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

| About: Traffix Inc. (TRFX)

Traffix, Inc. (TRFX) F3Q07 Earnings Call October 15, 0000 10:00 AM ET

Executives

David Burke - KCSA

Jeffrey L. Schwartz - Chairman of the Board, Chief ExecutiveOfficer

Daniel Harvey - Chief Financial Officer

Analysts

Ali Mogharabi - B. Riley & Company

Phil Higgins - Private Investor

Ava Horowitz - Old School Partners

Operator

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

David Burke

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

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

These statements are not guarantees of future performanceand involve risks and uncertainties that are difficult to predict, includingchanges in demand for the company’s services and products, changes intechnology and regulatory environment affecting the company’s business, and difficultiesencountered in the integration of acquired businesses.

Should one or more of these underlying assumptions proveincorrect, actual results may vary materially from those described here and asanticipated, believed, estimated, or expected.

The company does not intend to update these forward-lookingstatements.

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

Jeffrey L. Schwartz

Thank you, David. Good morning. With me today is AndrewStollman, our President, and Dan Harvey, our CFO. Dan Harvey, as always, willstart the call with a comparable and sequential basis overview of the financialresults for our third quarter of fiscal year 2007.

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

Daniel Harvey

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

This is the result of shifts within our revenue generatingactivities where increases in revenue have come from lower margin generatingbusiness. This is summarized in greater detail in the MD&A section of our10-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 inthe third fiscal quarter of 2006.

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

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

Net income for the third quarter was $847,000 and iscompared to net income of $842,000 as reported in the third fiscal quarter of2006. Net income and EPS, as described below, were negatively impacted by acurrent quarter permanent difference arising out of the tax treatment ofexpenses directly related to our proposed merger activity. This is the majorfactor contributing to our 10% effective rate increase in the third quarterwhen comparing an effective tax rate of 56% with fiscal 2006’s effective taxrate of 46%.

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

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

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

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

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

Adjusted EBITDA increased sequentially by 34% to $2.3million 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 quarter2007 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 forus. First, we are pleased to announce a very good quarter, building upon whatis already a very positive year for Traffix. Second, we recently announced ourplanned merger with New Motion, Inc. I will talk about this later in the call.

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

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

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

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

We are confident that this not only bodes well as aharbinger of our future success but speaks volumes as to the objective appealof 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, wehave recorded over $1 million in revenue from Gator and have a current activesubscriber base in excess of 90,000, which we expect to continue to grow.

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

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

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

Unfortunately, along with our increased contribution torevenue growth and total reported revenues comes the corresponding compressionof margin at the consolidated level. Hot Rocket has historically recognizedgross margins in the 20% range.

In June 2004, we acquired a small search engine marketingcompany named Sendtraffic. At the time we acquired the company, their revenueswere 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 andservicing their clients. We see no reason why they should not be able tocontinue to grow. Search engine marketing and search engine optimization arecore competencies for any company that hopes to succeed on the Internet today.

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

Our core proprietary web content business continues to enjoysteady 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 thanowning content.

Moreover, there are few companies on the web that can offeras 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 organicsearch initiatives. Quarter over quarter, we have seen sustained growth.Mastery of organic search is difficult at best, yet we believe that having goodcontent makes it sustainable and an area that we can grow for many years tocome.

Assuming the consummation of our proposed merger, we plan onbuilding more lifestyle targeted content sites that can be attractive asacquisition 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 musicdownloads. Because of the existing scale we have in the current New Motionsubscriber base, we believe we have the latitude to build smaller, more loyalpremium build mobile communities.

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

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

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

In our earnings release, we announced the issuance of aquarterly dividend of $0.08 per share, payable November 10, 2007, for holdersof 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 dividendsbetween now and the potential date of the closing of the merger transactionupon the receipt of shareholder approval.

