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INUVO, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Company Overview Inuvo, Inc. and subsidiaries ("we", "us" or "our") is an internet marketing and technology company that delivers targeted advertisements to websites and applications reaching both desktop and mobile devices. We deliver content and targeted advertisements over the internet and generate most of our revenue when an end user clicks on advertisements we have delivered. We manage our business as two segments, Partner Network and Owned and Operated Network. In the third quarter of 2013 we reorganized our segments and retrospectively applied the current presentation to prior periods. The Partner Network delivers advertisements to our partners' websites and applications on desktop, tablet and mobile devices. We generate revenue in this segment when an advertisement is clicked, and we share a portion of that revenue with our partners. Our proprietary technology platform allows for targeted distribution of advertisements at a scale that measures in the billions of advertisements delivered monthly. The Owned and Operated Network designs, builds and markets consumer websites and applications. This segment consists of our mobile-ready ALOT websites and the ALOT Appbar is focused on providing engaging content to our users. The majority of revenue generated by this segment is derived from clicks on advertisements delivered through web searches or advertisements displayed on the websites. We took several significant steps in 2013 to position our business for long-term success including a reduction in compensation and administrative expenses, which helped improve net income and make 2013 our first profitable year in recent memory. In 2014 we are focused on expanding our product portfolio and growing revenue and profitability. During 2013 and early 2014, we expanded our ALOT-branded websites and applications with the launch of ALOT Local, ALOT Health, ALOT Finance, ALOT Careers, ALOT Travel and ALOT Home. These sites are content rich, searchable, mobile-ready web properties. We plan to continue the expansion of our website and mobile application business throughout 2014. On January 25, 2013, we reached an agreement with the state of Arkansas and received a grant of up to $1.75 million for costs related to the relocation and the purchase of equipment necessary to begin operations in Arkansas. The grant is contingent upon us having at least 50 full-time equivalent, permanent positions within four years, maintaining at least 50 full-time equivalent permanent positions for the following six years and paying those positions an average total compensation of $90,000 per year. If we fail to meet the requirements of the grant after the initial four year period, we may be required to repay a portion of the grant, up to but not to exceed the full amount of the grant. Based on our hiring and financial forecasts, we believe we will meet all grant requirements. In conjunction with the relocation to Arkansas, we exited our Clearwater, FL office lease, found a subtenant for our office in New York City and completed the relocation of our New York City data centers to a single location in Arkansas. As a result, our compensation and selling, general and administrative expenses together are now less than $3 million per quarter. 17 -------------------------------------------------------------------------------- NYSE MKT Our common stock is listed on the NYSE MKT, LLC (the "Exchange"). In November 2012 we were notified by the Exchange that we were out of compliance with certain aspects of their continued listing requirements; specifically, due to losses from continuing operations and/or net losses in our five most recent fiscal years, the Exchange's minimum requirement for continued listing is stockholders' equity of not less than $6,000,000. We were afforded the opportunity to submit a plan of compliance to the Exchange by December 31, 2012 to demonstrate our ability to regain compliance with their listing standards. We submitted our plan and were notified on February 15, 2013 that it was accepted. The Exchange initially required that we regain compliance with the continued listing standards by April 24, 2014. While we reported net income in 2013, we reported a loss of $26,000 from continuing operations in 2013 which resulted in our company failing to regain compliance with the continued listing standards at the end of 2013 as initially expected. In April 2014, after discussions with the Exchange, the Exchange agreed to extend the time for our company to regain compliance with the continued listing standards to May 30, 2014. This date is the maximum period the Exchange is permitted to provide us to regain compliance with its continued listing standards and is not subject to further extension. We believe that as a result of reporting net income from continuing operations of $649,000 for the first quarter of 2014, as well as stockholders' equity in excess of $6,000,000, we are currently in compliance with the continued listing standards. The Exchange will continue to monitor our compliance with the continued listing standards through periodic review to determine whether we are making progress consistent with the plan. If we should fail to comply with continued listing standards in future periods, our common stock is subject to immediate delisting proceedings. Results of Operations During the third quarter of 2013, we changed our segment presentation and have retrospectively applied the current presentation to prior periods. Net Revenue For the Three Months Ended March 31, 2014 2013 Change % Change Partner