Inuvo Inc (INUV) 2009 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Inuvo third quarter earnings call. (Operator Instructions). At this time, it is my pleasure to turn the floor over to your host, Melissa Whit. Ma'am, the floor is yours.

Thank you, operator. Earlier Inuvo released it's financial results for the three months ended September 30, 2009. If you have not received the press release, it is available on the Investor Relations section of the Inuvo website at www.inuvo.com. This call is being webcast, and a replay will be available on the Company's website for 45 days. Before we begin, we would like to remind you that today's remarks contain forward-looking statements within the meaning of Federal Securities Law. These statements do not guarantee future performance and, therefore, undue reliance should not be placed on them.

We refer all of you to the risk factors contained in the Inuvo Form 10-K filed earlier today, for a more detailed discussion of the factors that could cause actual results to differ materially from any forward-looking projections or statements. Inuvo assumes no obligation to provide any forward-looking projections. This conference call contains time sensitive information that is accurate only as of the date of the live broadcast, Monday, November 23rd, 2009. Inuvo undertakes no obligation to revise or update any statements to reflect events or circumstances after the date of this conference call.

For those of you who are new to our story, Inuvo is an online marketing services Company. Through technology, the Company facilitates transactions between advertisers who are looking for customers, and publishers who are looking to monetize their website traffic. Additionally, the Company owns and operates a number of specialty web sites that generate revenue through advertising, the sale of products and the sale of information. As measured by conversions for advertisers, we maintain one of the highest quality traffic exchanges in our market. Our Exchange includes thousands of advertisers and publishers, and incorporates analytic technology that prevents click fraud and allocates ads based on the highest return. The Company operates two business segments, the Exchange segment and the Direct segment. Participating in today's call from the Company our Chief Executive Officer, Richard Howe and Chief Financial Officer, Gail Babitt. And with that I'd like to turn the call over to our CFO. Gail?

Thank you, Melissa. Good afternoon, everyone, and thank you for joining us today to discuss the Company's third quarter 2009 financial results and go-forward plans. I will discuss the following items during the call. First, the proposed change of accounting principles. Second, the operating results for the third quarter of 2009. Third, the update on the warrant exercise. And fourth, the status of our banking relationship with Wachovia. Let me explain the delay in reporting our operating results. We requested that the SEC provide interpretive guidance on an accelerated basis, related to the cost of lead acquisition within the Direct segment of our business. Guidance from the SEC is pending, and although we have discussed our attempt to resolve this prior to our filing, we have not yet concluded on the matter at this time.

Over the last two quarters, management and Board have been examining the strategy of the Company's consumer marketing business. In Q3, we began to implement the strategy for marketing leads acquired in ways beyond the product sale to a consumer. As such, we believe that the lead acquisition costs result in an asset that is a future benefit, and therefore, the cost should be capitalized and amortized. We have provided examples of several companies that capitalize and amortize their lead spend, and we believe a similar approach is appropriate for this segment of our business.

The SEC is reviewing our position and discussing it internally. The SEC's role is to determine if the change in accounting is both acceptable and preferable. The Company believes the change is both acceptable and preferable, as financial statements based on this accounting will better reflect our operating results. The Company's auditors have written a preference letter to that effect. In this release we have elected to account for the lead acquisition costs as it had been done in the past, and expense the costs as incurred. If the SEC concludes that the change in accounting is appropriate, we will reflect a retroactive impact within the year-end financial statements, with comparative applications for the prior year in the Company's Form 10-K.

Our quarter-over-quarter revenue increased by $0.4 million or 8% in our Direct segment, and increased by $0.6 million or 10% in our Exchange segment. Total revenue was up $1.1 million, or 9% over the second quarter of 2009. Our revenue from continuing operations was $12.9 million for the three months ended September 30, 2009, compared to $17.5 million for the comparable period in 2008. The reduction in revenue from continuing operations was driven primarily by our Direct segment, which experienced a decrease of 29% going from $8.6 million in 2008, to $6.1 million in 2009.

For the three months ended September 30, 2009, our Exchange segment also experienced a decline in revenue from $8.9 million in 2008, to $6.7 million in 2009. The decrease in revenue from the comparable period in 2008 within the Direct segment, was the result of a decline in popular offers in a tough consumer economic climate, which is partially offset by an increase in the consumer marketing and data business resulting from the renewed investment during the third quarter. The Company decided to reintroduce these operations in February of 2009. And as a result began to invest in lead acquisition during the second quarter, with a significant increase during the third quarter leading into the holiday season. As a result, the consumer marketing and data business within the Direct segment experienced a 44% increase in revenue from the second quarter of 2009, to the third quarter of 2009, and a slight increase over 2008 levels.

