Inuvo, Inc.: Form 10-Q for the period ended Sep 30, 2023

Company Overview

Inuvo is a technology company that develops and sells information technology solutions for marketing and advertising. These solutions predictively identify and message online audiences for any product, service or brand across devices, formats, and channels including video, mobile, connected TV, linear TV, display, social, search and native. These solutions allow Inuvo’s clients to engage with their audiences in a manner that drives responsiveness. Inuvo facilitates the delivery of hundreds of millions of marketing messages to consumers every single month and counts among its client’s numerous world-renowned brands across industries.

The Inuvo solution incorporates a proprietary form of artificial intelligence, or AI, branded the IntentKey. This patented technology is a model of the human language built from crawling public content on billions of webpages. The AI uses this model of the language to predict and action audiences based on the reasons why consumers are interested, not who the people are within those audiences. In this regard, the technology is designed for a consumer privacy conscious future while addressing the components of the advertising value chain most responsible for return on advertising spend, the intelligence behind the advertising decision.

Inuvo technology can be consumed both as a managed service and software-as-a-service. For certain clients, Inuvo has also developed proprietary digital properties collectively branded as Bonfire Publishing where content is created specifically to attack the audiences those clients are targeting. These online publications provide information across a wide range of topics including health, finance, travel, careers, auto, education and lifestyle. Collectively, these websites also provide the means to market test various Inuvo advertising technologies.

There are many barriers to entry associated with the Inuvo business model, including a proficiency in large scale information processing, predictive software development, marketing data products, analytics, artificial intelligence, integration to the internet of things ("IOT"), and the relationships required to execute within the IOT. Inuvo’s intellectual property is protected by19 issued and eight pending patents.

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, accounts receivable allowances, capitalized software costs, goodwill and stock-based compensation. 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 audited consolidated financial statements for 2022 appearing in our Annual Report on Form 10-K for the year ended December 31, 2022 as filed with the SEC on March 9, 2023. The estimates and assumptions that management makes affect the reported amounts of assets, liabilities, net revenues and expenses and disclosure of contingent assets and liabilities. The estimates and assumptions used 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 goodwill and purchased intangible asset valuations and valuation allowance. Actual results may differ from the estimates and assumptions used in preparing the accompanying consolidated financial statements, and such differences could be material.

Results of Operations

Net Revenue

Revenue for the three-month period ended September 30, 2023, increased 43.9% and revenue for the nine-month period ended September 30, 2023, decreased 9.0% as compared to the same periods in 2022, respectively. The higher revenue for the three-month period ended September 30, 2023 compared to comparable prior year period was primarily attributable to an increased focus on Indirect channels and customers since the start of the year. As a result, our indirect revenue for both periods ended September 30, 2023 increased. Our direct revenues this year compared to last year decreased in both the three-months and nine-months periods ended September 30, 2023 due to the loss of Direct clients during the fourth quarter 2022. Refer to the table in Note 2 for which provides revenues for Direct Customers and Indirect Customers.

Cost of Revenue

Cost of revenue is primarily composed of payments to advertising exchanges that provide access to digital inventory where we serve advertisements. To a lesser extent, cost of revenue includes payments to website publishers and app developers that host advertisements. The decline in cost of revenue for the three and nine months period ended September 30, 2023, compared to the same time periods in 2022 was related to the decline in Direct Customer revenues as discussed in the Net Revenue section above. The higher gross margin in the current year quarter, 90.7% compared to 60.3% in the same quarter last year was due to changes in revenue mix, where a greater percent of the revenue this year was from Indirect Customers which typically have higher gross margins.

Operating Expenses

Marketing costs consist mostly of traffic acquisition (i.e., Campaigns) costs and include those expenses required to attract an audience to various web properties. Marketing costs were 104.5% higher for the three months ended September 30, 2023 and 37.3% higher for the nine months ended September 30, 2023, compared to the same periods in 2022 due to higher spending focused on Indirect Customers.

