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Vertro, Inc. (NASDAQ:VTRO)

Q3 2011 Earnings Call

November 9, 2011 4:30 pm ET

Executives

Michael Buchanan – Director, Investor Relations

Peter A. Corrao – President, Chief Executive Officer

James G. Gallagher – Chief Financial Officer

Analysts

Eric Martinuzzi – Craig-Hallum Capital

John Gilliam – Point Clear Strategies

Operator

Good day, ladies and gentlemen, and welcome to the Vertro Inc., Third Quarter 2011 Financial Results. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host today’s conference, Mike Buchanan, Director of Investor Relations. You may begin.

Michael Buchanan

Thank you, and good afternoon, everyone. Welcome to Vertro’s third quarter 2011 financial results conference call. Joining me on the call today are President and CEO, Peter Corrao; CFO, Jim Gallagher; and General Manager, Rob Roe.

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 from those in the forward-looking statements. These risks and uncertainties will be outlined at the end of this conference call, and are also detailed in our filings with the SEC.

Before handing over to Peter, let me 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 EBITDA, earnings from continued operations before interest, income taxes, depreciation and amortization; adjusted EBITDA; EBITDA as adjusted for non-cash compensation expense and non-recurring items; adjusted income loss and adjusted income or loss per share. A description of our reasons for utilizing these measures as well as our definition about them and a reconciliation to the corresponding GAAP measurements can be found in the earnings release we issued today.

Certain of the ALOT user metrics we’ll be discussing this afternoon are broken out by Region One and the rest-of-world, ROW. As a reminder, Region One comprises English speaking users in the US, Canada, United Kingdom, Ireland, Australia and New Zealand. 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 at www.vertro.com, and a replay of this conference call will be available through 90 days.

I’d now like to turn the call over to our President and CEO, Peter Corrao. Peter?

Peter A. Corrao

Thanks Mike, and good afternoon, everyone. Thank you for joining us. During the third quarter of 2011 Vertro has presented with the combination of challenges that affected our revenues and overall results, some of which originated in the second quarter and were largely well under control in the third quarter and early in our current quarter.

While I’m disappointed with the results for the quarter, I am pleased with the response from our team. We moved quickly and put in initiatives in place to address the changes in our business and as a result, we exited the quarter on a more sound flooding and the stage has been set for improvements in our financial results.

We had anticipated a down quarter due to the effects of the change in our Search Engines Results Page or SERP, which was implemented in June of 2011. Initially we were uncertain as to how the changes in the SERP configuration would effect our buying model and how it would affect our ability to acquire users. Therefore, we decided to reduce our daily customer acquisition cost or ad spending in June and July, the residual effects on the reduction and ad spending resulted in fewer total users and subsequently decreased user revenues early in the quarter.

Customer acquisition cost are recognized in the period of which they are spent, but the user monetizes over a longer lifetime than the current period. However, in the middle of the third quarter the roll out of the new homepage product began to show significant increases in the expected Life Time Value or LTVs per user compared to our recent trends. Based on these expected LTVs, we increased spending at this point and continued to spent throughout the remainder of the quarter under the assumption of most of the benefit of this spending will be received over the Life Time Value of the users and subsequent future quarters.

So our strong spending late in the quarter was immediately expense, which added to our losses in Q3, while the majority of our revenue should be realized in Q4 and through out the reminder of 2012.

In order to properly simulate the SERP changes and its effect on our user base, we adjusted our buying model basically rebuilt it and we gradually accumulated new reliable pricing data.

And directly this cause some buying inefficiencies making us enable to acquire our desired number of users at appropriate prices. These inefficiencies arose from our lack of pricing history which I just mentioned and cause the average cost to acquire a user to increase.

We also experienced buying inefficiencies due to the changes to our direct marketing advertisements that required to be made at the request of the third party advertising network. This issue was addressed successfully at that time, when we continue to develop new advertising methods as third party requirements evolve.

We continue to work through the advertising policy issues and we believe that the application of our new methods will enable us to achieve the needed margin levels and volumes required for growth. Additionally, the mandated change to our SERP, that was implemented in June caused the reduction in the number of overall advertising impressions driving down click through rates on advertising.

Total search rates fell by 7% to 250 million queries, queries made by users in English speaking countries fell by $10 million or 9% while queries made in the rest of the world fell by 7.4 million or 4.9%. Total users fell by 100,000 or 1% from 8.3 million to 8.2 million users the impact on revenues however was more significant there was a shift in the consumer mix during that quarter.

