         (22)%         440.0         (6)%   

Amortization of intangible assets

     45.1         38.2         18%         92.0         (58)%   

Restructuring costs

     41.3         10.1         NM         38.3         (74)%   

NM = not meaningful

The following table represents our operating costs and expenses as a percentage of revenues for the periods presented:

 

     Years Ended December 31,  
       2013          2012          2011    

Costs of revenues

     74%         72%         72%   

General and administrative

     14           19           20     

Amortization of intangible assets

     2           2           4     

Restructuring costs

     1           0           2     
  

 

 

    

 

 

    

 

 

 

Total operating costs and expenses

     91%         93%         98%   
  

 

 

    

 

 

    

 

 

 

Costs of Revenues

The following categories of costs are generally included in costs of revenues: personnel and facilities costs, TAC, network-related costs, non-network depreciation and amortization and other costs of revenues. 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 Properties. 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 and payments for direct traffic delivered to AOL Properties priced on a per click basis (e.g., search engine marketing fees). These arrangements are primarily on a variable basis; however, the arrangements can also be on a fixed-fee basis, which often carry reciprocal performance guarantees by the counterparty, or a combination of fixed and variable fees.

 

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Costs of revenues for the years ended December 31, 2013, 2012 and 2011 are as follows (in millions):

 

     Years Ended December 31,  
     2013      2012      % Change
from 2012
to 2013
     2011      % Change
from 2011
to 2012
 

Costs of revenues:

              

Personnel costs

   $ 643.6      $ 648.8        (1)%       $ 646.2        0%   

Facilities costs

     56.4        53.5        5%         57.3        (7)%   

TAC

     479.4        356.9        34%         305.5        17%   

Network-related costs

     148.5        160.6        (8)%         186.6        (14)%   

Non-network depreciation and amortization

     57.6        63.0        (9)%         70.5        (11)%   

Other costs of revenues

     320.7        304.4        5%         318.3        (4)%   
  

 

 

    

 

 

       

 

 

    

Total costs of revenues

   $   1,706.2      $   1,587.2        7%       $   1,584.4        0%   
  

 

 

    

 

 

       

 

 

    

2013 vs. 2012

The increase in costs of revenues was primarily driven by the increase in TAC of $122.5 million. The increase in TAC was mainly driven by an increase in Third Party Network advertising revenues, which resulted in higher variable revenue share payments to our publishing partners of $84.1 million (including $48.9 million of TAC as a result of our acquisition of Adap.tv), and the increase in marketing-related efforts on search revenue of $35.2 million.

The increase in costs of revenues was also driven by other long-lived asset impairment charges of $10.4 million included in other costs of revenues, the majority of which related to Patch. In addition, costs of revenues increased due to our investment in programmatic platforms and premium formats, partially offset by special items incurred in 2012 related to a year-end employee bonus and an acquisition-related bonus.

The decrease in network-related costs of $12.1 million was primarily due to fewer depreciable network assets. Other costs of revenues also includes a decline in sales tax expense of $9.6 million related to expense incurred in 2012 from a Virginia sales tax settlement and an additional decline in sales and use tax expense of $3.5 million due to the favorable settlement of a tax matter resolved in the first quarter of 2013.

2012 vs. 2011

The increase in personnel costs is primarily due to the impact of increased headcount in areas of strategic focus, a special year-end employee bonus related to the patent transaction and an acquisition-related bonus of $4.7 million, partially offset by declines in retention compensation expense of $21.9 million related to our 2010 and 2011 acquisitions. Facilities costs decreased due to consolidation of office space during 2012.

TAC increased primarily due to the increase in Third Party Network advertising revenues, including video, and increases related to our search marketing initiatives. TAC also increased $21.8 million as a result of our consolidation of Ad.com Japan.

The decrease in network-related costs is primarily due to the decommissioning of certain network equipment, which is due in part to the decline in the number of domestic AOL subscribers. Costs of revenues also included a decline in non-network depreciation and amortization primarily due to a decline in depreciable and amortizable assets.

Other costs of revenues decreased primarily due to declines in internal content development costs of $23.4 million related primarily to our reduced reliance on freelancers and a decrease in billing expenses of $3.4 million

 

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due to a decline in AOL subscribers. These declines were partially offset by an increase in ad tracking and serving expense of $5.4 million due to increased demand and an increase in sales tax expense of $9.6 million relating to the Virginia sales tax settlement in the second quarter of 2012.

General and Administrative

2013 vs. 2012

General and administrative expenses decreased $91.2 million. The decrease includes the impacts of legal and consulting costs incurred in 2012 related to the patent transaction with Microsoft of $16.5 million and costs incurred related to the proxy contest of $10.7 million, as well as a $6.3 million benefit in June 2013 upon favorable resolution of a dispute over amounts to be reimbursed to us from escrow related to a prior acquisition.

Additionally, general and administrative expenses decreased due to a decline in marketing related costs of $27.6 million, a decline in personnel costs of $10.3 million as well as a decline in other general and administrative expenses as a result of our continued cost reduction efforts.

2012 vs. 2011

General and administrative expenses decreased $26.8 million primarily due to a decline in personnel costs of $25.9 million. The decline in personnel costs is primarily due to the impact of reduced corporate headcount, as well as a favorable change in our accrued vacation as a result of a change in policy and reduced stock compensation expense resulting from vesting of certain stock awards in December 2011. Other declines impacting general and administrative expenses included decreases in depreciation and amortization of $6.7 million primarily due to a decline in depreciable and amortizable assets, 2011 acquisition-related expenses of $12.4 million and 2011 legal settlement costs of $8.5 million. Partially offsetting these declines were increases of $5.5 million in marketing costs, $10.7 million of expenses related to the proxy contest and $16.5 million of expenses related to the patent sale and license and return of the related proceeds to shareholders.

Amortization of Intangible Assets

Amortization of intangible assets results primarily from acquired intangible assets including acquired technology, customer relationships and trade names.

Amortization of intangible assets increased for the year ended December 31, 2013 compared to the prior year period by $6.9 million primarily due to amortization of intangible assets acquired from Adap.tv. Amortization of intangible assets decreased $53.8 million for the year ended December 31, 2012 as compared to the prior year period primarily due to a $55.1 million decline resulting from certain intangible assets being fully amortized in 2011.

Restructuring Costs

In connection with our restructuring initiatives, we incurred restructuring costs of $41.3 million, $10.1 million, and $38.3 million for the years ended December 31, 2013, 2012 and 2011, respectively. The 2013 restructuring costs primarily related to our efforts to align our organizational structure with our strategy, including the restructuring of our Patch operations. The 2012 restructuring costs primarily related to organizational changes in the United States made in an effort to improve our ability to execute our strategy. The

 

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majority of these costs related to involuntary employee terminations. The 2011 restructuring costs primarily related to costs incurred as a result of our acquisition of The Huffington Post.com, Inc. (“The Huffington Post”), a reassessment of our operations in India and actions in the United States to align our costs with our strategy. The majority of these costs related to involuntary employee terminations.

Other Transactions Impacting Operating Income

The following table presents other transactions impacting operating income for the periods presented (in millions):

 

     Year Ended December 31,  
     2013      2012      % Change
from  2011
to 2012
     2011      % Change
from 2010
to 2011
 

Goodwill impairment charge

   $ 17.5       $ —           NM            $    —           NM   

Income from licensing of intellectual property

     —           (96.0)         (100)%         —           NM   

(Gain) loss on disposal of assets, net

     (2.5)         (962.9)         (100)%         1.6         NM   

Goodwill Impairment Charge

Goodwill is tested annually for impairment during the fourth quarter or earlier upon the occurrence of certain events or substantive changes in circumstances that indicate goodwill is more likely than not impaired.

We performed a goodwill impairment analysis as a result of a triggering event in our Patch reporting unit occurring during the third quarter of 2013. As a result, we recorded an impairment charge of $17.5 million for the three months ended September 30, 2013, fully impairing the goodwill related to Patch. We also performed our annual goodwill impairment test during the fourth quarter of 2013 for our three other reporting units. In each of these analyses, the estimated fair value of each reporting unit exceeded its respective carrying value and therefore no further goodwill impairment charges were recorded in the fourth quarter of 2013. See “Note 3” in our accompanying consolidated financial statements for additional information on our goodwill impairment analyses.

No goodwill impairment charges were recorded in 2012 or 2011.

Income from Licensing of Intellectual Property and Gain on Disposal of Assets, Net

Income from licensing of intellectual property of $96.0 million for the year ended December 31, 2012 reflects the license of our retained patent portfolio to Microsoft in June 2012. The gain on disposal of assets, net of $962.9 million for the year ended December 31, 2012 includes the gain on the sale of the Sold Patents to Microsoft of $946.5 million. See “Note 4” in our accompanying consolidated financial statements for additional information on the patent transaction. Additionally, gain on disposal of assets, net includes the release of a $16.4 million VAT indemnification reserve that was established upon the sale of our legacy access businesses in the United Kingdom and Germany in 2006 and 2007, respectively.

Operating Income (Loss)

Operating income decreased $1,011.6 million for the year ended December 31, 2013 as compared to the same period in 2012 primarily due to the gain on the disposition of the Sold Patents and income from licensing of intellectual property in 2012, an increase in costs of revenues and restructuring costs and an impairment of goodwill in September 2013 of $17.5 million, partially offset by an increase in revenue and declines in general and administrative costs.

 

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Operating income was $1,201.9 million for the year ended December 31, 2012, as compared to the operating income of $45.8 million for the year ended December 31, 2011. This increase was primarily due to the gain on the disposition of the Sold Patents, income from licensing of intellectual property, and the release of a VAT indemnification reserve, as well as declines in general and administrative costs, amortization of intangible assets and restructuring costs, partially offset by the decline in revenues.

Other Income Statement Amounts

The following table presents our other income statement amounts for the periods presented (in millions):

 

     Years Ended December 31,  
     2013      2012      % Change
from  2011
to 2012
     2011      % Change
from 2010

to 2011
 

Other income (loss), net

   $   (6.6)         $    8.2          NM          $   (3.5)         NM   

Income tax provision

     93.1         162.4          (43)%         29.2          NM   

Other Income (Loss), Net

Other loss, net was $6.6 million for the year ended December 31, 2013 as compared to other income, net of $8.2 million for the same period in 2012. The decrease was due primarily to the $10.8 million non-cash gain related to the consolidation of Ad.com Japan recorded in the first quarter of 2012 and to unfavorable foreign currency impacts of $3.3 million in 2013.

