UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

FORM 10-K

(Mark One)

þ	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

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

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.)

15550 Lightwave Drive, Third Floor, Clearwater, FL		33760
(Address of principal executive offices)		(Zip Code)

(727) 324-0046

(Registrant's telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

o Yes þ No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

o Yes þ No

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 such filing requirements for the past 90 days.

þ Yes o No

Indicate by check mark whether the registrant has submitted electronically and posted on its Corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

o Yes o No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company:

Large accelerated filer	o	Accelerated filer	o
Non-accelerated filer	o	Smaller reporting company	x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

o Yes þ No

The aggregate market value of the outstanding common stock, other than shares held by persons who may be deemed affiliates of the registrant, computed by reference to the closing sales price for the registrant’s common stock on June 30, 2009 (the last business day of the registrant’s most recently completed second quarter), as reported on the NYSE Amex, was approximately $14.4 million. As of March 23, 2010, there were 84,442,327 shares of common stock of the registrant outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2010 Annual Meeting of Stockholders, to be filed within 120 days of the year ended December 31, 2009, are incorporated by reference in Part III hereof.  Except with respect to information specifically incorporated by reference in this Form 10-K, the Proxy Statement is not deemed to be filed as part hereof.

 

TABLE OF CONTENTS

		Page No.
Part I
Item 1.	Business.	1
Item 1A.	Risk Factors	8
Item 1B.	Unresolved Staff Comments.	14
Item 2.	Properties.	14
Item 3.	Legal Proceedings.	14
Item 4.	(Removed and Reserved).	16
Part II
Item 5.	Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.	16
Item 6.	Selected Financial Data.	16
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operation.	17
Item 7A.	Quantative and Qualitative Disclosures About Market Risk.	29
Item 8.	Financial Statements and Supplementary Data.	29
Item 9.	Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.	29
Item 9A.(T)	Controls and Procedures.	30
Item 9B.	Other Information.	31
Part III
Item 10.	Directors, Executive Officers and Corporate Governance.	31
Item 11.	Executive Compensation.	31
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.	32
Item 13.	Certain Relationships and Related Transactions, and Director Independence.	32
Item 14.	Principal Accountant Fees and Services.	32
Part IV
Item 15.	Exhibits, Financial Statement Schedules.	32

 

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. 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. 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. These factors include, but are not limited to,

 

•

our history of losses,

•

risks frequently encountered by Internet marketing and advertising companies,

•

our ability to expand our relationships with other Internet media content, advertising and product providers,

•

the terms of our loan agreement with Wachovia Bank, N.A.,

•

our dependence upon a significant portion of our revenues from a single customer,

•

our ability to effectively compete,

•

the impact of increasing government regulations and consumer protection laws on our business model,

•

our need to keep pace with changes in technology,

•

the possible interruption of our services and our reliance on third-party providers,

•

our dependence on credit card processing companies and the risks of increasing fees,

•

the risks related to credit card fraud,

•

liabilities associated with information we retrieve from our websites,

•

the impact of natural disasters on our ability to operate,

•

any failure on our part to adequately protect personal information,

•

possible security breaches and computer viruses,

•

our reliance on our executive officers and key personnel,

•

the impact of “spam”, and

•

the impact of our quarterly operating results on our stock price.

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 Item 1A. - Risk Factors appear in this report. 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 the “Company,” "we," "us," "ours," and similar terms refers to Inuvo, Inc., a Nevada corporation formerly known as Kowabunga! Inc., and our subsidiaries.

When used in this report, “fiscal 2008” means the fiscal year ended December 31, 2008, “fiscal 2009” means the fiscal year ended December 31, 2009 and “fiscal 2010” means the fiscal year ending December 31, 2010.

The information which appears on our web site at www.inuvo.com is not part of this report.

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and

Stockholders of Inuvo, Inc.

We have audited the accompanying consolidated balance sheets of Inuvo, Inc. (the Company) as of December 31, 2009 and 2008 (as restated) and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended.  These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion of the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on the test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Inuvo, Inc. as of December 31, 2009 and 2008, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

 

/s/ Kirkland Russ Murphy & Tapp, PA
Clearwater, Florida
March 30, 2010

 

 

F-1

---

 

INUVO, INC.

CONSOLIDATED BALANCE SHEETS

December 31, 2009 and 2008

		December 31, 2009				December 31, 2008
						(As Restated)
Assets
Current Assets
Cash		$	4,843,128			$	360,315
Restricted Cash			638,285				992,074
Accounts Receivable, net of allowance for doubtful accounts of $1,807,730 and $2,510,583, respectively			4,811,069				7,298,406
Unbilled Revenue			179,940				504,894
Prepaid Expenses and Other Current Assets			400,028				578,863
Current Assets of Discontinued Operations			2,137,783				1,787,736
Total Current Assets			13,010,233				11,522,288
Property and Equipment, net			4,881,168				5,468,990
Other Assets
Goodwill			3,351,405				3,893,405
Intangible Assets			3,805,707				5,737,398
Other Assets			1,657				89,099
Other Assets of Discontinued Operations			775,000				1,330,142
Total Other Assets			7,933,769				11,050,044
Total Assets		$	25,825,170			$	28,041,322
Liabilities and Stockholders’ Equity
Current Liabilities
Term Note Payable– Current Portion		$	2,324,000			$	1,648,970
Accounts Payable			4,598,383				5,345,412
Deferred Revenue			549,635				353,684
Accrued Expenses and Other Current Liabilities			1,757,208				1,587,062
Current Liabilities of Discontinued Operations			1,914,367				1,660,886
Total Current Liabilities			11,143,593				10,596,014
Long-Term Liabilities
Term and Credit Notes Payable – Long Term			5,786,806				8,266,113
Other Long Term Liabilities			456,340				579,066
Long Term Liabilities of Discontinued Operations			214,829				211,634
Long-Term Liabilities			6,457,975				9,056,813
Stockholders’ Equity
Preferred Stock, $.001 par value:
Authorized Shares — 5,000,000 — none issued or outstanding			-				-
Common Stock, $.001 par value:
Authorized Shares 200,000,000, Issued Shares 89,959,283 and 71,125,024, respectively
Outstanding Shares — 84,442,327 and 65,608,068, respectively			89,959				71,125
Additional Paid in Capital			110,895,166				105,804,740
Accumulated Deficit			(100,665,417	)			(95,274,303	)
Accumulated Other Comprehensive Loss			-				(116,961	)
Treasury Stock, at cost — 5,516,956 Shares			(2,096,106	)			(2,096,106	)
Total Stockholders’ Equity			8,223,602				8,388,495
Total Liabilities and Stockholders’ Equity		$	25,825,170			$	28,041,322

INUVO, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31, 2009 and 2008

 

		2009				2008
Net Revenue		$	51,654,763			$	64,737,758
Cost of Revenue
Affiliate Payments			22,796,733				28,937,088
Data Acquisition			8,674,746				7,932,607
Merchant Processing Fees			2,254,979				2,817,319
Product Costs			1,455,879				1,620,758
Cost of Revenue			35,182,337				41,307,772
Gross Profit			16,472,426				23,429,986
Operating Expenses
Search Costs			1,213,410				471,440
Compensation			11,067,685				13,978,432
Selling, General and Administrative			9,174,968				13,842,202
Total Operating Expenses			21,456,063				28,292,074
Operating Loss			(4,983,637	)			(4,862,088	)
Other Income(Expense)
Interest Income			4,667				14,140
Interest Expense			(839,449	)			(750,452	)
Impairment of Assets			(849,083	)			(63,017,198	)
Other (Expense) Income			(330,796	)			584,389
Other Expenses, Net			(2,014,661	)			(63,169,121	)
Loss from Continuing Operations Before Taxes on Income			(6,998,298	)			(68,031,209	)
Income Tax Benefit			-				3,237,784
Net Loss from Continuing Operations			(6,998,298	)			(64,793,425	)
Income (loss) from Discontinued Operations net of Tax Expense of $0 and $212,429, respectively			1,607,184				(18,056,856	)
Net Loss		$	(5,391,114	)		$	(82,850,281	)
Per Common Share Data:
Basic and Diluted:
Loss from Continuing Operations		$	(0.10	)		$	(0.97	)
Profit (loss) from Discontinued Operations		$	0.02			$	(0.27	)
Net Loss		$	(0.08	)		$	(1.24	)
Weighted Average Shares    (Basic and Diluted)			66,793,190				66,549,326

INUVO, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE LOSS

YEARS ENDED DECEMBER 31, 2009 AND 2008

 

