Company Quick10K Filing
Quick10K
Inuvo
Closing Price ($) Shares Out (MM) Market Cap ($MM)
$1.22 34 $42
10-Q 2018-09-30 Quarter: 2018-09-30
10-Q 2018-06-30 Quarter: 2018-06-30
10-Q 2018-03-31 Quarter: 2018-03-31
10-K 2017-12-31 Annual: 2017-12-31
10-Q 2017-09-30 Quarter: 2017-09-30
10-Q 2017-06-30 Quarter: 2017-06-30
10-Q 2017-03-31 Quarter: 2017-03-31
10-K 2016-12-31 Annual: 2016-12-31
10-Q 2016-09-30 Quarter: 2016-09-30
10-Q 2016-06-30 Quarter: 2016-06-30
10-Q 2016-03-31 Quarter: 2016-03-31
10-K 2015-12-31 Annual: 2015-12-31
8-K 2019-02-19 Regulation FD, Exhibits
8-K 2019-02-06 Enter Agreement
8-K 2019-01-28 Enter Agreement
8-K 2019-01-28 Enter Agreement
8-K 2019-01-14 Regulation FD, Exhibits
8-K 2018-12-17 Regulation FD, Exhibits
8-K 2018-11-08 Regulation FD, Exhibits
8-K 2018-11-01 Other Events, Exhibits
8-K 2018-10-11 Enter Agreement, Other Events
8-K 2018-09-25 Enter Agreement
8-K 2018-09-06 Regulation FD, Exhibits
8-K 2018-09-04 Enter Agreement
8-K 2018-07-13 Officers
8-K 2018-07-09 Earnings, Exhibits
8-K 2018-06-29 Shareholder Vote
8-K 2018-05-22 Other Events
8-K 2018-05-16 Regulation FD, Exhibits
8-K 2018-05-15 Other Events, Exhibits
8-K 2018-05-11 Enter Agreement
8-K 2018-05-03 Earnings, Regulation FD, Exhibits
8-K 2018-04-24 Other Events
8-K 2018-04-03 Regulation FD, Exhibits
8-K 2018-03-06 Enter Agreement, Exhibits
8-K 2018-02-07 Earnings, Regulation FD, Exhibits
WPP WPP
IPG Interpublic Group of Companies
ANGI Angi Homeservices
QUOT Quotient Technology
NCMI National Cinemedia
FLNT Fluent
TLRA Telaria
HHS Harte Hanks
IZEA IZEA
ISIG Insignia Systems
INUV 2018-09-30
Part I - Financial Information
Item 1. Financial Statements
Note 1 - Organization and Business
Note 2 - Summary of Significant Accounting Policies
Note 3- Property and Equipment
Note 4 - Other Intangible Assets and Goodwill
Note 5 - Revolving Credit Line
Note 6 - Accrued Expenses and Other Current Liabilities
Note 7 - Other Long-Term Liabilities
Note 8 - Income Taxes
Note 9 - Stock-Based Compensation
Note 11 - Earnings per Share
Note 12 - Leases
Note 13 - 2017 Asset Acquisition
Note 14 - Related Party Transactions
Note 15 - Subsequent Events
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Item 4. Controls and Procedures.
Part II
Item 1. Legal Proceedings.
Item 1A. Risk Factors.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Item 3. Defaults Upon Senior Securities.
Item 4. Mine Safety and Disclosures.
Item 5. Other Information.
Item 6. Exhibits.
EX-10.1 inuv-ex1012018093018xq3.htm
EX-10.3 inuv-ex1032018093018xq3.htm
EX-10.4 inuv-ex1042018093018xq3.htm
EX-10.5 inuv-ex1052018093018xq3.htm
EX-31.1 inuv-ex3112018093018xq3.htm
EX-31.2 inuv-ex3122018093018xq3.htm
EX-32.1 inuv-ex321x2018093018x.htm
EX-32.2 inuv-ex3222018093018xq3.htm

Inuvo Earnings 2018-09-30

INUV 10Q Quarterly Report

Balance SheetIncome StatementCash Flow

Document
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)

x     QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018 
OR

o      TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________________ to ______________________
 
Commission file number: 001-32442
inuv-20180930_g1.jpg
Inuvo, Inc.
(Exact name of registrant as specified in its charter)

Nevada
87-0450450
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
 Identification No.)
500 President Clinton Ave., Suite 300 Little Rock, AR
72201 
(Address of principal executive offices)
(Zip Code)
(501) 205-8508
Registrant's telephone number, including area code
not applicable
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for at least the past 90 days.     Yes    x    No   o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes    x    No   o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company.  
Large accelerated filer
o
Accelerated filer
o
Non-accelerated filer
o
Smaller reporting company
x
Emerging growth company
o
If an emerging growth company, indicate by checkmark if the registrant has not elected to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 7(a)(2)(B) of the Securities Act:  o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o No  x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Title of Class November 2, 2018
Common Stock 32,435,446 




TABLE OF CONTENTS

Page No.
Part I 
Item 1. Financial Statements. 
Consolidated Balance Sheets 
Consolidated Statements of Operations 
Consolidated Statements of Cash Flows 
Notes to Consolidated Financial Statements 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 
Item 4. Controls and Procedures. 
Part II 
Item 1. Legal Proceedings. 
Item 1A. Risk Factors. 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 
Item 3. Defaults upon Senior Securities. 
Item 4. Mine Safety and Disclosures. 
Item 5. Other Information. 
Item 6. Exhibits. 
Signatures 


2


CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “will,” “should,” “intend,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue,” or the negative of such terms or other comparable terminology. This report includes, among others, statements regarding our:

• risks associated with our pending Merger;
• material dependence on our relationships with Yahoo!, Google and other demand partners and risks associated with declining revenue from Yahoo!;
• dependence on our financing arrangements with Western Alliance Bank; which is collateralized by our assets;
• dependence on relationships with supply partners and the introduction of new products and services, which require significant investment;
• the seasonality of our business and restricted cash flow during seasonal low periods;
• dependence on our ability to effectively market and attract traffic to our sites;
• risks associated with our failure to adhere to the covenants and restrictions in our grant agreement with the state of Arkansas;
• need to keep pace with technology changes;
• fluctuations of quarterly financial results and the trading price of our common stock;
• vulnerability to interruptions of services;
• dependence on key personnel;
• vulnerability to regulatory and legal uncertainties and our ability to comply with applicable laws and regulations;
• need to protect our intellectual property;
• vulnerability to publishers who could fabricate clicks;
• vulnerability to a downturn and to uncertainty in global economic conditions; and
• the dilutive impact to our stockholders from outstanding restricted stock grants and options.

These forward-looking statements were based on various factors and were derived utilizing numerous assumptions and other factors that could cause our actual results to differ materially from those in the forward-looking statements. Most of these factors are difficult to predict accurately and are generally beyond our control. You should consider the areas of risk described in connection with any forward-looking statements that may be made herein. Readers are cautioned not to place undue reliance on these forward-looking statements and readers should carefully review this report in its entirety, including the risks described in Part II, Item 1A. Risk Factors appearing in this report, together with those appearing in Item 1A. Risk Factors, in our Annual Report on Form 10-K for the year ended December 31, 2017 as filed with the SEC on February 8, 2018 and our subsequent filings with the Securities and Exchange Commission.

Except for our ongoing obligations to disclose material information under the Federal securities laws, we undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events. These forward-looking statements speak only as of the date of this report, and you should not rely on these statements without also considering the risks and uncertainties associated with these statements and our business.

OTHER PERTINENT INFORMATION

Unless specifically set forth to the contrary, when used in this report the terms "Inuvo," the “Company,” "we," "us," "our" and similar terms refer to Inuvo, Inc., a Nevada corporation, and its subsidiaries. When used in this report, "third quarter 2018" means for the three months ended September 30, 2018, "third quarter 2017" means for the three months ended September 30, 2017, “2017” means the fiscal year ended December 31, 2017 and "2018" means the fiscal year ending December 31, 2018. In February 2017, the Company acquired the assets and certain liabilities of a technology company, NetSeer, Inc. This acquisition will be referred to throughout the filing as the “2017 asset acquisition." The information which appears on our corporate web site at www.inuvo.com is not part of this report.

