Organization and Business and Accounting Policies

3 Months Ended

Mar. 31, 2012

Notes to Financial Statements

Note 1. Organization and Business and Accounting Policies

Inuvo® is an internet marketing and technology company specialized in marketing browser-based consumer applications, managing networks of website publishers and operating specialty websites. We develop software and analytics technology that is accessible over the internet for use by consumers, online advertisers and website publishers. 

On March 1, 2012 we completed our acquisition of Vertro, Inc. (“Vertro”), an internet company that owns and operates the ALOT product portfolio.  Effective with the merger, we are now organized into three operating segments: Software Search, Publisher Network and Partner Programs. Vertro’s operations are now part of our Software Search and Partner Programs segments. Our Publisher Network segment consists of the technology and analytics platforms that provide advertisers and publishers the capability to facilitate performance based advertising.  This segment also consists of websites we own and operate. The Partner Programs segment consists of consumer applications we have designed, developed and marketed.  The Software Search, Publisher Network and Partner Programs segments represent approximately 20%, 64% and 16%, respectively, of our total net revenue for the quarter ending March 31, 2012.  Prior to the period covered by this report, we were organized under two segments, Web Properties and Performance Marketing. For presentation purposes, our prior period results included herein included have been reclassified for our new segment structure.

Merger with Vertro

In evaluating the merger, we, and the management of Vertro believed that the combination of the two companies could create a stronger, more scalable business, from which to attract advertisers, publishers and consumers.  Expected benefits include:

● diversified revenue streams which should mitigate our dependence on one major customer;

● an existing install and distribution capability through Vertro’s ALOT toolbar applications for our consumer facing innovations;

● a stronger business from which to access both debt and capital markets to support growth;

● the combination of two experienced digital marketing teams; and

● the combination will eliminate approximately $2.9 million in overlapping annual operating and public company expenses.

We are currently integrating the operations of the two companies.

Software Search

Following our acquisition of Vertro, effective March 1, 2012, we are including the ALOT product line into what we now call our Software Search segment. The ALOT product line offers two primary products to consumers, ALOT Home, a homepage product, and ALOT Appbar, a software application that consumers install into their web browsers. Both ALOT Home and ALOT Appbar include a search box from which consumers conduct type-in web search requests. The ALOT Appbar provides access to a library of applications, which are used by consumers to receive dynamic information, perform useful tasks, or access their favorite content online. There are hundreds of apps available for consumers to choose from ranging from a weather app that provides an at-a-glance snapshot of the weather for the coming four days, to a radio app that enables consumers to instantly listen to thousands of radio stations from around the world. All ALOT products and apps are free to download and use.

In addition to displaying apps, the ALOT Home and ALOT Appbar products also include a search box from which a majority of the  revenue has historically been derived. Users conduct millions of searches per day producing both algorithmic results and sponsored listings. Both the algorithmic results and sponsored listings are provided by third parties with whom we have contractual relationships. If users click on a sponsored listing after conducting a search, we earn a percentage of the total click-through revenue provided by the third-party that placed the advertisement. Historically, search revenue from Google accounted for over 80% of revenue from the ALOT operations.

Publisher Network

The Publisher Network segment designs, builds, implements, manages and sells the various technology platforms and services we offer. In this business, we mediate between advertisers and publishers to facilitate performance-based advertising. Our Publisher Network is made up of thousands of different websites, from large, well-known portals to independent tech bloggers. The Publisher Network segment consolidates some of the disparate technologies and platforms we acquired between 2002 and 2008 into the Inuvo platform.  The Inuvo platform is an open, fraud filtering, lead generation marketplace designed to allow advertisers and publishers to manage their transactions in an automated and transparent environment. In addition to the core Inuvo platform for advertisers and publishers, we continue to sell services and license legacy platforms and directories within the Publisher Network segment, including:

· The ValidClick® service at www.validclick.com.  ValidClick is a fraud filtering, pay-per-click marketplace where publishers can integrate dynamically-generated advertisements within their websites based on the demographics and natural search behaviors of the consumer. ValidClick provides publishers with access to tens of thousands of advertisers in an easy-to-use XML-based implementation, giving the publisher greater control over content and integration than other competitive offerings.

· The LocalXML service at www.localxml.com.  LocalXML is a service which allows publishers to make real-time calls to the LocalXML database.  These calls answer the simple questions “what” and “where.”  For example, “what” equals “steaks” and “where” equals “Tampa,” from which the LocalXML database returns a complete listing of all local businesses in Tampa that meet this criteria.  Publishers may customize how the data appears on their site, and include user reviews of the businesses searched.  The LocalXML service is designed to be bundled with the ValidClick service described above.

· The Yellowise.com™ directory search web site at www.yellowise.com and the recently launched Local.ALOT.com web sites are included in the Publisher Network segment as well. Yellowise.com is a local search and review site powered by the LocalXML service.  Users may search by category and location, and receive requested search results.  Users may also post reviews of their favorite and not-so-favorite businesses making the reviews available to all other users of the site.  Yellowise.com is the in-market website we use to ensure the LocalXML service performs in accordance with market needs. 

Partner Programs

The Partner Programs segment designs, builds and implements unique offers that generate revenue from the sale of products, services, data and advertising. It consists of display revenues, affiliate programs, data sales, Kowabunga® and BargainMatch. This segment includes the non-search revenue generated from the ALOT products when users interact with certain applications from within the Appbars. We refer to these as sponsored apps and they generate either pay-per-click or cost-per-action revenue. Website page-views are also monetized through cost-per-thousand display ads. We also utilize user data to enhance product offering and generate additional revenue.