As we reported in our Form 10-Q filing for the quarterly period June 30, 2022, we previously identified certain advertising transactions with a prominent advertising network that, during the quarter ended June 30, 2022, appeared, according to our technology and assessment, to be comprised of invalid advertising clicks. As a result, in that quarter, we refunded $1.5 million to our clients that were impacted and reversed any revenue that would have been recognized related to this invalid traffic. In addition, in June 2022, we held back approximately $1.4 million in net payments due to the advertising network. On September 21, 2023 we reached an agreement with the advertising network resulting in extinguishing of all related liabilities and a reversal of Marketing costs.

Compensation expense was $289 thousand higher for the three months ended September 30, 2023 and $591 thousand higher for the nine months ended September 30, 2023, compared to the same time periods in 2022 primarily due to higher salary, commissions, and incentive expense. Our total employment, both full- and part-time, was 86 at September 30, 2023 compared to 92 at September 30, 2022.

General and administrative costs for the three and nine months ended September 30, 2023 increased 5.9% and 4.8%, respectively, compared to the same periods in 2022. The increase in expense for the three months period ended September 30, 2023 was due primarily to an increase in the reserve for doubtful accounts.

Financing expense, net

Financing (expense), net of interest income, for the three and nine months ended September 30, 2023, was approximately $20 thousand income and $37 thousand expense, respectively. We reported an interest income amount for the three months ended September 30, 2023 due to a decrease in our utilization of our line of credit and an increase in our bank interest income.

Other income, net

Other income (expense) in the three and nine months period ending on September 30, 2023 was income of $250, and $15 thousand, respectively.

Other income (expense), net, for the three and nine months ended September 30, 2022 was an expense of approximately $24

thousand and $401 thousand, respectively, from net realized and unrealized gains and losses discussed in Note 3 to our

Consolidated Financial Statements.

Liquidity and Capital Resources

As of September 30, 2023, we have approximately $7.0 million in cash and cash equivalents and our net working capital was approximately $1.7 million. We have encountered recurring losses and cash outflows from operations, which historically we have funded through equity offerings and debt facilities. In addition, our investment in internally developed software consists primarily of labor costs which are of a fixed nature. Through September 30, 2023, our accumulated deficit was $165.0 million.

Our principal sources of liquidity are the sale of our common stock and our credit facility discussed in Note 6 - Bank Debt. On May 30, 2023, we raised $4.0 million in gross proceeds in a registered direct offering, before expenses, through the sale of an aggregate of 16,000,000 shares of our common stock The shares were offered pursuant to an effective shelf registration statement on Form S-3 (the “Shelf Registration Statement”) and a prospectus supplement relating to the offering was filed with the SEC on May 26, 2023.

In March 2021, we contracted with an investment management company to manage our cash in excess of current operating

needs. We placed $2 million in cash equivalent accounts and $10 million in an interest-bearing account. At September 30, 2023, our funds with the investment management company were approximately $68 thousand and were invested in cash and cash equivalent accounts. A detail of the activity is described in Note 3 to our Consolidated Financial Statements.

On May 28, 2021, we entered into a Sales Agreement (the “Sales Agreement”) with A.G.P./Alliance Global Partners, as sales agent (the “Sales Agent”), pursuant to which we may offer and sell through or to the Sales Agent shares of our common stock (the “ATM Program”) up to an aggregate amount of gross proceeds of $14,611,900. During the year ended December 31, 2021 and through March 31, 2023, we did not issue any shares of common stock or receive any aggregate proceeds under the ATM Program, and we did not pay any commissions to the Sales Agent. During the quarter ended June 30, 2023, we sold 173,558 shares for gross proceeds totaling $63,136 under the ATM Program and paid the Sales Agent a commission of $1,902. We did not issues any shares of common stock or receive any aggregate proceeds under the ATM during, and we did not pay any commissions to the Sales Agent during the quarter ended September 30, 2023.Any shares of common stock offered and sold in the ATM Program will be issued pursuant to our universal shelf registration statement on Form S-3. The ATM Program will terminate upon (a) the election of the Sales Agent upon the occurrence of certain adverse events, (b) 10 days’ advance notice from one party to the other, or (c) the sale of the balance available under our Shelf Registration Statement. Under the terms of the Sales Agreement, the Sales Agent is entitled to a commission at a fixed rate of 3.0% of the gross proceeds from each sale of shares under the Sales Agreement.

