Harte Hanks Inc (HHS) 2005 Q4 法說會逐字稿

Good morning. And welcome to the Harte-Hanks fourth quarter and year-end 2005 earnings release 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. Now, I liked to introduce your first speaker, Mr. Richard Hochhauser, President and CEO of Harte-Hanks. Mr. Hochhauser, you may begin, sir.

Thank you. Good morning. 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. These forward-looking statements 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 Securities and Exchange Commission. After I make some opening remarks Dean will give financial details and then we'll take your questions. A good place to start is that 2005 was a terrific year in a lot of dimensions. We continued the momentum from 2004. We achieved another year of significantly improved ROS in direct marketing. We had yet another in a long series of strong shopper performances and we delivered solid results each quarter. We beat consensus earnings per share at the beginning of the year of $1.27 and it hit $1.34 versus $1.11 last year. We've generated $117.6 million in free cash flow, higher than we expected due mostly to increased earnings and a decline in capital spending driven by timing. This compares to the 91.2 million in 2004. We define free cash flow as net income, plus depreciation and amortization less capital spending. We generated 1.13 billion in revenues versus 1.03 billion in 2004.

Specifically for quarter four, we are pleased with the results our people delivered, particularly the bottom-line growth. But the Company as a whole, operating income was up 8.3% on a revenue growth of 8.5%. Earnings per share grew to $0.38 from $0.32 up over 18%. Our eighth consecutive quarter of double-digit year-over-year EPS growth. In quarter four direct marketing operating income increased 8.7% on revenue growth of 4.4%. We're pleased with our second consecutive year of significant margin improvement. Our healthcare/pharma vertical had very strong growth in the quarter and our select markets vertical also had double-digit revenue growth. Retail had mid single-digit growth against a very strong quarter in 2004, while financial services was down mid single-digits, and high-tech and telecom as we discussed in connection with our third quarter earnings release was down about 10%. While impacted by Hurricane Wilma in the quarter and Dean will talk more about this, shoppers otherwise had another solid quarter with revenue growth at 15.9%. Both revenue and operating income growth were helped by the Tampa Flyer acquisition that we completed in April. The operating income margin declined when compared to the same period last year was also attributable to this acquisition and the impact of Wilma. Absent the Tampa acquisition, revenue growth would have been in the target 6 to 8% range.

Both of our businesses performed well despite challenging revenue comparisons. Over the past year we enhanced our overall franchise in a number of important ways. In shoppers, we increased circulation by 1.3 million with a little under 1 million coming from the Tampa acquisition. We grew local living revenue. We experimented with glossy paper in our San Diego market. We acquired and successfully assimilated the Tampa Flyer. In direct marketing we added a resell of partners worldwide and committed to opening a facility in Manila. We've successfully integrated our Postfuture e-mail platform, as well as the acquisition in Australia; overcame losses in pharma and healthcare market due to drug recalls, and ended the year with a strong performance and a strong pipeline in this vertical; and improved industry analyst ratings for three of our offerings, our Allink database, Trillium, and Postfuture e-mail offerings. And in both shoppers and direct marketing we made significant progress in developing digital strategies. There are many opportunities going into 2006 as we are leaders in two businesses that are very sound. There are also some issues as there are every year. We know about the postage increase, which is now in place. We do not expect this to affect direct marketing and we have a price increase in place to offset the impact on shoppers. In addition, a half year ago we said there is uncertainty surrounding a few of our direct marketing customers currently involved in industry consolidations, though no large clients were lost, we will see some impact in 2006. As the year progresses the comparisons get a little easier and we're again poised to grow direct marketing in 2006. We also expect shoppers performance to be strong and to continue. We have plans to aggressively grow circulation.

Before turning it over to Dean let me make a few key summary points. We had an outstanding year. We had challenges in 2005 as we do every year and our performance was terrific. In direct marketing we continue to improve margins. Shopper progress by an acquisition of new products was strong. We are excited about the businesses and markets we're in and we feel that their growth will be strong for many years to come. We're committed to perform well in this fast changing environment which we believe is the norm. And to that end we are committed to investing in our future and know that many of the investments we have already made are providing returns now. Though I say this on every call and it bears repeating. Our people are special. They make it happen day in and day out. And thanks for everyone for what you did in 2005. Dean, over to you.