3


PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

INUVO, INC.
CONSOLIDATED BALANCE SHEETS
September 30, 2018 (Unaudited) and December 31, 2017 
20182017
Assets 
Current assets 
Cash $4,190,274 $4,084,686 
Accounts receivable, net of allowance for doubtful accounts of $43,727 and $83,789, respectively. 5,614,031 10,759,250 
Prepaid expenses and other current assets 307,256 400,191 
Total current assets 10,111,561 15,244,127 
Property and equipment, net 2,260,967 2,306,279 
Other assets 
Goodwill 9,853,342 9,853,342 
Intangible assets, net of accumulated amortization 9,779,307 10,808,018 
Other assets 35,171 36,070 
Total other assets 19,667,820 20,697,430 
Total assets $32,040,348 $38,247,836 
Liabilities and Stockholders’ Equity 
Current liabilities 
Accounts payable $9,021,255 $13,614,053 
Accrued expenses and other current liabilities 2,456,831 2,887,816 
Revolving credit line 4,825,000 4,900,000 
Total current liabilities 16,303,086 21,401,869 
Long-term liabilities 
Deferred tax liability 2,331,900 2,331,900 
Other long-term liabilities 250,959 426,725 
Total long-term liabilities 2,582,859 2,758,625 
Stockholders’ equity 
Preferred stock, $.001 par value: 
Authorized shares 500,000, none issued and outstanding   
Common stock, $.001 par value: 
Authorized shares 40,000,000; issued shares 32,810,202 and 28,994,981, respectively; outstanding shares 32,433,675 and 28,618,454, respectively 32,811 28,996 
Additional paid-in capital 138,779,584 136,033,967 
Accumulated deficit (124,261,433)(120,579,062)
Treasury stock, at cost - 376,527 shares (1,396,559)(1,396,559)
Total stockholders' equity 13,154,403 14,087,342 
Total liabilities and stockholders' equity $32,040,348 $38,247,836 
 
See accompanying notes to the consolidated financial statements.
4


INUVO, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three and Nine Months Ended 2018 and 2017 
(Unaudited)
For the Three Months Ended September 30, For the Nine Months Ended September 30, 
2018201720182017
Net revenue $16,806,170 $20,311,502 $56,315,006 $55,798,545 
Cost of revenue 6,196,057 9,649,295 21,965,955 25,161,761 
Gross profit 10,610,113 10,662,207 34,349,051 30,636,784 
Operating expenses 
Marketing costs (traffic acquisition costs or TAC) 8,285,465 7,161,905 25,025,922 21,122,489 
Compensation 1,806,111 2,363,901 6,749,280 7,053,308 
Selling, general and administrative 1,859,020 2,025,254 5,968,233 6,308,552 
Total operating expenses 11,950,596 11,551,060 37,743,435 34,484,349 
Operating loss (1,340,483)(888,853)(3,394,384)(3,847,565)
Interest expense, net (101,167)(97,318)(296,612)(212,922)
Loss from continuing operations before taxes (1,441,650)(986,171)(3,690,996)(4,060,487)
Income tax benefit   8,625  
Net loss from continuing operations (1,441,650)(986,171)(3,682,371)(4,060,487)
Net loss from discontinued operations    (1,109)
Net loss (1,441,650)(986,171)(3,682,371)(4,061,596)
Per common share data 
Basic and diluted: 
Net loss from continuing operations $(0.04)$(0.03)$(0.12)$(0.14)
Net loss from discontinued operations     
Net loss $(0.04)$(0.03)$(0.12)$(0.14)
Weighted average shares 
Basic 32,316,988 28,553,055 30,540,796 28,030,902 
Diluted 32,316,988 28,553,055 30,540,796 28,030,902 
 
See accompanying notes to the consolidated financial statements.
5


INUVO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

For the Nine Months Ended September 30, 
20182017
Operating activities: 
Net loss $(3,682,371)$(4,061,596)
Adjustments to reconcile net loss to net cash used in operating activities: 
Depreciation and amortization 2,371,958 2,239,498 
Stock based compensation 827,595 923,072 
Amortization of financing fees 19,200 19,200 
(Recovery) Provision of doubtful accounts (40,062)138,789 
Adjustment of European liabilities related to discontinued operations  1,109 
Change in operating assets and liabilities: 
Accounts receivable 5,183,579 (237,078)
Prepaid expenses and other current assets 74,634 81,485 
Accounts payable (4,592,798)(1,099,692)
Accrued expenses and other liabilities (445,857)(967,553)
Net cash used in operating activities (284,122)(2,962,766)
Investing activities: 
Purchases of equipment and capitalized development costs (1,300,179)(1,062,811)
Net cash received from 2017 asset acquisition  235,763 
Net cash used in investing activities (1,300,179)(827,048)
Financing activities: 
Net proceeds from sale of common stock 2,000,583  
Net (payments) proceeds on revolving credit line (75,000)5,000,000 
Net taxes paid on RSU grants exercised (77,044)(97,376)
Payments on capital leases (158,650)(97,300)
Treasury stock repurchase  (44,772)
Payoff of 2017 asset acquisition debt acquired  (2,015,577)
Net cash provided by financing activities 1,689,889 2,744,975 
Net change – cash 105,588 (1,044,839)
Cash, beginning of year 4,084,686 3,946,804 
Cash, end of period $4,190,274 $2,901,965 
Supplemental information: 
Interest paid $287,374 $180,796 
Non cash investing and financing activities: 
2017 asset acquisition stock issuance (See Note 13) $ $4,459,244 
Purchase of property and equipment under capital lease $ $523,518 
Write-down of domain names and corresponding contingent liability  $ $222,477 
 
See accompanying notes to the consolidated financial statements.
6


Inuvo, Inc.
Notes to Consolidated Financial Statements
(Unaudited)

Note 1 – Organization and Business
 
Company Overview
 
We develop technology that connects advertisers with consumers through interactions with content across devices. Inuvo provides the means to interact with tens of thousands of advertisers ("Demand") and tens of thousands of online publishers ("Supply"). We interact with Demand/Supply constituents directly and indirectly. We serve ads that associate with images, content, video and slideshows. We generate revenue from buyers of advertising inventory which include media partners, advertisers, agencies, agency trading desks, demand-side platforms and ad networks, collectively “Demand.” Our solution incorporates a proprietary form of artificial intelligence (“AI”) branded the IntentKey. This sophisticated machine learning technology uses interactions with Internet content as a source of information from which to determine Intent. The AI solution includes a continually updated database of over 500 million machine profiles which we utilize to deliver highly targeted online audiences to our Demand customers. We earn revenue when consumers view and/or click on our ads. Our business scales as we add Demand and Supply relationships.

We count among our many contractual relationships, three clients who collectively manage over 50% of all US digital advertising budgets. Included within our Supply portfolio is a collection of owned websites such as alot.com and earnspendlive.com, where we create content in health, finance, travel, careers, auto, education and living categories. These sites provide the means to test advertising technologies, while also delivering high quality consumers to advertisers through interaction with proprietary content in the form of images, videos, slideshows and the written word.
 
There are many barriers to entry to our business including the ability to process billions of transactions daily. Our intellectual property is protected by 15 issued and eight pending patents.

Liquidity

On October 11, 2018, we entered into the Amended and Restated Business Financing Agreement (the “Amended and Restated Financing Agreement”) with Western Alliance Bank. The Amended and Restated Financing Agreement, which is secured by all of our assets, superseded in its entirety the prior the Business Financing Agreement, as amended, that we entered into on March 1, 2012 with Bridge Bank, N.A. which is now owned by Western Alliance Bank. The Amended and Restated Financing Agreement does not have a term and either party may terminate upon notice to the other party. As a result of the amended terms of our lending relationship with Western Alliance Bank, we have additional access to credit (See Note 5 in the Notes to Consolidated Financial Statements).