We have focused our resources behind a plan to market our collective multi-channel advertising capabilities differentiated by our AI technology, the IntentKey, where we have a technology advantage and higher margins. If we are successful in implementing our plan, we expect to return to a positive cash flow from operations. However, there is no assurance that we will be able to achieve this objective.

Management plans to support the Company’s future operations and capital expenditures primarily through cash raised through the sale of stock in May 2023, cash generated from future operations and borrowings from the credit facility until reaching profitability. The credit facility is due upon demand and therefore there can be no assurances that sufficient borrowings will be available to support future operations until profitability is reached. We believe our current cash position and credit facility will be sufficient to sustain operations for at least the next twelve months from the date of this filing. If our plan to grow the IntentKey product is unsuccessful, we may need to fund operations through private or public sales of securities, debt financings or partnering/licensing transactions over the long term.

Cash Flows

The table below sets forth a summary of our cash flows for the nine months ended September 30, 2023 and 2022:

Cash Flows - Operating

Net cash used in operating activities was $457,716 during the nine months ended September 30, 2023. We reported a net loss of $7,988,323, which included non-cash expenses of depreciation and amortization expense of $1,984,139, depreciation of right of use assets of $77,790 and stock-based compensation expense of $1,471,683. The change in operating assets and liabilities during the nine months ended September 30, 2023 was a net use of cash of $3,265,938 primarily due to an increase of accrued liabilities and other liabilities of $3,279,560, partially offset by a lower accounts payable balance. Our terms are such that we generally collect receivables prior to paying trade payables. However, our Media sales arrangements typically have slower payment terms than the terms of related payables.

During the comparable nine-month period in 2022, cash used in operating activities was $2,820,344 from a net loss of $9,129,756 and included several non-cash expenses of depreciation and amortization expense of $1,949,845 and stock-based compensation expense of $1,890,991. The change in operating assets and liabilities during the nine months ended September 30, 2022, was a net use of cash of $1,713,374.

Cash Flows - Investing

Net cash provided by investing activities was $1,029,656 for the nine months ended September 30, 2023, and consisted primarily of the sale of marketable securities, partially offset by capitalized internal development costs.

Net cash used in investing activities was $1,601,996 for the nine months ended September 30, 2022, and consisted primarily of the purchase of marketable securities and capitalized internal development costs.

Cash Flows - Financing

Net cash provided by financing activities was $3,475,126 during the nine months ended September 30, 2023, and was primarily from proceeds from the capital raise (see Note 1).

Net cash used in financing activities during the nine months ended September 30, 2022 was $272,742.

Off Balance Sheet Arrangements

As of September 30, 2023, 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.

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.

As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of September 30, 2023, 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 quarter ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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, 2022, as filed with the SEC on March 9, 2023 and our subsequent filings with the SEC, 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 and our subsequent filings.

We rely on three customers for a significant portion of our revenues. We are reliant upon three customers for most of our revenue. During the third quarter of 2023, they accounted for 75.0%, 10.0% and 2.2% of our revenues, respectively. During the same period in 2022, these customers accounted for 10.2%, 33.1%, and 10.9% of our revenue sources, respectively. The amount of revenue we receive from these customers is dependent on a number of factors outside of our control, including changes in the respective customers advertising budget, both in terms of allocated dollars and media mix, financial resources of the customers, as well as general economic conditions. We would likely experience a significant decline in revenue and our business operations could be significantly harmed if these customers do not continue to utilize our services. Additionally, our business operations and financial condition could be significantly harmed if these customers do not pay for our services on a timely basis. The loss of any of these customers or a material change in the revenue or gross profit they generate or their failure to timely pay us for our services would have a material adverse impact on our business, results of operations and financial condition in future periods.