Thank you, Richard. And good morning. As Richard indicated we had a really good finish to an overall very positive year for Harte-Hanks. Here's a Company wide overview: Revenue was up 8.5% for the quarter and 10.1% for the year with revenue up in both direct marketing and shoppers. Direct marketing revenue was up 4.4% for the quarter and up 8.3% for the year. Shoppers revenue growth for the quarter was 15.9% and 13.2% for the year. Operating income was up 8.3% for the quarter and 15% for the year. For the quarter, direct marketing had an operating income growth of 8.7% and shoppers also was up 3.4%. For the year, direct marketing operating income was up 19% and shoppers was up 9.8%. Free cash flow for the year was 117.6 million up 29% from 91.2 million last year. We ended the year with 28.2 million in capital spending, compared to 35.1 million in 2004. In 2005, we had planned to spend more on capital, but we came in at a lower level partially because of the timing of projects. The rolling effect in 2006 coupled with continued investment and shopper capabilities and direct marketing initiatives will likely lead to capital spending in 2006 in the area of $40 million.

Turning to each of our two businesses, for the fourth quarter of '05 our direct marketing revenue was up 4.4% and operating income of 8.7%, with this positive leverage yielding operating income margins up 70 basis points year-over-year to 17.2%. For the year operating income margins finished at 15.6%, a 140 basis point improvement over 2004 margins. For our vertical markets in 2005, retail, our largest vertical represented 27% of direct marketing revenue; high-tech/telecom, 24%; financial, 20%; select market, 17%; and healthcare/pharma, 12%. International business represented 9% and 9.5% of our direct marketing revenue for the fourth quarter and year respectively. Our top 25 direct marketing customers represented 40% of direct marketing revenue for Q4 and 39% for the full year. Our largest customer in Q4, 2005 represented approximately 8.5% of our total direct marketing revenue and 7.5% for the year.

Turning to shoppers, shoppers grew revenue by 15.9% in the quarter and 13.2% for the year. Operating income increased 3.4%, compared to the prior year quarter and for the year it was up 9.8%. Tampa Flyer acquisition completed on April 20th of 2005 contributed a little more than half of the revenue growth in the quarter and about half of the revenue growth for the year. Organic revenue growth, that is, revenue growth not including the Tampa acquisition for both the quarter and the year was within the 6 to 8% revenue growth range we have targeted for our shopper business. While the competitive landscape in Southern California remains in essence unchanged, that is, lots of competition, our distribution revenue in the quarter was stabilized. Two factors impacted operating income margin performance in the quarter for shoppers. First, the Tampa acquisition, as we have said when acquired this business had lower margins than our shopper average and at the operating income level was further impacted by acquisition purchase accounting that resulted in additional amortization expense. And second, the impact on our Miami Flyer operation of Hurricane Wilma, which caused the loss of one week of publication and the delay of another week, as well as expense associated with damage to our facility. Our people really did a tremendous job recovering from this in our Miami operation. For the year, excluding Tampa's results, operating income margins were in essence flat.

We've talked in the past about plans for increasing circulation and shoppers through continuous geographic expansion. This expansion initiative started late in the third quarter of 2003. Our plan at that time called for adding 2 million circulation over a five-year period. To date, we have added over 1 million circulation under this initiative and are planning to make further progress against our goal in 2006. Our fourth quarter net income and EPS performance benefited from a lower effective tax rate. This lower effective rate in Q4 resulted from the favorable resolution of certain state tax issues in the quarter. For full year 2006, we expect our tax rate to be slightly higher than what it was for the full year 2005 but still under 40%. On the balance sheet at 12/31 we were showing a net debt balance of 37.4 million; book equity at December 31, 2005, was 561.3 million; net accounts receivable were 184.5 million versus 168.8 million at December 31, 2004; DSO at the end of December '05 was 56 days against 55 days at December '04. Looking at our statement of cash flows, net cash provided by operating activities for the quarter was 32.8 million and 145.4 million for the year. We've repurchased 1.5 million shares during the quarter and 4.3 million shares for the year. Since January of 1997, the Company has acquired 43.5 million shares and spent over $750 million under its repurchase program. We also recently announced that the Board of Directors declared a regular quarterly dividend for the first quarter of 2006 of $0.06 per share, an increase of 20% over the prior dividend level. This is the 11th time the dividend has been up in the past 11 years.

