Inuvo Inc (INUV) 2006 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for joining us today. This call is being recorded. I will now turn the call over to Mr. Weinberg, Vice President of Investor Relations. Mr. Weinberg, you may begin.

Thanks, Jimmy. Thank you and good afternoon. Welcome to MIVA's Third Quarter 2006 Financial Results Conference Call. Joining me on the call today are Chief Executive Officer, Peter Carrao, our President, Seb Bishop, joining us from the U.K., and Chief Financial Officer, William Seippel.

I'd like to remind everyone that today's comments include forward-looking statements. These statements are subject to risks and uncertainties that may cause actual results and events to differ materially. These risks and uncertainties will be outlined at the end of this conference call, and are also detailed in MIVA's filings with the Securities and Exchange Commission. To comply with the SEC's guidance on fair and open disclosure, we have made this conference call publicly available via audio webcast through the Investor Relations section of our website, and a replay of the conference call will be available for 90 days after the call.

I'd now like to turn the call over to our CEO, Peter Carrao. Peter?

Thank you, Peter. Good afternoon, everyone, and welcome to MIVA's Third Quarter 2006 Conference Call. We really appreciate having you on our call with us today.

Overall, we're making progress towards our longer term goal for stabilizing cash and returning to positive operating margins, and we believe our third quarter results are beginning to reflect incremental improvement. While we believe we are moving in the right direction, we recognize we still have a lot of work ahead of us. To that end, we remain committed to continuing with the turnaround time we set in place earlier this year to drive revenue improvements and expense reductions through a series of course-correcting steps.

The first course-correcting step was taken over Q2 through a global restructuring and integration plan aimed at reducing annualized cash expenses of $6 million. We believe our second quarter expense reductions have begun to flow through normalized operating expenses over Q3.

In Q3, we recorded an adjusted EBITDA loss of $1.2 million, which includes $700,000 in projected based--in project-based consulting fees, and excludes $800,000 to offset the non-cash benefit from certain non-recurring European business tax reimbursement recorded during the quarter. This compares to an adjusted EBITDA loss of $3.6 million in Q2, which includes $2.5 million in cash severance charges.

Adjusted EBITDA, excluding the consulting fees, was a loss of $500,000 in Q3 2006. This compares to adjusted EBITDA loss of $1.1 million in Q2, which excludes $2.5 million in cash severance charges.

Gross margins were 47% in Q3, down from 48% in Q2. This gross margin decrease cost us about $700,000 in incremental EBITDA. The margin compression was primarily due to a [sequential] cost of sales increase in our U.S. media business from 56% in Q2 to 58% of net revenues in Q3. The cost of sales increase was related to our investment in category-based traffic sources for our beta Precision Network initiative. We credit this second course-correcting step for the upside to our revenue expectations over Q3.

We will continue to take a balanced report--approach towards investments in category-based traffic. In the near term, our investments could impact gross margins. But over the long term, we believe our investment will result in operating margin improvements.

In connection with the Company's longer term goal to stabilize cash and return to positive operating margins, the Company has identified additional sources of savings and expects to further reduce its cost structure in coming quarters. We believe we have meaningful leverage on the cost side, and through another course-correcting step, we expect to further reduce our current annualized cash operating expenses over the first half of 2007.

As I've indicated, our third quarter came in above our initial forecast, due primarily to an early lift from the beta roll-out of our Precision Network initiatives. Our Precision Network program consists of new processes and proprietary optimization technology that enables more precise matching of advertiser and traffic characteristics along specific categories. This improved alignment essentially introduces a new layer of relevancy in addition to our matching algorithms, and enables more targeted advertising, which we believe will help our advertisers to maximize their conversion rates.

It's currently estimated that the Internet advertising accounts for 5% of all advertising spend, while consumers are now spending approximately 20% of their available media time online. We know that this gap must shrink as ad dollars follow eyeballs. We believe our advertisers have almost an unlimited budget for quality traffic. We need optimized inventory to show their ads against, and adding high quality category based traffic has been central to the early results of our Precision Network program.

Although we are encouraged by the early success of our beta Precision Network initiative, we want to underscore the initiative is yet to translate into a broader network lift, and we are just beginning to transition the program from beta to production. It's too early to understand the broader long term impact on volume pricing or its effect on advertiser conversion ratios or their return on investments.

However, an example of our early success with the Precision Network initiatives includes the ring tone category. In this category, average RPC increased from $0.11 in the second quarter to over $0.30 by the end of September, close to a 3x improvement in RPC.

Although we believe precise matching of advertiser and traffic characteristics along specific categories is an important step to driving more value for our current network of advertisers and traffic partners, we remain unsatisfied with our overall revenue stability. Our advertisers depend on our network of third party providers to supply the majority of their click-through traffic. If a traffic partner experiences a slow quarter, loses affiliates, or switches feed providers, our advertisers have less inventory to buy and we are subject to the negative consequences.

To address revenue consistency and lessen our reliance on third party sources of traffic, we expect to continue our mix shift into primary traffic, and we plan to maintain this course over 2007. Our MIVA Direct consumer-focused business illustrates our ongoing mix shift. In the third quarter, MIVA Direct represented 22% of total revenues, compared with only 12% in the prior year, and revenue year-over-year increased by 74%. Direct ended Q3 with approximately 7 million active users worldwide.

On top of the core MIVA Direct business, which has performed extremely well for us, we are broadening our primary traffic reach through MIVA-owned consumer destination sites. We have a growing portfolio of sites, including an Alexa Top 100 Ranked Site. An example of one site in this portfolio includes Screensavers.com, a website for free, safe, and easy to download screensavers and desktop wallpaper. In addition to generating pay-per-click ad revenue with sites like Screensavers, we monetize traffic through CPM banner ads and CBA lead generation for mobile content.