																		Accumulated
										Additional								Other								Total
		Common Stock								Paid in				Accumulated				Comprehensive				Treasury				Stockholders'
		Shares				Stock				Capital				Deficit				Income (loss)				Stock				Equity
Balances, December 31, 2007 (As previously reported)			67,646,350			$	70,295			$	106,524,393			$	(11,245,536	)		$	1,139,715			$	(843,881	)		$	95,644,986
Restatement of allowance for doubtful accounts (see Note 3)			-				-				-				(1,178,486	)			-								(1,178,486	)
Balances, December 31, 2007 (As Restated)			67,646,350			$	70,295			$	106,524,393			$	(12,424,022	)		$	1,139,715			$	(843,881	)		$	94,466,500
Adjustment for Contingent Shares			(500,000	)			(500	)			(999,500	)															(1,000,000	)
Options and Warrants Exercised, Net			100,000				100				12,900																13,000
Purchases of Treasury Stock			(212,700	)																			(160,375	)			(160,375	)
Stock Based Compensation			1,230,000				1,230				266,947																268,177
Settlement Agreement			(2,655,582	)																			(1,091,850	)			(1,091,850	)
Other Comprehensive Loss:
Net Loss															(82,850,281	)											(82,850,281	)
Unrealized Loss on Securities																			(11,591	)							(11,591	)
Fair Value Adjustment for Derivatives																			(101,943	)							(101,943	)
Foreign Currency Translation Adjustment																			(1,143,142	)							(1,143,142	)
Comprehensive Loss																											(84,106,957	)
Balances, December 31, 2008 (As Restated)			65,608,068			$	71,125			$	105,804,740			$	(95,274,303	)		$	(116,961	)		$	(2,096,106	)		$	8,388,495
Warrants Exercised, Net			2,260,931				2,261				608,190																610,451
Issuance of Common Stock for equity offering, net			16,740,000				16,740				4,047,242																4,063,982
Stock Based Compensation											434,827																434,827
Forfeited Restricted Stock Units			(166,672	)			(167	)			167
Other Comprehensive Loss:
Net Loss															(5,391,114	)											(5,391,114	)
Interest Rate Swap Termination																			101,943								101,943
Other																			15,018								15,018
Comprehensive Loss																											(5,274,153	)
Balances, December 31, 2009			84,442,327			$	89,959			$	110,895,166			$	(100,665,417	)			-			$	(2,096,106	)		$	8,223,602

INUVO, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2009 and 2008

 

		2009				2008
Operating Activities
Net Loss		$	(5,391,114	)		$	(82,850,281	)
Adjustments to reconcile Net Loss to net cash provided by operating activities:
Depreciation and Amortization			5,704,004				8,210,433
Impairment of Assets			849,083				80,624,119
Provision for Doubtful Accounts			304,598				1,850,279
Deferred Taxes			-				(3,022,347	)
Stock Based Compensation			434,827				268,177
Gain on Sale of Discontinued Operations			(168,813	)			(557,984	)
Stock Based Settlement			-				(1,091,850	)
Other			15,018				136,385
Change in operating assets and liabilities:
Restricted Cash			253,789				676,228
Accounts Receivable			2,548,432				403,443
Prepaid Expenses and Other Current Assets			(35,450	)			853,692
Other Assets			(18,439	)			-
Accounts Payable			(587,317	)			2,167,685
Deferred Revenue			180,076				(530,707	)
Accrued Expenses and Other Current Liabilities			588,849				(1,081,366	)
Net cash provided by operating activities			4,677,543				6,055,906
Investing Activities
Purchases of Equipment and Software			(1,376,790	)			(2,230,173	)
Purchase of Names Database			(2,099,897	)			(3,257,911	)
Proceeds from Sale of Discontinued Operation			749,985				-
Other			-				9,082
Net cash used in investing activities			(2,726,702	)			(5,479,002	)
Financing Activities
Proceeds from Term Note			2,700,000				-
Principal Payments Made on Term Note and Other Long Term Liabilities			(3,273,234	)			(1,454,295	)
Advances from Credit Note			39,284,056				40,101,228
Payments on Credit Note			(40,853,283	)			(41,288,000	)
Proceeds from Issuance of Common Stock, net of costs			4,674,433				13,000
Treasury Shares Repurchased			-				(160,375	)
Net cash provided by (used in) financing activities			2,531,972				(2,788,442	)
Effect of exchange rate Changes on Cash			-				(6,393	)
Net Increase (Decrease) in Cash			4,482,813				(2,217,931	)
Cash, Beginning of Year			360,315				2,578,246
Cash, End of Year		$	4,843,128			$	360,315
Supplemental Information
Interest Paid		$	743,789			$	780,292
Income Taxes Paid (Refunded), Net		$	20,904			$	(288,018	)
Non-Cash Investing Activities
Equipment Under Capital Leases		$	133,808			$	682,729

Notes to Consolidated Financial Statements

December 31, 2009 and 2008 (As Restated)

Note 1 – Organization and Business

 

Company Overview

Inuvo, Inc., a Nevada corporation formerly known as Kowabunga! Inc. (the “Company”) is an internet marketing services business headquartered in Clearwater, Florida.  Through their wholly-owned subsidiaries it provides world class marketing and technology solutions to businesses and individuals.  The Company is organized into two reporting segments:

•           Exchange, and

•           Direct.

The Exchange segment is focused on the technology, analytics and data necessary to facilitate business-to-business (“B2B”) advertising transactions.  The Exchange segment provides performance-based marketing and technology solutions to advertisers and publishers. These solutions help advertisers acquire customers with payment for services to Inuvo occurring either on a pay per click or pay per action basis. The Exchange has tens of thousands of advertisers and thousands of publisher partners.

Our Direct segment utilizes online techniques to acquire information about consumers that can, but has not always been, subsequently monetized over time. The primary means to monetize the consumer data has historically included a limited license of the database to other companies and/or the sale of products to the consumers whose contact information was collected.  The strategy for collecting consumer data has been to target individuals interested in home business opportunities, professional recertification, baby products and nutritional supplements.  We collect the consumer data, which includes name, address, phone number and email address to enable the Company to expand and develop the database and market various internal and external products to the consumers.  We determine the interest in a variety of product offers through a combination of inbound/outbound calls to a Company telemarketing representative, email marketing initiatives and postal offers.

 

The Company was incorporated in the State of Nevada in October 1987. As of March 23, 2010, the Company employed, through its operating subsidiaries, 115 people full time. The Company’s principal executive offices are located at 15550 Lightwave Drive, 3 rd floor, Clearwater, Florida 33760. The Company’s telephone number is (727) 324-0046. The address of its website is www.inuvo.com.

 

Discontinued Operations

 

During the second quarter of 2008, the Company made a decision to divest its MarketSmart Advertising, Inc. (“MSA”) operations and ceased operations of its Web Diversity Ltd. (“Web Diversity”) subsidiary which in total comprised its Advertising Segment. The Company also made a decision to divest its Cherish, Inc. (“Cherish”) and Vintacom Florida Inc (“Vintacom”) operations.  On February 17, 2009, the Company concluded the sale of Cherish.  In the fourth quarter of 2009, the Company ceased operations of Vintacom.

Internal Offers - Discontinued

 

The Company provided subscription website memberships for a variety of offers including online dating portals.  Through Cherish and Vintacom the Company offered a wide variety of online dating communities designed to allow individuals to search for friends, partners and future spouses using interactive websites. Some of Cherish’s websites also display adult content, and encourage the exploration of alternative lifestyles, in addition to providing dating and relationship services. Revenues from internal offers were generated from monthly membership fees which allowed users to obtain complete access to website portals associated with the offers.

Advertising Segment  - Discontinued

 

The Company provides traditional off-line advertising services including branding, collateral advertising, public relations, television advertising, and radio advertising services in seven states and the District of Columbia through MSA. It also offers interactive marketing solutions designed to help businesses increase revenues from their websites by utilizing a variety of interactive marketing channels, such as search engine optimization, paid search and affiliate marketing.

 

F-6

---

 

Note 1 – Organization and Business (Continued)

The Company provided paid search management and organic search optimizations services in the United Kingdom through its subsidiary Web Diversity until May of 2008 at which time the Company ceased operations in the United Kingdom.

Note 2 – Summary of Significant Accounting Policies

 

a)             Basis of presentation

 

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation.

 

b)            Cash and restricted cash

 

The Company considers all highly liquid investments with an original maturity of three months or less at the time of purchase to be cash equivalents. The Company’s cash deposits exceeded FDIC-insured limits at various financial institutions on December 31, 2009 and 2008 by approximately $4.2 million and $0.6 million, respectively, as reported before adjustment for outstanding checks. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant credit risk on cash.

 

The Company has restricted cash on deposit with its merchant processors. The majority of these funds are in non-interest bearing accounts. As of December 31, 2009 and 2008, the Company had approximately $0.6 million and $1.0 million, respectively, of restricted cash.

 

c)            Reclassification

For comparability, the 2008 consolidated financial statements reflect reclassifications where appropriate to conform to the consolidated financial statement presentation used in 2009. Certain prior period amounts have been reclassified to conform to the current presentation related to discontinued operations.  Such reclassifications had no effect on total stockholders’ equity or net loss.

 

d)            Revenue recognition

 

The Company recognizes revenue in accordance with Accounting Standards Codification(“ASC”) ASC 605-10 Revenue Recognition-General (“ASC 605-10”).   Under ASC 605-10, the Company recognizes revenue when the following criteria have been met: persuasive evidence of an arrangement exists, the fees are fixed and determinable, no significant obligations remain and collection of the related receivable is reasonably assured.

 

Exchange Segment

 

Affiliate Network - consistent with the provisions of ASC 605-45 Revenue Recognition-Principal Agent Considerations (“ASC 605-45”), the Company recognizes revenue as an agent in affiliate marketing transactions in which the Company is not the primary obligor. Accordingly, service fee revenue is recognized on a net basis because any affiliate expenses are the responsibility of the Company’s advertising customer. In certain instances, the Company assumes the position of primary obligor and thus recognizes revenue on a gross basis. Revenue is recognized when the related services are performed.

 

Search Network - In accordance with ASC 605-45, the Company records as revenue the gross amount received from advertisers and the amount paid to the publishers placing the advertisements as cost of sales. Revenue from company owned networks are based on “per click” basis and is recognized once the action is taken.

 

Affiliate Software - The Company recognizes revenue the month in which the software is utilized. Customers are invoiced on the first of the month for the monthly services. All overages for the month are billed at the end of the month and are included in our accounts receivable.

