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1. Organization and Business and Accounting Policies

9 Months Ended

Sep. 30, 2012

Organization And Business And Accounting Policies

1. Organization and Business and Accounting Policies

Inuvo® is an Internet marketing and technology company that manages a network of websites and builds and markets browser based consumer applications.

On March 1, 2012 we completed the acquisition of Vertro, Inc. (“Vertro”), an internet company that owns and operates the ALOT product portfolio. After seven months of combined operations, management has reduced the number of reporting segments from three to two. The new segments are Software Search and the Publisher Network. The Partner Programs segment from the previous reporting segments has been absorbed into the other two segments with consumer focused initiatives going to Software Search and all other business going to the Publisher Network. For presentation purposes, prior period results included herein have been reclassified for the new segment structure.

The former Vertro's operations are now part of the Software Search segment. 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 Software Search and Publisher Network segments represent approximately 50.9% and 49.1% respectively, of our total net revenue for the quarter ending September 30, 2012. Prior to 2012, we were organized under two segments; Web Properties and Performance Marketing.

Merger with Vertro

The merger with Vertro created a stronger, more scalable business, from which to attract advertisers, publishers and consumers. The benefits included:

	•	A more diversified revenue stream, which eliminated our dependence on one major customer;
	•	An install base in the Vertro ALOT toolbar, for the distribution of consumer facing innovations;

	•	A stronger business financially from which to access both debt and capital markets to support growth;
	•	The combination of two experienced digital marketing teams; and

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The elimination of approximately $2.9 million in overlapping annual operating and public company expenses.

Software Search

Following our acquisition of Vertro, effective March 1, 2012, we include 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 the ALOT Appbar, a software application that consumers install into their web browsers. Both ALOT Home and the ALOT Appbar include a search box from which consumers can 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.

The search box on the ALOT Home and ALOT Appbar products has historically been the source of a majority of the revenue. 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.

The Software Search segment also consists of affiliate programs, display revenues, data sales, and BargainMatch. Non-search revenue is generated from the interaction consumers have with certain applications launched from within the Appbar. 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 offerings and generate additional revenue.

The BargainMatch consumer product shopping, comparison and rewards application is a browser-based application where consumers can earn cashback on purchases made online through sponsored merchants.

Publisher Network

The Publisher Network segment is made up of thousands of different websites, from large, well-known portals to independent tech bloggers into which Inuvo serves advertisements. The technology that supports the Publisher Network, the Inuvo platform, is an open, fraud filtering, lead, click or sales generation marketplace designed to allow advertisers and publishers the ability to manage their transactions in an automated and transparent environment. The following brands continue to be used within the Publisher Network:

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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.

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The owned and operated websites including the Yellowise.com™ directory search website at www.yellowise.com and the recently launched Local.ALOT.com website. Both websites are local search and review sites powered by the LocalXML service which allows publishers the ability to make real-time calls to the LocalXML database and have users receive a listing of all local businesses that meet the search criteria. Users may also post reviews of their favorite and not-so-favorite businesses making the reviews available to all other users of the site.

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.

Liquidity

On March 1, 2012, we entered into a new Business Financing Agreement with Bridge Bank, N.A. for a revolving credit facility of up to $10 million and a term loan for up to $5 million (see Note 6). The Business Financing Agreement replaced our then existing $8 million revolving credit facility with Bridge Bank. The new credit facility is used primarily to satisfy our working capital needs. At September 30, 2012, we had a working capital deficit of approximately $3 million and availability under our revolving line of credit of approximately $1.1 million. We believe with the continued improvement in cash flow, the reduction of duplicate costs with respect to the merger with Vertro and the higher limit of the new bank facility, we will have sufficient cash for the next twelve months. On June 29, 2012, we entered into a modification of the Business Financing Agreement to waive certain events of default in April and May 2012, and modify the financial covenants thereafter. Subsequently, on October 11, 2012, we entered into a second modification of the Business Financing Agreement to waive certain events of default in July and August of 2012 and modify the financial covenants thereafter. As of September 30, 2012, we were not in compliance with all terms of the amended Bridge Bank credit facility, however we regained compliance upon execution of the Second Amendment.

Discontinued Operations

We reported a net gain of approximately $14,000 and a net loss of approximately $143,000 for the three and nine months ended September 2012, respectively, from discontinued operations associated with the European operations acquired with Vertro. For the nine months ended September 30, 2011 we reported a net gain of approximately $257,000 associated with the favorable settlement of a lawsuit involving a discontinued operation.

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 September 30, 2012 and for the three and nine months ended September 30, 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 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. Our consolidated financial statements for the nine months ended September 30, 2012 include seven months of the operations and financial results of the Vertro subsidiary which was acquired on March 1, 2012.

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 returns and redemptions, 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 September 30, 2012, we have two individual customers with accounts receivable balances greater than 10% of our gross accounts receivable from continuing operations. These customers owed approximately $5.5 million or 79.4% of gross accounts receivable from continuing operations at September 30, 2012. These same customers contributed approximately $14.2 million or 91.6% of total net revenue from continuing operations for the three months ended September 30, 2012 and $33.2 million or 86.5% of total net revenue from continuing operations for the nine months ended September 30, 2012. At September 30, 2011, we had one customer with receivable balance greater than 10% of our gross accounts receivable from continuing operations. This customer owed approximately $2.2 million or 66.1% of gross accounts receivable from continuing operations at September 30, 2011. This same customer contributed approximately $7.3 million or 88.8% of total net revenue from continuing operations for the three months ended September 30, 2011, and $25.2 million or 86.4% of total net revenue from continuing operations for the nine months ended September 30, 2011.