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INUV > SEC Filings for INUV > Form 10-Q on 8-Nov-2012All Recent SEC Filings

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Form 10-Q for INUVO, INC.


8-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Certain statements in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this quarterly report on Form 10-Q constitute "forward-looking statements" within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that are not historical, including statements regarding management's intentions, beliefs, expectations, representations, plans or predictions of the future and are typically identified by words such as "believe," "expect," "anticipate" "intend," "estimate," "may," "will," "should," and "could." These forward-looking statements involve numerous risks and uncertainties that could cause our actual results to be materially different from those set forth in the forward-looking statements including, without limitation, our lack of profitable operating history, changes in our business, potential need for additional capital and the other additional risks and uncertainties that are set forth in this Quarterly Report on Form 10-Q, as well as in our Annual Report on Form 10-K for the year ended December 31, 2011 and as filed with the Securities and Exchange Commission and our subsequent filings with the SEC. The risk factors described in our filings with the SEC are not the only risks we face. Additional risks and uncertainties not currently known to us or that we deem immaterial also may materially adversely affect our business, financial condition and/or operating results. The Company assumes no obligation to update any forward-looking statements as a result of new information or future events or developments, except as required by law. The following discussion should also be read in conjunction with the Consolidated Financial Statements and Notes thereto appearing elsewhere in this quarterly report on Form 10-Q.

Overview

Inuvo® is an Internet marketing and technology company that manages a network of websites and builds and markets browser based consumer applications. We develop software and analytics technology that is accessible over the Internet for use by consumers, online advertisers and website publishers.

On March 1, 2012 we completed the acquisition of Vertro, Inc. ("Vertro"), an Internet company that owns and operates the ALOT product portfolio. After seven months of combined operations, management has reduced the number of reporting segments from three to two. The new segments are Software Search and the Publisher Network. The Partner Programs segment from the previous reporting segments has been absorbed into the other two segments with consumer focused initiatives going to Software Search and all other business going to the Publisher Network. For presentation purposes, prior period results included herein have been reclassified for the new segment structure.

The former Vertro's operations are now part of the Software Search segment. Our Publisher Network segment consists of the technology and analytics platforms that provide advertisers and publishers the capability to facilitate performance-based advertising. This segment also consists of websites we own and operate. The Software Search and Publisher Network segments represent approximately 50.9% and 49.1% respectively, of our total net revenue for the quarter ending September 30, 2012. Prior to 2012, we were organized under two segments; Web Properties and Performance Marketing.

The Company's consolidated financial statements as of September 30, 2012 include the operations and financial results of the Vertro subsidiary for only seven months. For presentation purposes, our prior period results included herein have been reclassified for our new segment structure.

Software Search

Following our acquisition of Vertro, effective March 1, 2012, we include the ALOT product line into what we now call our Software Search segment. The ALOT product line offers two primary products to consumers; ALOT Home, a homepage product, and the ALOT Appbar, a software application that consumers install into their web browsers. Both ALOT Home and the ALOT Appbar include a search box from which consumers can conduct type-in web search requests. The ALOT Appbar provides access to a library of applications, which are used by consumers to receive dynamic information, perform useful tasks, or access their favorite content online. There are hundreds of apps available for consumers to choose from ranging from a weather app that provides an at-a-glance snapshot of the weather for the coming four days, to a radio app that enables consumers to instantly listen to thousands of radio stations from around the world. All ALOT products and apps are free to download and use.

The search box on the ALOT Home and ALOT Appbar products has historically been the source of a majority of the revenue. Users conduct millions of searches per day producing both algorithmic results and sponsored listings. Both the algorithmic results and sponsored listings are provided by third parties with whom we have contractual relationships. If users click on a sponsored listing after conducting a search, we earn a percentage of the total click-through revenue provided by the third-party that placed the advertisement. Historically, search revenue from Google accounted for over 80% of revenue from the ALOT operations.

The Software Search segment also consists of affiliate programs, display revenues, data sales, and BargainMatch. Non-search revenue is generated from the interaction consumers have with certain applications launched from within the Appbar. We refer to these as sponsored apps and they generate either pay-per-click or cost-per-action revenue. Website page-views are also monetized through cost-per-thousand display ads. We also utilize user data to enhance product offerings and generate additional revenue.

