Harte Hanks Inc (HHS) 2003 Q2 法說會逐字稿

Good morning ladies and gentleman, and welcome to the Second Quarter Harte-Hanks Earnings 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. If anyone should require assistance during the conference, please press "*" followed by "0" on your touchtone telephone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host Mr. Richard Hochhauser, CEO. Mr. Hochhauser you may begin.

Thank you and good morning. With me today are Larry Franklin, our Chairman; Dean Blythe, Chief Financial Officer; and Jessica Huff, Vice President Finance and 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. After I make a few opening comments, Dean will give us some financial details, and then we will take your questions.

At the end of the first quarter we indicated we will improve performance and we did, though we are not yet where we want to be in direct marketing. Specifically while revenue and margins did improve, we are continuing to take steps to get better. We showed EPS growth, which suggest that the goal of the increased earnings per share for the year is within reach. The $22m of free cash flow that is net income plus depreciation and amortization minus capital expenditures continues to make our financial health a competitive advantage. We said that we have the financial strength to aggressively pursue our plans and we are doing that. We are trending to the low-end of our guidance for free cash flow primarily from additional CAPEX spending, and Dean will discuss this and other financial issues in more detail.

Shopper performance was really strong in second quarter, so let me once again say thanks to the managers and all of the people in Shoppers to know what it means to make it happen. Going forward, we will be seeing more margin pressure from our expansion activities and other strategic initiatives. In direct marketing this is the third quarter in a row with stable revenue, client spending less is at its lowest level in nearly three years and it is most pronounced in retail. On the cost side, we picked up the pace of right sizing, and there are more steps which will be taken over the next few quarters. While this environment surely makes it harder than ever to have stable margins our people remain committed to continuing to deliver reasonable profit performance.

This despite the fact that we have only seen slight changes in the behavior of our clients. While they are feeling a little bit more optimistic than we have seen for a while they are still being quite cautious. The trends in market performance suggest strength in high-tech telecom and select markets and weakness in financial. Revenue from retail and pharmaceutical and healthcare have less quarterly consistency than the others, though longer-term we are confident that pharma and healthcare will be a growth sector for us as it was this quarter. High-tech telecom is now nearly 25% of our revenue, which is an all time high. We feel very good about performance of that sector. Before turning this over to Dean, I wanted to summarize the way we think about our business.

We still feel the economy will remain difficult for the full year 2003, and barring significant changes in worldwide events, we think there will be some improvements over time. We are committed to delivering increased earnings per share. We will deliver reasonable profits regardless of the environment. We are excited about the progress we are making on our strategic initiatives which started about a year ago. And all of which are making progress. There has been no change in the pricing pressures and the delays in decisions and these just are the new realities of the markets we serve. We are on a path to significantly grow shopper circulation and since we have had some delays from the original plans in Northern California, we will take some steps to grow circulation in the South starting at the end of quarter three of this year and little bit in Florida as well. We are a strong team we are committed to make it happen for all of our stakeholders. Now I want to introduce Dean, who I welcome as a speaker to this forum. Now all of you -- how pleased I am with this handling of this new job in the short time that he has been added, his intensity, his capabilities and insights are exceeding my high expectations, it is your Dean.

Thank you very much Richard and good morning everyone. As Richard indicated our second quarter performance showed marked improvement over our first quarter results as well as year-over-year improvement in revenue and diluted earnings per share. Here's a quick look accompanying why; revenue was up 2.3% for the quarter. Well, this is modest revenue growth; it did mark the fourth consecutive quarter of positive revenue performance. Revenue in the quarter for direct marketing was flat with shoppers up 6.1%. For the quarter free cash flow which we defined as net income plus depreciation minus capital expenditures was $22m versus $29.4m in the second quarter of last year. At the end of the first quarter we stated that we expected free cash flow for the year to be in the range of $80-90m. We now believe we will come in at the lower end of this range and this is driven mainly by the fact that we now believe we will come in at the high end of our expected capital expenditure range of $30-35m. We have said many times in the past our free cash flow profile gives us the financial strength to continue to invest in our businesses and we are using this strength for shopper facility expansion and company wide investments to generate future revenue growth. These initiatives are driving this year's capital expenditure level.

Turning to each of our two businesses for the second quarter in '03, direct marketing revenue was flat with operating cash flow down 12.3% and operating income down 13.1%. Direct marketing results were influenced by market factors including pricing pressures that Richard mentioned and extended sales cycle and the general economic environment. Our margins improved from the first quarter levels, cash flow margins improved 240 basis points to 18% and operating income margins improved 280 basis points to 13.5% in year-over-year comparisons in the second quarter. Cash flow margins declined 250 basis points while OI margins declined 210 basis points. We are not pleased with this year-over-year margin compression. We do expect the positive margin trend swing from the first to the second quarter to continue over the remainder of this year.

