Harte Hanks Inc (HHS) 2006 Q3 法說會逐字稿

Hello and welcome to the Harte-Hanks third-quarter earnings release call. This conference is being recorded at the request of Harte-Hanks. Should you have any objections, you may disconnect at this time. (OPERATOR INSTRUCTIONS). I would now like to turn the call over to today's post, Mr. Richard Hochhauser, President and CEO of Harte-Hanks. Sir, you may begin.

Thank you. Good morning. 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. 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 its 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 opening remarks, Dean will give some financial details, and then we are going to take your questions.

We thought this would be a more challenging year than the previous two, but it has been harder than we expected. Reported third-quarter EPS was up $0.01 over the prior year. Excluding the [$.9] million of stock-based compensation expense, EPS would have been up $0.02. But our goals were higher than that.

We said last year that we expected Direct Marketing revenue to start getting stronger in the second half, and the revenue growth of 3.1% in quarter three is the start of that improvement. On the cost side, we divested of a small print operation during the quarter and had losses associated with this operation. We also had stock-based compensation expense, and both of these factors directly impacted our margins in Direct Marketing. In fact, absent these two items, our third-quarter margins in Direct Marketing would have been up slightly from the prior year. We are generally pleased with this performance.

Before going to Shoppers, I wanted to mention how pleased I am about the strategic moves that we have made with the acquisitions of Aberdeen and Global Address, as well as the divestiture of our print operation.

Now for Shoppers. We had a solid revenue growth quarter of 6.8% but saw our margins continue to decline year-over-year. Increases in paper and postage rates, circulation expansions and stock-based compensation all hurt our margins in this quarter. In addition, as we discussed last quarter, we are dealing with some operational issues and expect these issues to continue to be a drag on Shoppers OI for another quarter or two.

We have made significant expansions over the past year, and this is so important to our future. However, expansions this year are more closely following our expansion model. That is losing money at the launch before breaking even a year out and turning profitable in the third year. This contrasts with the expansions we did two or three years ago when we had similar circulation expansion but at better profit levels than our models would have predicted. Perhaps that is because the economy was a little stronger back then.

The investments we're making on our Shoppers Web initiative also contributed slightly to this quarter's OI decline. But we are making progress based on the metrics we are using for content expansion. We are still really excited about these two businesses and are looking forward to next year when we can demonstrate the type of performance we hold ourselves accountable for. Based on our business model, our financial position and our terrific people, we are confident that we will make that happen.

Dean, over to you.

Thank you, Richard, and good morning, everyone. Here is a companywide overview of our third quarter. Revenue was up 4.6% with revenue up 3.1% on Direct Marketing and 6.8% in Shoppers. Operating income was down 8.2% with Direct Marketing down 4.2% and Shoppers down 11.6%. These comparisons versus operating income levels in the third 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 4.3%, Direct Marketing down .4% and Shoppers down 9.8%. Free cash flow in the quarter was $28.1 million, down from $31.4 million in last year's third quarter, and this was driven primarily by a higher level of capital expenditures in the third quarter of 2006 and in the same 2005 period based on timing. We have adjusted our free cash flow definition by adding back tax affected stock-based compensation expense to make the periods comparable.

Now turning to each of the businesses. In the third quarter of 2006, Direct Marketing revenue was up 3.1% with operating income down 4.2% with operating income margins of 14.5%. These results were impacted by the inclusion of stock-based compensation expense in the 2006 period. Excluding stock-based compensation from the 2006 period, Direct Marketing operating income would have been down very slightly at around $100,000, and operating margins would have been 15.1%, down 50 basis points from the 2005 third quarter.

At the very end of the quarter, September 28, we acquired the AberdeenGroup, a Boston-based provider of technology market research and demand generation services. We also recently completed the divestiture of a print operation that was a part of our Direct Marketing business segment. This operation, which had a similar level of revenue to that of Aberdeen, had been part of a larger previous acquisition from several years ago and had become increasingly less important to the solutions we offer our Direct Marketing customers. Losses in the quarter associated with this operation and its divestiture negatively impacted operating income in the quarter by approximately $1.5 million.

