Harte Hanks Inc (HHS) 2010 Q3 法說會逐字稿

Welcome and thank you for joining the third-quarter 2010 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. Larry Franklin, President and CEO of Harte-Hanks. You may begin.

Good morning. On the call with me today is Doug Shepard, our Executive Vice President and Chief Financial Officer; Robert Munden, Senior Vice President, General Counsel; Jessica Huff, Vice President of Finance and Controller; and also Gary Skidmore, EVP and President of Harte-Hanks Direct Marketing.

Robert has a voice problem today, so I am going to read this exciting text. Our call may include forward-looking statements. Examples may include statements about our strategies, initiatives, business plans, adjustments to our cost structure, financial outlook, capital resources, competitive factors, business and industry expectations, legal settlements, the economic downturn in the US 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 SEC and the cautionary statements 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 Harte-Hanks.com.

Okay, about our performance, I am really pleased with our third-quarter results, which includes 3.5% revenue growth, our first revenue growth since Q1 2007. Operating income increased 4.8% and earnings per share, $0.22, was flat with 2009. And in the 2010 earnings per share, there is a $1.4 million currency loss and a 5% increase in the tax rate. And Doug will talk more about those in his comments. We finished the quarter with $76.3 million in cash and that is after the Information Arts acquisition.

Looking at the two businesses, first, Direct Marketing. Direct Marketing at 7.3% revenue growth and an operating income decline of 4% in the third quarter. Toward the end of the quarter, one of our large, long-term pharma customers had a voluntary product recall and selected us to execute the fulfillment of all of their consumer communications. This nonrecurring project accounted for approximately 60% of our revenue growth in the quarter and again, Doug will talk in more detail about the impact of this project on our overall results.

In the quarter, we continued to strengthen our insight in multichannel and direct and digital capabilities. An example of this is our acquisition of Information Arts. Information Arts provides Harte-Hanks in Europe with the experienced strategists who can apply data-driven insight to enhance the marketing campaigns of existing customers to make multichannel marketing a reality.

Information Arts also has a strong data management practice that incorporates Trillium to provide best-of-breed data quality. And they have a strong customer base, which includes Vodafone, Cisco and Shell. This provides the opportunity for us to sell them other Harte-Hanks solutions.

During the last quarter's earnings call, we told you about the new customer insight team that we are building under the leadership of Jeff Simpson, our Senior Vice President of Direct Marketing. During the third quarter, we refined the process and tools that we are using to provide our customers greater insight to their customers and their multichannel marketing efforts.

One example of this is Momentium, an online assessment tool that provides our customers a score to evaluate their multichannel marketing efforts against the best-in-class companies in their industry. Momentium was developed using data from our retail practice at the Aberdeen Group, which, as you know, is a Harte-Hanks company. We launched Momentium this month at an industry conference and already have a number of companies engaged in the process. After a company completes the Momentium process, we can then build a multichannel roadmap, which we can help implement. This creates new revenues for our customers and opportunities for Harte-Hanks.

At our agencies, we are continuing to add social, mobile and other digital strategists, account planners, digital developers, account managers, creative staff to develop and deliver digital assignments and to onboard recent new wins. In the quarter, we won 15 new digital deals, 10 of which were with existing and very important clients. As you know, many of these are not large revenue deals, but they are very important to the long-term relationships with our customers. And as our customers add spending for different channels, this provides the opportunity for us to grow the accounts.

Some of these new hires are necessarily ahead of the revenue stream. We will be adding additional resources to product and solution management, which will allow us to more quickly and consistently deliver solutions to clients, which will help in selling and onboarding.

Another example of investing during the quarter, we developed [Quickstart], which is a solution that provides accurate and efficient collection of customer information necessary to create a single customer view. As its name implies, Quickstart can be implemented rapidly and without a large capital investment, while delivering powerful insight into our customers and their buying behaviors and enabling multichannel marketing. Many of our new database customers start with Quickstart while the database is being built.

During the quarter, we also released a new Trillium software version and the Basel III application, a new technology database and [RM Select], which is the digital preference portal, allowing our customers to individually tailor digital marketing for each of their customers.

We are also creating new ways to go to market with a more integrated solutions approach, using all the capabilities we have across our Company. As most of you know, we have a broad range of what we believe are unique assets, including the Trillium software, Aberdeen Group, the agency inside Harte-Hanks for B2B customers, Mason Zimbler for B2B and for -- and now Information Arts. These capabilities, coupled with our best-in-breed traditional services, we believe, gives us an opportunity to deliver on our customer insight-driven multichannel direct and digital solutions approach.