In May 2018, we completed our underwritten public offering of 2,860,000 shares of our common stock at a public offering price of $0.70 per share and an additional 429,000 shares to cover overallotments in connection with the offering. The net proceeds after deducting the underwriting discounts and commissions and estimated offering expenses payable was approximately $2.1 million.

During the third quarter of 2017, we filed an S-3 registration statement with the Securities and Exchange Commission ("SEC") to replace the existing, expiring S-3 "shelf" registration statement, which permits us to offer and sell up to $15 million of our securities from time to time in one or more offerings. In May 2018, we took down from this shelf registration statement approximately $2.3 million in the underwritten public offering.

For the three months ended September 30, 2018, our revenues declined 17.3% from the same quarter in the prior year. The lower revenue in this year’s quarter is principally responsible for our $1.4 million net loss in the third quarter of 2018. Since our credit facility is dependent upon receivables, the We do not know when, if ever, that our revenues will return to historic levels or if we will be able to replace those lost revenues with revenues from other demand partners. The combination of lower credit availability and negative cash flows generated from operating activities raises concern about our ability to continue without interruption. As described in note 15 to the notes to consolidated financial statements appearing earlier in this report, on November 2, 2018, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with ConversionPoint Technologies, Inc. (“CPT”) and certain related parties which provides that at the closing of this pending transaction (the “Merger”), which is subject to a number of conditions precedent, the Company will become a wholly-owned subsidiary of CPT. There are no assurances the Merger will be consummated. In addition, on November 2, 2018, we borrowed $1 million from an affiliate of CPT which we are using for working capital, and on November 2, 2018, four directors of the Company lent us $62,500 each, for an aggregate of $250,000, to cover certain costs associated with the pending Merger. Subject to the terms of
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the Merger Agreement and the credit facility with the additional borrowing, we believe we will have sufficient cash and credit to operate until the Merger closes. There are no assurances we will be successful in our efforts to generate revenues, report profitable operations or close the Merger in which case we would need to find additional sources of credit and make substantial reductions to operating expense.

Customer concentration

We generated the majority of our revenue from two Demand side customers, Yahoo! and Google as noted below:
For the Three Months Ended September 30, For the Nine Months Ended September 30, 
2018201720182017
Yahoo! 75.6 62.1 %72.9 %68.5 %
Google 8.5 8.9 %9.0 %10.8 %
Total 84.1 71.0 %81.9 %79.3 %

As of September 30, 2018, Yahoo! and Google accounted for 70.0% of our gross accounts receivable balance. As of December 31, 2017, two Demand side customers, Yahoo! and OpenX, accounted for 71.3% of our gross accounts receivable balance.

We still source the majority of our Demand revenue through these relationships where we have access to advertiser budgets indirectly. While this strategy creates a concentration risk, we believe that it also provides upside opportunities including; access to hundreds of thousands of advertisers across geographies; the ability to scale our business across verticals; an avoidance of the sales costs associated with a large direct to advertisers’ sales force; access to innovation; overall media budget market insights; attractive payment terms; and low risk on receivables.

Note 2 – Summary of Significant Accounting Policies
 
Basis of presentation
 
The consolidated financial statements presented are for Inuvo, Inc. and its consolidated subsidiaries. The accompanying unaudited consolidated financial statements have been prepared based upon SEC rules that permit reduced disclosure for interim periods. Certain information and footnote disclosures have been condensed or omitted in accordance with those rules and regulations. The accompanying consolidated balance sheet as of December 31, 2017, was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States ("GAAP"). In our opinion, these consolidated financial statements reflect all adjustments that are necessary for a fair presentation of results of operations and financial condition for the interim periods shown including normal recurring accruals and other items. The results for the interim periods are not necessarily indicative of results for the full year. For a more complete discussion of significant accounting policies and certain other information, this report should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2017, which was filed with the SEC on February 8, 2018.

Use of estimates

The preparation of financial statements, in accordance with GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, net revenues and expenses and disclosure of contingent assets and liabilities. The estimates and assumptions used in the accompanying consolidated financial statements are based upon management’s regular evaluation of the relevant facts and circumstances as of the date of the consolidated financial statements. We regularly evaluate estimates and assumptions related to allowances for doubtful accounts, accrued sales reserve, goodwill and purchased intangible asset valuations, lives of intangible assets, deferred income tax asset valuation allowances and stock compensation. Actual results may differ from the estimates and assumptions used in preparing the accompanying consolidated financial statements, and such differences could be material.

Revenue Recognition 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (Topic 606) "Revenue from contracts with Customers." Topic 606 supersedes the revenue recognition requirements in Topic 605 “Revenue Recognition” (Topic 605) and requires entities to recognize revenue when control of the promised goods or services is transferred to customers at an amount
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that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company adopted this guidance on January 1, 2018 using the modified retrospective approach. The adoption of Topic 606 from Topic 605 had no cumulative impact on retained earnings and no impact on revenue reported as of September 30, 2018.
Effective January 1, 2018, we recognize revenue following the five-step process outlined in Topic 606. We identify and have on file contracts with all customers. Our contracts with our major search partners pay upon delivery of a click. Additionally, our contracts with advertisers pay upon the serving of impressions. Our performance obligation is met when we deliver a click to a search partner or serve an impression to a digital publisher. We satisfy the performance obligation and recognize revenue when a click occurs from advertisements served to our digital properties or to those of our publishing partners in the period in which the click occurs. We serve as the principal in our contracts because we control the service to be performed by our publishing partners. The Company is ultimately responsible for fulfilling the promise to its customers and has latitude in pricing and publisher selection. There is no transaction price allocated to unsatisfied performance obligation and there were no contract assets or liabilities as of the date of adoption and as of September 30, 2018.

The following table presents our revenue disaggregated by channel:

For the Three Months Ended September 30, For the Nine Months Ended September 30, 
2018201720182017
Mobile $12,532,579 $12,899,583 $39,800,781 $33,241,487 
Desktop 4,014,356 7,202,772 15,671,684 21,790,230 
Other 259,235 209,147 842,541 766,828 
Total $16,806,170 $20,311,502 $56,315,006 $55,798,545 

Recent accounting pronouncements
 
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This standard will require all leases with durations greater than twelve months to be recognized on the balance sheet and is effective for interim and annual reporting periods beginning after December 15, 2018, although early adoption is permitted. We believe adoption of this standard will have an impact on our consolidated balance sheets. Although we have not completed our assessment, we do not expect the adoption to change the recognition, measurement or presentation of lease expenses within the results of operations.

Note 3– Property and Equipment
 
The net carrying value of property and equipment was as follows as of:
September 30, 2018December 31, 2017
Furniture and fixtures $293,152 $288,536 
Equipment 1,525,057 1,509,464 
Capitalized internal use and purchased software 8,809,333 7,582,181 
Leasehold improvements 421,016 455,850 
Subtotal 11,048,558 9,836,031 
Less: accumulated depreciation and amortization (8,787,591)(7,529,752)
Total $2,260,967 $2,306,279 

During the three and nine months ended September 30, 2018, depreciation expense was $457,272 and $1,343,247, respectively. During the three and nine months ended September 30, 2017, depreciation expense was $406,014 and $1,077,143, respectively.








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Note 4 – Other Intangible Assets and Goodwill
 
The following is a schedule of intangible assets as of September 30, 2018:
Term
Carrying Value Accumulated Amortization  
Net Carrying Value
Year-to-date Amortization
Customer list, Google 20 years$8,820,000 $(2,903,250)$5,916,750 $330,750 
Technology 5 years3,600,000 (1,200,000)2,400,000 540,000 
Customer list, all other 10 years1,610,000 (1,059,943)550,057 120,753 
Customer relationships 20 years570,000 (47,500)522,500 21,375 
Trade names, web properties (1) -390,000 — 390,000 — 
Brand 1 year121,000 (121,000) 10,083 
Non-competition agreements 1 year69,000 (69,000) 5,750 
Intangible assets classified as long-term
$15,180,000 $(5,400,693)$9,779,307 $1,028,711 
Goodwill, total 
-
$9,853,342 $— $9,853,342 $— 

(1) The trade names related to our web properties have an indefinite life, and as such are not amortized.
 
