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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)
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.
20
--------------------------------------------------------------------------------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.
21--------------------------------------------------------------------------------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 $1,166,000 from the same period in 2011 due to
higher operating expenses.
22--------------------------------------------------------------------------------Net Revenue
Total net revenue from our Publisher Network and Software Search segments for
the three months ended September 30, 2012 and 2011 were as follows (unaudited
and in thousands):
Three Months Ended September 30
2012 ($) % 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.
23
--------------------------------------------------------------------------------
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.
24--------------------------------------------------------------------------------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 %
25--------------------------------------------------------------------------------
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
Operating expenses 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
Search costs 5,832 37.7 % 1,959 23.9 % 3,873 197.7 %
Compensation and
telemarketing 1,649 10.7 % 1,481 18.1 % 168 11.3 %
Selling, general and
administrative 2,379 15.4 % 1,363 16.6 % 1,016 74.5 %
Total operating
expenses 9,860 63.7 % 4,803 58.6 % 5,057 105.3 %
Our operating expenses by segment were as follows for the periods presented
(unaudited and in thousands):
Three Months Ended September 30
2012 ($) % of Revenue 2011 ($) % of Revenue $ Change % Change
Publisher Network 718 4.6 % 2,379 29.0 % (1,661 ) (69.8 )%
Software Search 5,427 35.1 % 92 1.1 % 5,335 5,798.9 %
Corporate 3,715 24.0 % 2,332 28.4 % 1,383 59.3 %
Total operating expenses 9,860 63.7 % 4,803 58.6 % 5,057 105.3 %
Search costs increased 197.7% for the three months ended September 30, 2012
compared to the same period of 2011 primarily due to the advertising spend to
create download traffic for the ALOT appbar. This expense is expected to
increase, though not significantly in the future as we grow the ALOT user base
and revenue.
Compensation and telemarketing expense increased 11.3% for the three months
ended September 30, 2012 compared to the same period of 2011 primarily due to
the merger with Vertro. At September 30, 2012, we had a headcount of 45
employees compared to 28 employees at September 30, 2011.
Selling, general and administrative expense increased approximately $1 million
or 74.5% for the three months ended September 30, 2012 compared to the same
period of 2011 primarily due to higher depreciation and amortization expense
($544,000), IT services expense of ($205,000), rent expense ($91,000),
professional fees ($89,000), and other related to the acquired operations from
the merger with Vertro in March 2012.
Operating expenses for the nine months ended September 30, 2012 and 2011 were as
follows (unaudited and in thousands):
Nine Months Ended September 30
2012 ($) % of Revenue 2011 ($) % of Revenue $ Change % Change
Search costs 13,098 35.3 % 6,749 23.1 % 6,349 94.1 %
Compensation and
telemarketing 4,571 12.3 % 6,367 21.8 % (1,796 ) (28.2 )%
Selling, general and
administrative 6,735 18.1 % 4,019 13.8 % 2,716 67.6 %
Total operating
expenses 24,404 65.7 % 17,135 58.7 % 7,269 42.4 %
26--------------------------------------------------------------------------------Our operating expenses by segment were as follows for the periods presented
(unaudited and in thousands):
Nine Months Ended September 30
2012 ($) % of Revenue 2011 ($) % of Revenue $ Change % Change
Publisher Network 1,696 4.6 % 9,769 33.4 % (8,073 ) (82.6 )%
Software Search 12,649 34.1 % 193 0.7 % 12,456 6,453.9 %
Corporate 10,059 27.1 % 7,174 24.6 % 2,885 40.2 %
Total operating expenses 24,404 65.7 % 17,136 58.7 % 7,268 42.4 %
Search costs increased 94.1% for the nine months ended September 30, 2012
compared to the same period of 2011 primarily due to the advertising spend to
create download traffic for the ALOT appbar. This expense is expected to
increase, though not significantly in the future as we grow the ALOT user base
and revenue.
Compensation and telemarketing expense decreased 28.2% for the nine months ended
September 30, 2012 compared to the same period of 2011 primarily due to
discontinuing the telemarketing operations in the 2011.
Selling, general and administrative expense increased approximately $2.7 million
or 67.6% for the nine months ended September 30, 2012 compared to the same
period of 2011 primarily due to increases in depreciation and amortization
expense of ($1,020,000), rent of ($584,000), IT services of ($298,000),
consulting expense of ($205,000), and other general expenses of ($639,000) due
to the infrastructure growth related to the Vertro merger in March 2012.
Other Income (Expense), Net
During the third quarter of 2012, we settled a lawsuit resulting in a $75,000
charge. In the third quarter of 2011, we wrote off approximately $78,000 of
capital development associated with delays in launching a new business line.