We are very pleased with the results we were able to deliver in 2005 with over 20% earnings per share growth. We do not anticipate reaching this level of EPS growth in 2006. In 2006, we will be going against the very strong first quarter of 2005, which included the large nonrecurring project that we discussed in connection with that quarter's results. As described in the press release, we expect the impact of expensing stock options in 2006 to be $0.06 to $0.07 per share. If you look at 2005 and 2006 on a comparable stock option expense basis and based on what we know about 2006 at this early point in the year, our goal is to deliver good earnings per share growth in 2006 in the high single-digit or better range. This is on top of two consecutive very strong growth years. We are very proud of our people and our ability to deliver consistent EPS growth in all economic environments. With that, we'll be happy to answer your questions.

Thank you. [OPERATOR INSTRUCTIONS]. Our first question does come from Mr. Mark Bacurin with Robert W. Baird.

Good morning, gentlemen. Very good results. Congratulations. Couple things, Dean, first of all, could you clarify on the -- you said "X" the Tampa Flyer acquisition operating margins and the shopper business were flat, would that include costs related to getting things back up and running associated with Wilma?

Mark, I was just referring to the full year, not the quarter. And I just pro-formed out the Tampa acquisition, not the hurricane impact.

But can you quantify for us what sort of one-time or non-incurring costs would have been associated with your operations related to the hurricane?

Yes. We lost, as we said in the press release and in the comments, we lost a full week of publication and we had a delayed week of publication which caused some lost revenue. And so it was a million dollar issue or so probably on the revenue topline. And then when you add in the impact of some damage to the building, it was more than that on an operating income line.

Okay. And then as I look at Q4, it was a pretty big jump in both your production and distribution costs, as well as your SG&A line. Were there any one-time kind of passthrough-related projects in the quarter where that caused that number to spike?

I think on the production and distribution line, Mark, that you can look at the fact that shopper revenue was a greater percentage of revenue in the quarter because of the Tampa acquisition. And the shopper business inherently has a higher production in distribution as a percent of revenue than direct marketing. Additionally, a lot of the hurricane impact included damage to the facility. That showed up in the P&D line.

Okay, so that was part of it as well. But there was no -- like you had in Q1, there was no large project-oriented revenue this quarter?

No. That would have driven that line, no.

Okay. And then the select markets, I guess I'm a little surprised to see that growing as well, given that I think auto is probably the biggest category there. Can you comment on specifically what is helping drive the select market?

Well, you're right, auto is the biggest category. And it was in the quarter. And it had some nice growth. These are such big markets and while overall you're right, there is certainly some sluggish, there's still the need to market and there's still an opportunity for us to win share and there's still an opportunity for us to do what we do in direct marketing. So I was pleased to see that. We had some stability in revenues for awhile and it clicked up a bit.

Okay, great. And then one last quick one. On the postage rate increase, what of your -- as you're looking at the '06 guidance that you're giving, how much of a step up or boost to '06 revenue do you think the price increase on the shopper side, as well as any sort of past or postage cost you get in direct marketing, how much for contribution will that be to the year-over-year growth in '06? And then what are you seeing in terms of volume trends, thus far in January on the Hill to the postage rate increase?

Well, let me take part of this, if I may. First of all, in direct marketing postage is not in our revenue and so the answer to that is zero. In shoppers pricing, we've had pricing increases now for just about as long as I can remember and we are doing, I think it's a little bit higher this year, so I don't expect any disproportionate amount of our revenue growth, maybe a little bit, to come as a result of price. What we're trying to do, obviously, is offset the additional cost that comes from that in addition to getting what we normally do, which is a price increase that generates some revenue. But there are lots of ways that we grow our shopper revenue. We grow it with expansion. We grow it with new products. We grow it with selling more. And we grow it with price. Dean, do you want to add anything?

Mark, in terms of volumes and shoppers, our pricing increases literally are -- depending on the geography, one to two weeks old. So it's really too early for us to have done any analysis on it to find out. I mean one thing a lot of our competition has also passed through price increases, particularly the ones that are like us have postage as part of their expense. So the entire competitive market where we are in shoppers is our competition also has price increases, in fact, -- which is a factor in the results you get.

