Harte Hanks Inc (HHS) 2002 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Harte-Hanks fourth quarter 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, Mr. Richard Hochhauser. Mr. Hochhauser, you may begin.

Good morning. With me today are Larry Franklin, our Chairman, Jacques Kerrest our Chief Financial Officer, Dean Blythe, VP of Legal, Jessica Huff, our Corporate Controller. The 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. Jacques will provide some financial details after my prepared remarks and then we'll take some questions.

A year ago, Larry said that 2001 was obviously one of the most challenging in many years. The most rewarding part of the year was the way our people faced those challenges. It may not be very original, but I surely feel this way about 2002. In fact, 2002 was even a greater challenge because most of the obvious changes to the way we do business were already made in 2001. We pulled through and met our goal of increased earnings per share of 96 cents versus 94 cents a year ago. We did not have a down quarter and we grew cash flow by 8.3 percent to $106.1 million. Regarding quarter 4, we were pleased with our performance with EPS at 26 cents, a penny above quarter 4, '01. We saw a continuation of strong shopper growth and continued improvement in year-over-year revenue for Direct Marketing and this was the first revenue increase sense quarter 1 '01. Three vertical markets were up in Quarter 4, [Solect] pharma & healthcare and high-tech telecom and we experienced continued softness in financial. Jacques will give you more detail in all of those areas.

New revenue was pretty strong in Quarter 4, but current customers continued to spend less and this was a factor in declining margins. As you saw throughout our press release, we have made investments in people, products, systems, and share repurchases to support future growth and earn a reasonable return for our stakeholders. Throughout 2003, we will be discussing our strategic investments in more detail for both Shoppers and Direct Marketing. Suffice it to say, we are committed to investments in our future and to manage the company to optimize the short and longer term. Unfortunately, we do not see any fundamental change in the behavior of our Direct Marketing clients or prospects. You've heard it before and we live it every day. Price pressures, delay, uncertainties, and now add the political environment. This continues to dictate how we will run our company.

We're feeling better about '03 than '02 at the same time a year ago, reflects the relatively flat revenue in Direct Marketing now versus double-digit declines a year earlier. We now have the challenge of stabilizing that revenue and setting the stage for future growth. While we do expect a continuation of strong shopper performance we are coming up against some tough comparisons. We have said that before and done well, and our goal is to make that happen again. Because of the environment, our goals for '03 are not aggressive though we do expect to have better EPS growth than in '02. We made no acquisitions in '02. This was not for a lack of trying. We will continue to seek acquisitions that make sense financially and support the strategic objectives of Direct Marketing; that is, create strength in the solutions we offer and the markets we serve. Shopper acquisitions are not in our short-term thinking as contiguous expansion will dominate this group.

As a reminder we announced a dividend increase from 10 cents a share to 12 cents just yesterday. A special thanks to the senior management team at Harte-Hanks for their openness, spirit, their passion and performance. They make it happen for all of our stakeholders. Jacques will now give you some more financial details.

Thank you, Richard. And good morning. One point of clarification. The numbers which we reported reflect the adoptions of FAS 142 which eliminated goodwill amortization. We have excluded goodwill amortization from both years 2001 and 2002, so these numbers are comparable. And we have adjusted the EPS for three-for-two stock split which took effect on May 30, 2002.

As Richard indicated, the Company reported a good fourth quarter and full year 2002 in light of a difficult economic environment. Here are the highlights. One, revenue from our Direct Marketing in Shoppers units were up 2.8 percent for the quarter and down 1 percent for the year. The decline for the year was entirely due to our Direct Marketing unit. Two, our shopper unit performed exceptionally well for the full year 2002 with revenue up 6 percent, opening cash flow up 9.4, and opening income 10.5. Shoppers opening income margin was 22.3 percent for the year which is 100 basis points increase over 2001. Shopper O.I. margins have grown at least 100 basis points or more every year since 1996. Three, our Direct Marketing unit had another challenging year with revenue down 4.7%, operating cash flow down 10.4 percent and opening income down 13.7 percent. We generated 106.1 million dollars of free cash flow for the year beating our goal of $100 million. This was an increase of 8.3 percent over 2001, up 98 million. We defined free cash flow as net income plus depreciation less Cap Ex. If we were to use the cash flow from operations definition, our free cash flow for 2002 less Cap Ex was $124 million.