Amortization expense over the next five years and thereafter is as follows:
 
2018$337,626 
20191,350,504 
20201,350,504 
20211,350,504 
2022556,294 
Thereafter 4,443,875 
Total $9,389,307 

Note 5 - Revolving Credit Line
 
The following table summarizes our revolving credit line balances as of:

September 30, 2018 December 31, 2017
Revolving credit line - 6.25 percent at September 30, 2018 (prime plus 1.0 percent), due October 20, 2018 $4,825,000 $4,900,000 
Total $4,825,000 $4,900,000 

On October 11, 2018, we entered into the Amended and Restated Business Financing Agreement with Western Alliance Bank and superseded the Business Financing Agreement, as amended, we entered into on March 1, 2012 with Bridge Bank, N.A. which is now owned by Western Alliance Bank. The Amended and Restated Financing Agreement may be terminated by either party upon notice to the other party. As a result of the Amended and Restated Financing Agreement we have access to additional credit. The material terms of the Amended and Restated Financing Agreement include financing eligible invoiced receivables at an advance rate of 85% and an interest rate of prime plus 1% and a sub-limit of up to $2.5 million of uninvoiced eligible receivables at an advance rate of 75% and an interest rate of prime plus 2%. The sub-limit provision expires at the end of January 2019. The Amended and Restated Financing Agreement includes certain fees; a facility fee of $11,765 due at closing; an annual facility fee of 0.25% of the account balance due beginning on April 20, 2019; a monthly maintenance fee of 0.125% of the ending daily account balance; a $30,000 fee in lieu of a warrant; and $75,000 due upon termination of the agreement or repayment of our obligations under the agreement. The Amended and Restated Financing Agreement is secured by all of our assets.

On September 19, 2018, we entered into the Eleventh Business Financing Modification Agreement with Western Alliance Bank that modified the existing agreement by extending the maturity date to October 20, 2018.

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On March 1, 2012, we entered into a Business Financing Agreement with Bridge Bank, which is now owned by Western Alliance Bank. On April 18, 2018, we entered into the Tenth Business Financing Modification Agreement with Western Alliance Bank the parent company of Bridge Bank, N.A., our original lender, that modified the existing agreement. The modified terms require a monthly quick ratio of not less than .60 to 1.00 from February 1, 2018 through November 30, 2018; and a monthly quick ratio of not less than .70 to 1.00 on and after December 31, 2018; and the quarterly consolidated Adjusted EBITDA shall not negatively deviate from financial projections by more than $18,000 for the quarter ending March 31, 2018, $57,000 for the quarter ending June 30, 2018, $191,000 for the quarter ended September 30, 2018 and $496,000 for the quarter ended December 31, 2018, or with respect to any quarter in 2019 and beyond, by more than 25% from projections. In addition, the finance charge for outstanding advances is equal to Prime Rate plus one basis point. The agreement provided us with a revolving credit line of up to $10 million which we use to help satisfy our working capital needs. We have provided Western Alliance Bank with a first priority perfected security interest in all of our accounts and personal property as collateral for the credit facility. Available funds under the revolving credit line are 85% of eligible accounts receivable balances up to a limit of $10 million. Eligible accounts receivable is generally defined as those from United States based customers that are not more than 90 days from the date of invoice less certain contra accounts. 

We had no availability under the revolving credit line as of September 30, 2018 and the outstanding balance due on the revolving line of credit was $4.8 million. We were not in compliance with the agreement’s financial covenants as of September 30, 2018 and received a waiver from the bank of compliance with the financial covenants.


Note 6 – Accrued Expenses and Other Current Liabilities

The accrued expenses and other current liabilities consist of the following as of:
September 30, 2018December 31, 2017
Accrued marketing costs (TAC) $1,654,053 $1,107,404 
Accrued expenses and other 315,524 624,688 
Capital leases, current portion 204,430 209,940 
Accrued payroll and commission liabilities 184,405 867,634 
Accrued sales allowance 50,000 50,000 
Arkansas grant reserve 25,000 2,245 
Accrued taxes 23,419 25,905 
Total $2,456,831 $2,887,816 

Note 7 – Other Long-Term Liabilities
 
Other long-term liabilities consist of the following as of:
September 30, 2018December 31, 2017
Capital leases, less current portion $128,329 $281,470 
Deferred rent 108,868 131,493 
Accrued taxes, less current portion 13,762 13,762 
Total $250,959 $426,725 

Note 8 – Income Taxes

We have a deferred tax liability of $2,331,900 as of September 30, 2018 and December 31, 2017, related to intangible assets acquired in March 2012 and February 2017.

We also have a net deferred tax asset of $32,503,735. We believe it is more likely than not that essentially none of our deferred tax assets will be realized, and we have recorded a valuation allowance for the net deferred tax assets that may not be realized as of September 30, 2018 and December 31, 2017.

 


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Note 9 - Stock-Based Compensation
 
We maintain a stock-based compensation program intended to attract, retain and provide incentives for talented employees and directors and align stockholder and employee interests. Currently, we grant options and restricted stock units ("RSUs") from the 2010 Equity Compensation Plan (“2010 ECP”) and 2017 Equity Compensation Plan ("2017 ECP"). Option and RSUs vesting periods are generally up to three years and/or achieving certain financial targets.

Compensation Expense

For the three and nine months ended September 30, 2018, we recorded stock-based compensation expense for all equity incentive plans of $159,799 and $827,595, respectively. For the three and nine months ended September 30, 2017, we recorded stock-based compensation expense for all equity incentive plans of $336,913 and $923,072, respectively. Total compensation cost not yet recognized at September 30, 2018 was $1,138,696 to be recognized over a weighted-average recognition period of 1.7 years.

The following table summarizes the stock grants outstanding under our 2005 Long-Term Incentive Plan ("2005 LTIP"), the 2010 ECP and the 2017 ECP as of September 30, 2018:
Options Outstanding
RSUs Outstanding
Options and RSUs Exercised
Available Shares
Total
2017 ECP  733,500 41,664 1,374,836 2,150,000 
2010 ECP 250,498 910,449 3,380,919 290,152 4,832,018 
2005 LTIP (*) 13,748  950,085  963,833 
Total
264,246 1,643,949 4,372,668 1,664,988 7,945,851 
(*) Expired June 2015

The following table summarizes the activities of stock option awards under the 2005 LTIP and the 2010 ECP as of September 30, 2018:
Shares Subject to Options Outstanding
Number of Shares
Weighted Average Exercise Price
Weighted Average Remaining Contractual Term (in years)
Aggregate Intrinsic Value
Balance as of December 31, 2017 264,246 $2.84 2.7$2,019 
Stock options exercised
 $ — — 
Balance as of September 30, 2018 264,246 $2.84 2.7$2,019 
Stock options exercisable as of September 30, 2018 264,246 $2.84 2.7$2,019 

The following table summarizes the activities for our unvested RSUs for the nine months ended September 30, 2018:
Unvested RSUs
Number of Shares
Weighted Average Grant Date Fair Value
Unvested as of December 31, 2017
1,071,538 $1.84 
Granted 1,664,266 $0.76 
Vested 641,843 $2.26 
Forfeited 450,012 $1.05 
Unvested as of September 30, 2018 1,643,949 $0.80 
 

Note 10 – Discontinued Operations

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Certain of our subsidiaries previously operated in the European Union ("EU"). Though our operations ceased in 2009, statutory requirements required a continued presence in the EU for varying terms until November 2015. Profits and losses generated from the remaining assets and liabilities are accounted for as discontinued operations.

In the third quarter of 2016, our petition with the UK (United Kingdom) Companies House to strike off and dissolve our remaining subsidiary in the EU was approved. As a result, for the nine months ended September 30, 2017, we recorded a net loss of $1,109 due to a charge from a service provider.


Note 11 - Earnings per Share

During the three and nine month periods ended September 30, 2018 and September 30, 2017, we generated a net loss from continuing operations and as a result, all of our shares are anti-dilutive.


Note 12 - Leases

We lease certain office space and equipment. As leases expire, it can be expected that they will be renewed or replaced in the normal course of business. Rent expense from continuing operations was $101,767 and $309,596 for the three and nine months ended September 30, 2018, respectively, and $109,701 and $346,717 for the three and nine months ended September 30, 2017, respectively.