Interest expense, net which is primarily associated with our borrowings from
Bridge Bank, increased by 142% during the three months ended September 30, 2012
to approximately $128,000 as compared to approximately $53,000 for the same
period in 2011. This increase in interest expense is primarily is due to the
larger outstanding balance in the 2012 period compared to the same period in
2011, and to the amortization of fees to acquire the credit facilities.
During the nine month period ended September 30, 2012, we settled a lawsuit
resulting in a $75,000 charge. In the same nine month period of 2011, we
incurred a charge to litigation settlements of approximately $374,000 associated
with settlements of lawsuits brought by two former employees. In addition, we
wrote-off a note receivable of approximately $101,000 as a result of the
cancellation of our outsourced call center contract during the second quarter of
2011. In the third quarter of 2011, we wrote off approximately $78,000 of
capital development associated with delays in launching a new business line.
Interest expense, net which is primarily associated with our borrowings from
Bridge Bank, increased by 51.1% during the nine months ended September 30, 2012
to $399,000 as compared to $264,000 for the same period in 2011. This higher
interest expense in 2012 is primarily due to higher outstanding loan balances
and the write-off of $100,743 of fees related to the February 2011 Bridge Bank
credit facility that was superseded by a March 2012 Bridge Bank credit facility.
27
--------------------------------------------------------------------------------Income (Loss) from Discontinued Operations, Net of Tax Expense
The gain from discontinued operations for the three months ended September 30,
2012 was approximately $14,000 and is primarily attributed to Vertro's European
operations.
The loss from discontinued operations for the nine months ended September 30,
2012 was approximately $143,000 and is primarily attributed to the denial by
European authorities to hear our appeal for refunding of Value Added Taxes in
Germany. In the same nine month period of 2011, we reported a gain from
discontinued operations of approximately $257,000 due to a favorable litigation
settlement of a lease.
Liquidity and Capital Resources
Liquidity is our ability to generate adequate amounts of cash to meet the
company's needs for cash. At September 30, 2012 and December 31, 2011, we had
working capital deficit of approximately $3.0 million and $2.0 million,
respectively. Our principal sources of liquidity are cash from operations, cash
on hand and the Bridge Bank credit facility.
While we do not have any commitments for capital expenditures which come due
within the next 12 months, in the past our liquidity had been negatively
affected, as a result of a reduction in search marketing revenue. In response,
we implemented a cost reduction plan throughout 2011 to offset the reduced
revenue which included a reduction in employees and related expenses. We also
delayed payments to publishers and vendors in the management of our cash flows.
Additionally in 2011, our directors, executive officers and certain senior
managers agreed to a deferral of cash compensation which was ultimately
converted to common shares.
Upon merging with Vertro on March 1, 2012 we eliminated duplicate costs in
public company expense, and in the accounting, legal, and IT functions. The
program to reduce duplicate costs continues beyond the third quarter. We also
entered into a new Business Financing Agreement with our bank (see below). At
September 30, 2012 cash increased $3.2 million from the end of 2011 and bank
debt correspondingly increased from $2.9 million at December 31, 2011 to $7.9
million at the end of the third quarter 2012.
On March 1, 2012, we entered into a new Business Financing Agreement with Bridge
Bank for a revolving credit facility with a maximum limit of $10 million (the
"Revolving Credit Line") and a term loan with a maximum limit of $5 million (the
"Term Loan"). The Revolving Credit Line replaced the Company's then existing $8
million revolving credit facility with Bridge Bank. The new credit facility will
be used primarily to satisfy our working capital needs. As of September 30,
2012, there was approximately $1.1 million credit available on the Revolving
Credit Line and $0 on the Term Loan. Subject to the terms of the new agreement,
we are entitled to obtain advances against the Revolving Credit Line up to 80%
of eligible accounts receivable balances, which are generally those balances
owed by U.S. based customers that are less than 90 days from the date of
invoice plus $1 million up to the maximum limit of $10 million. In addition,
subject to the terms of the agreement, we are entitled to borrow up to $5
million under the Term Loan portion of the credit facility, which is repayable
in 45 equal monthly installments beginning June 2012. The Revolving Credit Line
portion of the credit facility expires on February 28, 2014, at which time all
loan advances under the Revolving Credit Line become due and payable. The Term
Loan expires in February 2016. Under the terms of the new agreement, we must
maintain certain depository, operating and investment accounts at Bridge Bank;
provide Bridge Bank a first priority perfected security interest in all of our
accounts and personal property; provide various monthly, quarterly and annual
reports; and limit additional indebtedness to $500,000 of purchase money
including capital leases and an additional $500,000 of all other indebtedness.