Let's look at our two businesses separately. For Q4 2002, our Direct Marketing revenues were up 1 percent and as I indicated, down 4.7 percent for the year. Operating cash flow was down 4 percent for the quarter and 10.4 percent for the year. Operating income down 3.6 percent for the quarter and 13.7 percent for the year. We are continuing to closely monitor our cost structure and will continue to take actions to reflect the weak business conditions.

Let me now give you some details about our vertical markets for the fourth quarter and the full year. The largest industry we served in Direct Marketing was the retail industry in Q4, and that was 32 percent of our total revenue and for the full year, 30 percent of total revenue for Direct Marketing. Our high-tech telecom markets were 21 percent in the Q4 and 21 percent in the full year. Finance industry which includes credit cards, diversified finance, retail banking, insurance and mutual funds, were 18 percent for the fourth quarter and 22 percent for the year. Select markets were 16 percent for both the fourth quarter and the full year. And healthcare, managed care and pharmaceuticals were 12 percent for the fourth quarter and 11 percent for the full year. For the fourth quarter 2002, our international business represented 7 percent of our total revenue for that quarter and also 7 percent for the total revenue for the year. Our top 25 customers represented 42 percent of our revenue in Direct Marketing for Q4 and for the full year, our top 25 customers represented 39 percent. Our largest customer represented 7.4 percent of our revenue for 2002.

Turning to Shoppers, in a struggling economy, we have strong revenue growth of 6.2 percent for the quarter and 6 percent for the full year. We continue to perform at the high end of our long established goal to grow the top line of this business between 4 and 6 percent. For the quarter, this was primarily due to strong ROP growth, especially real estate-related advertising. Operating cash flow increased 9.1 percent for Q4 and 9.4 percent for the year. Operating income increased 10.5 percent for both the quarter and the year. Operating income margins continue to improve increasing 90 basis points for the quarter and 100 basis points for the year. As Richard mentioned, we are making investment in our Shopper business and we expect this year to have slightly lower margin in this business.

Paper costs in the fourth quarter decreased 14.6 percent compared to 2001. And overall postage costs increased 6.3 percent due to both rate and volume.

A couple of comments now on variances in the P&L for the fourth quarter. Labor was up 1.1 percent mostly due to higher labor costs at Shoppers on higher revenue. Our production and distribution expense was up 6.4 percent due to higher temporary labor costs at -- in our Direct Marketing units and higher postage costs at our Shopper units. G&A expenses was down slightly at .7 percent. Depreciation expenses was down 6.1 percent due to less capital spending in both Direct Marketing and Shopper. Interest expense decreased 53 percent due to lower debt balance in Q4 2002 compared to 2001. An interest income decline also 49 percent due primarily to lower interest rates. Other expense decreased 9 percent primarily due to lower fixed assets write-off in Q2 -- in Q4 2002 compared to Q4 2001.

A couple of comments about our balance sheet. We were showing a net cash balance of $9 million at the end of December. Our book equity at December 31, 2002, was $533 million. Our net accounts receivables were $138 million compared to $134 million at September 30, 2002. And $138 million on December 31, 2001. Our DSO at the end of December 2002 was 53 days against 56 days at the end of Q3 and 56 days at the end of 2001. During the fourth quarter last year, we bought back 1.5 million shares and for the total of the year, we bought back 5.1 million shares. We spent for the full year $99 million buying back our shares and have 2.3 million shares available for repurchase under prior Board approval.

This concludes our prepared remarks. We will be happy to now answer your questions. Operator?

Thank you. If you have a question at this time, please press 1. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Again, if you have a question, please press the 1 key. Your first question is from Lauren Fine of Merrill Lynch.

