Harte Hanks Inc (HHS) 2005 Q2 法說會逐字稿

Good morning and welcome to the Harte-Hanks second quarter 2005 earnings release call. [OPERATOR INSTRUCTIONS] I would now 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 of finance and controller. The comments we make on this call will include forward-looking statements that are subject to known and unknown risks and uncertainties that may cause actual results to differ materially from those projected or implied in such forward-looking statements during this call. A description of some of the risks and uncertainties potentially impacting the company's business and future performance can be found in the company's filings with the SEC.

After I make a few opening remarks, Dean will give some financial details, and then we're going to take your questions.

We are excited about the results our people delivered this quarter. Overall, operating income was up 11.5% on strong revenue growth of 11.7%. Earnings per share grew to $0.34 from $0.29, up over 17%. In the quarter, we generated $28.7 million of free cash flow, which we define as net income, plus depreciation and amortization less capital spending.

Direct marketing operating income increased 12.7% on revenue growth of 8.9%, the 6th consecutive quarter of strong revenue growth. We are again pleased with our margin improvement over the last year plus.

All of our vertical markets had positive year-over-year growth with two of the five verticals -- financial services and select -- up double digits, and the remaining three verticals up in the mid single digits. Shoppers had another great quarter with operating income up 13.1% on revenue growth of 16.1%. Both revenue and operating income growth were helped by the Tampa flyer acquisition that we completed in April. The operating income margin decline was also attributable to this acquisition. Absent Tampa, revenue growth would have been in the high single digits and year-over-year operating income margins would have improved. Shopper revenue growth was driven by both Tampa and ROP, our in-book advertising. This was another in a long string of strong Shopper performances. We continue to be excited about our Shopper business, the addition of the Tampa flyer, and the prospects and opportunities this Shopper will present to us in the state of Florida.

For more than a year now, we have seen both of our businesses performing well. Direct marketing and Shopper showed strength at the top line and leverage at the bottom line with the exception of the Tampa acquisition. As we look out to the remainder of the year and into early next year, the robust revenue growth performance we have delivered over the past six quarters will be more challenging to match. In direct marketing we have more difficult year-over-year revenue comparisons. In addition, there is some uncertainty surrounding a few of our direct marketing customers who either have been or are currently involved in industry consolidations and specific company reorganizations.

Shoppers, the year-over-year growth will be positively affected by the Tampa flyer acquisition. The competitive environment in California has slowed the growth of our distribution revenue, and we are also currently working through situations of a few large Shopper customers that have recently cut back their advertising as a result of financial difficulties they have encountered.

Before turning it over to Dean, let me make a few summary points. Both of our businesses built momentum in 2004, and we are extremely pleased that we are able to carry that momentum into the first half of 2005. In direct marketing, we have had consistent revenue growth for the past year-and-a-half now, and we're thrilled to see the progress that's been made on the margin improvement as well. Over the past year-and-a-half, we've seen growth in all of our vertical markets.

Also for the quarter, double-digit revenue growth in two of our five verticals and mid-digit single revenue growth of the remaining three verticals was good performance. We are excited about new Shopper acquisition in Tampa. I've said in past remarks that we like this business, and this acquisition certainly underscores that point.

Thanks, again, everyone, for the great performance in quarter 2. Dean, over to you.

Thank you, Richard, and good morning, everyone. As Richard indicated, we delivered a very solid quarter in Q2. Here is a company-wide overview -- revenue up 11.7% for the quarter with direct marketing revenue up 8.9% and Shopper revenue growth for the quarter, 16.1%. Operating income, company-wide, was up 11.5% with direct marketing having operating income growth of 12.7% and Shoppers up 13.1%.

Earnings per share were up 17% to $0.34 per share from $0.29 per share in the second quarter of 2004. Free cash flow was $28.8 million with capital spending in the quarter of $8.2 million.

In the quarter, our tax rate declined resulting from the favorable resolution of a state tax matter with a net EPS effect of this item positive by a little under a penny a share.

