Inuvo's (INUV) CEO Richard Howe on Q2 2014 Results - Earnings Call Transcript

Aug. 2.14 | About: Inuvo, Inc (INUV)

Inuvo, Inc (NYSEMKT:INUV)

Q2 2014 Earnings Conference Call

July 31, 2014, 04:30 PM ET

Executives

Alan Sheinwald - Investor Relations, Alliance Advisors

Richard Howe - Chief Executive Officer

Wallace Ruiz - Chief Financial Officer

Analysts

Eric Martinuzzi - Lake Street Capital Markets

Howard Halpern - Taglich Brothers

Operator

Good day, and welcome to the Inuvo Incorporated 2014 second quarter conference call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Alan Sheinwald with Capital Markets Group, LLC. Please go ahead sir.

Alan Sheinwald

Thank you, operator, and good afternoon. I'd like to thank everyone for joining us today for the Inuvo second quarter 2014 shareholder update conference call. Mr. Richard Howe, Chief Executive Officer; and Mr. Wally Ruiz, Chief Financial Officer of Inuvo, will be your presenters on the call today.

Before we begin, I'm going to review the company's Safe Harbor statement. The statements in this conference call that are not descriptions of historical facts are forward-looking statements relating to future events and as such all forward-looking statements are made pursuant to the Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties and actual results may differ materially.

When used in this call the words anticipate, could, enable, estimate, intend, expect, believe, potential, will, should, project and similar expressions as they relate to Inuvo, Inc., are as such, a forward-looking statement. Investors are cautioned that all forward-looking statements involve risks and uncertainties, which may cause actual results to differ from those anticipated by Inuvo at this time. In addition, other risks are more fully described in Inuvo's public filings with the U.S. Securities and Exchange Commission, which can be reviewed at www.sec.gov.

Well, with that out of the way, I'd now like to congratulate management on another very successful quarter, and introduce Mr. Richard Howe, CEO of Inuvo. Rich, the floor is yours.

Richard Howe

Thank you, Alan, and thanks everyone for joining us today. It's been a busy and exciting time in Inuvo, and I'd like to review some of the highlights of the quarter ending June 30.

I'm very pleased to report that Q2 was another profitable quarter, delivering $382,000 of net income or $0.02 a share. To the first half of 2014, we've already delivered $1.1 million in net income, more than double the net income delivered in the entire fiscal year 2013.

And it may be interesting to note that on a cumulative basis, we've been GAAP net income positive over the last seven quarter period. We expect this trend to continue throughout the remainder of the year.

At the beginning of 2014, we reiterated our strategy to transition away from our toolbar product. The execution of that strategy, which began in 2013, meant that for 2014 revenues might decline on a comparative basis to 2013, but profitability and cash flow would be greatly improved.

We had expected Q1 2014 to be the point at which our new growth-focused initiative would reach scale and begin to outpace the topline revenue decline associated with the transition. I'm pleased to report that revenue growth has in fact paced as we had planned.

In Q2, we delivered nearly $11 million in revenue. That represents an 8% growth rate over the prior quarter and signals a crossover point, where the growth and new initiative is now exceeding the clients associated with the toolbar.

We currently expect revenue to continue to grow steadily throughout the remainder of the year. July unaudited revenue is expected to be approximately $4 million. For the remainder of the year, we expect the toolbar product to run between 1% and 3% of monthly revenue. It was 3% in July.

Sequential growth in the business came from both segments, with the Partner Network growing 2% and the Owned and Operated Network growing 15%. The big mover within the segments was the website and applications business, which grew 31% between Q1 and Q2.

For the 12 months ending in June, this business has had a very healthy 9.5% compounded monthly growth rate. Now, we had two primary strategic objectives in 2014, to increase the overall contribution of mobile revenue and to materially grow our network of Owned and Operated sites and applications.

I would like to now highlight these objectives within the context of my discussion about each of our segments, starting first with our Partner Network. As mentioned earlier, we saw sequential growth within this part of the business. This growth came from an improvement in overall network quality, which in turn, despite lower click volumes, translated into higher average revenue per click delivered to our advertising partners.

Now, this is the exact result we expected to see, based on changes we began to implement in 2013, with the deployment of new technology for both desktop, tablet and mobile, whose purposeful objective was to better identify and interrogate suspicious click activity earlier in the lifecycle of our relationship with new publishers.

