Inuvo, Inc.
Q3 2015 Earnings Call Transcript

Published: 23 Oct 2015

[Operator:]

Good day and welcome to the Inuvo 2015 Third Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Alan Sheinwald, 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 third quarter 2015 shareholders update conference call. Today, Mr. Richard Howe, Chief Executive Officer; and Mr. Wally Ruiz, Chief Financial Officer of Inuvo will be your presenters on the call. 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 it relates 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. With that out of the way, now I'd like to congratulate management on another outstanding quarter in growth, free cash flow in the third quarter and turn the call over to Mr. Richard Howe, CEO of Inuvo. Rich, the floor is all yours.

[Richard Howe:]

Thank you Alan, and thanks everyone for joining us here today. Since the first quarter of 2014 Inuvo has had a compelling quarterly growth rate. Through the first nine months of 2015 alone, revenue was up 45% year-over-year. This growth rate has resulted in a record third quarter revenue number for the company of $19.3 million, up 48% year-on-year. Now equally impressive over that same period of time is that growth has been accompanied by strong earnings and free cash flow. Strong enough in fact to not only make the investment necessary to grow the company and position for future success but also to reduce bank debt from over $6 million going into 2014 to zero as of the end of the third quarter here in 2015. Our GAAP based earnings in the quarter at $0.03 represent a 62% improvement year-over-year but perhaps more importantly, we had free cash flow of $1.7 million in the quarter. Now on a cash flow basis per share, the business has actually delivered $0.17 through the first nine months of the year compared to $0.07 per share on a GAAP income basis. Wally will be talking more about the strong cash generation in his remarks later. But suffice to say, it is this cash flow in the business that has allowed us to grow our cash balance while eliminating our bank debt. Let me share with you what we've been up to within each segment of the business starting first with the partner segment. The partner segment grew modestly 2% year-over-year to $7.2 million in the quarter. It's important to note as we look at this segment of our business that we actually acquired some sites from partners whose revenue now gets counted within the owned and operated segment. We made that change in Q2 and at that time it was approximately $1 million a quarter in contribution. It has grown since then as part of our O&O segment. If we adjust the partner revenues for this $1 million, we'd be looking at about a 15% year-over-year growth rate for the segment. We had also mentioned in Q2 that we were expecting a slowdown in revenue in Q3 associated with the sales of automotive clicks. As expected, we did have some weakness in this area, due primarily to a change in the implementation associated with one distribution partner which was the consequence of certain policy changes that were implemented by our advertising partner. However, we have now reengineered this implementation and in fact have redesigned the solution around search links. And we think the new implementation is actually a better solution for all, and we expect to grow this distribution partner modestly over the coming quarters. As we have continued to message, this segment of our business is now made up of what we call the partner ad business and the search links business. For partner ads, we expect to be opportunistic in our sales efforts. We will be strategic about accounts we sign thinking about them in the context of search links as was the case for the automotive example I cited earlier. Recently the new partner ads clients we have signed up have been mobile app publishers and they are already delivering hundreds of thousands of highly targeted mobile clicks to advertisers monthly. Overall, this business has been a solid cash flow generator for us and we've had only very minor issues following the shift we made about two years ago to higher quality partners and purging those who didn't meet our quality thresholds. We remain focused and committed within the segment of our business to delivering on the promise of search links. As we have previously mentioned, we are entering the native advertising market with this product. It's already a multi-billion dollar and growing marketplace but more importantly, it's a market in which we believe we can be competitive, both from a technical perspective and a core competency