For our vertical markets, retail which is our largest vertical market represented 27% of our direct marketing revenue, high-tech/telecom 24%, financial 21%, select markets 18%, and healthcare/pharma 10%. In the second quarter, international business represented 9% of our 142m of direct marketing revenue. Our top 25 direct marketing customers represented 38% of direct marketing revenue for Q2. This top 25 revenue concentration has remained relatively constant over the past several years. Our largest customer in the second quarter represented approximately 7% of our total direct marketing revenue.

Now turning to shoppers, we did have a good revenue growth in the quarter of 6.1%. This was driven by strong growth in ROP and distribution products. Operating cash flow increased 6.7% while operating income increased 6.1% compared to the prior year quarter. Margins increased 10 basis points at the operating cash flow level and were flat at the OI level. I should mention that we have talked in the past about plans for increasing circulation in shoppers through contiguous geographic expansion. Much of this geographic expansion beginning in 2004 would be in Northern California supported by the investment we are making in a new facility. We did add 85,000 in circulation in the second quarter through geographic expansion by adding new zones. New zones initially tend to contribute less from revenue per thousand perspectives than existing zones which will impact margins and shoppers as expansion is rolled out.

On the balance sheet at June 30, we were showing a net cash position of $11m. Book equity at June 30 was $534m, net accounts receivable $133m versus $138m at December 31 2002. DSO in the June was 52 days, and that compares against 53 days at the end of 2002 and 55 days at June 30, 2002. I'll answer a question that has been asked now for several quarters. Looking at our statement of cash flows, net cash provided by operating activities for the quarter was $24.8m. We repurchased 1.1m shares during the quarter at a cost of $19m with acquisitions completed in second quarter. And with that, we will be happy to take your questions.

Thank you. If you do have a question at this time please press the "1" key on your touchtone telephone. If your question has been answered or you wish to remove yourself form the queue, please press the "#" key. One moment for questions. Our first question is from Alexia Quadrani of Bear Stearns, and I do apologize for any mispronunciations. Please go ahead.

That was fine. Good morning. On longer term, I guess Richard, what is your confidence that the direct-to-marketing revenues will return to maybe more normalized rates or put another way, what are you seeing as the reasons for the pull back? Is it really just the tough economy or are you seeing a share shift and perhaps dollars being allocated to other mediums right now?

Well, all of the media are competitive, as you know, and we are seeing little bit of that. It is hard to give you a sort of general answer to it, but we are seeing a little bit of that shift. But we are also seeing continued enthusiasm for direct marketing. We are seeing a little bit more positive feelings on the part of our client, despite the fact that the economy is tough, as I said earlier, and despite the fact that pricing pressures do exist. So we are cautiously optimistic that things will get better and the fact that we have taken much quarters of being negative and turned it into three stable quarters makes me feel even better about that because the next step from stable is positive.

And then is there a way you can give us an indication of how the direct marketing business may be trended during the quarter -- I mean month-to-month?

You know, we -- I think we have once tried to answer that question and probably made a mistake doing it because I am not even sure quarter-to-quarter is the right way to do it, but month-to-month certainly isn't the right way.

Okay. And on the shopper side of the business, is there some guidance you can give us in terms of what sort of dilution we should expect in the profitability as you begin your expansion in the second half of this year?

Right. You know, we have talked about our expansion plans. You know, it is a fact that new zones, as I said, have lower revenue that does have a downward pressure on margins as you go forward, but no we were not giving any specific guidance about what we are seeing from our margins.

Other than generally, we have said that we expect margins to be down a little bit in Shoppers for the year.

Okay. Thank you very much.

You bet. Thank you.

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

Hi good morning. Two quick questions here both on the Shoppers segment. One Richard your -- you are coming in toward the top end of your, you know, 4-6% revenue growth range pretty consistently with the expansion effort that's going on, do you still think that's the right range? And secondly, you know cash flow margins were up in this business this quarter with your less investment this quarter and we will see more in the third and the fourth quarter and that's why we're seeing margin pressure?