We plan to continue deploying MIVA-owned consumer destination sites inside the same categories we constructed for our Precision Network program to provide advertisers with narrow and deep high quality traffic. We believe this transparent MIVA-owned network will have the capability to support new forms of monetization, in addition to pay-per-click, such as video and other rich media CPM and CBA.

Over time, we believe this transition towards MIVA-owned proprietary traffic will lead to improved growth in our operating margins as we begin to eliminate the revenue share or traffic acquisition costs associated with current third party revenue. Our Q3 average TAC represented 60% of every net click-through revenue dollar from our MIVA Media business, and does not include Direct. You can see why we'd like to move towards MIVA-owned primary traffic.

In conclusion, we believe the combination of another course-correcting step on the expense front over the first half of '07, more precise matching of advertiser and traffic characteristics along the specific categories, and importantly, our mix shift into MIVA-owned primary traffic, represents the right ingredients for completing our turnaround over the next year.

At this point, let me turn our call over to Will, our Chief Financial Officer.

Thank you, Peter. To begin with, let's review how we measure our financial performance. In addition to the standard GAAP measurements, we utilize certain profitability based metrics to evaluate our period-to-period and year-over-year performance. They are adjusted EBITDA and adjusted net income. Due to our adoption of Statement of Financial Accounting Standards Number 123R, effective January 1, 2006, we have modified our definition of adjusted EBITDA and adjusted net income to exclude non-cash stock compensation expense incurred as a result of our adoption of the standard.

We define adjusted EBITDA as EBITDA earnings before interest, income, taxes, depreciation and amortization, plus non-cash stock compensation expense, and plus or minus certain identified revenues or expenses that are not expected to recur or be representative of future ongoing operation of the business.

We define adjusted net income or loss as net income or loss, plus amortization, plus non-cash stock compensation expense, and plus or minus certain identified revenues or expenses that are not expected to recur or be representative of future ongoing operations of the business, in each case, including the tax effects, if any, of the adjustment. We believe the use of these measures does not lessen the importance of GAAP measures.

Now returning to our results. In Q3 2006, we've achieved revenues of $43.3 million, compared to $41.4 million in Q2 2006, representing a 4% sequential increase. On a year-over-year basis, revenue was flat, after normalizing Q3 2005 for $1.5 million in non-recurring revenue, due to the resolution of disputes with certain European distribution partners. We recorded 310 million total paid clicks in Q3 2006, compared to 256 million in Q2 2006, an increase of 21% sequentially.

In the U.S. Media Network, excluding private label and B-to-B, paid click-throughs were up 41% sequentially. As a result of the click volume increase, U.S. Media click revenue was up approximately $3.1 million sequentially. In the EU Media network, paid click-throughs were up 6% sequentially from Q2 2006. However, EU Media click revenue was down $1.5 million sequentially.

Overall, the U.S., which includes the Media Network, Private Label, B&B, MIVA Small Business and MIVA Direct, recorded $27.1 million in Q3 2006, or 63% of total revenue, while the EU recorded $16.2 million, or 37% of total revenue.

In the aggregate, B&B, MIVA Small Business, and MIVA Direct recorded revenue of approximately $12.9 million in Q3 2006, up approximately 2% over the $12.7 million recorded in Q2 2006. This compares to approximately $7.8 million recorded in Q3 2005. We recorded a GAAP net loss of $4.6 million, or $0.15 per diluted share, in Q3 2006. This compares to a GAAP net loss of $73 million, or $2.29 per diluted share in Q2 2006, which includes a $63.7 million non-cash impairment charge. We recorded an adjusted net loss of $0.09 per diluted share in Q3 2006, compared to an adjusted net loss of $0.27 per diluted share in Q2 2006.

Operating expenses, excluding the non-cash stock compensation charge of $1.1 million, were $23.5 million in Q3 2006. Operating expenses include $700,000 in project-based consulting fees, and $800,000 of non-cash benefit from certain non-recurring European business tax reimbursements recorded during the quarter. The majority of the $700,000 in consulting fees are non-recurring.

Operating expenses, excluding the consulting fees and the European tax reimbursement, were $23.6 million, or $1.2 million less than the Q2 2006 operating expenses of $24.8 million. The $23.6 million figure excludes the non-cash impairment charge of $63.7 million, the non-cash stock compensation charge of $3.3 million, and $2.5 million in cash severance charges related to our global restructuring and integrated--integration plan.

Adjusted EBITDA was a loss of $1.2 million in Q3 2006, which includes $700,000 in projected-based consulting fees, and excludes $800,000 to offset the non-cash benefit from certain non-recurring European business tax reimbursements recorded during the quarter. This compares to an adjusted EBITDA loss of $3.6 million in Q2 2006, which includes $2.5 million in severance charges.

Adjusted EBITDA, excluding the consulting fee, was a loss of $500,000 in Q3 2006. This compares to an adjusted EBITDA loss of $1.1 million in Q2 2006, which excludes $2.5 million in severance charges.

Amortization expense in Q3 2006 was $1.5 million, compared to $2.3 million for Q2 2006. Amortization expenses included $600,000 for acquired intangible assets and $900,000 for capitalized software and purchased software.

The Company finalized the estimated non-cash impairment charge taken in Q2 2006 and did not record any subsequent increase or decrease to the $63.7 million estimated charge over Q3. After recording the impairment charge, MIVA Media Europe's other intangible assets were eliminated with the balance of good will being approximately $14 million.