Other income, net was $8.2 million for the year ended December 31, 2012 as compared to other loss, net of $3.5 million for the same period in 2011. The increase was due primarily to the $10.8 million non-cash gain related to the consolidation of Ad.com Japan recorded in the first quarter of 2012.

Income Tax Provision

We recorded income before income taxes of $183.7 million and related income tax expense of $93.1 million, which resulted in an effective tax rate of 50.7% for the year ended December 31, 2013, as compared to the effective tax rate of 13.4% for the year ended December 31, 2012. The effective tax rate for the year ended December 31, 2013 differed from the statutory U.S. federal income tax rate of 35.0% primarily due to the non-deductible goodwill impairment charge and foreign losses that did not produce a tax benefit, offset by the benefit of research and development tax credits. The effective tax rate for the year ended December 31, 2013 increased compared to the effective tax rate for the period ended December 31, 2012 primarily due to the tax impact of the 2012 patent transaction with Microsoft which resulted in an effective tax rate lower than the statutory U.S. federal income tax rate.

We recorded income before income taxes of $1,210.1 million and related income tax expense of $162.4 million, which resulted in an effective tax rate of 13.4% for the year ended December 31, 2012, as compared to the effective tax rate of 69.0% for the year ended December 31, 2011. The effective tax rate for the year ended December 31, 2012 differed substantially from the statutory U.S. federal income tax rate of 35.0% primarily due to the tax impact of the patent transaction with Microsoft during the second quarter of 2012, offset by the unfavorable impact of foreign losses that did not produce a tax benefit. The effective tax rate for the year ended December 31, 2011 differed from the statutory U.S. federal income tax rate of 35.0% due to the impact of foreign losses, for which no benefit is received on our U.S. income tax provision, and non-deductible acquisition-related expenses incurred in 2011. These items were partially offset by a tax benefit associated with a worthless stock deduction related to the sale of a subsidiary in the first quarter of 2011 and favorable adjustments related to escrow disbursements for which we have concluded that we will be able to recognize a tax benefit.

 

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Adjusted OIBDA

We use Adjusted OIBDA as a supplemental measure of our performance. We define Adjusted OIBDA as operating income before depreciation and amortization excluding the impact of restructuring costs, non-cash equity-based compensation, gains and losses on all disposals of assets, non-cash asset impairments and write-offs and special items. We consider Adjusted OIBDA to be a useful metric for management and investors to evaluate and compare the ongoing operating performance of our business on a consistent basis across reporting periods, as it eliminates the effect of non-cash items such as depreciation of tangible assets, amortization of intangible assets that were primarily recognized in business combinations, asset impairments and write-offs, as well as the effect of restructurings, gains and losses on asset sales and special items, which we do not believe are indicative of our core operating performance. We exclude the impacts of equity-based compensation to allow us to be more closely aligned with the industry and analyst community.

A limitation of this measure, however, is that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our business or the current or future expected cash expenditures for restructuring costs. The Adjusted OIBDA measure also does not include equity-based compensation, which is and will remain a key element of our overall long-term compensation package. Moreover, the Adjusted OIBDA measures do not reflect gains and losses on asset sales, impairment charges and write-offs related to goodwill, intangible assets and fixed assets or special items which impact our operating performance. We evaluate the investments in such tangible and intangible assets through other financial measures, such as capital expenditure budgets, investment spending levels and return on capital.

Adjusted OIBDA is not a financial measure under generally accepted accounting principles (“GAAP”) and may be different than similarly-titled non-GAAP financial measures used by other companies. The presentation of this financial information is not intended to be considered in isolation or as a substitute for the financial information prepared and presented in accordance with GAAP.

The following table presents our reconciliation of Adjusted OIBDA to operating income (loss) (in millions):

 

     Years Ended December 31,  
     2013      2012      % Change
from 2012
to 2013
     2011      % Change
from 2011
to 2012
 

Operating income

   $   190.3       $   1,201.9         (84)%       $ 45.8          NM        

Add: Depreciation

     128.9         138.7         (7)%           160.9          (14)%   

Add: Amortization of intangible assets

     45.1         38.2         18 %         92.0          (58)%   

Add: Restructuring costs

     41.3         10.1         NM             38.3          (74)%   

Add: Equity-based compensation

     47.0         39.5         19 %         42.5          (7)%   

Add: Asset impairments and write-offs

     30.6         6.1         NM             7.6          (20)%   

Add: Losses/(gains) on disposal of assets, net

     (2.5)         (964.2)         (100)%         0.4          NM        

Add: Special items

     —           (57.7)         (100)%         21.2          NM        
  

 

 

    

 

 

       

 

 

    

Adjusted OIBDA

   $   480.7       $   412.6         17 %       $ 408.7          1 %   
  

 

 

    

 

 

       

 

 

    

Special items for the year ended December 31, 2012 include patent licensing income of $96.0 million and costs related to the patent sale and license of $15.7 million, as well as proxy contest costs of $8.9 million, $7.6 million of tax settlement expenses and acquisition-related costs of $5.1 million.

Adjusted OIBDA increased for the year ended December 31, 2013 as compared to the year ended December 31, 2012 primarily due to the increase in revenues and decline in general and administrative costs, partially offset by the increase in costs of revenues.

 

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Adjusted OIBDA increased for the year ended December 31, 2012 as compared to the year ended December 31, 2011 primarily due to the declines in general and administrative costs, partially offset by decline in revenues.

Segment Results of Operations

We have three reportable segments which are determined based on the properties, products and services we provide and how our chief operating decision maker evaluates the business. Our segment results reflect information presented on the same basis that we use for internal management reporting. The segment profitability measure used in our internal management reporting and presented herein is Adjusted OIBDA. See “Note 12” in our accompanying consolidated financial statements for additional information on our segments and a reconciliation of total consolidated Adjusted OIBDA to operating income (loss).

The following is a summary of segment operating results for the years ended December 31, 2013, 2012 and 2011:

 

     Years Ended December 31,  
     2013      2012      % Change
from 2012
to 2013
     2011      % Change
from 2011
to 2012
 

Revenue:

              

Brand Group

   $ 794.4       $ 730.2         9 %       $ 732.6         0 %   

Membership Group

     839.1         914.6         (8)%         1,035.5         (12)%   

AOL Networks

     785.0         644.1         22 %         491.2         31 %   

Corporate and Other

     0.6         1.5         (60)%         7.0         (79)%   

Intersegment eliminations

     (99.2)         (98.7)         (1)%         (64.2)         (54)%   
  

 

 

    

 

 

       

 

 

    

Total Revenue

   $   2,319.9       $   2,191.7         6 %       $   2,202.1         0 %   
  

 

 

    

 

 

       

 

 

    

Adjusted OIBDA:

              

Brand Group

   $ 40.2       $ (32.8)         NM           $ (48.4)         32 %   

Membership Group

     593.7         632.9         (6)%         711.9         (11)%   

AOL Networks

     (15.0)         7.3         NM             (39.5)         NM       

Corporate and Other

     (138.2)         (194.8)         29 %         (215.3)         10 %   
  

 

 

    

 

 

       

 

 

    

Total Adjusted OIBDA

   $ 480.7       $ 412.6         17 %       $ 408.7         1 %   
  

 

 

    

 

 

       

 

 

    

Brand Group

2013 vs. 2012

Brand Group revenue increased, reflecting an increase in global display revenue of $41.1 million and an increase in search revenue of $23.7 million. Global display revenue increased primarily driven by increased impressions sold on AOL Properties. The increase in search revenue was primarily driven by an increase in revenue per search.

Brand Group Adjusted OIBDA increased due to the year-over-year increases in revenue discussed above and declines in personnel, primarily at Patch, and declines in marketing and consulting related costs as a result of our continued cost reduction efforts, partially offset by an increase in TAC as a result of our marketing-related efforts on search.

 

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2012 vs. 2011

Brand Group revenue was essentially flat, reflecting a decrease in global display revenue of $14.3 million, offset by an increase in search revenue of $13.4 million. Global display revenue declined primarily due to an increase in Brand Group inventory sold through AOL Networks at a lower price, which was offset by growth in reserved pricing and continued growth in the sales of premium formats, including video, and Patch inventory. The increase in search revenue was driven by continued growth in revenue on AOL.com through the optimization of both the consumer and advertiser experiences, partially offset by a decline in queries on cobranded portals.

Adjusted OIBDA increased for the Brand Group, reflecting the changes in revenue discussed above as well as lower overall content creation expenses, including from Patch, of $26.0 million, partially offset by an increase in personnel costs. The decline in content creation costs is due primarily to the reduced reliance on freelancers. Increases in personnel costs reflect an increased investment in areas of strategic focus.

Membership Group

2013 vs. 2012

Membership Group revenue decreased due to the 10% decline in our domestic AOL subscribers, which resulted in a decline in subscription revenue of $99.8 million. This decline was partially offset by an increase in ARPU of 8%, which resulted in an increase in subscription revenue of $53.0 million. This increase is primarily due to price increases related to our value plan strategy that provides additional features and services to subscribers.

Adjusted OIBDA for the Membership Group decreased due to the decrease in revenue discussed above, partially offset by overall declines in costs associated with the declines in domestic AOL subscribers and the favorable disposition of a claim regarding a legal matter in the third quarter of 2013.

2012 vs. 2011

Membership Group revenue decreased 12% due to the 15% decline in our domestic AOL subscribers, which was partially offset by an increase in ARPU of 4%, and a decrease in display revenues of $8.8 million. Domestic display revenue declined due to fewer reserved impressions sold, primarily on AOL Mail, and an increase in the number of Membership Group properties impressions sold through AOL Networks at a lower price. Other revenue declined due to declines from our mobile messaging services.

Adjusted OIBDA for the Membership Group decreased due to the changes in revenue discussed above, partially offset by declines in network related costs, personnel and consulting costs. The decrease in network-related costs is primarily due to the decommissioning of certain network equipment, which is due in part to the decline in the number of domestic AOL subscribers.

