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Traffix, Inc. (TRFX) is an interactive media company that owns and operates a variety of websites with a broad range of content. The websites feature content ranging from music for downloads to sweepstakes. Virtually all of its websites generate revenue from client advertisements.

In addition, Traffix builds end-to-end online marketing solutions for clients who seek to generate new customer contacts and increase user transactions and sales. Its full solution marketing services group delivers media, analytics and results to third parties through its four business groups:

  • Hot Rocket Marketing is an online direct-response media firm servicing advertisers, publishers and agencies by leveraging vast online inventory across sites, networks, search engines and email to drive users to client web properties, generating qualified leads, registrations and sales. The marketing strategy integrates affiliate-marketing networks with [controversial] promotion-based lead generation programs;
  • mxFocus develops and distributes content and services for mobile phones and devices and provides interactive mobile media solutions for advertisers, marketers and content providers;
  • SendTraffic is a performance focused, search engine marketing firm focused on building online presence, optimizing marketing expenditures and retaining customers by leveraging proprietary solutions, such as search engine optimization and website analytics; and,
  • Traffix Performance Marketing offers marketers brand and performance based distribution solutions though the Traffix network of entertaining web destinations, via its proprietary ad-serving optimization technology.
  • Traffix generates and records revenue primarily on a performance-based model, whereby revenue is recognized upon the successful delivery of a qualifying lead, customer, survey, completed application, ultimate sale or the delivery of some other measurable marketing benefit as defined in the client’s underlying marketing agreement.

    Second Quarter Highlights

    On July 16, Traffix reported net income for the second-quarter ended May 31, 2007, of $765,000, or $0.05 per share, compared to net income of $637,000, or $0.04 per share, in the comparable quarter of 2006.

    Net Revenue for the quarter was $19.8 million, representing an increase of $0.8 million, when compared to net revenue of $19.0 million for the second quarter of fiscal 2006. The 4.4% increase in sales was driven principally by Search Engine Marketing services ($2.6 million, or 61%), offset by a nominal decline in Online Advertising ($0.51 million, or 4.0%).

    Search Engine Marketing service revenue increased as a result of an increased focus on the identification of new third party clients and the enhancement of existing Search client relationships. We view the decline in online advertising as transient, for management continues its focus on generating revenue via Websites for new wireless client relationships (offset—in the short-run--by anticipated declines in other historically traditional clientele).

    Gross Profit as a percentage of net revenue fell 590 basis points to 31.5% during the three months ended May 31, 2007, primarily attributable to a decrease in the gross profit margin of the Online Advertising component, which due to its higher relative revenue contribution (58.2% of net sales) yields a higher proportionate impact on the total relative decline.

    The 10Q Detective is cognizant that net income was boosted by an increase in consolidated Other Non-operating Income of approximately $305,000 for the three months ended May 31, 2007, up from approximately $140,000 for the three months ended May 31, 2006.

    The factors contributing to the increase were (i) a 16% increase in interest income of approximately $40,000,the result of more favorable rates available during Fiscal 2007; (ii) a $17,500 in realized gains on the sale of marketable securities.

    Liquidity & Capital Resources


    As of May 31, 2007, the Company had aggregate working capital of $30.5 million, compared to aggregate working capital of $31.7 million as of November 30, 2006.

    Free Cash Flow provided by operating activities was approximately $1.9 million for the six months ended May 31, 2007.

    Future plans and business strategy continue to call for Internet-based Online Advertising and Media Service activities to be the sole operating focus—as it was for the three and six-month periods ended May 31, 2007. Cash demands for capital expenditures and equipment lease obligations declined to $239,990 during the six months ended May 31, 2007, compared to $257,749 during the six months ended May 31, 2006. The significant portion of such capital expenditure was for email servers that substantially reduced Traffix’s reliance on and related additional costs associated with third party email delivery suppliers.