 

Hosting Arrangements - The Company recognizes revenue through a monthly hosting fee and additional usage fees as provided.

 

Direct Segment

 

Online Membership Income – The Company recognizes revenue from online memberships when payment is received and the service date of providing membership benefits has taken place.

 

Lead Sales - For lead sales, the Company’s revenue recognition varies depending on the arrangement with the purchaser. Where the arrangement provides for delivery only, revenue is recognized when the lead information is provided to the purchaser. Where the arrangement provides for compensation based on sales generated by the purchaser from the lead, the Company recognizes revenue in the period that the purchasing company makes a sale that was derived from the lead.

 

 

F-7

---

 

 

Note 2 – Summary of Significant Accounting Policies (Continued)

Product Sales - For product sales, the Company recognizes revenue when payment is received and the goods are shipped.

 

List Management Services - Substantially all of the Company’s revenue from list management services is recorded at the net amount of its gross billings less pass-through expenses charged to a customer. In most cases, the amount that is billed to customers exceeds the amount of revenue that is earned and reflected in our consolidated financial statements, because of various pass-through expenses. In compliance with ASC 605-45, the Company assesses whether the Company or a third-party supplier is the primary obligor. The Company has evaluated the terms of its customer agreements and considered other key indicators such as latitude in establishing price, discretion in supplier selection and credit risk to the vendor as part of this assessment. Accordingly, the Company generally records revenue net of pass-through charges.

 

Subscription Income – The Company recognizes revenue on monthly and multi-monthly subscription contracts on a straight-line basis over the term of the contract.  Funds that are collected in advance from customers are recorded as deferred revenue.

 

Discontinued Operations

 

Advertising Services – The Company recognizes revenue in the period in which services are performed.

Pay Per Click Management Fees – The Company recognizes revenue on pay per click management services in the month the services are performed.

 

 e)             Accounts Receivable

 

Accounts receivable are recorded at the net realizable value and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses on the Company’s existing accounts receivable. The Company reviews its allowance for doubtful accounts quarterly. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. In determining past due or delinquent status of a customer, the aged trial balance is continually reviewed by collections and generally any accounts older than 120 days are considered delinquent.

 

f)             Advertising expenses

 

The Company expenses advertising costs as incurred. Advertising costs from continuing operations as included in Selling General and Administrative Operating Expenses for the years ended December 31, 2009 and 2008 were approximately $1.1 million and $0.9 million, respectively. In addition, the Company expenses search costs as incurred, which is captured separately in operating expenses.

g)             Property and equipment

 

Property and equipment are stated at cost, net of accumulated depreciation and amortization. Major renewals and improvements are capitalized, while replacements, maintenance and repairs which do not improve or extend the life of the respective assets are expensed currently. Costs of assets sold or retired and the related accumulated depreciation and amortization are eliminated from accounts and the net gain or loss is reflected in the statement of operations within selling, general and administrative expenses.

 

Property and equipment are depreciated on a straight-line basis over 3 years for equipment, 5 to 7 years for furniture and fixtures and 3 to 5 years for software. Leasehold improvements are amortized over the lesser of the estimated useful life of the improvement or the remaining term of the lease. Depreciation and amortization expense was approximately $2.0 million for the years ended December 31, 2009 and 2008.

 

F-8

---

 

Note 2 – Summary of Significant Accounting Policies (Continued)

h)             Capitalized Software Costs

 

The Company capitalizes certain costs related to the acquisition and internally developed software and amortizes these costs using the straight-line method over the estimated useful life of the software. The Company utilizes all developed software for internal use. The Company does not sell developed software. Certain development costs not meeting the criteria for capitalization are expensed as incurred.

 

i)             Goodwill and other intangible assets

 

Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the net tangible and intangible assets acquired. In accordance with ASC 350, Goodwill and Other Intangible Assets (“ASC 350”), the Company tests goodwill for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis or more frequently if the Company believes indicators of impairment exist. The performance of the test involves a two-step process. The first step of the impairment test involves comparing the fair values of the applicable reporting units with their aggregate carrying value, including goodwill. The Company generally determines the fair value of its reporting units using the income approach methodology of valuation that includes the discounted cash flow method as well as other generally accepted valuation methodologies. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, the Company performs the second step of the goodwill impairment test to determine the amount of impairment loss. The second step of the goodwill impairment test involves comparing the implied fair value of the affected reporting unit’s goodwill with the carrying value of that goodwill (See Note 6).

 

The Company amortizes its identifiable intangible assets, which result from acquisitions accounted for under the purchase method of accounting, using the straight-line method over their estimated useful lives. Tradenames are not amortized as they are believed to have an indefinite life. Tradenames are reviewed annually for impairment under ASC 350.

 

j)              Income taxes

 

The Company utilizes the liability method of accounting for income taxes as set forth in ASC 740, Income Taxes (“ASC 740”). Under the liability method, deferred taxes are determined based on the temporary differences between the financial statement and tax bases of assets and liabilities. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized. In assessing the need for a valuation allowance the Company must project future levels of taxable income. This assessment requires significant judgment. The Company examines evidence related to the history of taxable losses or income, the economic conditions in which we operate, organizational characteristics, our forecasts and projections, as well as factors affecting liquidity.

Effective January 1, 2007, the Company adopted certain provisions of ASC 740. This statement clarifies the criteria that an individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements.  ASC 740 prescribes a recognition threshold of more-likely–than-not, and a measurement attribute for all tax positions taken or expected to be taken on a tax return, in order to be recognized in the financial statements.

k)              Impairment of long-lived assets

 

In accordance with ASC 360, Property, Plant and Equipment , long-lived assets, such as property and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of the asset is measured by comparison of its carrying amount to future net cash flows the asset is expected to generate. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the asset exceeds its fair value.  No impairment existed as of December 31, 2009 or 2008.

 

F-9

---

 

Note 2 – Summary of Significant Accounting Policies (Continued)

l)              Share-based compensation

 

The Company recognizes share based compensation at fair value pursuant to ASC 718, Compensation- Stock Compensation (“ASC 718) using the modified prospective transition method. The fair value of restricted stock units is determined using market value of the common stock on the date of the grant. The Company estimates the fair value of all stock option awards as of the grant date by applying the Black-Scholes-Merton option pricing model and recognizes the fair value as compensation expense in earnings over the requisite service period. The use of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of compensation expense and include the expected life of the option, stock price volatility, risk-free interest rate, dividend yield, exercise price, and forfeiture rate. Under ASC 718, forfeitures are estimated at the time of valuation and reduce expense ratably over the vesting period. The forfeiture rate, which is currently estimated at a weighted average of 25 percent of unvested options outstanding, is adjusted periodically based on the extent to which actual forfeitures differ, or are expected to differ, from the previous estimate. 

 

m)            Treasury Stock

 

The cost method was used in recording the purchase of the treasury stock.  Treasury stock changes as a result of common stock acquired in the market.

 

n)             Net loss per share

 

During the periods presented, the Company had securities that could potentially dilute basic earnings per share in the future, but were excluded from the computation of diluted net loss per share, as their effect would have been anti-dilutive.  Because the Company reported a net loss for all periods presented, shares associated with stock options, warrants and restricted stock are not included because they are anti-dilutive.  Basic and diluted net loss per share are the same for the periods presented.  Per share data is based on the weighted average number of shares outstanding.

 

o)             Comprehensive income

 

ASC 220, Comprehensive Income, requires disclosure of total comprehensive income. Other comprehensive income (loss) is defined as the change in equity during a period, from transactions and other events, excluding changes resulting from investments by owners (e.g., supplemental stock offering) and distributions to owners (e.g., dividends).

 

p)             Operating segments

 

ASC 280, Segment Reporting, requires disclosures of certain information about operating segments, products and services, geographic areas in which the Company operates, and their major customers. The Company has evaluated the effect of this standard and has determined that currently it operates in two segments, as defined in this statement (See Note 19).

 

q)             Concentration of credit risk

 

Financial instruments that potentially expose the Company to concentrations of risk consist primarily of cash and cash equivalents and accounts receivable, which are generally not collateralized. The Company’s policy is to place its cash and cash equivalents with high credit quality financial institutions in order to limit the amount of credit exposure. The Company does not require collateral from its customers, but its credit extension and collection policies include monitoring payments and aggressively pursuing delinquent accounts. The Company maintains allowances for potential credit losses.

r)             Risks and concentrations

 

When assessing credit risk, the Company considers whether the credit risk exists at both the individual and group level. Consideration is given to the activity, region and economic characteristics when assessing if there exists a group concentration risk. The following disclosures were calculated based on the entire Company results (both continuing and discontinued operations).  At December 31, 2009 and 2008, the Company had an individual customer with an accounts receivable balance greater than 10% of the total net accounts receivable. This customer owed approximately $2.5 million or 37.0% and $5.0 million or 55.4%, of the Company net accounts receivable balance at December 31, 2009 and 2008, respectively. At December 31, 2009, the accounts receivable balances for the Company’s five largest customers totaled approximately $3.5 million or 51.9% of the total net accounts

 

F-10

---

 

Note 2 – Summary of Significant Accounting Policies (Continued)

receivable balance. At December 31, 2008, the accounts receivable balances for the Company’s five largest customers totaled approximately $6.1 million or 67.6% of the total net accounts receivable balance. The Company’s largest customer for the year ended December 31, 2009 had net revenue of approximately $26.3 million or 40.8% of total net revenue for the Company. The Company’s five largest customers for the year ended December 31, 2009 had net revenue of approximately $38.7 million or 60.0% of total net revenue for the Company. The Company’s largest customer for the year ended December 31, 2008 had net revenue of approximately $24.7 million or 30.7% of total net revenue for the Company. The Company’s five largest customers for the year ended December 31, 2008 had net revenue of approximately $42.6 million or 53.2% of total net revenue for the Company. 

s)              Fair value of financial instruments

 

Effective January 1, 2008, the Company adopted ASC 820, Fair Value Measurements and Disclosures (“ASC 820”) for our financial assets and liabilities. Management uses the fair value hierarchy of ASC 820, which gives the highest priority to quoted prices in active markets. The fair value of financial instruments is estimated based on market trading information, where available. Absent published market values for an instrument or other assets, management uses observable market data to arrive at its estimates of fair value. Management believes that the carrying amount of accounts receivable, accrued expenses and long-term debt approximate fair value.

