Harte Hanks Inc (HHS) 2006 Q1 法說會逐字稿

Good morning, and welcome to the first quarter 2006 earnings release call. At this time, all participants will be in a listen-only mode. After the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded. If you have any objections, you may disconnect at this time.

Now, I'd like to turn the call over to President and CEO of Harte-Hanks, Mr. Richard Hochhauser. Sir, you may begin.

Thank you. Hi, everyone. On the call with me today is Dean Blythe, our Chief Financial Officer; and Jessica Huff, our VP of 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 the 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 Form 10-K and other documents filed with the Securities and Exchange Commission.

After I make a few general comments, Dean will give some financial details. And then we will take your questions.

Overall, we're pleased with our first quarter performance, given the difficult comparisons to the first quarter of 2005 and as a result of the large one-time project in direct marketing. Additionally, we recorded $1.8 million of stock-based compensation in the first quarter 2006 in connection with our adoption of FASB 123(R). Despite these factors, we were able to maintain the prior year's strong EPS level. And in fact, excluding the additional stock-based compensation, our EPS on a fully diluted basis would have been up by a penny.

Concerning direct marketing, we anticipated and discussed publicly that we were facing difficult comparisons in the first quarter of the year as a result of the exceptional first quarter we had in 2005, which had year-over-year revenue growth of over 17% and operating income growth of over 57%. About a third of this revenue growth in the first quarter of 2005 came from a large one-time project we have discussed in prior earnings calls.

Direct marketing results in the first quarter of 2006 also included stock-based compensation expense, and there was no corresponding expense in the prior year period. Consequently, direct marketing showed year-over-year declines in both revenue and operating income. Absent the impact of these two factors, the non-recurring project and stock-based compensation, direct marketing would have shown revenue growth in the low-single digits, and operating margins would have shown positive leverage.

While all of our vertical markets are not where we would like them to be, we are really proud of the performance of the pharma/healthcare vertical and the continuing strong growth in our select markets and the performance in retail in the face of the strong double-digit growth in the past, in the last year's first quarter.

Shoppers had another solid quarter with revenue growth of 16.1% and operating income growth of 5.1%. Dean is going to give you some additional detail on the shopper performance. But as in the past three quarters, shopper margins was impacted by our Tampa acquisition. In this quarter, there was also a margin impact from the inclusion of stock-based compensation in the segment. As always, margins are affected by a number of factors, some out of our control such as postage and paper prices, and some in our control such as expansion and other investments.

We said on the last few calls that the robust revenue growth performance we have delivered in 2004 and the first half of 2005 would be more challenging to match in the first half of this year. And our first quarter results reflect this. However, we feel that both of our businesses performed reasonably well despite these challenging comparisons.

Before I turn it over to Dean, here are a couple of summary points. We are pleased we were able to deliver EPS at a comparable level to the prior year's strong first quarter, particularly given the accounting changes that negatively affected our bottom line. The comparisons we faced this quarter will continue into the next quarter, but we're committed to managing our business to deliver solid EPS performances by the difficult year-over-year comparisons and the impact of stock-based compensation accounting changes.

In direct marketing, the strong revenue growth in our healthcare/pharma and select verticals was really exciting. Shopper expansion continues to be strong, and we added nearly 300,000 circulation in the first quarter. Shopper circulation is currently over 12.6 million weekly. Integration of the Tampa shopper continues to go well. Although this piece of business did continue to put some downward pressure on our overall shopper margins, we are achieving our margin improvement objectives in Tampa.

We remain committed to investing in our future and performing well in the fast changing environment that we believe is the norm. While business conditions seemed a little bit better last year, we remain excited about the businesses and the markets we are in. To that end, we are extremely pleased with the performance of our select market vertical in direct marketing, which we initiated several years ago as an approach to entering and growing the market. The effort is on several new markets, which collectively represented 20% of our direct marketing revenue in the quarter, its best performance to date.

And once again, our people at Harte-Hanks are very special. They make it happen for our clients and our stakeholders everyday. So I would be remiss if I didn't say thank you to everyone for all you do.

Dean, over to you.

Thank you, Richard, and good morning. As Richard indicated, given the difficult comparisons we were facing this quarter, we are pleased with our first quarter performance. Here's a companywide overview. Revenue was up 3.8% for the quarter, with revenue up 16.1% in shoppers and down 3.4% in direct marketing.

Operating income was down 6.5%, with shoppers up 5.1% and direct marketing down 16.9%. These comparisons versus operating income levels in the first quarter of 2005 were impacted by the inclusion of stock-based compensation in 2006. Excluding this expense from the 2006 numbers, operating income comparisons would be total company down 2.3%, shoppers up 7.1% and direct marketing down 12.1%.