Now turning to our balance sheet review, our cash, cash equivalents, and short-term investments at September 30, 2006 totaled $32.7 million, a decrease of $4.2 million from June 30, 2006. In addition to the cash impact from operating losses, significant transactions affecting cash during the quarter were capital expenditures of $2.4 million, share repurchases of $600,000, and severance payments of $300,000. As of September 30, 2006, we had an active base of 401 full-time employees, down from 483 at December 31, 2005.

Regarding our outlook for the Company, in connection with our longer term goal to stabilize cash and return to positive operating margins, we have identified additional sources of savings and we expect to further reduce our annualized cash operating expenses over the first half of 2007.

To address revenue consistency and lessen our reliance on third party sources of traffic, we expect to continue our mix shift into primary traffic. In Q3 2006, MIVA Direct, our consumer-focused business, represented 22% of total. For the three months ended December 31, 2006, we expect cash and cash equivalents to remain relatively neutral with the $32.7 million recorded as of September 30, 2006 before giving to effect to the $1 million in cash severance payments to certain former executives.

We are forecasting fourth quarter revenue and adjusted EBITDA marginally below our third quarter results because of our eliminated--limited operating history with the Precision Network and our ongoing transition into primary traffic.

Now with all that being said, I am enthusiastic about our early progress with the turnaround, as a result of the Precision Network and MIVA Direct. There may be some hiccups in the short term, and there is learning with new people and revised products and systems. This is to be expected in this stage of a turnaround, and thus, we are not ready to forecast continued quarter-over-quarter growth. And I want to be clear - this does not dampen any of my enthusiasm for the longer term.

And with that, I'll turn it back over to Peter.

Thanks, Will. So we believe we've made progress on our turnaround and we believe our past, and importantly, our planned course-correcting steps will lead us to achieve our long term goal for stabilizing cash and reverse--returning to positive operating margins. Thanks again for joining our Q3 '06 conference call. We look forward to updating you in the coming months and quarters.

And I'll now turn the call over to the operator for questions.

Certainly. (Operator Instructions.) And we'll take our first question from Eric Martinuzzi with Craig Hallum.

Good afternoon, gentlemen. I'm curious about the revenue. I understand you want to have more owned traffic. But I would have thought seasonally Q4 would have been up from Q3. Is it that you don't want to take on sort of revenue that wouldn't result in profits? Or is it that you're just that concerned about the legacy network effort?

Hi, Eric. This is Peter. I think there's a couple of reasons and one of them isn't one that you had mentioned. So the issue that we face is that when we look at historic December, especially for the Company, and specifically, historic December is led by Europe. We find that because we don't have a big eCommerce business, a lot of our advertisers tend to be service-based. That unlike some of our competitors, who do have a larger eCommerce business, and revenue tends to mount until Christmas and then fall off, our business historically tends to fall off around mid-December, and doesn't pick up again until January.

Again, I believe from what we see the only reason for that is that we're heavily service-based with our advertiser group and not heavily eCommerced and consequentially shopping-based with our advertiser group. So our Q4 seemingly compares differently than some of our competitors do. That's point one.

The second piece is that we're having success, as you know, in our precision network. It's brand new to us. The success has been relatively dramatic, as you saw in Q3, and we want to be certain about what we're forecasting into it. So we haven't forecasted any growth into the Precision Network simply because we don't have any history on it. The consequence of that, since we're not giving specific dollar guidance, was we sort of carefully chose to say, look, we think we'll be marginally below Q4 and we'll see what happens.

Well, how about just geographically, can you give any commentary? Are we troughing here with Europe at $16.2 million? Do we--can we at least expect flat or up on Europe, or is it too soon to say there?

I think it's really too soon to say there. Let me tell you where I can--where I know that we're going to continue to have growth and that's inside of our MIVA Direct group. That particular group we're very bullish about and very confident about. So, that's for sure.

But that's just a North American footprint?

Actually, for now, a North American footprint. But of the 7 million active users in MIVA Direct--and Peter can get to you with the exact number. I don't have it in front of me. But I think something like about 10% of them now, Eric, are pan-European. So the consequence of that would be about 10% of that revenue is European derived, and about 90% is U.S. derived. And further, we're readying a major push towards expansion in Europe with MIVA direct, so we're bullish about it in general, both from organic growth here in the states and the new growth as part of our initiative to take it and expand it into Europe.

Now, on the side that we want to be careful about, MIVA Media EU. We've got five countries there. We watch it very closely. We're anticipating that Q4 will be around flat, as we discussed, and we'll see--we're holding our breath really for what happens around mid-December. If we're surprised, then great, but for now, we're anticipated a mid-December fall off. We've recently looked at history back several years, clear back into the [eSpotting] days, and it's pretty clear that that group falls off sometime around the second week of December.

On the more bullish side, and yet we want to be careful, is MIVA Media U.S., where most of our initiative in the precision marketing has come out. As you know, the growth that we had that we enjoyed in Q3 came from mostly our initiative with the Precision Network in MIVA U.S. And we just want to be very careful that we don't over promise on the revenues from there until we've got some sort of history with it and we can see what happens with it. So I guess kind of breaking it all up, that's about it.

And then, of course, MIVA Small Business is really a non-starter as it relates to revenue. It's flat to slightly up and wouldn't make a hill of beans one way or the other.

Got it. Thank you.

Sure. Thank you, Eric.

We'll take our next question from Colin Gillis with Canaccord.

Yes. Good afternoon, everyone.

