Harte Hanks Inc (HHS) 2008 Q3 法說會逐字稿

Welcome and thank you for joining the Q3 2008 earnings 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 Chief Executive Officer of Harte-Hanks. Thank you, sir. You may begin.

Thank you. Good morning everyone. On the call with me today is Doug Shepard 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 with my remarks Bryan will make a few statements.

Thanks, Dean. Our call may include forward-looking statements. Examples may include statements about our strategies, initiatives and business plans, adjustments to our cost structure, financial outlook and capital resources, competitive factors, business and industry expectations, economic downturn in the U.S. and other economies 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 in the cautionary statement in today's earnings release. Our call may also include 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 will now turn the call back over to Dean.

Thank you, Brian. As I noted in the press release today we released our second quarter results 90 days ago we said that our customers were, "becoming cautious with their spending plans in the face of extreme economic uncertainty". Well, 90 days later to the extent we have had any lessening of uncertainty in the external economic environment it has been replaced by bad news. Today it is difficult to know with any degree of confidence what impact the current economic upheavals will have on our businesses. For the remainder of this year and into 2009.

Uncertainty is the prevailing description we are hearing from our customers regarding their spending plans in the coming quarters. Our operating assumption therefore is that the revenue environment will be difficult and we will operate our businesses accordingly. We firmly believe in the fundamental effectiveness and efficiency our businesses pride. We provide tremendous value to our thousands of business customers, whether they are Fortune 100 companies, mid-size, private business or small entrepreneurial businesses and these are across a wide range of industries that operate in international markets, nationwide domestically and in local markets.

Precisely because we operate across such a wide range of industries and sizes of customers there is no doubt that the external economic environment will negatively impact our performance. As for the length of this setback we simply cannot predict this until there is a return to some stability in the markets. We do know that in direct marketing we saw some impact in the third quarter and that we will be impacted in the current quarter. Our expectation is that the environment will certainly continue into 2009. This external outlook dictates our internal response. We are aggressively reshaping and reducing our infrastructure costs to reflect reduced levels of economic activity. And we will relentlessly focus on flawlessly delivering our products and services to continue to provide value to our customers. Doug will now give you some more detail on our results, Doug.

Thank you, Dean, didn't morning. Here is a Company-wide overview for the third quarter. Revenue decreased 5.9% for the quarter with an increase in revenues for direct marketer and decrease in revenue for Shoppers, decreased marketing revenue increase 0.7% and Shoppers revenue decreased 17.1%.

Moving to operating income, it decreased 21.9% for the quarter. The quarter direct marketing had an operating income decrease of 3.9% while Shoppers declined 58.6%, direct marketing operating margin was 14.5%, and Shoppers operating margin was 8.5% for the third quarter. Our free cash flow was $22.3 million versus $25.6 million in the third quarter of 2007. We spent $4.1 million in capital expenditures compared to $6.6 million in the third quarter of 2007.

Turning to our two businesses. For the third quarter of 2008 our direct marketing revenue increased 0.7% and operating income decreased 3.9%, resulting in an operating income margin of 14.5% for the third quarter of 2008 which is a decrease compared to an operating margin of 15.2% for the third quarter of 2007. In the third quarter our retail VAR -- vertical represented 26% of direct marketing revenue, high tech telecom was 26%, select markets were 22%, financial was 16% and healthcare pharma-was 10%.

Our top 25 direct marketing customers represented approximately 43% of direct marketing revenue in the third quarter. Our largest customer in the quarter represented almost 8% of our total direct marketing revenue.

Turning to Shoppers. Our third quarter total revenue decreased by 17.1%, about 0.5% of the revenue decrease was attributable to abandoning circulation of approximately 250,000 in August. Operating income for the quarter declined to 8.5% as compared to 17% for the third quarter of 2007. A decrease in operating income margin was primarily driven by 490 basis points increase in postage. Since postal costs are directly tied to circulation the increase is a result of declining revenues, a slight decrease in circulation compared to the third quarter of 2007.

Next we should alert you to a calendar change for Shoppers impacting the fourth quarter of 2008. Shoppers is published every Tuesday and therefore we will have one extra week of publication in the fourth quarter. Unfortunately due to the timing of the extra week being around Christmas and the new years holidays, the expected revenue impact will be much lower than our average weekly revenues and the operating income generated is expected to be minimal.

Our third quarter effective tax rate was 39.6% compared to 39.8% in the third quarter of 2007. On the balance sheet at September 30, we were showing a debt balance of $295.5 million, and a cash balance of $23.8 million, for a net debt balance of $271.7 million, compared to a net debt became of $286.4 million at June 30. Net accounts receivables were $178.1 million versus $199.2 million at December 31, 2007. Days outstanding at the end of September was 61 days consistent with our days sales outstanding at the end of June.