Okay. Thanks a lot.

Our next question is from Alexia Quadrani of Bear Stearns.

Thank you. Dean, just following up on the comments you made about the profitability and the shopper business. Is it fair to assume then since you said for the full year margins were flat, ex-Tampa, I guess is it fair to assume that your expansion in Northern California is going very well in the sense that you are seeing the profitability levels in Northern California are newer markets that are similar to the rest of your business where you've been around for longer periods of time?

Alexia, I think if you look at, when we first started our circulation expansion we said we were going to do 2 million over five years. I think we were pretty careful to point out that this wouldn't be 400 thousand a year for five years, that it would be opportunistic, as well as -- you put some on and then you make sure they're working and then you get your people lined up and you do that. And in '04 we had much more circulation expansion than we had in '05. So I don't think that you can -- we had a lower level of expansion in '05 and were planning a higher level again in '06. So I'm not sure you can leap to that conclusion. I think it's fair to say that our expansions we feel good about how they came out, that most of our expansions came out performing better than our model would show. And most of them have continued to show improvement.

So ultimately the goal is to reach the same levels of profitability in your newer markets that you've been able to obtain in your old markets if not even better I guess over the long run; is that fair?

Yes, that's certainly the goal.

And then on the direct marketing side, I guess if you could elaborate a little bit on the weakness and financial services. Was it one company and one client or was it broad, just sort of a general lackluster growth in the sector? And then the retail side, you've been very conservative in your guidance on the customer base for quite some time, which I guess is fair given the consolidation industry yet you continue to deliver great numbers on difficult comparisons. Is there anything new I guess in Q1 or anything you're seeing from your clients that are making you particularly conservative or its just general conservatism given the consolidation in the industry?

Well, I'll take a piece of it, Dean. And some of it's the general conservatism. And you have to remember that while we are delivering good results in retail we got hit pretty hard in retail over the years. So we're going up against lower numbers even though last year was strong. If you go back a couple more years you'll find that the numbers were even higher than they are today. So I don't -- I'm very pleased with what's happened in retail. And we may be able to see some additional improvement, but we're going to be start being more conservative with retail even than we have been. On financial, we did get some growth from the mutual fund sector and from insurance companies. And we had a little bit of decline from the credit card and diversified finance and retail bank part of the business. But these vary by quarter and any one given quarter does not a year make.

Okay. And just a nit-picking question. On the expenses associated with the hurricane damage in Tampa, I assume all that was taken care of in Q4, we shouldn't expect any additional expenses in Q1; is that fair?

That's correct.

Thank you.

Thank you. Our next question is from Lauren Fine of Merrill Lynch.

Hi, there. Thank you. Just a couple of questions, if I could. On the shopper margins, at what point would you forecast that Tampa's margins will be in-line with the rest of the group, is that something that can be achieved throughout '06? And then on direct marketing do you expect margin improvement again after the substantial improvement that you made in '05 and taking into account how much might have been related to the project in the first quarter of last year, so could those margins move up again? And then also, when you look at the tough comparison in the first quarter are you aware of any projects that could help offset sort of the one-time nature of the project that you enjoyed last year?

Well, the answer to the first -- the last one, Lauren, is we don't have any one-time projects in sight that we know about. There is surely a lot of good things happening on the revenue front with existing and perspective clients. But we have, as we've reported a wonderful one-time project. And it helped us and it's going to be -- make quarter one pretty difficult. But a lot of other good things are happening with our Company. On the margin side in direct marketing, as we either said or suggested, we improved our margins even better than we thought we would and it's going to be tough, particularly given that one-time project. It's going to be tough to continue at that pace, but it is our goal to do that. So we need to do what we need to do. It's running a business.

And Lauren, with respect to your question about the Tampa margins, I think there's a couple of parts to the answer. Certainly we saw when we bought that the opportunity to improve margin performance in that business. So I think yes, we will see margin improvement in '06 in the business. There are two factors though when you say "will it get up to the other level of our other business?"

In connection with the acquisition we had to put up some intangibles in connection with purchase accounting that are amortizing those similar types of expenses aren't hitting our existing operations. So that will be a drag on the Tampa margins relative to our other shoppers. But margin improvement we will see. The other thing that will impact if you just draw a circle around Tampa and measure its margins is, there is significant expansion opportunity in Tampa and how fast we go about that is going to impact the results from that P&L. Because as we said in the past when we go out with expansion, it tends to be dilutive to margin because the revenue per thousand and attempt to come out in a breakeven mode.