This change required that we adapt and deploy certain publisher-side technologies. And while this effort took the better part of two quarters to install, it is now implemented across roughly 95% of our Partner Network.

In addition to this focus on quality, we've also been hard at work, updating the platform that supports this business. We've been adding new features, designed to help publishers analyze traffic, and is a way to accommodate their and our mobile expansion objective.

This should help our publishers maximize the underlying drivers of their ROI for each implementation. We expect this effort to be completed in the third quarter.

Further, and as how we have reported in the past, we've had a goal for this segment that involves expanding the products we have to offer publishers. This goal is successful, which mean we would show up in more places within our publisher sites and applications, which in turn should translate to revenue and profit growth.

The product we have been building to accommodate this goal or what you might call, smart display ad units. Many of these ad units are already in production on both our Owned and Operated and publisher sites. And in keeping with our overall mobile strategy, they work across desktop, mobile and tablet. We have seen some encouraging results here.

Over the next two quarters, we will continue to expand our offerings in this area. For example, over the last quarter, we have been testing within our own properties, a new ad unit type that is more editorial in its nature.

This display-based ad unit uses more engaging images along with descriptive text, based on the content within the site. These ad units have the ability to adapt in accordance with ongoing performance measurements.

You can see these ad units live at any one of our website today, by navigating to the bottom of any article page we publish. And again, in keeping with our mobile objective, these ad units render beautifully on mobile devices.

Generally, we expect to continue expand the Partner Network of the business into these higher value-added publisher solutions, where we can leverage our breadth of advertising inventory and differentiate ourselves through the use of sophisticated marketing technologies. We believe, through these technologies, we can continue to be a market leader, helping small-to-medium size publishers better monetize their properties.

In the second quarter, the overall percentage of revenue from mobile within the Partner segment increased to 34%. A big jump from the 19% reported in the first quarter. This current trajectory is well ahead of where we expect it to be at this point in the year.

Turning now to the Owned and Operated segment of the business. This part of the company grew 16% as compared to the same quarter last year, and this, despite the fact that we had $2.2 million less in revenue year-over-year in the quarter as a result of the toolbar transition.

These results stem from a continued focus on the expansion of our overall network through content-rich Owned and Operated websites and applications that give us much greater control over both the consumer experience and the ads that accompany that experience across devices.

Continuing our expansion here, we launched yet another site in the quarter with living.alot.com. Thus bringing our Owned and Operated site total now to seven. Equally important was the fact between the first and second quarters of 2014, we actually doubled the amount of proprietary content offered through these sites.

In an online world, content is king, and content once created can be reused over-and-over again without additional cost. We expanded our in-house content team within the quarter and the quality of our content demonstrate the investments we are making here. Expect to see us to continue to invest in content both written and video in the coming months.

Additionally, and as a result of the continued success and quality of unique visitors coming to our sties, we recently signed an amendment to our contract with Google that provides access to a higher-quality display ad product, which we expect to deploy within the O&O site over the next month.

We now have 3.5 million unique visitors a month across the ALOT properties, up as you will recall from 3 million in the first quarter. This now represents a very significant audience, and as a result, an increasingly valuable asset.

In keeping with our desire to meet the demand of this audience, we have been redesigning the entire suite of ALOT websites, incorporating more social and graphical elements, and updating for a more modern look and feel across device types.

We will be rolling out the Living site on this new template within the next few weeks. And the rest of the sites will follow shortly thereafter. We are very excited about this new design.

And finally, as was hinted in the first quarter, we have been actively working on mobile applications that compliment our web properties. Essentially, we're using that content and delivering it to consumers through mobile applications we own and into which we serve ads; same content, different user experience.

We now have seven such mobile applications available in the Google Play Store, which can be accessed by typing alot.com in the search box at Google Play. These applications are providing us with in valuable information about mobile application monetization techniques, and in-market testing of various ad serving technologies for publishers that we are now also deploying within the Partner segment.

We, of course, have discussed in the past, the benefits of this kind of cross collaboration between our segments. As we look across the business overall, and as a direct result of our initiative, we now have over 40% of quarterly revenues that are directly attributable to mobile sources, a significant advancement of our overall mobile strategic objective.