For our vertical markets in the third quarter of 2006, retail, our largest vertical, represented 27% of Direct Marketing revenue, high-tech Telecom 22%, financial 20%, select markets 18%, and Healthcare Pharma 13%. While overall revenue growth was modest and somewhat less than we expected, we were encouraged that all verticals had year-over-year growth. Our Healthcare Pharma vertical lead the way with low double-digit growth in the quarter. Select markets was up mid single digits, and each of our retail high-tech telecom and financial verticals was up low single digits.

In the quarter, international businesses represented 9% of our Direct Marketing revenue, our top 25 Direct Marketing customers represented 41% of Direct Marketing revenue for Q3, and our largest customer in the third quarter represented 8.5% of our total Direct Marketing revenue.

Turning to Shoppers. Shoppers grew revenue by 6.8% in the quarter. Operating income decreased 11.6% or down 9.8% excluding stock option expense compared to the prior year's quarter. Revenue performance overall remained positive, although we have seen some softening in certain areas. ROP advertising continued its growth, and distribution revenue growth accelerated for the third consecutive quarter. The solid revenue performance, however, did not translate into the bottom line, which was negatively impacted by several factors.

First, the impact to the inclusion of stock-based compensation in the third quarter of 2006 results, which had a 40 basis point negative impact. Other factors impacting margin performance in the quarter were expansions over the last 12 months with circulation up 1 million on a year-over-year basis, continuing double-digit paper price increases, and the January 2006 postage rate increase.

Our third-quarter net effective tax rate was 35.7% and down from 39.5% in last year's third quarter, resulted from a higher level of available manufacturing tax deductions. For the full-year 2006, we now expect our tax rate to be between 37.5 to 38%.

On the balance sheet, at 9/30 our long-term debt balance of $167 million was up approximately $100 million from the debt balance at 6/30. Driven by an accelerated level of share repurchase activity, we spent approximately $70 million in the quarter and, as a result of acquisitions, about $50 million during the quarter. During the quarter we did enter into a five-year $200 million term loan facility which we may draw on at anytime until September of 2007. Coupled with our existing $125 million revolving credit facility, our total credit availability is now $325 million.

Book equity at September 30, 2006 was 514.3 million, net Accounts Receivable $182.8 million and DSO at the end of September was 56 days, the same as September of a year ago. During the quarter we repurchased 2.7 million shares, and since January of 1997, the Company has acquired 48.6 million shares and spent over $890 million under our repurchase program.

Also this quarter the board increased the share repurchase authorization by 6 million shares. The total remaining authorization at the end of the third quarter was 7.3 million shares.

At the beginning of the year, we stated that our goal for the year looking at 2005 and 2006 on a comparable stock-based compensation expense basis -- in other words, taking $0.06 out of the 2005 EPS number -- that our goal was to deliver good EPS growth for the full-year 2006 in the high single digit or better range. While depending on how we finish the fourth quarter, we may achieve the lower end of this guidance. We have benefited this year from some unanticipated events that have been positive to earnings. Specifically the receipt of the contract termination fee in the second quarter that we talked about last time and a tax pickup in this quarter. We have not, therefore, performed this year up to our expectations, including in the recently completed third quarter.

In Shoppers areas of underperformance have been slower starts for our Shoppers expansion circulation than in the recent past and not having been able to offset the substantial increase in production costs, primarily paper and postage, through accelerated revenue growth and price increases. In Direct Marketing, revenue has been inconsistent, and we incurred a loss from a business that we divested this quarter.

As Richard mentioned, however, our outlook continues to be positive for the industries we operated in and for our businesses in particular. These businesses continue to be very strongly profitable and to generate a significant amount of free cash flow.

With that, operator, we will be happy to answer questions.

(OPERATOR INSTRUCTIONS). [Hestor Ching], Merrill Lynch.

