Harte Hanks Inc (HHS) 2004 Q1 法說會逐字稿

Good morning, and welcome to the Harte-Hanks Q1 2004 earnings call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). Today's conference is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the meeting over to Mr. Richard Hochhauser, President and CEO of Harte-Hanks. Sir, you may begin.

Thank you. Good morning, everyone. On the call with me today is our Chief Financial Officer, Dean Blythe, and with him at the corporate office is Jessica Huff, our VP 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 very materially. After I make a few opening comments, Dean will give some financial details, and then we will take your questions.

Last year at this time, we discussed a difficult quarter, and I am pleased to report a healthy turnaround on most measures in both shoppers and direct marketing versus quarter one '03. Overall revenues were up a strong 9.2 percent, with operating income higher by 13.4 percent. EPS grew to 21 cents from 18 cents, which is nearly a 17 percent jump. We are pleased with our performance in the first quarter, and our goal is to continue to improve earnings per share.

In the quarter, we generated $16.5 million of free cash flow, which we define as net income plus depreciation and amortization less capital spending. Free cash flow this quarter was impacted by increased capital spending, as we continue to make prudent capital expenditures to support our future growth opportunities.

We will get into more detail in Dean's remarks and in the Q&A, but this quarter was marked by strong performances in both businesses. In direct marketing, we grew revenue by 7.6 percent and operating income by 8.2 percent. While we did have reasonably easy comparables from a year ago, this was the best revenue growth since quarter three 2000. We saw increase in both current customer spending and new customer revenue. Revenue gains came mostly from financial services and high-tech, and we were also pleased with the farmer revenue growth. Shopper revenue was a really strong 11.8 percent growth, and operating income showed strong positive leverage, coming in at 16.9 percent. We did have a favorable calendar in the first quarter, which helped a little, and we added revenue from expansion into 158,000 new homes in Florida and California, as well as the expansion in the last three quarters of 2003.

Before I turn this over to Dean, I did want to make a few summary comments. While we don't feel the same about the economy as we did in the mid to late '90s, we are surely feeling better now than we did a year ago. We will deliver reasonable profits regardless of the environment, and that goes for good times and bad.

We are excited about the progress we're making in both businesses so far in '04. The expansion of shopper circulation is continuing, and we are excited about our progress. I am pleased with our acquisition of Avellino Technologies. The Discovery software is already being integrated with Trillium, and we expect this to bring opportunities to our customers and improved opportunities for new revenue.

Congratulations again to our new officers and those who were promoted, and a special thanks to all those who worked so hard to make quarter one successful. We continue to make it happen for all of our stakeholders. Dean?

Thank you, Richard. Good morning, everyone. As Richard indicated, we got off to a solid start to the year in the first quarter. Companywide, revenue was up 9.2 percent for the quarter, with revenue up in both businesses, direct marketing and shoppers. Shoppers had strong revenue growth for the quarter, up 11.8 percent. Direct marketing also had solid revenue growth, up 7.6 percent for the quarter. Operating income was up 13.4 percent for the quarter. The increase in operating income was driven and contributed both by shoppers and direct marketing. Shopper operating income was up 16.9 percent, while direct marketing income increased 8.2 percent.

Free cash flow, which, as Richard indicated, we define as net income plus depreciation minus capital expenditures, was $16.5 million in the first quarter versus $16.3 million Q1 of 2003. We spent 9.5 million on capital in Q1 '04, and we expect to spend in the $40 million range for the year. At the end of February, we acquired Avellino Technologies, a leading provider of data profiling technology, located in the UK. As Richard mentioned, we're in the process of integrating our data software -- quality software Trillium with Avellino's data profiling software, Discovery, to provide a single solution. This was a strategic niche acquisition, and we do not expect any impact on our EPS from this transaction for 2004.

Turning to each of our two businesses, in the first quarter, direct marketing revenue was up 7.6 percent and operating income up 8.2 percent. Operating income margins were helped by lower depreciation costs, resulting from a relatively lower level of capital spending, both in 2001 and 2002.

For our vertical markets in the first quarter, high-tech telecom, for the first time our largest vertical, represented 25 percent of direct marketing revenue. Retail, which historically had been our largest vertical, was at 24 percent, financial 23 percent, select market 17 percent and health-care/pharma 12 percent.

We have talked about net customer spending. That is our existing customers spending more minus existing customers spending less. That net customer spending was positive for the third quarter in a row now in direct marketing, after a long period of time dating from the end of 2000 through the second quarter of 2003 of this net customer spending number being negative.