Free cash flow in the quarter was $22.2 million, down from 23.9 million in last year's first quarter. We have adjusted our free cash flow definition by adding back tax effective stock-based compensation expense to make the periods comparable. The decline in free cash flow was attributable to a higher level of capital spending in this year's first quarter, driven some by timing, projects we expected to be completed in 2005 rowing into 2006 and by our build-out of our new facility in Manila.

Turning to each of our two businesses, for the first quarter of 2006, our direct marketing revenue was down 3.4% and operating income down 16.9%, and again, down 12.1% excluding stock option expense, with operating income margins of 12.4%. Approximately half of the margin decline from last year is attributable to a combination of stock-based compensation, which was $1.2 million for direct marketing in the quarter, and Manila startup expenses. The remaining margin decline is attributable to the effect of the revenue decline, specifically the non-recurrence of the large one-time project in the first quarter of 2005, which had a contribution margin in excess of our incremental margin in that quarter.

For our vertical markets in the first quarter of 2006, retail, our largest vertical, represented 24% of direct marketing revenue; high-tech/telecom, 23%; select markets, 20%; financial, 19%; and healthcare/pharma, 15%. Our healthcare/pharma vertical had strong double-digit growth in the quarter, well over 20%. And our select vertical also had growth in excess of 10% over the prior year. This marks the fifth straight quarter of strong growth from our select vertical.

The retail vertical was up in the low-single digits after very strong growth in the first quarter of 2005, while financial was down low-double digits. Our high-tech/telecom vertical, which benefited from the one-time project in the first quarter of 2005, was down over 20% with more than half of the decline attributable to the one-time project. International business represented 9% of our direct marketing revenue for the first quarter. Our top 25 direct marketing customers represented 41% of direct marketing revenue for the first quarter. And our largest customer in the first quarter represented less than 6.5% of our direct marketing revenue.

Turning to shoppers, shoppers grew revenue by 16.1% in the quarter. Operating income increased 5.1%, again, up 7.1% excluding stock option expense. And again, this is compared to the prior year's quarter. The Tampa Flyer acquisition completed on April 20th of 2005 contributed about 10 percentage points of the revenue growth in the quarter. Organic revenue growth, that is revenue growth not including the Tampa acquisition for the quarter, was just slightly below the long-term 6% to 8% revenue growth range we have targeted for our shopper business.

Half of the operating income margin decline in shoppers in the quarter was caused by two factors. First, the impact of the inclusion of stock-based compensation in the first quarter 2006 results. And the second factor, as we have described in the past, was the effect of the Tampa acquisition. 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. Other factors impacting margin in the quarter were new expansions launched over the past 12 months, with circulation up 600,000 on a year-over-year basis, continuing double-digit paper price increases and the postage rate increase that took effect in early January.

We have talked in the past about plans for increasing circulation in Shoppers through a contiguous geographic expansion. This expansion initiative started late in the third quarter of 2003. Our plan called for adding 2 million circulation over a five-year period. In the first quarter, we added 276,000 in circulation, bringing the total number under this initiative to over 1.3 million. And we are planning to make further progress against our goal during the remainder of 2006.

Our first quarter net effective tax rate was 38.2%, down from 39.9% in last year's first quarter due to the favorable resolution of certain outstanding tax issues in the quarter. For the full year 2006, we now expect our tax rate to be approximately what it was for the full year 2005. The effective tax rate in 2005 was 38.6%.

On the balance sheet, at March 31st, we were showing a net debt balance of 32.6 million. Book equity at March 31 was 566.6 million. Net accounts receivable were 168.4 million. And DSO at the end of March were -- in '06 was 56 days against 58 days at the end of March in 2005.

Looking at our statement of cash flows, net cash provided by operating activities for the quarter was 34.8 million. During the quarter, we repurchased 800,000 shares, and since January of 1997, the company has acquired 44.3 million shares and spent over $775 million under our repurchase program. This quarter, we are facing comparisons against one of the best quarterly performances this company has delivered, made even stronger by a large one time non-recurring project in direct market.

Additionally, because of accounting rule changes, first quarter of 2006 results include $1.8 million of expense for stock based compensation. In spite of these factors, we delivered the same level of EPS in the first quarter of 2006 as we did in the first quarter of 2005. Going into this year, this is about how we thought we would perform in the first quarter.

Given this, we stand by our original commentary on outlook for 2006 EPS. Looking at 2005 and 2006 on a comparable stock option expense basis -- in other words, subtracting from our reported 2005 EPS results, the amount of stock based compensation we expect for 2006, which is $0.06 per share, our goal is to deliver good earnings per share growth in 2006 in the high single-digits or better range.