The search business within our Exchange segment had been stimulating growth for eight consecutive quarters since December of 2006. As a result of the economic climate, advertisers had reduced their marketing spend, and growth halted during the second quarter of 2009. The decline started in March of 2009, when we experienced a 30% decline month-over-month, and it troughed in June of 2009. Total gross profit from continuing operations was $3.4 million for the three months ended September 30, 2009, compared to $6.3 million for the some comparable period in 2008, reflecting the reduction in net revenue, as well as gross margin rates from 36% to 26%. The Direct segment gross profit decreased from $3.5 million or 41% of net revenue in 2008, to $1.6 million or 26% of net revenue in 2009. The Exchange segment gross profit decreased from $2.8 million in 2008, to $1.8 million in 2009.

During the third quarter of 2009, the decline in Direct segment margin rates was the result of an increase in investment in the acquisition of leads. These acquisition costs are being expensed as incurred, as described in the change in accounting discussion, even though these cost applied to the building of a names database that will be monetized in the future. The Company estimates the benefit period for the names acquired will be approximately 12 months. The Company does not believe this accounting treatment properly matches revenues, and expenses and the benefit period associated with the lead spend, and as such, the Company will provide a non-GAAP reconciliation that more appropriately reflects the business.

Within our Exchange segment, we experienced margin deterioration with rates declining from 32% in 2008, to 27% in 2009. This margin rate decline is a result of competitive pressure within the publisher market. Our Company-wide other operating costs from continuing operations decreased by 13% to $5.8 million for the three months ended September 30, 2009, compared to $6.6 million for the comparable period in 2008. The drivers of the decrease are a reduction of selling, general and administrative costs, primarily within the Exchange segment, and a reduction in merchant processing fees within the Direct segment.

The net loss for the Company was $2 million or $0.03 per share for the three months ended September 30, 2009, compared to a net loss of $3.6 million or $0.05 per share for the comparable period in 2008. The adjusted EBITDA for the Company was $1.1 million for the three months ended September 30, 2009, compared to $1.6 million for the comparable period in 2008, and $3.1 million for the nine months ended September 30, 2009, compared to $3.5 million for the comparable period in 2008. The reduction in EBITDA reflects the negative impact of the economic influences on revenue and gross profit, which is partially offset by operational improvements in discontinued operations, and cost containment measures in both continuing and discontinued operations. The adjusted EBITDA margin was 9% for the three months ended September 30, 2009 and 2008.

During the third quarter of 2009, the Company temporarily repriced the warrants issued to investors in 2006, as part of the purchase and conversion of Series A preferred stock. The Company provided a modification to the warrant agreements that, one, reduced the exercise price for all the warrants ranging from $2.00 to $3.50 per share, to $0.27 per share, which was the market price during the reduction period. And two, removed the cashless exercise feature. During the reduction period, 2.3 million warrants were exercised for $0.6 million in cash. The Company has been in discussions with Wachovia in an effort to restructure the existing loan. During this time, Wachovia has deferred through December 31, 2009, any reductions in the Company's borrowing base, pending completion of this new credit facility. Rich will provide additional detail about Wachovia in his section. I would now like to turn the call over to Rich. Rich?

Thank you, Gail. And thanks everyone for joining us today. On today's call I will summarize activity between Q4 2008 and Q2 2009, and then highlight important accomplishments and technological advancements that were introduced within the third quarter. I will also bring you up to speed on our discussions with Wachovia. At the end of Q4 2008, we had a number of market and business challenges and opportunities that needed immediate attention. In that quarter, revenue was declining, adjusted EBITDA was a negative $308,000, the Company's banking relationship was strained, and our strategy and organization was unclear.

In Q1 2009, we reduced SG&A expenses, we generated cash from the sale of unnecessary businesses. We stabilized our bank relationship. We reorganized around the two segments of Exchange and Direct that we now report on. We restructured the Management team, and the Board of Directors. And we reversed both a top and bottom line decline in what is today the Direct segment of our business. In Q1, we returned the Company to positive adjusted EBITDA of $770,000, despite an unprecedented economy, and despite continued top line pressure, resulting from market conditions outside of our control.