International businesses represented approximately 9 percent of direct marketing revenue for the first quarter. The top 25 direct marketing customers represented 41 percent of direct marketing revenues in Q1, with the largest customer in Q1 representing under 7 percent of our direct marketing revenue.

Turning to shoppers, we had nothing short of spectacular revenue growth, with 11.8 percent for the quarter. The revenue increase for the quarter was driven by strong growth in both ROP and distribution products. Within ROP, real estate and employment-related advertising, although they are relatively small pieces because we have such a diversified base, both of those categories were up strong.

For the quarter, shopper operating income increased 16.9 percent compared to the prior-year quarter. Margins improved 90 basis points over the prior year at the operating income line, helped in large measure by the very strong revenue performance in the quarter.

During the quarter, we expanded into 158,000 homes in California and Florida. As we have previously stated, newer zones initially tend to contribute less from a revenue-per-1000 prospective than existing zones, and in fact are typically expected to lose money at the beginning. Therefore, as expansions roll out, this will exert downward pressure on future margins.

On the balance sheet at March 31st, we were showing a net cash balance of $33 million. Book equity was $561 million. Net accounts receivable were 146 million versus 153 million at December 31, 2003. DSO at the end of March was 56 days against 56 days at the end of March '03.

Looking at our statement of cash flows, net cash provided by operating activities for the quarter -- this is prior to capital expenditures -- was $44.6 million. During the quarter, we repurchased 700,000 shares, making since January 1997 having acquired a total of 36.4 million shares and spent $573 million under the Company's stock repurchase program.

With that, operator, I would be happy to open this up for questions.

(OPERATOR INSTRUCTIONS). Lauren Fine, Merrill Lynch.

It was a nice quarter; good to see the revenues coming back in direct marketing. But I guess I am curious on the cash flow margin decline. It feels like that's two quarters in a row. Is this a product of new customers and sort of an investment that you need to make in them so that you get leverage from those customers later? Is in a function of some of the pricing compression that you have continued to note in the industry, or something else beyond that?

And then, relatedly, could you discuss what is going on with pricing and direct marketing right now? And then I have a follow-up question.

You do?

Of course.

I will start off, and then, Dean, you may want to add some things. We said, as the revenue picture started to pick up for direct marketing and we were beginning to go through the stability and then growth stage in revenue that we were achieving those as individual goals, and we wanted to get better and we did get better on the revenue side, from down to flat, from flat to up, from up to up more. We also said that we had the same goal on the margin side, and we are not there yet. We are not where we want to be.

You correctly stated some of the reasons. There are a wide range of reasons. Pricing is always a factor. We did see a nice revenue increase, and new revenue is always less profitable than old revenue -- not always, but mostly less profitable. But there are just a lot of factors out there, including the things that we control, and we are going to do a better job at it.

Dean, do you want to add anything to that?

No. Richard, I think that's right. I mean, Lauren -- while we are pleased with the quarter, in terms of the revenue growth rate, we still have a focus on margins in 2004. And that is going to be -- our challenge is going to be dropping more dollars to the bottom line, as we move forward throughout the year.

And, Richard, the total pricing right now?

It's about the same as we have seen. The pressures have not changed a lot. It's not an easy environment yet. We have said that when the economy got a lot better, and when capacity started to shrink dramatically, then we thought we might see some leveling off in pricing, and we have not seen that yet. But we anticipate seeing it at some point.

And then just my last question, and I will let other people get in. Why are you being so vague on guidance for the year, given both a strong start to the year and, presumably, some visibility in terms of long contracts on direct marketing?

Well, it's less vague than it was when we started the year.

Not really.

I think we said we would have improvement in earnings per share for the year, and now we are talking after seeing that improvement -- I will try to get the exact words that we used in the press release -- our goal is to continue to improve earnings per share. So there is a little bit more specificity, I think, to it now than there was then, and we feel comfortable with this level of specificity, given the environment.

Mark Bacurin, Robert W. Baird.

A couple things, and maybe just a follow-up on Lauren's question. Richard, when you say you are targeting better improvement going forward, does that mean up from the 21 cent level sequentially, or does that mean a better growth rate than the roughly 17 percent growth number produced in Q1?

Better than the increase that we have seen, so far.

On a year-over-year basis?

Yes.

Mark, our guidance going into the year was that we expect our earnings per share growth to be better in '04 than it was in '03. And obviously, after the performance in the first quarter, we would have already met that goal. We are not going to rest on our laurels, and we are going to strive to continue, and our goal is to continue to improve earnings per share for the remainder of the year. That's why we have slightly adjusted our initial guidance up to say the 3 cents up in the first quarter is already in the bank, so to speak. And we are looking at improving our earnings per share for the remainder of the year above what it was for the similar nine-month period in '03.