With that, we'll be happy to answer your questions. Operator?

[Operator instructions]

Our first question comes from Lauren Fine with Merrill Lynch.

Great. Thank you. Just a couple of quick ones, on the stock option expense, it looked like it was of course, 1.5 cents per quarter, so should it be pretty even since at $0.06 for the year throughout the remainder of the year, and should the breakdown by segment be similar and then I have a follow up?

It'll be slightly higher going forward, just from the timing of grants, and -- but the mix between segments should be about where it was.

Okay. And then also in the past, you've given commentary when you been referring to both the shopper and the direct marketing business about the effect of some client consolidations and other factors. And I'm wondering if you can give any additional color on how you're seeing that playing out and specifically I think as the retail vertical probably did hit tough comparison, how much was that a tough comparison versus specific client consolidation or other events.

And then also within the shopper business, if you could comment on Southern California and any changes in that market given the I think what's referred to LANG, Los Angeles Newspaper Group Formation with ABRO.

Okay. I'll try to do a couple of these things and Dean, you can add what you want on both my comments and some of the question, I guess, I didn't remember. First of all, retail. Most of what we saw in retail had to do with the really strong quarter we had last year.

In fact the strong performance we've had for quite some time now and the fact that we were able to grow retail -- and we've talked about retail not being a strong growth market for us. The fact that we were able to grow it off of that strength in quarter one of '05, makes me feel reasonably good. There is -- some of that consolidation does exist. And some of the declines that we talked about now I guess, nine months ago are real.

But on balance, it had to do with the strong quarter that we have last year. As far as the [ADVO] group is concerned the combination with newspaper of ADVO -- I think it's good news from what we understand ADVO, second day a week distribution package will now be for the most part become of the newspaper TMC product with some distribution in the newspapers and some through the mail.

Overtime, we've competed really successfully with the newspaper TMC products, given that we and our advertisers believe to be superior distribution systems through the mail -- would seem that the ship by ADVO will remove a significant amount of capacity and underutilized postage expense from the market and we talked a little about that last quarter. We expected that to happen, we didn't know the timing but we're pretty pleased that it's now behind us or at least it will be in, I guess, as I talked about August as the time frame.

Do you think that will help firm up pricing though, I mean, again if they can rationalize and become more profitable themselves or take some of the pressure off of pricing?

Yes. That's the point. I really do think it will help firm up pricing. You never know what is going to happen but I think it will -- it's a good on another payroll for us.

Right. Thank you.

Our next question comes to Alexia Quadrani with Bear Stearns.

Thank you. Just a couple of questions. First on the --the high-tech Telecom one time project last year -- how much of that, if any at all, dribbled into Q2 last year, just to get a sense of the comparisons going forward. Then I have a couple of follow-ups.

There was some Alexia, but not a lot.

Okay. And in the -- if you can talk a little bit about how the pricing is trending, particularly in the segments you're doing really well in -- healthcare/pharma and select group? Are you seeing better pricing or it just a huge demand right now in terms of fancier services?

Yes. I wouldn't call it our success or result of pricing flexibility. Pricing is always difficult in all of the markets we're in. It's just a fact of life, we've talked about it a lot. We have to deal with it, there is competition. We are in a good business, good business attracts lots of competitors. And that means the pricing is always pretty rough. So we're not -- as the economy gets better, certainly pricing is a little bit easier than perhaps it was during the height of the recession, but on balance, it's still not easy time price wise.

And you mentioned that Tampa was doing better in terms of margins. When -- do you have a sense of how long it will take before you get the probability of that acquisition more on par with the rest of your business and then along those lines any plans I guess, to move into another market in Florida?

In terms of the probability of Tampa, you did have to remember that in connection with the acquisition we did put some intangibles on the balance sheet that are amortizing. They have varying lies between 3 and 10 years. And so Tampa is always going to have that head win from a pure margin perspective. When you look at it from an operating income line.

The other impact in Tampa is going to be to the extent we expand in Florida and it's expanded within that specific P&L -- that's going to have some downward pressure on margins. But we have already seen margin improvement in Tampa, we're ahead of our plan in terms of margin improvement. I think, we're going to continue to see and we got more room -- and we'll continue to see margin improvement in that business over the next couple of years.

And we have done some expansion in Tampa as you know and we'll continue to do expansion from that geography.

Thank you.

Our next question comes from Mark Bacurin with Robert W. Baird.

Good morning, Richard. Good morning, Dean.

Hi, Mark.

