Blog Post

AOL Swings To Loss; Ad Revenues Plunge 27 Percent

While U.S. display advertising revenue fell year-over-year in Q2 2010, AOL (NYSE: AOL) did see some slight growth from Q1 thanks to improved premium inventory sales. But that likely will not be enough for investors who will have to gird themselves for continued tough times for the company as it works to establish itself as a stand-alone entity since separating from Time Warner (NYSE: TWX) last year. So far, Q2’s numbers weren’t inspiring, as AOL swung to a loss of $1.05 million and saw ad and subscription revenues both tumble 27 percent. Primarily, the declines reflected some major changes that AOL CEO Tim Armstrong has been taking with regard to its European business as well as its search deal with Google.

Advertising revenue declined $110.3 million versus Q209. About $70 million of that fall-off was related to what the company called “AOL-implemented initiatives and comprises,” including:

— $49.1 million in lower Third Party Network revenue associated with European shutdowns and a de-emphasis of low margin search engine campaign management and lead gen affiliate products.
— $11.2 million in lower search and contextual revenue as it moves away from contextual products and fewer queries in Germany and France.
— $10.3 million in lower international display revenue related to reduced operations in Germany and France. This number also reflects declines from Bebo, which AOL sold during the quarter.

Display: Taking a closer look at the U.S. display business, AOL said revenues fell by $7.9 million and reflected flat premium inventory sales compared to Q209. Part of that was due to a salesforce reorg in Q1. But mostly, it had to do with the reduced amount of ads on AOL’s content sites as directed by Armstrong in a bid to make the sites more reader-friendly and build traffic for its premium ad sales, an effort that will take some time to pull off, assuming AOL can do it. The remaining Third Party Network revenue decline primarily reflects the effects of restructuring efforts in the UK.

Operating income and charges: The negative ad dollars and continued restructuring drove down income, but that wasn’t the only thing affecting AOL’s profitability. The company also carried a goodwill impairment charge of $1.4 billion related to the transaction costs related to sale of ICQ operations which was done in Q3 and the already completed the sale of Bebo. At the same time, AOL’s net assets grew thanks to an increase in cash and the $302.7 million deferred tax asset related to the anticipated Bebo worthless stock deduction.

Subscriptions: One of the most difficult things of Armstrong’s turnaround involves what to do about the dwindling subscription revenues that AOL has depended on for so long and that once utterly defined its identity. While less and less people consider AOL an “internet dial-up service,” that also meant that in the short-term, the company’s 25 percent decline in access subs meant 27 percent lower revenues, which were $260 million in Q2 compared to last year’s $355.7 million. Still AOL did point to average monthly churn of 2.6 percent, which was was an improvement over last year and was the lowest level of churn in at least a decade.

“Subsequent event” is how AOL listed a tidbit about an investment in a rarely mentioned travel search engine called Kayak. On July 30, AOL said it entered into an agreement to sell its investment in the company, Kayak Software, for $18.9 million in cash. AOL expects to complete this sale in Q3, and expects to record a pre-tax gain of approximately $17.5 million on it. AOL and Kayak, which was founded by former executives at Orbitz, Expedia and Travelocity, struck a partnership about six years ago with the intention of creating a travel search engine under AOL. Since that deal was struck, however, not much was ever made of the arrangement and it sounds like it was all but forgotten until AOL executives started to take a closer look under Armstrong’s company-wide review.