perspective. Since we officially launched in July, we've been exceptionally busy focusing on a small set of in-market new accounts to assure we could deliver and perform for these new partners prior to making additional investments in sales and account management that will be required to scale the offering. With the multitude of operating systems, phones, browsers, tablets and other assorted environments available to consumers, this product launch is exceptionally challenging. And of course as a result subject to a high level of competitive differentiation for Inuvo. This barrier to entry was one of the reasons we entered this market. We purposely managed the scale of search links through August and September at about the same rate we reported in the July launch which was about $10,000 a day. This has allowed us to make product and operating decisions built around the learnings from this set of smaller publishers where if things didn't work out we wouldn't be at risk of potentially larger relationships in the future. This approach identified a number of important features that have subsequently been completed in October. We think we are now ready to scale beginning slowly for the rest of Q4 and accelerating into 2016. We have a solid pipeline and we are routinely setting up several new sites weekly. We also believe we can now move our sales efforts upstream to larger publishers. The majority of our focus within the partner segment will remain targeted at making search link successful. We will be hiring more engineers, data scientists, account management people and sales people in the segment as we scale the business. We had an outstanding quarter within the owned and operated segment of the business. Revenue there grew over 100% year-over-year, the result of additional content, additional sites and new marketing channels. The business did $12 million of revenue in the third quarter. Within this business we have continued to improve the efficiency of our content teams. In Q3, our team produced 50% more content than they did in Q2, also launching several new forms of content including in-house produced videos and image galleries. Within the quarter, we also began our efforts to build out our own in-house photography and video production capabilities. This effort underscores our dedication to an understanding of the importance of creating high quality original photography and video in an effort to improve the experience for our users as in-house produced image and video library will be a valuable asset in the development of additional and unique content, as well as enabling additional advertising and social marketing activity. Speaking of marketing efforts, this increase in content and content and types has supported extensive testing of no less than five native advertising platforms which we could use as new sources of traffic to all of our websites within the O&O segment. We worked extensively on our living and travel sites in Q3 and plan to continue to do so throughout Q4. With the industry wide growth in social sharing, generally, you shouldn't be too surprised to be hearing that we are also introducing additional social sharing functionality within the sites that will make it just that much easier to share content with family and friends. From a technology perspective Q3 was an important quarter. We continued to improve the marketing technology we had developed that supports our efforts to attract an audience. Collectively, all of these new changes resulted in a 30% increase in new users and a 25% increase in the average time spent on our site for each user quarter-over-quarter. Our continued growth in both users and page views has also allowed us to attract premium advertising which in turn is leading to an increase in the revenue we generate on the sites from display advertising. This increased viewership has also resulted in more advertising clicks which were up 60% quarter-over-quarter. Now this is all very encouraging and aligns with our overall initiative to increase revenue without proportionally increasing marketing expense. We of course continue to expand within our own sites the use of search links and the development of new search links ad units that will ultimately be offered more generally. This remains a significant differentiator for Inuvo. We continue to experience click through rates for search links on our own sites that are better than alternative products we could place in the same locations. And the revenue we generate from search links on our O&O sites will continue to rise over time. I'd like to now turn the call over to Wally.