Network $ 5,451,617 $ 8,916,997 $ (3,465,380 ) (38.9 %) Owned and Operated Network 4,670,100 7,002,782 (2,332,682 ) (33.3 %) Total net revenue $ 10,121,717 $ 15,919,779 $ (5,798,062 ) (36.4 %) The Owned and Operated Network revenue was 46 percent of our total revenue in 2014 as compared to 44 percent in 2013 reflecting our focus on expanding the ALOT branded websites and apps we developed over the past twelve months. The Partner Network segment revenue declined during the first quarter of 2014 from the comparable period in 2013. Growing revenue in this segment is dependent upon an increase in the number of transactions processed through our ValidClick platform and growing the number of advertisements delivered to mobile devices. We have focused on recruiting partners with high quality traffic, which we believe increases revenue per click and reduces exposure to click fraud. Within this Network, we have transitioned away from publishers who focus heavily on marketing models with non-standard traffic sources. As a result we experienced revenue declines at the end of 2013 from publishers we terminated and now see recovery from new publishers who fit our revised publisher policies. Also, with the fourth quarter of 2013, we have renewed our efforts to enforce publisher contract terms and conditions and our Network operating policies, including validating traffic sources, improved technological detection, periodic publisher auditing, and where appropriate, modifying publisher payment terms. We expect increased revenues in this segment to be driven by advertisements delivered to mobile devices and the deployment of new advertising solutions to our publishers. Revenue in our Owned and Operated Network is generated through our consumer-facing ALOT branded websites and applications. In early 2013, we decided, as a result of changes in the marketplace, to transition away from the Appbar business which we acquired in the Vertro acquisition in 2012 and apply the assets purchased in that acquisition towards growing an Owned and Operated website and mobile applications business. This transition is reflected in the decline in revenues in this segment. We expect Appbar revenue to continue to decline and website revenue to increase throughout 2014. We have now launched a number of properties under the ALOT brand including ALOT Home, ALOT Health, ALOT Finance, ALOT Careers, ALOT Local, ALOT Legal and ALOT Travel. These websites are content-rich and optimized for mobile and desktop devices, and are designed to capitalize on growing consumer demand for content, delivered both on the desktop and on mobile devices. 18 -------------------------------------------------------------------------------- We intend to continue to expand our Owned and Operated Network by enhancing our current websites and mobile applications as well as launching additional websites and mobile applications under the ALOT brand. Cost of Revenue For the Three Months Ended March 31, 2014 2013 Change % Change Partner Network $ 3,593,214 $ 7,114,638 $ (3,521,424 ) (49.5 %) Owned and Operated Network 83,541 366,230 (282,689 ) (77.2 %) Cost of revenue $ 3,676,755 $ 7,480,868 $ (3,804,113 ) (50.9 %) Cost of revenue in the Partner Network is generated by payments to website and application publishers who host our advertisements. The decrease in cost of revenue is directly associated with lower revenue in this segment. Additionally, as was described in the Net Revenue section above, we have renewed our efforts to enforce publisher contract terms and conditions and our Network operating policies, including validating traffic sources, improved technological detection, periodic publisher auditing and where appropriate, modifying publisher payments. This resulted in improved margins within the first quarter of 2014 that we expect to return to normal operating levels in subsequent quarters. Cost of revenue in the comparable period in 2013 was higher due to a $322,771 charge associated with the termination of a product line. The decrease in cost of revenue in the Owned and Operated Network was driven by a decision in 2013 to transition away from the ALOT Appbar product, which we stopped funding in 2014. Other cost of revenue in this segment consists of charges for web searches and content acquisition. Operating Expenses For the Three Months Ended March 31, 2014 2013 Change % Change Marketing costs $ 3,663,687 $ 4,692,889 $ (1,029,202 ) (21.9 %) Compensation 1,099,915 1,993,325 (893,410 ) (44.8 %)Selling, general and administrative 1,010,609 2,144,831 (1,134,222 ) (52.9 %) Operating expenses $ 5,774,211 $ 8,831,045 $ (3,056,834 ) (34.6 %) Operating expenses declined as compared to the prior year as a result of lower investment in marketing costs for the Appbar and expense savings resulting from the move to Arkansas, including reduced compensation and overhead expenses. Marketing costs include those expenses required to attract traffic to our owned and operated websites and to effect Appbar downloads. Marketing costs decreased in the first quarter of 2014 due to a decision to terminate certain investments required to acquire Appbar users. This was partially offset by the spend required to grow the owned and operated website and application business. We expect marketing costs to increase in the balance of 2014 as we launch additional ALOT branded websites and mobile applications. Compensation expense declined in the first quarter of 2014 as compared to the first quarter of 2013 due to operational efficiencies and reduced payroll related to the relocation to Arkansas. Compensation expense included severance charges of approximately $82,000 and $316,000 in the 