Now, turning to each of our businesses -- direct marketing revenue up 8.9% and operating income up 12.7% with operating income margins up 50 basis points year-over-year to 14.8%. For our vertical markets in the quarter, high-tech telecom was our largest vertical this quarter again, representing 24% of direct-marketing revenue, just slightly larger in this quarter than retail, which came in at 23% and financial, which came in a bit above 22%. Select markets represented 18% of the revenue with health care/pharma at 10%.

International business in the quarter was 10% of our direct marketing revenue. The top 25 direct marketing customers represented just under 40% of direct marketing revenue in the second quarter with our largest customer in the second quarter representing under 7% of our total direct marketing revenue.

Turning to Shoppers, Shoppers grew revenue by 16.1% in the quarter with operating income increasing 13.7% compared to the prior-year quarter. The Tampa flyer acquisition completed on April the 20th contributed slightly less than half of this growth with revenue up close to 9% absent the impact of this acquisition.

Operating income margins declined by 60 basis points in Shoppers compared to the second quarter of 2004. This decline was attributable to the Tampa acquisition. When acquired, this business had lower margins than our Shopper average margin, and at the operating income level was further impacted by acquisition purchase accounting that resulted in additional amortization expense. Absent the impact of the Tampa acquisition, operating income margins would have been up slightly despite the impact of continuing rise in newsprint rate and the impacts of our expansions that we have completed.

On the balance sheet at June 30, we were showing a debt balance, net of cash, of $17.5 million. On the balance sheet, the outstanding amount at June 30 of our credit facility of $43 million is classified as a current liability. This is because our existing three-year credit facility will expire in October of 2005. We are currently in the final stages of replacing this facility with a new five-year facility, which we expect to be completed within the next couple of weeks.

Book equity at June 30 was $594 million, net accounts receivable were $170.6 million. DSO at the end of June was 55 days versus 54 days in June of '04. Looking at our statement of cash flows, net cash provided by operating activities for the quarter was $28.6 million. During the quarter we repurchased approximately 500,000 shares and since January of 1997, we have acquired over 40 million shares and spent over $670 million under our share repurchase programs.

Over the last two-plus years, the comparative year-over-year results have improved for the company including the first quarter of this year when we benefited from the large, nonrecurring project we discussed in connection with our first quarter results. Our comparisons, going forward, therefore, become more difficult in subsequent quarters.

Our goal for 2005 remains to be to deliver EPS growth for the full year better than the growth we delivered in 2004.

With those comments, we will now be happy to take your questions.

[OPERATOR INSTRUCTIONS] Lauren Fine of Merrill Lynch.

I guess I'd like to drill in a little bit more in terms of the competitive environment in California. Presumably, you were referring to the fact that ADVO has a second mailing date in Southern California. And so I'm wondering if you could give us the prospective growth rates of your ROP versus FSI businesses and what the mix is and how you see that playing out, over time? Is it largely price competition at this point? Have you lost any customers? Just really any color you can give us of how you think that will play out.

And then, I guess, sticking with the Shopper business, can you give us a sense on the two large customers you noted that are cutting back? Would you still expect, excluding Tampa, to come into the 6% to 8% growth range of revenues for the year?

Well, let's see, there are about four or five questions built into that, so let me see if I can get a couple of them done, and then Dean can answer some of the others.

No, we have not lost customers, although being in the marketplace is a factor, though the distribution revenue growth that we saw that was lower than our ROP growth -- most of that was not related to ADVO. There is a general competitive environment, which includes ADVO as a subset of that, and those conditions are going to continue throughout the year and perhaps into next year.

You mentioned the two Shopper customers. We're not going to go into detail, obviously, about them, although I will tell you that the overall revenue from -- Dean, maybe you could help me with this -- from our top 25 customers are less than 15% of the total of all Shopper revenues. So I think probably that deserves a little bit of context.