[Wally Ruiz:]

Thank you, Rich. Good afternoon, everyone. Today we reported another consecutive quarter of strong revenue growth, profitability and cash flow. Inuvo reported revenue of $19.3 million in the third quarter of 2015 compared to $13 million in the same quarter last year, a 48% increase. The partner network which delivers advertisements to our partners' websites and applications reported $7.2 million in the third quarter this year compared to $7.1 million in the same quarter last year, a 2% increase. As mentioned at last quarters teleconference, the high volume of automotive advertising we experienced in the second quarter was not expected and it didn't materialize in the third quarter. In addition, the sites we acquired from a partner earlier this year now has its revenue recorded in the owned and operated segment which had the effect of lowering the partners' segment revenue and increasing the revenue in the Owned and Operated segment. Revenue as Rich mentioned, shifted about a $1 million per quarter when we acquired the sites earlier this year and has since grown quickly under Inuvo's ownership. The owned and operated network which is made up of a collection of websites and apps we own, and where income is derived from advertisements represented 62% of the company's total revenue in the current year quarter. The owned and operated network reported $12 million of revenue in the third quarter of 2015 which is 102% increase over the same quarter last year. The growth in this business segment is largely due to the investment made in proprietary content, effective marketing campaigns, and the acquisition of additional sites. Gross profit in the third quarter of 2015 was $13.4 million dollars compared to $7.1 million dollars last year, an 88% improvement. Gross profit as a percent of revenue was 69% in the third quarter of 2014 compared to 55% in the same quarter last year. The increase in this percentage is largely due to the mix between partner and Owned and Operated revenue where there was a shift towards the higher margin Owned and Operated network. Partner network gross profit in the third quarter of 2015 was approximately $1.4 million compared to $1.2 million last year. The improved gross profit in this year's quarter was primarily due to higher revenue associated with 13% more clicks on ads than during the same quarter last year, partially offset by somewhat lower RPC or revenue per click this year compared to same quarter last year. Gross profit in the Owned and Operated segment in the third quarter of 2015 was $12 million compared to $5.9 million last year. The higher gross profit in this year's quarter compared to last year is primarily due to higher revenue. Operating expense which is comprised of marketing cost, compensation expense, and selling and general and administrative expense was $12.7 million in the third quarter of 2015 compared to $6.7 million the same quarter last year. Marketing cost of the primary cost associated with the Owned and Operated network where dollars are spent to build an audience for the various sites and apps that we own. Marketing cost were $10.2 million in the third quarter of this year compared to $5.9 million increase over last year's quarter. The higher marketing spend allows us to build an audience while also driving rates like the 102% increase we saw in O&O revenue that we experienced in the third quarter. Compensation expense increased by $348,000 to $1.5 million in the third quarter of 2015 compared to the same quarter last year. The higher expense in the current year quarter is primarily due to higher payroll associated with additional hiring and company incentive plans. At September 30, 2015, we had 61 full-time and part-time employees, that compares to 50 full-time and part-time employees at the same time last year. SG&A expense, selling, general and administrative expense was $1 million in the third quarter of 2015 compared to $1.2 million in the same quarter last year. For the remainder of the year we will continue to invest in growth, recognizing that scale in our business model provides future opportunities for margin enhancement. We will continue to expand our web properties and market our native advertising product search links. We therefore expect marketing costs to increase in coming quarters, to measure it with growing revenue in the Owned and Operated network. We expect compensation expense to increase as we step up hiring, particularly to support the rollout of search links, and we expect SG&A expense to remain relatively flat. Net interest expense was $23,000 in the third quarter of this year, $62,000 less than last year's quarter and is due to lower loan balances this year. The net income from discontinued operations was $32,000 in the third quarter of this year compared to $23,000 net income last year – in the same quarter of last year. The income was due to foreign exchange translation adjustment, a favorable adjustment, and the extinguishing of very old publisher liabilities in the UK. The company reported a net income in the third quarter of this year of $651,000 or $0.03 per diluted share compared to $304,000 or $0.02 per diluted share in the prior year quarter, an increase of 61% year-over-year. EBITDA adjusted for stock-based compensation expense was $1.3 million in the quarter that ended September 30 of this year compared to $1.2 million in the same quarter of last year. Over the past several years, Inuvo has been able to generate an increasing cash flow. In the nine months of 2015 we have generated $4.1 million of free cash flow which as Rich pointed out earlier equates to $0.17 per diluted share. This is more than double the approximately $2 million of free cash flow we generated in the nine months of 2014. The results being by September 30 we reached a milestone at Inuvo, the full repayment of all of the outstanding bank debt. Also at September 30, 2015 we had on our balance sheet cash and cash equivalents of $3.9 million dollars. So with that I'd like to turn it back to Rich.

[Richard Howe:]

Thanks, Wally. In summary, we've had an exceptional third quarter and the first three quarters of 2015. On a trailing 12 month basis we now have a bank debt-free business that has delivered $65 million in revenue, $2.4 million in net income, $4.9 million in adjusted EBITDA, and $5.1 million in free cash flow. The focus for the foreseeable future remains to expand the content within the O&O segment and broadly distribute search links within the partner segment, and we have exciting plans in place to accomplish both. We continue to be vigilant to potential acquisitions we might make favoring the O&O business where valuations are currently attractive. October revenue has been solid, and as a result we are currently forecasting annual revenue for 2015 between $66 million and $68.5 million. The low end of this range implies a 33% year-over-year growth rate in 2015 and the high end implies 38%. With that, I'd like to now turn the call over to the operator for questions. Operator?

