Harte Hanks Inc (HHS) 2007 Q2 法說會逐字稿

Welcome to the Q2 2007 earnings 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)

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

Thank you. Good morning. On the call with me today is Dean Blythe, our Executive Vice President and Chief Financial Officer, Jessica Huff, our Vice President, Finance and Controller and Bryan Pechersky, our Senior Vice President, General Counsel and Secretary.

Before I begin my remarks, Bryan will make a few statements.

Thanks, Richard.

The comments we make on this call will include forward-looking statements. Examples may include statements about our strategies and initiatives, financial outlook, competitive factors, business and industry expectations and other statements that do not relate strictly to historical facts.

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 these forward-looking statements. A description of some of the risks and uncertainties potentially impacting our business and future performance can be found in our most recent Form 10-K and other documents find with the Securities and Exchange Commission and in the cautionary statement in today's earnings release.

Our call may also include a discussion of certain non-GAAP financial measures, please refer to today's earnings release for the required reconciliations and other related disclosures. Our earnings release is available on the Investor Relations section of our website, at www.Harte-Hanks.com.

I'll now turn the call back over to Richard.

Thanks, Bryan.

As in the past, after I make a few opening remarks, Dean will give you some financial details and then we'll take your questions.

There is no way around it, our performance in the second quarter was poor and obviously well below our expectations. We knew going into the quarter that achieving year-over-year EPS growth was going to be very difficult due to the contract termination fee recorded in the second quarter of 2006, however, even excluding the lift we received a year ago, we still failed to grow earnings.

Revenues were not where we had anticipated, and as a result, we have taken and are continuing to take actions to improve future revenue performance, and reduce future expenses. We incurred costs in the second quarter in both businesses as part of this effort and will incur additional costs related to these changes for the remainder of the year.

In Shoppers, we continue face a really tough economic environment in California and Florida. We've seen the much publicized real estate market issues effect the associated financing markets and spill over into virtually all of our revenue categories. As a result, we shut down approximately 600,000 circulation in June.

While we do not anticipate any further circulation reductions of this size in the near term, we will continue to monitor the performance of all of our circulations. Direct Marketing revenues were up, but we saw margins slip on a comparable basis from a year ago. Our select and high tech verticals did reasonably well, while the financial services vertical continues to be weak. New business growth was a bit slower than we have seen recently.

Before turning it over to Dean, let me summarize. We have and are responding to the issues we are facing in both businesses on both the revenue and the cost side. While this effort will negatively affect the bottom line, for the remainder of the year, we believe we're taking the actions necessary for the long term good of our company.

We really believe in the strength and the durability of the targeted marketing businesses we operate, and we continue to be a leader in both Direct Marketing and in Shoppers. The real estate and related elements in California and in Florida are expected to continue to hurt our Shopper business in the near term, but we continue to believe these geographies are wonderful places to have businesses in the long term. We remain committed to investing in our future, and we are going to continue to do so.

Dean, over to you.

Thank you, Richard, and good morning, everyone.

As Richard mentioned, this was both a difficult and a disappointing quarter. Here is a company-wide overview. Revenue was down 2.8% for the quarter with revenue for Direct Marketing essentially flat, up 0.4 of 1 percent and down 7.1% in Shoppers. Operating income was down 19.3% with Direct Marketing down 14.8% and Shoppers down 22.6%. Free cash flow in the quarter was $26.2 million, down from $32.8 million in last year's second quarter on a comparable level of capital spending.

Turning to each of our two businesses, for the second quarter, our Direct Marketing revenue was up slightly, 0.4% as I sad, with EBITDA down 10.7% and operating income down 14.8%, with operating income margin down 250 basis points to 13.9%. Excluding the impact of the $7 million contract termination fee that we received in the second quarter of 2006, revenue would have been up 4.6% with EBITDA up 2.7% and operating income up 1.4% with operating income margin down 50 basis points from the prior year.