A couple of questions on the Shoppers side. Could you talk a little bit about your growth was 6.8% this quarter, which is up from organic growth of around 5.8 over the last couple of quarters. I was wondering if you could talk about what kind of lead to that improvement? Are there particular categories? And then I have a follow-up.

You know, we had strong performance in both ROP and distribution. Distribution performance accelerated for the third consecutive quarter which I mentioned, and it was pretty much across the board in categories. There was good performance out of a lot of categories, including real estate.

Okay. Secondly, I'm not sure of the exact timing, but what are you seeing in Southern California in relation to ADVO with their partnership with the L.A. Times? Is there a positive or negative change that you're expecting to come from that?

We have said in the past that we thought that the stability created by that would be positive for us, and we certainly don't see very many negatives in the marketplace now other than the normal economic issues that one faces in any given market. But we are certainly happier today than we were two quarters ago when the seats were empty, and they were being filled at very low prices.

Okay. And then so I guess looking into the fourth quarter in terms of what are you seeing in terms of the Shoppers momentum relative to your historical target growth of like 68%, is it towards the lower end here, or is it really -- are we going to see the same momentum we saw this quarter?

Well, I don't know that --Dean, you want to take a crack at that?

Yes, first the fall, we don't give quarterly guidance on revenue. When we talk about growth rates, we talk about long-term growth rates, and what can happen in any particular quarter can vary. I did mention in my comments, and I believe Richard did as well, that we have seen some softening in certain areas in terms of revenue. So I don't think there -- if any trend there is, I think there has been a softening.

Alexia Quadrani, Bear Stearns.

A couple of questions. First, on the Direct Marketing side, it looks like the financial services vertical turned around a little bit quicker than I think we had expected given the loss of the client. Any particular verticals that you feel particularly positive about going into Q4 given a new client you have signed up or clients spending trends or any that you maybe are more cautious about going into Q4? Then I have a couple of follow-ups.

First of all, on the financial side, we are up slightly for the quarter. It will take us more than a single quarter to turn the vertical around. We have put in motion some structural and people changes to deal with that market, and over time we expect to see some stability and some growth.

Perhaps the other market that I will talk about, in the fourth quarter, we come up against some really tough comparables in our pharmaceutical healthcare one because of last fourth quarter being so strong. And also on the high-tech telecom area, we have now cycled through some of the challenging comparisons and the customer specific revenue issues, and we are pleased to see it return to some growth, albeit slight for the quarter. We indicated on a previous call that we were bringing new business revenue in the door in this vertical, and we are beginning to really see that the trend is continuing. So we were pleased with that.

And I think you may have mentioned that the print operations you divested in terms of revenue sort of lost at the AberdeenGroup revenue growth. Is Global Address significant in terms of revenue? I'm just trying to get a sense of what the uptick might be in Q4 in terms of revenue from that acquisition.

No, it is pretty small.

Okay.

I think it would be pretty much of a wash.

Okay. And then just on the Shoppers side, is there any particular real difference to the performance on the revenue line in the California markets versus Florida in the quarter?

Well, you know these are always the questions that get asked, and we always try to figure out a way to avoid answering them. But I appreciate your persistence. We don't break out revenue by market. There are always markets because we really classify this in terms of not only Florida versus California, but we look at San Diego versus the Los Angeles area versus Northern California versus Tampa versus Miami, and there are always some markets that are doing better than others, and that continues to be the case. There are markets where we have some really strong, focused efforts to show some improvement, but we're not going to go into the details.

Paul Ginocchio, Deutsche Bank.

This is David Clark for Paul. A couple of questions on the Shoppers side first. What portion of your Shoppers division cost increase year-over-year is due to expansion activity? I guess I'm just looking for, you know, ex-expansion what the growth in costs would have been?

And then I guess back in the first quarter, there was a question about your color advertising testing, and you said that later in the year you might be able to give us some insight into that. So I was wondering if we are at the point yet where you can make some determinations on that.