While there was reduction in users in Region One there was a corresponding increase in users in our non-English speaking markets or what we call the rest of the world, where the growth is high however, total revenue per user is lower in the rest-of-world due to lower advertising rates in these markets.

Overall, Vertro’s international users have increased as a percentage of total users to 58%, whereas Region One users represent 42% of total quarter end figures.

As of the end of Q3, we had 3.9 million Region One users a decline of 200,000 users or approximately 4.9% compared Q2 and 4.3 million rest-of-world users and increased of 100,000 or approximately 2.4% from the prior quarter.

Lastly, gross revenue achieved during the quarter did not meet our target say with key monetization partners in our tiered rate structure this resulted in a reduction of our revenue sharing rates from June through September driving down net revenues per click and per search.

So as you could see we faced a number of challenges to our revenue model during the third quarter most of which arose in the mandated change to our SERP. We believe we’ve addressed the challenges, the changes to our SERP presented and have made appropriate changes to our buying model.

During the later half of the quarter when we were confident as to the consistency of results, we increased our add spending to prior levels and we anticipate that this should result in a rebound in the fourth quarter and we are poised to capitalize on the upcoming holiday buying season as we’ll operating at those improved levels.

I’d like to now touch on the positive trend and the expected drivers of our future growth. We believe our average daily revenue reached its bottom in Q3 incurred rates are 20% above that low point. This should enable us to achieve gross revenue targets at a higher tiered revenue sharing rate at some point during the fourth quarter.

Attrition rates improved across key worldwide market better targeting as well as product enhancements and the introduction of our new more simple homepage. The reduction of the new homepage has resulted in significant improvements in revenue per install, which increased the revenue achieved, average rates above 30%, compared to recent trends. We believe the new version of the homepage products, strong increase in revenue rates are due to combination of better performance, increased usage as well as lower attrition rates, which I’ve just mentioned.

The company continues to build on its already strong base of app offerings, adding apps design to appeal to the user in established areas of interest such as general user friendly utility apps and those focused on entertainment, music and online shopping, food games, social media, social networks. We expect the new apps to further increase distribution and we have a continuing pipeline of the releases plan.

Some of the new apps are also designed to increase the lifetime value of our users by a lowering attrition or others are designed to enable us to diversify our revenue stream by increasing non-search revenue. Optimally, our new products will include a comp order of all three of these goals in varying degrees.

We expect to return to growth in Q4, realizing gradual improving returns and we look forward to achieve in our revenue goals based on the organic growth that we expect to generate and the continued successful execution of our RevPAR strategy.

Now before turning the call over to Jim, I want to take a moment to talk specifically about our planned merger with the Inuvo, Inc.. As it’s an important component to our long-term strategic plans. We start off by saying that with the guidance of our investment bankers, the merger was decided after both companies conducted market testing, extensive due diligence and a fairness analysis. Vertro’s Board determine they’re recommending in this particular transaction would be in the best interest of our stockholders. The combination of the two company’s has a great potential and should allow us to monetize in an enormous amount of traffic over diverse revenue strength as such as search, e-commerce, display and affiliate programs. In addition, the synergies we expect to realize will affect both earnings and revenues.

The anticipated cost savings should have an immediate effect on our earnings or the combination of the various products will enable us to offer increasingly rewarding benefits that will attract and retain consumers and result in increasing revenues.

In regards to product potential, we believe the combination of ALOT, direct to the consumer in the marketing experience and existing user base provides an excellent platform for the distribution of consumer applications will enable us to more aggressively compete in the multi platform distribution of internet publishing sector.

We expect to build app similar in concept that virtues a lot rewards app, which is a collaborative product that we released during the third quarter using a new BargainMatch platform. These app should help us increase retention or a lifetime value of the user and greatly increase search revenues per user. Additionally, we believe we’ll be able to attract users who will give us a significantly higher value through revenues generating capabilities at the Inuvo products such as BargainMatch or their Kowabunga product for example bring to the table.

Besides on the synergies in the two company’s products and the potential they have, the combination should immediately impact our bottom line. Our operational cost savings should be approximately $2.4 million annually obtain through the elimination of redundant public company cost and other operating efficiencies.

So in summary, the merger capitalizes on increasing growth in the Internet user experience and our combined strength in attracting keeping high quality users. The expected synergies and cost savings as a combined company should achieve the goal of increasing shareholder value immediately and over the longer term, and I am extremely excited at our company’s potential to attract and obtain consumers in order to drive them with multiple options to engage in the internet.

