Inuvo, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016. Inuvo provides internet advertising technology and digital publishing through its Partner Network and Owned and Operated Network. Revenue is primarily generated when users click on advertisements.
Financial results and liquidity
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net revenue | $18.73 million | $13.42 million | +39.6% |
| Gross profit / margin | $14.45 million / 77.1% | $7.35 million / 54.8% | Margin +22.3 percentage points |
| Operating income / margin | $403,007 / 2.2% | $250,759 / 1.9% | Income +60.7% |
| Net income | $374,274 | $626,310 | -40.2% |
| Diluted EPS | $0.02 | $0.03 | Down $0.01 |
| Operating cash flow | $573,742 provided | $1.12 million used | Improved |
Cash was $4.43 million at quarter-end, up from $4.26 million at December 31, 2015. Current assets were $9.79 million and current liabilities $10.52 million; the resulting working-capital deficit was approximately $737,000. The filing reports no balance on the Bridge Bank term loan or revolving line at March 31 and approximately $4.9 million of revolving availability. The company was in compliance with bank covenants. The existing revolving facility was due to expire in September 2016, and management intended to obtain a replacement.
Investing activities used $372,598, primarily for equipment and capitalized development costs; financing activities used $24,811. Total assets were $26.71 million, including $5.76 million of goodwill and $9.09 million of net intangible assets. Total stockholders’ equity was $11.68 million.
Business trends and changes
- Owned and Operated Network revenue rose 130.1% to $13.46 million, or 71.8% of revenue. Management attributed growth to increased marketing, more users and advertisements, expanded content and verticals, and a site acquired from a former partner.
- Partner Network revenue fell 30.3% to $5.28 million. Management said much of the decline reflected revenue reclassified to Owned and Operated after the 2015 website acquisition, as well as lower publisher volume.
- Marketing costs increased 124.8% to $11.07 million, primarily to attract traffic to owned properties. Compensation increased 44.1% to $1.72 million; headcount was 71 versus 52 a year earlier. Total operating expenses rose 97.8% to $14.04 million.
- Net income was lower despite higher operating income. Q1 2015 included a one-time $406,453 income tax benefit related to settlement of a New Jersey tax claim; Q1 2016 recorded $7,235 of state income tax expense. Q1 2016 also included a $250,000 sales-allowance adjustment after no advertiser chargeback occurred within a year.
- Yahoo! and Google accounted for 97.4% of Q1 2016 revenue (59.9% and 37.5%, respectively), compared with 98.3% in Q1 2015. Together they represented 98.6% of gross accounts receivable at quarter-end.
Outlook, risks and contingencies
Management said Q1 typically has softer advertiser demand and lower revenue per click, and that this year softness began in March. It expected advertiser demand to increase in Q2. Management expected SearchLinks, launched in 2015, to contribute to 2016 growth, and planned to expand ALOT properties, mobile applications, content, publisher relationships and acquired web properties. It also expected marketing, compensation and general and administrative expenses to rise as the business expands. The filing provides no quantified revenue or earnings guidance.
On March 31, 2016, Inuvo amended its Yahoo! Publisher Network contract, extending its term from July 24, 2016 to May 31, 2018. Key risks include dependence on Yahoo! and Google, whose contract terms, advertising supply, policies and approval of websites can affect revenue; dependence on distribution partners; traffic-acquisition costs and effectiveness; and the need to renew or replace the bank credit facility. The company also cited technology, service interruption, regulatory, legal, seasonality and dilution risks.
An Alberta wrongful-dismissal case filed by former employees remains in discovery, with no reported progress since April 2013; the company was holding the matter in abeyance pending action by the plaintiffs. The filing reports no material off-balance-sheet arrangements. Management concluded disclosure controls were effective at providing reasonable assurance; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether revenue growth and Owned and Operated expansion can continue while marketing costs rise sharply, and whether traffic spending produces sustainable returns.
- Whether seasonal advertiser demand recovered as management expected, and how revenue per click and user/advertisement volumes developed after March.
- Continuity of Yahoo! and Google relationships and the implications of the Yahoo! contract extension; customer concentration remains exceptionally high.
- Renewal or replacement of the revolving credit facility before its September 2016 expiry, and liquidity given the working-capital deficit.
- Performance of SearchLinks and the acquired websites, including any contingent stock consideration tied to performance targets.
- Potential dilution from outstanding options, restricted stock units and warrants, and developments in the pending Alberta litigation.