Great and then one last question. That was helpful. On the shopper business, I think you made one reference to one line item in shopper revenues. I'm wondering if you could just review the different businesses insert and alike, and how they have performed in the quarter?

Yes, on our shopper business we talked about the distribution revenue. I think our distribution revenue in Q3 was down a little bit. We actually saw that turn around in the fourth quarter and stabilized and saw a little bit of growth in our distribution revenue and then, again, had strong growth in our ROP.

Great. Thank you.

Thank you. And our next question is from Ed Atorino of Benchmark.

Hi, good morning. You've talked about the pipeline and the shopper business, could you provide some details? And would you talk about sort of -- it's sort of been answered already in a way, but if you could just go over the trends in the direct mail category that you're seeing? Also, would you discuss the possible outcome at Albertson's and how it might affect you? And then you went through the breakdown of revenues. Would you mind repeating them? I wasn't writing fast enough, I apologize. Oh, and lastly, you've been buying about 1 million or so shares a quarter is that sort of Company policy or Company plan to maintain that type of share buyback program? Thanks a lot.

Richard -- we'll, I'll give you a couple of answers. First of all, I'm not sure we talked about a shopper pipeline. I think though at least in my remarks, the only time I used the word pipeline was regarding our pharmaceutical vertical [multiple speakers] --.

Okay, I apologize.

-- in direct marketing.

Okay.

And we have actually been talking about some of the difficulties we've been having in pharmaceutical given the drug recalls. But we were also talking about the optimism of beginning to fill that void. And, off course, in the fourth quarter we delivered really good results and we have a pipeline to continue that momentum into 2006.

Got you.

On Albertson's, I think that deal's getting closed today or tomorrow and there's still a lot of unknown about what will happen to some stores. It's the cause of the second-day-a-week thing or at least the impetus for that. For ADVO I don't know what they're going to do. That could affect us. There is the possibility of some of our clients buying some of their stores and if they do that will help us. I do not see a negative on the horizon from what's going with [multiple speakers] --.

Well, that's what I was getting at.

Albertson's is not a very large advertiser with us at all. So in --.

I meant in terms of doing as much with the other guys. So you take away some competition perhaps.

We -- it's hard -- we don't know.

Okay. Thanks a lot. Again, could you -- would you mind going over the revenue breakdown again? Was that for the year?

Okay. Is this by vertical?

Yes, by retail, telecom, financial.

Okay. Yes, one second. I'm sorry.

I apologize.

This is for the year, Ed?

Right. Got you.

Retail 27.

Got that.

High-tech, 24.

High-tech, got that.

Financial, 20.

Got it.

Select, 17.

Got it.

Healthcare/pharma 12.

Okay. Thank you. That's the one I missed. Thank you very much. I apologize.

Thank you. And our next question is from Paul Ginocchio of Deutsche Bank.

Yes, thanks. Two questions. First the -- just following off from that, what's the pitch activity like right now for the direct marketing business? Is it pretty robust maybe relative to where it's been over the last couple of quarters and maybe relative to where it was a year ago at the start of the year? And then second, I guess the DMA reported as sort of reduced effectiveness of direct mail. Is that -- have you heard any clients talking about that? And has there been any shift from direct mail to e-mail? Thanks.

Paul, let me talk about the last question, if I might, first. There will always be shifting across media as a general answer. There will be shifting -- we saw that going on in newspapers and clients trying different things. And now that direct marketing has gained as much prominence as it has we anticipate seeing the same kind of shifting within direct marketing. Our goal is to be as channel independent as we can with our clients. We want to do what works for them. Mail is an important direct marketing medium and will always be an important direct marketing in medium.

The irony of what you said is there was a report today that came across my screen from the Winterberry Group and it said that "below the line" is going to be doing really well and what they call below the line is database marketing, direct mail and interactive marketing. And they specifically said that below the line creates measurable results, ROI metrics that are important to marketers under growing pressure to prove the value of their campaigns. We expect the demand for quantitative results will continue to intensify for the next five years. That was really pretty exciting news. It's something we've been feeling and we've been talking about. And that includes all of the direct marketing kinds of things that they refer to from database down to mail and interactive work. So if there's a shifting -- and we do not see any unusual shifting taking place to answer the question specifically -- but if there is one, we are expecting to see that over the next few years. We're expecting to see trial and change and retreat and going back to other things. So it's going to be business as usual for us.