In the second quarter earnings call we stated our stock repurchase activity would be dependent on the deteriorating economy and credit markets. Both further deteriorated during the third quarter. We did not repurchase any stock. During the first nine months of 2008 we have spent $76.6 million on stock repurchases compared to $121.6 million in the first nine months of 2007. We have reduced our net debt by $14.7 million during the quarter and ended the quarter with a leverage ratio of 1.7 times. We currently have $110 million available under our revolver. Our balance sheet remains conservatively leveraged with strong free cash flow giving us good flexibility. With that, operator, we will turn the call over for questions.

(OPERATOR INSTRUCTIONS) Our first question comes from Matt Chesler, Deutsche Bank.

Good morning. You commented that you saw some impact in the third quarter and then continuing into the fourth quarter. Can you give us some more commentary on the progression of the trends that you are seeing in your businesses as the months rolled on throughout the third quarter?

Matt, no, but I think you can say that September 15, which is the day that I believe is the day that Lehman Brothers filed for bankruptcy and Banc of America announced that it had taken over Merrill Lynch I think was a seminal date in the quarter. I think from that date forward with some of our financial customers we saw very erratic volumes on a going forward basis with a lot of our retail customers we saw increasing caution about their outlook for the fourth quarter. So this is relatively new. It's less than five or six weeks old. So I don't think I can give you any, quote progressive trends throughout the quarter other than we have seen volumes and events not roll-out as anticipated and volumes decline.

Okay. If you would just talk about your historical experience with the business, as you approach the fourth quarter in a typical fourth quarter, in generality is there a sense of, how much of a revenue in a given quarter, particularly the fourth quarter, is what someone might consider to be known revenue? And how much of the revenue base might be subject to project related work that comes and goes in any normal quarter? And also is related to work that you might expect to pick up as the quarter progresses?

Let me try to answer that. In terms of the project related, I mean I think part of the problem is what's the definitional. I mean, we do a series of projects for our customers and we've been doing them for some of these customers for 20 years. So for retailers as an example our historical fourth quarter experience is that we end up with more money spent by retailers than we quote, have known going into the fourth quarter. It's been an historical trend and it's based on the behavior of retailers to adjust their plans on a real time basis during the holidays. We are certainly not seeing that as much this year. We are not seeing incremental retail dollars being spent yet and we are already into, toward the end of October. So that is change from what we've seen in the past. We are not, this is not about customers going away and this is not about customers shutting down but a lot of what we do is volume based. And volumes are down.

Is there any, in this environment what can you say about the nature of the type of work that you are doing for your clients and how that's changing as they confront their new realities? Any differences in services that you're providing that are worth noting?

No. Again, it's not a people leaving one service and going to another or leaving one service for another.

It's hard to follow you replacing the highest priority on deleveraging in this current environment but where your leverage is at and where your stock is at don't you view this as a historic opportunity to buy back some shares?

Matt, I think we view this as an historic time.

Indeed, we are in historic times. But just one final housecleaning, how much did Mason Zimbler contribute to direct marketing growth in the quarter?

Mason Zimbler was a little bit over a point of growth. So it was all of our growth in the quarter.

So hence that explains why you describe your growth as flat?

I'm sorry, Matt, I can't?

That explains why you describe your direct marketing growth as flat?

Well, 0.7% I think is what we reported. We describe that as flat whether it came from acquisition or organic.

All right. Thanks, Dean.

Our next question comes from Troy Mastin, William Blair & Company.

Thank you, good morning. A question about the production and distribution expenses, the costs were up fairly substantially as a percentage of revenue and I'm curious if there was anything abnormal in there, if there is a heavy energy related component that might go down in time or is this primarily just the effect of high fixed costs?

I don't think necessarily you can tie it to quote, energy pricing. I think more is postage is part of in that line. Our outsource services to the extent we outsource some services for capacity and specialty stuff is in that line and a lot of costs were increasing. Transportation is in that line. And that despite our labor line which we dropped during the quarter and our SG&A line which we dropped in the quarter the production line did actually increase.

Is this a line item you can have effect on in the intermediate term but it's really difficult to effect in the very short term like a quarter?

Well, it also depends on revenue distribution because some of the revenue that we produce, depends, has a larger production component and some of the revenue we produce has a larger labor component. Some of what you are seeing in that line is some of that being revenue distribution. So it looks perhaps the increase looks bigger than if all the revenue had been the same distribution throughout the period of time you are looking at.