AOL Networks

2013 vs. 2012

AOL Networks revenue increased primarily due to growth in the sale of premium formats across our programmatic platform and by the inclusion of revenue from Adap.tv. AOL Networks revenue includes $78.4

 

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million related to Adap.tv, which was acquired in September 2013. The increase in AOL Networks revenue was partially offset by the absence of revenue from StudioNow due to the divestiture in Q1 2013. StudioNow contributed $7.5 million in revenue to AOL Networks in 2012.

AOL Network Adjusted OIBDA decreased primarily due to our investment in programmatic platforms and premium formats.

2012 vs. 2011

AOL Networks revenue increased primarily due to growth in the sale of inventory of third party properties through Advertising.com (including $32.7 million of revenues in 2012 related to Ad.com Japan, which we began consolidating in the first quarter of 2012). Growth is being driven primarily by an increase in publishers and advertisers utilizing AOL Networks and increased sales of premium packages and products, including video. AOL Networks revenue growth also reflects growth in inventory from AOL owned and operated sites sold through AOL Networks.

Adjusted OIBDA for AOL Networks increased, reflecting the increase in revenues discussed above and a decrease in retention compensation expenses associated with prior period acquisitions, partially offset by an increase in TAC, associated with the increased revenue, and increased personnel expenses. TAC also increased $21.8 million as a result of our consolidation of Ad.com Japan.

Corporate and Other

In addition to the above reportable segments, we have a corporate and other category that includes activities that are not directly attributable or allocable to a specific segment. This category primarily consists of costs associated with broad corporate functions including legal, human resources, finance and accounting, and activities not directly attributable to a segment such as tax settlements and other general business costs.

Corporate and other Adjusted OIBDA for the year ended December 31, 2013 as compared to the year ended December 31, 2012 improved primarily due to declines in marketing and personnel costs as a result of cost reduction efforts as well as a decrease in legal fees. Additionally, Adjusted OIBDA was favorably impacted by a decline in consulting costs and the $6.3 million favorable resolution in June 2013 of a dispute over amounts to be reimbursed to us from escrow related to a prior acquisition.

For the year ended December 31, 2012 as compared to the year ended December 31, 2011, revenue decreased due to a decrease in revenues from international hosting. Adjusted OIBDA increased due to lower personnel costs resulting from headcount reductions and a decrease in marketing costs, partially offset by the decrease in revenues discussed above.

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. Forecasts of future cash flows are dependent on many factors, including future economic conditions and the execution of our strategy. We believe our existing cash balance, cash flows from operations and the Credit Facility Agreement are sufficient to fund our ongoing working capital, investing and financing requirements, including future repurchases of common stock. To date, we have not borrowed under the terms of the Credit Facility Agreement. We regularly review our capital structure in light of our strategic growth objectives and we may look to access the capital markets depending on several factors, including market

 

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conditions, liquidity needs, and our capital allocation priorities. See “Principal Debt Obligations” for additional information on the Credit Facility Agreement.

At December 31, 2013, our cash and equivalents totaled $207.3 million, as compared to $466.6 million at December 31, 2012. The decrease in cash and equivalents was primarily due to the acquisition of Adap.tv in the third quarter of 2013 and the repurchase of common stock throughout 2013, partially offset by cash provided by operations. Our cash and equivalents consist of cash and other highly liquid short-term investments that are readily convertible to cash.

Approximately 29% of our cash and equivalents as of December 31, 2013 is held internationally, primarily in Luxembourg, the United Kingdom, Japan, Germany, Canada and India, and is utilized to fund our foreign operations. Cash held internationally may be repatriated and would be available to be used to fund our domestic operations. However, repatriation of funds may result in additional tax liabilities. We believe the cash balance in the U.S. is sufficient to fund our domestic working capital needs.

Summary Cash Flow Information

Our cash flows from operations are driven by net income adjusted for non-cash and non-operating items such as depreciation and amortization, asset impairments and write-offs, equity-based compensation expense and other activities impacting net income such as the gains and losses on the sale of assets. Cash flows from investing activities consist primarily of the cash used in the acquisitions of various businesses, cash used for capital expenditures and cash received from the disposal of assets. Capital expenditures and product development costs are mainly for the purchase of computer hardware, software, network equipment, furniture, fixtures and other office equipment. Cash flows from financing activities relate primarily to repurchases of common stock, principal payments made on capital lease obligations, tax withholdings related to net share settlements of restricted stock units, proceeds from the exercise of stock options and payment of the Special Cash Dividend in the fourth quarter of 2012.

Operating Activities

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

 

     Years Ended December 31,  
     2013      2012      2011  

Net income

   $ 90.6       $   1,047.7       $ 13.1   

Adjustments for non-cash and non-operating items:

        

Depreciation and amortization

     174.0         176.9         252.9   

Asset impairments and write-offs

     30.6         6.1         7.6   

(Gain) loss on step acquisitions and disposal of assets, net

     (1.5)         (975.5)         1.6   

Equity-based compensation

     47.0         39.5         42.5   

Deferred income taxes

     51.5         124.1         23.3   

All other, net, including working capital changes

     (73.3)         (53.2)         (45.0)   
  

 

 

    

 

 

    

 

 

 

Cash provided by operating activities

   $   318.9       $ 365.6       $   296.0   
  

 

 

    

 

 

    

 

 

 

Cash provided by operating activities decreased $46.7 million for the year ended December 31, 2013, as compared to the year ended December 31, 2012, driven mainly by a decrease in operating income of $65.1

 

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million (excluding the $946.5 million gain on the sale of patents) which was primarily the result of the $96 million in cash received from licensing our retained patent portfolio to Microsoft in 2012. Cash provided by operating activities also declined due to the timing of changes in working capital.

Cash provided by operating activities increased $69.6 million for the year ended December 31, 2012, as compared to the year ended December 31, 2011, driven mainly by the $96.0 million cash received from licensing our retained patent portfolio to Microsoft during the second quarter of 2012 and lower restructuring payments during 2012, partially offset by incentive compensation payments made in 2012 related to prior year acquisitions and a decrease due to the timing of changes in working capital.

Investing Activities

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

 

     Years Ended December 31,  
     2013      2012      2011  

Investments and acquisitions, net of cash acquired

   $   (337.9)       $ (32.0)       $ (377.9)   

Proceeds from disposal of assets, net

            1.5           952.3                4.7   

Capital expenditures and product development costs

     (65.7)         (64.9)         (82.3)   
  

 

 

    

 

 

    

 

 

 

Cash (used) provided by investing activities

   $ (402.1)       $ 855.4      $ (455.5)   
  

 

 

    

 

 

    

 

 

 

Cash used by investing activities was $402.1 million for the year ended December 31, 2013, as compared to cash provided by investing activities of $855.4 million for the year ended December 31, 2012. The $1,257.5 million decrease in cash used by investing activities was primarily due to approximately $950 million in proceeds (net of transaction costs paid) from the disposition of the Sold Patents in 2012 and the acquisition payment of $329.5 million related to Adap.tv in 2013.

Cash provided by investing activities was $855.4 million for the year ended December 31, 2012, as compared to cash used by investing activities of $455.5 million for the year ended December 31, 2011. The $1,310.9 million increase in cash provided by investing activities was primarily due to approximately $950 million in proceeds (net of transaction costs paid) from the disposition of the Sold Patents in 2012, a decrease in capital expenditures and product development costs and acquisition payments related to The Huffington Post and goviral ApS (“goviral”, now referred to as Be On) during the year ended December 31, 2011. These increases in cash provided by investing activities were partially offset by acquisition payments in 2012 related to Buysight, Inc. and StyleMePretty, LLC (“StyleMePretty”). In addition, investments and acquisitions, net of cash acquired, for the year ended December 31, 2012 includes $6.9 million of cash acquired from the business combination achieved in stages (“step acquisition”) of Ad.com Japan (net of $1.2 million cash paid for the additional 3% interest) during the first quarter of 2012.

 

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Financing Activities

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

 

     Years Ended December 31,  
     2013      2012      2011  

Repurchase of common stock

   $   (134.8)         $  (698.7)       $   (173.6)   

Principal payments on capital leases

     (61.1)         (55.6)         (49.0)   

Tax withholdings related to net share settlements of restricted stock units

     (16.5)         (7.6)         (0.4)   

Proceeds from exercise of stock options

     35.3         35.2         1.0   

Cash dividends paid and dividend equivalent payments on restricted stock units

     (4.4)         (434.4)         —     

Other financing activities

     6.1         0.3         (12.8)   
  

 

 

    

 

 

    

 

 

 

Cash used by financing activities

   $   (175.4)       $   (1,160.8)       $   (234.8)   
  

 

 

    

 

 

    

 

 

 

Cash used by financing activities decreased $985.4 million for the year ended December 31, 2013, as compared to the year ended December 31, 2012, primarily due to a decrease in cash paid for the repurchase of our common stock as we completed repurchases under the ASR Agreement (as defined below) in 2012 and the $434.4 million Special Cash Dividend payment during the fourth quarter of 2012.

Cash used by financing activities increased $926.0 million for the year ended December 31, 2012, as compared to the year ended December 31, 2011, primarily due to repurchases of common stock during 2012 and the $434.4 million Special Cash Dividend payment during the fourth quarter of 2012, partially offset by $35.2 million of cash provided by the exercise of stock options in 2012.

On August 26, 2012, we entered into a fixed dollar collared accelerated stock repurchase agreement with Barclay’s Capital Inc. (“Barclays”), as agent for Barclays Bank PLC, effective August 27, 2012 (the “ASR Agreement”). Included in the $698.7 million related to repurchases of common stock for the year ended December 31, 2012 was $654.1 million paid to Barclays on August 30, 2012 to repurchase outstanding shares of common stock under the ASR Agreement, and the remainder was used to repurchase shares on the open market under the stock repurchase program approved on August 10, 2011 and through the modified Dutch auction tender offer. $54.1 million of the consideration paid to Barclays to repurchase shares was in contemplation of the Special Cash Dividend, and represented the present value upon execution of the ASR Agreement of the one-time cash dividend with respect to those shares deliverable under the ASR Agreement. See “Note 7” in our accompanying consolidated financial statements for additional information on our stock repurchase programs and Special Cash Dividend.

