Harte Hanks Inc (HHS) 2002 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Harte-Hanks second quarter earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. As a reminder this conference call is being recorded. I would now like to introduce your host for today's conference, Richard Hochhauser. Mr. Hochhauser, you may begin.

Thank you, good morning. With me today are Larry Franklin, our Chairman, Jacques Kerrest, CFO, Dean , our VP legal and Jessica Huff, the corporate controller. Comments we make on this call will include forward-looking statements that involve a number of risks and uncertainties which can cause actual results to vary materially. And after I make a few opening comments, Jacques will give some financial details and then we'll take your questions.

We're generally pleased with the second quarter results. Revenue was close to be flat overall and this is a continuation of the improvement in the trend of year over year comparisons that we observed in the first quarter. As you know, there was a slight positive influence from the acquisition of sale support services as there was in quarter one. Now, while this acquisition was a small one, we're pleased with the synergy and the results so far. The 25 cents EPS was an increase of one penny over last year. The environment is still quite difficult, making a return to EPS growth, albeit only slight outstanding performance. This was delivered by the same people in Harte-Hanks who have contributed so much during these troubled times. And these same people remain committed to continue delivering reasonable profit performance, regardless of the environment.

The 25 - $29.4 million of free cash flow, that is net income plus depreciation and amortization minus capital expenditures continues to make our financial health a competitive advantage in these tough times. And with positive net cash - net cash position at the end of the second quarter, we surely have the financial strength to aggressively pursue our plans.

We'll get into more detail in Jacques' remarks and in the Q&A, but this quarter was marked by a continuation of strong shopper performance - 6.6 percent revenue growth. The minus four percent direct marketing revenue performance, while not where we want it to be, was an improvement over prior trends and year-over-year comparisons and we hope to see continued improvement in period-to-period comparisons moving forward. I must add, however, that we have not seen any fundamental change in the behavior of our clients. That is, caution and uncertainty continue to describe their behavior.

Revenue from our health care segment, our smallest industry vertical, comprising less than 10 percent of our direct marketing revenues was the only market to not show improvement in period-to-period comparisons in the second quarter, relative to the first. That is, health care was our only industry vertical to be down more this quarter than last. The financial markets continue soft, though it did show improvement in the quarter-to-quarter trends. Retail, our largest vertical, actually, slightly grew. And you may recall this was the market that started to decline the earliest. We did have some expansion in the accounts recently sold in the high-tech and telecom markets, so we actually saw growth there for the first time in quite awhile. We all know these are difficult industries, but it was great to see the performance. WorldCom does not use our services.

There continues to be some exciting things happening in our select market group, particularly in the automotive sector. And while the growth in that group was positively influenced by the sales support acquisition, we see this area as a long-term growth opportunity for the company.

Before turning this over to Jacques, I wanted to take the opportunity to repeat and to reinforce what has already been said since the beginning of this year. First, the economy will remain difficult for the full year '02. We will benefit from easier revenue comparisons as we go through the year. We have been cycling against expense reductions implemented throughout 2001 and will continue to focus on controlling costs. We are committed to delivering increased earnings per share. We will deliver reasonable profits regardless of the environment. We are proud of our people who have really made that happen. Jacques?

Thank you, Richard, and good morning. Just one point of clarification. All the numbers that Richard will talk about, reflect the adoption of FAS 142, which eliminated goodwill amortization. We have excluded goodwill amortization for both years so they are comparable and we have adjusted the EPS for the three-for-two stock split, which took effect on May 30.

As Richard has indicated, the company reported a very good quarter in light of the difficult economy conditions. Here are the highlights. Revenue from our direct marketing and shopper units were basically flat for the quarter compared to Q2 2001. A shopper unit, as Richard has indicated, performed exceptionally well in Q2, with revenue up 6.3 percent and cash flow up 7.8 percent and operating income up 8.6 percent.

For the quarter, free cash flow as defined by Richard, was $29.4 million.

Let's look at our two businesses separately. For Q2 2002, revenue from our direct marketing operations were down four percent, with operating cash flow and operating income operating cash flow and operating income decreased 6.6 and 9.2 percent respectively.

We are continuing to closely monitor our cost structure and will continue to take action to reflect the weak business conditions.

Let me now give you some details about our vertical markets for the quarter. The retail industry was 29 percent of our total direct marketing revenue for the quarter. The finance industry, which includes diversified finance, credit card, non-bank finance, insurance and retail banking and mutual funds, was 24 percent of total revenue. High tech telecom, 22 percent, health care and farmer, 10 percent, and select markets, 16 percent.