And just to be -- oh, I'm sorry. Better than the numbers, the year-over-year numbers, not necessarily the growth rate, but the absolute EPS number?

Correct.

Also, in looking at the delta, I guess particularly on the margin side, to dig in there a little bit, it looked like the labor cost item was really where the biggest margin degradation occurred. Could you just comment on were there any specific items within the labor categories that cause the compression?

The labor was the same percent of revenues in first quarter '04 as it was in the first quarter of 2003. So I am not sure that I would agree that that was what drove the margin compression.

Maybe I have wrong numbers, but I had it was almost 40 percent in Q1 and about 38 percent in Q1 '03.

Okay. Are you looking off the press release, Mark, the current press release? Or are you looking off some other information?

Well, going to historical numbers. I didn't go back and necessarily check. Were there some restatements?

There was a reclassification that we noted in the footnote of the press release. We did some reclassification, which had the impact of moving some temporary labor expenses that we used to report in production and distribution up into the labor line.

I see that. Sorry.

So that's why. But when you pro forma that, or when you reclassify the '03 number versus the '04 number, there was no negative leverage at the labor line. It was 39.8 percent in both periods.

I see that adjustment; thanks. And just finally, could you talk about -- obviously, shoppers growth trends are higher than kind of the 4 to 6 percent range you guys talked about, and clearly, some of that is extended distribution. But can we expect kind of a low double-digit growth trend until we start to lap the prior-year period when you first started expanding the distribution? Is that a fair assumption?

Well, there are a couple of points. We changed our guidance of revenue from 4 to 6 to 6 to 8, and you correctly say that 4 to 6 was our guidance this year, because we were coming up against a 53-week year last year. And so that was about 2 percentage points in that, and we just -- we moved the numbers to reflect that unusual one-in-every-eight-year cycle. Having said that, we are coming off some some pretty good numbers from last year, starting in the second and going certainly right through the fourth quarter, where we are going to come up against that extra week. So I think we are there already, in terms of comparables. We had just then outstanding performance in the first quarter. We do see expansion continuing. That will help us with our revenue gains, and we are hopeful that we are at the high end of that revenue range that we talked to you about.

Frederick Searby, JP Morgan.

Just one question. One of your competitors notably has mentioned a nice uptick in credit card marketing, and sort of the infrastructure and the data warehousing for that. Could you comment on whether you're seeing that, as well, in you financial category? I know it's not as critically important for you, but what you are seeing and what the outlook is there?

Richard, do you want me to --?

Go ahead, Dean.

-- take a crack at this? Our financial was up strong in the quarter; the total financial picture was up strong. It's after a period of some rough performance in that vertical. I think last quarter we saw some improvement, and then this quarter was --

Was that mutual funds or credit --

It was really across the board. We break that down to about five or six different subcategories. They all were positive --

As they were last quarter, too, if I recall. That is, we had good across-the-board performance in the last quarter and this quarter.

Yes. It was not particularly the credit card subvertical that was driving it; there was strong performance kind of across the board.

So, to your point, we have benefited -- if there is something going on in the credit card industry that looks good for services companies like ours, we are benefiting from it.

February mailings were up sharply, and it's been kind of stuck at 1 billion pieces a the quarter. And I'm just curious whether -- and Big Arkansas (ph) came out and said they have seen a recent uptick in activity, and that really came not in the fourth quarter or even throughout the first quarter, but really was discreetly, at the end of the first quarter, rising. So that was kind of the question.

Well, I don't have the specifics. But that's a relatively -- it's just not a big part of our revenue stream. We do some of it.

Right; I know that.

But the kind of movement that you would see from a material change, it just would not affect us that much.

Alexia Quadrani, Bear Stearns.

Just following up on your comments and your questions earlier about the shopper business, I think some might assume that you might see some margin pressure this year, given the expansion effort. And clearly, you have had some great performance already. Do you think it's possible we may actually see the year come out with margin improvement this year, despite the expansion costs?

Well, we have come off -- Dean, I'll just take a quick crack at it, and you can correct me if I mess it up. But we have come off of a statement where we said we might be slightly down in margin due to that expansion, to where we think we have a chance now of having flat margins, which is some correction from the obviously up margins that we saw in the first quarter. We are really pleased with what we saw in the first quarter, and a lot of it is driven by our ROP advertising is disproportionately profitable, and we have a strong quarter in ROP advertising. And revenues were pretty high, and so the higher they tick, the more leverage you get.

I know the groceries are not a big part of your revenues, out in California. But I think it does have some incremental impact. The end of the are grocery strikes -- is that a further positive, I guess, for going forward now?