Well, I guess, I'll go back and ask the question -- or repeat the question I asked -- in view of the competitive environment and these two large Shopper customers and excluding Tampa, are you still thinking 6% to 8% revenue growth for this business? And then on the competitive environment, is it also -- obviously, Tribune has stepped up their efforts in LA in terms of having made a big investment in distribution as well, or is it just collectively everything and is it more pricing than anything else?

Richard, let me try to take a cut at that. Lauren, I think the two customers in Shoppers that have cut back their advertising as a result of their financial difficulties, that is not a competitive environment issue; that is not an ADVO issue for us. Again, our top 25 Shopper customers represent less than 15% of our revenue. These happen to be two of the larger customers that, because of circumstances, happened to hit at the same time.

So if these people don't return, the combined is probably a couple of points of revenue between those two customers. So if they don't return, then we could take a revenue hit from our existing business. I think, over time, we still feel comfortable with the 6% to 8% revenue growth because of the impact of this specific event and because of some turmoil in the market in Southern California. What that revenue growth is on a quarter-by-quarter basis as we roll forward, we're not sure, but, over time, we still feel comfortable with the 6% to 8%.

Okay, and then I guess the last part was really just trying to understand how the competition is playing out. Is it largely on pricing, and is it as much related to the newspaper guys also?

Well, it is primarily the result of ADVO. If you listened to their call yesterday, they gave some metrics, which may give you some indication. The pricing that they are yielding in their "expansion" products, which is primarily Southern California, is, I believe, close to 30% lower than their system average, which probably gives you some indication of what the pricing environment is out there. Again, I believe they generated about $5 million incrementally in the market in Southern California, which yields a 15% revenue growth for them, and that cost them $13 million in incremental postage to generate the $5 million of revenue.

So there is a lot of, in essence, capacity in the Southern California market and until ADVO fills its second-day-a-week package, there is going to be uncertainty in that market.

And in the last call, somebody asked whether we had lost any customers, and we said on the last call that we hadn't lost anything that was material, and we can continue to say that on this call.

Mark Bacurin of Robert W. Baird & Company.

Good morning. Maybe a switch over to the direct marketing side -- you commented on some consolidation within the financial services industry that is clouding the visibility on the back half of the year. Did you see any impact from that in the current quarter, and is there any way to ballpark for us, of the big players that have merged, how much revenue exposure you have there?

Well, the answer to your question is there was a little of it that we saw in this quarter, but the events that are surrounding us and we see in the newspapers and we feel in the marketplace, we feel may affect us, going forward, which is why we've used the language we have. Dean, I don't know if you want to add anything to that.

Yes, there was some in Q2, I think, when you just look at the number of events out there and the number of the customers -- there is a finite number of our customers that are impacted by this. There is uncertainty out there, and we don't know exactly what it's going to mean, but the suspicion would be that there is going to be some changes as a result of these, which may impact their spending patterns, which may impact us, going forward.

Any sort of indication of how large the potentially impacted clients are in terms of revenue contribution to direct marketing?

That's going to depend a lot on what happens. Standing here, there is not a really good way to know that.

I don't necessarily mean projecting going forward, but how big are they today?

Well, the largest client in direct marketing is not financial, and the largest financial client in direct marketing -- we've never really talked about size -- but it's well under 5% of our revenue. And our goal through this consolidation is not to lose any customers but rather potentially lose projects and programs. So you start peeling that onion back, and you get to a point where you say, "Okay, I could sort of quantify that," and I've given you probably enough information to do that.

That's helpful, thank you. And then on the two large clients within the Shopper side of the business, are they both in the same industry, and can you comment -- what industry verticals these clients are within?

They were in different industry verticals. I think these are really customer-specific issues at this point as opposed to industry. They were in different verticals and, again, in Shoppers, no one vertical is 10% of the revenue. I think these were more individual customer-specific issues.

Great, and then could you just comment on the trend within ROP and specific categories within that, where you're seeing the strength that we've missed in terms of classifieds, real estate, et cetera?

We've seen employment continue to be strong, real estate continues to be up but not as up as much as it has been in the past. Those are a couple of the major trends.