With that, I'd like to now turn the call over to Wally for a more detailed accounting of our second quarter results. Wally?

Wallace Ruiz

Thank you, Rich. Good afternoon. Thank you for joining us today to review the company's financial results for the second quarter of 2014. Our 10-Q as of June 30 will be filed with the SEC and be available this afternoon.

Inuvo reported revenue of $10.9 million in the second quarter of 2014 compared to $10.1 million in the first quarter of this year, and compared to $13.1 million in the second quarter of last year. $5.6 million came from the Partner Network and $5.4 million from the Owned and Operated Network.

The Partner Network delivers advertisements to our partner's websites and applications. The $5.6 million reported by the Partner Network in the second quarter of this year was 35% lower than the same quarter last year, but 2% higher than the first quarter of this year.

The revenue decrease in the current quarter compared to the same quarter last year is due in part to the planned program we initiated in the fourth quarter last year that was designed to improve overall traffic quality through the deployment of technology and the enforcement of publisher contract. The result of these changes was lower revenue compared to last year, but higher revenue per click due to better quality.

The Owned and Operated Network, which delivers advertisements to the ALOT branded websites and applications that Inuvo designs, builds, and markets, represents 49% of the company's total revenue in the current quarter. The Owned and Operated Network reported $5.4 million of revenue in the second quarter of this year, a 16% increase over the same quarter of last year, and a 15% increase over the first quarter of this year. The increases are in spite of lower revenue in the segment due to our decision to transition away from the toolbar product.

The toolbar revenue in the second quarter of this year was $542,000, and that's down from $2.7 million in the same quarter last year. Revenue from the ALOT sites and applications was $4.8 million, and that's up 156% from the second quarter of last year, and up 31% over the immediate prior quarter.

Gross profit in the second quarter of 2014 was $6.3 million and that compares to $6.2 million last year. Partner Network gross profit was approximately $1 million compared to $1.9 million last year. The lower gross profit in this year's quarter was primarily due to lower revenue and the accrual of a sales allowance.

During the second quarter, we established a sales allowance to account for the typical adjustments we get from time-to-time from Yahoo! and Google for a variety of reasons. The amount charged to the allowance in the second quarter was $165,000. The establishment of an allowance reduce both partner revenue and gross profit in the current quarter.

Gross profit in the Owned and Operated segment was $5.3 million compared to $4.3 million last year. The higher gross profit is due to higher revenue this year compared to last year. As a percent of revenue the Owned and Operated segment gross profit was 99% in the second quarter compared to 93% in the same quarter last year. And that's due to the transitioning away from the toolbar product where we no longer incur marketing expense.

Operating expense was $5.8 million in the second quarter compared to $6.1 million in the same quarter last year. Marketing costs are the primary cost associated with the Owned and Operated segment, where we spend money to attract consumer sites.

Marketing cost increased $622,000 in the second quarter of 2014 from the same quarter last year. The higher marketing costs are related to the increased investments, as part of the launch of the new ALOT sites and applications and to grow the existing sites and applications.

Compensation expense decreased by $316,000 in the second quarter from the same quarter last year and the lower expense in the current quarter is primarily due to generally lower salaries and lower commission expense.

Selling, general and administrative expense decreased to $578,000 in the second quarter of 2014 compared to the same quarter last year.

The decrease in the current quarter SG&A expense is due primarily to lower depreciation expense associated with the closing last year of offices and data centers in New York and Florida, lower facility expense due to the move to our Arkansas, and lower T&E expenses, now that the relocation is complete and most of the employees are now resident in Arkansas.

Going forward on a quarterly basis, we expect marketing cost to increase as we roll out new and operated websites and applications. Compensation expense to increase as we step up hiring commensurate with our growth and S&G expense remain relatively flat.

Other net expense is primarily interest expense, and it was $103,000 in the second quarter of this year. Last year's other net expense was $66,000. This year's higher expense is due to the higher interest rate on the term debt that we're carrying.

The company reported a $79,000 income tax benefit in the second quarter of last year due to amortizing its deferred tax liability generated from the intangible assets acquired in the March 2012 acquisition. No tax benefit was recorded in this year's second quarter and that's due to the uncertainty of the timing of the reversal of temporary differences.