The BargainMatch consumer product shopping, comparison and rewards application is a browser-based application where consumers can earn cashback on purchases made online through sponsored merchants.


Publisher Network

The Publisher Network segment is made up of thousands of different websites, from large, well-known portals to independent tech bloggers into which Inuvo serves advertisements. The technology that supports the Publisher Network, the Inuvo platform, is an open, fraud filtering, lead, click or sales generation marketplace designed to allow advertisers and publishers the ability to manage their transactions in an automated and transparent environment. The following brands continue to be used within the Publisher Network:

? The ValidClick® service at www.validclick.com. ValidClick is a fraud filtering, pay-per-click marketplace where publishers can integrate dynamically-generated advertisements within their websites based on the demographics and natural search behaviors of the consumer. ValidClick provides publishers with access to tens of thousands of advertisers in an easy-to-use XML-based implementation, giving the publisher greater control over content and integration than other competitive offerings.

? The owned and operated websites including the Yellowise.com™ directory search website at www.yellowise.com and the recently launched Local.ALOT.com website. Both websites are local search and review sites powered by the LocalXML service which allows publishers the ability to make real-time calls to the LocalXML database and have users receive a listing of all local businesses that meet the search criteria. Users may also post reviews of their favorite and not-so-favorite businesses making the reviews available to all other users of the site.

? The MyAP® Affiliate Platform at www.MyAP.com. MyAP is a complete affiliate tracking and management software solution providing advertisers the ability to sign up, manage and track the activities of their publishers through a reliable, easy-to-use, and privately-branded platform with full data transparency. Where the Inuvo Platform is an open platform where many advertisers and publishers interact, the MyAP platform is designed specifically to allow merchants to build private affiliate networks. Each advertising customer of MyAP is supported by a unique implementation of the software, customized to suit their individual needs and populated by publishers.

NYSE MKT

On May 9, 2011, we received notice from the NYSE MKT, LLC (formerly NYSE Amex) (the exchange) that we did not meet certain of the exchange's continued listing standards due to stockholders' equity of less than $4.0 million and losses from continuing operations and/or net losses in three of our four most recent fiscal years as set forth in Section 1003(a) (ii) of the NYSE MKT Company Guide. The exchange accepted our plan to regain compliance with the continued listing standards and on September 11, 2012, we received notification from the exchange that the continued listing deficiencies were resolved. However, due to of the company's continuing net losses, the exchange's minimum requirement for continued listing becomes a minimum stockholders' equity of $6.0 million. At September 30, 2012, our stockholders' equity was $5.1 million and we did not meet the exchange's minimum listing requirement. We believe we will achieve the exchange's minimum stockholders' requirement and regain compliance with the continued listing standard in 2013 due to cost containment and revenue growth.

? Cost Containment. With the Vertro merger we anticipated that we would save approximately $2.9 million in operating expense synergies on an annualized run rate. As of September 30, 2012 we were on a run rate of approximately $0.9 million ahead of that expectation and we expect these savings to flow through to our bottom line throughout the fourth quarter of 2012 and beyond.

? Revenue Growth. Our Publisher Network segment had a revenue growth rate of 40% in the third quarter of 2012 compared to the second quarter of 2012. Our Software Search segment had a revenue growth rate of 6% for the third quarter of 2012 compared to the second quarter of 2012. In September 2012, we attained revenue growth leading to a higher revenue share from Yahoo! for our Publisher Network segment and in July 2012, revenue growth in our Software Search Segment reached a level that yielded a higher revenue share from Google. We expect these higher revenue share rates to continue into the fourth quarter of 2012 and the higher percentage revenue share with each advertising partner is substantial and a meaningful component of our revenue growth. Our Yellowise and Local.alot owned and operated sites are contributing meaningful incremental revenues on a quarter by quarter basis and we expect their growth to continue. In addition we expect to see meaningful revenue coming from our BargainMatch.com product.

In aggregate, we believe the continued cost containment described above and the growth in revenue will allow us to satisfy the NYSE/MKT listing requirements for shareholder equity in 2013.