Just one quick one, finally, you had a decent spike in advertising in the SG&A expense this quarter. Is that largely a function of the Tampa acquisition?

Actually, it's more a function of a couple of the customers that we talked about in Shoppers, and taking some reserves versus the receivables that we had outstanding against those customers as well as the way the state tax matter was resolved. That resulted in the booking of some professional services consulting fees in the quarter, and it was those two things that drove the increase in SG&A.

And how big was that accrual this quarter, Dean, for those two big clients?

It's fully reflected in the number. I think if you take away the two items that I talked about, the increase in SG&A would have been about the increase in revenue. So I think that gives you some indication about what those two items were.

Alexia Quadrani of Bear Stearns.

Thank you. In the Shopper business, for clients that are about the size of the two large ones you referred to, what type of visibility do you typically have in revenues for them? Like, how far in advance do they book this book out?

Well, it varies. The contracts for the larger distribution clients tend to be anywhere from a few months to a few years, but it's really hard. Those contracts often, like the ones in direct marketing, don't deal with volume. They deal with if we're going to advertise kind of thing, and so you get companies that are not doing quite as well as we had hoped, and so they still might be living up to their contractual terms but not able to advertise. We have a fair amount of visibility in Shoppers, and I think the consistency with which we have shown that 6% to 8% plus performance over the past -- I guess it's been about five years now -- suggests that.

And then if I could jump over to the direct marketing side for a second -- you did show some very good growth in the quarter. Is there a way you can ballpark how much of that growth came from new customers versus existing customers? And if you could just touch on pricing trends in direct marketing -- are you seeing any improvement there? And, lastly, was there any revenue from the first quarter special project trickling into Q2?

I'll answer the pricing one -- they're just a fact of life, and we're dealing with them through operational efficiencies and product innovation. Dean, do you want to take the others?

Yes, Alexia, in terms of the revenue growth, revenue growth was driven both by existing customers spending more and by new business in the quarter. A larger portion of the growth this quarter was driven by new customers than the growth in existing. Existing customers are still growing, but they didn't grow at the rate that they grew in the past quarter or two, but new-customer spending was the driver of the growth this quarter.

In terms of the Q1 project, there was some spillover into the second quarter, but the amount of the spillover -- we spiked out the project in the first quarter because of the size of that. We always have, from time to time, one-time kind of projects that come and go. The amount that spilled over into the second quarter wouldn't have been anything that we would have spiked out absent the large amount in the first quarter. It was significantly less than that and is pretty much ramped out now.

Paul Ginocchio of Deutsche Bank.

Thank you. Obviously, your margins were good in direct marketing in the second quarter, up year-on-year, but not as much as the first. Was that because that special project had very high incremental margins, or was there something else going on -- mix that's obviously -- be a lid on the margin improvement relative to the first quarter?

Then, second, your corporate costs achieved in the 30% growth range -- what are we looking for in the second half?

I'll try, at least, to tackle the first half and, Dean, maybe you can think about the second half. In the first half, the first quarter is our smallest quarter, and so when we had a spike in revenue, we have a real opportunity to change margins in that quarter moreso than in any other. That's part of the answer. Part of the answer is that it was disproportionately profitable. We talked about that in the first quarter call; that is, the one-time project was. So that's what you're seeing.

We are really quite pleased with the improvement in margins in the second quarter, and it is really taking us to the path that we hoped we'd be on this year with the continued margin improvement that we saw last year. Dean, do you want to talk about anything else?

Yes, just to give further color on that, Paul, in terms of the first quarter. The margin spike was driven primarily by the revenue spike. It was 17.6%, I believe, in the first quarter, and the incremental margin -- we have pretty decent incremental margins, so it was the high revenue that caused that moreso than the fact that the project was disproportionately profitable. While it was a profitable project, it was more the total revenue spike that drove it.

In terms of corporate costs, I think what you saw in the second quarter, I mentioned the state tax resolution matter that resulted in an expense that hit the corporate line that drove quite a bit of that increase, and I think if you took that out, that increase would be -- I'm going to have to get that number -- but it would be significantly below the 30% increase.