Revenue performance in Direct Marketing has not been as robust as we anticipated coming into this year. We have also seen a drop in profitability of our revenue a part of which is related to having delivered less revenue than expected. As a result, we did not reduce costs quickly or deeply enough to align our expense structure with current levels in this business. For our vertical markets in the second quarter of 2007, retail, our largest vertical, represented 26% of Direct Marketing revenue, followed by high tech telecom at 25%, select markets, 19%, financial, 17% and healthcare pharma, 13%. Revenue on our high tech telecom vertical had double digit growth in the quarter, helped in part by our Aberdeen acquisition back in September of 2006. The select vertical showed continued solid growth with revenue increasing in the high single digits over the prior year.

The healthcare pharma vertical was up in the mid-single digits and the retail vertical was flat. The only vertical showing a decline was financial which was down double digits mainly as a result of the receipt of the contract termination fee in the second quarter of 2006. Our top 25 Direct Marketing customers represented 40% of Direct Marketing revenue in the second quarter and our largest customer in the quarter represented 7.5% of our total Direct Marketing revenue.

Turning to Shoppers. Shoppers had another difficult quarter. Revenue was down 7.1% to last year's second quarter, with and EBITDA decline of 20.2% and an operating income decline of 22.6%. The revenue environment continues to be difficult and we believe worsened in the quarter. We do believe this environment is primarily contributable to the condition of the real estate and associated financing markets in the California and Florida geographies. Other advertising related businesses that operate in these parts of the country have recently reported negative results out of these regions particularly as compared to other parts of the country. Unfortunately, we believe these conditions will continue for the remainder of 2007. Over the long term, however, we could not be in two better markets for this business.

The decline in operating income was partially the result of a negative operating leverage associated with the revenue decline. Operating income margins also continued to be negatively impacted in the quarter by the large circulation expansions we completed during the second half of 2006. As we previously announced at the beginning of June, we have shut down approximately 600,000 of circulation which generated losses of about $2 million in the first half of 2007. While this action will remove the drain on profitability in the second half, it will also result in the loss of revenue. This circulation generated $3 million of revenue in the first half.

In the press release we mentioned that for the Company as a whole we had incurred over $2 million of expenses in the second quarter related to actions that will have a positive impact on future profitability. Shutting some Shopper circulation, consolidating facilities and exiting leases early, and reducing head count which had associated severance. All of these actions were effective relatively late in the second quarter, so we saw little, if any benefit in this quarter--the second quarter.

We also mentioned that we were going to spend at least another $2 million during the remainder of 2007 on similar actions. Given the timing of all of this, we do not expect any net savings from the past and planned actions in calendar year 2007. In 2008, however, we expect that these actions will result in savings of at least the amount of expenses we incurred in 2007 and the savings should, in fact, be more than that. Of course these actions can't be looked at in a vacuum, our results--our future results will depend on lots of other things as well, including our ability to control and reduce expenses through measures that do not have associated costs, and the revenue performance we will be able to deliver from our businesses.

Our second quarter net effective takes rate was 40.1%up slightly from 39.8% in last year's second quarter. For the full year, 2007, we expect our tax rate to be higher than what it was for the full year 2006. The effective tax rate for 2006 was 37.6% and we expect 2007 to be over 100 basis points higher than that.

The year-over-year difference in tax rate through the first half, however, is up only 35 basis points. The second half rate, therefore, will be up much more with most of the difference being in the third quarter as the result of a favorable resolution of a state tax matter in the third quarter of 2006, which lowered our effective tax rate in that period.

On the balance sheet at June 30th we were showing a net debt balance of $178 million, book equity was $468.1 million. Net accounts receivable were $170.7 million, with DSO at the end of June, 54 days against 53 days at the end of June of 2006. We repurchased 1.6 million shares during the quarter.

Since January 1997, the Company has acquired 53.5 million shares and spent over $1 billion under our repurchase program including more than $200 million over the last 12 months. We've delivered lower earnings through the first half of 2007 than we had in the first half of 2006. We have not yet seen the lift in performance from our Direct Marketing business that we anticipated coming into the year, and the external factors impacting Shopper top line performance are likely to be present for the remainder of the year.