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

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

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

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

Question-and-AnswerSession

Operator

(Operator Instructions) Our first question is coming fromAli 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 balancesheet, you’ve got about $30 million in cash. I looked at the guidance that youguys gave last I think it was basically on the New Motion call, saying you canguys can generate what, around [$145 million, $160 million] in revenue, solet’s say $80 million, $85 million of that is coming from you guys. I guesswhat I’m trying to get at is at $6.30 a share, and I think that’s where it’strading at right now, it’s basically trading about half of sales, so correct meif I’m wrong, Jeff, but it’s pretty cheap here.

Jeffrey L. Schwartz

You are certainly preaching to the converted. We think it isvery cheap here and we are optimistic that the value is going to start to berealized and recognized and we plan on visiting with lots of the appropriatepeople in the near future to get the story out, but I am very excited because Ithink now with this quarter and when New Motion reports, I think the streetwill 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 doyou -- I’m expecting that you guys do see comparable top line growth goingforward, especially combining with New Motion. Am I thinking the right way, Iguess?

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 guysdo expect pretty strong double-digit top line growth going forward.

Jeffrey L. Schwartz

Without getting too granular, obviously we expect growthgoing forward. We expect the synergies to add quite a bit of value and toincrease our ability to grow and that was part of the excitement for us incontemplating 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 bothbusinesses.

Ali Mogharabi - B.Riley & Company

With all of that said, that’s certainly another reason whyit looks so cheap here. One last question, Jeff: we do know that you have theoption to sell I think it was over a million shares, but I wouldn’t sell it atthis level, just telling you. I mean, with so much upside, so I’m hoping youare 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 fromPhil Higgins, a private investor.

Phil Higgins -Private Investor

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

Clearly New Motion is illiquid and yes, we can all smile andsay hey, what a great company we’ve got and how cheap the company is and thestock 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 thisgoing to take a lot longer than you personally had anticipated?

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

Jeffrey L. Schwartz

First of all, my personal preferences, unfortunately we arenot as relevant as one might think. When a company like Traffix entertains astrategic option, the necessity is to immediately form a special committee,which we did. And once that special committee is formed, any decision to takeany action rests with the special committee, not the CEO. And we had otheropportunities 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 wasthe best opportunity for the shareholders.

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

How and when I come to a liquidity event, we’ll see whatgoes on in the future but like the rest of the shareholders, I’m sitting herehoping and expecting the stock to appreciate dramatically with thiscombination.

Phil Higgins -Private Investor

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

Jeffrey L. Schwartz

No, I don’t think that’s appropriate, or legal. But it isobvious 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 - OldSchool 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 onlyquestion I am hoping you can give me an answer to is when you think theearliest this deal could actually close, if at this point you guys arecomfortable giving out that info.

Jeffrey L. Schwartz

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

Ava Horowitz - OldSchool Partners

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

Jeffrey L. Schwartz

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

Ava Horowitz - OldSchool Partners

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

Jeffrey L. Schwartz

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

Ava Horowitz - OldSchool Partners

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

Jeffrey L. Schwartz

I think there are going to be some economies that arerealized 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 humantalent and resources that the two entities have than eliminating because we arelooking at growing a business, not -- what I’m looking at our first objectiveto improve margin, not that that’s not on the agenda, but the real objective isto grow the top line and grow absolute margin.

Ava Horowitz - OldSchool Partners

Okay. Congratulations and take care.

Operator

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

Phil Higgins -Private Investor

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

Jeffrey L. Schwartz

Dan.

Daniel Harvey

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

Phil Higgins -Private Investor

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

Daniel Harvey

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

Phil Higgins -Private Investor

Okay, but considering where the original offer price was, ortheoretical 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 farsooner than 20 days previous to a meeting? I think the shareholders areentitled to know what you considered, what you received, and what you possiblyturned down prior to 20 days prior to a meeting.

Daniel Harvey

I’ll take that under recommendation and take it up withcounsel.

Phil Higgins -Private Investor

I appreciate that. Thank you.

Operator

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

Jeffrey L. Schwartz

Thank you. If there are no further questions, I think wewill 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 maynow disconnect.

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