Free Cash Flow

We use Free Cash Flow as a supplemental measure of our performance. We define Free Cash Flow as cash provided by operating activities, less capital expenditures, product development costs and principal payments on capital leases. We consider Free Cash Flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated by the business that, after capital expenditures, capitalized product development costs and principal payments on capital leases, can be used for strategic opportunities, including investing in our business, making strategic acquisitions and strengthening the balance sheet. Analysis of Free Cash Flow also facilitates management’s comparisons of our operating results to competitors’ operating results. A limitation on the use of this metric is that Free Cash Flow does not represent the total increase or decrease in cash for the period because it excludes certain non-operating cash flows.

 

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Free Cash Flow is a non-GAAP financial measure and may be different than similarly-titled non-GAAP financial measures used by other companies. The presentation of this financial information is not intended to be considered in isolation or as a substitute for the financial information prepared and presented in accordance with GAAP.

The following table presents our reconciliation of Free Cash Flow to cash provided by operating activities (in millions):

 

     Years Ended December 31,  
     2013      2012      2011  

Cash provided by operating activities

   $   318.9      $   365.6      $   296.0  

Less: Capital expenditures and product development costs

     65.7        64.9        82.3  

Less: Principal payments on capital leases

     61.1        55.6        49.0  
  

 

 

    

 

 

    

 

 

 

Free Cash Flow

   $   192.1      $   245.1      $   164.7  
  

 

 

    

 

 

    

 

 

 

Free Cash Flow decreased for the year ended December 31, 2013 as compared to the year ended December 31, 2012. This decrease is due to the decline in cash provided by operating activities, discussed in “Summary Cash Flow Information—Operating Activities” above.

Free Cash Flow increased for the year ended December 31, 2012 as compared to the year ended December 31, 2011. This increase is due to the increase in cash provided by continuing operations, discussed in “Summary Cash Flow Information—Operating Activities” above and due to reduced capital expenditures and product development costs resulting from the shift in late 2011 to begin leasing certain assets.

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, 2013 (in millions):

 

     Total      2014      2015-2016      2017-2018      Thereafter  

Capital lease obligations

   $   119.5      $   59.8      $ 50.0      $ 9.7      $ —    

Operating lease obligations, net of sublease income

     230.2        40.4        63.8        48.6        77.4  

Purchase obligations

     84.2        62.3        21.4        0.3        0.2  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 433.9      $   162.5      $   135.2      $   58.6      $   77.6  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following is a description of our material contractual obligations at December 31, 2013:

 

   

Capital lease obligations represent the minimum lease payments under non-cancelable capital leases, primarily for network equipment financed under capital leases. See “Note 5” in our accompanying consolidated financial statements for more information.

 

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Net operating lease obligations represent the minimum lease payments under operating leases, net of contractually committed sublease income, primarily for our real estate in various locations around the world. Included in the above table are approximately $164.2 million of payments associated with the lease of our corporate headquarters in New York. We have leased our corporate headquarters for an initial lease term that ends February 2023, and we have the option to extend the lease for an additional five years. Monthly rental payments to the landlord under this lease escalate by approximately 7% after the end of the fifth year and tenth year of the lease term. Included in the above table are approximately $28.6 million of payments associated with a leased building in California. We have leased this space for an initial lease term that ends in June 2017 with no renewal options. Rent was abated for the first nine months of the lease term with partial rent abatement for an additional three months. Only operating expenses were paid during the rent abatement period. See “Note 10” in our accompanying 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 software licensing agreements and guaranteed royalty payments. 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 with an initial contractual term in excess of one year meeting the definition of a purchase obligation (i.e., 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, 2013, and did not assume renewal or replacement of the contracts at the end of their respective terms. See “Note 10” in our accompanying consolidated financial statements.

The net liability for uncertain tax positions of $55.6 million is not reflected in the above contractual obligations table as we are not able to reasonably estimate the timing of payments in individual years due to uncertainties in the timing of audit outcomes.

Off-Balance Sheet Arrangements

As of December 31, 2013, 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

In the ordinary course of business, we incur indemnification obligations of varying scope and terms to third parties, which could include, without limitation, customers, vendors, distributors, licensors, licensees, 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, software, data or content to be provided by us, taxes, tariffs, our use of services, software, data or content provided by third parties, the

 

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export or import of our software or data, compliance with applicable laws and regulations, infringement of third party intellectual property or property rights 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, 2013, management concluded that the likelihood of any material amounts being paid by us under such indemnifications is remote. As of December 31, 2013, amounts accrued in our financial statements related to indemnification obligations are not material.

Principal Debt Obligations

On July 1, 2013, we entered into the Credit Facility Agreement, which we intend to use, as necessary, for general corporate purposes. The maturity date of the Credit Facility Agreement is July 1, 2018. To date, we have not borrowed under the terms of the Credit Facility Agreement. See “Note 5” in our accompanying consolidated financial statements for additional information.

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 service and is dispersed among many different counterparties.

We had gross accounts receivable of approximately $499.3 million and maintained an allowance for doubtful accounts of $8.3 million at December 31, 2013. No single customer had a receivable balance at December 31, 2013 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, rating 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.

Critical Accounting Policies

Our accompanying consolidated financial statements are prepared in accordance with GAAP, which require management to make estimates, judgments and assumptions that affect the amounts reported in the accompanying 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 related to the following matters to be critical accounting policies: (a) gross versus net revenue recognition; (b) impairment of goodwill; and (c) income taxes.

 

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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, video and search advertising. In connection with our advertising offerings on the Third Party Network, we sometimes 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 costs of revenues 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 the principal or an agent in a transaction involves judgment and is based on an evaluation of the terms of an arrangement. We recognize revenue on a gross basis in situations in which we believe we are the principal in the transactions, considering all of the indicators set forth in the accounting guidance for principal agent considerations. 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, and whether we have inventory risk.

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 TAC within 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, (v) bearing sole liability for fulfillment of the advertising and (vi) bearing general inventory risk. Accordingly, in these arrangements, we generally believe that we are the primary obligor and therefore report revenues earned and costs incurred related to these transactions on a gross basis. During 2013, we earned and reported gross advertising revenues of $614.7 million and incurred TAC of $393.8 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 that indicate goodwill is more likely than not impaired. These indicators include a sustained, significant decline in our stock price; a decline in our expected future cash flows; significant disposition activity; a significant adverse change in the economic or business environment; and the testing for recoverability of a significant asset group, among others. The occurrence of these indicators could have a significant impact on the recoverability of goodwill and could have a material impact on our accompanying consolidated financial statements.

The testing of goodwill for impairment is required to be performed at the level referred to as the reporting unit. Based on how management evaluates the business, we concluded that as of our December 1, 2013 annual impairment testing date we have four reporting units for purposes of the goodwill impairment test; the Brand

 

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Group, the Membership Group, AOL Networks and Patch (the Patch reporting unit goodwill was fully impaired prior to December 1, as discussed further below). There are no components below these four reporting units for which discrete financial information is available and regularly reviewed by segment management. 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.

Goodwill impairment is determined using a two-step process. The first step involves a comparison of the estimated fair value of a reporting unit to its carrying amount, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired and the second step of the impairment test is not necessary. If the carrying amount of a reporting unit exceeds its estimated fair value, then the second step of the goodwill impairment test must be performed. To measure the amount of impairment loss, if any, we determine the implied fair value of goodwill in the same manner as the amount of goodwill recognized in a business combination. Specifically, the estimated fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.

As part of our continuing effort to reduce our expenses and invest in areas of strategic focus, on August 15, 2013, we approved a restructuring plan for our Patch operations. We determined that the restructuring of our Patch operations constituted a substantive change in circumstances that could potentially reduce the fair value of the Patch reporting unit below its carrying amount. Accordingly, we tested the Patch reporting unit for impairment as of the interim testing date, August 31, 2013.

Based on our goodwill impairment analysis as of the interim testing date, the carrying value of the Patch reporting unit exceeded its fair value. Accordingly, step two of the goodwill impairment test was performed, where we determined the estimated fair value of Patch’s assets and liabilities. As a result of our step two evaluation, we recorded a goodwill impairment charge of $17.5 million during the third quarter of 2013, fully impairing the goodwill related to Patch.

We performed our annual goodwill impairment test for the Brand Group, AOL Networks and Membership Group reporting units as of December 1, 2013. We determined the fair value for each of the reporting units using an income approach, or discounted cash flow (“DCF”) method. The reasonableness of the DCF approach was assessed by reference to a market-based approach based on analysis of comparable multiples for each of the reporting units, which reconciled to the fair value of the consolidated business determined based on market-capitalization approach.

Based on the goodwill impairment tests performed at December 1, 2013, the estimated fair value exceeded the carrying value for each reporting unit, and therefore, the second step of the goodwill impairment test was not required for any of our reporting units. For each of the Membership Group, Brand Group and AOL Networks reporting units, the estimated fair value of the reporting unit exceeded its respective book value by in excess of 20%.

Determining the fair value of our reporting units requires the exercise of significant judgment, including judgments about the appropriate discount rates, terminal growth rates, weighted average costs of capital and the amount and timing of expected future cash flows. The cash flows employed in the DCF analysis 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

 

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future revenue streams and cash flows of the reporting unit. The discount rates utilized in the 2013 analyses ranged from 10% to 23% and a constant terminal growth rate was used in the DCF analyses of 3.0%. Failure to execute against our business plan for any of our reporting units could have a negative effect on the fair value of such reporting unit, and increase the risk of a goodwill impairment in the future.

Income Taxes

Income taxes are presented in the accompanying consolidated financial statements using the asset and liability method prescribed by the accounting guidance for income taxes. 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 expected future tax benefits (i.e., assets) and future tax costs (i.e., liabilities). The tax effect of net operating losses, capital losses and general business credit carryovers result in deferred tax assets. The tax effect of temporary differences between the carrying amount of assets and liabilities for financial statement and the basis amount for income tax purposes, as determined based upon currently-enacted tax laws and rates, result in deferred tax assets and liabilities. Significant judgments are made in computing our income tax provision and deferred income taxes.