Minimum future lease payments under non-cancelable operating leases as of September 30, 2018 are:
2018$118,870 
2019477,319 
2020405,606 
2021242,558 
2022163,284 
Total $1,407,637 

In April 2015, we entered into a five-year agreement to lease office space in Little Rock, Arkansas commencing October 1, 2015, to serve as our headquarters. The lease is for 12,245 square feet and cost approximately $171,000 during its first year. Thereafter, the lease payment increases by 2%. 

As part of the 2017 asset acquisition, Inuvo assumed the office space lease and a lease obligation in Sunnyvale, CA. The lease was for 15,717 square feet and cost approximately $95,000 for the remaining term of the lease which expired in July 2017.

In June 2017, we entered into an agreement to lease 4,801 square feet of office space in San Jose, CA commencing on July 17, 2017. The lease has a term of five years and cost approximately $216,000 during its first year.  After the first year, the lease payments increase by 3% per annum.

In June 2017, we entered into an agreement with Dell Financial Services to lease computer equipment for our data centers. The lease has a term of three years and will cost approximately $173,000 over the life of the lease.











Capital lease obligations and future minimum lease payments under non-cancelable capital leases as of September 30, 2018 are:

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Lease Payments 
2018$59,527 
2019$213,685 
2020$82,404 
Total payments under capital lease obligations $355,616 
Less amount representing interest (22,857)
Present value of capital lease obligations 332,759 
Current portion of capital lease obligations (204,430)
Capital lease obligations, net of current portion $128,329 

Assets acquired under capital lease obligations are included in property and equipment in the accompanying consolidated balance sheets. Cost and related accumulated depreciation as of:

September 30, 2018December 31, 2017
Equipment $707,264 $707,264 
Less accumulated depreciation (393,806)(242,169)
Equipment, net $313,458 $465,095 

Depreciation expense on assets under capital lease obligations was $47,277 and $151,637 for the three and nine months ended September 30, 2018, respectively, and $107,531 and $66,245 for the three and nine months ended September 30, 2017, respectively, and is included in the consolidated statements of operations.

In February 2017, we acquired assets and certain liabilities including the capital lease for computer equipment with a remaining value at that time of $88,575.

In June 2017, we entered into an agreement with Dell Financial Services to lease computer equipment for our data centers. The lease has a term of three years and will cost approximately $516,000 over the life of the lease.


Note 13 - 2017 Asset Acquisition

On February 6, 2017, we entered into an Asset Purchase Agreement to acquire substantially all of the assets and certain liabilities and personnel obligations, in exchange for 3,529,000 shares of our common stock. Of this amount, 529,350 shares were deposited into escrow with our counsel under the terms of an escrow agreement pending possible post-closing adjustments in the purchase price related to working capital and audited financial statement adjustments, as well as in connection with possible indemnification claims post-closing. In August 2017, these shares were released from escrow and delivered to the sellers in accordance with the terms of the Asset Purchase Agreement. The operating results of this acquisition have been included in the consolidated statements of operations since the acquisition date. As a result of the business acquisition, the Company recognized goodwill in the amount of $4,013,034. The factors contributing to the recognition of the amount of goodwill are based on strategic benefits that are expected to be realized from the asset acquisition. The Company incurred approximately $350,000 in acquisition related costs, which are recorded in selling, general and administrative expenses in the accompanying consolidated statements of operations.
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Total consideration paid in common stock (with marketability discount applied) $4,459,244 
Fair value of assets acquired: 
Accounts receivable, net (2,292,485)
Prepaid expenses and other current assets (236,163)
Property and equipment, net (119,101)
Goodwill (4,013,034)
Intangible assets (4,360,000)
Fair value of liabilities assumed: 
Accounts payable $3,579,787 
Accrued expenses and other current liabilities 1,152,789 
Other long-term liabilities 49,149 
Debt 2,015,577 
Cash received in acquisition $235,763 

In accordance with ASC guidance related to business combinations, net consideration was first allocated to the fair value of assets acquired, including specifically identifiable intangible assets and liabilities assumed, with the excess being recorded as goodwill. Goodwill related to this acquisition is not deductible for tax purposes and is not amortized, but instead is subject to periodic impairment tests.

The purchase includes the assumption of gross customer accounts receivable totaling $2,292,485. The Company has collected most of these receivables and has recorded them at their fair value, the gross contractual amount. Specifically, identifiable intangible assets consist of $4,360,000 and are amortized on a straight-line basis over the estimated useful life. Additionally, revenue totaling approximately $10.0 million from the 2017 asset acquisition is included in the consolidated statement of operations as of as of September 30, 2017.

Note 14 - Related Party Transactions

For the three and nine months ended September 30, 2018, the Company received a total of $10,500 and $31,500, respectively, and for the three and nine months ended September 30, 2017, $27,576 and $91,718, respectively, from First Orion Corp., which is partially owned by two directors and shareholders of Inuvo, for providing IT services.

Note 15 - Subsequent Events

Effective October 11, 2018, the Company entered into a new agreement with Western Alliance Bank for a working capital credit line (see Note 5).

On November 2, 2018 the Company entered into an Indemnification Agreement with each of the current directors and executive officers of the Company (collectively, the “Indemnities”). The Indemnification Agreements clarify and supplement indemnification provisions already contained in the Company's Bylaws and generally provide that the Company shall indemnify the Indemnities to the fullest extent permitted by applicable law, subject to certain exceptions, against expenses, judgments, fines and other amounts actually and reasonably incurred in connection with their service as a director or officer and also provide for rights to advancement of expenses and contribution.

On November 2, 2018, the Company entered into the Merger Agreement with CPT, ConversionPoint Holdings, Inc., a wholly-owned subsidiary of CPT (“Parent”), CPT Merger Sub, Inc., a wholly-owned subsidiary of Parent (“CPT Merger Sub”), and CPT Cigar Merger Sub, Inc., a wholly-owned subsidiary of Parent (“Inuvo Merger Sub”). The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, the Company will merge with and into Inuvo Merger Sub with the Company as the surviving corporation in the Inuvo Merger (the “Inuvo Merger”), and CPT merging with and into CPT Merger Sub with CPT as the surviving corporation in the CPT Merger (the “CPT Merger” and collectively with the Inuvo Merger, the “Merger”). Upon consummation of the Merger, CPT and Inuvo will be wholly-owned subsidiaries of Parent. The Merger Agreement was unanimously approved by the Board of Directors of each of the Company, CPT, Parent, CPT Merger Sub, and Inuvo Merger Sub.
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Upon the terms and subject to the conditions set forth in the Merger Agreement, at the effective time of the Merger the Company’s shareholders will be entitled to receive $0.45 in cash and 0.18877 shares of Parent common stock for each share of common stock of the Company, and CPT’s stockholders will be entitled to receive 0.9840 shares of Parent common stock for each share of common stock of CPT. Each outstanding option to acquire a share of the Company’s common stock will be converted into an option to acquire 0.2370 shares of Parent’s common stock. In addition, unvested restricted stock units will vest in full immediately prior to consummation of the Merger and will be entitled to receive the merger consideration. No fractional shares of Parent common stock will be issued in the Merger and Parent stockholders and CPT stockholders will receive cash in lieu of any fractional interests.

The Merger Agreement contains customary representations and warranties from each party to the agreement, and each party has agreed to customary covenants, including, among others, covenants relating to (1) the conduct of the CPT’s and the Company’s businesses during the interim period between the execution of the Merger Agreement and the closing of the Merger, (2) the Company’s obligations to facilitate its shareholders’ consideration of, and voting upon, the Merger Agreement and the Inuvo Merger, (3) CPT’s obligations to facilitate its stockholders’ consideration of, and voting upon, the Merger Agreement and the CPT Merger, (4) the recommendation by the Board of Directors of the Company in favor of approval of the Merger Agreement and the Inuvo Merger by the Company’s shareholders, and (5) the Company’s non-solicitation obligations relating to alternative business combination transactions.

