Harte Hanks Inc (HHS) 2004 Q2 法說會逐字稿

I would like you to welcome to the second quarter release call. This call is being recorded.

I would like to introduce 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 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 can cause actual results to vary materially. After I make a few opening remarks, Dean will give some financial details and then we'll take your questions.

We were very pleased with our performance in the second quarter which was a continuation of our strong first-quarter results. Overall operating income was up 11.5% on solid revenue growth of 9%. Earnings-per-share grew to 29 cents from 26 cents up nearly 12%. Our earnings-per-share is up 6% year-to-date over the prior year and our goal is to continue to improve earnings-per-share in the last half of 2004 compared to the prior year. In the quarter we generated $26.1 million of free cash flow which we define as net income plus depreciation and amortization, less capital spending.

We continued to be a strong generator of free cash flow with 42.5 million generated year-to-date, compared to 38.3 million last year. Direct marketing operating income increased 15.3% on revenue growth of 8.9%. We are especially pleased with our margin improvement over last year which we have said is a goal for our direct marketing business and which we see continuing in the second half.

All of our vertical markets have positive year-over-year growth which hasn't happened since the second quarter of 2000 and 3 out of the 5 verticals were up double digits. Shoppers had another great quarter with operating income up 10.2% on revenue growth of 9.2%. Revenue was helped by expansion into 293,500 homes during the quarter to bring the total year-to-date expansion to 451,500 homes. We expect shoppers strong performance to continue in the second half but we temper that with a negative impact expansion has on margins and the difficult comparison to the prior year as the fourth quarter of 2003 had an extra publication week.

Before turning it over to Dean, let me make some key points. Our employees turn in a very good second quarter in the first half. We're on the right track to have a successful year. In direct marketing we have had consistent revenue growth for a number of quarters now, and we are now making progress on margin improvement. Also our revenue growth in all verticals was really exciting. The expansion of shoppers circulation is continuing, and we're excited with the progress. We are building real value.

The resources in this company are great from our people to our financial strength. And our goal for the second half 2004 is to improve earnings-per-share compared to the prior year. I'm proud of our people who make it happen for all of our stakeholders. Dean, over to you.

Thank you, Richard, and good morning. As Richard indicated we did have a very good second quarter this year.

Here's the company-wide overview. Revenue was up 9% for the quarter with revenue up in both direct marketing and shoppers. Shoppers had another strong revenue growth quarter up 9.2%. Direct marketing also had strong revenue growth up 8.9% for the quarter. Operating income company-wide was up 11.5% for the quarter. The increase in operating income was also driven by both shoppers and direct marketing. Shopper operating income was up 10.2% while direct marketing operating income increased 15.3%.

Operating income margins increased 40 basis points with direct marketing up 80 basis points and shoppers up 20 basis points. Company-wide operating income margins were tempered by an increase in corporate expenses which was primarily driven by higher incentive compensation expense related to the company's better performance relative to last year. This incentive compensation increase also had a similar impact on the direct marketing margins and results. Free cash flow, which we define as net income plus depreciation minus capital expenditures, was $26.1 million in the quarter versus 22 million in the second quarter of 2003. We spent $6.7 million on capital this quarter, and expect to spend in the $40 million range for the year.

Turning to each of the two businesses, for the second quarter of 2004 our direct marketing revenue was up 8.9% and operating income up 15.3%. As noted in the press release, our focus has been on improving the profitability of our direct marketing business, and we are encouraged by the fact that we are making some progress here with margins up 80 bases points over the prior year.

Operating income margins were helped by lower depreciation costs and lower production and distribution expenses in relation to the increase in revenue. This was offset in part by the increase in incentive compensation expense I mentioned earlier, again which was driven by direct marketing improved performance. In future quarters we do not expect to see the same lift in operating margins from the depreciation line. For the first six months of this-year depreciation expense declined on a year-over-year basis and this will eventually flatten and then we'll experience absolute depreciation increases based on our historical and planned investment and capital expenditures.

However, given the revenue picture and underlying fundamentals of our direct marketing business coupled with other items such as more normalized period-over-period comparisons and incentive compensation expense, we believe we will continue to see margin improvement in our direct marketing business.