Valuation allowances are established when management determines it is “more likely than not” that some portion or the entire deferred tax asset may not be realized. We consider all positive and negative evidence in evaluating our ability to realize our deferred income tax assets, including our operating results, ongoing tax planning, and forecast of future taxable income, on a jurisdiction by jurisdiction basis. 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 performed an analysis of the recoverability of our deferred tax assets as of December 31, 2013, which took into consideration our historical operating results, as well as our projections of future operating results and taxable income. Certain deferred tax assets related to capital losses, certain state net operating losses and other state temporary differences, the majority of the foreign net operating losses and certain other foreign temporary differences did not reach the “more likely than not” realizability criteria and accordingly, were subject to a valuation allowance. We analyzed the remaining deferred tax assets using all positive and negative evidence to determine whether we met the “more likely than not” criteria. We considered the fact that we have reported cumulative income in the past three years in the relevant jurisdictions for which these deferred tax assets are recorded, which generally provides positive evidence regarding realizability of deferred tax assets. Our conclusion that such remaining deferred tax assets were “more likely than not” realizable also relied on the weight of positive evidence related to projecting future taxable income based on management’s financial projections and based on our historical results of operations. We currently expect positive growth in our projected taxable income over our long-term planning horizon as we focus our resources on our core competitive strengths in web and local content production, advertising and paid services while expanding the distribution of our content, product and service offerings on multiple platforms and digital devices, including on portable wireless devices such as smartphones and tablets. As a result of this analysis, we concluded that our deferred tax assets, other than those for which a valuation allowance was recorded, continued to be more likely than not to be realized. However, in the circumstance that the financial projections are not achieved, our ability to realize these deferred tax assets may be significantly impacted.

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

 

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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 liability or reduce deferred tax assets 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. We record a liability (or reduce deferred tax assets) for the difference between the benefit recognized and measured pursuant to the accounting guidance for income taxes and the tax position taken on our tax return. 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.

Recent Accounting Standards Impacting Future Periods

Accounting for Cumulative Translation Adjustments

In March 2013, new guidance was issued related to accounting for the cumulative translation adjustment upon derecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity. The new guidance clarifies that companies are required to apply the guidance in the foreign currency accounting subtopic to release any related cumulative translation adjustment into net income. The guidance also applies to step acquisitions.

The new guidance became effective for us in January 2014. We do not expect the new guidance to have a material impact on the way we currently release cumulative translation adjustments into net income upon disposition or deconsolidation of a subsidiary.

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the potential gain or loss arising from changes in market rates and prices, which historically for us, has been associated primarily with changes in foreign currency exchange rates. We transact business in various foreign currencies which exposes us to the risk of fluctuations in foreign currency exchange rates. Foreign currency exchange gains and losses are not material to our earnings in 2013, 2012 and 2011. At December 31, 2013, while the majority of our cash and accounts receivable balances were denominated in U.S. dollars, cash and accounts receivable denominated in foreign currencies made up approximately 19% of total cash and accounts receivable, including 6% in Euros, 6% in British pounds, 3% in Canadian dollars and 2% in Japanese yen.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of AOL Inc.

We have audited the accompanying consolidated balance sheets of AOL Inc. as of December 31, 2013 and 2012, and the related consolidated statements of comprehensive income (loss), equity and cash flows for each of the three years in the period ended December 31, 2013. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of AOL Inc. at December 31, 2013 and 2012, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), AOL Inc.’s internal control over financial reporting as of December 31, 2013 based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our report dated February 19, 2014 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

New York, New York

February 19, 2014

 

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In millions, except per share amounts)

 

     Years Ended December 31,  
     2013      2012      2011  

Revenues:

        

Advertising

   $   1,613.4       $ 1,418.5       $   1,314.2   

Subscription

     650.1         705.3         803.2   

Other

     56.4         67.9         84.7   
  

 

 

    

 

 

    

 

 

 

Total revenues

     2,319.9         2,191.7         2,202.1   

Costs of revenues

     1,706.2         1,587.2         1,584.4   

General and administrative

     322.0         413.2         440.0   

Amortization of intangible assets

     45.1         38.2         92.0   

Restructuring costs

     41.3         10.1         38.3   

Goodwill impairment charge

     17.5         —           —     

Income from licensing of intellectual property

     —           (96.0)         —     

(Gain) loss on disposal of assets, net

     (2.5)         (962.9)         1.6   
  

 

 

    

 

 

    

 

 

 

Operating income

     190.3         1,201.9         45.8   

Other income (loss), net

     (6.6)         8.2         (3.5)   
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     183.7         1,210.1         42.3   

Income tax provision

     93.1         162.4         29.2   
  

 

 

    

 

 

    

 

 

 

Net income

   $ 90.6       $ 1,047.7       $ 13.1   

Net (income) loss attributable to noncontrolling interests

     1.8         0.7         —     
  

 

 

    

 

 

    

 

 

 

Net income attributable to AOL Inc.

   $ 92.4       $   1,048.4       $ 13.1   
  

 

 

    

 

 

    

 

 

 

Per share information attributable to AOL Inc. common stockholders:

        

Basic net income per common share

   $ 1.19       $ 11.51       $ 0.13   
  

 

 

    

 

 

    

 

 

 

Diluted net income per common share

   $ 1.13       $ 11.21       $ 0.12   
  

 

 

    

 

 

    

 

 

 

Shares used in computing basic income per common share

     77.6         91.1         104.2   
  

 

 

    

 

 

    

 

 

 

Shares used in computing diluted income per common share

     82.0         93.5         106.0   
  

 

 

    

 

 

    

 

 

 

Cash dividends paid per common share

   $ —         $ 5.15       $ —     
  

 

 

    

 

 

    

 

 

 

Comprehensive income (loss) attributable to AOL Inc.:

        

Foreign currency translation adjustments

   $ 0.4       $ (7.9)       $ 0.4   

Unrealized gains on equity method investments

     0.6         0.4         —     
  

 

 

    

 

 

    

 

 

 

Other comprehensive income (loss), net of tax

   $ 1.0       $ (7.5)       $ 0.4   
  

 

 

    

 

 

    

 

 

 

Comprehensive income

     91.6         1,040.2         13.5   

Comprehensive (income) loss attributable to noncontrolling interests

     4.5         1.6         —     
  

 

 

    

 

 

    

 

 

 

Comprehensive income attributable to AOL Inc.

   $ 96.1       $ 1,041.8       $ 13.5   
  

 

 

    

 

 

    

 

 

 

See accompanying notes.

 

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AOL INC.

CONSOLIDATED BALANCE SHEETS

(In millions, except per share amounts)

 

     December 31,  
     2013      2012  
Assets      

Current assets:

     

Cash and equivalents

   $ 207.3       $ 466.6   

Accounts receivable, net of allowances of $8.3 and $6.6, respectively

     491.0         351.9   

Prepaid expenses and other current assets

     34.1         28.5   

Deferred income taxes, net

     30.7         40.6   
  

 

 

    

 

 

 

Total current assets

     763.1         887.6   

Property and equipment, net

     467.9         478.3   

Goodwill

     1,361.7         1,084.1   

Intangible assets, net

     208.4         133.2   

Long-term deferred income taxes, net

     110.6         148.8   

Other long-term assets

     71.7         65.3   
  

 

 

    

 

 

 

Total assets

   $   2,983.4       $   2,797.3   
  

 

 

    

 

 

 
Liabilities, Redeemable Noncontrolling Interest and Equity      

Current liabilities:

     

Accounts payable

   $ 101.0       $ 76.1   

Accrued compensation and benefits

     127.0         151.4   

Accrued expenses and other current liabilities

     197.3         175.3   

Deferred revenue

     67.2         57.8   

Current portion of obligations under capital leases

     55.5         49.6   
  

 

 

    

 

 

 

Total current liabilities

     548.0         510.2   

Long-term portion of obligations under capital leases

     56.2         56.3   

Long-term deferred income taxes

     4.4         5.8   

Other long-term liabilities

     97.6         73.8   
  

 

 

    

 

 

 

Total liabilities

     706.2         646.1   
  

 

 

    

 

 

 

Commitments and contingencies (See Note 10)

     

Redeemable noncontrolling interest (See Note 1)

     9.7         13.4   

Equity:

     

Common stock, $0.01 par value, 114.1 million shares issued and 79.2 million shares outstanding as of December 31, 2013 and 110.1 million shares issued and 76.6 million shares outstanding as of December 31, 2012

     1.1         1.1   

Additional paid-in capital

     3,592.7         3,457.5   

Accumulated other comprehensive income (loss), net

     (290.4)         (294.1)   

Accumulated deficit

     (93.6)         (188.0)   

Treasury stock, at cost, 34.9 million shares at December 31, 2013 and 33.5 million shares at December 31, 2012

     (942.9)         (838.4)   
  

 

 

    

 

 

 

Total stockholders’ equity

     2,266.9         2,138.1   

Noncontrolling interest

     0.6         (0.3)   
  

 

 

    

 

 

 

Total equity

     2,267.5         2,137.8   
  

 

 

    

 

 

 

Total liabilities, redeemable noncontrolling interest and equity

   $ 2,983.4       $ 2,797.3   
  

 

 

    

 

 

 

See accompanying notes.

 

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AOL INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

 

     Years Ended December 31,  
     2013      2012      2011  

Operating Activities

        

Net income

   $ 90.6       $ 1,047.7       $ 13.1   

Adjustments for non-cash and non-operating items:

        

Depreciation and amortization

     174.0         176.9         252.9   

Asset impairments and write-offs

     30.6         6.1         7.6   

(Gain) loss on step acquisitions and disposal of assets, net

     (1.5)         (975.5)         1.6   

Equity-based compensation

     47.0         39.5        42.5   

Deferred income taxes

     51.5         124.1         23.3   

Other non-cash adjustments

     4.4         (2.6)         2.4   

Changes in operating assets and liabilities, net of acquisitions

        

Receivables

       (104.5)         (33.4)         12.2   

Accrued expenses

     21.7         4.6         (29.2)   

Deferred revenue

     7.9         (12.7)         (24.0)   

Other balance sheet changes

     (2.8)         (9.1)         (6.4)   
  

 

 

    

 

 

    

 

 

 

Cash provided by operating activities

     318.9         365.6         296.0   

Investing Activities

        

Investments and acquisitions, net of cash acquired

     (337.9)         (32.0)         (377.9)   

Proceeds from disposal of assets, net

     1.5         952.3         4.7   

Capital expenditures and product development costs

     (65.7)         (64.9)         (82.3)   
  

 

 

    

 

 

    

 

 

 

Cash (used) provided by investing activities

     (402.1)         855.4         (455.5)   

Financing Activities

        

Repurchase of common stock (See Note 7)

     (134.8)         (698.7)         (173.6)   

Principal payments on capital leases

     (61.1)         (55.6)         (49.0)   

Tax withholdings related to net share settlements of restricted stock units

     (16.5)         (7.6)         (0.4)   

Proceeds from exercise of stock options

     35.3         35.2         1.0   

Cash dividends paid and dividend equivalent payments on restricted stock units

     (4.4)         (434.4)         —     

Other financing activities

     6.1         0.3         (12.8)   
  

 

 

    

 

 

    

 

 

 

Cash used by financing activities

       (175.4)           (1,160.8)           (234.8)   

Effect of exchange rate changes on cash and equivalents

     (0.7)         (1.1)         —     
  

 

 

    

 

 

    

 

 

 

(Decrease) increase in cash and equivalents

     (259.3)         59.1         (394.3)   

Cash and equivalents at beginning of period

     466.6         407.5         801.8   
  

 

 

    

 

 

    

 

 

 

Cash and equivalents at end of period

   $ 207.3       $ 466.6       $ 407.5   
  

 

 

    

 

 

    

 

 

 

Supplemental disclosures of cash flow information

        

Cash paid for interest

   $ 6.0       $ 6.1       $ 6.4   
  

 

 

    

 

 

    

 

 

 

Cash paid for income taxes

   $ 12.8       $ 26.3       $ 15.0   
  

 

 

    

 

 

    

 

 

 

See accompanying notes.