We had indicated that it did not materially affect us during the down cycle, and it's not going to materially affect us now that it's settled.

And then I noticed in your press release you mentioned expansion or opening of, I think, an office in Germany on the direct side. Are you seeing any real pickup in that market over there, just the direct business in Europe?

Part of that is -- I believe it was last quarter we announced a large contract in Europe, and part of that is to fulfill the requirements of the contract that we won at the end of last year. That will likely improve our Europe revenue in '04 versus '03.

And just lastly, on the retail side, I am seeing some strength in the retail industry in general, in terms of pickup in spending. Is your less than, I guess, stellar performance in the retail industry or relatively weaker performance in the retail area -- is that more client-specific?

There's some of that, Alexia. To take you back to where we started, Harte-Hanks in direct marketing was a retail business at the end of the '80s, when we sort of got into this direct marketing business and started consolidating it. And we had a very specific goal in mind then, to diversify by vertical market, because we knew there were ups and downs and cycles, and we have achieved that; we have been a good job. We are seeing two other markets at about the same size, one a little bit more and one a little bit less than retail. And so I am pleased that we have gone through that diversification.

Having said that, we would rather be doing better in retail. And I am hopeful that that will stabilize and begin to be a little more positive, because we certainly should have growth in our retail revenue.

So are you saying that -- I mean, am I understanding correctly that maybe it's not so much that it's down or really weak, it's just not as strong as the other areas?

Dean, do you want to --?

Well, in the quarter, it was actually -- it was down year over year in the mid-single-digit area. And it has been sluggish and weak for several quarters.

Dean, you'd mentioned that net customer spending was up for the third quarter in a row, if I heard correctly. Did you give the number how much it was up?

I did not.

Chris Owen, ThinkEquity Partners.

A quick question. Could you provide any more color on the direct marketing segment as a whole? You have had three relatively good quarters, although you have obviously benefited from the favorable comparison this quarter. If we think about a normalized -- whatever that means -- 5 to 7 percent growth rate, is it reasonable to think that you could attain that this year? Or are we still in a somewhat depressed environment versus that?

Well, certainly that would represent a target for us. The extent to which we can achieve it is going to unfold as the year unfolds, but that's the kind of target we're looking at. If you think about the last two quarters of last year, we were up 5, up 4, round numbers. And now we have beaten that by a few percentage points. Our goal is to stay at that higher level. I am hopeful that we can do that. It's going to get harder as we get toward the end of the year, because we are coming up against some growth quarters, but I'm just hopeful that the economy will stay reasonable, and that our performance will be even better than that.

Is there anything to read into the three verticals having double-digit growth this quarter? Or is that noise?

It's nice that we have -- there are a couple of things to read into it. Number one is that this is the second quarter in a row where financial has had a big rebound. I think last quarter we said that we did not expect that kind of 20 percent level to maintain itself, and in fact it did maintain itself. But I will repeat what went on last quarter. We don't expect that to continue at that rate, but it's nice to see that kind of rebound. And high-tech, which suffered a little bit last quarter, and that's the problem with doing these quarterly measures, rebounded again and was strong again. So we are really pleased with our high-tech performance and have been, as you know, for a few years now.

And on the software side, did you say the calendar contributed to the strong growth this quarter? Can you amplify that comment?

I'll give the simple answer, and if it gets more complicated I will let Dean try to explain it to you. But the first publication date this year was the 7th of January, and the first publication date last year was the 1st, and we just benefit from it being more into the year than at the very beginning of the year. So we got a little bit of help from that calendarization.

Is there any way to estimate that help the way that you estimated the help from the extra week last quarter?

Chris, there really isn't. Directionally -- and we can look at numbers, but there's so many factors -- it helped us a little bit in the quarter. It did not help us, certainly, as much as the 14th week in the fourth quarter did. It help us a little bit and contributed, but there is no way to quantify with any certainty what the impact was.

Chris Pitt (ph), Credit Suisse First Boston.

Most of my questions have been asked and answered. I wonder if I could just ask a quick follow-up on the retail vertical. We have noticed a bit of a change in behavior among some of our companies we follow, with respect to retailers holding less inventory and kind of being a little more cost-conscious. Have you seen a change in attitude toward direct mail within that vertical, or would you say it was more, like we said before, company-specific?

Well, it is company-specific. There is also -- retailer mentality, I believe, has always been that way. And the third element of the answer has to do with -- we've said this before -- that management changes, and new things are tried, and sales are not what they expected, and people react and do different things, and we see that constantly. So there are ins and outs all the time, and there are some company-specific things, as one of the questioners pointed out earlier.