For Q2 of this year, our international business represented five percent of our total $142 million of revenue of direct marketing.

For Q2 2002, our services offered by our direct marketing units were broken down between CRM, 63 percent, and marketing services, 37 percent.

Looking at it by segments, B to C, business to consumer was 61 percent, and B to B, 39 percent of our direct marketing revenue for the quarter.

Our top 25 customers represented 40 percent of our $142 million of revenue of direct marketing in Q2.

Our largest customer in Q2 represented approximately 7 percent of our total direct marketing revenue.

Turning to shoppers. In this weak economy, we have strong revenue growth of 6.3 percent for the quarter. This follows the 5.3 percent revenue growth reported for Q1 2002, and the 5.8 percent reported for all of 2001.

Our shoppers division had revenue growth, which exceeded five percent in 11 out of the last - in 11 out of the last 12 quarters. This was due to strong growth in both distribution and ROP products.

For the quarter, ROP product grew 7.3 percent, and distribution grew 3. 8 percent.

Here again, we'll continue to closely monitor our cost structure, but we were able to show positive leverage in production costs.

Although we had slightly leverage in labor costs due primarily to higher health costs - health care costs and investment in sales management in California.

Opening cash flow increased 7.8 percent for Q2 compared to the same quarter last year, only 6.3 percent revenue growth that we indicated.

Margins continue to improve increasing 40 basis points for the quarter at the operating cash flow level and 50 basis points at the OI level.

Looking at some of the costs. Paper costs decreased 11 percent in Q2 compared to same quarter in 2001. Overall, postage costs increased seven percent due to rates and volume.

I'd like to make some comments on our expense variances in our P&L. Labor was down four point three percent, mostly due to reduced head count in direct marketing. Production and distribution expense was up four point two percent, due to higher logistic costs and higher lease expenses in direct marketing and higher postage costs as we discussed in shoppers. G&A expense was slightly up, point six percent due to - due to our shoppers where we had a higher promotion costs and facility service costs. This was offset on the G&A costs at the direct marketing level by lower professional services costs. Depreciation expense was up one point five percent, due to the higher 2001 cap ex in direct marketing. Interest expense decreased 70 percent due to lower debt balances in quarter two, 2002 compared to the same quarter in 2001.

Interest income increased 40 percent due to higher average invested cash balance last quarter compared to the same quarter last year.

Other expenses decreased 48 percent due primarily to investment write down in Q2, '01.

Some comments on our balance sheet, we were showing a net cash balance of seven million dollars, as Richard indicated at the end of June. Our book equity at the end of June was $563 million. Our net account receivable for the whole company were $134 million at the end of June, compared to 127 at the end of March and 138 million at the end of December, last year. DSO, at the end of June, was 55 days against 55 days at the end of the first quarter of this year and 59 days at the end of last year.

As we indicated in the press release, we bought back one point nine million shares during the quarter towards the end of the quarter and a little more than $40 million for these shares.

This concludes our prepared remarks. We'll be happy now to take some questions. Operator?

Thank you. If you have a question at this time, please press the one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, press the pound key. Once again, if you have a question at this time, please press the one key. And our first question is from .

Thank you, from Merrill Lynch. Good quarter, guys. It's nice to see the improvement. I'm wondering if you could quantify the new business in the quarter maybe on an annualized revenue basis and discuss if there were any big account losses. And then, I'm also wondering if you could talk about pricing trends. It's our sense that almost all of your declines in revenue at this point, direct marketing, are probably coming from pricing pressure. And I'm wondering if you expect to see that change over time get worse, get better?

Well let me answer , the second question and give Jacques some time to figure out the answer to the first one.

Pricing is playing a role in our revenue decline, but it is more volume related than it is pricing related. We anticipate pricing to play a role in the future as well. It's just part of the life we're living today. So, your sense is correct, but in terms or proportion, it's more volume than it is price.

The answer to the first part of your question, Lauren, you know, when we look at our revenue for the quarter, we always try to do a roll forward of what happened to the prior year same quarter, and look at how many accounts came in, how much the existing accounts spend, how much less did they spend with us, how much more did they spend with us. And if you look over time, what we've seen in the last quarter, and we've kept talking about this, our existing accounts were spending less with us throughout the year last year. It seems that that trend has changed a little bit and they have the gap between our existing accounts spending less and our existing accounts spending more have been narrowing. It's still a negative trend, they're still spending less with us, but this gap is smaller today than it was before.