We believe that further opportunities in global markets will be significant going forward. Our plan is to assimilate the company’s operations and their products as quickly as possible after the expected closing. Most importantly, we expect to produce adjusted EBITDA profit excluding deal cost in the first quarter of operations as a combined company. We expect the Registration Statement on Form S-4 for the transaction we filed early next week.

As we continue to move forward through the remainder of the fourth quarter ended 2012, we continue to focus on attracting new high quality longer term users that will further increase distribution and Life Time Value through greater user retention as well as diversify revenue streams to multiple product offerings.

Overall, we believe although we’ve met the challenges presented during Q2 and again in Q3 regarding the SERP changes, while is a temporary set back, we believe that the issues were dealt with effectively within that quarter. We’re also looking forward to return this growth in Q4 and beyond and we look forward to the coming quarters in the prospects of both strong organic growth and synergistic growth that we expect to arise from our planned merger with Inuvo, Inc.

So with all that said, let me hand the call over to Jim Gallagher, our CFO to discuss our financial results. Jim?

James G. Gallagher

Thanks Peter, and good afternoon everyone. As Peter explained, Q3 presented Vertro with number of challenging issues, primarily concerning the changes that are required to make to our SERP that impacted revenues and overall results.

For the quarter, total revenues were $6.3 million compared to $7.5 million in Q2, 2011. This represents a decline of approximately $1.2 million. As Peter outlined, the revenue decline was a result of a number of churn factors arising from the mandated change in our SERP as well as an internal decision to reduce customer acquisition cost during June and July. As previously noted, the reduction in our customer acquisition cost directly causes a decline in users, which resulted few searches and consequently reduces revenue.

While the factors were all interrelated I’ll put it simply that we are unable to acquire our desired number of users at the appropriate prices. With that said, we are in the process of returning to growth during fourth quarter as our direct marketing efforts are back on track, we are broadening our scope and scale of product offerings and our operating expense or OpEx remains steady.

As to OpEx we are able to maintain tight controls of our expenses with total operating cost of approximately $2.2 million, which is the same to the prior quarter after making substantial cut short cost in the first quarter of 2011.

We experienced to launch in continuing operations in the third quarter of 2011 of approximately $1.6 million or $0.22 per diluted share as compared to a loss of continuing operations of $300,000 or $5.05 cents per diluted share in the previous quarter.

EBITDA and adjusted EBITDA for the quarter of 2011 third quarter 2011 reflected a loss of $1.3 and $0.9 million respectively as compared to an EBITDA loss of $0.2 million and an adjusted EBITDA income of $100,000 prior quarter.

Adjusted net income was $12 million or $1.60 per diluted share in the third quarter of 2011. This figure is the direct result of income from discontinued operations of approximately $13 million during the quarter.

As some of you may recall, in March of 2009, we sold the assets of our former MIVA Media division and transactions and adjustments related to the MIVA Media division or their asset class find in discontinuing operations. This quarter’s net income from discontinuing operations represents the reversal of the accumulation of prior net foreign currency translation adjustments of approximately $12.9 million that arose as part of the former MIVA Media EU operations. During the quarter, the accumulated balance was released to income as the related foreign entities net assets have been substantially liquidated.

Cash and cash equivalents decreased to $4 million as of September 30, 2011 a decrease of approximately $0.9 from June of 2011, cash which was $4.9 million. The decrease was primarily due to reduced cash flow from operations, as we tackle the issues Peter previously outlined. We believe that we currently have sufficient cash from continuing operations and I one point out that we’re continuing to maintain our untapped financing facility with Bridge Bank for approximately $8 million which was renegotiated back in June of 2011.

With that, I’m going to turn the call back to the operator for any questions. Jen?

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Eric Martinuzzi with Craig-Hallum.

Eric Martinuzzi – Craig-Hallum Capital

Thanks for taking my question. I appreciate the commentary on the Inuvo transaction, just curious to know with the filing of the S4 if that give you any better sense of timing for the potential closing of the acquisition?

James G. Gallagher

We’re really looking towards probably first quarter 2012 to get things ramped up and to move it forward from there.

Eric Martinuzzi – Craig-Hallum Capital

I’m sorry, you cut out there. Could you repeat what you just said?