Okay. A question on the direct marketing business. Has there been any effect in the quarter or do you see any effect in the very near term due to any bankruptcies, reorganizations, consolidations that have occurred in financial services or retail or other industry's for that matter?

Yes. I mean our bad debt and right off associated with those type of events in the quarter, if we had not had those we would have improved margin in direct marketing. We have had retail customers who have filed for Chapter Eleven and are now in the process of liquidating. And we believe that with the outlook for the fourth quarter in the retail, for retail sales, we have a lot of retail customers. It would not surprise us that if the fourth quarter is as soft as people are saying it's going to be with retailers some of our existing customers may have trouble as we move into the first and second quarter of 2009.

Can you quantify the effect that those had on your costs in terms of bad debt or whatever else we should quantify?

Well, I think, I mean, I think I gave you an indicator that our margins would have gone up if we hadn't had that. So I mean I think what we are down about $1 million in operating income in the quarter on $1 million of revenue growth. So you can say it was definitely a seven figure impact, more than a seven figure impact in Q3.

Okay. And then is there, in the Shoppers business if you think about your mix of clients I'm sure some categories are very weak, certainly real estate I think would be in that group and I'm sure some other categories are relatively strong have you done some sort of mix analysis that might tell you that there's a floor somewhere, if you let the mix trends run out that we would potentially bottom at current trends in the next several quarters or next year or something along those lines?

Well, I think you are exactly right, we certainly have categories of mortgage brokers as an example that can't decline any more because we don't have any revenue, no, we have $1.98 of revenue a week or something like that. So there are certain categories that have been hurting us that have reached virtually zero so we are not going to suffer on a going forward basis those trends. So that gives us some comfort and hope that we are going to start seeing stability in the revenues but I do have to say that if consumer spending has seized up which everything we read and says consumer spending has fallen off a cliff that ultimately impacts our advertisers in Shoppers. We haven't seen it yet but we are going to -- we do look at external data to try to judge what our business is going to be like and a shut down in consumer spending will not help us.

Okay. If you look at that mix in Shoppers, were you maybe tracking towards before September 15, that stabilization point and do you have an idea where maybe that stabilization point might have been had we not hit September 15?

I can't speculate on that, Troy, I really couldn't.

Finally on Shoppers, what's your opportunity or willingness to take further steps on circulation from this point?

It has always been a consideration. We will continue to look at it and look at it very closely obviously as revenues continues to decline. Areas that were once profitable become less profitable and maybe even drop below profitability. We have strong fundamental franchises and have a strong believe that this is an effective medium that we will, that this will pass in these markets and so we are not going to damage our franchise to save $1 million. But we will take a very close look at circulation and we have continued to trim circulation and I expect that we will take more of a scalpel than a hatchet.

Okay. Good. Thanks.

Our next question comes from Alexia Quadrani, JPMorgan. Your line is open.

Thanks, this is [Townsend Buckles] for Alexia. I have a few questions, first in direct marketing can you talk about what drove the strong growth in select verticals and how auto fit into that and where you are seeing declines in the pharma-healthcare and is that something you expect to continue?

In the select group, automotive was one of the big drivers of that. Part of that was a new customer win for us that was significant. Remember, again, auto is a relatively small piece, I mean it's not even a third of the vertical itself. So, again, one customer win can drive some very good growth in that. But auto was the driver of that increase for us. There was, we have some travel and leisure which is a pretty small piece, that was an increase for us in that.

In terms of healthcare and pharmaceutical, -- healthcare continues to be the larger decline within that vertical. Those are really two very different businesses. I mean, they are similar obviously to put into a similar vertical but the pharmaceutical customers are manufacturers of drugs, or marketers of drugs. And the healthcare customers that we have are principally healthcare organizations that have members. And so what you're doing are pretty different things and the healthcare piece of that vertical has been hurt more. Part of that I think is we described last quarter, some of the healthcare plans that people had out there they were actually losing money every time they got a member so they stopped member marketing.

In the pharmaceutical group, look at the front page of the Wall Street Journal today. A large pharmaceutical company, Merck, announced a 28% profit decline and they are laying off 12% of their workforce. These are our customers.

In the auto win, is that a longer term client or is that sort of a one off project?

No, it's not a one off project. It's a new client relationship that we would expect would continue.

Okay. And then I guess can we expect further substantial cost cutting initiatives, I guess probably in the layoff category particularly and direct marketing if you are beginning to see a prolonged downturn in the business? And on the Shoppers side outside of trimming circulation further is there room to cut more or are you sort of getting closer to the bone at this point?