[Operator:]

Thank you. [Operator Instructions] And we'll take our first question from William Gibson with Roth Capital Partners. Please go ahead sir.

[William Gibson:]

Hi, Rich. You talked about number of users being up 30% and time spent up 25%. Can you share with us roughly what that number is in terms of users and time spent?

[Richard Howe:]

I don't have the time spent directly with me Bill, but we've said – I think we said as recently as last quarter or the quarter before while that we are running around 4 million uniques, and then I think we told everybody we're running five million uniques, and what I can tell you is we're running about 6.5 million unique visitors a month now, and that's your 30-odd percentage points.

[William Gibson:]

Good. And do you measure stickiness at O&O, in other words, did you increase marketing and someone comes to your site, do you have measurements of how often they return or what percent becomes a regular?

[Richard Howe:]

We do track that, it's not a – you can't track it perfectly because the technological methods used to track expire. But yes, we track everything and anything we can about our users and that's why we give those two metrics we just gave which was the growth and the number of people we see coming uniquely, and then the amount of time they spend on the site that the latter being a measure of what we call the engagement. We want people to not just show up but hang around, and obviously we want them to hang around because the longer they spend with us, the greater the opportunity we have to make money while giving them what they want.

[William Gibson:]

And just one last one and then I'll turn it over to someone else. Could you maybe give us a little more detail on the penetration of search links at the partner networks? I know it's relatively just introduced but…

[Richard Howe:]

Yes, we're pretty pleased with the progress we've already made with a product that's quite frankly brand new. So you can just do the math on it yourself, we're doing about $10,000 a day, that's roughly a $1 million a quarter. The partner business is doing $7 million, so it's a product that didn't exist nine months ago, that's already – whatever that is Wally, 15% of revenue in that segment and of course we believe that overtime that search links business is going to be the business for our partner business. So we're excited about it and we're – and as a result we're being calculated with regard to how we go to market with the product, we're being diligent in making sure that we don't make missteps because many of us here have introduced products in the past and we know that if you make some mistakes and missteps early on you can, you can cause yourself some grief down the road. So we're being very calculated about it and I'm pleased right now.

[William Gibson:]

Thanks, Rich.

[Operator:]

And we'll take our next question from Amit Dale [ph] with HC Wainwright & Company. Please go ahead, sir.

[Unidentified Analyst:]

Thank you. Congratulations guys on the traction. You guys are seeing – my main question is around growth in marketing spend versus growth in revenues. Is there a level where we cap – we or the management looks to cap marketing spend as a percentage of overall revenues?

[Richard Howe:]

Amit, we don't look at it that way in terms of capping it out. We look at a different way. We think about our marketing activity in regards to our efforts to build a world-class audience for our digital publishing business. That's no small thing to do at the 6.5 million or so unique visitors we have right now which we kind of look at as being our audience which is it is, that's a significant audience relative to anybody else as audience that you might think about. The key to being successful and making that audience be 2X, 3X or 4X that size is in part marketing, particularly early on when you're building a digital publishing business, frankly because you're trying to also build a brand. So the old thought process that you could build a site like we have with a lot, populate it with great content like we have and great technology and then just sit there and hope that you're going to build an audience is I think not practical in today's DNA. So the key to being successful in a digital publishing business is doing the kinds of things we are doing which is having an extreme competency in marketing, having an extreme competency in ad delivery, and being good at delivering content. Wally, do you want to add something there?

[Wally Ruiz:]

Yes, I think I mean if you're – if there is a ceiling here, the ceiling is that we will remain – we will expand marketing just like Rich said but we will remain profitable and still generate cash. So if there is a ceiling that is it.

[Richard Howe:]

I think it's not something to fear, it's something to look at – when you look at our new one and say, wow, clearly they have a core competency in this area otherwise they wouldn't be making any money. And I think it is a differentiator for us because many other companies don't have that competency and as a result can't build a digital publishing business as fast or as big as we have and still have the room to make it even bigger.