Richard, if I could follow-up on that, too. Have any of your clients been -- I mean has there been any -- I don't know if you saw the DMA report, I think it was up regarding financial services, and whether your new clients have been asking about the effectiveness of direct mail or maybe it's just not been an issue.

Well, I have not seen the report. And we have not had very much conversation with regard to that with our clients. That is certainly not a cause of anything we're seeing in the marketplace.

Great.

Paul, I think a lot of that is probably skewed by credit card acquisition activity. And that's not a big part of who we are when you look across our revenue. So I think -- from what I have seen of the report, I think a lot of that is driven by that one sector.

Perfect. Thank you. And then pitch activity?

Pitch activity was -- you asked about it now versus what it was like last year. It was pretty good last year and it's pretty good this year. I contrast that to times during the '01, '02, '03 period where things were a lot slower. But there's a fair amount of activity going on. We actually -- internally we actually look at that every week and we see what it gets added to, a pipeline. We obviously don't talk about pipeline very much because lots of stuff happens between prospects saying they're interested in getting something signed up. But I've balanced the activity levels about the same over the course of the year.

Perfect. Thank you very much.

Thank you. And our next question is from Fred Searby of JPMorgan.

Thanks. Couple of questions. One, in L.A. in the past you had mentioned the ADVO kind of Tribune and some of the ancillary or collateral damage. Is there any impact that that's having on shoppers from a pricing perspective or has that been negligible? And not to beat a dead horse to death, Rich, but direct mail had a good year last year. And with postal rates up, paper prices up, and response rates now do you think it will still continue? What would be your forecast prognostication kind of 6%-type growth in '06? And then finally in healthcare notwithstanding the drug recalls is there dollars or are your clients telling you they're taking money out of DTC and TV and some of the other traditional media and shifting it to a more measured media like direct mail? Thanks.

On the last question I'm not sure I understood the first one. I hope Dean maybe you did and you can respond. But on the last question that -- we don't get to see the strategic decisions very often on our clients' part. And we know to some extent whether we're winning share because we know when we're winning a new deal where it's coming from. But we're feeling, on the healthcare/pharma side, we're feeling pretty good. We alluded to that in the past. We were hopeful that it would build momentum. We finally saw some of that momentum materialize in the fourth quarter and we expect it to continue into '06. Any given quarter it's hard to say, but we expect on balance that momentum to continue.

The first question was basically ADVO Tribune and inserts, and the impact that that's having. We had talked about, Richard, in the past you and I and you said that was reasonable there might be some kind of impact given what was happening there. I wondered if that is playing out or if the effect is negligible?

Well, we've had an impact. We've seen the flatness or slight decline to flatness in our distribution revenue. You never know for sure where all that's coming from, although my sense is that there's an impact. We see some pricing pressure. A normal thing in a competitive situation. I can tell you that what we find ourselves doing when we come up against competition is -- and this is not a 100% statement -- but it is we win a lot with shoppers. And we feel really good about the retention of our customers in the kind of competitive environment that we're in. Having said that, that doesn't mean that things are as rosy as they were two years ago with distribution revenues growing in the high single-digits. That's not happened for three or four quarters now.

Okay. Thank you.

Thank you. And our next question is from Michael Kupinski of A.G. Edwards.

Thank you. I just want to follow-up on that real quick. You mentioned before that ADVO is likely to create a lot of pressure in that market place until their package is full. And I was just wondering, do you have a sense where they are in filling their package and if there is some sense that pricing pressures could abate this year? And then I just have a couple other questions.

Mike, let me try and take a shot at it. First of all just to give you some perspective, we've been competing vigorously with ADVO for decades in that market. Now, they certainly changed some things when they came out with the second-day-a-week. But it's always been a battle in that market. And we think we've done pretty well and won our share.