Then finally, on the Direct Marketing side, could you size for us the impact of the contracts won that will show up in fourth quarter that were not in the third quarter? I guess you mentioned a couple in the press release, and maybe there were some others, and also possibly any contracts that were lost year-over-year for the fourth quarter?

Well, there are about five questions there, so I have written down a couple of them. I'm trying to answer a few, and Dean, you can please chime in for not only the ones that I answer but the ones that I don't.

We don't talk about the specific size of our contracts. There is a bit of revenue momentum that we have in Direct Marketing. As I said earlier, that the 3.1% of growth is the beginning of revenue growth that we have not seen for a couple of quarters due to a number of factors. So we see that, and we have some expectations of that continuing, particularly as we cycle through some of the events that we have talked about over the past four quarters.

As far as color is concerned, I think what we talked about in the early part of the year was that we were testing different paper that had color in it and that we would make a determination of whether that could be rolled out based on our ability to generate significantly increased revenue because the cost were quite a bit higher, and we have not made that determination yet. It is not going as well as we would like. But it is one of those areas where it is a new product, and the good news is we're not losing money on it, but it is not going as well as we had hoped.

Okay. And then the costs for the Shoppers division, ex expansion activity roughly?

I think you asked the question is -- the way I understood the question was, how much of the expense increase was due to expansion?

Right.

About 25%.

Okay. Great. Thank you. Appreciate it.

Troy Mastin, William Blair & Co.

First question. You made a statement initially in the call about delivering the type of performance that you hold yourself accountable for I think you said next year. I just want to make sure I understand what that is. I believe it is somewhere in the neighborhood of high single-digit revenue growth and low double-digit EPS growth. Is that how you think about the business long-term?

It is how we think about the business long-term. Any given set of periods and the year happens to be bordered by a fourth quarter of one year and a first quarter of a following year and it is somewhat arbitrary. But those are our long-term objectives, that is correct, and we see ourselves aspiring to hitting those. We did not achieve those objectives so far this year and will not when you measure it at the end of the year.

Okay. And then regarding your statement about the fourth quarter depending on how it finishes, you may still make that high single digit, the lower end of that high single digit range? Is there anything in particular that has to do go or not go your way for that to happen, or is at a combination of many things?

Well, it is not only a combination of many things, but some of those things are bigger than others. And if the big ones go up and the little ones go down, we will be in good shape. If the big ones go down and the little ones go up, it won't be quite as good.

But there are so many variables. There are so many different businesses we are in that it is just hard to project that from where we are sitting today. Dean, you might want to add something to that.

I was going to say that if we can execute and operate, then that continues to be our goal and we may hit that. It is not like there has to be a Hail Mary to happen to be completed. So it is about execution. The question is, in trying to predict in any very short period of time a penny one way or another makes a difference, and that can be driven by a relatively small amount either at the revenues line or at the expense line.

Okay, good. And then you referenced a slower start in expansion of Shoppers. I assume that means in some new markets you are getting a slower revenue ramp than you expected. Is that unusually slow versus past experience? You kind of characterized Shoppers' expansion as unprofitable year one, breakeven year two and profitable year three. Is that what you're seeing in this expansion that you're talking about, or is the expansion you referenced actually trending below historical performance, and if so, anything in particular you think you can point to?

Richard, let me just try to take a quick shot at this. I think we announced our circulation expansion initiative in the third quarter of 2003, and I think however many quarters that may have been, we have described what our expansion financial model is, which is expansions lose money in the first year, breakeven in the second year, start making money in year three and hopefully mature in years five to seven. We have said consistently that our first expansions as part of this initiative did better than that. Actually several of them came out making money initially. What we have seen recently is these expansions more closely following our financial model, which we have described over the past three years.

Okay. Great. Finally, do you have anymore visibility on the postal rate situation for next year and what you expect to see as an increase?