Given this, it is unlikely that we will be able to deliver the same level of EPS for the full year 2007 as the $1.39 of earnings per share that we reported in 2006. This is disappointing to us, and we know to all of our stakeholders as well. We, however, continue to believe in the sound fundamentals of each of our businesses and the markets in which they operate, and we are absolutely committed to delivering improved performance .

Operator, with that, we would like to open up the call to

Thank you. (OPERATOR INSTRUCTIONS)

Our first question come from Karl Choi of Merrill Lynch. Your line is open, you may ask your question.

Sure. Question on the Direct Marketing business, just wondering if you can elaborate a little bit as to why you think the performance hasn't picked up this year? Is it a market situation, pricing, a market share or is it more specific to Harte-Hanks?

I think it's a bit of a combination of all of those. It's--we really thought that revenue would grow faster than it has. We didn't expect a robust year, but it hasn't yet quite picked up the way we had anticipated. I have to--some of that belongs to us. Some of it belongs to an advertising market that is in fact by all reports a little bit softer than everybody expected it to be, but, we don't want to point fingers too far away from us, because we're in control of our own destiny, and we should have done better.

And any specific product lines where you are seeing the softness or is it pretty broad based?

Yes, Karl, I don't think there's any particular product line that is softer than others that we've seen. Excluding the impact of the termination fee, there was about 4.5%, 4.6% revenue growth with is certainly a couple of points lower than we would have thought, but I don't think it's concentrated in any particular area.

And you mentioned that Shoppers weakness looks like it's going to continue, but based on what you are seeing, do you expect the Direct Marketing business to pick up in the second half or probably more likely to be similar to the growth rate in the past?

I don't think the revenue growth in Direct Marketing has been a little bit softer than what we thought, and I think we're kind of a wait and see, we've got some--always have good news, that we think about, but I'm not sure what--if we're on point. A lot of the business that we have in the second half of the year is cyclical, is seasonal, related to--in particular in our retail business, and I think there's obviously some uncertainty around that as we go into the holiday season.

And last question, in terms of the pace of share buybacks should we expect any changes in the second half now that the stock has been quite weak (inaudible)?

It's a much better value, isn't it?

Okay. Thank you.

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

Reduction issues you referred today, beyond the circulation reduction, could you give us a little bit more color on what that entails, specifically regards to Direct Marketing side of the business?

Alexia, I'm sorry, I think you cut out the first part of your question, and I didn't understand the question.

The question was, you talk about in the press release and on the conference call more cost reductions issues you're taking beyond the initial discussion earlier in the second quarter about your circulation reduction, and I was just asking on what specifically these cost reduction issues entail, and specifically what are you doing on the Direct Marketing side to reduce expenses?

There are people, parts to this, there are structure parts to this, all of these have costs associated with the changes, when people get laid off, there's severance, when you consolidate functions, there are costs that you incur, clearly what we're doing here is aiming at long term growth, but short term, short term it hurts.

Is the incremental reductions you announced today, are they more heavily weighted toward the Shoppers than the Direct Marketing?

Alexia, I don't think they are more heavily weighted one or the other, we will be taking further actions and have further actions planned in both businesses.

And when you look at your major in the Direct Marketing side, you look at your major verticals and how they trended year to date, any reason to expect a change in any one of those verticals going forward? I guess particularly focusing on maybe your comments in the retail and the financial side.

The retail vertical continues to be soft, I think we were flat in the quarter. Again, a lot of that business is weighted in the fourth quarter. It is a seasonal business, and so I think we have to see the health of the business, kind of the economy going into the quarter. Our financial vertical has been soft, and continues to be soft. We're taking some action in there, but we--we haven't turned the corner in that vertical.

And lastly, I think you mentioned that the new business trends have been a little bit weaker. Is that business going someplace else, or is there just not as much new business?

Alexia, I don't think--it's hard to track, this is a big industry, it's a fractionalized industry, we do lots of different things. I don't think--it just so happened in this particular quarter the new business was a little bit softer than we've seen. I don't think that portends any trends. I don't think you can make any generalizations about it going elsewhere, I think it is just so happens in the revenue in this quarter was a little bit softer than we've seen.

