AOL Post earnings comments

AOL reported 4Q10 results this past week of $596MM in revenue above the Street and Adjusted EBITDA of $149MM also better than the Street.O&O Domestic Display Revenue was $140MM (up 24% Q/Q). Comments from the call follow from AOL IR:



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DISPLAY
Now, midway through Q1 2011, our salesforce is operating in a structure vertically aligned by industry, pricing has improved and we are ramping up sales of our new ad format, all of which bodes well for 2011 display revenue. For Q1, we are making progress in closing the gap to achieving year-over-year growth, but keep in mind that we continue to comp against a quarter last year when we were still reducing the amount of AOL property inventory sold through the network. Q1 will be the last quarter when we have this comp issue.

SEARCH
Our new 5-year contract with Google began on January 1 and over the next 60 days you will see the phase in of the new product, but while we expect the product to be superior to the current offering, it is too premature to say what if any impact this will have on revenue. I think the best way to approach this for modeling purposes is to continue to model query declines in parallel to the decline in the access subscribers although the year-over-year rate of decline should improve somewhat as we lap our de-emphasis of the contextual products.

THIRD PARTY NETWORK
In the Third Party Network, absent the impacts of our own initiatives, revenue declined because of increased competition for network advertiser dollars. We are focused on improving performance here, especially given the quality of the inventory and technology embedded in Ad.com. We have taken steps to continue to educate clients on the realities of our capabilities in the space. We expect to see improved results going forward.

SUBSCRIPTION
Excluding this benefit, subscription revenue declined 25%, which is similar to what we saw throughout 2010. Subscriber churn dropped to 2.3% in Q4 which again is the lowest level it has been in a decade and compares to 3% in the fourth quarter last year and 2.6% in Q3 2010. Meanwhile, ARPU continued to hold steady, down 2% year-over-year, but flat to last two quarters. Looking forward we continue to expect the same trends to persist.

PATCH
On Patch, as you know we have been executing on an aggressive role out plan and in Q4 we entered over 500 new towns to end the year in 775 towns. This faster than anticipated rollout put our run rate expense for Patch at approximately $40 million at the end of the quarter which is higher than the $30 million we talked about on our last call and that incremental expense is likely to flow directly to the bottom line in Q1 and Q2. However, we have begun directing more sales attention to Patch and as a result we expect that during 2011 a number of Patchs will begin to contribute to AOL’s profitability.

EXPENSES
I want to spend just a moment talking about the way we have structured recent acquisitions and how they impact our expenses. A large determinant for us in any acquisition we make is talent and whether we can acquire great technology, brands and audience, while also retaining the talent that created them. As such, we structured our deals whereby the employees of the acquired companies commit to deferring a portion of their proceeds from the purchase price over multiple years subject to ongoing employment. From an accounting standpoint, the deferred payments are treated as compensation expense (a portion of which are tax deductible) and we expect to have approximately $35 million of accounting expenses related to those arrangements in 2011. From a cash perspective, we expect to pay out approximately $12 million related to these transactions in 2011 … One final note on the goviral acquisition is that we have a large NOL position in Europe that we expect to take advantage of for this business which is already cash flow positive.

So for 2011, as you model out the year you should take into consideration the run rate increase in Patch expenses as compared to the approximate $75 million we spent in 2010, an approximate $10 million increase in equity-based compensation expense; an approximate $70 million in expenses related to recent acquisitions which includes an approximate $35 million increase in deferred compensation related to those acquisitions, partially offset by a mid-single digit decline in all other expenses. Most of this you have already heard before, but what is new here is that we previously told you deferred consideration related to recent acquisitions in 2011 would be $15 million and it is now $35 million following the acquisitions of Pictela, About.me and goviral. Additionally, stock based comp will increase $10 million and the accelerated Patch rollout increases the losses there by $25 million for the year.

Turning now to cash, AOL continues to generate substantial amounts of cash each quarter. We generated $70 million of free cash flow for the quarter. Keep in mind that Q4 tends to be a user of free cash from a working capital perspective given the timing of receivable collections. Remember, we continue to benefit from a meaningful tax shield and while we utilized some of this asset in 2010, we still have approximately $160 million net cash savings left to go. Following the goviral acquisition we have approximately $725 million of cash on hand which compares very well with the approximate $150 million we started 2010 with.

4 additional items relevant to the quarter and your models as you think about 2011 …

o First, as you think about earnings for Q1 remember to take into account the increase in expenses I just spoke about which will result in more of a drop from Q4 to Q1 earnings this year than in prior years. For the full year, year-over-year declines in Q1 and Q2 will be the steepest with year-over-year declines moderating in the back half of the year due primarily to increased display revenue growth.

o Second, in addition to these expenses, Q1 cash flow will be impacted by approximately $65 million in bonus payments this year versus last year when only $37 million was paid out in the same time period, because half of the 2009 bonus payment was actually paid out in 2009.

o Third, we continue to manage our portfolio smartly, adding assets which facilitate a quicker execution of our strategy more quickly, while unlocking value by shedding non-core assets when practical. Over the course of the year we unlocked over $650 million in value through dispositions allowing us to fund our acquisitions while simultaneously building cash on the balance sheet. In Q4, we made two acquisitions for $31 million net of cash acquired and $12 million of deferred payments. Earlier this week we announced the acquisition of goviral for $74 million and $23 million of deferred payments. Meanwhile, we exited an investment in Brightcove, adding $17 million back to the cash position and recall that we closed the sale of part of our Dulles campus in Q4.

o And finally, in terms of CAPEX we spent just south of $100 million in 2010. We manage CAPEX very carefully and in 2011 we expect to spend a similar amount to 2010. Also, for the purposes of EPS, our depreciation and amortization expense for the year will run at approximately 2 times the rate of our CAPEX amount and while we are not currently a cash taxpayer, we will record book tax expense for income statement purposes.