The completion of the Merger is subject to (1) the approval of CPT’s stockholders and the Company’s shareholders, (2) regulatory approvals, (3) the closing of financing to the Parent of $36,000,000 (the “Financing”), (4) the approval of the listing of shares of Parent’s common stock on NASDAQ and conditional approval for listing on the TSX, (5) the delivery of customary opinions from counsel to the CPT and the Company to the effect that the Merger will qualify as a tax-free exchange for federal income tax purposes (6) Parent entering into separation agreements with Mr. Howe, the Company Chief Executive Officer, Mr. Ruiz, the Company’s Chief Financial Officer and Secretary, and Mr. Pisaris, the Company’s General Counsel, and (7) other customary closing conditions. Immediately following the Merger, Richard K. Howe will serve as non-executive chairman of the board of directors of the Parent and an additional individual appointed by Inuvo shall serve on the seven member board of directors of the Parent.

The Merger Agreement contains customary termination rights for both the Company and CPT and further provides that (1) a termination payment of approximately $2.8 million will be payable by the Company to CPT in certain circumstances; and (2) a termination payment of approximately $2.8 million will be payable by CPT to the Company in certain circumstances, including if the Parent fails to consummate the Financing by May 31, 2019.

On November 2, 2018, the Company and ConversionPoint Investments, LLC., an affiliate of CPT (the "Noteholder") entered into a Securities Purchase Agreement for up to $2 million pursuant to which the Company issued and sold a $1,000,000 principal amount 10% senior unsecured subordinated convertible promissory note ("the Subordinated Promissory Note") to the Noteholder which we are using for working capital.

The Subordinated Promissory Note, which bears interest at the rate of 10% per annum, and the principal and accrued interest is due on November 2, 2019. The maturity date of the Subordinated Promissory Note is subject to acceleration in the event (i) the Closing (as that term is defined in the Merger Agreement) occur pursuant to the Merger Agreement, in which event the maturity date is accelerated to the fifth day after the Closing Date (as that term is defined in the Merger Agreement) and (ii) immediately upon an Event of Default (as that term is defined in the Subordinated Promissory Note). The Company has the right to prepay the amounts due under the Subordinated Promissory Note at any time, upon 15 days prior written notice to the Noteholder, subject to the term of the note and Noteholder consent. The Company’s obligations under the Subordinated Promissory Note are unsecured and subordinate to its obligations to Western Alliance Bank, the Company’s secured lender.

In the event Merger Agreement is terminated, and providing that the shares issuable upon the possible conversion of the Subordinated Promissory Note have been approved for listing on the NYSE American, the Noteholder may, upon 15 days written notice to the Company, elect to convert all or any portion of the principal and accrued and unpaid interest due under the Subordinated Promissory Note into shares of the Company’s common stock at a conversion price of $0.44 per share, or $0.35 per share if the Merger Agreement is terminated for any reason other than in connection with a Superior Proposal (as defined in the Merger Agreement). The conversion prices are subject to proportional adjustment in the event of stock split or adjustments. The Subordinated Promissory Note also contains a provision limiting the Company’s ability to issue any shares of our common stock upon any voluntary conversion by the Noteholder which, when aggregated with all shares of its common stock issued pursuant to a conversion of the Subordinated Promissory Note, would exceed 19.99% of our issued and outstanding shares of common stock immediately preceding the issuance of the note without first obtaining stockholder approval in accordance with the rules of the NYSE American.

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On November 2, 2018 the Company also entered into a Registration Rights Agreement (the “Registration Rights Agreement”) with the Noteholder covering the shares of its common stock which may be issued upon a conversion of the Subordinated Promissory Note.

On November 2, 2018, each of Messrs. Richard K. Howe, the Company’s Chief Executive Officer and member of our board of directors, and Charles D. Morgan, G. Kent Burnett and Gordon Cameron, members of the Company’s board of directors, lent the Company $62,500, for an aggregate of $250,000, under the terms of 10% Promissory Notes. The Company is using the proceeds from these notes to pay certain costs associated with the pending Merger. The notes are unsecured, bear interest at 10% per annum and the principal and accrued interest is due on November 2, 2019, subject to acceleration upon an Event of Default or Change of Control (as both terms are defined in the note).


ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 

Company Overview

We develop technology that connects advertisers with consumers through interactions with content across devices. Inuvo provides the means to interact with tens of thousands of advertisers ("Demand") and tens of thousands of online publishers ("Supply"). We interact with Demand/Supply constituents directly and indirectly. We serve ads that associate with images, content, video and slideshows. We generate revenue from buyers of advertising inventory which include media partners, advertisers, agencies, agency trading desks, demand-side platforms and ad networks, collectively “Demand”. Our solution incorporates a proprietary form of artificial intelligence (“AI”) branded the IntentKey. This sophisticated machine learning technology uses interactions with Internet content as a source of information from which to determine Intent. The AI solution includes a continually updated database of over 500 million machine profiles which we utilize to deliver highly targeted online audiences to our Demand customers. We earn revenue when consumers view and/or click on our ads. Our business scales as we add Demand and Supply relationships.

We count among our many contractual relationships, three clients who collectively manage over 50% of all US digital advertising budgets. Included within our Supply portfolio is a collection of owned websites such as alot.com and earnspendlive.com, where we create content in health, finance, travel, careers, auto, education and living categories. These sites provide the means to test advertising technologies, while also delivering high quality consumers to advertisers through interaction with proprietary content in the form of images, videos, slideshows and the written word.
 
There are many barriers to entry to our business including the ability to process billions of transactions daily. Our intellectual property is protected by 15 issued and eight pending patents.

Industry Trends
The U.S. digital advertising is expected to grow 18.7% in 2018 to $107.30 billion from $90.39 billion in 2017, with the two companies, Facebook and Google capturing a combined 58.5% of the 2017 digital ad investment, according to eMarketer. In addition, mobile advertising spend is expected to continue to grow from $63.5 billion in 2017 to $78.9 billion in 2018, according to eMarketer.  

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses during the reported periods. The more critical accounting estimates include estimates related to revenue recognition and accounts receivable allowances. We also have other key accounting policies, which involve the use of estimates, judgments and assumptions that are significant to understanding our results, which are described in Note 2 to our unaudited consolidated financial statements appearing earlier in this report.

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Results of Operations

For the Three Months Ended September 30, For the Nine Months Ended September 30, 
20182017Change % Change 20182017Change % Change 
Net Revenue $16,806,170 $20,311,502 $(3,505,332)(17.3)%$56,315,006 $55,798,545 $516,461 0.9 %
Cost of Revenue 6,196,057 9,649,295 (3,453,238)(35.8)%21,965,955 25,161,761 (3,195,806)(12.7)%
Gross Profit $10,610,113 $10,662,207 (52,094)(0.5)%$34,349,051 $30,636,784 $3,712,267 12.1 %
Net Revenue

Net revenue for the third quarter 2018 was $16.8 million, 17% lower than the same quarter of 2017 and $56.3 million for the first nine months of the year, 1% higher compared to 2017. The decline in net revenue in the current quarter was primarily due to our decision earlier this year to reduce support of our proprietary Supply Side Platform (“SSP”) and focus on the Demand side of our business where our IntentKey technology provides maximum competitive differentiation. This realignment caused a 74% reduction in revenue generated from the SSP as compared to the prior year with a rate of decline faster than we had expected. In addition, during the last half of the third quarter of 2018 we experienced lower monetization for our inventory from our largest Demand partner. We have not seen an appreciable change in monetization for our inventory subsequent to the third quarter of 2018 and we do not know whether monetization will return to former levels. Though net revenue was 12% higher in the first six months of the current year over 2017, the lower third quarter revenue of the current year reduced the year to date increase to 1%.

Cost of Revenue
Cost of revenue is primarily generated by payments to website publishers and app developers that host advertisements we serve and to ad exchanges that provide access to supply inventory where we serve advertisements. The decrease in the cost of revenue in the third quarter of 2018 compared to the same time period in 2017 and for the nine months ended September 30, 2018 compared to the same time period in 2017 is due primarily to lower revenue and to the lower demand for clicks mentioned above in Net Revenue.
 