Well, Townsend, I just want to repeat what I said we are aggressively reshaping and reducing our infrastructure costs. So, yes, we will adjust our costs based on the level of economic activity we see, circulation is one area that we will look at in Shoppers. There are other areas available. I mean, our, quote, are we getting closer to the bone? Well, that is, I can't remember the word but that's logically true if you cut before and you cut again you get closer to the bone.

Just finally, you do have a strong balance sheet and positive free cash flow. Can we assume that your dividend is in great shape for next year going forward?

No. I don't think -- we consider the dividend on, pretty much on an annual basis toward the end of the year and we will consider that again and we always take all kinds of factors into effect. I have no comment on that. We have no plans at this point to do anything different than what we've done.

Okay. Thank you.

Our next question comes from Dan Leben, Robert W. Baird.

Great, thanks, good morning. You mentioned the September 15, as being kind of the seminal event when things slowed down. Kind of a very similar situation where we had the last time we were going into a recession in 2001 with 911 and just looking back at the growth rates in the direct marketing business kind of fell off about 10% from June to December. Is that the kind of environment we can think about the current environment in the same type of context or have there been some fundamental changes in the business that make it less cyclical from that point?

Dan, I think as I've said in the press release or as we said in the press release and in my prepared comments, anything I told you would be pure speculation and guess.

I guess I'm trying to get a sense of, are there ways the business has changed, different verticals you've gotten into or anything within the mix that make the business different than that last cycle?

Well, there are a couple of things, I think. We are a larger Company in terms of revenue and probably a little bit more diverse in terms of revenue, in terms of the distribution of revenue throughout our verticals. So I think that would be a good thing compared to 2001. I believe that we have seen a change in the advertising environment where measurable advertising, measurable media such as our direct marketing business and even our Shoppers business is more favored than traditional mass media. Therefore if people are going to cut they are going to be less likely to cut programs that have a measurable ROI So I think that's a favorable trend. So we think that.

And to be quite honest, we had revenue growth in the first two quarters and I think the last quarter of 2007, I mean, while September 15, was a seminal event the economic pressure has been here longer than that and our revenue is holding up very good. So that gave us proof points to the hypothetical that people are going to spend with measurable media where they are seeing an ROI. So we believe that people understand that better today than they did in September. So we think that's a positive event.

Okay. Great. I was just out at the DMA trade show last week and one of the things that came out of there is a theme we are hearing from some retailers in advance of what they thought was going to be a pretty awful Christmas season had actually done some things to pull some mailings and some spending forward into the third quarter, try and get out and get into customers wallets a little bit earlier and try and gain share that way. Did you see any of that in the direct marketing business?

No.

Okay. Then one last question, just on the paper cost side, and are you getting any relief here from falling gas prices, Canadian dollars plummeting below $0.80 today, any help there as we look out into '09?

The predictions and expectations were for significant paper price increase. I would have to believe that to the extent that was true that it's less true today given what's going to happen with demand. So I think, I guess our expectation is we were looking at some pretty hefty increases in paper rates. I think our expectation now is that those, if there is an increase at all it will not be significant. But again it's a little early to know. The mills are still trying to push through rate increases.

Thanks, guys.

Our next question comes from Dan Salmon, BMO.

Good morning, guys. Most of my questions have been covered so just maybe two quickies. In the tech vertical I know in the past that that's been seeing some nice growth from a handful of sort of five or six main clients and leveled off this quarter. Can you comment if that was across the board in that category or maybe if that was focused on a couple of clients?

It was, actually it was in the driver of the lower rate was in our telecommunications part of that vertical and that was more a client specific as opposed to anything across the board. The high tech piece maintains some respectable growth.

Okay. That's helpful. And then, Doug, maybe can you just remind us of any of the relevant covenants for the credit facility or for the term loan?

Yes, there's two covenant. One is a leverage and the other is interest. The leverage ratio of the covenant is three times, or 1.7. So there's plenty of flexibility there. And the interest coverage is not even close. You got to exceed 2.75 and we are like 12.7, 12.8. So plenty of flexibility in addition to the revolvers almost fully available.

That's great. Thank you.

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

Thank you very much. Thanks for taking the question. I just want to go back real quick. In terms of that auto win, I know that up until now you have not focused on foreign manufacturers. Was the recent win a foreign manufacturer or was it still domestic?

Mike, good to hear you. You missed our last call.

I'm back.

You're back. Well, let me, I remember Richard and I had a comical exchange about this in front of all of you about a year ago, maybe two years ago. Our automobile customers are almost exclusively, I think that's right, foreign manufacturers but we do marketing for them in the United States.

Okay.

And the win, again, fits in that category, a foreign manufacturer to be their marketing partner in the United States.