    We observed that days-sales-outstanding ("DSO") in accounts receivable at May 31, 2007 improved: at 42 days, compared to 44 days at February 28, 2007, 45 days at November 30, 2006, and 56 days at August 31, 2006. The two day, or 4.5% decrease in the current quarter’s DSO compared to the first quarter of this fiscal year was due to continued efforts in monitoring clients and improving rates of collection across all of client relationships.

    Investment Risks & Considerations

    The income tax provision for the three months ended May 31, 2007, was approximately $643,000, or 45.7%, that differed immaterially from Traffix’s annual effective rate of 46.2% recognized during the year ended November 30, 2006.

    Under its current tax structure, the Company’s Canadian subsidiary’s foreign earnings are fully taxed in Canada, and as such, based on the lack of any foreign source income, a foreign tax credit is not available to Traffix on the related foreign taxes. Ergo, with such taxes being fully included in the US tax provision; the result was inordinately high tax rates. Management is formulating tax planning that should be in place for the 2H:07, whereby the future effective tax rate should decline in the range from approximately 36% to 39 percent.

    The Company’s Success Depends On Its Ability To Continue Forming Relationships With Other Internet And Interactive Media Content, Service And Product Providers
    .

    Today’s online lead-generation space is a crowded and highly competitive industry. The Company is modifying its business methods and practices, including diversification of its revenue drivers, in an effort to diversify its customer base. However, as in prior fiscal periods, a significant portion of the Company’s revenue is still dependent on a limited number of major customers. Albeit no single customer exceed 10% of the Company’s consolidated net revenue, Traffix’s five largest customers during the six months ended May 31, 2007 accounted for 8.3%, 8.1%, 8.1%, 6.1% and 4.3% of consolidated net revenues during this period.

    Demand For Traffix’s Services May Decline Due To The Proliferation Of "Spam" And Software Designed To Prevent Its Delivery.

    On May 18, 2007, online advertising competitor ValueClick, Inc. (VLCK) received a letter from the Federal Trade Commission("FTC") stating that the FTC was conducting an inquiry to determine whether the Company's lead generation activities violated either the Federal Trade Commission Act or the CAN-SPAM Act. Specifically, the FTC is investigating certain ValueClick websites, which promised consumers a free gift of substantial value, and the manner in which the Company drives traffic to such websites, in particular through email.

    ValueClick defines the use of ValueClick websites that promise consumers a free gift as "promotion-based" lead generation.

    During the six months ended May 31, 2007, Traffix recognized a decline in its email marketing revenue of approximately 55% when compared to the six months ended May 31, 2006. In our view, the potential for state and/or federal legislation to further limit the Company’s ability to contact consumers online is already discounted in its share-price.

    Buy Thesis

    The Internet operating landscape is changing. Numerous studies show that it is easier and as much as six times less expensive to sell to an existing customer than to acquire a new one. Consequently, the demand for lead generation and customer value management and retention demands more complex customer intelligence processing—entailing a 360-degree view of the customer

    Management previously said that future plans and business strategy called for Internet-based Online Advertising and Media Service activities to be Traffix’s sole operating focus; however, we believe that the product-mix should be inclusive of the Internet Game Development subsidiary, too—given gross profits of 69 percent!

    Traffix rewards its shareholders with a 5.6% dividend yield to patiently hold the stock while management works to re-define its growth strategy and execute on growing its bottom-line. The catalysts for a sustained upward swing in share valuation will come once management demonstrates its ability to execute on prior promises: sustainable online advertising sales combined with sequential profits generated by the build-out of Traffix’s proprietary search optimization platform.

    The valuation is compelling—despite the aforementioned risks. Market capitalization, Price/sales, Book Value/share, and debt of $86.20 million, 1.15 times, $3.08, and nil, respectively.

    Author David J Phillips holds a financial interest in shares of Traffix, Inc. The 10Q Detective has a Full Disclosure Policy.

    TRFX 17 month chart:

    Source: Traffix: Possible Further FTC Anti-Spam Legislation Priced In