 

ASC 820 defines fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, ASC 820 establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. The three levels of inputs used to measure fair value are as follows:

Level 1

Quoted prices in active markets for identical assets or liabilities.

 

Level 2

Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted price for identical or similar assets and liabilities in markets that are not active; or other input that are observable or can be corroborated by observable market data.

Level 3

Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

As of December 31, 2009, the Company has no financial assets or liabilities that were measured at fair value on a recurring basis.

 

The following table summarizes our financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2008, segregated among the appropriate levels within the fair value hierarchy:

 

Fair Value Measurements at December 31, 2008 with:

(in thousands)

Quoted prices in active markets for identical

Significant other observable inputs

Significant unobservable

(Level 1)

(Level 2)

(Level 3)

Liabilities

Interest rate swap

$

-

$

102,000

$

-

 

The Company adopted ASC 825, Financial Instruments (“ASC 825”) on January 1, 2008. ASC 825 permits companies to make an election to carry certain eligible financial assets and liabilities at fair value, even if fair value measurement has not historically been required for such assets and liabilities under U.S. GAAP. Upon adoption of ASC 825, the Company made no elections to record assets and liabilities at fair market value.

 

F-11

---

 

Note 2 – Summary of Significant Accounting Policies (Continued)

t)              Derivative financial instruments

 

The Company accounts for its interest rate swap agreements in accordance with ASC 815, Derivatives and Hedging. This standard requires the Company to recognize all derivatives on the balance sheet at fair value. Our interest rate swap agreement qualifies as a cash flow hedge. Therefore, the effective portion of the fair value change is recorded through other comprehensive income, a component of stockholders’equity while any ineffectiveness is recorded in the statement of operations.  In March 2009, the Company cancelled its only derivative and incurred a related expense of $94,000 included in Interest Expense on the 2009 consolidated statements of operations, which was previously reflected in other accumulated comprehensive loss.  At December 31, 2009 and 2008, the value of the interest rate swap on the consolidated balance sheets was $0 and approximately $102,000, respectively.

u)             Use of estimates

 

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America 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. The Company regularly evaluates estimates and assumptions related to allowances for doubtful accounts, useful lives of property and equipment, goodwill and purchased intangible asset valuations and lives, derivatives, deferred income tax asset valuation allowances, stock compensation, and valuation of stock option and warrants. The Company bases its estimates and assumptions on current facts, historical experience and on various other factors that it believes 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 the Company 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.

 

v)             Litigation and Settlement Costs

 

From time to time, the Company is involved in disputes, litigation and other legal actions. In accordance with ASC 450, Contingencies , the Company records a charge equal to at least the minimum estimated liability for a loss contingency when both of the following conditions are met: (i) information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred as of the date of the financial statements and (ii) the range of loss can be reasonably estimated (See Note 17).

w)             Recent accounting pronouncements

 

In January 2010, the Financial Accounting Standards Board (“FASB”) issued guidance amending the existing fair value measurements and disclosure guidance. The amendment requires new disclosures regarding the transfers in and out of level 1 and 2 fair value measurements and activity in level 3 fair value measurements. The amendment also clarifies existing disclosures regarding the level of disaggregated information as well as more disclosure around valuation techniques and inputs to fair value measurements. The guidance is effective for interim and annual reporting periods commencing after December 15, 2009, with a portion effective for fiscal years beginning after December 15, 2010. The adoption of this guidance is not expected to have a material impact on the Company’s Consolidated Financial Statements.

 

In June 2009, the FASB issued new accounting guidance for determining whether an entity is a variable interest entity and requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. This guidance also requires an enterprise to assess whether it has an implicit financial responsibility to ensure that a variable interest entity operates as designed when determining whether it has power to direct the activities of the variable interest entity that most significantly impacts the entity’s economic performance. This guidance also requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity, requires enhanced disclosures and eliminates the scope exclusion for qualifying special-purpose entities. This guidance is effective for annual reporting periods beginning after November 15, 2009. The adoption of this guidance is not expected to have a material impact on the Company’s Consolidated Financial Statements.

 

In June 2009, the FASB issued new accounting guidance to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. Additionally, on and after the effective date, the concept of a qualifying special-purpose entity is no longer relevant for accounting purposes. This guidance is

 

 

F-12

---

 

Note 2 – Summary of Significant Accounting Policies (Continued)

 

effective for annual reporting periods beginning after November 15, 2009. The adoption of this guidance is not expected to have a material impact on the Company’s Consolidated Financial Statements.

 

In May 2009, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 165, Subsequent Events, which was primarily codified into Topic 855 “Subsequent Events” in the ASC. This guidance was issued in order to establish principles and requirements for reviewing and reporting subsequent events. On February 24 th 2010, the FASB issued Accounting Standards Update (ASU) 2010-09 to amend ASC 855, Subsequent Events. As a result, SEC registrants will not disclose the date through which management evaluated subsequent events in the financial statements—either in originally issued financial statements or reissued financial statements (See Note 20).

 

Other recent accounting pronouncements issued by the FASB, the AICPA, and the SEC did not or are not believed by management to have a material impact on the Company’s present or future financial statements.

Note 3 – Prior Period Adjustment

On March 22, 2010, the Audit Committee of the Board of Directors of Inuvo, Inc. determined that the consolidated balance sheet at December 31, 2007 and the consolidated statement of operations and consolidated statement of stockholders’ equity for the year ended December 31, 2007 could no longer be relied upon.  The consolidated balance sheet at December 31, 2007 and the consolidated statement of operations and the consolidated statement of stockholders’ equity for the year ended December 31, 2007 as filed with the Annual Report on Form 10-K for the year ended December 31, 2008, as amended, contained an error related to allowance for doubtful accounts and bad debt expense during the year then ended.  The Company has determined that the allowance for doubtful accounts was underestimated by approximately $1.2 million at December 31, 2007. As a result of this error in 2007 which impacts the beginning balances on certain of the 2008 consolidated financial statements, on March 22, 2010 the Audit Committee of the Board of Directors also determined that the consolidated balance sheet at December 31, 2008 and the consolidated statement of stockholders’ equity and comprehensive loss which also appeared in the Annual Report on Form 10-K for the year ended December 31, 2008, as amended, could no longer be relied upon.  Accordingly, the consolidated balance sheet at December 31, 2008 and the consolidated statement of stockholders’ equity and comprehensive loss for the year ended December 31, 2008 have been restated to correct the 2007 accounting error related to the allowance for doubtful accounts.

 

The effect of correcting this accounting error on the consolidated balance sheet at December 31, 2007 and the consolidated statement of operations for the year ended December 31, 2007 (as filed with the Annual Report on Form 10-K for the year ended December 31, 2008, as amended) are shown in the table below.  The effect on the consolidated statement of stockholders’ equity for the year ended December 31, 2007 is reflected in the changes to the balance sheet at December 31, 2007.  This error had no net effect on the consolidated statement of cash flows for the year ended December 31, 2007.

		December 31, 2007
		As filed				Adjustment to Restate				As Restated
Consolidated Balance Sheet Data
Assets
Accounts receivable		$	8,302,782			$	(1,178,486	)		$	7,124,296
Total current assets		$	19,740,303			$	(1,178,486	)		$	18,561,817
Total assets		$	121,125,513			$	(1,178,486	)		$	119,947,027
Stockholders’ equity
Accumulated deficit		$	(11,245,536	)		$	(1,178,486	)		$	(12,424,022	)
Total stockholders’ equity		$	95,644,986			$	(1,178,486	)		$	94,466,500
Total liabilities and stockholders’ equity		$	121,125,513			$	(1,178,486	)		$	119,947,027
Consolidated Statement of Operations Data
Operating expenses
Selling, general and administrative		$	(18,626,506	)		$	(1,178,486	)		$	(19,804,992	)
Net loss from continuing operations before income taxes		$	(4,526,882	)		$	(1,178,486	)		$	(5,705,368	)
Net loss from continuing operations		$	(3,123,549	)		$	(1,178,486	)		$	(4,302,035	)
Net Loss		$	(1,107,825	)		$	(1,178,486	)		$	(2,286,311	)
Per Common Share Data
Basic and Diluted
Net Loss From Continuing Operations		$	(0.05	)		$	(0.01	)		$	(0.06	)
Net Loss		$	(0.02	)		$	(0.01	)		$	(0.03	)

The effect of correcting this 2007 accounting error on the consolidated balance sheet at December 31, 2008 is shown in the table below. The effect on the consolidated statement of stockholders’ equity for the year ended December 31, 2008 is reflected in the changes to the consolidated balance sheet at December 31, 2008.  This 2007 accounting error had no effect on the consolidated statements of operations or the consolidated statement of cash flows for the year ended December 31, 2008.