Good morning and thank you. I have a couple of questions. Starting on the Direct Marketing side, I'm wondering if you could just discuss the relative performance of CRM versus marketing services and then also in the past, Richard, you've discussed that you know, pricing has been, you know, under pressure. Have you seen any change in that at all in terms of the market in the competitive environment? And then a third piece related to Direct Marketing, in the release, you were able to note a fair degree of new business. I'm wondering if you could give us a sense of the annualized revenue that you expect from this new business or sort of what the average size of the contract is?

Let's see if I can remember all your questions, Lauren.

Okay.

First of all, on the new business front, the way we define new business is revenue in the quarter that wasn't in the same quarter a year earlier. And if you get to some of the newest accounts in our press release, including our most recent one, it was at cumulation of those accounts that yielded some really positive fourth quarter revenue. We do expect that to continue to roll into '03. We the know the rate of that rollout because everybody's budget's different and those programs are all different. As far as price pressures are concerned, they continue. They are unabated. And they are a reality of our life. We have to deal with that in the way we run our company. And in fact, even sometimes in the way we decline business because not all business is profitable. So it is something we have to live with day in and day out and our senior management is paying a great deal of attention to it. I'm going to let Jacques answer the question about the differences in CRM and marketing services, although we as a company think of ourselves more as a whole as we continue to try to integrate these services more and more.

Uhm, yeah, just first of all the breakdown between the two in terms of the total Direct Marketing is about the same, two-thirds, one-third. The growth is almost similar for both units in the quarter, Lauren.

One last question. Could you talk about on an absolute basis the costs in the fourth quarter in Direct Marketing were higher than we were expecting and higher relative to the third quarter. What changes either from a seasonal point of view or were there some incentive compensation, other costs, I mean, I don't understand what caused the cost pressure there especially since revenues were up.

Costs go up when revenues go up. So I'm not sure I --

Well, okay. I'll take it a different way. The margin was lower than we would have expected in the quarter. So I'm just curious if any particular, you know, change in momentum on the cost that isn't explained by the revenue growth.

The margin went up, Lauren, between third quarter and fourth quarter in Direct Marketing by about 200 basis points plus. So in both operating income and operate cash flow. We had and we explained in the third quarter the unusual business that we took in the third quarter and we had said that you know, you should always look at more than one quarter and it came through this quarter if you look. As I said, 200 basis point margin improvement over the third quarter. We had slightly negative leverage still in Direct Marketing, but as I indicated much better than third quarter for sure.

So the margins were what you expected in the quarter, then?

Yes.

Yes.

Okay. Thanks.

Thank you. Your next question is from Bill Warmington of SunTrust Robinson.

Good morning, everyone.

Good morning.

A question for you on Direct Marketing and the revenue trends you have been seeing there. If you could give us a little bit more color in terms of new-new account wins, you know, what you're seeing in terms of new account wins, number of accounts lost, what's been going on with the existing clients spend and, uhm, and the accounts that you've got from acquisition.

Acquisitions is, as you may know, not a real factor in Quarter 4. The purchase of the the -- most recent acquisition we made was in the fourth quarter of '01. So that is not a factor in our numbers. Our business losses are coming from for the most part coming from companies that we either feel are not the right ones to do business with because of their own financial condition -- and in some cases, bankruptcies. So, you knows, part of our business loss issue is just the general economic environment and what it's doing to our client base. The business wins which we were comforted by in this quarter and we saw some of the momentum building tend to be a little bit larger than average, than our average of business wins. And we see the revenue building with some of those accounts as we get to work with them and we see other things we can do with them. So what we're encouraged a little bit about that.

I wanted to also see if I could get a couple -- a little bit more detail in terms of the financial services revenue as a percentage of total excluding or -- if we could break out insurance and then also break out pharma from healthcare, see if we can do that.

We would rather not do this, Bill.

Okay.

Because these numbers are small and vary from quarter to quarter and that's why we give you the healthcare, pharmaceutical together, for instance.

Gotcha. All right, then. Final question is, do you have the cash from operations and the Cap Ex figures?

Yes. The Cap Ex figure for the year was 17.3 million.

Gotcha.

I think I gave the cash flow from operations for the year which was 124 million. If you look at the quarter under the same definition of cash flow from operations, it was 28.5 million and free cash flow as defined under our simple definition of net income plus D&A minus -- plus d, really, minus Cap Ex is 26.7.