Okay. Perfect. Just following-up on that I know that direct marketing business was or has been extremely fragmented with a lot of mom and pops. Do you think this cycle might shake out a number of those to a point where you emerge a little stronger and potentially capture some share? And in particular to this recent win, was just wondering if it was a Company getting out of the business or just been able to support the client, what was the reason, how did you capture this client?

It wasn't a result of a customer, excuse me, a vendor disappearing from that client. That wasn't why we won; if that was your question.

Okay.

I think it was more maybe a new initiative for that customer that we were in front of them and won. And I'm sorry, I just drew a blank, what was your first question?

I was just talking about the shake out, in the past Michael, we saw a number of shake outs in the industry here.

I think we are seeing that both in the Shoppers side of the business where a lot of rack products and kind of mailers and things like that, we are seeing exit the market and I think for sure you are going to see the same thing happening on the direct marketing side. It is a very fragmented business. We are a brand name within the direct marketing business. We are known for our strength. The positive side we are seeing here is we are having our customers and other customers approach us because they are concerned about their vendors and they have comfort and faith in our name that given our financial strength that we are a safe place.

It could be a contra event here where we see, quote, people talk about flight to safety, we are that safe bet in this environment. Or viewed as that safe bet among our customers. So we have, we are not rolling up the awnings or anything. We are still aggressively doing business but we just have to be realistic about, unfortunately I read the paper every day and I watch TV and you just need to be realistic about economic activity.

In terms of the Shoppers, was California weaker than Florida or the decline in, was pretty much across the board? And I mean of course excluding the distribution adjustments that you made? And was the distribution adjust, was that more in California than Florida?

The circulation I believe was more in California than it was in Florida as a percentage of circuit may have been about the same, I think, probably, because again, we have 80% of our circulation in California and 20% in Florida, roughly. And the, if you look at some of the newspaper results, [McClapia] as an example released yesterday or the day before and they break out their revenue by geography and Florida was worse this quarter for them and from a revenue perspective than California was. And I think we are seeing the same thing. Some of that may be seasonal. I mean, there were a couple of expected hurricanes in Florida that actually came over here to Texas instead. But that did impact revenue. But I think we are seeing, I would say that Florida is today softer than California.

Right. What is the total distribution in California at this time?

I think it is slightly under $10 million.

Okay. It seems like--?

Or right at $10 million.

It seems like you scaled back capital expenditures. Any update on the CapEx for the fourth quarter or possibly thoughts on 2009?

I would expect given the environment that we will, we will be watching. We typically always watch capital but that we will reduce capital spending on a going forward basis.

Would the third quarter be a good run rate for the fourth quarter or is it, you think you might cut it further?

Given the timing of when you order equipment and when you pay for it and those a kinds of things, it's hard to say on a quarter to quarter basis. I think generally if you look at our capital expectation of around, what $30 million this year and about $30 million last year that we will come in for the year less than $30 million this year and we will spend well less than $30 million in 2009.

Okay. Perfect. Thanks much. Appreciate it.

Our next question comes from Andrew Cash, Point Clear Value Management.

Hello, I was wondering if you could explain the reasons behind the payroll reduction costs? Was it headcount, hourly reduction or was there something else there?

It was -- I'm sorry, it was driven by, you're talking about the labor line?

The payroll line was down 8% in third quarter versus year ago. Excuse me.

It was a combination of headcount reductions and to the extent we have variable compensation based on performance, it was also, that was lower this period than a year ago.

Going forward do you have some flexibility in terms of being able to pull those levers some more?

Yes.

Would hourly reduction be something that's easy for you to get your hands on versus headcount reduction so you don't have to--?

What reduction, I'm sorry?

Hourly reductions, time spent during the week?

It's different depending on the businesses. We have, Shoppers probably has a larger percentage of hourly workers where you can adjust shifts and cut back shifts and things like that than does direct marketing. So there is some availability there but if, that is not a primary driver of when the labor, on the labor line. We manage that always based on volumes.

The other question I had has to do with, was there any severance or restructuring charges, or unusual charges you had to take in the third quarter and do you expect any going forward that are related to your cost reduction efforts?

We certainly had, there was severance expense in the quarter. And we would anticipate that we will have some expense going forward based on reshaping and reducing the size of our infrastructure.

Can you say if it was a significant number, was it $0.01 was it $0.05?

In the quarter?

Yes.

It wasn't, it certainly wasn't $0.05.

Okay. Thank you very much.

We have no further questions. I would now like to turn the call back over to Mr. Blythe for closing comments.

Appreciate it, thank you all very much and we look forward to speaking to you again in the future. Good bye.

That does conclude today's conference. Thank you for participating. You may disconnect at this time