Hi, Colin.

Hey, Peter, could you just talk a little bit about within MIVA Direct, any other particular properties you're seeing exceptional traction with, whether it's a Screensavers.com or a SuperHoroscopes.com, and what we should think about in terms of expansion of that going forward?

Yes. So, Colin, interestingly, it almost feels like a softball because every property inside of MIVA Direct is just on fire for us right now. We're having--you saw the year-over-year numbers where they--well, we just talked about them--74, 75% year-over-year growth. Across the board, we seem to be enjoying that growth. We've got a site--it's just an interesting one. It's not driving substantial revenue, but one that I would point you to that we're excited about. We've got a site that has only been up three or four months. In that three or four months, this site is an Alexa Top something--I think Top 50 - I could be wrong about this - Joke and Humor site. The site is called JokeBanana. You're welcome to go take a look at it.

We also have on a Top 100 Alexa site that has growth going like crazy in it. Screensavers - there seems to be no end to it. So one of the places that we feel very bullish about are almost all properties inside of MIVA Direct. Now, more specifically, as it relates to the future. We don't have much experience in Europe with MIVA Direct. But, as I just mentioned on the question to Eric, we do have now whatever it is--8 or 10% of our revenue of MIVA Direct is European-based subscribers--or European-based users--not subscribers now. And if we--our intention is to try to expand all of the same properties with the appropriate languages over into our European operations.

And then, we would anticipate later--no forecast on this. But we would anticipate later that--take the user base for Europe, as opposed to the user base in the U.S. Usually that's around three-fifths of the U.S. And at some point, we would hope that--to grow that business up to three-fifths of our total would be--would come from Europe. So we would anticipate the growth would be even on this much larger business today, that the growth from MIVA Direct would be comparable or even greater than what it has been over the last year or so.

And Peter, if I could just slip one more in. In terms of the inline ads. What's the feedback you're getting back from publishers in terms of having more real estate available? And maybe I missed this, but do you plan to be using inline ads with MIVA Direct?

We do. And rather--if I could, since Seb is on the call with us from Europe, and Seb has been mounting the effort against our MIVA inline product--and we do have a lot of good things to say about it. If you don't mind, Colin, let me turn it over to him and I'll let you--I'll let him give you a little color on MIVA Inline.

Sure. Thanks, Peter. Yes, Colin, I mean, we're having--what's nice about our product compared to other products in the market place with the inline product is it allows us to add site search functionalities. And since we approached it as a search company into the inline product, if you're a publisher, when you actually hover over the keyword on a particular page, it will also show you links related to other pages within that publisher's website, so increasing not only the real estate for them to place ads, but also to actually navigate and actually circulate traffic within their websites. So it's proving very popular.

I think we'll probably sort of give you sort of more color in terms of number maybe next quarter or the quarter after. Obviously, it's a new product. We've only been inline with for a month and a half. But so far, so good.

So is there any patent protection that MIVA is going to be able to pursue on this technology?

No, not on the actual inline. Not the actual serving of ads within that. But obviously, other applications that bear fruit from that. Obviously, potentially, there are ideas surrounding that, of course.

Yes. Well, it's very creative. Thank you.

No problem.

We'll take our next question from Youseff Squali with Jefferies and Company.

Thanks. This is Peggy Rydell for Youseff. Can you expand a little bit on RPC trends in Europe? Obviously, it was down this quarter given the strong traffic--or CPC--or sorry, paid clicks that you reported. How do you think of that going forward?

Peggy, can you--it's Peter. And I want to answer it. But can you just form the question again? I want to be careful on RPC. Are you asking do we have a trend that we're estimating for RPC in Europe? Is that the question?

Yes. And also, if you can just comment on what drove it down this quarter.

Yes, good.

Peggy, this is Will. Our RPC--and I hate to use the total RPC for the Company because on a macro basis it doesn't tell you a whole lot. The mix in Europe, for example, really depends by country. And the country mix varies from quarter-to-quarter. The RPC in Italy is much less than the RPC in Europe. Overall, over a longer-term trend in Europe, the revenue share from the U.K. has come down. And that on--there's negative growth in the E--in the U.K. But on the other hand, the growth in Germany and France has been decent.

So you really need to understand--and we're not going to get into putting out revenue by country. But a lot of it is driven by the mix of the different countries in Europe. And the U.S., it's really dependent on what comes through the system for search feed, all versus MIVA Media. And so, we want to start looking at this internally. And we're changing the reporting internally to be much more focused on vertical. And then, breaking out the verticals from the search feed type of volume versus the traditional MIVA Media.

Peggy, this is Peter. To add a little more color to that, there's been in MIVA Media EU a precipitous drop since Q4 '04 and possibly Q3, but I have actually recently looked at data from Q4 '04. RPC has been down, oh, I'm guessing in the 50% range over that period. I can tell you that while we're struggling with RPC this quarter, we do not expend--expect that RPC over the next four or five quarters would be down another 50%. So I'm not ready yet to put a stake in Europe, as in we've hit the bottom. But I think we're either a lot closer to the bottom or perhaps on our way out of that trough now, instead of continuing this five-quarter trend that I just talked about.

Great, thanks. And just another--.

--Another piece to that is you'll notice in our release we're trying to give you guys a little bit more color now in terms of volumes and revenues by piece of our business. And while it's not safe to take just volumes and divide it by revenues and come up with an RPC because there's lots of other information in there, directionally, we'll be able to follow this quarter-over-quarter and get sort of a sense of how that's going. So again, I want to be clear. Not ready--this is Peter. I'm not ready yet to put a stake that we've met the bottom in Europe, that we are nearly certain that we aren't going to continue that precipitous drop that we've had in the past, and possibly, either there or a quarter or two away from stabilizing RPCs there.