The other thing that we're seeing are some increased expenses, year-over-year in terms of Sarbanes-Oxley, audit fees, and internal headcount on those things.

If I could just ask a quick follow-up -- if some of these mergers take out a project, I would assume most of your costs are variable and they can be taken out quite quickly, or would there be a hit to margins as well.

Well, certainly, if you take a look back for four-and-a-half, five years ago when the recession started, and we probably got wind of it earlier than most and probably acted quicker than most and, in fact, what happened during that period is our margins went up because we took out as much cost as we took out. We are surely hopeful that those conditions do not materialize again. It was a painful process. I think we behaved well during that process, but it was hard.

So actually we saw revenue -- margins increase during that. Clearly, at some point, as we learned quarter after quarter after quarter through that period, the low-hanging fruit was taken, and then margins began to decline, and now we're recovering from that period.

And, Paul, just to mention, absent the impact of the state tax matter, the corporate costs would have grown slightly less than the revenue growth.

Brandon Dobell of Credit Suisse First Boston.

Thanks, just a couple of quick ones -- if you could talk a little bit about the impact of all the recent activity in the auto space, both in terms of Shoppers and direct marketing. Is there anything in Q2 that we should be aware of that might be -- I wouldn't call one-time in nature, but a little bit of extra, given all the promotions that are running through.

And then, second, I want to get a little bit better sense -- you mentioned in the Shoppers product in San Diego, you rolled out a little bit more of a glossy thing down there, 16 glossy pages. Maybe if you could walk us through how that process works; how you guys think about what it's going to take to make an investment like that work for you; what is it going to generate in terms of extra client interest or revenues for you guys; and is it based on a prior run that you did in a different area or is it just based on your market research in the San Diego area?

Well, the first question and, Dean, correct me if you know something that I don't. There is really nothing that we know in the automotive space that will materially impact us, going forward, either plus or minus.

On the glossy project, we are testing glossy paper in San Diego specifically. That is our test market. It is not coming from another test market. It is a fairly large test market driven by the fact of production realities; that is, it's pretty hard to test this in a smaller market because of the plate changes and other things you would have to do.

In terms of our progress, this is a multi-year test to see if we can do what we seek, which is to improve readership and to create new advertising categories and to increase the level of advertising from existing customers.

We put together a detailed financial plan when we first started this, and we are at about the levels -- maybe a little bit better -- but about the levels that that plan showed for this period of time since its initiation.

So we're pleased with the progress that we've made. We know it's a much longer-term thing because you have to come against yourself, you have to see if you can fight down some new categories and some perceptions of some advertisers, and so we're in the early stages of this test but so far so good.

Does this generate a different type of customer for you or just somebody who wants a different -- the same customer who wants a different kind of image, a little bit more upscale? Or is it more geared towards generating different people who might not use or might not think of PennySaver as the right vehicle to use?

The goal is to do both. Now, what it does do is part of what this test is about. It's, first of all, creating new categories of advertisers. It's hard. It takes different approaches, it takes different people; there are a lot of things involved in it, and that takes time. So are we hopeful that it will do that? Yes. Should it do that, in theory? Yes. But theory and practice are two different things, and we're going to fight our way through it to see if we can make that happen.

And then one final one -- as you think about the timeframe for which you would either have a yes or a no vote on this from a return perspective or from an on-plan or off-plan perspective, when should we think about you guys having enough information to make this either a more widespread offering or to say it just didn't quite get it to where we wanted it to be?

I don't know the answer to that. It's certainly not this year, and it will be well into next year before we have, really, I think, a definitive answer. There are lots of answers. There are answers that say, "This is good enough to move forward with, even though it's not going to materially impact revenue and profits, but it will impact positively our image." For example, that's one down-the-path approach. Another down-the-path approach is that it's a homerun. It's doing everything we had hoped it would do and therefore we're going to roll it out even sooner than we anticipated. Another possible path is that we're just unsure. We have to go at it using some different approaches, and we're not losing or making enough money to make us change our mind, so we're going to continue down this path of testing. There are just so many of these options.