Okay. Thank you.

Paul Ginocchio of Deutsche Bank, you may ask your question.

Hi, good morning this is Dave Clark for Paul, a couple of related questions.

First, what portion of your Shopper revenue comes from the distribution of inserts? And then second, we've heard that Walgreen's and Lowe's have changed their national marketing strategy and eliminated or reduced distribution in non-paid publications. I was wondering if that had any impact on your Shopper business in the second quarter, and I guess more broadly, have you noticed a trend or change in sentiment among national retailers regarding the use of non-paid distribution? Thank you.

Dave, over the course of a period of time, distribution revenue was about 40% of Shoppers total revenue.

Thank you.

And you mentioned Walgreen's and Lowe's I believe?

Yes.

As you said that had decided to reduce the amount they distributed through unpaid circulation?

Right.

I don't expect that to have any particular impact on us.

And I guess just more broadly, I was wondering if you had noticed any trend or comments from national retailers regarding the use of non-paid distribution?

No, I don't believe we have.

Okay. Thank you.

Mark Bacurin of Robert W. Baird, you may ask your question.

Good morning. Dean, I just wanted to clarify, you spent--it sounds like you said you spent $2 million of one time charges in this quarter, and you expect a similar amount over the back half of the year, and at that, I think if I understood it correctly should yield at least $4 million of savings in '08?

Correct.

So of the $2 million you are going to spend for the remainder of this year, are you saying that those--that those expenditures will essentially offset any benefit you will, or possibly would have have seen from the Q--what you spend in Q2? I mean the savings you would have achieved through the cost reduction initiatives you implemented in Q2?

That's correct.

Okay.

Yes, and plus, I mean I'm talking about a full year here, not any particular period. So we spent $2 million in--pretty much at the end of Q2. The annualized savings are higher than that, but we only have 6 months of savings.

Right, I got you.

In the calendar year, so these comments are related to the calendar year 2007.

All right, so If you picked up a $1 million in the back half of this year from what you did in Q2, you're still going to spend an incremental two for the back half of the year, so--

Correct, and we'll get some savings from that, but it depends upon the timing of those, whether they hit some time in Q3 or early Q4, and some of that timing we're still working through right now because it's not all in our control.

Okay, I'm with you. On the--this has been touched on a little bit, but just curious, on the direct marketing side of the business, I know we had the big postage rate increase in May, and presumably you went out with some sort of a price increase, and just wondering what impact that may be having on your volumes and the trends in Direct Marketing for the quarter.

Mark, the postage impact in Direct Marketing would not have impacted our prices at all, because we do not pay for postage, our customers pay for postage, so there wouldn't have been any "price increase" from us related to the postage increase.

Yes, right, sorry, I meant more along the lines of have you seen advertisers pulling back on volumes because of the rate increase.

We've seen advertisers--there's a little bit of that, there's a little bit of advertisers looking to change the size of their piece so that they can accommodate the structure better--the rate structure better, I would classify it as a factor, but not a big one.

Okay, and then as it relates to the Shopper side of the business, how effective--what role did that play in terms of the margin performance there and how successful you've been able to pass through any price increases offsetting the postage increase?

Well, Mark, actually as a result of us changing the way that we label the product, which we've talked about in the past, we used to label it through a detached card, we now are labeling the product on--we're ink jetting the address on the product itself. As a result of taking that action, which was implemented in the second quarter, we actually saw no postage rate increase in rate in the quarter. Now, we did have expenses associated with that because this was a fairly significant manufacturing change so we had training costs associated with that in the quarter, and then obviously, it has hurt productivity to a slight degree in that business.

And you were still, I think, planning on putting through some level of price increase to offset some of those costs incurred to make that change though, were you not?

Mark, in this market, price increases are not--they are not easy, if they are not possible in the difficult markets we're facing right now.

Okay, and if you look at on the Shopper side, you've stratified in the past with the pyramid and the inverted pyramid, local, regional, national, where the softness is coming. I know you said it's pretty broad based in the Shoppers business and kind of started with housing and is trickling into all areas, but are you seeing any noticeable differences in trends between national and local or national and regional or--?