Net income from discontinued operations was $18,000 in the second quarter of this year and was composed of a reverse of liabilities to web publishers and vendors from 2009 and earlier. The $18,000 compares to $283,000 net income in the same quarter last year for discontinued operations.

The company reported a net income in the second quarter of 2014 of $382,000 or $0.02 per diluted share. That compares to $381,000 or $0.02 per diluted share for the same quarter last year.

EBITDA adjusted for stock compensation expense and accrued severances was approximately $1.2 million in the quarter that ended June 30, 2014, and that compares to an adjusted EBITDA last year for the same period of $848,000.

Turning to the balance sheet. Cash and cash equivalents at the end of June of this year was $3.4 million and that compares to $3.1 million at the end of December 2013. Bank debt was $5.3 million at the end of June and that compares to $6.1 million at the end of December 2013. Stockholders' equity at the end of June was $6.7 million.

As mentioned on our last call, we have been actively soliciting proposals from commercial banking institutions. Though our current bank agreement provides adequate financing to meet current objectives, we are entertaining proposals to refinance our debt under better terms and obtain additional capital to accelerate growth.

Not surprisingly, as our performance has continued to improve, so has our attractiveness to potential lenders. By negotiating a more favorable debt facility, we will increase our access to capital and further improve our cash flow with better terms than the existing debt agreement. We expect to update shareholders on this new facility in the very near future.

With that, I'll like to turn the call back over to Rich for closing remarks.

Richard Howe

Thanks, Wally. We had a positive second quarter and we're off to a great start for the first half of 2014. We remain excited about our prospects for the remainder of the year.

Let me now summarize what has been said today. Owned segment of the business grew sequentially, but more importantly sequential growth signals a crossover point, where the new initiatives are outpacing the reductions associated with the toolbar, which now represents 3% of revenue.

The sites and mobile apps business grew 31% sequentially and has had a compound growth rate of 9.5% per month over the past 12 months. This business is up 154% over the same quarter in 2013.

Revenue from mobile sources in Q2 was greater than 40% of our topline. Now, considering we entered 2014 at 15%, this represents a significant and positive shift in the business.

Net income for the first half of the year was $1.1 million, already more than double the net income delivered in all of 2013. And finally free cash flow was strong in the first half and materially improved over the comparable period in 2013.

Looking forward to the second half of the year, we expect revenue to exceed the first half and profitability trends to continue. And perhaps, before I turn the call over to the operator, I would like to remind you that we also added in the quarter an exceptional new board member.

Bill Conner brings an incredible background in telecommunications, softwares and service, marketing, and is himself an accomplished operator. Having recently and very successfully sold his Entrust business, we had a rare opportunity to catch Bill at just the right time. I expect Bill to be an instrumental part in helping us refine our strategies. Bill has already demonstrated his commitment to a new role through an ownership in the company that now exceeds 1%.

With that, I will now turn the call back over to the operator for questions-and-answers.

Question-and-Answer Session

Operator

(Operator Instructions) And we'll take our first question from Eric Martinuzzi from Lake Street Capital Markets.

Eric Martinuzzi - Lake Street Capital Markets

Thanks for taking my question and congratulations on the good progress in the quarter. That growth that you're seeing there on the Owned and Operated side, are you seeing it -- you're obviously seeing it into the mobile side, but are you seeing the same on the non-mobile parts of the business? Is it also strong or is it all coming from the mobile?

Richard Howe

I'd say the line share of the growth is coming from mobile, Eric.

Eric Martinuzzi - Lake Street Capital Markets

And is it any particular application partner or just you're figuring out which mobile partner is -- sorry, which mobile apps are working best?

Richard Howe

So from an operating perspective, practically we've been designing the entire environment to support our mobile audience. From a marketing perspective, we are equally targeting, if you will, mobile audience. So it may not be all that surprising that the mobile number there, are so impressive. Well, it's that way, because we're targeting it that way. We want that audience and we're designing for the audience.

Eric Martinuzzi - Lake Street Capital Markets

Now, you mentioned that the July revenue, I think you said it was at a $4 million run rate unaudited. Is that correct?

Richard Howe

That is correct.

Eric Martinuzzi - Lake Street Capital Markets

Is there any seasonality in the business that would cause that to decline in August or September?

Richard Howe

Not typically in the third quarter.