Brandon, just to go back to your automotive question, I think your question was that you see a blip in the quarter as a result of that. The answer is no. Primarily, in direct marketing, we are -- the foreign automotive manufacturers are the ones who are our customers, and those weren't the ones participating in the employee discount. And in Shoppers, we're more after-market as opposed to new-car dealers, and actually the growth rate, probably in automotive, both in direct marketing and in Shoppers, lag the overall growth.

Frederick Searby of J.P. Morgan.

A couple of questions -- one, Postfuture -- if you could just talk about how that's doing and specifically what piques my interest here is are you seeing any shift on retention -- I assume it would be retention -- or prospecting dollars out of direct mail into e-mail -- is that beginning or is it more complementary? And then, secondly, just to understand the client consolidation, are you saying the risk is that they go with another vendor serving one of the other consolidated entities or that there are pricing pressures because they demand a discount or that they just -- the consolidated entity -- you're conserving both of them, and then they just cut back from 1+1 to 1.5? If I just understand that.

First of all, on the consolidation part of the question, it's all of the above, and --

Is there a competitor in there that you're kind of bidding against for the consolidated entity that --

Well, there are, certainly, and, again, this is not about -- at least, so far, this is not about the loss of clients but rather the loss of projects or programs. So that deserves some context. But, yes, there are competitors. Sometimes the competitors are in-house, sometimes the competitors are the favorite company of whoever is the winner in the internal fight for power. There are just so many things going on.

On Postfuture, to answer your question, it is a complementary medium. We've always talked about it as being complementary. That doesn't mean, of course, that some companies don't have a devoted effort to e-mail -- they do, and we're hopeful to participate in that. The acquisition is going really well. It's going really well both on a stand-alone, doing-it's-own-thing basis as well as beginning to catch up with some of the integrative things that we had hoped to achieve with it. So I'm very pleased with that acquisition.

And just to follow-up on Postfuture, though -- are there any clients who are just saying, hey -- I know this hasn't happened, and direct mail is still very vibrant, but are there any clients who are just saying, "Hey, I want to experiment with just doing e-mail," or have you seen any signs that were an inflection point? Can you just tell us -- is it pretty much in the bag, a 6% postal increase next year? Is that your read?

You're sneaking up different questions each time. To stay with Postfuture for a second, we have really not seen e-mail as a replacement, certainly, in its entirety. It is taking different parts of the mix. Sometimes it's expanding the size of the pie. So it's everything we thought it would be when we sought an e-mail company acquisition a few years ago.

On postage -- yes, that is about the rate that we expect sometime in the first quarter of next year, and to answer your follow-up question, it, as you know, is a cost item for shoppers. At that cost level, we feel reasonably comfortable in getting those costs passed on during the course of the first year, and for direct marketing, we feel reasonably confident that it will not materially impact the mailing that goes from our client. It's their costs, not ours. But, clearly, increased costs affected them, but we don't see it as a material effect at that level.

Troy Mastin of William Blair & Company.

Thank you, good morning. I wanted to follow-up a little bit on the question regarding the direct marketing business. The client lost potential -- is there also an opportunity here so some of your clients, maybe be acquired, that you can service the parent as they are acquiring these companies?

The answer is "yes." There is always that opportunity. We win some of these, and we lose some of these. It is the nature of this kind of thing. It depends on where we sit and how lucky we are. We have a long history of winning and losing in these things. What we are trying to project here is at least a little bit of the knowledge we have about what's going on. It's not all firm, but there are some situations that we know that we at least feel are not going to be as strong as we had hoped, and that's why the press release says what it does.

The operative words were "uncertainty." That's what we're trying to describe.

Okay, and then within that business unit, still, I suppose you're suggesting that conditions looking more challenging even when excluding the special project you saw in Q1 and part of Q2, correct?