 

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AOL INC.

CONSOLIDATED STATEMENTS OF EQUITY

(In millions)

 

    Common Stock    

Additional

Paid-In

   

Accumulated

Other

Comprehensive

    Accumulated    

Treasury

Stock,

   

Non-

Controlling

    Total  
    Shares     Amount     Capital     Income (Loss)     Deficit     at Cost     Interest     Equity  

Balance at December 31, 2010

    106.7      $ 1.1      $   3,376.6      $   (287.9)      $ (802.9)      $ —        $ —        $   2,286.9   

Net Income

    —          —          —          —          13.1        —          —          13.1   

Foreign currency translation adjustments

    —          —          —          0.4        —          —          —          0.4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

    —          —          —          0.4        13.1        —          —          13.5   

Amounts related to equity-based compensation, net of tax withholdings

    —          —          44.5        —          —          —          —          44.5   

Issuance of common stock

    0.3        —          0.4        —          —          —          —          0.4   

Repurchase of common stock

    (12.7)        —          —          —          —          (173.6)        —          (173.6)   

Other

    —          —          0.9        —          —          —          —          0.9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2011

    94.3      $ 1.1      $ 3,422.4      $ (287.5)      $ (789.8)      $ (173.6)      $ —        $ 2,172.6   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    —          —          —          —          1,048.4        —            (0.6)        1,047.8   

Contributions from noncontrolling interest owners

    —          —          —          —          —          —          0.3        0.3   

Unrealized gain on equity method investments

    —          —          —          0.4        —          —          —          0.4   

Foreign currency translation adjustments

    —          —          —          (7.0)        —          —          —          (7.0)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

    —          —          —          (6.6)          1,048.4        —          (0.3)        1,041.5   

Amounts related to equity-based compensation, net of tax withholdings

    —          —          33.8        —          —          —          —          33.8   

Issuance of common stock

    3.1        —          35.2        —          —          —          —          35.2   

Repurchase of common stock

    (20.8)        —          (33.9)        —          —          (664.8)        —          (698.7)   

Dividends declared

    —          —          —          —          (446.6)        —          —          (446.6)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2012

    76.6     $ 1.1      $ 3,457.5      $ (294.1)      $ (188.0)      $ (838.4)      $ (0.3)      $ 2,137.8   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    —          —          —          —          92.4        —          (1.2)        91.2   

Unrealized gain on equity method investments

    —          —          —          0.6        —          —          —          0.6   

Foreign currency translation adjustments

    —          —          —          3.1        —          —          (0.1)        3.0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

    —          —          —          3.7        92.4        —          (1.3)        94.8   

Contributions from noncontrolling interest owners

    —          —          —          —          —          —          2.2        2.2   

Amounts related to equity-based compensation, net of tax withholdings (see Note 7)

    —          —          31.4        —          —          —          —          31.4   

Issuance of common stock

    6.5        —          69.9        —          —          64.2        —          134.1   

Repurchase of common stock

    (3.9)        —          33.9        —          —          (168.7)        —          (134.8)   

Other

    —          —          —          —          2.0        —          —          2.0   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2013

    79.2      $   1.1      $ 3,592.7      $ (290.4)      $ (93.6)      $   (942.9)      $ 0.6      $ 2,267.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

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Table of Contents

AOL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1—DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of Business

AOL Inc. (“AOL” or the “Company”) is a leading global media and technology company with a substantial worldwide audience and a suite of digital brands, products and services that it offers to consumers, advertisers, publishers and subscribers. AOL is focused on attracting and engaging consumers by creating and offering high quality branded digital content, products and services and providing valuable online advertising services on both its owned and operated properties and third-party websites.

The Company’s strategy is to focus its resources on AOL’s core competitive strengths in content, advertising, technology platforms, video and paid services while expanding the distribution of its premium content, product and service offerings on multiple platforms and digital devices, including on internet-enabled televisions, smartphones and tablets. AOL continues to reinvigorate its culture and brand by prioritizing the consumer experience, making greater use of data-driven insights and encouraging innovation.

AOL’s reportable segments are the Brand Group, the Membership Group and AOL Networks. In addition to the above reportable segments, AOL has a corporate and other category that includes activities that are not directly attributable to or allocable to a specific segment.

Brand Group

The Brand Group consists of AOL’s portfolio of distinct and unique content and certain of its service brands. The results for this segment reflect the performance of the Company’s advertising offerings on a number of owned and operated sites, such as AOL.com, The Huffington Post, TechCrunch, and MapQuest. The Brand Group also includes co-branded websites owned or operated by third parties for which certain criteria have been met, including that the internet traffic has been assigned to us.

Membership Group

The Membership Group consists of offerings that serve AOL registered account holders, both free and paid, and are focused on delivering world-class experiences to AOL’s users who rely on these AOL products and properties. The results for this segment include AOL’s subscription offerings and advertising offerings on Membership Group properties, including communications products such as AOL Mail.

AOL Networks

AOL Networks consists of interconnected programmatic, video and premium advertising offerings that advertisers and publishers use to reach consumers across all devices and includes offerings in formats such as display, video and social. AOL Network’s offerings enable publishers and advertisers to utilize AOL’s third-party advertising network as well as AOL’s inventory within the Brand Group and Membership Group sold by AOL Networks. The results for this segment include the performance of Advertising.com, AdLearn Open Platform, Adap.tv, Marketplace by ADTECH (“Marketplace”), The AOL On Network, Be On, ADTECH and Pictela. The Company generates advertising revenues on AOL Networks through the sale of advertising on third party websites and from advertising inventory on AOL Properties not sold directly to advertisers, as described above. AOL’s advertising offerings on AOL Networks consist primarily of the sale of display advertising and also include search advertising through sponsored listings.

 

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Table of Contents

AOL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

Corporate and Other

Corporate and other primarily consists of broad corporate functions including legal, human resources, accounting, finance, marketing and activities and costs not directly attributable or allocable to a specific segment such as tax settlements and other general business costs.

Basis of Presentation

Basis of Consolidation

The consolidated financial statements include 100% of the assets, liabilities, revenues, expenses and cash flows of AOL and all voting interest entities in which AOL has a controlling voting interest (“subsidiaries”) and variable interest entities in which AOL is the primary beneficiary in accordance with the consolidation accounting guidance. Intercompany accounts and transactions between consolidated companies have been eliminated in consolidation. The consolidated balances of the Company’s variable interest entities are not material to the Company’s consolidated financial statements for the periods presented.

The financial position and operating results of the majority of AOL’s foreign operations are consolidated using the local currency as the functional currency. Local currency assets and liabilities are translated at the rates of exchange on the balance sheet date, and local currency revenues and expenses are translated at average rates of exchange during the period. Resulting translation gains or losses are included in the consolidated balance sheet as a component of accumulated other comprehensive income (loss), net and in the consolidated statement of comprehensive income (loss) as a component of other comprehensive income (loss), net of tax.

Redeemable Noncontrolling Interest

The noncontrolling interest in a joint venture between Mitsui & Company Ltd. (“Mitsui”) and AOL (“Ad.com Japan”) is classified outside of permanent equity in the Company’s consolidated balance sheet for the years ended December 31, 2013 and 2012, due to a redemption right available to the noncontrolling interest holder in the future. The noncontrolling interest holder’s right to redeem its stock is exercisable any time between July 1 and July 30 of any year, commencing with July 1, 2014. Net income in the consolidated statement of comprehensive income (loss) reflects 100% of the results of Ad.com Japan for the years ended December 31, 2013 and 2012 as the Company has a controlling financial interest in the entity. Net income is subsequently adjusted to exclude AOL’s noncontrolling interests to arrive at net income attributable to AOL Inc.

Use of Estimates

The preparation of the financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements and footnotes thereto. Actual results could differ from those estimates. Significant estimates inherent in the preparation of the consolidated financial statements include asset impairments, reserves established for doubtful accounts, equity-based compensation, depreciation and amortization, business combinations, income taxes, litigation matters and contingencies.

Summary of Significant Accounting Policies

Revenues

The Company generates revenue primarily from advertising and from its subscription services. Revenue is recognized when persuasive evidence of an arrangement exists, performance under the contract has begun, the contract price is fixed or determinable and collectability of the related fee is reasonably assured.

 

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Table of Contents

AOL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

Advertising Revenues

Advertising revenues are generated on AOL Properties through display advertising and search advertising. Display advertising revenue is generated by the display of graphical advertisements and other performance-based advertising. Agreements for advertising on AOL Properties typically take the forms of impression-based contracts, time-based contracts or performance-based contracts. Search advertising revenue is generated when a consumer clicks on a text-based advertisement on their screen. These text-based advertisements are either generated from a consumer-initiated search query or generated based on the content of the webpage the consumer is viewing. In addition to advertising revenues generated on AOL Properties, the Company also generates revenue from its advertising offerings on its Third Party Network, which consist primarily of the sale of display advertising and also include search advertising. Advertising arrangements for the sale of Third Party Network inventory typically take the form of impression-based contracts or performance-based contracts.

