Traffix F3Q07 (Qtr End 8/31/07) Earnings Call Transcript

Traffix, Inc. (TRFX)

F3Q07 Earnings Call

October 15, 2007 10:00 am ET

Executives

David Burke - KCSA

Jeffrey L. Schwartz - Chairman of the Board, Chief Executive Officer

Daniel Harvey - Chief Financial Officer

Analysts

Ali Mogharabi - B. Riley & Company

Phil Higgins - Private Investor

Ava Horowitz - Old School Partners

Presentation

Operator

Good morning. My name is Barbara and I will be your conference operator today. (Operator Instructions) Thank you. It is now my pleasure to turn the floor over to your host, Mr. David Burke. Sir, you may begin your conference.

David Burke

Thank you, Barbara and thank you, everyone, for joining us for the Traffix 2007 third quarter earnings conference call. I would like to just provide some cautionary language before I turn the call over to Jeffrey Schwartz.

Before we begin, I would like to mention that this call contains certain forward-looking statements and information relating to Traffix that is based on the beliefs of Traffix management as well as the assumptions made by and information currently available to the company. Such statements reflect the current views of the company with respect to future events, including estimates and projections about Traffix's business based on certain assumptions of Traffix's management, including those described on this conference call.

These statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict, including changes in demand for the company’s services and products, changes in technology and regulatory environment affecting the company’s business, and difficulties encountered in the integration of acquired businesses.

Should one or more of these underlying assumptions prove incorrect, actual results may vary materially from those described here and as anticipated, believed, estimated, or expected.

The company does not intend to update these forward-looking statements.

With nothing further, I would like to now turn the call over to Mr. Jeffrey Schwartz, Chairman and Chief Executive Officer of Traffix Incorporated. Jeff, the floor is yours.

Jeffrey L. Schwartz

Thank you, David. Good morning. With me today is Andrew Stollman, our President, and Dan Harvey, our CFO. Dan Harvey, as always, will start the call with a comparable and sequential basis overview of the financial results for our third quarter of fiscal year 2007.

Following the overview, I will then discuss several factors that influenced our third quarter and the prospects for the remainder of the fiscal year.

Daniel Harvey

Good morning, ladies and gentlemen. Our quarterly financial results were as follows: consolidated revenue for the third fiscal quarter, which ended August 31, 2007, was $25.7 million, an increase of 30% from $19.7 million for the third fiscal quarter of 2006. Gross margin in terms of absolute dollars generated decreased by approximately $200,000. The corresponding contribution margin decreased to 26.9% from 36.2% when comparing the third quarter to fiscal 2007 and 2006.

This is the result of shifts within our revenue generating activities where increases in revenue have come from lower margin generating business. This is summarized in greater detail in the MD&A section of our 10-Q that will be filed this afternoon.

Income from operations for the third fiscal quarter was $1.63 million, a decrease of 2% from income from operations of $1.6 million in the third fiscal quarter of 2006.

Adjusted EBITDA recognized a similar decrease of approximately 3%, comparing EBITDA of $2.26 million in the third quarter of fiscal 2007 with EBITDA of $2.34 million in the third quarter of fiscal 2006.

Both income from operations and EBITDA were negatively impacted in the recent quarter from over $300,000 in professional fees and other related expenses primarily arising from our proposed merger activity.

Net income for the third quarter was $847,000 and is compared to net income of $842,000 as reported in the third fiscal quarter of 2006. Net income and EPS, as described below, were negatively impacted by a current quarter permanent difference arising out of the tax treatment of expenses directly related to our proposed merger activity. This is the major factor contributing to our 10% effective rate increase in the third quarter when comparing an effective tax rate of 56% with fiscal 2006’s effective tax rate of 46%.

Diluted earnings per share were $0.06 in the third quarters of both fiscal 2007 and 2006.

On a sequential basis, net revenue increased in the third quarter by $5.9 million, or 30% from $19.8 million in the second fiscal quarter of 2007. Revenue generated from our marketing relationship with New Motion Inc., our proposed merger partner, contributed approximately $5.5 million to third quarter revenue, compared to approximately $1 million in the second quarter. In our first quarter of 2007 and prior, our revenues from New Motion were insignificant.

Sequentially, gross margin in terms of absolute dollars generated increased approximately $690,000. The corresponding contribution margin decreased 26.9% from 31.5% when comparing the sequential fiscal 2007 period.

The decline as noted above was the result of shifts within our revenue-generating activities where recent increases in revenue came from lower margin generating activities. This was attributable to both our internal decision to forego certain levels of margin so that we could increase our volume, as well as organic growth of other lower margin revenue mix components.