Hurricane Sandy

Our corporate headquarters and a significant portion of our operations are located in New York City. Our office was closed for a week due to the impact of Hurricane Sandy. One of our data centers in New York City has been without power since the hurricane and we have been operating a portion of our Software Search segment business out of a redundant data center. Our business and operating systems were not materially impacted by the office closure and our employees were able to work remotely.


Results of Operations for the Three months and Nine Months ended September 30, 2012 and 2011

The following table sets forth selected information concerning our results of operations for the three months and nine months ended September 30, 2012 and 2011 (unaudited and in thousands):

                                  Three Months ended September 30                                  Nine Months ended September 30
                      2012        % of Revenue         2011       % of Revenue         2012       % of Revenue         2011       % of Revenue
Net revenues        $ 15,481                100 %    $  8,203               100 %    $ 37,123               100 %    $ 29,210               100 %
Cost of revenue        6,745               43.6 %       4,636              56.5 %      18,190                49 %      16,106              55.1 %
Gross Profit           8,736               56.4 %       3,567              43.5        18,933                51 %      13,103              44.9 %
Total operating
expenses               9,860               63.7 %       4,803              58.6        24,404              65.7 %      17,136              58.7 %
Operating Loss        (1,124 )             (7.3 %)     (1,236 )           (15.1 %)     (5,471 )           (14.7 %)     (4,032 )           (13.8 %)
Other expenses          (202 )             (1.3 %)       (132 )            (1.6 %)       (474 )            (1.3 %)       (817 )            (2.8 %)
Income tax
expense                  ( 9 )             (0.1 %)          -                --           (71 )            (0.2 %)          -                 -
Net loss from
continuing
operations            (1,335 )             (8.6 %)     (1,368 )           (16.7 %)     (6,016 )           (16.2 %)     (4,850 )           (16.6 %)
Discontinued
operations                14                0.1 %           -                 -          (143 )            (0.4 %)        257               0.9 %
Net loss            $ (1,321 )             (8.5 %)   $ (1,368 )           (16.7 %)   $ (6,159 )           (16.6 %)   $ (4,592 )           (15.7 %)

In the three months ended September 30, 2012, net revenues increased 88.7% from the same period of 2011. Additionally, gross profit also increased 144.9% in the three months ended September 30, 2012 compared to the same period of 2011. These increases were due primarily from revenue from our Software Search segment as a result of our merger with Vertro. In the three months ended September 30, 2012, our operating expenses increased by approximately 105.3% over the same period in 2011 due primarily to customer acquisition costs from our Software Search segment as a result of our merger with Vertro.

Our net loss from continuing operations for the three months ended September 30, 2012 decreased by approximately $33,000 or 2.4% from the same period in 2011 due to improved gross profit and the cost synergies derived from the merger with Vertro.

The financial results for the nine months ended September 30, 2012 include only seven months of combined financial results of the merger with Vertro on March 1, 2012. In the nine months ended September 30, 2012, net revenues increased 27.1% from the same period of 2011. Additionally, gross profit also increased by 44.5% in the nine months ended September 30, 2012 compared to the same period of 2011. These increases were due primarily from revenue from our Software Search segment as a result of our merger with Vertro. In the nine months ended September 30, 2012, our operating expenses increased by approximately 42.4% over the same period in 2011 due primarily to customer acquisition costs from our Software Search segment as a result of our merger with Vertro.

Our net loss from continuing operations for the nine months ended September 30, 2012 increased by approximately $1,166,000 from the same period in 2011 due to higher operating expenses.


Net Revenue

Total net revenue from our Publisher Network and Software Search segments for
the three months ended September 30, 2012 and 2011 were as follows (unaudited
and in thousands):

                                                      Three Months Ended September 30
                         2012 ($)       % of Revenue     2011 ($)       % of Revenue      $ Change       % Change
Publisher Network            7,605             49.1 %        8,153             99.4 %         (548 )         (6.7 )%
Software Search              7,876             50.9 %           50              0.6 %        7,826       15,652.0 %
Total net revenue           15,481            100.0 %        8,203            100.0 %        7,278           88.7 %