Consolidated Balance Sheet Data		December 31, 2008
		As filed				Adjustment to Restate				As Restated
Assets
Accounts receivable, net of allowance		$	8,476,892			$	(1,178,486	)		$	7,298,406
Total current assets		$	12,700,774			$	(1,178,486	)		$	11,522,288
Total assets		$	29,219,808			$	(1,178,486	)		$	28,041,322
Stockholders’ equity
Accumulated deficit		$	(94,095,817	)		$	(1,178,486	)		$	(95,274,303	)
Total stockholders’ equity		$	9,566,981			$	(1,178,486	)		$	8,388,495
Total liabilities and stockholders’ equity		$	29,219,808			$	(1,178,486	)		$	28,041,322

 

The effect of the 2007 accounting error had no impact on the reported quarterly earnings or earnings per share of the Company during the years ended December 31, 2008 and 2009.

 

 

 

F-13

---

 

Note 4 – Allowance for Doubtful Accounts Receivable:

 

The activity in the allowance for doubtful accounts receivable was as follows during the years ended December 31, 2009 and 2008:

 

		2009				2008
Balance at the beginning of year		$	2,510,583			$	1,562,031
Provision for bad debts			304,598				1,850,279
Charge-offs			(1,007,451)				(905,797	)
Recoveries			-				4,070
Balance at the end of year		$	1,807,730			$	2,510,583

Note 5– Property and Equipment

 

The net carrying value of property and equipment at December 31, 2009 and 2008 was as follows:

 

		December 31, 2009				December 31, 2008
Furniture and Fixtures		$	639,107			$	659,206
Equipment			3,161,665				3,000,609
Software			4,862,195				3,093,722
Leasehold Improvements			321,873				293,864
Assets Not Yet in Service			25,912				497,344
Subtotal			9,010,752				7,544,745
Less: Accumulated Depreciation and Amortization			4,973,777				3,034,132
Net Property and Equipment from Continuing Operations		$	4,036,975			$	4,510,613
Net Property and Equipment from Discontinued Operations			844,193				958,377
Total		$	4,881,168			$	5,468,990

Note 6 – Intangible Assets and Goodwill

 

Since 2004, the Company has entered into fourteen purchase agreements in which it allocated a total of $103.4 million of the purchase price to intangible assets, including goodwill.

As a result of the Company’s plan to divest certain assets and due to declines in the Company’s stock price and market capitalization, the Company tested all of its reporting units as of June 30, 2008 for impairment. When completing step 1 of the impairment tests the Company determined that the carrying values of some of the Company’s reporting units had indicators of impairment.

The Company proceeded to complete step 2 of the analysis and recorded impairment charges during the second and third quarters of 2008. Due to continued declines in the Company’s market capitalization and deterioration in the overall markets that the Company operates in the Company again tested its goodwill for impairment as of December 31, 2008. During the process the Company determined that all of its reporting units were impaired and the Company recorded additional impairment charges in the fourth quarter of 2008. Overall in 2008, the Company recognized impairment charges of approximately $63.0 million and $17.6 million to the Company’s continuing operations and discontinued operations, respectively.

 

During 2009, the Company tested all reporting units for impairment.  When completing step 1 of the impairment tests, the Company determined that there were no indicators of impairment.  Subsequent to December 31, 2009, the Company was notified by its merchant processors that the merchant processors would be unable to continue to process transactions from the negative option marketing business, which was included in the Direct Segment.   As a result of this change to the business, the Company deemed all intangible assets and goodwill associated with the iLead Media, Inc. acquisition as of December 31, 2009 to be impaired.  The Company has included approximately $0.8 million in impairment of assets in the accompanying consolidated statement of operations for the year ended December 31, 2009 associated with this impairment.

 

F-14

---

 

 

Note 6 – Intangible Assets and Goodwill (continued)

The following is a schedule of the Company’s intangible assets from its continuing operations as of December 31, 2009:

	Term		Carrying Value				Accumulated Amortization and Impairment				Net Carrying Value
Names Database (1)	1-2 Years		$	11,803,351			$	(10,143,103	)		$	1,660,248
Website Development	5 Years			4,210,000				(3,268,727	)			941,273
Customer Lists	5 Years			3,895,000				(3,572,814	)			322,186
Vendor Relations	3 Years			2,682,000				(2,682,000	)			—
Software	5 Years			1,195,000				(1,195,000	)			—
Reference Materials	4 Years			571,000				(571,000	)			—
Tradenames	Indefinite			882,000				—				882,000
Total Intangible Assets			$	25,238,351			$	(21,432,644	)		$	3,805,707
Goodwill			$	3,893,405			$	(542,000	)		$	3,351,405

The following is a schedule of the Company’s intangible assets from its continuing operations as of December 31, 2008:

	Term		Carrying Value				Accumulated Amortization and Impairment				Net Carrying Value
Employment Agreements	3-5 Years		$	1,594,011			$	(1,594,011	)		$	—
Names Database (1)	1-2 Years			9,703,454				(8,299,598	)			1,403,856
Website Development	5 Years			4,210,000				(2,426,727	)			1,783,273
Customer Lists	5 Years			3,895,000				(2,872,814	)			1,022,186
Vendor Relations	3 Years			2,682,000				(2,682,000	)			—
Software	5 Years			1,195,000				(557,917	)			637,083
Reference Materials	4 Years			571,000				(562,000	)			9,000
Tradenames	Indefinite			1,522,000				(640,000	)			882,000
Total Intangible Assets			$	25,372,465			$	(19,635,067	)		$	5,737,398
Goodwill			$	61,779,401			$	(57,885,996	)		$	3,893,405

th

 

(1)	Amortization of Names Database included in cost of revenue for the years ended December 31, 2009 and 2008 was approximately $1.8 million and $3.2 million, respectively.

 

The Company’s amortization expense over the next five years is as follows:

 

2010		$	2,382,688
2011			541,019
2012			—
2013			—
2014			—
Total		$	2,923,707

 

F-15

---

 

Note 7 - Notes Payable

 

The following table summarizes the Company’s notes payable balance as of December 31, 2009 and 2008:

Lender		Due Date		Interest Rate		2009				2008
Wachovia Bank – Term Note		March 2011		LIBOR + 7%		$	3,465,806			$	3,700,855
Wachovia Bank – Credit Note		March 2011		LIBOR + 7%			4,645,000				6,214,228
Totals							8,110,806				9,915,083
Less: Term Note Payable-current portion							2,324,000				1,648,970
Term and Credit Notes Payable-Long Term						$	5,786,806			$	8,266,113

Principal Payments Due

 

Principal payments due are as follows:

2010		$	2,324,000
2011			5,786,806
TOTAL		$	8,110,806

 

Wachovia Credit and Term Notes Payable

 

On December 24, 2009, the Company entered into the Second Amended and Restated Loan Agreements with Wachovia Bank, N.A.(“Wachovia”) pursuant to which the Company restructured its obligations with Wachovia to reallocate the amounts owed to the bank between the term note and the credit note and to extend the due date of the remaining portion of the obligations. Under the terms of the Second Amended and Restated Loan Agreements ("Amended Loan Agreement"), which have superseded all prior loan agreements with Wachovia, the Company issued Wachovia the Second Amended and Restated Revolving Credit Promissory Note in the principal amount of $5.3 million (the “Credit Note”) and the Second Amended and Restated Term Promissory Note in the principal amount of approximately $4.1 million (the “Term Note”).  Both the Credit Note and Term Note bear interest at the rate of LIBOR plus 7%, with a floor of 7%, (7.23% at December 31, 2009) and are due on March 31, 2011.  Prior to the restructure, the Company owed Wachovia approximately $6.4 million under the previous credit note, with a maximum borrowing of $8,000,000. As described below, the maximum borrowing was reduced by $2.7 million and reallocated to the balance of the Term Note. The Company is permitted to have aggregate principal advances outstanding under this Credit Note of the greater of (i) $5.3 million or (ii) 80% of eligible accounts receivable less reserves plus an “over-advance” of $2.1 million through May 31, 2010 which, over time, is reduced to $1.0 million at January 1, 2011, which remains at that level through maturity of the Credit Note.  Prior to the restructure, the Company owed Wachovia approximately $1.4 million under the previous term note. As part of the restructure, this amount was increased by $2.7 million.  The Company’s obligations under the loan agreement and the notes continue to be secured by a first priority lien, in favor of Wachovia, on all of the Company assets, including the stock of each of the operating subsidiaries, and are subject to certain financial covenants.

 

 

F-16

---

 

Note 7 - Notes Payable (continued)

The Company agreed to reduce the amounts owed Wachovia by approximately $0.1 million at closing, $0.4 million on or before December 31, 2009 and $0.5 million split between March 31, 2010 and July 31, 2010. In addition, 25% of all net proceeds from equity sales made by the Company after July 31, 2010 and 100% of the net proceeds from the sale of any collateral or subsidiary will be used to further reduce our obligations to Wachovia. Under the terms of the loan agreement, the Company used funds from the exercise of warrants as previously disclosed and from the sale of our stock for these reductions, The amounts due under the notes can be accelerated if an event of default occurs as described in the notes, and our outstanding letter of credit of approximately $0.5 million must be terminated or replaced by the maturity date of the notes.  The availability under the Credit Note will be reduced by the outstanding balance of any letters of credit.

 

Per the amended loan agreement with Wachovia, the Company is required to calculate its borrowing base monthly based on eligible accounts receivable. The Company’s outstanding balance as of December 31, 2009 was approximately $4.6 million. In addition, the Company has approximately $0.5 million under a letter of credit with our landlord. The Credit Note Availability is calculated as principal less the outstanding balance less the outstanding letters of credit. As of December 31, 2009, the Company’s availability under its Credit Note was approximately $0.2 million. As of December 31, 2009, the Company’s outstanding balance on the term loan was approximately $3.5 million.