2014 and 2013 periods, respectively, related to a reduction in force during the first quarter of 2014 and to the relocation to Arkansas in the same period of 2013. The head count of permanent, full-time employees was 32 at March 31, 2014 compared to 48 at the same date last year. The decrease in selling, general and administrative costs is primarily due to cost savings related to the relocation to Arkansas and other operating efficiencies. The primary reasons for the lower cost in the three months ended March 31, 2014 compared to the same period last year are approximately $470,000 lower amortization and depreciation expense; $264,000 lower facilities cost; $129,000 lower professional fees; and $74,000 lower travel and entertainment costs. Also, the lower expense in the first quarter of 2014 was partially due to an adjustment of approximately $107,000 to payables which we had over accrued in prior periods. We expect compensation and selling, general and administrative costs combined to remain at less than $3 million per quarter for the remainder of 2014. 19 -------------------------------------------------------------------------------- Other Expense, net Other expense, net was $97,802 and $106,669 for the three months ended March 31, 2014 and 2013, respectively. These charges primarily include interest on the credit facility with Bridge Bank, which declined as a result of lower balances during 2014. 20 -------------------------------------------------------------------------------- Income (loss) from Discontinued Operations For the year ended March 31, 2014, we recognized net income from discontinued operations of $26,112, generated primarily by an adjustment of certain accrued liabilities originating in 2009 and earlier. During the year ended March 31, 2013, we recognized net income of $125,093 primarily related to the favorable resolution of a tax audit. Liquidity and Capital Resources Lower revenue in the fourth quarter of 2013 reflected both a seasonal decline as well as the effects of an accelerated transition out of the Appbar product into higher growth, content based, mobile ready websites and applications. This lower revenue resulted in lower borrowing capacity which we dealt with by reducing operating expenses and lengthening account payables where appropriate.. As a result, covenant waivers and modification of terms were successfully negotiated with Bridge Bank. (see Note 6, "Notes Payable"). Since the end of 2013, the company's average daily revenue has grown as expected and as a result the company's liquidity has improved. We are now in a position to be able to immediately leverage additional capital towards growth and as such we anticipate securing additional debt financing in 2014. There are no assurances that additional financing will be available to us upon terms and conditions, which are acceptable to the company. We also have access to a revolving line of credit under our agreement, as amended with Bridge Bank, which had approximately $627,000 in availability as of March 31, 2014. We believe the revolving line of credit and cash generated by operations will provide sufficient cash for operations over the next twelve months. During the first quarter of 2014, we filed an S-3 registration statement with the Securities and Exchange Commission ("SEC") to replace the existing, expiring S-3 "shelf" registration statement. This shelf registration statement enhances our ability to quickly raise additional capital through the sale of equity, however, we are not presently a party to any agreement or understanding for the sale of our equity securities and there are no assurances we will proceed with such a transaction during 2014. Cash Flows - Operating Net cash provided by operating activities was $380,069 during the first quarter of 2014. We produced net income of $674,759, which included non-cash depreciation and amortization expense of $454,473 and stock-based compensation expense of $130,448. The change in operating assets and liabilities was a $759,662 use of cash as a result of better operating performance. During the comparable period in 2013 we generated cash from operating activities of $653,393 and a net loss of $290,710 which was offset by non-cash depreciation and amortization expenses of $1,252,633 and stock-based compensation expenses of $189,993. Cash Flows - Investing Net cash used in investing activities was $178,423 and $197,218 for the first quarters of 2014 and 2013, respectively. Cash used in investing activities during the 2014 period primarily consisted of capitalized internal development costs, which are slightly lower than the previous year as a result of the decline in overall payroll costs associated with those activities. Cash Flows - Financing Net cash used in provided by financing activities was $615,818 during the first quarter of 2014. We used cash generated from operations to make net payments on the credit facility of $615,818. During the 2013 period, net cash provided by financing activities was $611,418, net payments on the credit facility of $948,916 and the letter of credit on our Clearwater, FL office of $301,158. 21 -------------------------------------------------------------------------------- Off Balance Sheet Arrangements As of March 31, 2014, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. The term "off-balance sheet arrangement" generally means any transaction, agreement or other contractual arrangement to which an entity unconsolidated with us is a party, under which we have any obligation arising under a guarantee contract, derivative instrument or variable interest or a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets. |