For our vertical markets in the first quarter high-tech telecom for the second quarter in row, our largest vertical, represented 26% of direct marketing revenue. Retail, which historically has been our largest vertical, 25%, financial 21%, select markets 18%, and healthcare/pharma 11%. International business represented 8% of our direct marketing revenue for the first quarter. Top 25 direct marketing customers represented 41% of direct marketing revenue for the second quarter. Our largest customer in this quarter represented 7% of our total direct marketing revenue.

Turning to shoppers, we had a very good revenue growth of 9.2% for the quarter. The revenue increase for the quarter was driven by strong growth in both ROP and distribution products as well as revenue from an expansion circulation over the past 12 months. Within our ROP, our real estate and employment related advertising were especially strong. Second half revenue comparisons will become more difficult particularly as a result of the 53rd publication week we had in the calendar year 2003.

For the quarter, shopper operating income increased 10.2% compared to the prior year quarter with margins up 20 basis points over the prior year at operating income line. During the quarter we expanded into 293,500 homes in California and Florida for year-to-date expansion of just short of a half million homes. As we have previously stated, newer zones initial tend to contribute less from a revenue per-thousand perspective than existing zones and impact are typically expected to lose money at the beginning. And, therefore, the expansions have tempered existing margins although in the quarter absolute margins in shoppers did improve, and will insert download pressure on future margins..

On the balance sheet at June 30 we were showing a net cash balance of $15 million. Book equity at June 30 was $553 million. Net accounts receivables were 152 million versus 153 million at December 31, 2003. DSO at the end of June '04 was 54 days against 52 days at June 2003.

Looking at our statement of cash flows, net cash provided by operating activities for the quarter was $24.8 million. We repurchased 1.4 million shares during the quarter bringing the year-to-date total to 2.1 million shares. In May, our board of directors authorized an increase of 5 million shares in the company's stock repurchase program represented approximately 5.8% of our outstanding shares. With this 5 million share authorization there are approximately 7.1 million shares remaining from repurchase authorizations at June 30. Since January 1997 we have acquired 37.8 million shares on a split adjusted basis under our repurchase programs and have spent $606 million.

One point of clarification, I think when Richard mentioned our EPS growth rate for the first six months, it's actually 6 cents a share which year-over-year which represents 13.6% year-over-year increase. With that we will be happy to take your questions.

Thank you. At this time we are ready to begin a formal question-and-answer session. Our first question comes from the from Ms. Lauren Fine of Merrill Lynch, you may ask your question.

Thank you. And it's nice to see those margins moving up. Couple questions for you. If you could estimate what the revenue impact was from Avellino on the direct marketing business? And then also within the direct marketing segment could you tell us sort of where you're seeing which services are in more demand than others? And then a final question. Are you seeing any firming up in pricing or change in I think what was described in the past was excess supply in the direct marketing industry, maybe coming from the printers?

Let me take a cut at this, and Dean can correct me when I make another mistake. First of all, Avellino is less than 1% of the revenue in the second quarter. All of our service categories, the ones that we -- the large categories of revenue that we looked at are up in the second quarter, and the pricing issue is, you know, it's going to be there, but we're seeing some softening in that as the economy gets a little bit better it's less of a focus for us and there are so many other factors that we're having to deal with. As I said on the last quarter [inaudible], we're managing our business and getting on with it.

You know, just Richard, back on it's services where you're saying they're all up, are you seeing any of them distinguish themselves in terms of faster growth rate or areas where you're more optimistic about the future in terms of either secular changes as marketers look more towards a different mix between marketing advertising, anything that gives you any degree of extra confidence perspectively?

Lauren, in any given quarter it's so hard to make a judgment like that. One client does well in one quarter, and you can make a conclusion and I think it would be the wrong conclusion to make. We're very pleased with the balance of the services that we offer and the fact that all of them are doing really nicely overall. So the answer is no, we don't see anything unique.

Okay, and then I guess I'll sneak one last one in. Dean, when you were talking about the largest customer in the past it's been a retail customer? Is that still true today.

Yes. That's correct.

Great. Thank you.

Fredrick Searby at JP Morgan, you may ask your question.