Repayment Terms; Interest Rates . Interest on the unpaid principal balance of the credit note and term note accrues at LIBOR Market Index Rate plus 7% provided further that the interest rate shall in no event be less than 7%. The credit note matures on March 31, 2011. Amounts due under the Term Note are payable in monthly payments of approximately $152,000 with any remaining principal due on March 31, 2011, the Term Note’s maturity. The principal amount of the Term Note will be reduced by the net proceeds to the Company upon the sale of MarketSmart Advertising, Inc.

Covenants . As detailed further in the Loan Amendment, so long as there remain any amounts outstanding under the credit note, the Company is required to maintain: (1) a “Total Debt to EBITDA Ratio” (i) as of December 31, 2009 of not more than 4.25 to 1.00; ( ii) as of March 31, 2010 of not more than 3.25 to 1.00; (iii) as of June 30, 2010 of not more than 2.50 to 1.00; (iv) as of September 30, 2010 of not more than 2.00 to 1.00; and (v) as of December 31, 2010 of not more than 1.50 to 1.00. This covenant shall be calculated at year end and quarterly, on a rolling four quarter   basis; (2) a “Fixed Charge Coverage Ratio” (i) as of December 31, 2009 of not less than 0.50 to 1.00; (ii) as of March 31, 2010 of not less than 0.50 to 1.00; (iii) as of June 30, 2010 of not less than 0.75 to 1.00; (iv) as of September 30, 2010 of not less than 1.50 to 1.00; and (v) as of December 31, 2010 of not less than 2.50 to 1.00. This covenant shall be calculated at year end and quarterly, on a rolling four quarter basis .   In addition, the Company may not: (a) make capital expenditures (excludes acquired names and capitalized software) during any year exceeding $500,000; (b) incur any additional indebtedness unless approved by Wachovia; and (c) declare or pay dividends unless approved by Wachovia.  Additionally, so long as the credit facility remains in effect, the Company may not acquire or invest in, directly or indirectly, any business unless approved by Wachovia. The Company may not purchase, redeem, retire or otherwise acquire, directly or indirectly, any stock, securities, or evidence of indebtedness, unless approved by Wachovia.  The Company was in compliance at December 31, 2009.

 

On March 29, 2010, the Company amended the Amended Loan Agreement (See Note 20).

 

Note 8 - Derivatives and Hedging Transactions

 

In the normal course of business, the Company is exposed to the impact of interest rate changes. The Company limits these risks by following established risk management policies and procedures, including the use of derivatives. Derivatives are used to align rate movements associated with its financing debt and manage the related cost of debt. The Company does not use derivative financial instruments for purposes other than hedging underlying commercial or financial exposures of the Company.

 

On March 18, 2009, the Company terminated the interest rate swap early as part of the Loan Amendment between the Company and Wachovia and incurred a related expense of approximately $94,000 included in interest expense on the 2009 consolidated statement of operations which was previously reflected in other accumulated comprehensive loss.

 

Prior to the termination, the Company had entered into an interest swap agreement to reduce the impact of changes in interest rates on its floating rate long-term debt. At December 31, 2008, the Company had outstanding an interest rate swap agreement with Wachovia, having a total notional amount of $5,000,000. This agreement effectively changes the Company’s interest rate exposure on its original $5,000,000 floating rate note that was due February 15, 2011 to a fixed interest rate of 5.9%. The interest rate swap agreement originally matured at the time the related note matured. The Company is exposed to credit loss in the event of nonperformance by Wachovia in the interest rate swap agreement; however, the Company does not anticipate nonperformance and the related note is held by Wachovia. The Company has designated its interest rate swap as a cash flow hedge for accounting purposes. As a result, changes in the fair value of the swap are recorded as a component of other comprehensive income. At December 31, 2008, a loss of approximately $102,000 was recorded in other comprehensive income (loss) and is included in other long-term liabilities.

 

F-17

---

 

Note 8 - Derivatives and Hedging Transactions (continued)

  

Changes in fair value on interest rate swaps are initially recorded in other comprehensive income (loss) and are subsequently reclassified to interest expense in the same period in which the variable cash flows affect earnings. Any ineffectiveness in the hedging relationship is recognized immediately in earnings. For the period ending December 31, 2008, there were no gains or losses recognized in earnings due to hedge ineffectiveness because the hedge was 100 percent effective.

Note 9 – Accrued Expenses and Other Current Liabilities

 

The accrued expenses and other current liabilities consist of the following at December 31, 2009 and 2008:

		2009				2008
Accrued Expenses		$	978,333			$	713,957
Accrued Affiliate Payments			202,153				185,508
Accrued Judgment			310,450				-
Accrued Payroll Liabilities			89,335				379,482
Capital Lease – Current Portion			176,937				308,115
Total		$	1,757,208			$	1,587,062

Note 10 – Other Long-Term Liabilities

 

The other long-term liabilities consist of the following at December 31, 2009 and 2008:

			2009				2008
Capital Lease – Net of Current Portion		$	190,867			$	262,248
Deferred Rent			265,473				214,875
Derivative Liability			-				101,943
Total		$	456,340			$	579,066

Note 11 – Income Taxes

Provision (Benefit) for Income Taxes

 

The provision for income taxes consists of the following:

 

		2009				2008
Current Tax Provision		$	-			$	-
Deferred Tax(Benefit) Provision			-				(1,980,051	)
Total Tax (Benefit) Provision		$	-			$	(1,980,051	)

 

 

 

 

F-18

---

 

 

Note 11 – Income Taxes (continued)

A reconciliation of the expected Federal statutory rate of 34% to the Company’s actual rate as reported for each of the periods presented is as follows:

 

		2009				2008
Expected statutory rate			(34	)%			(34	)%
State Income tax rate, net of federal benefit			(4	)%			(4	)%
Permanent Differences			99	%			-
Impairment Differences			-				16	%
Valuation Allowance			(68	)%			18	%
Other			7	%			-
			-				(4	)%

Deferred Income Taxes

 

Deferred income taxes are the result of timing differences between book and tax basis of certain assets and liabilities, timing of income and expense recognition of certain items and net operating loss carry-forwards.

 

The Company assesses temporary differences resulting from different treatments of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are recorded in the consolidated balance sheets. The Company evaluates the realizability of its deferred tax assets and assesses the need for a valuation allowance on an ongoing basis. In evaluating its deferred tax assets, the Company considers whether it is more likely than not that the deferred income tax assets will be realized. The ultimate realization of deferred tax assets depends upon generating sufficient future taxable income prior to the expiration of the tax attributes. In assessing the need for a valuation allowance the Company must project future levels of taxable income. This assessment requires significant judgment. The Company examined the evidence related to a recent history of tax losses, the economic conditions in which it operates, recent organizational changes, its forecasts and projections, as well as the recent changes in its financing agreement with Wachovia. As a result, the Company was unable to support a conclusion that it is more likely than not that any of its deferred tax assets will be realized. The Company therefore has recorded a full valuation for the net deferred tax assets as of December 31, 2009 and 2008. The Company will continue to evaluate its deferred tax assets to determine whether any changes in circumstances could affect the realization of their future benefit. If it is determined in future periods that portions of the Company’s deferred income tax assets satisfies the realization standard, the valuation allowance will be reduced accordingly. The 2009 net change in valuation allowance related to deferred tax assets was an increase of approximately $9.6 million primarily relating to operating carryforwards.

 

 

F-19

---

 

 

Note 11 – Income Taxes (continued)

The following is a schedule of the deferred tax assets and liabilities as of December 31, 2009 and 2008:

		2009				2008
Deferred Tax Assets
Net Operating Loss Carry Forwards		$	12,184,000			$	2,578,098
Intangible Assets			10,531,000				8,787,180
Deferred Rent			122,000				162,591
Allowance for Doubtful Accounts			676,000				943,979
Stock Based Expenses			347,000				283,183
Other			17,000				17,188
Subtotal			23,877,000				12,772,219
Less Valuation Allowance			19,911,000				10,283,883
Total			3,966,000				2,488,336
Less: Current portion			—				—
Non-Current portion		$	3,966,000			$	2,488,336
Deferred Tax Liabilities
Depreciation		$	553,000			$	707,350
Intangibles			3,413,000				1,780,986
Total			3,966,000				2,488,336
Less: Current portion			—				—
Non-Current portion		$	3,966,000			$	2,488,336
Total Deferred Tax Assets (Liabilities)		$	—			$	—

 

The net operating losses amounted to approximately $37.1 million and expire beginning 2022 through 2029.

 

Under the Internal Revenue Code of 1986, as amended, these losses can be carried forward twenty years. The Company has approximately $2.8 million of carry forward deductions from 2006 relating to stock options exercised as of December 31, 2009.

 

The adoption of provisions, required by ASC 740, did not result in any adjustments.

 

The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the years ending December 31, 2005 through 2008. The Company’s 2004 income tax return was reviewed by the Internal Revenue Service. No material items were discovered and the review was finalized in 2006. The Company and its subsidiaries state income tax returns are open to audit under the statute of limitations for the years ending December 31, 2005 through 2008.

 

The Company recognizes interest and penalties related to income taxes in income tax expense. The Company had incurred no penalties and interest for the years ended December 31, 2009 and 2008.