Thank you. Can you quantify the revenue impact of new business, not for the quarter, but just on a run rate basis of business you won this quarter. What it might add to revenues?

Well, it's very difficult to say, you know, over time, because we've signed contracts this quarter which may have impacted revenue only to a very small extent and the full contract, you know, over the next year, we might get, you know, a couple million dollars out of this contract and we've only booked a couple hundred thousand for the quarter. It's, I mean, I don't know, Richard, do you have a better sense?

Well, it even gets more complicated than that because sometimes we have the contract signed and, like all contracts, there are often times few commitments that are being made and there is a change in strategy and changes in strategy at the senior levels in corporations today seem to be rampant as you read about them in "The Wall Street Journal", and so, we're not even sure that what we thought we'd get in a new contract will actually materialize. Generally, we're pleased with the level of business activity that's going on, but we're seeing the same set of phenomena that we've seen in the last 3 or 4 quarters, which is that it is taking longer, it's slower, we're being pushed harder and in some cases, things are going on now for 9 months. With the contracts that we've signed, we see not only the opportunities for the revenue that are in the contracts, but also for some additional revenues down the road as we establish relationships for the customers. Which also makes that question hard to answer.

Alright, one last question then. On cap ex, so far this year, you're spending below what I thought was a 30 million goal for the year. Is that still the goal or have you slowed down and should we be concerned at all that you're not investing so that when there is an upturn you're in good position to take advantage of it.

Let me answer the number question and then Richard can talk a little bit about the philosophy, I guess. Yes, you're right, we spent only 3 million dollars in Q2 - so far this year, 6.5 million. That's, you know, 12 million less than last year at this same time. I think it obviously has to do - some of it has to do with timing. I have said, we have said earlier this year that our budget for the year for the two businesses combined were $30 million. We think we'll end up around 20 to 25 million for this year spent. Last year we did 26 million. So, it's slightly less than last year, but, Richard, why don't you talk a little bit about the philosophy here and ...

Well, we have the financial strength to use capital to our advantage and so the question really is one of where are the opportunities, how secure we feel about those opportunities, what's the risk profile of them. And we're actually reviewing, in just a short period of time, a number of those opportunities to see which ones are going to deserve some capital spending that is not even currently in our thinking in the numbers that Jacques gave. So, we're there - we're going to spend the capital dollars mostly for revenue, but also for some cost reduction elements as well. It is not inhibiting us in any way. There's no corporate directive that says let's significant reduce our capital profile here.

Thank you.

Just one more thing, . When you compare to last year, there may have been some exceptional items like - last year - like a building that we've built in Europe that may have skewed the numbers, too. So, we have to be careful when we just compare quarter to quarter or even six months to six months.

Great. Thank you.

And our next question is from Alexia Quadrani of Bear Stearns.

Hi. Good morning. On the impressive growth, you keep saying in the shopper business. Is - where is that predominantly coming from? Is that from clients just increasing their spending on that vehicle or is it really reallocation of dollars from maybe another promotional medium in the California area?

Well, that's a hard question. We do know that the other media are not performing as well as we do, which would lead you to say that it's a reallocation. But I think, overall, including everything, there's a downward spending trend and we're seeing an upward one. So, we're - I think we're winning share. It appears that way. Hard to measure, but I think we're winning share. And we're winning it in all of the areas we want to win it in, which is the - in the book - particularly in the book areas where the franchise is built.

And ...

Alexia, I'd also - an answer - you know, our largest clients in shoppers is only three percent of our shoppers revenue. So, we really don't get huge swings one way or the other from large clients. It is, like Richard indicated, an increase, overall, of 10,000 clients, rather than, you know, a couple of clients making the difference.

OK. Great. And just a question on the postage increase. Is there - and this also may be very difficult to answer, but is there a way to quantify if you got any benefit in the second quarter, if at all, from the fact that the postage hike was coming, you know, at the end of the quarter?

Well, certainly in shoppers that would not be the case because they're - the pricing doesn't add postage. In direct marketing it does and we might have gotten a little bit of positive influence because somebody wanted to move up a mailing. But it was very small.

And no noticeable signs of any clients in the direct marketing area, maybe pulling back because of postage so far in the - in the new quarter?

No, I mean, the pulling back that we're seeing is very much in line with the overall economic environment, not having to do with the postage pricing.

OK. Great. Thanks very much.

Our next question is from of Neuberger Berman.