Advertising revenues derived from impression-based contracts, in which AOL provides impressions in exchange for a fixed fee (generally stated as cost-per-thousand impressions), are generally recognized as the impressions are delivered. An “impression” is delivered when an advertisement appears in web pages viewed by users. Revenues derived from time-based contracts, in which AOL provides promotion over a specified time period for a fixed fee, are recognized on a straight-line basis over the term of the contract, provided that AOL is meeting and will continue to meet its obligations under the contract (e.g., delivery of impressions over the term of the contract). Advertising revenues derived from contracts where AOL is compensated based on certain performance criteria are recognized as AOL completes the contractually specified performance. Performance is measured in terms of either “click-throughs” when a user clicks on a company’s advertisement or other user actions such as product/customer registrations, survey participation, sales leads, product purchases or other revenue sharing relationships.

Gross versus Net Revenue Recognition

In the normal course of business, the Company sometimes acts as or uses an intermediary or agent in executing transactions with third parties. The determination of whether revenue should be reported gross or net is based on an assessment of whether the Company is acting as the principal or an agent in the transaction. If the Company is acting as the principal in a transaction, the Company reports revenue on a gross basis. If the Company is acting as an agent in a transaction, the Company reports revenue on a net basis. In determining whether the Company acts as the principal or an agent, the Company follows the accounting guidance for principal-agent considerations and the Company places the most weight on whether or not the Company is the primary obligor in the arrangement.

Multiple-Element Transactions

Management analyzes contracts with multiple elements under the accounting guidance for multiple-element arrangements. The Company’s multiple-element arrangements generally include online advertising and non-advertising (i.e., insertion orders and production of a “microsite”) and involve multiple deliverables to customers across AOL Properties and/or the Third Party Network. The guidance requires that revenue arrangements with multiple deliverables should be divided into separate units of accounting if the deliverables in the arrangement have value to the customer on a standalone basis, and if the delivery of the undelivered items in the arrangement is considered probable and substantially in the control of the vendor. If these criteria are met, then the arrangement consideration is allocated among the separate units of accounting based on their relative estimated selling prices. In such circumstances, the Company uses a selling price hierarchy to determine the selling price to be used for allocating revenue to the deliverables: (i) vendor-specific objective evidence of fair value (“VSOE”), (ii) third-party evidence of selling price, and (iii) best estimate of the selling price (“BESP”). VSOE generally

 

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AOL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

exists only when the Company sells the deliverable separately and VSOE is the price actually charged by the Company for that deliverable. BESPs reflect the Company’s best estimates of what the selling prices of deliverables would be if they were sold regularly on a stand-alone basis. The Company recognizes revenue from the provision of online advertising and non-advertising contracts when the advertising campaigns and the productions are delivered.

If the deliverables cannot be separated into multiple units of accounting, then the arrangement is accounted for as a combined unit of accounting and recognized into revenue based on the lower of (i) performance or (ii) straight-line as calculated in aggregate for the entire deal. Straight-line revenue recognition is determined by taking the total sold value of all deal components and recognizing that value evenly over the entire deal term.

Subscription Revenues

The Company earns revenue from its subscription services in the form of monthly or annual fees paid by subscribers to its service offerings, and such revenues are recognized on a straight-line basis as the service is provided.

Traffic Acquisition Costs

AOL incurs costs through arrangements in which it acquires online advertising inventory from publishers for resale to advertisers and arrangements whereby partners distribute AOL’s free products or services or otherwise direct traffic to AOL Properties. AOL considers these costs to be traffic acquisition costs (“TAC”). TAC arrangements have a number of different economic structures, the most common of which are: (i) payments based on a cost-per-thousand impressions or based on a percentage of the ultimate advertising revenues generated from the advertising inventory acquired for resale, (ii) payments for direct traffic delivered to AOL Properties priced on a per-click basis (e.g., search engine marketing fees) and (iii) payments to partners in exchange for distributing AOL products to their users (e.g., agreements with computer manufacturers to distribute the AOL toolbar or a co-branded web portal on computers shipped to end users). These arrangements can be on a fixed-fee basis (which often carry reciprocal performance guarantees by the counterparty), on a variable basis or, in some cases, a combination of the two. TAC agreements with fixed payments are typically expensed ratably over the term of the agreement. TAC agreements with variable payments are typically expensed based on the volume of the underlying activity at the specified contractual rates. TAC agreements with a combination of a fixed fee for a minimum amount of traffic delivered or other underlying activity and variable payments for delivery or performance in excess of the minimum are typically recognized into expense at the greater of straight-line or actual performance, taking into account counterparty performance to date and the projected counterparty performance over the term of the agreement.

Restructuring Costs

Restructuring costs consist primarily of employee termination benefits and contract termination costs, including lease exit costs. The Company’s restructuring actions include one-time involuntary termination benefits as well as certain contractual termination benefits or employee terminations under ongoing benefit arrangements. One-time involuntary termination benefits are recognized as a liability at estimated fair value when the plan of termination has been communicated to employees and certain other criteria are met. Ongoing termination benefit arrangements are recognized as a liability at estimated fair value when it is probable that amounts will be paid to employees and such amounts are reasonably estimable. Contract termination costs are recognized as a liability at fair value when a contract is terminated in accordance with its terms, or when AOL has otherwise executed a written termination of the contract. When AOL ceases using a facility but does not intend to or is unable to terminate the operating lease, AOL records a liability for the present value of the

 

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remaining lease payments, net of estimated sublease income, if any, that could be reasonably obtained for the property (even if the Company does not intend to sublease the facility for the remaining term of the lease). Costs associated with exit or disposal activities, including the related one-time and ongoing involuntary termination benefits, are reflected as restructuring costs in the consolidated statements of comprehensive income. See “Note 9” for additional information about the Company’s restructuring activities.

Equity-Based Compensation

AOL records compensation expense under AOL’s equity-based compensation incentive plans based on the equity awards granted to employees.

In accounting for equity-based compensation awards, the Company follows the accounting guidance for equity-based compensation, which requires that a company measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost associated with stock options is estimated using the Black-Scholes option-pricing model. The cost of equity instruments granted to employees is recognized in the consolidated statements of comprehensive income on a straight-line basis (net of estimated forfeitures) over the period during which an employee is required to provide service in exchange for the award. The Company begins recording equity-based compensation expense related to employee awards with performance conditions when it is considered probable that the performance conditions will be met. See “Note 8” for additional information on equity-based compensation.

Asset Impairments

Goodwill

Goodwill is tested annually for impairment during the fourth quarter or earlier upon the occurrence of certain events or substantive changes in circumstances that indicate goodwill is more likely than not impaired. These indicators include a sustained, significant decline in the Company’s stock price; a decline in its expected future cash flows; significant disposition activity; a significant adverse change in the economic or business environment; and the testing for recoverability of a significant asset group, among others. The occurrence of these indicators could have a significant impact on the recoverability of goodwill and could have a material impact on the Company’s consolidated financial statements.

The testing of goodwill for impairment is required to be performed at the level referred to as the reporting unit. During 2013, the Company had four reporting units for purposes of the goodwill impairment test; the Brand Group, the Membership Group, AOL Networks and Patch.

Goodwill impairment is determined using a two-step process. The first step involves a comparison of the estimated fair value of a reporting unit to its carrying amount, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired and the second step of the impairment test is not necessary. If the carrying amount of a reporting unit exceeds its estimated fair value, then the second step of the goodwill impairment test must be performed. To measure the amount of impairment loss, if any, AOL determines the implied fair value of goodwill in the same manner as the amount of goodwill recognized in a business combination. Specifically, the estimated fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.

 

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The Company determined that certain events occurring in the third quarter of 2013 constituted substantive changes in circumstances that would more likely than not reduce the fair value of the Company’s Patch reporting unit below its carrying amount. Accordingly, the Company tested the Patch reporting unit for impairment as of August 31, 2013 (the “interim testing date”), which resulted in the Company recording a goodwill impairment charge to the full balance of Patch goodwill of $17.5 million during the third quarter of 2013.

See “Note 3” for more information on the goodwill impairment testing for 2013.

Long-lived Assets

Long-lived assets, including finite-lived intangible assets (e.g., acquired technology and customer relationships), do not require that an annual impairment test be performed; instead, long-lived assets are tested for impairment upon the occurrence of an indicator of potential impairment. Once an indicator of potential impairment has occurred, the impairment test is based on whether the intent is to hold the asset for continued use or to hold the asset for sale. If the intent is to hold the asset for continued use, the impairment test first requires a comparison of estimated undiscounted future cash flows generated by the asset group against the carrying value of the asset group. The Company groups long-lived assets for purposes of recognition and measurement of an impairment loss at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. If the carrying value of the asset group exceeds the estimated undiscounted future cash flows, the asset group would be deemed to be potentially impaired. Impairment, if any, would then be measured as the difference between the estimated fair value of the asset and its carrying value. Fair value is generally determined by discounting the future cash flows associated with that asset group. If the intent is to hold the asset group for sale and certain other criteria are met (i.e., the asset group can be disposed of currently, appropriate levels of authority have approved the sale and there is an active program to locate a buyer), the impairment test involves comparing the asset group’s carrying value to its estimated fair value less estimated costs of disposal. To the extent the carrying value is greater than the asset group’s estimated fair value less estimated costs of disposal, an impairment loss is recognized for the difference.

AOL recorded non-cash asset impairments and write-offs related to long-lived assets held and used and held for sale of $12.1 million, $4.9 million and $7.6 million in 2013, 2012 and 2011, respectively, included in costs of revenues and general and administrative costs in the consolidated statements of comprehensive income (loss). The charge recorded in 2013 included a $7.5 million charge related to internal-use software related to Patch. The charges recorded in 2012 and 2011 related primarily to asset write-offs in connection with facility consolidation, computer retirements and capitalized internal-use software project terminations.

Income Taxes

Income taxes are presented in the consolidated financial statements using the asset and liability method prescribed by the accounting guidance for income taxes. Income taxes (e.g., deferred tax assets, deferred tax liabilities, taxes currently payable/refunds receivable and tax expense) are recorded based on amounts refundable or payable in the current year and include the deferred income tax effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases, stated at enacted tax rates expected to be in effect when the taxes are actually paid or recovered. Deferred income taxes reflect expected future tax benefits (i.e., assets) and future tax costs (i.e., liabilities). The tax effect of net operating loss, capital loss and general business credit carryovers result in deferred tax assets. Valuation allowances are established when management determines it is “more likely than not” that some portion or all of the deferred tax asset may not be realized. The Company considers all positive and negative evidence in evaluating its ability to realize its deferred income tax assets, including its historical operating results, ongoing tax planning, and forecast of future taxable income, on a jurisdiction by jurisdiction basis.