 

 

F-20

---

 

 

Note 12 - Stock-Based Compensation Plan

 

The stock option program is a long-term retention program that is intended to attract, retain and provide incentives for talented employees, officers and directors, and to align stockholder and employee interests. We consider our option programs critical to our operation and productivity. Currently, the Company grants options and restricted stock units ("RSUs") from the 2005 Long-Term Incentive Plan ("2005 LTIP"). Option and restricted stock unit vesting periods are generally zero to three years.

 

As of December 31, 2009, the Company had reserved 10.0 million shares of common stock for issuance under our 2005 LTIP. Under the 2005 LTIP, the Company has i) 8,883,621 options outstanding, ii) 400,000 shares issued to a former executive as severance and iii) 663,333 RSUs provided to employees, officers or directors. There were 243,332 of the RSUs vested at December 31, 2009. As of December 31, 2009, we had approximately 53,000 shares available for grant under our 2005 LTIP.

 

The Company recorded stock-based compensation expense for all equity incentive plans of approximately $435,000 and $268,000 for the years ended December 31, 2009 and 2008, respectively.

 

During 2008, the Company recalculated its projected forfeiture rate as it applies to stock-based compensation based on an analysis of historical data and recent trends. The forfeiture rate was changed from 9.25% to 25.0% of all non-vested stock options. The impact of this change in estimate was to reduce operating expenses and decrease in net loss for 2008 by approximately $70,000 which did not change both basic and diluted earnings per share. Actual results, and future changes in estimates, may differ substantially from the Company’s current estimates. For 2009, the Company continued to use a 25.0% forfeiture rate.

 

During 2008, the Company realized a benefit from actual forfeiture experience that was higher than previously estimated for unvested stock options and restricted common stock, resulting primarily from executive departures from the Company. The impact of these events was a reduction in operating expenses and decrease in net loss of approximately $474,000 for 2008.

 

At December 31, 2009, the aggregate intrinsic value of all outstanding options was $0.6 million with a weighted average remaining contractual term of 4.15 years, of which 4,277,064 of the outstanding options are currently exercisable with an aggregate intrinsic value of $0.1 million, a weighted average exercise price of $0.85 and a weighted average remaining contractual term of 3.76 years. The total intrinsic value of options exercised during the years ended December 31, 2009 and 2008 was approximately $0 and $34,000, respectively. The total compensation cost at December 31, 2009 related to non-vested awards not yet recognized was $0.8 million with an average expense recognition period of 2.39 years. The total fair value of options vested during 2009 and 2008 was approximately $0.4 million and $0.3 million, respectively.

 

The following table summarizes information about stock option activity during the years ended December 31, 2009 and 2008:

 

		2009								2008
		Options				Weighted Average Exercise Price				Options				Weighted Average Exercise Price
Outstanding, Beginning of Year			7,355,010			$	0.94				3,891,020			$	1.95
Granted			4,706,000			$	0.26				5,942,455			$	0.51
Forfeited or Expired			(2,181,380	)		$	1.16				(2,378,465	)		$	1.55
Exercised			-			$	-				(100,000	)		$	0.13
Outstanding, End of Year			9,879,630			$	0.57				7,355,010			$	0.94
Exercisable, End of Year			4,277,064			$	0.85				1,792,387			$	1.92

The weighted average grant date fair value of options granted during 2009 and 2008 were $0.19 and $0.16, respectively.

 

Cash received from option exercises under all share-based payment arrangements for the years ended December 31, 2009 and 2008 was approximately $0 and $13,000, respectively.

 

 

F-21

---

 

Note 12 - Stock-Based Compensation Plan (continued)

The following table summarizes information about stock options outstanding as of December 31, 2009, which includes 8,883,621 2005 LTIP options and 996,009 non-2005 LTIP options:

 

Range of Exercise Price				Shares				Weighted Average Remaining Contractual Life (Years)				Weighted Average Exercise Price
$	0.13-$0.15				417,891				3.43			$	0.13
$	0.16-$0.30				6,748,623				4.41			$	0.26
$	0.31-$0.99				1,773,147				3.41			$	0.69
$	1.00-$2.50				604,296				4.92			$	2.13
$	2.51-$5.30				335,673				2.47			$	4.02
Total					9,879,630				4.15			$	0.57

 

In accordance with ASC 718, the fair values of options granted prior to adoption and determined for purposes of disclosure under ASC 718 have not been changed. The fair value of options granted was estimated assuming the following weighted averages:

		2009				2008
Expected Life(in years)			4.70				3.50
Volatility			1.34				0.88
Risk Free Interest Rate			1.92	%			2.23	%
Dividend Yield			0.00	%			0.00	%

 

Expected volatility is based on the historical volatility of the Company’s common stock over the period commensurate with or longer than the expected life of the options. 

 

Note 13 – Stockholder’s Equity

 

Significant Equity Transactions

On December 16, 2009, the Company entered into subscription agreements for the sale of an aggregate of 16,740,000 shares of common stock at a purchase price of $0.25 per share resulting in gross proceeds of approximately $4.2 million. This offering was an "at the market" offering conducted as a takedown from the Company’s shelf registration statement which was declared effective by the Securities and Exchange Commission in January 2007. Under the terms of the subscription agreements, the closing of the offering was subject to the restructure of the Wachovia obligations and the proceeds from the subscriptions were deposited in escrow pending satisfaction of the closing condition. On December 28, 2009, following the restructure of the Wachovia obligations as described earlier in this report, the offering was closed. Included purchasers in this offering along with several institutional investors were members of the Company’s Board of Directors, their affiliates, and our executive officers who purchased an aggregate of approximately $1.7 million in the offering upon the same terms and conditions as the other investors. The Company did not engage the services of an underwriter or placement agent in this offering, but paid a finder’s fee of $48,000 to a broker dealer and member of FINRA. Additional fees incurred with the sale of common stock included $45,000 in listing fees and approximately $45,000 in legal fees.

 

Treasury Stock

 

The Company has 5,516,956 shares of stock in its treasury at a combined total value of approximately $2.1 million. The cost method was used in recording the purchase of the treasury stock.

Warrants Outstanding

 

As of December 31, 2009, the Company had outstanding warrants for the potential issuance of 6,484,521 shares of common stock. Exercise price ranges from $0.30 to $3.50 as of December 31, 2009. These warrants were primarily issued in connection with private placements and debt issuances and reflect the balances after the 2,260,931 shares were exercised in September 2009 (see below) for approximately $0.6 million or $0.27 per share. In August 2009, the Company issued 400,000 warrants to an Investor Relations firm as partial compensation for services. The 400,000 warrants are divided into four tranches of 100,000 warrants per tranche with exercises prices of $0.30, $0.50, $1.00 and $1.50. The warrants exercise over a 24 month period on a pro-rata basis and have a term of five years. All of these warrants are exercisable for five years.

 

 

F-22

---

 

Note 13 – Stockholder’s Equity (continued)

As a result of the granting of the investor relations warrants, the Company triggered the anti-dilution protection for warrants issued to investors in 2006 as part of their purchase and conversion of Series A Preferred Stock (“Investor Warrants”). As a result of the floor on each warrant the following represents the warrants that were outstanding, the stated exercise price and the adjusted exercise price. The Company issued 5,200,000 warrants with an exercise price of $2.50 per share, which was reduced to the floor of $2.00 per share. The Company issued 2,000,007 warrants with an exercise price of $3.05 per share, which was reduced to the floor of $2.50 per share. The Company issued 1,000,006 warrants with an exercise price of $4.00 per share, which was reduced to the floor of $3.50 per share.  Additionally, during the third quarter of 2009 the Company temporarily, from September 21, 2009 to September 29, 2009 (“Reduction Period”), re-priced the Investor Warrants. The Company provided a modification to the warrant agreements that i) reduced the exercise price from all the warrants ranging from $2.00 - $3.50 per share to $0.27 per share, the market price during the Reduction Period and ii) removed the cashless exercise feature. During the Reduction Period, 2,260,931 warrants were exercised.

 

The following table summarizes information about stock warrants outstanding as of December 31, 2009:

 

Range of Exercise Price				Shares				Weighted Average Remaining Contractual Life (Years)				Weighted Average Exercise Price
$	0.30-1.50				444,939				4.17			$	0.84
$	1.51-2.50				3,764,900				1.26				2.00
$	2.51-3.50				2,274,682				1.83				2.72
Total					6,484,521				1.66			$	2.17
Exercisable					6,167,854				1.51			$	2.61

Note 14 – Discontinued Operations

 

During 2008, the Company made a decision to cease operations at its Web Diversity Ltd subsidiary in the United Kingdom and divest its MarketSmart Advertising operations which comprised its Advertising Segment. The Company also decided to divest its Online Dating operation which was a portion of its Direct Segment. As a result, the related assets are classified as held for sale and their respective carrying values have been adjusted down to their estimated fair value less selling costs. The write down to fair value resulted in a charge to loss from discontinued operations of approximately $17.8 million, net of tax expense for year ended December 31, 2008. Additionally, the results of operations of these reporting units have been reported as a profit or loss from discontinued operations in the consolidated statements of operations.

The table below summarizes financial results for the assets classified as held for sale for the years ended December 31, 2009 and 2008:

		2009				2008
Net sales		$	12,865,855			$	15,490,491
Profit (Loss) from discontinued operations before income taxes		$	1,607,184			$	(17,844,427	)
Income Tax Expense			-				(212,429	)
Profit (Loss) from discontinued operations		$	1,607,184			$	(18,056,856	)

 

Note 15 – Retirement Plan Costs

 

The Company sponsors a defined contribution plan to help eligible employees provide for retirement. The Company began matching employees’ contributions in April of 2007. The Company currently matches 50% of employee contributions up to 6% of eligible contributions. The Company’s total matching contributions for the years ended December 31, 2009 and 2008 were approximately $124,000 and $163,000, respectively.