Operating Expenses 
 
For the Three Months Ended September 30, For the Nine Months Ended September 30, 
20182017Change % Change 20182017Change % Change 
Marketing costs $8,285,465 $7,161,905 $1,123,560 15.7 %$25,025,922 $21,122,489 $3,903,433 18.5 %
Compensation 1,806,111 2,363,901 (557,790)(23.6)%6,749,280 7,053,308 $(304,028)(4.3)%
Selling, general and administrative 1,859,020 2,025,254 (166,234)(8.2)%5,968,233 6,308,552 $(340,319)(5.4)%
Operating expenses $11,950,596 $11,551,060 $399,536 3.5 %$37,743,435 $34,484,349 $3,259,086 9.5 %

Overall, our operating expenses for the three and nine months ended September 30, 2018, increased 3.5% and 9.5%, respectively, compared to the same periods in 2017.

Marketing costs include those expenses required to attract an audience to our owned web properties. The increase in marketing costs in the three and nine months ended September 30, 2018 compared to the same periods in the prior year was partially due to adjusting traffic acquisition campaigns to the lower monetization as described above in Net Revenue that the market place experienced in the third quarter.

Compensation expense decreased for the three and nine month periods ended September 30, 2018 as compared to the same periods in 2017 due primarily to lower headcount. The average headcount, both full-time and part-time, at September 30, 2018 was 68 compared to 90 for the same quarter last year. We expect a stable compensation expense in the coming quarters as we have shifted our focus to the Demand side of the business.

Selling, general and administrative expenses were $1.9 million for the three month period ended September 30, 2018 and $6.0 million for the nine month period ended September 30, 2018, slightly lower from the prior year periods. We expect quarterly selling, general and administrative expense to continue to be relatively flat.

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Interest expense, net
 
Interest expense, net, which represents interest expense on the bank credit facility and capital lease obligations, increased approximately $4,000 to $101,000 in the quarter ended September 30, 2018 compared to the same period in 2017 and $84,000 to $297,000 for the nine months ended September 30, 2018 compared to the same period in 2017 primarily due to higher interest rates on the credit line this year compared to last year.

Income from discontinued operations

In the third quarter of 2016, our petition with the UK (United Kingdom) Companies House to strike off and dissolve our remaining subsidiary in the EU was approved. As a result, for the nine months ended September 30, 2017, we recorded a net loss of $1,109 due to a charge from a service provider.


Liquidity and Capital Resources
 
On October 11, 2018, we entered into the Amended and Restated Business Financing Agreement with Western Alliance Bank. The Amended and Restated Financing Agreement, which is secured by all of our assets, amended and superseded in its entirety the Business Financing Agreement, as amended, that we entered into on March 1, 2012 with Bridge Bank, N.A. which is now owned by Western Alliance Bank. The Amended and Restated Financing Agreement does not have a term and either party may terminate upon notice to the other party. As a result of the amended terms of our lending relationship with Western Alliance Bank, we have additional access to credit. See note 5 of the consolidated financial statements appearing earlier in this report.

In May 2018, we completed our underwritten public offering of 2,860,000 shares of our common stock at a public offering price of $0.70 per share and an additional 429,000 shares to cover over allotments in connection with the offering. The net proceeds after deducting the underwriting discounts and commissions and estimated offering expenses payable was approximately $2.1 million.

During the third quarter of 2017, we filed an S-3 registration statement with the Securities and Exchange Commission ("SEC") to replace the existing, expiring S-3 "shelf" registration statement, which permits us to offer and sell up to $15 million of our securities from time to time in one or more offerings. In May 2018, we took down from this shelf registration statement approximately $2.3 million in the underwritten public offering.

For the three months ended September 30, 2018, our revenues declined 17.3% from the same quarter in the prior year. The lower revenue in this year’s quarter is principally responsible for our $1.4 million net loss in the third quarter of 2018. Since our credit facility is dependent upon receivables, the lower revenue reduces our credit availability. We do not know when, if ever, that our revenues will return to historic levels or if we will be able to replace those lost revenues with revenues from other demand partners. The combination of lower credit availability and negative cash flows generated from operating activities raises concern about our ability to continue without interruption. As described in note 15 to the notes to consolidated financial statements appearing earlier in this report, on November 2, 2018, we entered into the Merger Agreement and an affiliate of ConversionPoint Technologies lent us $1 million for working capital, and our Chief Executive Officer and members of our board of directors have lent us an aggregate of $250,000 to cover certain costs associated with the pending Merger. Subject to the terms of the Merger Agreement and the credit facility, with the additional borrowing, we believe we will have sufficient cash and credit to operate until the Merger closes. However, there are no assurances that the Merger will be consummated. While the merger is pending, our ability to raise additional working capital is limited by the terms of the Merger Agreement. There are no assurances we will be successful in our efforts to generate revenues, report profitable operations or close the Merger in which case we would need to find additional sources of credit and make substantial reduction to operating expense.

Cash Flows - Operating

Net cash used in operating activities was $284,122 during the nine months ended September 30, 2018. We reported a net loss of $3,682,371, which included non-cash expenses; depreciation and amortization expense of $2,371,958 and stock-based compensation expense of $827,595. The change in operating assets and liabilities during the nine months ended September 30, 2018 was a provision of cash of $219,558 primarily due to a decrease in the accounts receivable balance by $5,183,579, partially offset by a decrease in the accounts payable balance by $4,592,798. Our terms are such that we generally collect receivables prior to paying trade payables. Media sales, which are part of the business acquired in 2017, typically have slower payment terms than the terms of related payables.
 
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During the comparable period in 2017, cash used in operating activities was $2,962,766 from a net loss of $4,061,596, which included several non-cash expenses; depreciation and amortization of $2,239,498 and stock-based compensation of $923,072. The cash used was further increased by a change in the accounts payable balance by $1,099,692 and a change in the accounts receivable balances of $237,078 largely due to the working capital needs of the business acquired in 2017.

Cash Flows - Investing

Net cash used in investing activities was $1,300,179 and $827,048 for the nine months ended September 30, 2018 and September 30, 2017, respectively, and primarily consisted of capitalized internal development costs.

Cash Flows - Financing

Net cash provided financing activities was $1,689,889 during 2018 primarily from proceeds of the sale of 3,289,000 shares of common stock, net of repayments on our revolving line of credit and capital leases.

In 2017, net cash provided by financing activities was $2,744,975 which largely consisted of proceeds from the revolving credit facility used to pay off the debt acquired in the 2017 asset acquisition, net of debt repayment.

Off Balance Sheet Arrangements

As of September 30, 2018, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. The term "off-balance sheet arrangement" generally means any transaction, agreement or other contractual arrangement to which an entity unconsolidated with us is a party, under which we have any obligation arising under a guarantee contract, derivative instrument or variable interest or a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets.


ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable to a smaller reporting company.

ITEM 4.  CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

We maintain “disclosure controls and procedures” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934.  Disclosure controls and procedures are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, such as this report, is recorded, processed, summarized and reported within the time periods prescribed by SEC rules and regulations, and to reasonably assure that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

Our management does not expect that our disclosure controls will prevent all errors and fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. In addition, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the control. The design of any systems of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of these inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

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As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of September 30, 2018, the end of the period covered by this report, our management concluded their evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. As of the evaluation date, our Chief Executive Officer and Chief Financial Officer concluded that we maintain disclosure controls and procedures that are effective in providing reasonable assurance that information required to be disclosed in our reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods prescribed by SEC rules and regulations, and that such information is accumulated and communicated to our management to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the period ended September 30, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


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PART II

ITEM 1. LEGAL PROCEEDINGS.

None.

ITEM 1A. RISK FACTORS.

We desire to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Accordingly, we incorporate by reference the risk factors disclosed in Part I, Item 1A of our Form 10-K for the year ended December 31, 2017, filed with the Securities and Exchange Commission on February 8, 2018 subject to the new or modified risk factors appearing below that should be read in conjunction with the risk factors disclosed in such Form 10-K.