Yes, thank you. I was wondering whether when you look out at shoppers what your outlook is for real estate specifically and how much now that represents of shoppers and whether if you think there was a bubble up there and if it bursts what kind of impact it would have? And if you could also just give us, you know, some sense of the help wanted how much that is of shoppers as well and what kind of contributions making, you continue to have exceptional results there.

Fred, this is Dean. From the real estate perspective, one of the beauties of our shoppers's business is we have diversification not only by customer but by segment. So, no one segment really dominates. Real estate is, we certainly have a lot of real estate advertising that includes both houses for sale as well as mortgage refinancing, but that's under 10% of our revenue and obviously to the extent that the real estate market is sensitive to interest rates, as interest rates go up there certainly would be some impact on our real estate advertising but we don't think that's going to be a driver. As some categories go down, others go up. Again, our employment advertising has been increasing over the pst several quarters, but that's still representing like real estate under 10% of our total revenue.

When you say under 10% am I to assume it's close to 10%, however,?

No, I mean, I'd say --

Can you give us some sense of what the number.

10% range.

Out of [inaudible]?

I'm sorry?

Can you give me some sense of what percent those two categories are of our revenues per shoppers.

Combined?

Individually would be even nicer.

Combined they're under 15%.

Okay. Thank you very much.

Mark Bacurin of R.W. Baird You may ask your question.

Good morning. Maybe you can kind of expand on Lauren's question. With regard to the growth trend in direct marketing, can you give us some sense of maybe what is attributable to clients coming back on product based revenues and increasing spending historic levels, versus maybe what has been driven by new product introductions and or competitive wins?

We are up in both new clients and up in existing clients spending more as we have been now for a quarter or two. It's where we want it to be. Where our new products are taking hold. It's tough to distinguish those numbers because both our new clients as well as our existing clients are buying them so it's sort of a cross over answer. But we're really pleased with all elements of our revenue increase.

Richard, do you think, I mean, I guess the question is how sustainable is the top lines, high single digit top-line growth in direct marketing and I'm wondering if we haven't benefited from refreshing of [inaudible] and customers coming back who maybe put off updates and things like that and we seem to benefit now and so where do we go from here, and I'm kind of curious, is the high single digit number the right way to think about direct marketing going forward, or do you think we could see some further acceleration?

We're sort of -- this is a hard one for me because you recall that we had revenue declines for a while and then we had revenue stability and then we had sort of a positive trends in revenue and we said we wanted to make that even better and now we're there. We're at better. Do we want to be better than where we are today? Yes, we do. Do you think we could get to the low double digit areas? Yes, we do. How long that will take? We're unsure, but we had a long period of sustained revenue growth at that level and the same issues apply. Will it continue to increase? Well, it increased for a long period of time and it must have been nearly a decade of seeing those increases, so we're not concerned other than the events of the economy, we're not concerned about the fundamentals of our business. We think the fundamentals of our business are strong.

Great, and just on the share repurchase, obviously, you've stepped up quite a bit in the second quarter. Is there a way to think about, you know, what percentage of free cash flow generation going forward you guys might be allocating to share repurchases to help us try to get a better sense of how to model that?

If you look at historically, our share repurchase is opportunistic, it has both to do what the market price is, as well as availability of shares. It just so happened in the second quarter it was more the availability of shares that led to the level versus the first quarter. I mean, I think we are opportunistic, if you look historically over the past five or six years, the company [inaudible] a fairly significant portion of it's free cash flow to the share repurchases, and we always look at alternative uses of capital and where our balance sheet is but at these levels we anticipate we will continue to be in the market at similar levels.

And again, debt bounced up a little bit, in part to help fund some of that share repurchase activity. Should we expect that to go back to 0 and extra cash be used for share repurchases as well? Or is there an increasing desire to take on measures to fund repurchases as well?

Yeah, I think if we look from a net debt position, I believe we had 15 or $20 million of cash at the end quarter from a net debt position, I think we had $30 million of cash.

$30 million in cash.

And $15 million of debt. You know, that varies, it has to do with timing of share repurchases, timing of capital expenditures, timing of tax payments, and again, alternative uses of capital, so that debt has fluctuated between, you know, 0 to $20 million probably over the last 12 to 18 months and absent something else, a transaction, something like that it'll probably continue in that range.

Great. And then just two nit-picky ones. Could you give us, is the 39.9 tax rate this quarter good going forward, and what was the actual share count at quarter end?