Well, you never know what is going to happen, but what we are expecting to happen is a relatively small increase for Shoppers, assuming we change the way we produce the Shoppers. We have talked about that on our previous calls. We are prepared to do what it takes to get that relatively low postage increase, which we think is going to be in the midyear timeframe.

The Direct Marketing side is going to be a little bit higher. As you know, we do not pay those postage costs, and from a timing point of view, it is pretty good in Direct Marketing because the middle of the year is the beginning of preparation for a lot of mail, and so the demand is strong. A good time to have an increase is when demand is strong. So we are generally feeling okay about the next postage increase.

Mark Bacurin, Robert W. Baird.

I don't want to beat up the Shoppers margin question too much, but I think you said 25% of the year-over-year cost increase was expansion, which presumably I guess the rest would be paper and postage, etc.

But looking at your second-quarter results, you experienced a more significant year-over-year decline in margin, and given the postage I think hit at the very beginning of the year and I'm not sure paper has moved up much, I'm just curious if there was anything else? Maybe Q3 last year was stronger than normal or any other items that we should focus on?

I'm sorry. What was your comment about the second quarter?

Your second-quarter Shoppers margin decline from Q2 '05 was not as significant as the drop-off you saw Q3 to Q3. And so --

That is correct. The expansion impact was larger in Q3 than it was in Q2. That is one of the examples.

Okay. And then Tampa Flyer, presumably you guys are making progress moving margins on that business closer to the overall average. Is that still the case in Q3, or did that take a step backwards?

We are thrilled to death to be in that business. We are doing what we need to do. We are hitting all of our targets.

Is there still additional upside in moving that business' margins more in line with the overall Company average?

Yes, the margins of that business are still below the overall Company average, and our goals long-term are to improve those margins. That is correct.

Okay. And then advertising SG&A line, I'm not sure what the breakdown is there between Direct Marketing and Shoppers, but that is the line that seems to be more lumpy. I was just curious if there was any one-time tradeshow type advertising or anything else that you guys did that maybe caused expenses to spike there?

We talked about the divestiture of the print operation and experiencing a loss on that. That loss shows up principally in the SG&A line.

So that is an increase to your expenses on the sale of that business?

Correct. It is a loss experience on the sale of the business.

And it shows up in the SG&A line?

Yes.

Okay. And then just finally, you guys have had a lot of nice announcements over the last quarter, bringing in some additional partners for your PennySaverUSA.com growth plans. I just wondered if, you know, another quarter into this if you've got any better ideas to what the revenue model is going to look like there? Are you seeing any traction yet?

Well, you know one of -- I think we have said this before and I don't blame you for continuing to ask the question -- but one of the goals that we strongly voiced at the beginning of this year was that we wanted to improve the content of our site. All of the announcements that we have made centered on that improvement. We will continue to make those announcements.

What we're going to do over the next couple of weeks and months as we prepare for 2007 is begin to look at what revenue buckets we can expect from that improved content. It is really premature for us to have that discussion now for a lot of reasons, not the least of which I am unable to answer them. But we will get to them.

Fair enough. I will ask you again on the fourth-quarter call.

Thank you. I know you will.

Michael Kupinski, A.G. Edwards.

I was wondering if you can give me any thoughts on the pricing in Direct Marketing? Has it improved? You mentioned that virtually all the verticals showed a little bit of growth, but what verticals are you seeing if any pricing power, or is the revenue currently coming solely from volume? And I have a couple of quick other questions.

The revenue is volume based, and pricing does not have a lot of room in our business anymore. I don't think I -- it is not -- we have to figure out how to produce effectively based on the rates that are in the market in a very competitive marketplace.

I was just wondering do you have any other additional color on the Aberdeen acquisition? Any surprises there as you dig into the operations? Has the acquisition been hinting at expectations in the short timeframe that you owned it?

Well, thank you for the copy out of short timeframe. It really has been quite short. And so far, so good.

Okay. Are you anticipating seeing any push forward on campaigns due to poster trade increases in midyear next year in Direct Marketing, particularly into the first quarter?