Thanks. Also just maybe you can expand a little bit on your guidance for the bottom line. Can you specifically point to where the additional sources of cash savings are coming from? Is it more in G&A or in sales and marketing, or in the cost of revenue line?

I just think it's fair to say that the overall infrastructure of the Company, there's still room--having gone through and looked at that, there's still significant room to improve. And for those of you--and I'm actually real upbeat on this call and I want to make that clear. For those of you that have followed us and followed Peter and I through here, and for me it's a little bit longer than Peter, we started with about 553 people. We're now somewhere at, below, or slightly above 400, if you were going to look at this in the beginning of November.

And this for us is one of the better revenue quarters since I've been here, if not the best. And we're also processing a lot more transactions to get to that revenue and our cost structure is coming down. Now, I think there's still some room to be more efficient. I don't want to be real particular because it obviously impacts certain people in certain places. But it's certainly not contacting our customer, understanding our customer, and interacting with our customer. We're going to get better and better there.

And the information systems are getting to the point that I know when I got here this information was very difficult, if not impossible, to find. To talk about how we wanted to look at revenue per click a little bit here and understanding it by vertical and understanding it by groups of advertiser. And we're just about--we finished the SAP conversion in Europe and all the data migration this last quarter.

We just finished MIVA Small Business and have migrated off of Quick Books. And in January we'll close on SAP for the rest of the Company and have a common chart of accounts. So these things are allowing us to have more efficiencies. I said back a year ago it would. And I believe over the next six months we can start realizing the fruit of that and better understand and communicate with the customer.

Next from Gilder Gagnon, we'll hear from Michael McCormick.

Good afternoon. I was wondering if you could just clarify the guidance that you had given for the adjusted EBITDA. Should we be including the $700,000 of non-recurring consulting cost in this number? So are you guiding that you'll be kind of a $500,000 loss in the fourth quarter, or are you guiding you'll be $1.3 million kind of on an adjusted basis?

About 1.2 flat.

About 1.2?

Yes.

Can you then clarify for me--because you just spent some time talking about additional costs that might be coming out of the network. And additional--and if these costs are nonrecurring, why should it be that you have a flattish or, as I see it, a slight increase in adjusted EBITDA loss?

The costs will not be coming out in Q4. They'll be coming out in Q1 and Q2.

Okay.

And I suspect we'll--beside the obvious cash--the cash out that we've talked about, in regards to the payments of former executives, we may have some additional severance. And we're also continuing to invest in primary traffic, which costs us money and hits the expense line. The group of costs I am talking about in regards to reducing the infrastructure will be things that will be done in Q1 and Q2. And by the end of the year, I believe we'll be at a much better normalized ongoing expense rate and hopefully profit rate.

Well, it's my assumption that you want to drive your primary traffic as fast as possible. So what is the return on investment on that? If that's going to be a primary factor of increasing your loss while better business--can you walk me through that?

We're not calculating this on an individual ROI basis. It's very clear on an intuitive longer term basis it's what the Company needs to do.

So could you walk us through what the incremental investment would be for primary traffic growth?

We're not going to get into that at the moment. Peter has discussed some of the efforts that we are undertaking. And I'd be more than glad to sit down with you when we come--if you're in New York when we come to New York and go through some of the things. But we're not going to go through it on an ROI case-by-case basis.

Michael, we would be happy though when we're--this is Peter--when we're together with you. One of the reasons that we don't talk to specifics about how the Precision Network and proprietary--primary and proprietary traffic for us is working is we don't want to get picked off by our competitors. Separately though, we're happy to walk you through the examples of the investments that have been made into precision traffic and the verticals over some of the last quarter and how that parlays into future quarters.

And I will tell you on a vertical by vertical basis, we've had--I don't think though--please correct me, you guys around the table, if I'm wrong. I don't think we've had any verticals yet that we haven't met. In other words, after getting the verticals lined up, I don't think we've got any verticals yet where we haven't come back at least to ROI neutral from a company investment standpoint. And some of the verticals we've been able to turn around and get back to parity within several weeks - not all the verticals, Michael, but some. And the investment in total, as you can see in Q3, was in the $700,000 range.

So we're happy to do that on a one-by-one basis. The reason we don't call it out is because on a vertical by vertical basis, we don't want our competitors to see what we're doing, know exactly what it is, and then try to play our game with some different type of traffic.

Okay.

Some of it, clearly, we're trying to understand what the drag effect is. If you look at just in the different pieces of the network, and understand how when we move something in one place it impacts something in the traffic elsewhere. And--or how does it impact our match rate up front?

Okay.

And so, we're getting there and we're getting better at understanding it here and we'll get better at explaining it. But it's still fairly early.

Could you do me a favor also and explain to me, just because of my lack of knowledge, why you need to wait until the first quarter or second quarter for these incremental costs to come out of the operating side?

Yes. Mostly--we'll both help answer that. This is Peter. The--what we did to--let me go back and give you a little background, then take you into Q1 and Q2. When I took over the Company in mid-April, almost immediately we went through and carved out $6 million worth of costs. Much of it was employer related on that cost reduction that Will told you with headcount going at its all-time high in the Company a little over a year ago - 561 - down to a current headcount of about 400.