At the end of Q1, and then throughout Q2, we began to execute on a technology vision for the Company. The foundation for this vision would be based on the technology within our search and affiliate marketing businesses, augmented by proprietary data and analytics. In Q2, our search business, which had seen eight quarters of continuous growth, began to experience the impact of reduced marketing budgets. This trend, which started in March, continued through the end of June. This trend reversed in July, and we have continued to see growth in the Exchange ever since. What is perhaps more important is the fact that we have been able to maintain exceptionally high quality scores for the traffic we generate within this part of our Exchange, despite market conditions and changes implemented by our partners. We believe this is a testament to our ability to prevent real-time click fraud, and put into operation search-driven advertising within the markets we serve.

Many of our peers have not had similar experiences. These quality scores are calculated based on a number of variables, and whether or not clicks turn into conversions for advertisers is one of the more relevant of those variables. By the end of Q2, the Direct segment of our business had already started to grow again, having experienced top line improvement between Q2 and Q1. This growth was the result of new lead generation tactics, the introduction of new product offers, and the start of initiative to monetize information assets collected through our lead generation activity online.

Q2 adjusted EBITDA of $1.2 million was improved quarter-over-quarter, the result of aggressive cost cutting and operational efficiencies implemented at the beginning of Q1. Turning to our current quarter, Q3 has been an important and very productive three months for Inuvo. In this quarter, we rebranded the Company, launched a beta version of our new online platform, and re-engineered the Company's website to be the entry location for that platform. In this quarter, we also started building an internal analytics and media buying team, as a means to accelerate data and analytic developments within the platform. And as a way to increase competency within the highly analytical function that is search engine marketing. This latter initiative is designed to drive more traffic to our existing web sites, and drive higher ROI leads for the Direct business.

To lead this important new part of our business, we hired Craig Dillon. Craig brings to Inuvo a PhD in computer science, and over a decade of experience designing, building, and implementing analytic-based transaction processing systems for risk management, fraud prevention, and marketing ROI, having worked at companies like Fair Isaac and HNC Software. We also hired Robert Vanselow as head of sales this quarter. Under his leadership, we have now consolidated all sales, account management and customer service into one group. Rob brings a wealth of online and offline experience at companies like NewsMax Media, Vayan Marketing and Media Whiz. Rob's solution selling experience includes e-mail, affiliate marketing, display advertising, co-registration and data-based marketing.

These changes in sales are already beginning to have an impact on our pipeline. We are now calling directly on advertisers, and working with agencies of record. This quarter, we secured business with companies like Equifax, ITT Tech, ConsumerDirect and Disney. Additionally in the quarter, we also retained the experienced micro-cap technology investment relations team at Genesis Select, to help bring our exciting new story to Wall Street. We made investments in the acquisitions of leads within the Direct segment this past quarter, that we believe will deliver revenue over the next 12 months through a combination of product and data sales activities. The Direct segment of our business has now experienced two consecutive quarters of growth.

More importantly, however, is the fact that across the Inuvo enterprise, we currently generate considerable quantities of information that could be monetized within our own platforms, and in other company's direct-to-consumer marketing programs. Our babytobee website, for example, which caters to prenatal mothers now has in excess of 10 million consumer records going back five years. With the correct implementation, our intention will be to use the non-personally identifiable parts of information assets like these, for behavioral, contextual and geo-based targeting within our platform.

Concurrently, both advertisers and publishers will be able to use this information, as a means to improve their understanding of customer and prospect demographics across marketing channels, both off and online. Our Direct segment is now being viewed as much as a contributor to our information and analytics strategy within the Exchange, as it is a direct-to-consumer marketing business. Within the Exchange segment, as disclosed in our press release on November 9th, we have also launched a new service for our publishers with a Local XML engine and a showcase website Yellowise.com. More on that later.

Revenue for the third quarter was up 9% quarter-over-quarter, with the larger part of that growth coming from the technology-heavy Exchange segment. Adjusted EBITDA was flat quarter-over-quarter, with operating income down as a result of investments in lead generation activity leading into Q4 and fiscal year 2010. From a market perspective, we have seen the amount advertisers are willing to pay for clicks stabilize, and overall click volume within our Exchange segment was up over 20% quarter-over-quarter. Lead generation activity within the Direct segment was also up in the quarter, with total leads generated up over 50% quarter-over-quarter.

The Inuvo platform beta launch in August is progressing in line with expectations. As stated on the Q2 conference call, we had not planned for revenue growth from the platform in 2009. Rather, we have been introducing features based on feedback from a significant number of advertiser and publisher partners, who have now signed up for the beta program. Since its launch in August, we have now implemented in excess of 25 features, directly as a result of this feedback. The platform is now generating revenue for Inuvo, and we expect the beta program to end in the first quarter of 2010.