The company’s income from operations increased sequentially by 48% to $1.63 million in the third quarter from $1.1 million in the second quarter. As mentioned in the comparative period discussion, the third quarter was encumbered by over $300,000 in expenses with the majority associated with the merger that were not specific to operating efficiencies.

Adjusted EBITDA increased sequentially by 34% to $2.3 million in the third quarter from $1.7 million in the second fiscal quarter. The company’s diluted earnings per share were $0.06 in the third fiscal quarter 2007 and $0.05 in the second fiscal quarter of 2007.

I now turn the chair back to our CEO, Mr. Schwartz.

Jeffrey L. Schwartz

Thank you, Dan. This is a particularly exhilarating call for us. First, we are pleased to announce a very good quarter, building upon what is already a very positive year for Traffix. Second, we recently announced our planned merger with New Motion, Inc. I will talk about this later in the call.

Previously, I had reported on our commitment to and enthusiasm for the potential and growth in the mobile entertainment marketing space. I stated then and I believe that Traffix's unique portfolio of corporate assets placed us squarely at the forefront of this rapidly evolving space.

I believe this quarter’s results demonstrated the accuracy of those predictions.

This quarter’s results were greatly impacted by this trend. Revenues from our marketing of mobile entertainment products and services accounted for over 32% of our revenue this quarter, compared to 12% in the second quarter and 19% of revenues in fiscal 2006’s third quarter.

Our client list in the mobile space numbered over 14 during the quarter. New Motion, our merger partner, made up a significant percentage of these mobile revenues, comprising approximately 65% of our mobile business as well as 21% of our consolidated revenues.

We are confident that this not only bodes well as a harbinger of our future success but speaks volumes as to the objective appeal of their programs to the Internet community.

Last quarter, we reported on the launch of Gator Arcade. This site and service was built in partnership with New Motion. To date, we have recorded over $1 million in revenue from Gator and have a current active subscriber base in excess of 90,000, which we expect to continue to grow.

All of the Traffix units contributed in a meaningful way to this quarter’s growth. Hot Rocket, our affiliate marketing company, delivered approximately $11.7 million in revenue for the quarter prior to inter-company eliminations, compared to $6 million in fiscal 2006’s third quarter. On a comparable basis, this represented a 95% increase.

Hot Rocket’s role in the proposed new merger entity looks to be even more pronounced. Having exclusive access to the mobile programs that are developed in the future we believe will help us to continue to attract more publishers and advertisers.

We are confident that this area of our business will be ripe for expansion, both organically and through acquisition.

Unfortunately, along with our increased contribution to revenue growth and total reported revenues comes the corresponding compression of margin at the consolidated level. Hot Rocket has historically recognized gross margins in the 20% range.

In June 2004, we acquired a small search engine marketing company named Sendtraffic. At the time we acquired the company, their revenues were less than $4.5 million annually. This quarter, their revenues were over $8.5 million, a 108% increase over the comparable period in 2006.

The team has done a superb job in growing the business and servicing their clients. We see no reason why they should not be able to continue to grow. Search engine marketing and search engine optimization are core competencies for any company that hopes to succeed on the Internet today.

We plan on making Sendtraffic the key players in the proposed new merged entity. We believe using our proprietary technology, experience and skill will enable us to grow our future mobile subscription base efficiently and with a focused minute-to-minute eye on the P&L.

Our core proprietary web content business continues to enjoy steady growth as well. This does not come without its day-to-day challenges. The value of the content we own or license, such as our music library, continues to grow in value. I can’t imagine a higher barrier to entry than owning content.

Moreover, there are few companies on the web that can offer as large a quantity of free music and games to the online audience as Traffix. During prior calls, I referred to the success we have had with our organic search initiatives. Quarter over quarter, we have seen sustained growth. Mastery of organic search is difficult at best, yet we believe that having good content makes it sustainable and an area that we can grow for many years to come.

Assuming the consummation of our proposed merger, we plan on building more lifestyle targeted content sites that can be attractive as acquisition engines for acquiring new subscribers to our mobile entertainment network. The areas we pursue can be as niche as new mothers or as broad as music downloads. Because of the existing scale we have in the current New Motion subscriber base, we believe we have the latitude to build smaller, more loyal premium build mobile communities.

We at Traffix are thrilled and excited by our proposed merger with New Motion. We have worked for them for nearly a year now and the chemistry between the groups has been excellent. We all share the same drive and vision to become the leader in mobile entertainment. Our products are unique and exciting and we plan on introducing more of them in the future.

