AOL Earnings: Restructuring Lowers Profitability Even As Ad Revenues Soar

AOL ( AOL ) reported its Q1 2014 results on May 7. While the company posted 8% year-over-year growth in total revenues for the quarter to $583.3 million, its net income declined by 64% year over year to $9.3 million due to restructuring and asset impairment charges. Some of these charges are one time in nature and will be overlooked by most investors.

In our pre-earnings note , we had stated that we will be closely following AOL's programmatic advertising platform for revenue growth and that it will be a key growth driver for AOL going ahead. As expected, much of the revenue growth for AOL came from the growth of programmatic platform across the third-party network. Its third-party display ads division grew by 55% year over year. However, AOL witnessed 1% decline in search and contextual advertising, 3% decline in display ads and 10% decline in core subscription revenues, which partially offset the growth in third-party revenues.

See our complete analysis of AOL here

Rising Costs Lowers Profitability

During the quarter, the company reported a $64 million increase in cost of revenues, primarily due to growth in traffic acquisition cost ( TAC ) from and the third-party platform. Furthermore, operating income, net income and diluted EPS were negatively impacted by a pre-tax restructuring charge of $12 million primarily related to a reduction in headcount in certain areas of the company, and a $10 million asset impairment charge resulting from the write-off of capitalized software development costs in the membership segment. As a result, the company reported a 64% year-over-year decline in net income from $25.9 million Q1 2013 to $9.3 million in Q1 2014.

Programmatic Platform Boosts Third-Party Display Ads Revenues

According to our estimates, the third-party display ads division constitutes over 35% of AOL's value. In the first quarter, revenues from third-party display ads continued to witness growth. Revenues from this division grew by 55% to $186.9 million, driven by growth in the sale of premium formats across AOL's programmatic platform, and by the inclusion of revenue from Third-party network revenue grew 18% excluding

AOL is aggressively developing its programmatic ads platform to sell more ads on third-party sites. During the quarter, the company also acquired Convertro Inc., a leading provider of multi-touch attribution modeling technology for brands and agencies for approximately $101 million to further improve its programmatic platform. The company not only reported growth in the number of ads sold through the programmatic platform, but also an increase in revenue per page view. Furthermore, its DSP, SSP and reported triple-digit growth during the quarter.

We believe that a strong programmatic platform will be a key driver in boosting AOL's revenues by closely matching an advertiser's ads with relevant content inventory. RTB (real-time bidding) aggregates the impression slots offered across multiple ad networks and matches them (based on the advertisers target, budget and placement requirements) with the most appropriate ads. With relevant ads displayed across content, AOL can continue to charge higher revenue per page view ( RPM ) to advertisers. Currently, we expect revenue per page view to grow from $4.50 to $5.90 by the end of our forecast period.

Display Ads And Search Ads Division Falter

According to our estimates, the display ads division makes up 30%, and the search ads division constitutes 18% of AOL's value. While display ads division did witness a growth in the ad pricing, the number of impression sold declined in the quarter. Furthermore, revenues from search ads division declined by 1% to $97.6 million. The decline was primarily due to fewer queries from AOL clients in international markets and a decline in the number of subscribers. However, the company plans to build sustainable video content library, and search products in partnership with Google so that its display and search revenues are stable in the future.

We are in the process of updating our AOL model. At present, we have a $41.51 price estimate for AOL , which is approximately 20% above the current market price.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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