· The Kowabunga consumer daily deals website at www.kowabunga.com.  Kowabunga is a daily deal program focused on rural America, a market Inuvo believes is underserved by market leaders. Inuvo has access to millions of consumers through its search marketing operations that are potential customers for a local deal of the day. Inuvo is partnering with a national direct marketer, which currently markets offers from thousands of merchants in rural America. Inuvo has developed the infrastructure to present daily local offers from the inventory of its partner to the consumers from the Inuvo Platform.  Inuvo believes that the potential reach of this program is to approximately 20 million households in 25 states, with a potential for 90% household penetration, 2,500 national and local retail advertisers. Kowabunga was launched in the third quarter of 2011.

· The BargainMatch consumer product comparison-shopping and Shopping rewards website at www.BargainMatch.com.  BargainMatch is also a service which allows publishers to offer their visitors an online shopping experienced branded around their site with rewards to consumers coming in the form of cash back on every online purchase made through the publisher. The service has been designed and positioned as a consumer loyalty solution.  The product line also includes a consumer facing application which can be downloaded at www.bargainmatch.com/installnow.

· The MyAP® Affiliate Platform at www.MyAP.com.  MyAP is a complete affiliate tracking and management software solution providing advertisers the ability to sign up, manage and track the activities of their publishers through a reliable, easy-to-use, and privately-branded platform with full data transparency.  Where the Inuvo Platform is an open platform where many advertisers and publishers interact, the MyAP platform is designed specifically to allow merchants to build private affiliate networks. Each advertising customer of MyAP is supported by a unique implementation of the software, customized to suit their individual needs and populated by publishers who use the platform exclusively for that advertiser.  Today, MyAP supports hundreds of customers.

· ALOT Display comprises various display advertising opportunities throughout the ALOT product platform, including our www.alothome.com default home page, hundreds of Apps in our ALOT Appbar, and other ALOT-branded websites.

Liquidity

On March 1, 2012, we entered into a new Business Financing Agreement with Bridge Bank, N.A. for up a to $10 million revolving credit facility and a $5 million term loan. The Revolving Credit Line replaced our then existing $8 million revolving credit facility with Bridge Bank. The new credit facility will be used primarily to satisfy our working capital needs.  We believe with the higher loan availability from the new bank facility and our plan to reduce duplicate costs with respect to the merger with Vertro, we will have sufficient cash for the next twelve months.

Discontinued Operations

At March 31, 2012, we reported a small loss from discontinued operations associated with Vertro’s European operations.

During the three months ended March 31, 2011, we settled a lawsuit resulting in a gain of approximately $257,000 from a business sold in 2010, MarketSmart Advertising (“MSA”).

Basis of Presentation

The consolidated financial statements include our accounts and those of our subsidiaries.  All inter-company accounts and transactions are eliminated in consolidation.

The accompanying unaudited interim consolidated financial statements as of March 31, 2012 and for the three months ended March 31, 2012 and 2011 are prepared pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) are condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for for the year ended December 31, 2011 and filed with the SEC. The interim consolidated financial information contained herein is not certified or audited; it reflects all adjustments (consisting of only normal recurring accruals) which are, in the opinion of management, necessary for a fair statement of the operating results for the periods presented, stated on a basis consistent with that of the audited consolidated financial statements. The results of operations for any interim period are not necessarily indicative of results to be expected for the full year. Further, with the acquisition of Vertro effective March 1, 2012, our consolidated financial statements as of March 31, 2012 include the operations and financial results of the Vertro subsidiary for one month. 

Reclassification

For comparability, the 2011 consolidated financial statements reflect reclassifications where appropriate to conform to the interim consolidated financial statement presentation used in 2012. These reclassifications have no effect on total stockholders’ equity (deficit) or net loss.

Use of Estimates

The preparation of the consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements and the reported amounts of net revenue and expenses in the reporting period. We regularly evaluate estimates and assumptions related to allowances for doubtful accounts, goodwill and purchased intangible asset valuations, lives of intangible assets, deferred income tax asset valuation allowances, stock compensation, and the value of stock options and warrants. We base our estimates and assumptions on current facts, historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from management’s estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected.

Credit Risk, Customer and Vendor Evaluation

Accounts receivable are typically unsecured and are derived from sales to customers. We perform ongoing credit evaluations of our customers and maintain allowances for estimated credit losses. We apply judgment as to our ability to collect outstanding receivables based primarily on management’s evaluation of the customer’s financial condition and past collection history and records a specific allowance. In addition, we record an allowance based on the length of time the receivables are past due.

At March 31, 2012 and subsequent to the merger with Vertro, we have two individual customers with accounts receivable balances greater than 10% of our gross accounts receivable from continuing operations. These customers owed approximately $4.4 million or 82.7% of gross accounts receivable from continuing operations at March 31, 2012. These same customers contributed approximately $7.8 million or 88.4% of total net revenue from continuing operations for the three months ended March 31, 2012.   At March 31, 2011, we had one customer with receivable balance greater than 10% of our gross accounts receivable from continuing operations. This customer owed approximately $3.6 million or 69.9% of gross accounts receivable from continuing operations at March 31, 2011. This same customer contributed approximately $9.8 million or 83.4% of total net revenue from continuing operations for the three months ended March 31, 2011.