As best I can explain it to you, Michael, in terms of simply reviewing and taking headcount adjustments and doing the reorganization the Company has done, I believe all it can do at this point. And now, between now and the end of the year, only has sort of like onesy-twosys that we can pick off and perhaps we get another $1 million or a little bit more than that out of the Company's cost structure between now and the end of the year.

You noticed that we talked about consulting expense. We've engaged with an outside consulting firm that works with us on a daily basis right now. And we're putting a project plan together that simply can't be done kind of--we can't drive the car and put the tires on it at the same time is what it boils down to. So we're going through an extensive project plan with our outside consulting group and plan to execute against that plan literally on the first day of the new year in '06.

Part of the reason that we haven't done--I'm sorry--in '06. Excuse me. Part of the reason that we haven't moved any quicker is because we've run into the holidays. And it's hard to execute something as big as we're thinking while you're going through the holidays and up until the second week of December we're as busy as we can be around here. So we want to make sure that we can bring all the revenue possible in with the current structure that we have and then all forms of reorganization that we would have for '07 wouldn't hit until we get into very early January. But I think you'll be surprised when you get to January how quickly we're going to move on our cost cutting maneuvers.

It's taken time--keep in mind, I said we'll be up on the common system to close in January. And if you consider the--a company this small having numerous charts of accounts, which we're down to I believe two, numerous types of ledger packages, and just not even having a common language to speak within the company in regards to what it is that we're doing. And so, part of this has clearly been waiting for an infrastructure to support to make these type of changes.

We'll take our next question from Peter Schleider with Peninsula Capital.

Yes. Hello. Congratulations on a great revenue quarter. That's like just to me it underscores the opportunity for the properties that we have. I guess that I'll go back to the previous caller's questions in the sense that if you--is it right to do the math on the MIVA Direct business and say that it's around a 25% operating margin business? If all the company were at MIVA Direct kind of rates we'd be somewhere around that level? Or is it much lower than that?

I'm trying to understand your math a little bit, Peter. Help me.

Well, 91% gross on 9.4, and then take the 6.1 against that. Is there other additional costs I guess to MIVA Direct than the 6.1 that you outline in the press release?

There is. I mean, you have the gross margin then you have media expenses. You also have people and you have a building. Now we think we can do better with--also with ultimately, if you look at the operating income of MIVA Direct, and growth is great. And we ought to be able to get better at getting more cash and therefore more operating income out of it.

Hey, Peter. This is Peter. Thanks for the question. The other thing I would add to that is without getting to the very specifics of the number and what the gross operating margins could be, you're on the right track with the question, which is in the case of MIVA Direct, we rely on our own sources of traffic and don't have third party traffic providers to pay. And the consequence of that is, from whatever our net revenue is, we don't have to share 50, 60, 70% of it off with the next guy, and we're--importantly, we're in control.

So we've got a business that we're in control of, we can grow like crazy, that ultimately has great margins with it. But all we have to do is have sticky enough products that consumers want to come back to and use and it just generally is a better model. If it were a standalone business model, it's generally a better buy-low-sell-high business model than the other components of our business. And importantly, that's exactly the types of products and services that we're trying to provide to our clients in the future as we introduce new proprietary destination sites that our advertiser base could go to.

So clearly, it's right to say that we could have better operating margins after the transition was made. And yet, we've got--we're trying to chew gum and tap our stomach at the same time. The chew gum part is we're trying to be certain that every component of MIVA Direct is able to continue to grow at this fabulous growth rate that's way above the market rates for growth. We want to be able to keep--continue to accelerate that. At the very moment we're trying to do that, we're trying to take the bigger piece of the business - the other 75% - and morph it from third party to proprietary traffic. In doing so, we think we can drive RPCs up, and at the same time, get rid of the cost of the TAC.

Now the trick is, the 60% TAC that we currently pay the third party providers, if you thought of that as our investment dollars, can we invest that 60% into proprietary traffic and sites at a rate where the investment goes from 60 to 59 to 58? We believe we can. As Michael talked, we're happy to come out and show you guys individually how we'll play that game. And we're bullish about our ability to do that, just don't have any history yet. But whether your number for gross operating margins is right or not, we'll have to have--we'll go back and work with the guys and find it. But I assure you they can be better in the world we want to move into and more predictable than in the world that we're in today.

So--and again, as we dig up exactly what that new world will look like, we'll be happy to share it with you guys.

Where would you all like to see the business in a couple of years in terms of balance between MIVA Direct and the traditional business?

Yes. What I would say is MIVA Direct we want to continue to grow, but that is a division that's slightly less important than I'd like to see in a couple of years this transition from--I know MIVA Direct is only 22%. But bear with me for a second. Instead of one-quarter our own primary traffic, and three-quarters third party drive traffic, I would hope that before several years from now, we could have made the conversion to three-quarters proprietary traffic and the ensuing margins that run with that, and one-quarter of the remaining business.

Having said that, we don't intend to lose the business that we've got today from a base. So you can get an idea of how big we would expect we could grow the Company if only one-quarter of our revenue in several years from now, Peter, was derived off of the same base today that we have about $140 million business on.

That's great.

And Peter, I would tell you that the first thing I'll be doing tomorrow is to start focusing on--we've already started. But the CFO hasn't started--focusing on the budget for next year. And I would suspect when I look out after what obviously are going to be some transitional type of costs, and you look at the normalized profit going out of the year--and I'm saying profit, which is what I expect and not a loss--on a run rate going out of the year, it's more likely to be two digits than one digit as a percent.

Now we obviously also have to look at our tax loss carry forward, which is going to be very advantageous to the Company. And so, we have a lot to do when we get out of here. And you know I've been--I've personally have been a little focused on a health problem that's fixed. But this is the mission that we have and we have to meet with our Board in mid-December and take them through it.