The Merger is subject to closing conditions that, if not satisfied or waived in a timely manner or at all, will result in the Merger not being completed or delayed. A failure to complete or delay in completing the Merger may have an adverse effect on our businesses due to uncertainty or operating restrictions while the Merger are pending or cause the market price of our common stock to decline. The Merger will not be completed unless all of the conditions to the Merger have been satisfied or, if permissible, waived. We cannot predict what the effect on the market price of our common stock would be if the Merger is not completed, but depending on market conditions at the time, it could result in a decline in market price. A substantial delay in completing the Merger due to the need to satisfy the conditions to closing the Merger, or the imposition of any unfavorable terms, conditions, or restrictions in obtaining a waiver from such conditions or otherwise, could have a material adverse effect on the anticipated benefits of, or increase the costs associated with the Merger. In addition, we are subject to certain restrictions on the operation of our business while the Merger are pending, which could impair our ability to operate our businesses and prevent us from pursuing attractive business opportunities that may arise prior to the completion of the Merger. Any of these situations could also result in a decline in the market price of our common stock. Also, the uncertainty regarding whether the Merger will be completed (including uncertainty regarding whether the conditions to closing will be met) could impact our relationships with our employees, suppliers and partners. These restrictions and uncertainties could have an adverse impact on our business, financial condition, or results of operations and could result in a decline in the market price of our common stock or an increase in the volatility of the market prices.

We rely on two customers for a significant portion of our revenues. We are reliant upon Yahoo! and Google for most of our revenue. During the third quarter of 2018, Yahoo! accounted for 75.6% and Google accounted for 8.5% of our revenues, respectively, and during the same period in 2017, 62.1% and 8.9%, respectively. The amount of revenue we receive from these customers is dependent on a number of factors outside of our control, including the amount they charge for advertisements, the depth of advertisements available from them, and their ability to display relevant ads in response to end-user queries. Our revenue in the third quarter 2018 was 17.3% lower than the same quarter of 2017 due to demand and pricing changes by our largest customer, Yahoo!. The result was approximately a 40% decrease in RPCs. We have not seen an appreciable change in RPCs and we do not know whether RPCs will return to their former levels.

We would likely experience a significant decline in revenue and our business operations could be significantly harmed if these customers do not approve our new websites and applications, or if we violate their guidelines or they change their guidelines. In addition, if any of these preceding circumstances were to occur, we may not be able to find a suitable alternate paid search results provider or otherwise replace the lost revenues. The loss of any of these customers or a material change in the revenue or gross profit they generate would have a material adverse impact on our business, results of operations and financial condition in future periods.

Failure to comply with the covenants and restrictions in our credit facility could impact our ability to access capital as needed. We have a credit facility with Western Alliance Bank under which we had $4.8 million in debt outstanding and no availability as of September 30, 2018. The facility expired in September 2018 and was extended to October 2018. We signed a new facility agreement with Western Alliance Bank on October 11, 2018. The new agreement has no financial covenants. The credit facility contains a number of requirements, among other things:

•  pay fees to the lender associated with the credit facility;
• maintain our corporate existence in good standing;
• grant the lender a security interest in our assets;
• provide financial information to the lender; and
• refrain from any transfer of any of our business or property, subject to customary exceptions.

We have historically had difficulties meeting the financial covenants set forth in our credit agreement. During the third quarter of 2018 we failed to comply with the minimum revenue and adjusted EBITDA requirement. Our lender has given us waivers in
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the past, including in connection with our failure to meet the covenants during the third quarter of 2018, and reset our financial covenants several times. A breach in our covenants could result in a default under the credit facility, and in such event Western Alliance Bank could elect to declare all borrowings outstanding, if any, to be due and payable. If this occurs and we have outstanding obligations and are not able to repay, Western Alliance Bank could require us to apply all of our available cash to repay the debt amounts and could then proceed against the underlying collateral. Should this occur, we cannot assure you that our assets would be sufficient to repay our debt in full, we would be able to borrow sufficient funds to refinance the debt, or that we would be able to obtain a waiver to cure any such default. In such an event, our ability to conduct our business as it is currently conducted would be in jeopardy.

Failure to comply with the covenants and restrictions in our grant agreement with the State of Arkansas could result in the repayment of a portion of the grant, which we may not be able to repay or finance on favorable terms. In January 2013, we entered into an agreement with the State of Arkansas whereby we were granted $1,750,000 for the relocation of the Company to Arkansas and for the purchase of equipment. The grant was contingent upon us having at least 50 full-time equivalent permanent positions within four years, maintaining at least 50 full-time equivalent permanent positions for the following six years and paying those positions an average total compensation of $90,000 per year.

If we fail to meet the requirements of the grant after the initial four-year period, we may be required to repay a portion of the grant, up to but not to exceed the full amount of the grant. Should this occur, we cannot assure you that our assets would be sufficient to repay our grant in full, we would be able to borrow sufficient funds to refinance the grant, or that we would be able to obtain a waiver to cure any such default. In such an event, our ability to conduct our business as it is currently conducted would be in jeopardy. As of September 30, 2018, we had 39 full-time, permanent positions in Arkansas.

Our business is seasonal and our financial results and cash availability may vary significantly from period to period. Historically, the last half of the year has stronger demand and therefore greater revenue than the first half of the year. We experience lower RPCs due to a decline in demand for inventory on website and app space and the recalibrating of advertiser’s marketing budgets after the holiday selling season. If we are not able to appropriately adjust to seasonal or other factors, it could have a material adverse effect on our financial results. A material percentage of our operating expense is fixed and does
not vary significantly with revenue. When revenue is seasonally lower cash availability is constrained. The bank credit facility and cash generated by operations may be insufficient to continue normal operations. We may elect to sell securities to the public or to selected investors, or borrow under the current or any replacement line of credit or other debt instruments which
may cause dilution.


ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.


ITEM 4.  MINE SAFETY AND DISCLOSURES.
 
Not applicable.


ITEM 5. OTHER INFORMATION.

On November 2, 2018 the Company entered into an Indemnification Agreement with each of the current directors and executive officers of the Company (collectively, the “Indemnitees”). The Indemnification Agreements clarify and supplement indemnification provisions already contained in the Company's Bylaws and generally provide that the Company shall indemnify the Indemnitees to the fullest extent permitted by applicable law, subject to certain exceptions, against expenses, judgments, fines and other amounts actually and reasonably incurred in connection with their service as a director or officer and also provide for rights to advancement of expenses and contribution. The form of Indemnification Agreement is filed as Exhibit 10.5 to this report.
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ITEM 6. EXHIBITS.
No. Exhibit Description Form Date Filed Number Filed or Furnished Herewith 
1.1 8-K   5/11/181.1 
2.1 8-K 11/5/182.1 
2.2 8-K 11/5/182.2 
2.3 8-K 11/5/182.3 
2.4 8-K 11/5/182.4 
2.5 8-K 11/5/182.5 
3(i).1 10-KSB 3/1/04
3(i).2 10-KSB 3/31/063.2 
3(i).3 8-K 7/24/093.4 
3(i).4 8-K 12/10/103.1.4 
3(i).5 10-K 3/29/123(i).5 
3(i).6 10-K 3/29/123(i).6 
3(ii).1 10-K 3/31/103(ii).4 
3(ii).2 8-K 3/6/123(ii).1 
10.1 Filed*** 
10.2 INTENTIONALLY OMITTED 
10.3 Filed 
10.4 Filed 
10.5 Filed 
31.1 Filed 
31.2 Filed 
32.1 Filed 
32.2 
99.1 8-K 11/5/1899.1 
99.2 8-K 11/5/1899.2 
99.3 8-K 11/5/1899.3 
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99.4 8-K 11/5/1899.4 
99.5 8-K 11/5/1899.5 
99.6 8-K 11/5/1899.6 
99.7 8-K 11/5/1899.7 
99.8 8-K 11/5/1899.8 
101.INS XBRL Instance Document  Filed 
101.SCH XBRL Taxonomy Extension Schema Document   Filed 
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document  Filed 
101.DEF XBRL Taxonomy Extension Definition Linkbase Document  Filed 
101.LAB XBRL Taxonomy Extension Label Linkbase Document