[Unidentified Analyst:]

Right, I agree. I think you know the studies into the previous callers, question about stickiness, I mean if we could see a little bit more leverage coming out of the spend, I think we would probably see a lot stronger bottom line. That's what I'm trying to get at in terms of – revenues are growing really fast, especially on the O&O side which has higher margins for you but some of those margins sort of go away. On the marketing spend what do we do to increase stickiness if these monthly unique is growing so that we start seeing a stronger bottom line as well?

[Richard Howe:]

Yes, I think you are right. I mean you're clearly right about the way you're looking at it and I guess the answer I would say to you is, in our business model scale has efficiencies. And so the bigger we get, the better we are in attracting large advertisers. The more we can better negotiate deals with them for higher revenues on the advertising place. The more we do video, for example, it gives us the ability to introduce a new type of advertising. These are all techniques and tactics and features that we are embedding in the site that upon scale should translate at scale to more leverage.

[Unidentified Analyst:]

Right. Just a final question from my side on the searching links product. On the strategy and I agree with you, you are taking your time to make sure you have the right product for the customers. But from ad deck industry point of view, we always see something new come to the market and things change fast. Is there a risk that you know the time we're taking to put this product out in the market and leverage our revenues from it would hurt us in the sense that there could be other technologies, other offerings coming to the market, you know users could veer towards other options. So in terms of accelerating the process to bring this to the market could we be doing things faster? Is there any risk around the approach you are taking?

[Richard Howe:]

I think the question is a good question and there is always risk, particularly in an ad tech market that we're playing in that does as you pointed out move very, very rapidly. I don't think with this particular product and the market we're entering that there is a large risk associated with what you've described. So that's point one. Point two is, I don't think we could possibly have moved any faster with the development testing and deployment of this product. And I believe that large part because our business model was built around being able to test this of course within our own properties which is an advantage we have that other ad tech companies do not possess. So I feel really good about the length of time it's taken us to get here. And I think at this point we are feeling pretty comfortable that we've got the product that we wanted. And we should start at this point to scale, and I'll give you an example just for everybody's benefit who is on the phone because it may be to give you some insight. I'll give you one example of something we learned in the third quarter as part of our in-market test. So we had a number of publishers that launched the product who themselves had relationships with certain advertisers that would want them to have us actually exclude advertisers from the results. Though basically you know they are already doing business with one person and they don't want to see the competitors of that person show up in any ads that get shown. This was not a feature that we had placed in the product. We knew it might exist but we just didn't think it was going to be that important but it was coming up over and over again, so we had to put it in there because we knew that if it's showing up in quite a few of the people that it will probably show up in many of the bigger ones. And quite frankly it's something – the bigger publishers will want more than the smaller publishers will. But there is an example for you Amit, one thing that happened, that we learned that is part of our process.

[Unidentified Analyst:]

That's great. And I think you guys are doing a great job on all these fronts. Just one final question I guess, now that the debt has been paid off and really good job on generating the cash flow to do this, should we eliminate all interest expenses that we have projected in our model going forward?

[Wally Ruiz:]

I wouldn't say eliminate all but it will be pretty insignificant.

[Unidentified Analyst:]

Okay, got it. Thank you.

[Operator:]

And we'll go ahead and take our next question from Lisa Thompson with Zacks Investments. Please go ahead.

[Lisa Thompson:]

Good afternoon. So Rich, I am fascinated about the fact that you've managed to increase content 50% but yet only add 11 employees. Is there some sort of magic going on or how does that work and how is that going forward?

