Q3 Earnings Update for Inuvo/Vertro
Last week, both Vertro and Inuvo reported third quarter earnings. As expected, Q3 was difficult for both companies, but in each report and the conference calls that followed, investors were given reason to be optimistic on the prospects of each and for the potential of the combined enterprise. Our thoughts on the reports are below:
Vertro – as we discussed when in our “Time to Buy Vertro Again” blog post in September, we knew that Q3 would be challenging and fully expected to see a significant decline in revenue and other metrics from Q2 levels due to the changes in search engine results pages (SERPs) required by Google. These changes in SERP caused them to significantly pare down ad spending in June and July while the impact of these changes were assessed. As has been the case historically, such a reduction results in fewer new customers acquired and fewer searches, impressions and clicks. The timing of these changes and the reduction in ad spend causes a “double whammy” of sorts for Vertro’s revenue – 1) fewer searches, clicks and impressions means lower revenue generally and 2) Vertro’s contract with Google has breakpoints at which the company earns a higher percentage of the ad revenue and the declines discussed above led to the company’s falling below these breakpoints in each month of Q3. We note that the company’s ad spend was $5.2m, just like the prior quarters spend, but management indicated that the bulk of the ad spend occurred very late in Q3 which means we took the hit for this spend as an expense in Q3, but we should see the increased searches, impressions and clicks as a result of this spend during Q4 if historical trends hold true. Management shared the following notes about the trends in the final month of Q3 and early Q4:
1) Attrition rates improved across key markets, on a worldwide basis, due to better targeting as well as product enhancements.
2) Management believes that average daily revenue reached its bottom in Q3 and current rates are 20% above that low point.
3) The introduction of the new Homepage has resulted in significant improvements in revenue per install, with increases in revenue achieving average rates above 30%.
These trends and the other factors discussed above lead us to believe that the business has (in the words of Vertro CEO Peter Corrao) “..turned a corner and is poised for markedly improved results”.
Inuvo – Q2 and Q3 were transitional quarters for Inuvo and the changes made during this period led us to believe that the company would not only survive, but thrive going forward. As such and for all the other reasons stated in our initial due diligence report, we added Inuvo as a focus stock on the first trading day of Q4 (October 3, 2011). Obviously, much has changed about the outlook given the pending merger with Vertro, but we believe that these changes are positive and we fully expected Q3 to be challenging. We were quite pleased with the discussion of QTD improvements on the Q3 earnings conference call and found several reasons for optimism –
1) We believe that the GrooveVC community is having a positive impact on Inuvo and the numbers for Q4 to date are the best evidence – management indicated that they have experienced an uptick since the start of October that pushed their revenue for the month to $2.9m, substantially higher than the prior month’s $2.2m. While it is difficult to know with certainty how much of this gain was related to the adaptation of Yellowise, BargainMatch and Kowabunga into the daily use flow by Groove community members, we do not believe that the timing of Inuvo’s revenue rebound is a coincidence and we fully expect to see the company report revenue at this higher run rate going forward. We note that management also indicated that revenue for November through the day prior to the call were running at about the same daily rate.
2) Recent headcount/expense reductions were implemented with a stated goal of creating an expense structure that allows for positive adjusted EBITDA at the revenue level reported for September ($2.2m) which we expect to represent a revenue trough. We believe that this will allow the company to operate profitably going forward as best evidenced by management’s comments that the company was able to achieve adjusted EBITDA in October of approximately $170k with trends looking for similar for the first week of November.
We expected weak Q3 numbers and felt that a poor Q3 was being priced into the shares. Of course, given the merger we expect there to be significant volatility in the stock price until the deal closes and also would not be surprised to see weakness related to end of year tax loss selling. We note that the stock has already traded back down to the price at which we initially suggested that Groove members take a position ($1.05 on October 3) and we believe that any such end of year weakness makes for a tremendous buying opportunity, as we expect the results for a Inuvo/Vertro combination will be much stronger than either could achieve individually and believe that the combined company’s stock price will move considerably higher over the next 12 months.
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