Harte Hanks Inc (HHS) 2008 Q2 法說會逐字稿

Welcome. Thank you for joining the Harte-Hanks second quarter 2008 earnings conference call. At this time, all participants are in a listen-only mode. (OPERATOR INSTRUCTIONS). Today's conference is being recorded, if you have any objections you may disconnect at this time.

Now I will turn the meeting over to Mr. Dean Blythe, President and CEO of Harte-Hanks. Sir, you may begin.

Good morning, everybody. On the call with me today is our Doug Shepard, our Executive Vice President and Chief Financial Officer, Jessica Huff, our Vice President and Financial Controller, and Bryan Pechersky, our Senior Vice President, General Counsel, and Secretary.

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

Thanks Dean, our call may include forward-looking statements, about our strategies, initiatives and business plans, financial outlook and capital resources, competitive factors, business and industry expectations, and other statements that are not historical facts, actual results may differ materially from those projected or implied in these statements. Because of various risks and uncertainties, including those described in our most recent Form 10-K, and other documents filed with the Securities and Exchange Commission, and the cautionary statement in today's earnings release.

Our call may also include nonGAAP 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 will now turn the call back over to Dean.

Thanks Bryan. We have one focus today, a return to earnings growth, and we did not achieve this in the second quarter. We did however, see some signs in the quarter of progress towards achieving our earnings growth.

First, the direct marketing business continued a steady top line growth in the quarter, consistent with what we have seen over the last nine quarters, in spite of what has been a deteriorating macro economic environment over the period, and with this revenue growth, we delivered positive leverage at the bottom line and improved margins, second, while the year-over-year Shoppers comparisons continue to be dismal, the quarterly sequential progression at Shoppers, that is our performance in the second quarter of 2008 versus our performance in the first quarter of 2008, does show some positives.

Revenue in the second quarter was higher than in the first quarter, a typical seasonal flow of revenue for this business. On the $3 million of incremental revenue from Q1 to Q2, we delivered 4 million of incremental operating income, showing the impact of our continued emphasis on cost reduction. These are difficult times and difficult results for this business, but this was good hard work, and good performance from our Shoppers team.

We remain optimistic about the long term performance, and the strength of each of these businesses. The positive signs we saw in the second quarter, reconfirm this optimism, and our belief in the fundamental value of our businesses. That being said however, there is no doubt that the current external environment has not given us any help, and will not give us any help in achieving our earnings goal, at least through the remainder of this calendar year.

The local markets in California and Florida are the worst we have seen in our Shoppers business, and do not appear to be showing any signs of improvement. As I noted earlier, we have delivered very steady revenue growth from our direct marketing business for over two years, despite a weakening environment, but are increasingly seeing more of our customers across all verticals, becoming cautious with their spending plans.

The external forces potentially impacting our revenue performance, are driving and will continue to drive our behavior in managing our businesses. We will continue to aggressively pursue actions to keep our costs in-line with our revenue levels, and improve our efficiency and effectiveness in delivering our products and services to our customers.

Before I turn it over the Doug to give details on our results this quarter, let me briefly address how our people are responding to today's market calendar. Following the economic news on a daily basis, and seeing up close the challenges faced by our customers, make all of us think and act differently about how we approach our business and our jobs. The positives in this quarter were the result of this different thinking and action. I want to thank all of our people for their continued efforts to strengthen and improve our Company as we move forward.

Doug Shepard will now give you some more details on our results, Doug?

Thank you Dean. Good morning. Here is a company-wide over view of the second quarter, revenue decreased 5.3% for the quarter, with an increase in revenues for direct marketing, and a decrease in Shoppers. Direct marketing revenue increased 4.4% for the quarter, compared to 4.1% in the second quarter of 2007. Direct marketing revenue has increase 17 of the last 18 quarters, and exceeded 4% growth in six of the last seven quarters. Shoppers revenue decreased 20% for the quarter.

Moving to operating income. It decreased 16.4% for the quarter. For the quarter direct marketing had an operating income growth of 6.6%, while Shoppers declined 42.4%. Direct marketing operating margin was 14.2%, and Shoppers operating margin was 12.7% for the second quarter. The second quarter our free cash flow was 22.9 million, versus 26.2 million in the second quarter of 2007. We spent 5.3 million in capital expenditures compared to 7 million in the second quarter of 2007.