Question on -- maybe Dean you can shed some light on. You guys are talking about high single-digit earnings growth as your hope for the year on an adjusted basis, obviously for the stock-based comp.

I'm wondering if you could help us, you know how you would break that down between topline growths versus margin expansion versus share reductions from ongoing share buyback. I guess the basis of the question is that you started out in the first quarter obviously with a margin decline, so I'm wondering if it's reasonable to assume that you could actually achieve margin expansion this year given that the hole you started in Q1.

Well, you are going to -- you know the stock option expense, which drove some of the margin decline in as a whole and in each business continues throughout the quarter. So you can continue to have that as a just a year-over-year margin comparison basis.

I think, you know, we're -- obviously, in terms of how we view the year, it's going to be a combination of our margin performance. We have been in the market and believe our stock to be a very good buy at current prices and continue to be a buyer of our stock. So we expect further share reduction and we expect topline growth.

Okay. So is the combination of all three of those items? I mean it's not margin contraction that you're offsetting some of your topline growth?

Well, Mark, I think I -- you know as I mentioned, there is going to be that margin impact of the stock option expense when you're looking at it from a year-over-year basis.

Sure. But I think I'm adjusting that out in the '05 numbers as well, correct? You're still talking about the high single-digit earnings growth on an adjusted '05 number?

That's correct.

And I was wondering if that high single-digit is all -- you know high single-digit topline growth with flat margins and maybe some share buyback or mid single-digit topline growth with some margin expansion as well.

I think we've talked about the year and feel comfortable with, kind of, the way we described it and do feel comfortable with that -- the EPS goal that we have set. And to get into specifics like that I just -- we're comfortable with where we are.

Yes. Okay. Fair enough. I guess I was surprised at how profitable that project was. It looked like incremental margins on that are 40% are better, does that amount sound right? What was the driver there and are there more of those out there that you guys could go capture?

That's funny because somebody asked us why we bother to take the project because it would make it so difficult for the next quarter's report, which of course now we're talking about.

It was a good margin project. Most projects that are like that that, sort of come quickly tend to have better margins. But it was a current client - a current client that asked us to drop lots of stuff and get on with the program for them because we were doing good work for that current client in other areas. And we responded and we delivered, as you pointed out, we delivered some pretty good margins on it.

And whenever any revenue comes quickly, it can be pretty profitable. And we have a fairly high incremental margin anyway and this was slightly above that.

Are there more of those in the pipeline that could help the back half of the year?

No. We don't see anything of that magnitude on the horizon. No.

Okay. Great. And just a couple of - nick-picky ones. The FAS 123 -- was helpful in terms of the break up between of the segments, did that all fall from a P&L category in the payroll expense line or was it broken up among several categories?

It was all in payroll.

Okay. Great. And then, one final quick one. Freight now at 20% of revenue, I think, auto is a big component at any thought to when you might break out auto for us?

Well, we're working on it. We get it big enough, maybe we'll able to do it but, you know, we're not looking to break things out and have single-digit revenue numbers in it. So we will buy our time and we'll figure out how to do it. I mean the good news is it continues to grow, and our projections are for further growth this year.

So it fair to say it's still less than 10% though?

It's fair to say.

Okay. Thanks, guys.

Is that right, Dean?

Yes.

Our next question comes from Paul Ginocchio with Deutsche Bank.

Great. Thank you. Just three quick ones. You talked about I think last quarter distribution revenue in Southern California being up year-on-year. I was just wondering how the trends were in the first quarter? Also, the auto client that you took -- you won in the quarter was that domestic and foreign? And then finally, any update on the color testing in San Diego? Thanks.

Some of the testing that we're doing in San Diego is doing a lot of good things for us. But it's still a little bit too early -- for us to be able to tell what the economic impact is. You know, we're -- I mean the good news is, unlike a lot of projects where you make an investment, we're not losing money, probably are hurting margin a little bit as a result of it. We are improving readership as a result of it.

We do get good comments from advertisers when they see the quality of the paper we're using and the color reproduction. But it is not quite living up to the pretty high expectations we had for it and -- but it's really still at early. We haven't even finished the year yet. I'm sorry -- that was part of your question. Dean you want to handle the other part?

Yes. Paul, you asked about the automotive client, let me be very specific. It is a foreign based manufacturer. But we're doing work for their domestic operations.

And I agree with that wholeheartedly, Dean.

And you still haven't really cracked it - maybe not that you want to-- you haven't really cracked the domestic ones, correct?

This is -- that's correct. I mean we had -- we do have -- we have in the past and we do have some work from domestic but that's where out automotive revenue is and this isn't the world's best time to be making sales calls.