Net revenue from our Publisher Network segment decreased 6.7% for the three months ended September 30, 2012 compared to the same period of 2011 primarily due to the decrease in the number of transactions driven through our owned and operated websites and through third party affiliates using the ValidClick platform. In December 2011, Yahoo! provided preliminary notice that it had identified certain traffic irregularities across its publisher network, to which Inuvo is a contributor. While this irregular traffic did not originate within the Inuvo network, it passed through some websites the company manages and in some cases owns and operates. Yahoo! made advertiser refunds as a result of identified traffic irregularities that it charged back to us. In the first quarter of 2012, the chargeback was approximately $238,000. This amount was a reduction of our revenue in the first quarter 2012 and most of this amount has been charged back to our vendors. In the third quarter of 2012, we charged revenue a reserve of $170,000 in anticipation of an additional chargeback from Yahoo! We have reduced traffic to some websites we manage in response to these irregularities. While growing, these websites have not yet achieved the traffic levels reached in 2011. There can be no assurance that we will be able to successfully return these campaigns to their previous levels. We have also restructured the ValidClick business to focus on smaller publishers rather than larger ones where traffic origin is less certain. The revenue of this segment has been volatile due to the decrease in transactions as described above and though we expect the volatility to continue in the near future, we believe the focus on smaller publishers will improve traffic quality and promote a steady growth of the segment. In September 2012, the revenue growth had attained a contractual level yielding a higher revenue share from Yahoo! The recent trend in the Publisher Network segment is a revenue growth rate of 40% in the third quarter of 2012 over the most recent sequential quarter, the second quarter of 2012.

Net revenue from our Software Search segment is primarily a result of the merger with Vertro on March 1, 2012. Net revenue from the Software Search segment is derived from the ALOT users conducting searches that produce both algorithmic results and sponsored listings. Both the algorithmic results and sponsored listings are provided by third parties with whom we have contractual relationships. When users click on a sponsored listing after conducting a search, we earn a percentage of the total click-through revenue provided by the third-party that placed the advertisement. This segment also includes the non-search revenue generated from the ALOT products. The largest portion of non-search revenue is derived from display ads presented on the Alot homepage. Recently we have seen a decline in Display advertising due to implementation changes made by our display advertising provider. The recent trend in the Software Search segment is an increase of net revenue of 6% for the three months ended September 30, 2012 compared to the most recent sequential quarter, ended June 30, 2012. In July 2012, for the first time in over a year, revenue growth had attained a contractual level yielding a higher commission rate from Google.

One provider of paid search results for our Software Search segment accounted for approximately 49.2% of our consolidated revenues for the three months ended September 30, 2012. No revenue from that paid search provider was included in our consolidated revenue for the three months ended September 30, 2011. Additionally, one provider of paid search results for our Publisher Network segment accounted for approximately 42.4% and 88.8% of consolidated revenues for the three month periods ended September 30, 2012 and 2011, respectively. The lower percentage this year is due to the diversification of the revenue streams achieved by merging with Vertro in March 2012.


Total net revenue from our Publisher Network and Software Search segments for the nine months ended September 30, 2012 and 2011 were as follows (unaudited and in thousands):

                                                      Nine Months Ended September 30
                         2012 ($)       % of Revenue     2011 ($)       % of Revenue     $ Change       % Change
Publisher Network           19,429             52.3 %       29,160             99.8 %      (9,731 )       (33.4 )%
Software Search             17,694             47.7 %           50              0.2 %      17,644        35,288 %
Total net revenue           37,123            100.0 %       29,210            100.0 %       7,913          27.1 %

Net revenue from our Publisher Network segment decreased 33.4% for the nine months ended September 30, 2012 compared to the same period of 2011 primarily due to the decrease in the number of transactions driven through our owned and operated websites and through third party affiliates using the ValidClick platform as described above.

Net revenue from our Software Search segment is entirely a result of the merger with Vertro on March 1, 2012 as described above.

One provider of paid search results for our Software Search segment accounted for approximately 41.8% of our consolidated revenues for the nine months ended September 30, 2012. No revenue from that paid search provider was included in our consolidated revenue for the nine months ended September 30, 2011. Additionally, one provider of paid search results for our Publisher Network segment accounted for approximately 44.7% and 86.4% of consolidated revenues for the nine month periods ended September 30, 2012 and 2011, respectively. The lower percentage this year is due to the diversification of the revenue streams achieved by merging with Vertro in March 2012.