I'm sorry, would you say it again?

I'm assuming, based on your language, that even if you were to exclude the positive benefit of the project you saw in Q1 that also flowed into Q2, that you still would expect conditions to be more challenging for the direct marketing side of the business?

Yes, I think even if things were perfectly normal, that would the case, given the growth that we've had.

And, remember, in the first quarter, absent the special project, we had double-digit revenue growth in direct marketing.

Okay, and then to move on to Shoppers, the two clients you've identified as potentially spending less -- if they do spend less, I know it's only a couple of points of revenue but is that heavily isolated into some particular geographies, and would that have an adverse effect on overall margins versus the revenue impact?

It would not have a disproportionate impact on margins. These are both actually distribution customers for us, which typically would not have an adverse impact on margin if they were to continue not to advertise.

Okay, and then can you give us some insight on the impact on profitability in the quarter from the two things you identify -- the Tampa flyer and the purchase accounting methodologies? So they're lower margins, I mean, and then the purchase accounting that you have to run through the P&L and how those costs will figure into Shoppers business on a going forward basis. So I imagine, in time, Tampa flyer margins will go up, and the purchase accounting expenses will be relatively stable, but if you could just give some insight there, I would appreciate that.

What we said is absent -- there was close to 9% -- 8.8% -- revenue growth in Shoppers excluding the Tampa revenue. Margins in that business excluding Tampa and Shoppers would have been up. So with the revenue growth at 16% driven by Tampa, our margins were down 60 basis points, and all of that -- that's the impact of the Tampa acquisition. It was more than a 60-basis-point impact in the quarter negative for us.

That resulted from two things -- Tampa, when we acquired the business, had a lower margin than our Shopper average margin. We think that's an opportunity. And then the purchase accounting, further, is going to depress the margin from that revenue stream. It's about a little over $1 million a year in amortization expense resulting from the purchase accounting. That will be staying stable for a period of time and then will decline because the various assets have lives ranging between two to 10 years. So two to three years out, we'll start seeing a little bit of a decline and then those finally go away after 10 years.

And if I may give you a softer answer to that question, we're really excited about what's going on in Tampa. Every acquisition has its assimilation challenges, but I can tell you, so far, this feels really good.

In the past, what has been your track record in improving margins of acquired businesses? Does it take one year, two years, six months, what's your experience been in really getting the margins up to what you would consider maybe an equilibrium type level?

It totally varies by the type of business, and the extent to which that business gets assimilated into the company and how it gets assimilated into the company for Shoppers, which tend to be a little bit more stand-alone, although there is a certain amount of that synergy stuff that goes on in Shoppers as well. For this acquisition, we do expect to see improvement, and we do expect to see improvement beginning next year. But we're not going to get to the same levels of profitability in some cases just because of size. You get some margin just because you're the size that you are, for example, in Southern California.

Okay, and then, finally, one last on the health care side of the business -- have you seen any negative impact to demand there or potential demand, going forward, as a result of some of the concerns regarding pharmaceutical marketing or is there maybe a positive impact?

Well, it's both. The health care vertical was up mid single digits. We have felt some effects of the drug recalls in this vertical and anticipate that it will continue to have somewhat of a negative impact in revenue in the near future. But, overall, we're optimistic about the growth potential for the vertical because of some of the upside things that are going on as well.

In most of the discussion about the DTC advertising, it's really dealt with primarily mass media and TV advertising. We think these people are going to continue to spend money to market their drugs. The spotlight has been on the mass media TV spots.

Michael Kupinski of AG Edwards.

I was just wondering -- you gave us the percentage of revenues for the verticals in direct marketing. I was just wondering if you can give us the year-over-year growth. I guess I can figure that out, but if you can break that out for me? And, in particular, I know that retail segment is the one I really want to focus on, because I know retail had been surprisingly strong. It's probably one of your most mature verticals in that in the last several quarters it's showed some pretty decent growth. And I know that a number of other mediums were anticipating that retail, as a category, might be a good growth vehicle for them as they go into the second half and into the Christmas selling season. I was just wondering what your thoughts are on that particular category as well?