And all of the--that sounds great. Are all of the operating cost savings reflected in the adjusted EBITDA number? Are we still kind of trailing through some costs that are still included in that number? Costs that we've cut or have been in the process of cutting.

Peter, we have--your line is breaking up and we think you're talking something about costs, but I can't hear what you're saying.

We--for example, we have--I think it's fair to say we have two less Vice Presidents this month in the Company than we had last month.

The cost reductions.

Pardon?

There's still a continuation of cost reductions from what we've seen out of--just reflected in the quarter just reported.

Absolutely.

Yes. Okay.

Again, Peter, to dimensionalize that a little bit, the $6 million worth of costs that we talked about right after I took over in mid-April is behind us. Now, Will can tell you how that reflects to being in the P&L. I believe that there's another--and we've continued with that--there's another around $1 million to $2 million that we're trying to get out on a onesy-twosy basis, as I talked about, by the end of the year, which is coming on us quick.

And then, the third component is a separate subject which is this whole consulting group that I've got in here helping us to try to completely reconfigure the Company after January into a dramatically lower cost structure than we have today. So don't think that we're resting on our laurels with only the $6 million behind us. We think there's more there. We'll continue to take it out, but it will be not to the tune of the $6 million. It will be Q1 and Q2 and beyond next year when we can get this bigger chunk of costs out of the Company.

If you look at the capital that's been spent, and it's obvious we talked a little bit about it. And some of that capital is going to come to a stop in regards to spending. We've been spending money on the SAP system. We moved two large data centers. We got out of a very bad situation in Paris and moved to Amsterdam, all just recently, where we had room to improve our redundancy capability. And also, it's a much more favorable tax area as we look at all turning back profitable.

We had a very large move from New York into a non-SAS-70-compliant data center down to Dulles. And within the last I think it was three months, we opened a facility in San Diego. And there were things that we needed to do to get the network to where we think we needed to get it for longer term. And we have one more data center move ahead of us and we're done. And so, again, these are all things that we needed to do to get prepared to go forward. But even in the CapEx area, I'm very hopeful that you won't be seeing things of the same magnitude. In some cases they were out of pocket expenses.

We'll take our next question from [John Sixthorne] with [Dialectic Capital].

Yes. Hi, guys. Nice job on the quarter. A couple of questions. You guided cash to flat sequentially, which was better than I had expected. Could you maybe talk about how we should expect, or where we should expect cash to bottom going forward? Somewhat related to your last answer I guess.

John, there's no balance sheet or income statement cash--or account I like better than cash. Cash is my friend. I think, and if I look through it at the uses in this quarter, I was very optimistic when you take out some of the things like the CapEx--that we did a pretty good job. But I still would like to see it go flat from quarter-to-quarter historically.

Going forward, I hope, other than if we start looking at things that potentially we could end up acquiring, but at the normal company for who we are today, that it's pretty well flattened out except for severance expenses. I think we're done with the heavy CapEx on the equipment side. There's some things I'm even looking at going forward whether we pay as we drink. And--because MIVA owns about if not all of its capital that it uses in the network. But I'm hopeful other than the severance or buying things that this is about where we stay.

So I can think of you with all the caveats in place as kind of a cash flow break even company at this point and hopefully growing and becoming cash flow profitable going forward?

Yes. And Peter, who was on the phone, he went through with me a similar experience before. And the Company got to be known as the strongest bank in Texas. Cash is important to the Company and we're going to focus on it. And Peter and I are very optimistic that there's more cost coming. And again, there'll be some expenses in regards to that transition. But I want to look at big green on the bottom line by the end of next year.

Beautiful. Last question is, you've talked about matching your clicks better in getting high cost traffic matched with high cost advertisers and vice versa. How should we measure your success in that effort?

Well, so--part of the reason that we've tried to give you guys a little more visibility into our separate divisions of the Company that you saw in the press release was so that you will be able to judge from a combination of our volumes and our revenues how we're doing on if not RPC, at least on our gross margins, which would just be the cost of the traffic.

So rather than--I know as I've been out on the street talking to a lot of the--instead of having everybody guessing at what we're doing all the time, we're clearly trying to be more--give you guys more disclosure into the businesses. And I think that we'll give you enough information you'll actually be able to peg us on a quarter-by-quarter basis to see if we're making progress or not.

A big piece of that was to break MIVA Direct out of it, which we've never done in the past. So here, there's fully more disclosure there by simply taking MIVA Direct and their larger gross margins out, allowing you guys to look at the individual components of our business. And we believe as we get more primary and proprietary traffic inside of the other pieces of our business that you'll see the gross margins grow with that, and it will be evident on a quarter-by-quarter basis as we disclose.

Secondly, once we--there's a--we're trying to get some of the secret sauce inside of our vertical initiatives patented. As we think we've got protection around some of that secret sauce, we could even be more--make more visible to you what it is that we're doing and how we're doing it. And I'd be happy then to let you guys--after we thought we had it protected--be very [indiscernible] focused on how we're doing on a category basis. We're just not there yet.

Super. Thanks a lot, guys.

As we've been talking though, I'm doing everything I can to get you more visibility not less.

Excellent. Well, keep it up.

Thank you.

(Operator Instructions.) Next we'll hear from [James Bosch] with Dialectic Capital.

Hey, guys. Congratulations on a strong quarter and solid guidance. I just wanted to follow-up from John's question. And then, do you guys internally--are you targeting a certain percentage of revenues from MIVA Direct, or is it really kind on a case-by-case ROI basis? I would say out over the next 12 months.