Cost of Revenue and Gross Profit

Cost of revenue for the three months ended September 30, 2012 and 2011 were as
follows (unaudited and in thousands):

                                                       Three Months Ended September 30
                         2012 ($)       % of Revenue       2011 ($)       % of Revenue       $ Change       % Change
Affiliate expenses           5,472               35.4 %        3,922               47.8 %        1,550           39.5 %
Data acquisition             1,054                6.8 %          688                8.4 %          366          53.2% %
Merchant processing
fees and product
costs                          219                1.4 %           26                0.3 %          193          742.3 %
   Total cost of
revenue                      6,745               43.6 %        4,636               56.5 %        2,109           45.5 %

The lower affiliate payments as a percentage of revenue in the three months ended September 30, 2012 compared to the same period in 2011 is due primarily to restructuring the ValidClick business to focus on smaller publishers to host advertising.

The increase in data acquisition costs for the three months ended September 30, 2012 as compared to the same period of 2011 is due primarily to acquiring bundled downloads to drive revenue through our ALOT Appbar which was acquired in the Vertro acquisition in March 2012. We do not expect these costs to increase in the future.


Cost of revenue for the nine months ended September 30, 2012 and 2011 were as follows (unaudited and in thousands):

                                                       Nine Months Ended September 30
                         2012 ($)       % of Revenue       2011 ($)       % of Revenue       $ Change       % Change
Affiliate expenses          14,119               38.0 %       14,090               48.2 %           29            0.2 %
Data acquisition             3,572                9.7 %        1,943                6.7 %        1,629           83.8 %
Merchant processing
fees and product
costs                          500                1.3 %           73                0.3 %          427          584.9 %
Total cost of revenue       18,191               49.0 %       16,106               55.1 %        2,085           12.9 %

The affiliate payments in the nine months ended September 30, 2012 compared to the same period in 2011 were nearly the same. The lower affiliate payments as a percentage of revenue for the nine months ended September 30, 2012 compared to the same period in 2011 is primarily due to restructuring the ValidClick business to focus on smaller publishers to host advertising.

The increase in data acquisition costs both in dollars and as a percentage of revenue for the nine months ended September 30, 2012 as compared to the same period of 2011 is due primarily to acquiring bundled downloads to drive revenue through our ALOT Appbar which was acquired in the Vertro acquisition in March 2012.
We do not expect these costs to increase in the future.

The following table provides information on gross profit by operating segment for each of the periods presented (unaudited and in thousands):

                                                     Three Months Ended September 30
                         2012 ($)       % of Revenue     2011 ($)       % of Revenue       $ Change      % Change
Publisher Network            1,894             12.9 %        3,517               42.9 %      (1,623 )        (46.1 )%
Software Search              6,842             50.9 %           50                0.2 %       6,792       13,584.0 %
Total gross profit           8,736            63.8  %        3,567               43.1 %       5,169          144.9 %

Gross profit from our Publisher Network segment decreased 46.1% for the three months ended September 30, 2012 compared to the same period of 2011 primarily due to lower revenue of owned and operated websites associated with reducing traffic as described above in "Net Revenue".

Gross profit from the Software Search segment increased as a result of the ALOT operations acquired in the merger with Vertro in March 2012.

The following table provides information on gross profit by operating segment for each of the periods presented (unaudited and in thousands):

                                                      Nine Months Ended September 30
                         2012 ($)       % of Revenue     2011 ($)       % of Revenue     $ Change       % Change
Publisher Network            4,326            11.7 %        13,053            44.7 %       (8,727 )       (66.9 )%
Software Search             14,606            39.3 %            50             0.2 %       14,556        29,112 %
Total gross profit          18,932            51.0 %        13,103            44.9 %        5,829          44.5 %


Gross profit from our Publisher Network segment decreased 66.9% for the nine months ended September 30, 2012 compared to the same period of 2011 primarily due to lower revenue from owned and operated websites associated with reducing traffic as described above in "Net Revenue".

Gross profit from the Software Search segment is resulted from the ALOT operations acquired in the merger with Vertro in March 2012.

Operating Expenses

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