James G. Gallagher

Yeah. What I said was if we file it next week, will go through an SEC process and then, we will probably be in a position to get this fairly well wrapped up by the early part of 2012, that is the first quarter of 2012?

Eric Martinuzzi – Craig-Hallum Capital

Okay. Got you, all right. And then, your language it’s obviously you’re a little bit more encouraged, you see some positive trends you were using words like prepared for rebound and there is a return to growth in Q4. Is that to say sequential growth in Q4 versus Q3?

Peter A. Corrao

Yeah. Well, look we’re falling short of making a big proclamation Eric, because we've had such a tough time of it in Q3. We think that we’ll grow revenues. We think that we’ll have EBITDAs in Q4. We think we’ll get really all of our metrics going again, including we've got to get our users going again, and we've got to get our ratio back to 50/50 of Region One or closer to 50/50 on Region One and rest of the world. So, we had a tough goal a little bit, the SERP change not to start our (inaudible) pretty well, but we think we've got that behind us. It almost was offset by the changes that we made to the product. We've got some ongoing issues with our ability to attract new users, but we think we’ve got to fix in place for all of that and we can get back to growth again. As you know, we've dropped or as you don’t know, maybe in Q3, we again dropped our OpEx down. We anticipate besides ads, we anticipate bringing OpEx down again in Q4 I guess, right Jim and other 30, 40, $50,000 possibly. So, we think we're on good shape on all fronts if we can get buying, going again, which we’re feeling pretty good about, get our growth again and we think that our lifetime value expectations for consumers or as good as they’ve ever been right now in recent histories. And so, when I say recent histories, Rob, I guess I’d say back into the '09 and '10 range when we were on a bit of a roll there, we got LTVs now back to those ranges there, so if that falls toward enough volume of users, we projected that we could have a pretty quarter coming up in Q4.

Eric Martinuzzi – Craig-Hallum Capital

Okay. And the assumption then you talked about obviously working towards having a positive EBITDA in Q4. Is the implication there then the cash on the balance sheet would rise on the December 31 snapshot?

James G. Gallagher

Eric, I think they’re looking at something as maintaining a comparable balance to where we are right now. We're looking just to give some color to what Peter has mentioned before. Our average OpEx for the third quarter of 2011 was down to about $0.733 million per month. We are anticipating to be lower than that in the fourth quarter. By comparable amounts, if we looked at the first quarter, we were at about $0.933 million, so there is a significant reduction of almost $200 per month it’s been factored in there from the first quarter to the third quarter. Now we’ve gone to some cost reductions and things like that, so we continue to really watch the operating expenses as much as we possibly can and obviously conserve cash where we possibly can do that as well.

Peter A. Corrao

Well, the cash issue, Eric’s point was that if we were expecting to make money in EBITDA then will that translate to cash, my point Jim and for Eric and the rest of them is, because we’re trying to still grow our base, our cash may then drop a little bit but not below the numbers you’re talking. I said because we would continue to spend if we could through the holiday period.

James G. Gallagher

That’s true, that’s true.

Eric Martinuzzi – Craig-Hallum Capital

Okay, well then the customer acquisition cost, maybe let me ask you in a different way. The customer acquisition cost is $5.2 million in Q3 and it was $5.2 million in Q2. You’re saying you would be greater than that, is the expectation in Q4?

Robert D. Roe

I think so. It of course it all depends on how it goes towards the holiday period There is definitely the loss towards the end of the year and it will depend on how the performance on a particular LTV is in that period how that looks. So definitely we are going to be adjusting through out the period, but our anticipation is that it would be higher.

Eric Martinuzzi – Craig-Hallum Capital

Okay. I think I follow that. And then one last one if I might, as I looked at the non-financial metrics, you’ve seem to obviously had the same issues across the board as you overhauling the SERP, the Search Engines Results Page in accordance with your partners desires here, but it looks like the Region One versus the rest-of-world. It seems like the Region One fell off more if I look at the search queries I see just sequentially Region One down 9% sequentially but rest-of-world only down roughly 5% sequentially; what’s the explanation there?

James G. Gallagher

Again, it’s all driven by customer acquisitions, so we’ve had more success in non-Region One acquisitions in terms of meeting the desired margin targets, we’d had particular success in couple markets; one in Latin America, one in Europe. So that has definitely driven some of the disproportionate growth in non-Region One. Obviously we would like to grow Region One too, we would like to grow the whole thing in proportion and that’s certainly going to be our goal for Q4, but it’s really driven mostly by acquisition.