Great. Well thank you very much.

Thank you. Your next question is from David Doft of CIBC World Markets.

Good morning.

Good morning.

I have a couple of questions. Up with, can you give us a sense on -- one, can you give us a sense on the cross-selling activity? You had mentioned the efforts to integrate it more so looking at it as one company on the Direct Marketing side. How successful has that been?

We don't have a -- I can't give you a quantitative answer to that question. But we have started a number of programs in our company that will foster more of that and we are seeing some signs of that working. Whenever you're in a cross-selling opportunity situation, it takes time to figure out what it is that the customer needs and where we can best serve the customer. But we are seeing -- we're breaking some ground that we haven't broken before and we're a little bit optimistic about that and I say a little bit because it's really hard to be optimistic in this economic climate. And it's really hard to tell how good our cross-selling efforts are given the reluctance of all of our clients to be spending more money in general.

Right but there is no metric in terms of percent of clients that use multiple services or anything like that?

Yeah, we actually have some of those metrics and if you'll bear with us, we'll get you a couple of them. There are lots of ways in our company to break out cross-selling. We have major groupings of revenue and then we have revenue broken into, I don't know, what is it, 12 or 15 categories. Jacques, do you have them?

Yeah. And we -- I mean, we have the numbers for the top 25 clients because as you know, we have, you know, 400, 500 clients. So -- but it looks like if you look at the top 25, I mean, general numbers, and as Richard indicated, if you look at, you know, 14, 15 services offerings that we have, at least 10 our top 25 clients take, you know, take half of our services or buy half of the offerings that we have.

Okay. Great, that's very helpful. And is that an improvement from a year ago?

I'm sorry, I don't have the number for a year ago. This number really -- I mean, we look at it on a quarterly basis doesn't fluctuate that much but I will check and get back to you.

Okay. Great. And then on the Shoppers side, with the investments you are make there is in the expansion of the facilities, could you talk about the timing of that?

Obviously, there is nothing very exact when you're moving into new real estate, but we're anticipating that, uhm, our facility move will be in the third quarter. And we need some time to stabilize operations before we initiate some circulation rollout, although we do anticipate circulation rollout in Northern California, in Florida, and in Southern California in the year 2003.

Okay. And just to clarify, Jacques, you did say then that the Shoppers margin for '03 would be down year-over-year?

We anticipated it to be slightly down.

Okay. So given that do you have any expectations on the Direct Marketing side with the margin?

We expect this year -- I mean, depending on the top-line growth, obviously, but we expect margin to be slightly up from 2003 compared to 2002.

Is that kind of in line with the historical you talked about 30 or 50 basis points movement. Is that kind of the idea?

Yeah.

Okay.

One of the things that we have going on in Direct Marketing in 2003 that is a little unusual is, you know, as you look at your company and you look at ways that you can redefine yourselves and be more competitive, one of the areas we have looked at is facilities. And we're in fact making a few changes in our facilities environment in the year 2003, and we're not finished with the planning of all of that yet. But we will have some costs associated with that the good news is that we will also have savings after that because this is all aimed at creating savings.

Right. Okay. And then last question, in terms of the competitive landscape, you had talked about you know, the business wins, looking a little bit better. Do you see that as industry wide or is that specific to Harte-Hanks? Are you winning business away from competitors and, you know, who is, uhm, who is, you know, high up in the competitive landscape right now?

This question gets asked every quarter and the answer is pretty much the same. There is not a lot of change. I can tell you that among the smaller competitors, and I'm sure you know this as well as I, there are a number of small public companies, almost all of which have been hurt quite a bit by this economic environment. The larger competitors are the stronger competitors. The ones that we face all the time. I do not see any decline in share. In fact, maybe because of the positive movement we had in the fourth quarter, we -- we might have even out a little bit of gain but it's very hard to measure. So it's impossible for me to define that for you.

Okay. Thank you very much.

Thank you. Your next question is from Kevin Sullivan of Lehman Brothers.