 

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With respect to uncertain tax positions, AOL recognizes in the consolidated financial statements those tax positions determined to be “more likely than not” of being sustained upon examination, based on the technical merits of the positions. AOL records a liability for the difference between the benefit recognized and measured pursuant to the accounting guidance for income taxes and the tax position taken on its tax return. The Company adjusts its estimated liabilities for uncertain tax positions periodically because of ongoing examinations by, and settlements with, the various taxing authorities, as well as changes in tax laws, regulations and interpretations. The consolidated tax provision for any given year includes adjustments to prior year income tax accruals that are considered appropriate and any related estimated interest. The Company’s policy is to recognize, when applicable, interest and penalties on uncertain tax positions as part of income tax expense.

Certain Risks and Concentrations

The Company’s financial instruments include primarily cash and equivalents, accounts receivable, accounts payable, accrued expenses and other current liabilities. Due to the short-term nature of these assets and liabilities, their carrying amounts approximate their fair value. Financial instruments that potentially subject the Company to concentrations of credit risk are primarily cash and accounts receivable.

The Company maintains its cash and equivalents balances in the form of money market accounts and time deposits. The Company maintains cash deposits with banks that at times exceed applicable insurance limits. The Company reduces its exposure to credit risk by maintaining such deposits with high quality financial institutions that management believes are creditworthy.

The Company’s exposure to customer credit risk relates primarily to advertising customers and individual subscribers to AOL’s subscription services, and is dispersed among many different counterparties, with no single customer having a receivable balance in excess of 10% of total net receivables at December 31, 2013 or 2012.

For each of the periods presented herein, the Company has had a contractual relationship with Google whereby Google provides paid text-based search advertising on AOL Properties. For the years ended December 31, 2013, 2012 and 2011, the revenues associated with the Google relationship (substantially all of which were search revenues generated on AOL Properties), were $373.3 million, $350.9 million and $335.3 million, respectively.

Cash and Equivalents

Cash equivalents primarily consist of highly liquid short-term investments with an original maturity of three months or less, which include money market accounts and time deposits that are readily convertible into cash. Cash equivalents are carried at cost plus accrued interest, which approximates fair value. These are included within cash and cash equivalents as level one fair value measurements.

Restricted Cash

In the first quarter of 2011, the Company posted cash collateral for letters of credit related to certain of the Company’s lease agreements. The collateral amounts are legally restricted as to withdrawal and use for a period in excess of twelve months. Accordingly, the collateral balances have been classified as restricted cash within other long-term assets and are omitted from cash and equivalents on the consolidated balance sheets. Also included in restricted cash are security deposits held by the Company from lessees that are restricted as to use. The Company had $11.2 million of restricted cash included in other long-term assets on the consolidated balance sheet as of December 31, 2013.

 

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Allowance for Doubtful Accounts

AOL’s receivables consist primarily of two components, receivables from individual subscribers to AOL’s subscription services and receivables from advertising customers. Management performs separate evaluations of these components to determine if the balances will ultimately be fully collected considering management’s views on trends in the overall aging of receivables as well as past collection experience. In addition, for certain advertising receivables, management prepares an analysis of specific risks on a customer-by-customer basis. Using this information, management reserves an amount that is expected to be uncollectible. Receivables are written off when amounts are deemed to be uncollectible and internal collection efforts are closed.

Property and Equipment

Property and equipment are stated at cost. Depreciation, which includes amortization of capitalized software costs and amortization of assets under capital leases, is provided on a straight-line basis over the estimated useful lives of the assets. AOL evaluates the depreciation periods of property and equipment to determine whether events or circumstances warrant revised estimates of useful lives. Depreciation expense, recorded in costs of revenues and general and administrative expense, totaled $128.9 million, $138.7 million and $160.9 million for the years ended December 31, 2013, 2012 and 2011, respectively. Costs related to leasehold improvements are capitalized and amortized on a straight-line basis over the shorter of the economic useful life of the improvements or the remaining lease term.

Property and equipment, including assets under capital lease, consist of ($ in millions):

 

     December 31,      Estimated
Useful Lives
     2013      2012     

Land(a)

   $ 39.2       $ 39.2       —  

Buildings and building improvements

     275.6         280.2       15 to 40 years

Capitalized internal-use software costs

     434.6         484.5        1 to 5 years

Leasehold improvements

     108.6         99.2       Up to 16 years

Furniture, fixtures and other equipment

     591.5         640.6        2 to 5 years
  

 

 

    

 

 

    
     1,449.5         1,543.7      

Less accumulated depreciation

       (981.6)           (1,065.4)      
  

 

 

    

 

 

    

Total

   $ 467.9       $ 478.3      
  

 

 

    

 

 

    

 

(a) Land is not depreciated.

Capitalized Internal-Use Software Costs

AOL capitalizes certain costs incurred for the purchase and development of internal-use software. These costs, which include the costs associated with coding, software configuration, major upgrades and enhancements and are related to both AOL’s internal systems (such as billing and accounting) and AOL’s user-facing internet offerings, are included in property and equipment, net in the consolidated balance sheet. For the years ended December 31, 2013, 2012, and 2011, AOL capitalized $43.7 million, $40.5 million and $21.1 million, respectively, related to the purchase and development of internal-use software. At December 31, 2013 and 2012, the net book value of capitalized internal-use software was $68.2 million and $57.6 million, respectively.

 

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Research and Development

Research and development costs, which are expensed as incurred, are included in costs of revenues and totaled $40.6 million, $44.8 million and $56.9 million for the years ended December 31, 2013, 2012, and 2011, respectively. These costs consist primarily of personnel and related costs that are incurred related to the development of software and user-facing internet offerings that do not qualify for capitalization.

Leases

The Company leases operating equipment and office space in various locations worldwide. Lease obligations are classified as operating leases or capital leases, as appropriate. Leased equipment and property that meets the capital lease criteria is capitalized and the present value of the future minimum lease payments is recorded as an asset under capital lease with a related capital lease obligation in the consolidated balance sheets.

Rent expense under operating leases is recognized on a straight-line basis over the lease term taking into consideration scheduled rent increases and any lease incentives.

Intangible Assets

AOL has a significant number of intangible assets, including acquired technology, trademarks and customer relationships. AOL does not recognize the fair value of internally generated intangible assets. Intangible assets acquired in business combinations are recorded at fair value on the Company’s consolidated balance sheets and are amortized over estimated useful lives on a straight-line basis. Intangible assets subject to amortization are tested for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. AOL does not have any indefinite lived intangible assets other than goodwill.

Advertising Costs

The Company expenses advertising costs as they are incurred. Advertising expense was $61.6 million, $85.8 million and $76.9 million for the years ended December 31, 2013, 2012, and 2011, respectively, and is included in general and administrative costs on the consolidated statements of comprehensive income (loss).

Loss Contingencies

In the normal course of business, the Company is involved in legal proceedings, tax audits (other than income taxes) and other matters that give rise to potential loss contingencies. The Company accrues a liability for such matters when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. In situations where the Company can determine a best estimate within the range of potential loss, the Company records the best estimate of the potential loss as a liability. In situations where the Company has determined a range of loss, but no amount within the range is a better estimate than any other amount within the range, the Company records the minimum amount of the range of loss as a liability.

Other Comprehensive Income (Loss)

Other comprehensive income (loss) is included within comprehensive income (loss) in the consolidated statements of comprehensive income (loss) and stockholders’ equity in the consolidated balance sheets and consists of net income (loss) and other gains and losses affecting equity that, under GAAP, are excluded from net income (loss).

 

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NOTE 2—INCOME (LOSS) PER COMMON SHARE

Basic income per common share is calculated by dividing net income attributable to AOL common stockholders by the weighted average number of shares of common stock outstanding during the reporting period. Diluted income per common share is calculated to give effect to all potentially dilutive common shares that were outstanding during the reporting period. The dilutive effect of outstanding equity-based compensation awards is reflected in diluted income per common share by application of the treasury stock method, only in periods in which such effect would have been dilutive for the period.

For the years ended December 31, 2013, 2012 and 2011, the Company had 1.0 million, 2.9 million and 9.0 million, respectively, of weighted-average potentially dilutive common shares that were not included in the computation of diluted earnings per share because to do so would be anti-dilutive for those periods.

The following table is a reconciliation of basic and diluted net income attributable to AOL common stockholders per common share (in millions, except per share amounts):

 

     Years Ended December 31,  
     2013      2012      2011  

Net income attributable to AOL Inc. common stockholders

   $   92.4      $   1,048.4      $ 13.1  
  

 

 

    

 

 

    

 

 

 

Shares used in computing basic income per common share

     77.6        91.1          104.2  

Dilutive effect of equity-based awards

     4.4        2.4        1.8  
  

 

 

    

 

 

    

 

 

 

Shares used in computing diluted income per common share

     82.0        93.5        106.0  
  

 

 

    

 

 

    

 

 

 

Basic net income per common share

   $ 1.19      $ 11.51      $ 0.13  
  

 

 

    

 

 

    

 

 

 

Diluted net income per common share

   $ 1.13      $ 11.21      $ 0.12  
  

 

 

    

 

 

    

 

 

 

 

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NOTE 3—GOODWILL AND INTANGIBLE ASSETS

A summary of changes in the Company’s goodwill during the years ended December 31, 2013 and 2012 is as follows (in millions):

 

    December 31,
2011
    Acquisitions     Translation
adjustments
    Allocations at
December 1,
2012
    Acquisitions     Translation
adjustments
    December 31,
2012
    Acquisitions     Dispositions     Impairments     Translation
Adjustments
    December 31,
2013
 

Brand Group

                       

Gross Goodwill

  $ —        $ —        $ —        $ 282.1      $ 0.1      $ —        $ 282.2      $ 1.5      $ (0.2)      $ —        $ —        $ 283.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Goodwill

    —          —          —          282.1        0.1        —          282.2        1.5        (0.2)        —          —          283.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Membership Group

                       

Gross Goodwill

    —          —          —          604.2        —          —          604.2        —          —          —          0.8        605.0