Let me sneak up on some of this. For the first half of this year and the last half of last year, a lot of the improvement that we've seen in retail came principally from the incremental spending by existing customers and, certainly, while we're pleased with that retail performance, some of it was catch-up, and we don't see a fundamental change in the outlook for the vertical. As you said, it's a mature market, and therefore it's going to be a challenging one.

What was the second part, I'm sorry?

Mike, I think you asked about the growth rates of the verticals?

Right.

Select and financial were both up, I believe, low to mid teens. And then the remaining three verticals were all up mid single-digit level.

Okay, and then I know that you've been just tremendous in managing your margins in the past, and I was just wondering -- but it seems like in the last several quarters at the beginning of last year, you were kind of in the investment mode to grow your direct marketing revenues, and I was just wondering -- and that certainly has paid dividends, so far, this year. I'm just wondering, with the cautious statements that you have in terms of the prospect of slower revenue growth, what your thoughts might be in terms of managing expenses, given that you had been investing a little bit. And what are the implications for margins in the second half, because I have them pretty much flat with the types of margins that you had in the first half.

Well, first of all, just because it's so recent, it's hard to forget the three-year difficult period that we've been through, and we are not jumping in the streets and have not jumped in the streets even though we have had some very strong performance over the past year, year-and-a-half. So we continue to be cautious in our approach.

Secondly, investment is part of what we do. You may recall, we made some investments right in the middle of the down cycle. It's something we do as a matter of course. We hopefully are judicious about the way we approach that, but I can tell you that it was just yesterday that I had a conversation with one of our senior people about a series of 18 different prospective investments in our company, certainly not all of which are going to make it to the point where we spend money, but it's something we talk about and do on a regular basis.

I was just wondering, too, Richard, any thoughts on acquisition prospects? I know it's a common question on these calls, but I was just wondering if you're seeing anything out there at this point that might be of interest to Harte-Hanks?

Well, there is a good pipeline. There always seems to be it is at least as good now as ever, and there are some things that are interesting, and that's all I'm going to talk about.

Mike, I might just comment that we manage expenses whether revenues are going up or going down. That's kind of a day-to-day job.

Do you have any thoughts on the margin perspective, though, in the prospect of seeing some slower growth? I mean, in general -- I understand that you manage expenses, but do you have any thoughts on the margins themselves? Do you think that the margins will be flat, do you think they'll be going down a little bit, or -- in direct marketing, particularly?

We look to improve margins, and we have done it now for five consecutive quarters, I believe, and our goal remains, over time, to continue to raise margins from their current levels and how that shakes out on a quarter-to-quarter basis is much harder to predict, but our goal is to continue to improve our margin.

Alexia Quadrani of Bear Stearns.

Dean, just a quick follow-up from my earlier question -- when you mentioned that some of -- or a majority of the growth in direct marketing in the quarter was coming from new customers, are those generally customers coming from competitors or are customers that maybe had previously spent ad dollars on a different medium that was shifting a bit of their budgets to direct marketing? And the second part of that question was, in general, I know each case is different, but, in general, do new customers tend to be a bit lower-margin as they're ramping up versus an existing customer?

To answer the first part of the question, some of those we know that this business came from competitors. I don't think we can identify any that this is new money being spent because of a shift in media. That may be the case, but we can't point to any of that revenue. I think, generally, new customers -- there is a ramp-up period, so, generally, they tend to become more profitable, over time.

[OPERATOR INSTRUCTIONS] Lauren Fine of Merrill Lynch.

Hey, Dean, I was just curious on the tax rate, given the favorable adjustment -- if you could give us any sense what it should look like in the second half, if there will be any big changes?

Overall, for '05, I think we're projecting the overall tax rate to be somewhere in the 38.5% to 39% range overall for the full year.

At this time, we are showing no further questions.

Thank you very much, everyone. Have a great day. Bye-bye.