The 30 -- for the year we're probably still going to be slightly over 40% from a tax rate perspective, so I think the second half of the year we'll be at a higher effective tax rate. And the actual share counts is -- I'm sorry. Actual count is 85 million 980, that is not a fully diluted number.

That's a primary number.

Yes.

Great, thank you.

Mr. [inaudible] of Credit Suisse First Boston. You may ask your question.

It's actually Brandon. Quick question for you guys on the glossy products, or color part of shoppers's business, trying to get an idea of maybe what the revenue per item would be difference between a color or a regular, trying to also figure out is there a target that you have for how much contribution like glossy products, or color products should be contributing to shopper's business or is it more just of an opportunity based kind of decision? I'm just trying to get a better sense for how that business might change from a margin or structural margin perspective exclusive of circulation changes over the next two, three years?

I'm sorry, when you talk about the glossy color part of the business, are you talking about color in the book?

Yeah, that, I guess in two perspectives, color in the book and separate products that are more kind of more quote-unquote flashy if I want to call it that looking at new product development if there's different areas that you can go into to address a particular, like the dreams product, for example, is the market going that way in totality, is there still a big demand for your basic black and white product?

In general terms what we're seeing and have been seeing quite sometime, is that color plays a larger role in the minds of the advertisers, so we have reacted to that by putting more color in the book and that is in part responsible for our increased capital spending. And we've also reacted to that by having glossy products. I think in this press release we mentioned, did we mention [Sondo] and in the press release as an example of a glossy product which gets inserted into our shopper because the demand for advertisers is to look better. Our product, in general, looks better today than it did three or four years ago. And we're gaining revenue as a result of that. Did that fully answer the question?

Yeah. Is there a -- I guess on the business model part of it, is there a material difference in the cost of the advertiser or the margins to you guys from going with say a color insert product in the shopper.

The color insert products are more expensive both for us and for the advertiser. The color in the book, we do better with but, you know, the really critical dimension of all this is we get better readership as a result of having color, and that's proof, that's born out by readership scores that we have from independent sources. So readership is going to drive the demand for more advertising. It's hard to quantify the question that you're asking other than we know all arrows are pointing in the same direction.

That's fair. And one other quick one. Retail was up slightly in the quarter. Is the outlook for that division still kind of a sluggish outlook? Are you seeing any acceleration in certain parts of the market or is it just going to be tough the back half of the year?

We don't look at that market as a big growth market for us today, so I prefer to not use the word sluggish, but it's not going to be robust.

Okay. That's fair. Thanks.

Chris Olin of ThinkEquity Partners, you may answer your question.

Thank you. And congratulations on the quarter.

Thanks.

Just in terms of trying to understand the 80 basis point year-over-year increase in direct marketing margins, is that primarily attributable to the revenue ramp or is it do the expense issues that you mention play a significant role in that?

It is -- I mean, it's the totality of everything that goes on, I mean, is the short answer. Yes, we had revenue growth and with revenue growth you would hope for and expect margin improvement. We had, you know, kind of look at it from what's our fundamental business, you know, what happens every day, and what's the profitability of that business, then you have all kinds of other things, you've got your depreciation amortization expense, how is that moving? You've got other types of costs that while in our operating numbers we think of sometimes differently, things like healthcare and workers' comp which are relatively less controllable than that first bucket I talked about. In this quarter because of the relative performance I mentioned a couple times in the press release, we had more incentive compensation in the quarter than we had on a prior-year basis. You know, totality of all those things, I mean, the fundamental, you know, the first bucket underlying business is improving and these other things surrounding it on a net basis are positive for us. And so we're starting to see margin improvement.

And what you're saying in terms of the outlook would be that it should be less than 80 basis points going forward? Is that a fair interpretation?

We didn't say that, but we did say that the second half, we would say we would see margin improvement as well.

In terms of the verticals, it looks like in high-tech telecom and healthcare/pharma, you've had about five quarters of positive growth? Can you provide any further color on those verticals and whether that's attributable to share gain or to general market left?