Good morning. Jacques, in past conference call you have given actual growth rates for the various Direct Marketing categories. I was hoping you can do that again. And secondly, can you just provide a little color around some of the select markets, some of the trends you are seeing there, which ones seem to hold out the most promise? Thanks.

I think, Richard, in his remarks, indicated the trend of some of these vertical markets. But we're not giving the exact numbers.

And we once again saw some -- some strength in our select markets in the automotive area and we've reported on that in the past. We're very excited about it. There continues to be a pipeline in that area for us. And so we're hoping for some momentum. Although you know the story about pipeline and how long things take and all that sort of stuff. But we continue to see that in that market.

Okay. And any Cap Ex number or estimate for '03? I don't know if I missed that. I apologize.

You didn't miss that because I didn't give it. We anticipate to spend between 25 and $30 million for the year 2003. Depending, obviously, on market conditions. And that's why we have kind of a range, you know, we have the strengths to spend more depending on what we are going to see as the year progresses. But that --

And would you anticipate free cash flow being better in '03 than '02?

It's difficult to say at this time because of the Cap Ex which is, you know, one of the factors of free cash.

I'm sure.

It -- so it might be flat for the year or might be slightly up. So....

Okay. Excellent. Thank you.

Thank you. Your next question is from Alexia Quadrani of Bear Stearns.

Good morning. The investments you made in the Los Angeles area for the computer-to-plate devices, is that the beginning of a further similar investments we should expect to see in other regions?

We hope that's the case. When we make the -- the beauty of the way we're built in Shoppers is that we have the opportunity to make investments in one location, watch to see how we do, and then roll them out as we see them doing well. And it is our anticipation that that will happen there.

And, uhm, just a follow-up question on the Direct Marketing side. In the weakness that we saw in the quarter, the financial services area, is that purely just pullback from existing customers, or were there some client losses in that sector?

I think it's existing customers spending less. And as we have mentioned in quarters, -- prior quarters, it's really influenced by a couple of factors, but the largest one being the mutual funds being down. So....

And just lastly, on the share buy-back program, what do we expect in the authorization program to be announced shortly?

We still have some room, but and I can't anticipate what the board usually does but --

It's likely? Okay. Thank you.

Thank you. Again, if you have a question, please press the 1 key. Your next question is from Todd Lowdon of Think Equity Partners.

Good morning. If you said it already, I missed it. Jacques, in the past you have talked about this you use internally the number of clients purchasing more versus the number of clients purchasing less, the net of those. Can you -- if you said that before, I missed it, sorry. But has that gone -- is that number up or down or stabilized relative to last quarter?

We had said in the third quarter it had improved slightly, I mean, it continued to improve throughout the year. And on -- in the fourth quarter it was about to the same level that it was in Q3. So --

Okay. Still, if I recall still negative but improving?

That's right.

Okay. Next question is, do you all anticipate the pending dividend legislation proposed by the Bush administration having any impact on your use of cash flows?

I don't -- I don't believe really -- I mean, the answer is -- is not at this time. I don't think so.

Okay. And finally, you had said in the past that a number of the smaller boutique agencies and shops on the Direct Marketing side were driving a lot of pricing pressure, and in the past couple of quarters, hanging in there longer than I think maybe you had expected that they would. Have you seen any relief on that side from the smaller players on the pricing, sort of fallen off the way?

I'm amazed that some of them are still around, actually. They're still there and creating pricing pressure. But pricing pressure also comes from the clients side, as well. Being driven by consultants, which come in and figure out ways to help our clients lower their supplier costs. So it comes from a lot of directions. But we have not seen them fall off the earth yet but the opening in the earth is pretty big. (Laughter).

Okay, thank you.

Thank you. Your next question is from Frederick Searby of J.P. Morgan.

Hi. It's Fred Searby. Couple of questions for you. Really one question. Uhm, does it sounds like you've got some acquisitions at least in the pipeline and I'm curious as to whether you -- there is a vertical you really want to increase your presence in or there is a competency you want it acquire that's purely you think, you know, with some of the players in trouble, there's some opportunistic buy here on a financial basis, and if it's not a competency you want to acquire, why do you really need to acquire them? Can't you just let these guys go under and pick off their clients?