And finally, Southern Cal distribution revenues?

Our distribution revenues were up slightly system-wide and they were also up actually a little more in Southern California than system-wide.

So it's a little bit better than the fourth quarter in Southern California?

It was about the same, maybe slightly better but just about same.

Thank you.

You know the -- I do want to comment on distribution revenue, which was up slightly. Overall, we were at the six -- you know, on a pro forma basis right around the 6% growth level. We did experience very strong growth in the ROP product. That continues to be the franchise for that business, and we're very encouraged by the continued strength in ROP segment.

Excellent. Thank you.

Our next question comes from Ed Atorino with Benchmark.

On direct mail, you talked about sort of the tone of business going forward, the economy and other things going on and another company in the business sort of seem to say things are getting stretched out a little bit or pushed back a little bit. Do you see any of that in any of your key categories?

Well, you know, it's -- I think the general way to answer that is that it -- and I think it was mentioned in my remarks, but it felt a little bit better last year at this time than it does this year. And some of that is what you're saying and some of it is the general economic activity and some of it is the strong growth we experienced last year. But you know it's not as -- it's not quite as strong as it was -- as robust as it was last year.

Okay. Thanks.

Our next question comes from Brandon Dobell with Credit Suisse First Boston.

Hi, Dean, a quick nick-pick one for you. D&A in the quarter, is that a good proxy to use for the balance of the year or is there (inaudible) scale up a little bit, perhaps for the amortization of the Tampa stuff.

Yes. We've got -- in the quarter you've got the Tampa acquisition still impacting some of the D&A increase.

Yes.

But we're largely through that acquisition difference. We'll have about a month or so in Q2.

Okay. So using this quarter number might not be bad way to start?

Right.

Okay. And then more of kind of a macro question in California, have you seen any impact, are you anticipating the impact from some of the sites like our Craig's list or some of this local classified, local search opportunities that might be more kind of user generated social network, the right word is to use?

Well, you know, that's the world clearly is different today than it was some years ago. Digital is a reality. We're playing in that field as well. We have a Website and we've had it for quite some time and we are focusing on it. But I think it's really important to remember that the part our business that is growing the fastest is the part of our business that is on the Web.

That is the ROP stuff, is what's generating the growth for Shoppers and has for the last couple of three quarters and that's the part that you mentioned Craig's list that's the part that Craig's list does. So it's sort of ironic, that while world is changing some, and we're changing with it, the traditional media that we have, our shopper publications are doing really well in those categories.

Okay. Thanks a lot.

[Operator instructions]

Our next question comes from Fred Searby with JP Morgan.

Hi guys. How are you doing?

Good.

I will limit it to one question. What -- you know one of your peers is talking about postal service and what the outlook is there -- that there could be fairly complicated, but it sounds like a discreet price hike in 2007. So I wondered if you had any thoughts, you typically have been pretty good prognosticating on this? Thanks.

This is a tough one because there are certainly a number of factors that align themselves toward an increase. The timing of which is going to be obviously difficult to predict. But if you think about the fuel prices, the hurricane, those sorts of things, certainly don't go in our favor for price stability.

We have even seen FedEx and UPS announcing price increases based on those factors. So we're a little bit concerned little bit more than normal concerned about those factors causing the need for postal increases. At the same time, we're hopeful and we don't know when the next price increase will occur. If I were a betting person, I guess, I would probably bet that '07 was going to be a year that we would see a price increase, and I would bet that it would be late in the year. But that is sheer speculation.

Thank you.

Our next question comes from Steven Barlow with Prudential.

Thanks. Could you talk about your labor number a bit, I joined late. Just any organic change, year-over-year, including Tampa on the number of FTEs, and then what kind of wage increases do you have baked in your numbers for the year?

Steven the labor numbers that you see, first of all, there is the inclusion of stock option expense that is where that expense is or stock-based compensation expenses is in that labor number. On a year-over-year basis, our headcount really hasn't changed materially, excluding obviously the impact of the Tampa acquisition.

And there is your standard wage increase for 2006?

Yes. We have I mean, built in obviously, built into our numbers -- we have wage adjustments and increases throughout the year, it's not all on a single date. And we have that built into our budgeted numbers and our expectations for the year as well as -- again since those increases occurs throughout the year, it's not as if you're going to see a particular movement spike because of wage increases in any particular period.

If I guess, I was trying to get more specific numbers, when you're talking 2%, 3% or 4%?

No. We are a merit based company. We have a budgeted amount but it's in that range.

Thanks, Dean.

So, at this time, we show no further questions.

Thank you very much for all of your questions and for your time. Have a great day.

Thank you.