Turning to our two businesses. The second quarter of 2008, direct marketing revenue increased 4.4%, and operating income increased 6.6%. Resulting in an operating income margin of 14.2% for the second quarter of 2008, which is an increase, compared to an operating margin of 13.9% for the second quarter of 2007.

Direct marketing delivered positive leverage for the quarter with incremental operating income representing 20.7% of the incremental revenue growth. For the second quarter our high tech telecom vertical represented 27% of direct marketing revenue, retail was 24%, select markets were 22%, financial was 17%, and health care pharma was 10%. Our Top 25 direct marketing customers, represented approximately 42% of direct marketing revenue in the second quarter. Our largest customer in the quarter represented almost 7.5% of our total direct marketing revenue.

Turning to Shoppers, our second quarter revenue decreased by 20%. Operating income margin for the quarter declined to 12.7%, as compared to 17.6% for the second quarter of 2007. The decrease in operating income margin was primarily driven by a 460 basis point increase in postage. These postal costs are directly tied to circulation, the increase is a result of declining revenues with relatively flat circulation, compared for the second quarter of 2007.

In response to the continuing economic problems in California and Florida, early in the third quarter we recently reduced circulation by approximately 250,000 households per week. This reduction was primarily in California, and was concentrated in unprofitable areas. No material charges should be expected for this action. Our total Shoppers circulation is now approximately 12.8 million.

Our second quarter effective tax rate was 39.9%, compared for 40.1% in the second quarter of 2007. We anticipate our effective tax rate for the remaining quarters of the year, will be comparable to 2007 quarterly effective tax rates. On the balance sheet at June 30th, we were showing a debt balance of $309.4 million, and a cash balance of $23 million, for a debt net balance of $286.4 million. Net Accounts Receivable were 183.4 million, versus 199.2 million at December 31 2007. Days Sales Outstanding at the end of June was 61 days, a slight increase over the 59 days outstanding at the end of March.

During the first six months of 2008, we spent $76.6 million on stock repurchases, compared to 76.2 million in the first six months of 2007. We have approximately 10.5 million shares remaining from the repurchase authorizations as of June 30th. In the second quarter we did not repurchase any shares.

As a result of the tremendous turmoil and deterioration we saw in the overall economic and credit markets in the second quarter, we took a more cautious approach to our free cash flow and available debt capacity in the quarter. We will continue to closely monitor external market and economic conditions, as we consider uses of capital and free cash flow.

In summary as Dean mentioned, we remain confident in the long term fundamentals of our business. Our direct marketing business continues to provide solid revenue growth, and deliver good bottom line results. The Shoppers business delivered higher revenues and operating income in the second quarter than in the first quarter, which is consistent with the historical seasonality in this business.

We continue to be strong generators of cash with $22.9 million in free cash flow during the quarter. Our quarterly earnings have exceeded the Consensus, and the company has a strong balance sheet, with 96 million available under our revolver as of June 30th.

With that, operator, we will turn the call over for questions.

Thank you. (OPERATOR INSTRUCTIONS). One moment for our first question.

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

Good morning guys, a couple of things in the press release you noted, and I think you even said in the prepared remarks. You sound a little more cautious, in terms of the expectations for direct marketing in the back half of the year. Is there anything specific, or anything in that vertical that you can point to, to kind of give you that caution, or is it just more watching the macro economic environment?

Mark, this is Dean. There is nothing as specific, other than we stay as close as possible as we can to our customers. And we hear it from our customers. They are nervous. So when they get nervous, we get nervous.

And do you get the sense that maybe people are reigning back for Q3, with the expectation maybe saying a little bit of dry powder for Q4, going into the holiday period, or is it just--?

That is probably on the retail side. That is probably correct. I am not sure if it applies to the other verticals.

Okay. Driving in to the direct marketing a little bit. Health care, pharma seemingly a fairly non-cyclical industry, but you are experiencing some softness there, can you give some color on what is going on?

I think there are probably three things impacting that market. It is two different, it is pharmaceuticals and it is healthcare providers. On the healthcare provider side, which is the majority of the weakness, we help healthcare organizations drive membership. Healthcare organizations today for a couple of reasons are pulling back.