Well, certainly our behavior in the year 2002 would suggest that we're following some of that logic. We do look at acquisitions all the time. We continue to look at them. There is a pipeline. And for us to talk about what we want and look again at what's available, there's going to be a lot of conjecture there so I'd rather not do that. I can say that the guidelines that we use have been the same for quite a number of years. We want to look at products that will complement our current offerings or markets that will either strengthen or expand what we currently do. Those are our primary guidelines. We've held to them. Then once we pass that screening criterion, we look to the financials and, you know, one of the things I may have said on the last conference call is because these things sometimes get extended, we take a look at projections and then we find out when the real numbers come in and the numbers are down from projections during the year, and then what you look at the company and you scratch your head and say, you know, what's really there? So this opportunism that you've referred to may in fact be opportunism for something really bad. So we've been very cautious.

Okay. Maybe I misinterpreted it but it sounded like the language sounded like there is -- you're more hot to trot, though, than you were last year in the sense of there's more opportunity but I understand your sentiments. Thank you.

Thanks.

Thank you. Your next question is from Michael Kupinski of AG Edwards.

Thank you. You explained that the production and distribution expenses were higher than normal as it was in the third quarter and now this expense item accounts for about 37 percent of revenues. Much higher than historic levels in the 34 percent of sales range. How much is a postage in that line item and what was the effective postal rate increase that you had? And what will their run rate for that expense item going forward be? And then finally, usually in the fourth quarter, there falls some software sales like [Trillium] and I know that provides some lumpiness in the quarter. Were there any significant software sales in the quarter? If so, what would the apples-to-apples comparison with the earlier year quarter excluding software sales be?

Let me answer the second part of the question while Jacques looks up some numbers for the first part. There was nothing particularly different about this fourth quarter than other fourth quarters. All fourth quarters tend to have a trend up in software sales for us. So there was nothing -- yes, they were up, but they were also up last year. So there was nothing unusual about it.

Okay.

And -- and --

Would software sales be up year over year, Richard or....

Yes, they are.

Okay.

Uhm, yeah, again, uhm, you know, I guess the question that you asked was postage in terms of percentage of the total costs.

Right.

Yeah, well, obviously, we have always said that postage in terms of total cost of Shoppers is around 10 percent.

No, no.

30 percent, sorry. In terms of the total the Company is obviously much smaller. And the influence as I indicated in my remarks, they was much higher postage costs in the fourth quarter 2002 because of the increase that we experienced in the third quarter.

Jacques, would you be able to break it out between what postage is in terms of production and distribution expenses?

Uhm... You mean what's the percentage of postage in the production --

Right, correct.

Yes. It is about 20... I would say about 25 percent.

Okay. And what increase did you see the effect of postal rate increase did you see for that?

In dollar terms?

Well, in terms of the year-over-year increase? Or in dollar terms, that's fine, too.

I mean, postage for the fourth quarter went up about 6 percent. How much did it go up for the year? Uhm... I mean, that 6 percent Q4 gets -- it's about the same number for the full year compared to the full year 2001. So....

And we expect that to continue into the first half of next year.

Right. Because the -- you know, the -- The anniversary of it in June, I guess, right?

Exactly.

Or July. Okay. Great, thank you.

Thank you. You have a follow-up question from Lauren Fine.

Uhm, I'm just wondering, you know, the guidance that you had given for 2003, it is fairly modest if you could give us any sense on Direct Marketing in particular based on the new business activity you have seen and looking at the different verticals, if you have any sense of, you know, what kind of revenue growth you would look for in that segment or what range of growth you would look for?

Lauren, we're not -- we're not giving guidance that way. You're right, the -- we have given modest guidance, if you will, using your word. It's less modest than we gave last year. So I guess everything is relative. If we had any visibility, uhm, we might be a little bit more aggressive. But we just don't have it. And -- and, unfortunately, it's been a consistent message from us for quite some time now, but as we finish each quarter, we feel that the message that we've given has been a reasonably accurate one.

Okay. Thank you.

Thank you. I am showing no further questions.

Thank you very much.

Thank you.

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