There is a lot of competition. You have to remember that is an enormous media market. Enormous amount of ad dollars and still a growing market. So on a case-by-case basis we're still battling against ADVO, as we always have. We're still winning our fair share, from time to time we're losing some. How they are coming versus filling their package, I don't know how much I can really comment on that. You can listen to their comments but we have'nt seen any significant trends and losses of people moving away from us. So if they're filling it, it's got to be coming from somewhere else.

Okay. And you mentioned about the expansion in Northern California and hinted about circulation -- or distribution in Tampa. I was wondering have you outlined any distribution plans. I know that Orlando is sitting out there and that looks like a ripe market for you. Are you waiting to get the margins up a little bit there in your market place or do you need any facilities upgrade to buildout distribution there?

Well, we're not going to talk about the specifics of our plan. You're right that that's an attractive market. There are a number of attractive markets that are now available to us. We are going to more aggressively expand in the State of Florida than we had anticipated prior to the purchase of the Flyer. But I don't want to tip our hat and talk about specifically where we're going to go. I can surely tell you that we try to balance the realities of our margin dilution with our capability of expanding and we feel good having -- I don't want to use the word "rested," but it was a slower expansion in 2005 than it was in '04. We feel good about our ability to now go back into the markets and do more expansions. Some of that will be off of our Tampa market. So we think that that's one of the locations in '06 that we will expand from.

And Dean, I was wondering did you outline your CapEx -- I know that you said CapEx in 2006 would be about 40 million. Did you outline where that money will be spent?

I didn't. I did not. Mike, we've missed CapEx a couple years in a row. Some of it is timing. Some of it is timing related. It seems like we always have projects lined up and Q4 is a very busy time for our businesses. Plus you've got the holidays and it seems like there's a lot of slippage. But from -- in general, that will be close to the revenue split if you look at between our two segments. In other words, that the CapEx spend would -- the proportion of the $40 million would be the same proportion as the revenue split is.

And keep in mind that we did have a pretty sizable capital commitment to our Northern California market. I think much bigger than we will need for expansions in '06 and '07. So we've already probably hit the high mark in capital spending for our expansion and that's behind us.

Okay, great. Thank you.

Thank you. And our next question is from Troy Mastin of William Blair & Company.

Good morning. You mentioned some uncertainty with a few direct marketing customers. I wanted to see if you could give a little more insight here as to how that might play out in 2006. I think you said it would be a bigger impact in the first half of the year. Could you give us some idea how the comparative growth rates might look first half and second half in DM?

Okay, Richard, I -- Troy, what specifically are you referring to? I'm not sure --.

In Richard's prepared remarks he said that there was some uncertainty with a few direct marketing customers, that you didn't lose any major clients but you're going to see an impact in '06. And I think he said it would be more meaningful in the first half of the year; the impact. I'm just trying to understand if that's going to be pretty pronounced in the first half, not so pronounced in the second half. And he did say that he thought direct marketing would grow next year. I'm just trying to decipher these comments a little bit more to understand how's it's going to play out through the year.

Richard, do you want me to take a crack at that?

Well, first my congratulations. That's good investigative work. I did say as the year progresses the comparisons get a little bit easier. And Dean, I will turn it over to you. But for the most part I was referring to that combination of that and that one-time project.

Yes, again, Troy, I think it was just -- if you look at the revenue growth rates over the course of the year, I think Richard's comment was more related to that. I mean we went with the one-time project from the double-digit to where we ended up in the second half of the year. So I think it was a comparative comp basis.

Okay. So the tough comp in the Q1 is only related to that project. I guess I was trying to figure out if you said you had lost some business in direct marketing.

Well, Troy, in the normal course of events, there's always some level of customer churn. We always got customers coming in and going out, and some customers growing and some customers shrinking. And by and large that all nets out to growth. We've mentioned a quarter back that there seemed to be more M&A activity within our customer base than usual. And we said at that time that what that meant is that there was situations where there was uncertainty. Now, today we've got a better view of those situations than we had when we talked about it before, and we do expect and will see less revenue in '06 from a couple of these customers than we saw in '05. But we're going to continue to do work for these customers.

So in the grand scheme of things, we're talking about single percentage point situations that we're looking at in terms of this activity. And so the question is, is that going to impact our growth? Certainly. Whatever growth we end up with in 2006, it would have been higher if we had more revenue from these customers. But by and large we expect our current customer base to continue to grow and spend more with us in the coming year.