Additionally, we have in Q3 also started to migrate what was for formerly referred to as the primary ads business to the Inuvo platform. In part, the Inuvo platform is aimed at making it easier for advertisers to work directly with publishers. As such, many affiliate marketing networks like primary ads, are at risk of being disintermediated by such technological advancement. We have been migrating primary advertisers and affiliates to the platform in Q4. We have experienced some revenue decline in the primary ad service as a result of the transition, but we believe strongly that the scalability of the new platform will offset these early declines. We now believe we have critical mass of both advertisers and publishers within the platform to allow for the acceleration of improvements necessary for us to grow our market share in this industry.

Earlier, I referred to the launch of the Local XML engine and the Yellowise.com website. I'd like to take a few minutes, and explain in more detail this part of the Inuvo strategy. We currently operate a search syndication network ,where we have a direct relationship with thousands of web sites. Many of those website owners have requested technologies from Inuvo that would help them increase revenue through better content and improved user experience. The LocalXML engine which allows publishers to cost effectively incorporate a local search function within their own websites, or mobile or search social applications, complemented by advertising delivered by Inuvo, offers our publishers a way to increase both their user page views, and the monetization of those page views.

The Yellowise.com site is a production implementation of the Local XML engine,and a working example of how quickly and efficiently the service can be implemented. Combined, our LocalXML engine which provides access to over 16 million business listings, and our ValidClick XML engine which provides access to hundreds of thousands of advertisements, offers our publishers a flexible method to build out beta driven website user experiences for their customers. We will continue to explore other data delivery engines like these, that allow our website publishers the opportunity to customize user experiences based on unique content. We have already signed up four publishers for the LocalXML beta program.

I am also pleased to report that we have acquired business-to-business information website, Zubican.com, Where Yellowise.com is an example of a site where consumers search for local information on businesses, Zubican.com is a site specifically targeted at helping business to business buyers and sellers connect with each other. Zubican Is another example of our strategy to power web properties, where the experience is determined based on data that is requested by a user. The synergy for Inuvo with Zubican is straightforward. The site itself will be powered by data from the LocalXML engine, and advertising from ValidClick will monetize the page views. Under the terms of the agreement, Inuvo will compensate Zubican shareholders through a royalty payment that is based on a percentage of the gross profit generated by the website over the next four years.

Let me now comment on our discussions with Wachovia. The banking relationship we have today has two parts, a term loan, and a revolving loan. As of September 30th, the total loan outstanding was $7.6 million, $1.7 million of which was the term piece. Since Q4 of 2008, we have paid down our loan by approximately $2.3 million. Our total loan availability is based on a calculation of two times trailing 12 month EBITDA. In October, that calculation was to be modified to 1.5 times trailing 12 month EBITDA. The bank did not apply that reduction, and together we have been working on a new loan facility that better meets the Company's longer term objectives.

Currently, we are in the progress -- process of finalizing a term sheet with the bank, and working towards having new loan documents signed as soon as possible. While the new loan terms are still in negotiation, the guiding principles have been as follows. That the amount of cash available to the Company be comparable to today. That the new facility should be asset-based, as opposed to EBITDA-based. That any difference in loan availability as a result of the change to asset-based, be covered by an increase to the existing term loan. That the term loan principal and interest be paid off in reasonable increments. That the period for the loan extends through March of 2011. Our discussions with Wachovia are ongoing. We will issue an 8-K when the process is completed.

Given the economic and turnaround hurdles we overcame in Q1 and Q2, I am very pleased with our 9% quarter-over-quarter top line growth in Q3. Going into Q4, and then leading into 2010, I feel good about our future prospects. Both segments of our business are now growing again. SG&A expenses have been controlled. New products, technologies and web properties have been brought to market. The introduction of a more data and analytics driven technology strategy ,as a means to improve advertising conversion is fast becoming core to our DNA, and we are seeing marketing dollars beginning to slowly flow back into the system as the recession eases. In closing, I would like to briefly comment on guidance. The Inuvo Board discusses whether or not we should provide guidance, each and every quarter when we meet. While we are not yet prepared to issue guidance, you have our committment that as our business and corporate direction solidifies, we will begin to share metrics around our future performance And with that, I would like to now turn the call back over to the operator for the questions and answers. Operator?

Thank you. (Operator Instructions). Our first question comes from Eric Martinuzzi of Craig-Hallum. Please state your question.