Troy Mastin, William Blair.

This is actually Wes Selke for Troy. I just had a quick question on the Avellino acquisition. I know you guys did not quantify the revenue impact that it's going to have this year when you made the acquisition. But I'm just wondering, looking at direct marketing revenue growth of 7.6 percent in the quarter -- I was wondering if you can quantify if any of that was related to the acquisition. And I have a follow-up question.

Well, again, I will try to give you the qualitative answer to that. It's a small acquisition. Overall, it will have a very small impact, and in the first quarter -- we did the acquisition toward the end of February, I believe. And so we did not even have a full quarter, so it was pretty small. But Dean, I don't know if you want to comment further on it?

Yes, again, we have one month of revenue. The impact on the growth rate was well under 1 percent in the first quarter.

And then on the direct marketing side, I think it was brought up earlier, just with payroll expenses being up this quarter, it does not look like you are getting a whole lot of leverage, at least in this quarter, with the direct marketing business, with EBITDA increasing about 2 percent on a 7.6 percent increase in revenue. Last quarter, you guys had talked about seeing operating margins at the levels you guys were seeing, I think you said, pre-2001, which would, I think, indicate kind of a 15 percent operating income in the next couple of years. I was just wondering if that is kind of still on track.

Richard?

Well, let me just start it, and I will let you clean it up for me. We also said, I think, last year that our goal was to improve our margin performance as the year progressed in 2004. And that's not making an excuse, because earlier I said that it's not where we want it to be. But it is our goal to improve it as the year progresses, and we are through the first quarter now.

Dean, you may want to --

Wes, I think the question had been asked earlier. If you look at the labor as a percent of revenue, it was unchanged from first quarter '03 to first quarter of '04 at 39.8 percent. If you're looking at historical data that is not in the press release, we reclassed some expenses, temporary labor expenses that we had historically counted in production and distribution expenses. We reclassed that up into the labor line, so when you look at that on the same classification in each period, it was same percent of revenue at the labor line. That was not a driver of the margin compression.

Nor did we benefit from the revenue increases one might expect; you might think labor could tick down as a percent of the total, which I think may be where you were headed with the question. Some of that has to do with new revenue and what it takes to develop new revenues, and some of that has to do with all of the issues related to pricing and the economy and those sorts of things that we talked about earlier.

Lauren Fine, Merrill Lynch.

A couple of follow-ups. If you could talk about, on the revenue side, was there much of a positive impact from foreign exchange in the quarter? I am also wondering if you could tell us on direct marketing what the trend has been in FTEs. And, Dean, if you could comment on the remaining share authorization that you have? And then a fourth question -- any granularity you can give us on select markets, in terms of the pieces that were up or down? Specifically, I'm interested in auto.

Dean, these are yours, every one of them.

All seven of them?

All seven.

There were only four.

The first one was currency exchange rate fluctuation?

Yes.

There was an impact in the first quarter that is positive to revenue. Again, it was an under 1 percent impact companywide.

The second question was --

Headcount in direct marketing.

I'm sorry. Headcount in direct marketing?

(multiple speakers) direction, whether it's up or down, and what percent are you having to add people now that you're getting more new business, is what I am trying to find out.

The headcount in direct marketing on a year-over-year basis is flat to a little bit up. And this is on more revenue.

The third question was the remaining authorization.

Remaining authorization -- we are at 3.5 million shares remaining under our authorization.

And then, within select markets, what was up and down, or was it all down?

Lauren, let me pull his. You are making me flip through a lot of different pages at the same time here.

Think of it as exercise.

We had -- auto had a pretty good quarter. Some of our government nonprofit business was a little bit down. So those are two of the larger segments in there, with one being up and one being down.

Larry Lee, CIBC World Markets.

With acquisition of Avellino, I think that was the first company you guys have bought in quite a while. I was wondering if you could comment -- have you seen any changes in the acquisition pipeline? Maybe the market is loosening up a little bit?

We really have -- the only change that we have seen is we have seen a pickup in activity in general terms, in M&A terms. We've seen interest, we've seen money people following this industry more than the quiet period of almost three years. But we have not seen any material changes in the pipeline itself.

Dean, do you think that's a fair statement?

Yes, I don't think we have seen. As things stabilize, it's a little easier to look at these businesses, because we saw several businesses that we got a chance to look at over a period of time what they thought they were going to do change six months later when we looked at them for the second time. So, as the overall environment stabilizes, I think it's going to be easier to look at these companies and figure out whether this is something that we want to pursue.

At this time, there are no further questions.

Well, we appreciate everybody's participation in the call. Thank you.

Thank you.