There was on more investments this quarter than last. As far as our revenue guidance for shoppers we think that overtime we feel more comfortable with the high end of our guidance than the low end and we are putting into that the fact that we will have expansion revenue, but you are not going to really see the effects of that, you can see a little bit this year and toward the end of the first quarter we will start again in Northern California. So for practical purposes it will be in the middle and next year before you really begin to see the material effects from expansion -- from a revenue perspective.

Okay great thank you.

Thank you. Our next question is from Chris Owen of ThinkEquity Partners.

Good morning. I was just wondering if you could just provide a little bit more color on the cost reduction that you talked about and had discussed in the first quarter call and how much further benefit there might be going further in that?

Well, we have talked about our infrastructure cost and the need to make sure where right size is possible. There are couple of things you do when -- for us when leases come do we evaluate where we are and how expensive those things are and we in the case of one of our facilities in Southern California for example we moved this month we moved and we while we will not see savings in the third quarter from that move we will see. I think significant savings going forward. You don't want to put numbers on these things, but its material for us and we are going to -- we have more of those opportunities going forward and we are going to take advantage of those things as they occur.

That's fair to assume that the margin on direct marketing could go up even if revenues doesn't materially increase from current expectations?

We expect improvement in margins -- I can have -- greater than the first half yes.

Thank you.

Thank you. Once again if you do have a question please press the "1" key on your touchtone telephone. Our next question is from Serra Gubens of Merrill Lynch.

Hi, good morning.

Hi Serra.

A couple of questions, first on the revenue side indirect marketing within the segments that had increased during the quarter. Just wanted to get a little bit more color on that. Are you getting more business from existing clients or is that growth due to business from new clients.

We broken that down by the segments do you know, I mean overall it is new revenue more than the difference between increases and decreases in spending. We are going to take a look, while you asked your second question about what that might look like within verticals.

Okay, great. So when you said new revenues that meant...

Yes it wasn't overall.

Okay. Also in direct marketing, I am wondering if you can give us a sense of how it's trending so far for the second half of the year. I know it's very early into it, but it sounds like based on the last quarter that it's really been...

Well, you know, wish we could see out this far a little bit better. I am comforted by the stability as I have said. We need to get onto the next level of performance, which is coming out of stability into growth. I am hopeful that we'll see a little bit of it in the second half, but this growth is not going to -- double-digit growth is not going to just materialize.

Right.

Sometime, and so we are just going to sneak up on it and work hard toward getting growth consistently and hopefully we'll see little bit of that in the second half.

One quick question about the tax rate. I think that on the last quarter's call there was a question about whether or not it would remain at the 39.5% rate, at the end of Q1 and I saw that it was down to 39% this year -- this quarter and wondering what you are expecting for the second half of the year.

I think what we said that the rate in the first quarter we think it is going to be our rate for the year.

Okay so it will be 39.5% for the year?

For the year, yes.

Okay. Thanks

At some, you know, some quarterly swings, but that is for the year.

Right. And those are all my question. So I don't -- if you have got any more detail on the first one that would be great.

No we don't -- I am sorry we don't thank you.

Okay, thanks.

Thank you, your next question is from Troy Mastin of William Blair.

Good morning, thank you, wanted to ask if you could provide any more color on potential impact of the national [inaudible], I think we talked about it last quarter, but I thought you might have some more visibility on how it could impact your response management businesses, you know [inaudible] significant in direct mail?

Let's first talk about the phone consumer telemarketing for Harte-Hanks -- the impact is minimum. It is not a big part of who we are. Then let's go to what happens if in fact most people are speculating that money will go out of telemarketing and into other media. And while it is purely speculation, our feeling is that in fact that is true that if there is a decline in up to the productivity of telemarketing, there will be money set aside for other media, we believe that. We also believe that there will be a lot of experimentation that takes place with other media. Most of the people that are spending money in direct marketing tend to understand the direct media and may look elsewhere as a result of having some extra funds on hand. I think overtime, we expect that if in fact telemarketing does show a decrease in productivity, we will be a beneficiary at that time.

Have you received any indications yet from any clients or is it too early to tell what you might see -- what medium's might benefit the most?

We have not received any indications yet from our clients. So we are in fact talking with some of them now about it, but we have not received any indications yet.

Okay. Second Question, I wanted to get some details on Shoppers and I just wanted to get an idea. You may have sort of given that idea through suggesting it would be towards the high end of the range for the second half of the year, but given what appears to be a nice recovery in the overall media, economy are pacing or interest levels increasing for Shoppers given this demand for media, if you give some detail on that, but then also give us a little more detail if you could on your expansion plans in terms of circulation for Shoppers going out 6,12, maybe 18-24 months? How you think circulation might grow? And if you will extend in markets outside of California and Florida, if that's on the docket yet? Thanks.