Hi, I have a couple of questions. If you look at your free cash flow that you saw in the quarter, how much of that was generated toward out of working capital and what do you think is a reasonable target for the full year and what would be the contribution from changes in working cap?

Well , good morning. The numbers that we've given in free cash flow doesn't take the working capital into consideration. Remember, our definition is, net income, plus D&A, minus cap ex. Now if you take the working capital into account and in that capsulation I have it in front of me and I have the advantage to have the numbers. It's - it's larger than the numbers that we gave of 29 million. I always tend not to give the working capital swings because they could go up and down. But for the quarter, counting working capital the cash flow net cash from operating activity was 35.8 minus the of cap ex. So that would come out to 32.8 million.

Again, we give our definitions, and we put our definition in the press so that everybody can calculate it.

Right. With that comparable number be year to date to the 32...

...well to year to date, that number would be 70 million. 75 million from operating activity minus the 6.5 of cap ex year to date.

OK...

...and that's you know, that compared to - it's almost comparable to last year in a sense, that we had more cap ex last year but we had more from operating activity. So...

...OK, and what would - what do you think of the reasonable target for the full year using your definition for free cash flow? And do you still think, given the environment you see, that working capital be a source of funds at least in the next back half?

Well, under our definition, we've said that the target for the year would be around 100 million...

...yes...

...and I don't think working capital you know, if the business - I mean last year we had a big pick up of working capital, but receivables went down. So I think if you look at the second half of the year and according to what we can see in the business, I don't think working capital will have a big affect on it.

OK. And the primary uses of that free cash flow at this point?

Well, as you...

...so obviously you bought a chunk of stock?

Yes, I mean our first priority is obviously to look at acquisitions, and we continue to do this. But when we don't find acquisitions, we know that our stock is a good investment.

OK. And earlier if I recall correctly, I think you were looking for some sort of a slow down in the sharper side of the business, which didn't appear to materialize. I don't know if my recollection is correct there or not, but would you expect to be able to sustain this kind of growth on the shaper side of the business going forward? I realize you have in the last you know, so many quarters.

Well, , but that - just , the numbers obviously, we had said that earlier because in 2000 the full year we had increase in revenue by one in ten percent. Last year we have 5.8...

...right...

...keep saying we'll do between four and six percent. We still believe we'll do this -- this year, between four and six percent growth.

OK.

, do you want to talk a little bit about the future?

?

We're cautiously optimistic. The shoppers are continuing to defy the general advertising marketplace. And they've done it for long enough where we are cautiously optimistic. It's a nice - it's a nice performance. My hats off to and the shopper team and we're looking forward to more of the same. We don't think the postage increase will materially impact us. And we're looking forward to continued strength there.

OK and final question. Is there any way to expand this business? I mean this seems like a pretty nice business.

Well, there are a lot of ways to expand the business. The easiest one to understand is the contiguous geography to the current zones of our shoppers and that represents a pretty significant expansion opportunity. Is it about, Jacques, about two million circulation ...

That's right.

... of potential of - so that's 20 percent of our total. That's one area. And we have plans on the board for that. Another area for expansion is that we can create new products within the shopper book and we're working on one or two of those. We have some experimentation going on with multiple products in the same zone. And so far they're performing well. So there's potential there. And it's just - it's an exciting business and there are a lot of ways to grow it. And we're going to be looking at every one of those ways.

And this really truly my last question, but is this an area of focus on acquisitions or is it on the other side of your business?

It - because of the two million that we have within our midst, because that two million is contiguous, because it does not require additional infrastructure from a people perspective, we're going to focus on that two million. When that gets done, then we got to look elsewhere.

OK. I was just referring generally to the two sides of the business in terms of capital outlay.

Well, my answer was on the shopper side.

Yes.

Obviously on the direct marketing side we continue to look ...

You're looking there as well.

... at acquisitions and we get to see a lot of them.

OK. Thanks a lot.

Yes.

Just to expand what Richard said. Obviously when we refer to the two million extra circulations here, this is over a period of time, obviously, that we will expand in that - in these new territories. It's obviously not, it's take a while to get through it and we're talking three to five years here in terms of the two million circulation.

Our next question is from of .

Yes. Good morning. I just have a quick question for Jacques. Can you quantify the contribution of acquisitions to the second quarter and the first half revenue number?

Yes. The contribution to the total revenue of the company is about a couple percent.

And both of those periods are the same?

Yes.

Yes? Good. Thank you.

Our next question is from , .