We have thought for quite a long time now that we are gaining share in the high-tech marketing. There were quarters when the business was really soft that we had growth in high-tech. And, therefore, we believe we were gaining share. We continue to believe that. In Pharma, we talked about a couple quarters ago, the need to do better than we were doing and, in fact, we're beginning to deliver on the goal of doing better. You know, the financial marketplace also, we're coming off of two double-digit growth quarters and now our -- is it at 9%, 9% increase this quarter so we're pleased with that as well. I mean, in general terms, is that a win of share in financial? I think, you know, it's so hard to tell but I think probably over the past three quarters I'd say yes.

You have to remember, these are huge markets, and when you're measuring what our share is, first of all, you have to define, you know, what the market is and direct marketing can be a pretty broad so these are enormous markets and our share is --

-- minuscule.

Small.

Thank you.

Mike Kupinski of AG Edwards, you may ask your question.

Thank you. And congratulations again on your quarter. How much of the growth in direct marketing came from new clients? And if you can also talk about if there were any significant sales of [Trillium] that influenced the numbers in the quarter?

Mike, to answer your first question, I'm sorry, was how much came from new clients?

Right. How much of the growth came from new clients?

I mean, it's hard to measure. Again, we look at new customers, lost customers and kind of customer spending more, customers spending less so it's kind of hard to pick any one and say x% came from that, because you've got the other things that are going up and down. We did have more won business than lost business in the quarter. And we did have our existing customers spending more in the quarter. You know, and I think the kind of the net two of those were fairly equal in driving the growth in the quarter.

Okay. In the [Trillium] sales?

Actually, [Trillium] sales was --

They were up for the quarter, again, but they were not a driver of the revenue gain, they were not disproportionate to our revenue gain.

I was just wondering in terms of direct marketing, as it relates to new clients, I was wondering because it seems like the revenue growth that you had I would have expected that maybe margins would have picked up a little bit more even though you exceeded my expectations. I was just wondering, are you investing into new verticals, or were there an influx of new clients that you had to ramp-up expenses in the quarter?

Dean said this in his last set of comments, there are so many factors and he reviewed some all those factors and some of them were up and some of them were down, and the net of it all came out to what I was very pleased with because our goal, which we stated for quite some time now, is to stabilize and then increase, and we have stabilized, and now for the first time,have shown an increase and expect to see more of that in the second half.

Okay. Do you have a dollar impact from the extra publication date in the shopper segment for the fourth quarter, I mean, how much the revenues were influenced by that?

Actually, we did give that number, Mike, in the first quarter. And I believe, yeah, I'm sorry, I'm going to have to get back. I don't know if I have that number in front of me.

Okay.

It was, hang on a second. I can calculate it here for you real quick, I think. Yeah, I think it was $4.6 million, Mike.

Okay.

Is my recollection of what it was in -- we did say that, we did talk about that in our first quarter or year-end call.

Okay. You mentioned about the shoppers facing more difficult comparisons in the second half but so does direct marketing, because it was in the second half of last year that direct marketing business really started to turn towards growth, and I was just wondering if you can talk about the trends that you're seeing in the seconds quarter, trends that you had in the second quarter, are they continuing into the third, and do you anticipate an acceleration in revenue trends for the second half of 2004 in the direct marketing business?

We do anticipate acceleration. We're hopeful that it could happen. We don't anticipate it. We do expect a pretty good second half though and we've given some guidance about being up so that's about all we're going to say about it.

Okay. And then the final question is the postal commission appears poised to recommend raising postal rates effective in 2006, and I believe that you pass through postage costs to your clients, but can you talk about the impact of postal ratings [inaudible] you've had on your business in the past?

In direct marketing?

Yes.

If it's a very large rate increase, in the high teens, it has a short-term couple quarter impact and then things begin to stabilize. If it's a 5%, 6%, 8%, kind of increase it really doesn't materially affect the mailing part of our business which is one of many elements of our business.

And in the shopper's business is there any particular impact there?

Well, their postage, we pay the bill on that one.

Right.

. And, therefore, we do have an impact, the good news about postage rate increases it is understood by the consumer, or the average person, that there is an increase because the stamp price goes up. It allows us to pass along the increase given by the postal service, but, again, if it's a significant increase, that pass along will take a little bit of time. If it's a moderate increase, we tend to get that done and accomplished in the same year.

All right. Thank you.