Okay. In reverse order. We will not be expanding in markets outside of California and Florida. It is our intention to continue to do contiguous expansions in the markets that we're in. There's plenty of room to do that. We're excited about doing it and that's our approach. We are not going to get into the specifics of expansion, but we have some -- you know for us because we have not done a lot of expansion recently -- some decent size expansion at end of the third quarter and the bigger expansions we're going to be seeing toward the end of the first quarter, middle of next year in Northern California. Shoppers have been -- to your first question -- Shoppers have been, as you know, somewhat counter cyclical. When media were having a bad time 2 or 3 years ago and Shoppers were going 6-10%, we saw that we were doing things differently then other medias. So I think some of the pick ups that you are seeing in other media may not really affect our business. Our business is different to local business and we are not seeing the same kinds of impacts that you are seeing for general media.

As Richard said, Shoppers has had consistent revenue growth at the high end of our range for the past couple of years while Media has been in decline. So when you say there is a pick up, you got to remember where you are starting from.

Can you give any indication on -- I don't know -- five years out. How much bigger the circulation of Shoppers can be to give us an idea what that market potential might be?

It can $2m higher in five years, it can be.

Okay. Thanks.

You are welcome. Thank you.

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

Hi Fred.

Hi guys. It's Frederick Searby. Just a couple of questions. One is, I know you don't actually own an e-mail engine, but you know as you deal with your clients across platforms -- and we've heard about, you know, the issues with spam. Are they actually taking money out of e-mail or are they finding new ways to deal with that? And is that money going generally to direct mail or where do you see that kind of migrating to? And what do you think sort of the outlook is for all of these potential for the legislation we are seeing on do-not-spam and how it could actually be implemented?

First of all, the amount of revenue that's gone into e-mail is in the scheme of thing is relatively small.

Right.

Though moving in and out of e-mail does not materially affect Harte-Hanks. We are concerned about legislation. There are bills currently in the legislature. There is some fairly extensive lobbying efforts that are going on now to prevent a do-not-e-mail list. There is -- the good news is that there is software that works reasonably well, and we are hopeful that those kinds of techniques will be used rather than legislative techniques to interfere with our approach to direct marketing.

Can I ask one follow on question -- may I know the e-mail small affairs conceptually. You know, retail I was a little confused, I thought you said that when you listed as a category that you saw our strength in, is that correct? That you saw sustainable strength in the retail category?

No we were -- we said we were down in retail.

You were down in retail. Okay. That's what I thought, but then you -- so you think that that's -- I mean we have seen a fair amount of weakness obviously in the news paper side as well on the retail categories so that that would be consistent with that generally?

Yes, you know, people have speculated that some of those dollars may have gone to television and we are not sure, it's really hard to know that because, you know, TV advances were up pretty significantly last quarter and I don't know if they -- we don't know what the trend is this quarter there, but clearly for us there has been some softening in it and it has to do with spending less to the most part, it doesn't have to do with the client attrition.

Yes, I think that Richard comment that you picked up on was that we saw the level of customer spending less at a lower rate, that was more, the customer spending less was more pronounced in retail than in our other verticals.

Okay. And where do you, I mean do you see retail kind of stabilizing in the all important in kind of fourth quarter -- do you have any sense?

You know in our business we have the start, we've been pleasantly surprised by strength in the later quarters, but we're really cautious about it because of the trend that we saw in this quarter and so we are just sort of holding our breath a little bit and working with retailers to figure out new ways of driving revenue for them. But we are little bit cautious about it.

Okay and that's mainly on the department store side or you are seeing that across?

We are seeing it -- do you have the numbers -- that we are seeing it across all categories. We are little bit more optimistic about specialty, but the larger most department stores are the problems.

Okay, great. Thank you.

Operator Thank you, our next question is from Richard Phyree of Delphy Management

Can you give me little bit of color on the environment in Northern California. Right now I don't know how much penetration you have there and what the competitive landscape looks like?

How much penetration, well we know there are some 2m households that we have the potential to penetrate over and that's the number I used earlier over a 5 approximately 5 year period. There is competition - there is competition everywhere we are and we have grown our page count in Northern California pretty consistently as we reported last year, we are continuing to do that. So we are feeling good about as we enter into a phase of expansion, we are feeling better today than we did a year ago about our ability to do well with that expansion. You know it's always risky Northern California is the newer circulation areas in Southern California, it's less established and therefore higher risks, but we are feeling better about it today than we did it just a year ago.