As a consequence of the proposed merger, I would be stepping down as CEO. The plan calls for me to stay on for the next two years as a consultant to the company and to the new CEO, Burton Katz. I am passing the baton to one of the most energetic, hardworking people I’ve ever had the pleasure of working with.

Burton Katz has the commitment and drive that only an up-and-coming 35-year old executive can have. He has already earned the respect and admiration of my team. I am sure he will earn the respect and favor of the investing public, particularly our shareholders.

In our earnings release, we announced the issuance of a quarterly dividend of $0.08 per share, payable November 10, 2007, for holders of record as of November 1, 2007. Subsequent to the above referenced dividend, the company’s board has agreed not to consider the grant of any dividends between now and the potential date of the closing of the merger transaction upon the receipt of shareholder approval.

In all probability, this will be the last time I deliver a report on the results of Traffix. It has been a lot of hard work, which I embraced with 100% commitment and focus. There have been many people at Traffix who have contributed to our success. They have been my co-workers and friends and have supported all of our efforts.

I want to thank you all for getting us to this point and helping me to achieve many of my personal career goals. I hope I have helped you to achieve yours. Traffix has never been better positioned to become an industry leader. Hopefully the success we have had this quarter and throughout the year validates that for you.

It is my personal belief and hope that our new entity will greatly increase shareholder value and confirm for you that this is just one of those rare opportunities that you have to be part of.

Thank you. I will now open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is coming from Ali Mogharabi from B. Riley & Company.

Ali Mogharabi - B. Riley & Company

Jeff, I was looking at the numbers here -- can you hear me?

Operator

The question is coming from Ali Mogharabi from B. Riley & Company.

Ali Mogharabi - B. Riley & Company

Can you guys hear me?

Jeffrey L. Schwartz

Yes, we can hear you.

Ali Mogharabi - B. Riley & Company

I was actually looking at the numbers, look at the balance sheet, you’ve got about $30 million in cash. I looked at the guidance that you guys gave last I think it was basically on the New Motion call, saying you can guys can generate what, around [$145 million, $160 million] in revenue, so let’s say $80 million, $85 million of that is coming from you guys. I guess what I’m trying to get at is at $6.30 a share, and I think that’s where it’s trading at right now, it’s basically trading about half of sales, so correct me if I’m wrong, Jeff, but it’s pretty cheap here.

Jeffrey L. Schwartz

You are certainly preaching to the converted. We think it is very cheap here and we are optimistic that the value is going to start to be realized and recognized and we plan on visiting with lots of the appropriate people in the near future to get the story out, but I am very excited because I think now with this quarter and when New Motion reports, I think the street will really see the value and the potential in this story.

Ali Mogharabi - B. Riley & Company

I agree with you, Jeff. I guess my question also would be do you -- I’m expecting that you guys do see comparable top line growth going forward, especially combining with New Motion. Am I thinking the right way, I guess?

Jeffrey L. Schwartz

I’m not sure I understand the question, Ali.

Ali Mogharabi - B. Riley & Company

Well, I’m looking at basically revenue growth this quarter, it was what, over 30%? This can’t go on forever but I’m assuming that you guys do expect pretty strong double-digit top line growth going forward.

Jeffrey L. Schwartz

Without getting too granular, obviously we expect growth going forward. We expect the synergies to add quite a bit of value and to increase our ability to grow and that was part of the excitement for us in contemplating this merger. As this space continues to evolve, the mobile space, the opportunities are just getting bigger and bigger and bigger.

We have lots of plans, obviously, post merger to grow both businesses.

Ali Mogharabi - B. Riley & Company

With all of that said, that’s certainly another reason why it looks so cheap here. One last question, Jeff: we do know that you have the option to sell I think it was over a million shares, but I wouldn’t sell it at this level, just telling you. I mean, with so much upside, so I’m hoping you are assuming the same thing.

Jeffrey L. Schwartz

I can’t comment but I can read the tea leaves.

Operator

(Operator Instructions) Our next question is coming from Phil Higgins, a private investor.

Phil Higgins - Private Investor

Jeff, how are you today? Nice quarter, especially on the revenue side and as the previous caller stated, you guys obviously had nice sequential EBITDA growth and I wanted to ask a similar question. Obviously you are not comfortable talking about your personal sales, where and what levels you will be selling them. My question to you more importantly is what was your thinking behind -- it seems to me you clearly personally were looking for a liquidity event, and if that’s the case, if I were looking for a liquidity event, I would be merging, selling, et cetera to a company that was liquid.

Clearly New Motion is illiquid and yes, we can all smile and say hey, what a great company we’ve got and how cheap the company is and the stock is here, but what was your thinking about selling to an illiquid company? And how do you plan to actually sell your stock and extract value and is this going to take a lot longer than you personally had anticipated?