What we call our national businesses is, I think, really regional, because we are a regional player. So grocery stores that have outlets throughout our geographies, we do have some national advertisers but those are typically bought on a regionalized basis. I don't think we have seen much change from the deterioration of revenue, it hasn't been concentrated in national versus local, it's been across the board.

Okay, great, and then just finally, I noticed your stocks pulled back a little bit here, so as you said, better value from a share repurchase stand point, but what are you seeing on the M&A environment, you've indicated that's another use of your free cash flow, presumably private equity has made it challenging to find anything that's attractive value, but with some the fall out that's going on in the advertising space, I would imagine there's new opportunities that are popping up, so anything interesting to discuss there?

Do we ever comment about the specifics of acquisition?

I have to ask every quarter.

I know you do, you try hard to get it. The pipeline is pretty much the way we say it ever quarter. The pipeline is there, we get calls, we're involved in a lot of things, we do evaluations, we assess whether these are strategically good and viable opportunities for us, so there's nothing particularly different about today versus, say, a year ago. It's still there and we're still evaluating.

Any major hold that you would like to plug?

There are a few. We're not going to talk about what they are, for obvious reasons, they tend not to be major. They tend to be niche in nature, and an example of that was the--what we did in the lead management business when we made a number of acquisitions over the years to create an enterprise that dealt with lead management in probably 3 or 4 different directions. Aberdeen being the most recent acquisition in that arena, so there are those kinds of opportunities that exist, but as I said, we are not going to talk about those specifics because that will raise the price of the acquisitions.

Fair enough, thank you.

(OPERATOR INSTRUCTIONS)

Our next question comes from Michael Kupinski of Noble Financial, your line is open.

Thank you for taking the question.

I was just wondering what is the percentage of real estate advertising in the Shoppers business? Have you identified that?

Mike, we have in the past, part of it is definitional, we look at real estate advertising as homes for sale, apartments for rent, and mortgage. That is about--well, historically, is about 10% of the revenue. Then you get into, okay, that's real estate, then what's kind of associated with real estate? What about contractors and plumbers and carpenters and those kinds of things. Granite countertops, those are real estate related, but it's the direct real estate is about 10% of the business.

Okay, and the Company historically set long term growth rates for the Shoppers business in the 6% to 8% range, if I recall. What do you think the long term growth rate of this business to be going forward and can you break out of growth between what you anticipate to be pricing expansion and distribution and maybe household growth?

I don't think our opinion about the long term growth rate is materially changed. There's obviously an issue that we're facing. We believe that it is for the most part, not all, but for the most part, environmental. I think we're going to need to see the recovery through that environmental issue to give you a better answer to that question, but there's nothing that we know today that would change our long term outlook.

Richard, in that 6% to 8% long term growth, was there expansion in distribution reflected in that number or was that just mostly coming from household growth and pricing?

There was expansion in it.

Okay.

And it's in our long term plans.

Okay, and can you talk a little bit about the pacings for the Direct Marketing business, the business faces more difficult comps in the second half of the year, you mentioned that the underlying growth excluding the termination fee was like 4.6%. Are you seeing that type of pacings in the second half in that 4% to 5% range or are you seeing things a little bit slower?

Mike, I think I commented earlier in the call about our revenue outlook. We are not really providing a revenue outlook for Direct Marketing for the second half. As I said, we had a little bit softer in the first half than we anticipated going in through the year. We expect we'll have continued--continue to have growth though as we go through the year.

Okay, and historically, you've done really an excellent job at reducing costs, particularly in Direct Marketing when it faced double digit declines in revenue. Can you talk about the ability to cut costs from here and what type of margins--I don't think you've addressed that particularly in the second half, what are you looking for from these levels? How--what is the ability then to cut costs? Where do you think you will cut the cost if you have identified where you might be able to axe a few things.

You know, the abilities, which is is the question you asked, is clearly there. The ability, which is the question you asked, is clearly there. As I said in my prepared remarks, we were surprised a little bit and so the speed with which we implemented was not perhaps characteristic of who we've been in the past and what you've seen in the past, but we were surprised. We have taken a different approach in the second quarter, we've incurred some expenses, we're going to incur some more, and we're going to get some more costs out of the system until we better understand what is going on, because visibility is not quite as good as we would like it to be.