Thanks and good afternoon, Richard and Gail. Congratulations on the sequential growth. It's good to see that coming back. Just curious to know, and I know you're not giving guidance, but is there a seasonality to your business whereby we should anticipate, with a lot of the companies, that I'm aware of in online advertising, Q4 does get a boost from Q3, just sort of back-to-school, back-to-work, back to holiday e-tail. Could you comment on the business seasonality, please?

I think you've positioned it probably as well as we could at this point, Eric. The history of the business has not shown a lot of variation as a result of seasonality, so I don't have a lot of history to draw a conclusion one way or the other on. Just having been around the marketing services business for as long as I have been, there is typically some increase at the end of the year as a result of the holiday season.

Okay. And then I'm also aware, there's a big shift going on out there as Yahoo repositions itself, certainly on the search side. You have them as a key partner, and what we have seen is definitely there's been some quality issues where certain partners of Yahoo are getting their traffic treated differently, i.e., the revenue share is being tweaked in most cases less advantageously. Curious to know if you've had a quality review by Yahoo, and if so, how that turned out?

So we don't typically talk about our Tier 1 advertising partner, so maybe I'll try and generalize the answer to the question, Eric, if you wouldn't mind. So you are correct, Tier 1 advertisers like Yahoo have been adjusting the manner in which they pay out to their search syndication partners, based on the quality of the traffic that they receive from those partners. I can't comment on other people's traffic, but I do know for a fact that we have always been maintaining a very high level of quality in the traffic that we generate on behalf of our partners. And that's a scale that they measure us upon.

And as a result of that, some of the changes that have been implemented by those partners as it relates to paying revenue out in, essence, reducing the amount of revenue payout to low quality traffic and maintaining, I would say is the best way to put it for high quality traffic. We have not been impacted by that, which should give you a suggestion that the quality of our traffic has maintained very good quality.

Okay. I know one of the key things that your development team is working on is your next generation platform for affiliate marketing. I'm familiar with some other names in that space, that space has been around for a while, it's very competitive. What do you feel that the Inuvo development team is going to be bringing to the table that's different from the current platforms out there?

So one of the things that we've done on the platform, that others potentially are still trying to get implemented, is we're trying to create a much closer relationship between the advertiser and the publisher themselves. And we're providing a lot more transparency to what's going on at the transaction level, for that advertiser and that publisher. We're also going to be implementing a number of analytic technologies that we have across other parts of our business within the platform. And then as we move into the second half of 2010, we're going to consolidate both the affiliate and the search parts of our technologies, into one single platform. So we'll in essence have a platform that advertisers can make decisions about from a "do I want to run a CPA campaign" or "do I want to run a CPC campaign". And publishers will have the ability to choose from either a CPA-based offer or a click based offer.

I see. Okay, a couple of housekeeping items, on the credit facility I know you're negotiating that as we speak, but just balance-wise, what's your expectation for where that ending balance is December 31, 2009. You've done a nice job of whittling it back a little bit from 2009, but where it is from the $7.6 million that we've got at September 30th.

Hi, Eric, this is Gail speaking. I expect it to be relatively flat, because we are investing in some avenues that we're going to grow our business with, so we expect it to stay around the $7.6 million, which is part of what the negotiations are about with Wachovia.

Okay. Then lastly, on the share count, given the warrant transaction that you had in the quarter, and given where the stock is, what should we be using for a diluted share count for -- or maybe both a basic and a diluted, for calculations on earnings for Q4 2009?

So Eric, currently we're at $67.7 million from the exercise of the warrants, plus the shares we have outstanding. So that's the number we have to date.

Okay. All right. That covers it for me. I'll hand off the microphone.

Thank you. Our next question comes from Del Warmington of Delwar Capital. Please state your question.

Quick question, as it relates to gross margins, you it reduced from 36 down to 26.4. Is -- I mean -- do you have a target in terms of gross margin in terms of your long-term business plan?

Yes. So I'll respond to this question. So Del, for the current quarter, what we do is we show the 36 and the 26% which is the combined, so I'll talk about our two businesses separately. For our Exchange business,we're targeting 25% to 28% as a normalized margin rate, and that's what we see going forward. For the Direct segment, the challenge is actually faced by the review that we're pending from the SEC. So until we have clear guidance from them in our accounting treatment for lead acquisition costs, it's hard to pin down what our target margin rate will be, because it differs significantly from that treatment.

Okay. Thanks a million.

You're welcome.

(Operator Instructions). There appear to be no further questions at this time.

Thank you, operator. I would like to thank everyone who joined us on today's call. We appreciate your continued interest in Inuvo, and look forward to reporting progress over the coming quarters.

Thank you. That does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time. And have a great day.