In addition, the new agreement required that we maintain through May 2012 an
"operating profit" of net income plus interest and taxes plus non-cash expenses
for amortization, depreciation, stock based compensation, discontinued
operations, non-recurring non-cash items and certain closing costs associated
with the Merger Transaction with Vertro of not less than $200,000 for the
immediate proceeding three month period; after May 2012 a Debt Service Coverage
Ratio of at least 1.50 to 1.0 tested on the immediate proceeding three month
period; and an Asset Coverage Ratio of not less than 1.10 to 1.0 at all times
until September 30, 2012 and 1.25 to 1.0 thereafter. Interest on the Revolving
Credit Line is payable monthly at prime plus 0.5% (3.75% at September 30, 2012)
plus a monthly maintenance fee of 0.125 percentage points on the average daily
account balance. Interest on the Term Loan bears interest at prime plus 1%
(4.25% at September 30, 2012). In connection with establishing the credit
facility, the Company incurred fees payable to Bridge Bank of approximately
$100,000. The agreement calls for a termination fee until the first anniversary
and prepayment fee on the Term Loan until the first anniversary.
28
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On October 11, 2012 we entered into the Second Business Financing Modification
Agreement with Bridge Bank (the "Second Amendment") changed the minimum asset
coverage ratio to 0.9 to 1.0 for September 2012 and October 2012, 1.0 to 1.0 for
November and December 2012 and 1.15 to 1.0 for each measuring period thereafter
beginning January 2013. It also changed the minimum operating profit measured
monthly on a trailing 3 month basis to not less than $600,000 for the September
2012 measuring period and $1,000,000 for the October 2012 measuring period. Also
changed was the minimum debt service ratio, measured monthly on a trailing 3
month basis, to not less than 1.1 to 1.0 for November 2012 measuring period,
1.25 to 1.0 for December 2012 and 1.50 to 1.0 for each measuring period
thereafter beginning January 2013. Further, the Second Amendment waived the
event of default caused by the non-compliance of the operating profit in July
and August 2012. Additionally, pursuant to the Second Amendment, the Company
issued Bridge Bank a warrant to purchase 51,724 shares of our own common stock
exercisable at $0.87 per share until October 2017.
As of September 30, 2012, we were not in compliance with all terms of the
amended Bridge Bank credit facility, however we regained compliance upon
execution of the Second Amendment.
We may seek to raise additional capital through public or private equity
financings in order to fund our operations, take advantage of favorable business
opportunities, develop and upgrade our technology infrastructure, develop new
product and service offerings, take advantage of favorable conditions in capital
markets, sell certain of our operations or respond to competitive pressures in
an effort to maintain our market position. We cannot be assured that additional
financing will be available to us on favorable terms, or at all. If we issue
additional equity, our existing stockholders may experience substantial
dilution. If we continue to generate losses and are unable to comply with the
continued listing standards of NYSE MKT, we could be delisted and be unable to
raise additional capital at a reasonable cost. At September 30, 2012, we had a
working capital deficit of approximately $3 million and availability under our
revolving line of credit of approximately $1.1 million. We believe with the
continued improvement in cash flow, the reduction of duplicate costs with
respect to the merger with Vertro and the higher limit of the new bank facility,
we will have sufficient cash for the next twelve months.
Cash flows
Net cash provided in operating activities for the nine months ended September
30, 2012 totaled approximately $541,000 compared to approximately $408,000
during the same period in 2011. The net cash provided in operating activities in
2012 is primarily due to stock compensation costs of $632,000, an increase in
accounts receivable of $881,000 and prepaid expenses and other assets of
$266,000. This was offset by uses of cash to decrease accounts payable
($263,000) and other accrued expenses and current liabilities ($842,000). The
net cash provided by operating activities for the nine months ended September
30, 2011 was primarily due to a decrease in accounts receivable of approximately
$1.5 million and the deferred compensation program instituted last year to
preserve the company's cash reserves ($368,000) partially offset by a decrease
in accounts payable of $1.3 million.
Net cash used in investing activities in 2012 of $1,254,000 was primarily due to
the purchase of bundled downloads for the Alot AppBar and capitalized
development costs. Net cash used in investing activities for the nine months
ended September 30, 2011 of $2.6 million was primarily associated with the
purchase of names for resale in the BabytoBee and lead generation businesses.
Net cash provided by financing activities during the nine months ended September
30, 2012 and 2011 were approximately $3.9 million and $3.2 million,
respectively. The cash provided by financing activities for the period in 2012
resulted from the proceeds from the bank term note and draw downs from the bank
credit facility. In the nine month period of 2011, the cash provided was
primarily from the sale of our common stock in June 2011 and due to draw downs
from the bank credit facility.
Off Balance Sheet Arrangements
As of September 30, 2012, 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.
29--------------------------------------------------------------------------------
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