[Richard Howe:]

I don't think its magic, Lisa. It's more – we're just – the team that we've got that writes this content is now getting very, very efficient, both in the writing and in the integration of that writing with the marketing and ad technologies that we have. So I would chalk it up to efficiency. This is not a very expensive part of our business as a side note, a lot of people ask us lot of times, boy it must be expensive to produce as much content as you do, at the scale that you're producing at, and we remind everybody that one of the reasons why we actually moved to Arkansas wasn't part because we have a pretty healthy university system that surrounds where our headquarters are located and as a result, we have the ability to tap into a lot of college students who are either still in college in the work on a part-time basis with us as interns or graduates, mainly out of college, who are now working for us full-time in various writing profession. So I think it's just by design, we kind of set it up right and we're seeing the efficiencies.

[Lisa Thompson:]

That's great. Coming back to search links, is there any place you can go to see at live or are you not kind of letting anybody know who the customers are yet?

[Richard Howe:]

We're pretty careful about giving out publishers that aren't our own sites but we're happy to show you a plethora of examples where it's running on the allotted sites. We will – at some point we'll start disclosing some publishers who are using it, but we're just trying to be very, very cautious right now as you can imagine it's a competitive environment and we're just were sort of militant about our competition and wanting to win.

[Wally Ruiz:]

Yes, Lisa we would be happy to walk you through it but if you go to healththatalot.com [ph] you'll probably see it yourself on the bottom of the page.

[Lisa Thompson:]

Right. I was just wondering with when we're going to see some outside customers, the physical?

[Richard Howe:]

Hang in there, we'll throw you some bones here.

[Lisa Thompson:]

Alright, anytime soon. And then I'm curious to go back to the competitive pitch you make with search joints. You said that you had success on your own sites where you've had better results in using competitors' products. Can you talk about that a little, like quantitative figure, how do you go in and pitch this when you're going up against to bowl out [ph] someone?

[Richard Howe:]

Well, we don't have to pitch them, we have everybody on the planet because we have 6.5 million unique's now wanting to be an advertiser on our sites. So these people are all coming to us, so we don't have to pitch them at all. So as a result because the one that runs this P&L for us is a digital publishers, she wants to make the most money possible. So search links have to compete with her for anything else that she could put in that spot which makes it very interesting because that – you know we've got two P&Ls right, we've got a partner P&L and O&O P&L. On the partner P&L there are multiple for search links and there they are trying to sell that P&L owner this product and she wouldn't put it there if it wasn't beating all the alternatives.

[Wally Ruiz:]

Lisa, you're talking about how we compete with a competitor for a publisher spot or are on our own?

[Richard Howe:]

On our own.

[Lisa Thompson:]

Yes, but she is making a decision right, whether it's you or the other two or three people that she could use. And you're saying…

[Richard Howe:]

Exactly the same way it is in the market for us Lisa which is why the model works really well, now of course we could force it on her, right?

[Lisa Thompson:]

Right

[Richard Howe:]

But she – we kind of like the way it's set up to have to compete because she is going to act exactly like every other publisher that we're going to sell this product to and which she does.

[Lisa Thompson:]

Right. So is there anything – I mean, you said you get better results, like quantitatively, what does that mean?

[Richard Howe:]

It's mean that the click through rates on the ad unit is better than the alternatives. And as a result, it's generating more revenue for us in that spot which is exactly one of a number of the pitches that we have and we go out and sell publishers, the other one being the alignment with the content which we think is better than anybody else's product in the marketplace.

[Lisa Thompson:]

And how do you measure that or how do they measure it when they look at it?

[Richard Howe:]

It's hard, they can't measure it but they look at the product and the page it's on. Let's say you wrote an article about sunscreens and you have ads showing that have nothing to do with sunscreen. Well that's a pretty good indication that you don't have a good match, right. Of course our approach to that as is technological, we read the page, we extract the essence of the page and then we pick from all library of ads that are aligned.

[Lisa Thompson:]

And that's all automated?

[Richard Howe:]

All automated.

[Lisa Thompson:]

Okay, cool, great. That sounds great, look forward to seeing you progress on this. Thank you.

[Richard Howe:]

Thanks, Lisa.

[Operator:]

[Operator Instructions] And it appears there are no further questions at this time.

[Richard Howe:]

That's great. 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:]

That does conclude today's conference. We'd like to thank you for your participation.