Okay. So is it fair to assume that the loss was, you said single point percentages, since you're still going to grow in direct marketing I would assume it would have to be low single point percentage. And the only unusual growth we would see would be in Q1 because of the project?

Well, we -- our toughest comp obviously is in Q1 from a number of factors, particularly the large one-time project that we talked about in connection with Q1 earnings released last year.

But otherwise the growth -- there's no reason to think the growth is going to be sort of unusual through the year because of some lost business? It would be somewhat radical through the year?

Yes, I -- Troy -- we really don't --.

Okay. I understand.

We don't like to talk about parts in the quarters. I mean you can see how the revenue progressed in the course of the year. We have the one-time project. So we don't look at it on that basis.

Okay. That's fine. Can you give me some insight on your automotive exposure in the shoppers publication, the nature of it, if you have insight on that classified versus on page? And do you have any specific expectations here given some of the challenges the auto vertical has right now?

Yes, Troy, I think you can say in our shopper business, most of our shopper auto business is used car inventory as opposed to new car inventory. So I don't if that gives you some idea.

And it's not manufacturer-related as it is in direct marketing.

Okay. And is it mostly classified or is it mostly on page or a balance between the two?

It is in both that's, for sure.

And do you have an idea roughly what your total exposure is to auto in shoppers?

It is -- shoppers again, the beauty about that business is the diversity of both the industry segments and individual customers. We don't have any segment that's over 10% of the revenue, so I can guarantee before I look up at the numbers that it's under 10% of our shopper revenue. And I think it's significantly below that.

Thank you. Our next question is from Brandon Dobell of Credit Suisse.

Hi, thanks. Maybe you can talk about the operations initiative in Manila maybe from a timing, investments and competitive advantage perspective. Trying to get a sense on what you guys see as the opportunity there. Is it just [inaudible] is it a longer term opportunity to build a bigger business there and expand your capabilities or is just for a particular group of customers? Thanks.

Well, it is a low-cost labor market strategy. We have had experience in Manila and other English-speaking countries that achieve that goal. We made the decision that we would want to own a facility and chose Manila as the location. We then made the decision after looking at acquisition alternatives that build versus buy was a much sounder economic decision for us and our shareholders. And we are within now a few weeks I guess, three or four weeks of opening that facility. And we're very excited about it. It's not new to us. We have some of our people who we know really well physically living there. And we think we could do even better than our projection said, when we first did the model to say should we do this? We had projections and everything that's happened since that time, which is the last three or four months has been positive. So I'm excited about it.

Is there a big delta in the CapEx needs, the investment needs or the margin profile of doing it there versus the U.S. or --?

No.

-- are we saying that they're just pressuring you on [inaudible] like they pressure you here?

It's not CapEx.

Okay.

It's labor costs.

All right. Appreciate it. Thanks.

Thank you. And our last question is from Mr. Mark Bacurin of Robert W. Baird.

Hi, just one -- a couple of quick follow-ups. Dean, I had my notes that the one-time project revenue in the first quarter of '05 was roughly $8 million. First I want to verify that that's correct. And then second, could you give us some sense of what the incremental margin contribution on that was?

Mark I think that -- yes, what we had, we had 17.5% growth in Q1 '05 versus Q1 '04 and we said that we would have had double-digit without it. So I think your $8 million number is in the ballpark. It was -- you can look at our incremental margin throughout the year and you can say that that project was probably there or a little better than there.

Okay. And then on the -- you mention that you saw some softness in Q3 on the distribution revenue in Southern California and that you saw it actually return to some positive growth this quarter. Is there anything specific in terms of client verticals or -- that drove that bounce back or was it more of just kind of a lift from a macro standpoint?

[multiple speakers]. I mean the deltas were not that big on the downside or the upside, and in any given quarter there are going to be variations. It's blocking and tackling and getting the job done.

So no specific vertical one way or the other? You mentioned you didn't have any specific client losses that were notable but just curious if there was more just a return to spending.

No, I mean, the categories -- the competition comes in the larger categories. But I think it was -- there was no specific category that drove it either up or down.

Okay. Thanks.

I show no additional questions.

Thank you very much, everyone. Have a great day.

Thank you.

Thank you. And that does conclude our conference call for today. Thank you all for participating and you may disconnect at this time.