Good morning everyone.

Hi.

Hi. Just making sure I'm on there. I had a couple of questions for you. The first was to see if you could talk a little bit about what type of operating leverage you think you can get in the direct marketing business? You've done a lot of cost cutting, and it would seem you have the potential there to grow revenues faster than costs and I just wanted to see if we could put some numbers or some, somehow quantify that a little bit.

Well, I'll just start, Jacques, you can pick up. It is certainly true that we have the potential to grow revenue faster than we grow cost. As witnessed by some historical performance, but Jacques, you want to answer it more specifically?

Yes, I guess, you know, if, and we've talked before, Bill, about variable, again, fixed costs, and if you look at quarter to quarter sequentially, we obviously increased, you know, operating income numbers. You have, and I think we have a good foundation today of cost that if we were to get a bunch of revenue on the direct marketing side, we will get a pick up in, and a good leverage pick up on the bottom line. But over time, as revenue continues to grow, you're going to see, obviously, a tightening of the difference between the increase in revenue and the increase in the income. You know, we say that we have variable cost of maybe 50%, you know, the biggest costs in the direct marketing is payroll costs, and obviously, we think we have a good level of payroll today to sustain the business for a while. But as I said before, if business, obviously picks up and continues to pick up, you know, over time, you'll see that cost increasing.

And my second question, is, just wanted to ask if you could provide a little bit more color into the three major verticals in the direct marketing side, the retail, the financial and the high tech telecom, in terms of what you see going on into each of those verticals.

Well, as I indicated, in retail, it was the market that hit us earliest and what we're seeing now is some real stability in that market. It's really hard to know whether that's going to continue or not. We're cautiously optimistic there as well. But, it's, since it's our biggest market, it helps, that stability helps us a lot. We were troubled a little bit on the financial markets by the mutual funds and the credit, what is it, what am I thinking of Jacques? Credit card companies that are...

The sub-prime.

Sub-prime credit card companies. And so we were hurt there which caused the continued decline in that revenue performance, although it still was a little bit better on the period to period comparisons. So, those are the two big ones. In high tech telecom, we benefited a little bit, by the expansion of some revenue generation over the past quarter or two and it was particularly true in the smaller of those areas, in the telecom area because high tech is still a troubled situation.

Well, thank you very much and congratulations on a good performance in a tough environment.

Thank you, Bill.

Thank you.

Ladies and gentlemen, once again, if you have a question at this time, please press the 1 key on your touch-tone telephone. One moment for question.

J.P. Morgan. Sir, your line is open. Go ahead.

Hello?

Fred?

Yeah. Hey, I'm sorry, I'm joining the call late. It's Fred Searby from J. P. Morgan. A couple call - questions. One, the simple one. You guys have been pretty conservative with options, historically. I know you commented upon that, but do you plan on expensing them, proactively taking the steps to that and run it through the P&L? And then, secondly, if you could just give me some more color on the health care and the trends there. I mean, this is one that we'd seen some recent weakness in, but that we had expected more stability. So, if you could just - on that vertical, as well.

I'll answer the second question again. Jacques, maybe you can do the first one. The health care market is, as you know, our smallest and when you look at the smallest market, the variability of marketing expenditures by one or two clients can affect the numbers. And that, in fact, is what happened to us. We do see some softness, in general, in that area - more so than we've seen in the past. But in this particular quarter, it was influenced by those changes in marketing expenditures.

Regarding the options, in answer to the questions, first of all, I would refer you to page 27 of our annual report, note H.

Yeah. I've - we've been there and I've seen what ...

So, just - I mean, the reason I mention it, I don't think we're being conservative. I think, you know, our total options number compared to the - and, obviously, this number in the annual report is before the spread. So, you have to multiply by 1.5. But I think we are around eight to 10 percent of total outstanding.

Now, the second part of the answer is are we looking into it in terms of expensing? The answer is yes. And, in fact, if - well, sorry. To go back to the annual report, you could see that the number there looks like seven cents. But, again, you have to adjust it for the split, which comes out to about four cents. Now, if we were to adopt it and assuming - because you have to assume that we would issue the same number of options during 2003 that we've issued in the last, let's see, an average of the last three to four years. The estimated impact for us for 2003 would be one cent per share.

OK. All right. Thank you.

Gentlemen, I'm showing no further questions at this time. I'll turn the program back to you.

Great. Well, we thank you very much for your time.

Thank you.

Bye.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may disconnect at this time and have a pleasant day.