One is, some of the programs they have today, they lose money for every new member they recruit. So they have decided not to spend money to recruit new members. People also are very interested in what is going to happen in November, and how that may or may not impact healthcare plans going forward. So there has been a significant cutback in healthcare membership drive spending.

In pharmaceutical, there have been a lot of drugs in the news, in terms of studies coming out showing that these drugs aren't, don't do what they said they were going to do. While we are not directly impacted by any of those recent statements, in other words we don't do work for those particular drugs, we do work for the companies that have investments, or own those drug brands. And several of those companies have slashed marketing spending across their entire organization. And we have been impacted by that.

Great, that is very helpful. On the decision this quarter to use free cash flow more for debt reduction than stock buy-back, are you looking at any specific covenant issues, as you kind of go out through the next few quarters that give you some concern, you wanted some wiggle room there, or--?

Mark this is not a covenant issue at all, we are a million miles away from any covenant issues.

So you just chose to delever a little bit? It just seems like your balance sheet is not very heavily levered relative to most companies, and rates are coming down, so just curious for the decision to pay down debt instead of buying back stock, and what your thoughts are going forward on that?

Yes, I don't think I can say a lot more than what Doug said. These are historic times. If you pick up the paper, the amount of uncertainty in the market and the external markets, and in particular, in some of the markets that we operate in on the local side. We haven't seen things like this in decades. And in those economic times, we made a decision this quarter, and it is not forever, to preserve capital in the face of extreme economic uncertainty.

Okay. And then just finally the circ cut, it sounds like it was low profitability. Does that actually help margins in the back half of the year, and what is the revenue with that 500,000 or so households?

It wasn't 500,000, I think it was 250 or 275, 250.

Sorry, I misheard that.

I think the revenue is probably on an annual basis probably under 2 million, no, let me confirm that number. Because I think when we did 600,000, it was about 5 million in revenue. So the 250,000 would be somewhere in the 2 to $3 million range.

Yes, will it help margins? All else being equal, the answer is yes, we were losing money on that circulation, so we won't lose money. So therefore yes, it would improve margins. But Doug mentioned in his comments, we lost 490 basis points in Shoppers overall.

Now the impact of declining revenues with flat postage expense, because the postage expense is fixed, based on the number of packages and your circulation. 460 of the 490 basis point loss was the result of the fixed postage expense. So as long as revenue is declining at the rate that it is declining, we continue to face that margin, that significant margin impact. And so we are doing things obviously to combat that. And cutting circulation a little bit will help.

Just to make sure, I understand you, Dean, that 460 of the 490, that is just basically negative operating leverage on that fixed cost base?

Exactly.

Yes, okay. Thank you very much.

Alexia Quadrani of JPMorgan, you may ask your question.

Hi. Just a follow-up on your comments about the clients in direct marketing being more cautious, would you say that it was a notable change, maybe as recently with the muted growth in the second half? Then I have a couple of follow-ups.

We have said at the beginning of the year and at the end of the first quarter, that we had seen some of our customers in some verticals. And we were primarily talking about retail and financial. I just think that since, I wouldn't say it is recent within the last couple of weeks, but I would say within the last 90 days we have just seen more of that, than outside of those two verticals.

And then on the select vertical, if you can give us a bit more color on what you are seeing there, you had some good performance despite the fact that auto is in that category. Can you give us more detail on that?

Our auto is actually up this quarter. Our automotive was up this quarter. We do work with the foreign manufacturers. We have very little work with Detroit. And some of our guys are doing pretty well. Auto was up.

Our government, nonprofit sector was up in that. And those were a couple of the drivers.

Is the government nonprofit a big chunk of that? Or was it pretty evenly divided in verticals?

It is not exactly evenly divided, but it's one of the, kind of the three biggest pieces in that are automotive, government nonprofit, and what we actually call, consumer durable goods.

Would you say in the government stuff, is it election related or not?

Not at all. We don't have any political work in direct marketing.

Okay. Okay. And then just on, again back to the good numbers in direct marketing, I don't know if you can read this far into what you are seeing from your clients, but do you think it is a shift in spending maybe from mass media, maybe to more direct accountable media, or do you think this is just part of the business that hasn't been cut yet, because it is more accountable? Are you getting money from other places necessarily?