Yes, but specifically against some of the local newspapers, can you give me anymore color there?

They established a competition just like other media, but we are not seeing anything unusual.

Alright. Thank you very much.

You are welcome.

Thank you our next question is from Mark Bacurin of Robert W. Baird.

Hi this is Eric Jacobsohn in for Mark, just want to ask you a little bit on the CAPEX, the increase to the higher end of the range. Is that more due to the shopper's expansion or is that more due to the company wide investments?

Yes, it's a combination of stuff. I mean, I think it's probably the company wide investments driving us to the higher end of the range, but its combination.

Okay and then do you expect a financial services vertical to improve with improved stock market activity and mutual funds inputs.

We haven't seen it as you know from this report we haven't seen it yet, and we have to do this on our own, you know, the environment we need to turn the things around and are working hard to do that. We don't' expect the environment to help us that much over the next couple of quarters and we are hopeful that we can do it ourselves, but so far we have.

Okay and lastly do you expect the Capital One and the flat postage to help direct mail volumes in our second half '03 and '04.

The deal that the postal service club with Capital One is that what you are?

Yes.

As far as I know, nobody else has done a deal with the postal service. I asked that question about a month or two ago of our people who work closely with them. So, I am not sure it will do anything but as you probably know postage is going to be stable into the year -- we think into the year '06 and that in of itself is a cost factor [that sure can] hurt us.

Sure, alright, thank you.

You bet.

Thank you. Our next question is from Michael Kupinski, and once again if you do have a question, please press the "1" key.

Thanks. Most of my questions have been answered but can you talk a little bit about acquisition prospects given the tough environment that everyone is having in the direct marketing space? Has that moved any closer to selling; at this point are you seeing any prospects there in increase? And then secondly can you talk about the prospect of the select markets and particularly from the automobile vertical. I believe it was in terms of contributions down a little bit from the first quarter and I was wondering if you are hearing anything on the auto front especially from the manufacturers that may be ramping up on local mediums rather than networks and stay -- kind of stay out of the network upfront. Do you seem to think that there might be a fourth quarter push on the auto vertical? Do you have much visibility on their programs?

Most of the stuff we are doing with automotive manufacturers are ongoing revenue streams that are not influenced that much. They do change their mind fair amount and we kind of -- one of our clients; for example, that we are doing a fair amount of business in the first quarter decided they weren't going to do very much in the second quarter and so those kinds of things have happened. We don't have visibility in the fourth quarter. That second quarter phenomenon, for example, occurred at the beginning of the second quarter. It just happened. It is the nature of that business. The acquisition question -- it almost sounds like a broken record and it feels that way a little bit. Now that we have six quarters and not having done one, but we do see deals; we are looking at them weekly; there are, I don't know if I mentioned this in the last call but it was quote that I thought was particularly appropriate, of that Red Aurbach about the coach and owner of the Boston Celtics made many, many years ago when he said, some of the of the best trades he ever made were the ones he didn't make. And there may be some applicability of that quote to acquisitions as well given the climate that we've had. That's not to say we don't want to though, we do want to, and we've seen a few recently that we have some interest in but you know that interest is a long way from getting a deal done and so we have -- we can't sit here and say that there is anything that's imminent.

Richard these are basically tuck in acquisitions though are these large, I mean are these like in the $10-20m range or last; are we talking something more substantive?

Yeah they are tuck in.

Okay, all right, great thanks.

We have a question from Troy Mastin of William Blair, a follow up.

Couple of quick follow ups; I wanted to see if you can give some commentary on how progresses is in the Trillium product line and then also do you expect any paper increases say for price increase, I think generally it passes along but and there is only risk that you wouldn't be able to do that forward, thanks?

On the paper side, we actually historically pressing paper increases is not been the same as postage because most of our small retailers that we do business within Shoppers are very aware of what postage rates are because its public information and they read it in the newspapers; paper is little bit more difficult. We have been seeing some small increases in paper cost, we don't know -- it's trending the wrong way, but it's slow and so, you know, we are little bit guarded about that cost development, which is about 9% of our cost structure. What was the first question?

Trillium update.

Yeah, we were little soft in the quarter. Trillium, we are still up year-to-date.

So bit soft means it was up little year-over-year?

The year-to-date numbers are up. The quarter was around flat.

Okay, thanks a lot.

Yeah, I am showing no more questions at this time.

Great thank you very much

Thank you.

Ladies and gentlemen this does today's conference. You may disconnect at this time and have a wonderful afternoon.