 

F-23

---

 

 

Note 16 - Leases

 

The Company leases certain office space and equipment. As leases expire, it can be expected that, in the normal course of business, certain leases will be renewed or replaced.

 

Rent expense was approximately $1.3 million and $1.7 million for the years ended December 31, 2009 and 2008, respectively.

Minimum lease payments under non-cancelable operating leases as of December 31, 2009 are:

2010		$	783,675
2011			811,328
2012			839,692
2013			869,003
2014			899,342
Thereafter			692,106

 

The Company had a subsidiary, MarketSmart Interactive (“Interactive”) that was dissolved in 2007.   Interactive was a party to an operating lease. There is currently a legal action filed by the Lessor of the Interactive lease   Interactive was insolvent when it was dissolved.  Refer to Note 17 for further discussion of this matter.

Note 17 - Commitments and Contingencies

Earnouts

In connection with its prior acquisitions, the merger consideration may be increased as the former shareholders of each entity are entitled to earn payments in cash or stock contingent upon the satisfaction of certain future internal performance goals set forth in the applicable merger and amended merger agreements. Future consideration which may be earned by the former shareholders of each entity will be treated as additional purchase price and allocated to goodwill. As of December 31, 2009 and 2008, no additional compensation was owed to former shareholders of acquired entities and no amounts were paid during the years ended December 31, 2009 and 2008.

 

 

 

 

F-24

---

 

 

Note 17 -- Commitments and Contingencies (continued)

 

As of December 31, 2009 and 2008, there are no liabilities under any other earnout agreements.

 

Legal Related

 

From time to time, the Company is a party as plaintiff or defendant to various legal proceedings related to our normal business operations.

 

A former employee filed a breach of contract claim and wrongful termination lawsuit against the Company.  There was a judgment against the Company in December 2009 in the amount of approximately $0.8 million, $0.3 million for Count 1 and $0.5 million for Count 2.  The Company appealed the ruling and, subsequent to year end, the judge ruled to reverse the ruling on Count 2, which has been set for trial.  The Company has filed an appeal on Count 1 and intends to vigorously defend both Counts, although, the Company accrued approximately $0.3 million as of December 31, 2009 relating to this matter.

 

A dissolved subsidiary, Interactive was party to a real estate lease in North Carolina (“the Property”).  The lessor of the Property has filed a suit against Interactive, the dissolved lessee and MSA.  Interactive was insolvent at the time of dissolution and MSA was not party to the lease.  The Company intends to vigorously defend this matter.

 

In the opinion of management, although the outcome of any legal proceeding cannot be predicted with certainty, the ultimate liability of the Company in connection with its legal proceedings will not have a material adverse effect on the Company’s financial position, but could be material to the results of operations in any one future accounting period. Defense costs are expensed as incurred.

 

Note 18 – Related Party Transactions

 

Separation Agreement

 

On April 18, 2008, Mr. Mitchell resigned his position as the Chief Executive Officer and President of the Company. Effective as of April 24, 2008, the Company and Scott P. Mitchell entered into a Separation Agreement and a Consulting Agreement, pursuant to which Mr. Mitchell resigned as a member of its Board of Directors.

 

F-25

---

 

Note 18 – Related Party Transactions (continued)

During 2008, pursuant to the Agreements, the Company granted Mr. Mitchell, under the Company’s 2005 LTIP, 400,000 unrestricted shares of the Company’s common stock, in consideration for providing consulting services to the Company for six months. The Company recorded a charge of $328,000 during the second quarter of 2008 relating to the fair value of the stock. Mr. Mitchell’s Employment Agreement with the Company, dated August 3, 2006, was terminated. All of his options and warrants received directly from the Company, whether vested or unvested, were forfeited. Mr. Mitchell had a total of 725,000 options and warrants with exercise prices ranging from $1.69 to $2.40 per share. Mr. Mitchell and the Company exchanged releases. Mr. Mitchell agreed not to sell more than 50,000 shares of the stock grant he received under the Agreements in any weekly period on the open market, and for 12 months he agreed not to engage in any business that competes with the Company in the U.S. and in certain foreign jurisdictions or solicit any of the Company’s employees or customers.

Settlement Agreements

 

On June 27, 2008, the Company entered into a Settlement Agreement and Mutual Release with Brady Whittingham, a former Company executive. The Agreement settled the litigation and claims which the Company brought against Mr. Whittingham in U.S. District Court for the District of Utah. Pursuant to the Agreement, the Company received 2,359,406 shares of the Company’s common stock owned by Mr. Whittingham; all his vested stock options were forfeited; all claims to any earnout payments, which he acquired from the April 27, 2006 sale of iLead Media, Inc. to the Company, were forfeited; and a Company subsidiary’s lease of office premises from an affiliate of Mr. Whittingham was terminated early. Mr. Whittingham further agreed for one year not to engage in any business that competes with certain businesses of the Company or to solicit any of the Company’s employees and not to interfere with any business relationships between the Company and its customers or vendors. He agreed to provide limited consulting services for six months. Mr. Whittingham and the Company exchanged full general releases excepting only claims that arise out of or relate to the Agreement. The stock was recorded at its fair value on June 27, 2008. The Company offset legal fees directly related to the lawsuit against the value of the stock when presenting the gain from the settlement which is included in discontinued operations.

On September 5, 2008, the Company entered into a Settlement Agreement and Mutual Release with David Nelson, a former Company executive. The Agreement settled the litigation and claims which the Company brought against Mr. Nelson in U.S. District Court for the District of Utah. Pursuant to the Agreement, the Company received 296,176 shares of the Company’s common stock owned by Mr. Nelson; $100,000 in immediately available funds; and all his vested stock options were forfeited; all claims to any earnout payments, which he acquired from the April 27, 2006 sale of iLead Media, Inc. to the Company, were forfeited. Mr. Nelson further agreed for eighteen months not to engage in any business that competes with certain businesses of the Company or to solicit any of the Company’s employees and not to interfere with any business relationships between the Company and its customers or vendors. Mr. Nelson and the Company exchanged full general releases excepting only claims that arise out of or relate to the Agreement. The stock was recorded at its fair value on September 5, 2008. The Company offset legal fees directly related to the lawsuit against the value of the stock when presenting the gain from the settlement which is included in discontinued operations.

 

Note 19 - Segment Analysis

 

The Company’s operations are divided into operating segments using individual products or services or groups of related products and services. During the second quarter of 2008, the Company made a decision to divest its MarketSmart Advertising operations and ceased operations of its Web Diversity subsidiary which in total comprised its Advertising Segment. The Company also made a decision to divest its Online Dating

operations which was a portion of its Direct Segment. All prior periods have been adjusted for the new presentation. The Officer’s of each of the Company’s subsidiaries reports to the Chief Executive Officer of the Company, who makes decisions about performance assessment and resource allocation for all segments. The Company had two operating segments as of December 31, 2009:  Exchange and Direct.  The Company evaluates the performance of each segment using earnings before interest, taxes, depreciation and amortization (“EBITDA”).

 

 

F-26

---

 

Note 19 - Segment Analysis (continued)

Listed below is a presentation of revenue, gross profit and EBITDA for all reportable segments. The Company currently only tracks certain assets at the segment level and therefore assets by segment are not presented below. The “corporate” category in EBITDA table consists of corporate expenses not directly attributable to any segment.

 

Net Revenue by Industry Segment

 

		2009								2008
Segment		Amount				Percent				Amount				Percent
Exchange		$	28,842,342				55.8	%		$	30,966,424				47.8	%
Direct			22,812,421				44.2	%			33,771,334				52.2	%
Total Revenue		$	51,654,763				100.0	%		$	64,737,758				100.0	%

 

Gross Profit by Industry Segment

 

Segment		2009				2008
Exchange		$	7,597,317			$	10,158,619
Direct			8,875,109				13,271,367
Total		$	16,472,426			$	23,429,986

Earnings (Loss) before Interest, Taxes, Depreciation and Amortization by Industry Segment

 

Segment		2009				2008
Exchange		$	2,785,642			$	3,004,454
Direct			2,554,517				6,005,201
Corporate			(4,516,090	)			(6,154,723	)
Total		$	824,069			$	2,854,932

Note 20 – Subsequent Events

 

The Company is a defendant in a wrongful termination suit with a former Executive Officer.  A judgment was entered against the Company on two counts prior to December 31, 2009.  Subsequent to year end, yet before issuance of the December 31, 2009 financial statements, the Court vacated the judgment on one of the counts.   The accompanying consolidated financial statements reflect only the remaining outstanding judgment of approximately $0.3 million.

On March 1, 2010, the Company determined that as a result of recent market pressures from credit-card processors to accelerate its decision to exit the negative-option marketing programs which became part of the Company’s Direct Segment following the iLead Media, Inc. acquisition in 2006. The Company is currently exploring a number of transitional opportunities related to these online consumer programs, which collectively have represented as much as 20% of the historical net revenue from continuing operations of the Company.  As a result in this change to the iLead Media, Inc. business, the Company deemed all remaining intangible assets associated with this business as of December 31, 2009 to be impaired.

On March 29, 2010, the Company entered into a First Amendment to the Second Amended and Restated Loan Agreement and First Amendment to Second Amended and Restated Revolving Credit Promissory Note with Wachovia Bank, N.A. which modified certain terms of the December 2009 agreement and Credit Note.