No I am sorry, Alexia, you lost me, are you asking, is our relatively positive top line performance based on a shift from mass media into direct?

Yes, you say it much better than I did, but yes.

We can't tie any dollars, but it certainly seems like some other media within some of our customers may be getting cut more than what we are doing. I don't know if it is a shift of dollars, but the reductions, maybe the reductions are less in this form of media than others.

And then not to beat a dead horse, but I am a little surprised about your comments by the share buyback in the quarter, I understand it is historic times, but the stocks also have hit historic lows from a valuation perspective. Is there a stock price that you guys internally maybe look to, and say at this point, we just have to make a move and buy back stock, or is it really just, we are so nervous about the economy that we don't think any kind of use of free cash flow in that way right now is prudent?

No, there is no magic stock price that makes us turn this on or turn this off. It was more of the totality of the circumstances. We bought an enormous amount of stock in the first quarter.

Okay.

And if you look at it, does that mean that we are not buying every single day that we changed our mind, no. It is kind of like over a period of time, we bought more in the first six months of this year than we bought in the first six months of last year. We just didn't do it on a steady straight-line basis.

So it is not necessarily, we shouldn't read into it that you are not going to be doing it in the third quarter?

I would think, that is correct, but I don't think you should read the opposite either. We continue to evaluate this on an ongoing basis.

Okay, thank you.

Troy Mastin, of William Blair and Company, you may ask your question.

Thank you, good morning. You mentioned [inaudible-microphone inaccessible] Q1 to Q2, I wonder if you could help us understand how you view this, I think it was positive in 2003 and 2004, but negative in '05, '06, and '07, how do see this business going forward?

Troy, I think the reason to focus on that is that the signs, this business forever, revenue in Q2 has been higher than revenue in Q1 in any year because of seasonality, with Q1 being a very low revenue period. Q2, between Q2 and Q3 has not followed that trend, in other words, sometimes it is higher and sometimes it is lower.

So there is established no seasonal trend. I think we highlighted the seasonal trend between Q1 and Q2 to say yes, it is pretty bad on a year-over-year basis. But at least it has returned to some degree of normalcy in the revenue flow. Now we don't have that same historic benchmark between Q2 and Q3.

Okay, so we can't read much into Q3 relative to Q2, similar to Q2 and Q1?

I would say that is correct.

Okay, and what about the progression of the Shoppers business within the quarter? Some of the newspaper companies seem to see less negative results in the earlier parts of the quarter, and more negative results in the latter parts of the quarter. Did you see a trend like that?

Yes.

And has that weakness in June, or softness in June, carried into July from what you see so far?

Troy over the last, since the fourth quarter of 2006, we have seen 52 trends. And we have learned that two weeks or three weeks does not a trend make in either direction. So the revenue is more volatile than it was. And that is why we are very cautious about the future, because we are not seeing trends yet.

Okay. So if there was an apparent trend in some areas, you may look as a comparable to you, say April stronger than May, stronger than June. You are not necessarily seeing a trend you can tease out of your results?

I am saying that you can look backwards you can make some factual comments about which month did better, I am not sure that portends what the future is going to do.

Okay. And what can you tell us about paper prices at Shoppers, are you seeing upward pressure there, you mentioned postage had an impact on the margins, what kind of an impact did paper have year-over-year? And what is the outlook for paper going forward?

There are two impacts, mostly postage and with paper, one is the rate impact, and one is the volume impact. With postage we had very little volume benefit. In other words there was no volume decline, because postage is fixed on the number of packages that you send out, or virtually fix. Our newsprint consumption is actually declining, because our advertising is declining, and we print as many pages as we have advertising.

On a rate basis, we are actually slightly down year-to-date in newspaper rates. With projections and expectations that they will increase in the second half of the year.

Can you give us some order of magnitude, as to how much of an order of margin of impact that might be in the back half of the year?

Margin impact. I think the rates are in the neighborhood of, we are projecting potentially for a 10% increase in the second half of a year-over-year basis. Close to that, and we will pay for somewhere between 10 to 15% of our revenue base. So that would be 100 basis points of spending on a year-over-year basis.

So you will make some of that up at the circulation cut, but you might give it right back in the form of paper?

And we will make it up, there are lots of ins and outs.