And then, just as a follow-up, were there any other bids that you guys considered, any other companies you considered merging with? Are there any other bids on the table and would you consider another company at this time? Thank you.

Jeffrey L. Schwartz

First of all, my personal preferences, unfortunately we are not as relevant as one might think. When a company like Traffix entertains a strategic option, the necessity is to immediately form a special committee, which we did. And once that special committee is formed, any decision to take any action rests with the special committee, not the CEO. And we had other opportunities that the special committee evaluated and after much deliberation, which much meaning months, of looking at other options, the special committee, in line with management, unanimously agreed that the New Motion opportunity was the best opportunity for the shareholders.

What was best for Jeff Schwartz was not in the cards and that was not one of the considerations.

How and when I come to a liquidity event, we’ll see what goes on in the future but like the rest of the shareholders, I’m sitting here hoping and expecting the stock to appreciate dramatically with this combination.

Phil Higgins - Private Investor

Is there any sort of public filing you can make or statement, maybe not at this time, that at a certain level that you won’t be selling the stock at?

Jeffrey L. Schwartz

No, I don’t think that’s appropriate, or legal. But it is obvious I haven’t sold any.

Phil Higgins - Private Investor

Yes.

Operator

Thank you. Our next question is coming from Andy [Horowitz] from [Old School] Partners.

Ava Horowitz - Old School Partners

Hi, Jeff, this is Ava Horowitz. Congratulations on the deal. As someone who knows Burt, I understand why you did the deal. I guess my only question I am hoping you can give me an answer to is when you think the earliest this deal could actually close, if at this point you guys are comfortable giving out that info.

Jeffrey L. Schwartz

Yes, I am comfortable telling you what I know. I can’t tell you what I don’t know but I think if everything went well with the SEC, I guess it could close in mid-December. Realistically, I think it is going to be somewhere between December 15th and January 14th.

Ava Horowitz - Old School Partners

Okay. What do you need to do right now? What are the roadblocks to get it closed?

Jeffrey L. Schwartz

There’s no roadblocks. Procedure. I guess I could let Dan amplify on the answer but the attorneys are feverishly preparing an S4, which has to get filed with the SEC. The SEC reviews the S4. Once you are done with that process, which could take more than one submit, I think we file a proxy for shareholder vote.

Ava Horowitz - Old School Partners

I guess on the S4 we’ll get a better sense of the combination of the two companies, what your expectations are?

Jeffrey L. Schwartz

I think so. The S4 makes a prospectus look like child’s play. I mean, there’s just so much information in them.

Ava Horowitz - Old School Partners

Can we assume streamlining, cost cutting in Traffix over the next couple of months?

Jeffrey L. Schwartz

I think there are going to be some economies that are realized between the combination. You know, some of them are very obvious. Others are not so obvious but we are looking at this more to leverage the human talent and resources that the two entities have than eliminating because we are looking at growing a business, not -- what I’m looking at our first objective to improve margin, not that that’s not on the agenda, but the real objective is to grow the top line and grow absolute margin.

Ava Horowitz - Old School Partners

Okay. Congratulations and take care.

Operator

Thank you. We do have a follow-up question from Phil Higgins.

Phil Higgins - Private Investor

Jeff, one last question; did you consider or receive any cash offers from any public or private companies?

Jeffrey L. Schwartz

Dan.

Daniel Harvey

This will be taken up in detail in the background of the merger. That will be a product of the S4. I think we will leave it at that for the time being.

Phil Higgins - Private Investor

And how quickly can we expect for that to be made public and first be able to read that?

Daniel Harvey

Depending on the progress of the document through the SEC review, it would have to be available at least 20 days before any proposed meeting, so just to stick to Jeff’s timeframe of a January 14th date, that should be available for public review some time in mid-December.

Phil Higgins - Private Investor

Okay, but considering where the original offer price was, or theoretical offer price of $10.59, and considering where the stock is now, don’t you think it would be more than appropriate for you to get that out far sooner than 20 days previous to a meeting? I think the shareholders are entitled to know what you considered, what you received, and what you possibly turned down prior to 20 days prior to a meeting.

Daniel Harvey

I’ll take that under recommendation and take it up with counsel.

Phil Higgins - Private Investor

I appreciate that. Thank you.

Operator

Thank you. At this time, I would like to turn the floor back over to Jeff Schwartz.

Jeffrey L. Schwartz

Thank you. If there are no further questions, I think we will wrap this call up and if there are any specific questions going forward, Dan and I will make ourselves available. Thank you.

Operator

Thank you. This concludes today’s conference call. You may now disconnect.

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