So I'll answer the question as best I know because it's how I'm thinking of the business inside of MIVA Direct. For the most part, we're looking at MIVA Direct taking the base U.S. business and anticipating sort of a trend--although it's a bigger company than it--only 2.5 years ago we bought a company that was doing $6 or $8 million, and is now on a run rate to do 6 to whatever that number is--8, 7 or 8 times that, right? So we have to normalize a little bit for the Company's become larger and how much of a user base can we get. But for the most part, we're anticipating that its growth in the states will continue. That's number one.

On top of that, we're anticipating that soon, I'm guessing in the February or March timeframe, we will have ramped up to the point that we can really expand MIVA Direct, not just opportunistically expand, but really on focus on expanding MIVA Direct into Europe. In doing so, we don't have the numbers yet for that, James, but we will. And we anticipate that over some period of time - I guess it probably will be an 18-month timeframe - that we'd be able to ramp up users in Europe comparable to users in the states because our learning curve is behind us and we'll just go to play the same way there.

So what I--the way I think about MIVA Direct is continued growth similar to what we've got in the states, exaggerated growth in Europe, and exaggerated growth in Europe that wouldn't start until again February or March of next year. And with that exaggerated in MIVA Direct will come for a moment incremental spending.

Further on MIVA Direct, so that you--so that you're clear about it. With our third party traffic providers and the traditional MIVA Media business, if I cut a 60% deal for the Company today and we sign that third party traffic provider up, tomorrow we'll spend the 60% on a daily basis. And tomorrow night, we'll have the revenue from the customer on a 60% basis. So it is nearly a real-time activity with third party providers.

That's slightly different than the MIVA Direct business. When we're out there trying to get our own proprietary sites up, getting consumers back to those proprietary sites, marking them as their favorites, or putting software on their site that allows us advertise to them, we clearly have the formula down for how to do that in an efficient fashion. But the lead lag between the advertising spend and the revenue received is in the three, four, five-month range. So $1 out today doesn't return that $1 plus until three, four, five months from now.

Now, we've got the formula down, we know how to do it without disrupting all of our ratios as we go. But again, it's slightly different than if we find a partner on MIVA Direct where we could announce it today and tomorrow the revenue's coming in. In MIVA Direct, we've got that three, four, five-month lag. But we clearly think you'll see exaggerated growth off of it.

A whole separate story is primary sites that we're trying to feed our MIVA Network with and we think we'll get growth off of that, too. And again, that's a next year initiative. And it's amongst the things that we're beginning to put money in now. And it's amongst the components that you saw that additional $700,000 this quarter that went into driving those revenues.

Importantly, unlike the past, however, when we're driving revenues with the $700,000 into our own investments now, it's not simply money gone. Part of it is money gone because we've used it up. Part of it is an investment where we can continue to reap those benefits for months and quarters in years to come.

Got it. Now--.

--And we'll give you guys more visibility into that as we launch more products and services.

I'm kind of excited--I mean, we just hired our first really sharp finance person for MIVA Direct to sit up there with the people in New York. She's already having a pretty positive impact in some of the analysis that we're doing for there. And the Company grew very fast while we were going through a lot of changes down there--or down here in Florida. And just getting her in there has been very good.

We have--and we look at the ROI type of situation for expanding in Europe in very good detail. But it would be interesting if you get a young person up there, down in the Village area, the MIVA Direct building, and they want to put up a JokeBanana website. I can tell you with a couple of days of programming we didn't look at the ROI on something like that.

Okay.

It's just a neat little idea and you go put a couple days of programming into it.

Sounds good. I appreciate your time.

And at this time, we have no further questions coming in. I'll hand the conference back to Mr. Weinberg for closing comments.

Thanks, Jimmy. This conference contained certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Words or expressions, such as plan, intend, believe, or expect, or variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are based on Management's current expectations and are subject to uncertainty and changes in circumstances. Actual results may vary materially from the expectations contained in the forward-looking statements. Key risks are described in MIVA's report filed with the U.S. Securities and Exchange Commission, including the Form 10-K for fiscal 2005 and its most recently filed quarterly report on Form 10-Q.

In addition, past performance cannot be relied upon as a guide to future performance. The following factors, among others, could cause actual results to differ materially from those described in the forward-looking statements. Potential that the information and estimates used to predict anticipated revenues and expenses were not accurate, the risks associated with the fact that we have material weaknesses in our internal control over financial reporting that may prevent us from being able to accurately report our financial results or prevent fraud, the risk that we have in the past and may in the future incur goodwill impairment charges that materially adversely affect our earnings and our operating results, the risk that we have made significant investments in new initiatives that may not meet our expectations in terms of the viability, success, or profitability of such initiatives, potential that demand for our services will decrease, the risk that we will not be able to continue to enter into new online marketing relationships to drive qualified traffic to our advertisers, the risk that our distribution partners will use unacceptable means to obtain users, the risk that one of our major ad feed providers accounts for a significant portion of our revenue and the loss of that advertiser feed provider could reduce our revenue, risks associated with our ability to compete with competitors and increased competition for distribution partners, political and global economic risks attendant to our business, risks associated with legal and cultural pressures on certain of our advertisers, service and/or product offerings, other economic business and competitive factors generally affecting our business, the risk that operation of certain of our technology infringes upon intellectual property rights held by others, our reliance on distribution partners for revenue generating traffic, risks associated with our expanding international presence, difficulties executing integration strategies or achieving plans -- [technical difficulty - audio ends abruptly].