Peter A. Corrao

So one of the just to build on what Rob is saying I think he is right on the (inaudible) with that, but when the SERP change hit us, as you know we monitor our CPA or cost for getting in and our LTV on a product by product basis, which was on a country basis. Also does – some of the international markets actually have higher margins than English speaking markets.

So when we decided to cut back on our spending in Q2 and Q3, because we didn’t know what the new LTVs would be because our greater margins were in the non-English speaking countries, we were able to continue to spend in some of those because we are pretty certain that we would be okay. But we weren’t able to spend into some of the Tier 1 markets where we work certainly would be okay. So I think we are still certainly looking the residuals of that.

Eric Martinuzzi – Craig-Hallum Capital

I understand, thanks for taking my question.

Peter A. Corrao

Sure, good question. Thanks Eric.

Operator

Thank you. Our next question comes from John Gilliam with Point Clear Strategies.

John Gilliam – Point Clear Strategies

Good afternoon gentlemen. you mentioned some changes to your advertising is required by third party, could you provide a little more color on that?

Robert D. Roe

Hey, John this is Rob, not too much. Yeah I think so – John we definitely experienced we always have to deal with the third party requirement for advertising.

So already advertising networks that we work which has policies and policies generally – generally all the advertising also policies that is tied specifically to advertisers who distribute software.

We had an incident in June which affected us going into Q3 because that was the tail end of Q2, so obviously most of our investment in advertising or customer acquisition towards the end of the quarter really has most of this impact in the following quarter and we believe we will successful address those issues there was specific changes that we made which I wont go into detail on that we felt we’re effective, we did more recently fix additional changes with advertising policy changes and we’ve made changes to that address those.

And some of the things that we learned early in Q3 and at the end of Q2 are directly applied to the more recent issues and we believe there we’re having some success there. But it takes time to apply these changes; it takes time for us to adjust our buying model.

Because the model is based on analyzing the history of the campaign, we are required to make a significant change through our method that’s disruptive for that campaign and we end up having to basically build a new historical model to then optimize the cost or the pricing of the advertising that we’re buying. So it’s definitely disruptive and it definitely takes days and weeks to resolve, but not month.

John Gilliam – Point Clear Strategies

Okay. And is it relate to the consumers opting in or out of the various products that we offer with each campaign?

Peter A. Corrao

No. we haven't made any changes to our products or the disclosure to other things about. They’re delivered as part of the product installation, but there are changes that we needed to be made to maybe advertising creator or advertising [topic].

John Gilliam – Point Clear Strategies

Okay. Peter I believe you said that you expect to hit these higher rev share at some point in Q4 was in your major partners. Did we hit that level in October?

Peter A. Corrao

We don't know we would have claimed it. John, what happens is we get up from our biggest partner, we get kind of a true (inaudible) account and we won't know what that trope is until around the 28 to 29, I guess of this month meeting the month of November. So that would give you sense of how close it is right. So we’re right on the cost above it, and if I was guaranteed over we would climb up, but we’re right there and it all has to do with the estimate on the payment at the end of the quarter. I’m sorry, at the end of this month, which is pruning up October.

John Gilliam – Point Clear Strategies

Right. Right. I gotcha. Okay. And let’s see I think that’s all I have, thank you guys.

Peter A. Corrao

Thank you.

Operator

(Operator Instructions) And I’m showing no further questions.

Michael Buchanan

Okay. To close; this conference call contains 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, will, intend, anticipate, belief or expect or variations on such words and similar expressions are intended to identify such forward-looking statements including: 1) our ability to successfully execute upon our corporate strategies including our proposed merger with Inuvo, Inc.; 2) our ability to distribute and monetize our international products at rates sufficient to meet our expectations; 3) our ability to develop and successfully market new products and services; 4) the potential acceptance of new products in the market; and 5) the impact of changes to our monetization partners implementation guidelines.

These statements are based on management’s current expectations and are subject to uncertainty and changes in circumstances. Actual results may vary materially from those expectations contained in the forward-looking statements. Key risks are described in Vertro’s reports filed with the US Securities and Exchange Commission including Form 10-Q for Q2 2011 and our 10-Q for the third quarter 2011 which we filed. In addition, past performance cannot be relied upon as a guide to future performance.

That concludes our call today. Thank you for listening.

Operator

Ladies and gentlemen, this does conclude you conference. You may all disconnect and have a wonderful day.

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