Well, it somewhat depends on the expectation of when those rates will hit. Usually when there is pushing or movement of mail like that, it is weeks not months. So I don't anticipate a difference in quarters.

Kevane Wong, GMP Securities.

Most of the questions are already taken, but a couple of quick ones. One, I don't know if you touched on this, but Direct Marketing, can you give us a sense on just overall revenue contribution by acquisition? So if you take PrintSmart, StepDot, Global Address together, how much was their contribution in the quarter?

There was no revenue impact from our PrintSmart acquisition. We acquired a vendor, so that was we're getting that revenue anyway.

In the other, the Aberdeen we acquired on September 28. So there was virtually no impact in the quarter. And then the other two were relatively small. It was well under .5%.

Okay. And then also, just trying to get a sense on the macro outlook for the Direct Marketing. It seems like a lot of Direct Marketing guys are sort of having some issues. You know you mentioned that you guys are sort of seeing some pickup here, which was nice at that 3% kind of figure. But when you're looking at the overall market, has that changed? Has that gotten a little tougher? It seems like a lot of guys are having issues. I'm sort of curious if you are seeing a tougher market but just executing a little bit better, or what generally are you seeing?

Well, we have been pretty consistent about talking about this year as not feeling quite as good as the prior two years. But also not feeling like the kind of recession period that we had the beginning of this decade or century. So I don't see any difference today versus what we saw last quarter or the quarter before. There is that overhang of a little bit of softening, but it is not the kind of softening that should prevent us from grabbing the gold ring as we go around. Because we can and should do better than we are doing.

And then also it is nice thing you mentioning distribution being up in Shoppers. I just wanted to get a little bit of -- get some more sense on that. One of the things I come across as sort of a -- which is more of a ADVO sort of issue -- but basically in-store kiosk, sort of attacking some of the freestanding inserts that they provide. Have you seen any sort of new entrants like that that are on the horizon that you are sort of watching for, or has it really just not had an impact on the distribution side of the business?

You know, one of the things we try to not do is come to conclusions when we look at any given quarter. The fact that we have had three quarters now of up as opposed to down, which we saw during that period where those seats were being filled at low prices, makes us feel really good. That means that we're doing our part. But any given quarter it is really hard to know that. So it is another way of saying that there is nothing out there that is impacting our business materially. It is probably more up to us.

Charlie Carter, Trustco.

Just getting back on the Shoppers, I just wanted to ask a question more topline-related. Because if I just did my quick math correctly, the costs are up high single-digit there, maybe low double-digit. And I wonder since you should have some good visibility on these costs increasing, are you able to increase pricing that much in the marketplace, or is it a volume issue, or what is happening there? Because I'm presuming that these organic launches are contributing to the topline growth that you are having there. And if you back out the costs that you said are related to those expansions, you still have some pretty significant margin compression happening. So I'm wondering how you all think about that and how you all go to market and deal with that?

Well, I will give a topline on it, and Dean, please add to it. We went into the year with a higher postage increase than we have had in awhile. We adjusted pricing to deal with that. The result has not been as good as we had hoped from those price increases. Obviously it is not terrible. Revenue is still growing at a decent level. We expected higher revenue growth, though, as a result of those increases. So we are not quite where we wanted to be with that. So pricing did not hold quite as good as we had hoped it would.

Okay. So I guess there may be another postage increase coming and maybe paper prices have peaked, but we really are not sure. So I guess should we expect kind of going forward that you're going to be limited in the amount of pricing that you're going to be able to take?

Well, the next postage increase is somewhere about half the size of the one that we just had, and that makes a material difference. So we do not expect as much difficulty the next time around as we had this time around, you know, from where we are sitting today, and it is nine months out.

At this time, I am showing no further questions. I would like to turn the call back over to you for any closing remarks you may have.

I sure appreciate everybody's questions, and I hope you have a great day. Bye-bye.

Thank you.

This concludes today's Harte-Hanks quarterly earnings release call. Thanks for attending and have a great day.