Eric Martinuzzi - Lake Street Capital Markets

And then on the gross margin side, you've been talking about a 52% to 55% gross margin expectation. You're able to put up the 57% number. Is that sustainable?

Wallace Ruiz

We think that we said in the first quarter that we'd been going back hit to historical rate, because the first quarter was fairly high gross margin. And yes, we think that the rate that we're at now in Q2 is sustainable. Yes.

Eric Martinuzzi - Lake Street Capital Markets

And then just on the OpEx side, you did mention that you expect the market cost to increase and the compensation cost to increase. Can you get a little bit more specific in that, just given what we saw here? You've been running now, I guess there was a $5.8 million -- $5.7 million, $5.8 million. Is this something that jumps up 10% sequentially or is it going to be more modest than that on those two growing expense lines?

Richard Howe

I think the marketing cost are going to grow in the very similar relationship to revenue that you've seen in the past, so I don't think that's going to be out of line. The compensation to grow should -- it will grow a little bit from where we are at now, but there will be some steady growth, because the company is growing and we're going to need additional employees to help fuel that growth. But you're not going to see an unusual spike or anything like that. And the SG&A, I think that you're going to see is going to be rather flat.

Operator

Our next question will come from Howard Halpern from Taglich Brothers

Howard Halpern - Taglich Brothers

Congratulations guys. Great quarter. My first question relates I guess, to the hiring. How many new employees did you have in Q2? And what do you expect for the balance of the year.

Richard Howe

Right now we have, at the end of June we have 38 employees. So we brought on about two or three employees during the quarter in Q2. And we're probably going to see that rate or a little bit more into Q3. So it's not, like I said before you're not going to see a big spike, but you are going to see a gradual increase in compensation expenses associated with that.

Howard Halpern - Taglich Brothers

And would it be possible for you to, on the Owned and Operated side to go through the seven and rank them in term of average daily revenue generation for the quarter?

Wallace Ruiz

We don't disclose, Howard, the individual contributions and revenue from the seven sites, but I'll speak more generally to this, and I think, I'll try to answer the question as best as I can in light of that.

So when we went down this path with this business unit, we had a design construct in mind and the construct was every new vertical we enter, we should be able to achieve a revenue run rate somewhere around $25,000 to $30,000 a day, which is roughly $900,000 or $1 million, if you want to round everything up, say about a $1 million a amount.

And of course it takes time to build up that kind of revenue stream. What I will say is that the first two sites that we launched, the very two first two verticals, which was our local vertical and our health vertical are both exceeding our underlying construct. The remainder of the sites are all making progress towards that goal and we're pleased with the progress overall.

Howard Halpern - Taglich Brothers

And in terms again of the marketing cost, I know they're going to go up incrementally, but like the two sites, that your first two sites, have those marketing cost stabilized or gone down, and then there is sort of a reallocation to the new site with maybe some added marketing cost?

Richard Howe

So the way I want to think about looking at this is, if you're trying to build an audience like we are, a substantial audience in today's day and age, you got to spend some money into marketing. I think everybody probably realizes that that's how it's done. So no matter whether you'd be selling out a website or you're selling a product, you got to find an audience for it.

The way that typically manifests itself is you spend some money and with any luck you don't loose your shirt while you're trying to build that audience. And if you're being successful at it, your margins should increase steadily, because you're getting more people coming to the site on a regular basis.

I would say that that's typically the way to look at it. With the more mature sites, we actually see margin expansion. If we're seeing margin expansion there is no reason for us to stop spending money, particularly if that margin expansion is positive, which it is by the way, with the two sites we're talking about.

In fact, it's incumbent on us to go ahead and spend some more money. We're making money, so why not, and attract an even wider audience.

With the newer sites, you tend to go in a situation where you're running a loss at first, and then it starts getting better, and it starts getting better, and hopefully it starts getting better, and depending upon the sites design, the content, all these sort of peripheral things that you do to make sure you have to operate a positive environment. And then they get positive and you keep going from there.

Operator

And it appears there are no further questions at this time. Mr. Howe, I'd like to turn the conference back to you for any additional or closing remarks.

Richard Howe

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

Operator

This concludes today's conference. Thank you for your participation.

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Inuvo (NYSEMKT:INUV): Q2 EPS of $0.02 beats by $0.03. Revenue of $10.94M (-16.7% Y/Y) misses by $0.36M.