Okay. Fair enough. Thank you.

Troy Mastin of William Blair & Company, your line is open.

Thank you. Good morning.

Quick question on Shoppers, a couple questions on Shoppers, you addressed kind of long term revenue, but I'm curious about long term margins, if you feel that anything has changed with regards to your ability to get margins back into say the low 20s, in Shoppers?

Troy, that business with revenue growth you do get margin expansion in that business. We do have a, I'll call it--it's not fixed costs, but when you have a circulation base there's a certain amount of expense there, and when you get incremental revenue, you can drop a lot of that to the bottom line so I think with revenue growth, we will see margin expansion.

And I would assume there's no reason you couldn't get back to some more historical levels of margins in Shoppers if you get that revenue growth, correct?

That's particularly correct, because the postal rate environment is going to be a reasonable one going forward, we think. The paper price environment is pretty high today so we don't--it's always tough to predict, but we don't see the kind of exaggerated increases that we saw over the past few years, so from today's vantage point, those two cost elements which other than people are the primary ones in Shoppers, are in decent shape.

Okay, and then it sounds like you feel this is predominantly a cyclical issue in Shoppers, not a secular one. I'm curious what gives you confidence that it is mostly cyclical and not secular?

Troy, I think what gives me confidence is if you look at the timing of what's happened. Our Shopper business started to suffer as the geographic markets we were in began to be impacted by the real estate market, I mean, we started to see a little bit of softness in Q3 of 2006 which was exactly the time when the housing market started to get shaky, and we were doing well for a decade before that. So, I don't think it's coincidence that our Shopper results have coincided with the decline in the real estate market. That's what gives us confidence that this is a cyclical thing, not a secular change.

Okay, and then regarding the outlook for the rest of this year without asking for anything in particular in terms of numbers, you did say that Shoppers is worse and that you expect that to continue for the rest of the year. I just want to understand what that means, do you expect it to worsen further, or do you feel like we're kind of at the troughs in terms of the year over year declines?

Well, you've got a number of things going on. From a top line perspective, we shut down circulation so we're going to lose some revenue that we had in the first half of the year. We don't see any change in the external environment in terms of top line, we are taking action on the middle line, we've got to remember that we talked about this business, this is a business that generated $115 million of revenue and over $20 million of operating income in the quarter. This is a good business.

Is it year-over-year, are we suffering from a comparison basis? Yes, we are, and the external factors impacting us as we've said in both the press release and the prepared remarks, we don't see those changing throughout the remainder of the year.

I guess my real question is on what does changing mean? Does it mean deteriorating further, or do you feel like you have some visibility on this is as bad as it's going to get. I know you never for sure, but can you see any notable change in the trend line?

No, and we don't have a great deal of visibility going forward, so we are looking at what people are talking about externally in terms of the housing market, in terms of the local economies, but we don't have a crystal ball.

Okay, and then the cost reductions, I just want to understand specifically what the numbers are, I know say $2 million in the quarter, I think that's just for Shoppers, I want to make sure of that because I think you also took steps to reduce Direct Marketing?

No, no that was not--that was both Shoppers and Direct Marketing.

Okay. Okay. That clarifies, and the going forward reductions will apply to both businesses as well, correct?

Correct.

Okay. Thank you.

Edward Atorino of Benchmark, your line is open.

Would you repeat the--I apologize, would you repeat tax rate outlook for the second half? It looks like it was 40% in the second quarter, does it sort of go back down to normal in the rest of the year?

No, what I said was the tax rate is going to be higher in the--higher relative to 2006 in the second half of the year than it was in the first half of the year.

Okay.

We expect the full year to be over 100 basis points higher for the year, and we were only 35 basis points higher in the first 6 months.

Got you. Thanks very much.

At this time, we are showing no further questions.

Great, thank you. Thank you for your patience and for your understanding and for listening, appreciate your time.

Thank you.