Okay, as you look across your cost cutting that you have been pretty effective at, or cost control, is it getting much more challenging for you to find other areas to eliminate costs, low hanging fruit, is it largely gone? Or are you getting continually more creative to where you think you can keep driving, or blunting the impact of the revenue downturn through more effective cost management?

Yes, there are always things that you can address, cutting expenses, et cetera. But you are correct, that we have taken a lot of the low hanging fruit in Shoppers, et cetera. And it does get harder, obviously as you progress into the future, to take as big a cut, as we have in the past.

But Troy, the other thing is it depends on revenue levels. To produce revenue we have expense. So if the revenue isn't there, then we can get at that expense fairly readily.

Okay. And then finally one more question on the direct marketing side. Are there any types of services that are standing out as areas of strength, not verticals but services? If it is a particular one that is driving a good portion of that 4.4% growth?

Yes, in any given quarter we do a lot of different things for a lot of different customers. And probably over this nine quarter period of time, we have had 10 different things driving the growth. So I don't think so there are any trends in particular, it varies from quarter to quarter. But I don't think there is a long term trend that we are seeing.

Okay, good, I will let someone else ask. Thanks.

Dan Salmon of BMO Capital Markets. You may ask your question.

Hi guys, thank you. Could you break out the contribution of Mason Zimbler to the direct marketing unit growth? And then further on just, any significant difference between how that business is performing versus the rest of your business? Thanks.

Okay, the Mason Zimbler I believe on the revenue basis is about 1% of the growth.

Okay. And is that business, do you see any significance, you said it sounds like pretty broadly customers across all verticals, throughout the business starting to pull back a little bit. Any significant difference with clients that are focused there, versus --?

I am sorry, focus where, Dan?

The clients that are focused, that you acquired mainly through Mason, and the work you are doing with them there. Do you see any particular difference with their trends, versus the rest of your client business?

Dan, Mason Zimbler is 1% of our total revenue, 1% of our total revenue, so they have you got 10 customers, and we have got 10,000. So I don't think we can really draw any trends from those comparisons.

Okay. Thanks. I will let someone else on.

(OPERATOR INSTRUCTIONS). Edward Atorino of Benchmark, you may ask your question.

Hi, looking at the debt level, and your strategy there, should we assume that those expenses are going to stay where it is, unless of course you ramp up your share repurchase program again? Second, I hate to beat this thing to death. But if there has been rather nasty trend in the Shoppers business, go back the last few quarters. The rate of decline has sort of accelerated from 7% to 20%, and now it has sort of stabilized.

And in terms of the rate of decline in revenues, you have sort of gone from 9 to 22, which is sort of starting to stabilize, I am not sure if there is any message there. But I guess there is you don't know, but it looks like you might be stabilizing somewhere in the mid-80s level. Of course, I guess that is all sort of guess work. Second question on the cost side, it looks like your cost is start to stabilize in the $80 million plus or minus range there, are we near a base in that category?

And then lastly, on the corporate line, you did a good job in squeezing corporate down. Would that be a run rate to look at the second quarter, roughly $3 million, give or take a little? Would that be a run rate going forward?

I think there are three questions, corporate rates.

Interest, and then the trend, quote unquote on the Shoppers side?

The corporate run rate, the answer is yes. That is a good run rate.

The Shoppers, I guess the question was really we kind of, are we seeing stability, know in the mid-to high to 90 million revenue range on the revenue side, and $80 million on the cost side?

Yes, I think that sort of tightens it up, yes.

I will have to go back to I think it was with Troy, what I was talking about is. I would love to be able to tell you that.

Yes, I understand.

And we are certainly hoping that that is what we are driving at. But we just don't have enough [empirical] data to say that is happening.

I understand.

The first question was is our interest expense going to stay where it is. About half of our outstanding debt is floating. So certainly with rate movement, one way or the other, which I don't know if there is much more downward room, but there is certain upward room.

Yes, I understand.

That rate is going to increase. And then as I mentioned with Alexia earlier, what we do with our free cash flow.

I understand, yes, you don't need to belabor that. I understand that totally. Thanks a lot.

Thank you.

I would like to now turn the call back to Mr. Blythe for closing comments.

I want to thank everyone for joining us today, and we look forward to speaking with you next quarter. Good-bye.