Alexia Quadrani of Bear Stearns, you may ask your question.

This is Julia Choi asking on behalf of Alexia. I was just wondering what the Hispanic shoppers publication contributed to growth this quarter?

It was very small. It's just started and it's -- and, you know, it's one of our new product tries. We're hopeful, we know it's a good market. But we don't know if it's going to work in this medium and so far the indicators are good. But it's really, really early to tell. It certainly did not have an impact on our performance in the first quarter, material impact.

I don't know if you can give us a detailed answer to this, but just regarding second half earnings growth, is there any reason to believe just given sort a of the improving fundamental trends that we're seeing to believe EPS [inaudible] should decelerate in the second half compared to what we've seen in the first half of this year?

We've given our -- we've made our comments about what we think will happen. I know you're doing your job here, but I think that's what we want to say.

Thank you.

Bill Warmington of SunTrust Robinson Humphreys. You may ask your question.

Good morning, and also, nice performance on the revenue and operating lines [inaudible]. A question for you on the employment market. You mentioned tha,t that has been a big contributor for shoppers this quarter, and I'd like to ask, when you started to see that pick up in the employment, the advertising and how that's flowed through the second quarter and whether you're still seeing that in the third quarter?

We're trying to look for the answer to that question, Bill. Do you have any other questions while we look. I'm not sure we're going to get at it.

Sure.

Bill, the question was, we have seen employment, revenue from the employment category improve over the last several quarters.

Yeah.

Again I talked earlier that it is not, you know, we have such a diverse segment, you know, diverse segments in shoppers so it is, it's an under 10% of the revenue business.

How has it been in July?

Yeah, I mean, we -- July 27th and, you know, -- it's way too early to say a trends.

We're troubled about having to report in quarters, now we're [inaudible]months.

Okay. The other question I have for you is on the guidance. If I'm interpret this correctly that the last half of last year you did 54 cents, correct? And that the First Call consensus right now is at 61 cents and so there you have a 7 cent difference there. I just wanted to ask, first of all, if I was looking at that correctly, and second of all if that is correct, it seems like there's a large grap there and just wanted to see if I could get your comment on that gap?

54 cents was the number for us last year.

Okay. And then the current number on the street is 61 cents for the consensus. Seems like there a --

Yeah, I think that's correct as well.

So the question is, it seems like there's a large gap there versus expectations. Why, in terms of your guidance, I just wanted to ask what's behind that?

We've been reasonably consistent in our guidance, I think, from the beginning of the year. One could say that it was understated since we achieved our guidance objectives in the first quarter. What we try to do in this quarter was just say that, you know, we've got our 3 cent improvement in quarter one, we've got our 3 cent improvement in quarter two. We've surpassed the guidance that we gave at the beginning of the year, and all our goal was to do is say that we're not stopping now.

Okay. All right. Thank you.

Troy Mastin of William Blair Company. You may ask your question.

Yes, I wanted to ask about what the International opportunities might be ahead of for the company. Several of your competitors seem to be increasingly focused on investing over in other markets, probably most notably in Europe. I know you've got some exposure there, haven't heard much new from you in that area. Is that an area of increasing focus?

We have actually -- yes, from an internal point of view, we are focusing on all of our geographies and all of our operations and we have a number of operations in Europe. We have -- we recently announced an IBM deal, that was actually announced without name in a prior press release, and we're optimistic that the current operations will continue to sell more like that in Europe. And so while we're not aggressively pursuing acquisitions in Europe, that done mean we're not pursuing them, just not aggressively pursuing them. We're comfortable with the way we're approaching the marketplace there.

Okay. And then if I could ask another, on the do-not-call list ,which late last year was put into place, do you have any sense if you felt a positive benefit from this, and if so, how does that play into your revenue growth, is it a one-time benefit the following year, or is something that would leak in the results over a period of several years?

I think we said last year and I think there's just is no indication that the things that we're doing have benefitted from the do-not-call list. We have not been told by our clients that this is why we're getting work. Whether it's there or not it's hard to tell, but we've not been told that. Therefore, we don't see it as a one-time event for our strong performance in either the first or the second quarter.

Okay. Thank you.

Thank you, Troy.

There are no questions, sir.

Thank you, everyone. Have a great day.

Thank you,