While we are very excited about the progress we are making, it has broad implications for our people structure and investment in each and very importantly, it takes time. We are committed to executing against this plan simply because we are convinced and our customers are confirming that their success will be determined not only by how good their tools are, but how well we help them use the tools to analyze and understand the connection with their customers, including their shopping and purchasing behavior across all channels.

With this said, there continues to be uncertainty about the general business environment, which is why we are cautious about revenue over the next few quarters even though we expect to have growth.

Now for Shoppers, the third quarter was another excellent Shopper performance, 4.2% revenue decline, our lowest in many quarters and $1.9 million OI improvement. We had another good quarter in distribution accounts, which generally are our larger accounts. These accounts performed better than Shoppers overall. Account penetration is improving in California and Florida, but revenue per account is still down, which we believe is a strong indication of the uncertainty these small and midsized businesses face. Account penetration has been and will continue to be a key focus for us going forward.

Looking at revenue from the more important industry SIC codes we serve, real estate continues to be a significant challenge with the decline in the third quarter, the worst in four quarters and I believe reflects the reality in the housing market.

In the services area, we saw the best overall growth in several quarters, primarily driven by health services from both new and existing customers. Educational services had continued growth, but at a lower rate than the previous quarter and personal services continued to decline in the double-digit rate.

This was the second consecutive quarter that consumer spending categories were worse than the previous quarter. Automotive improved for the second consecutive quarter with growth in Q3. Communications continues to do very well. In Q3, we again made outstanding progress in all areas of our digital initiative -- account growth, increased penetration of our print advertisers, increased revenue, product improvement with new features and new services, some of which are mentioned in the highlighted section.

We have been aggressively investing in digital during 2010 and while the 2011 plan is not completely finalized, we have an even more aggressive plan for 2011, both in terms of additional people and product development.

A couple of points about some costs for Shoppers. The PRC did not approve the USPS request for a one-time 5.6% increase in postage in January 2011. And while this decision will be appealed, industry analysts say we should plan on a small CPI increase in May. And as I think most of you know, postage is about 35% of our cost.

Paper prices are increasing and will result in slightly higher expense in Q4 after having reductions in expenses in the previous three quarters. Paper is about 8% of our cost and some of our heat set printing that we don't print is also influenced by paper cost and that is about 6% of our total cost. The full effect of the price increases will not be felt until 2011 because of the inventory levels. 2011, we think the paper prices could be up 15%, plus or minus.

While we are excited about the future of our Shoppers, we are painfully aware that the economic climates in California and Florida are not getting better with unemployment in California remaining over 12% and Florida over 11%, and there is little, if any, encouraging news in the real estate markets and the states have serious budget deficit issues, particularly California.

In conclusion, our leadership focuses on investing in both of these businesses while at the same time carefully managing everything that we do, always looking for ways to make the businesses more efficient while providing more value to our customers. We are committed to doing just that and I am confident that we will be successful. Doug?

Thank you, Larry and good morning. Here is a Company-wide overview of the third quarter. Consolidated revenues increased 3.5% for the quarter to $216.7 million. Direct Marketing increased 7.3% for the quarter and Shoppers decreased 4.2%. Consolidated operating income increased 4.8% for the quarter to $25.1 million. Direct Marketing operating income declined 4% while Shoppers increased 58.4%. Consolidated operating income margin increased to 11.6% for the quarter versus 11.4% last year. For the quarter, our free cash flow was $15.9 million versus $18.7 million in 2009. We ended the quarter with $4.4 million in capital expenditures compared to the $3.5 million spent in 2009.

Turning to the businesses. In the quarter, Direct Marketing revenue increased 7.3% and operating income decreased 4%, resulting in an operating income margin of 15.2% compared to 17% in the third quarter of 2009. As we have previously mentioned, about 60% of the revenue increase is due to the one-time project for a long-standing customer involving consumer communications related to a voluntary recall.

Operating income decreased due to higher mail supply chain costs and higher outsource costs. Profitability related to the one-time project was below the average operating margin for Direct Marketing.

On August 31, we closed on one acquisition. Information Arts will add about 1% to 2% total Direct Marketing revenues on an annual basis and its profit profile is in line with the rest of our Direct Marketing portfolio.

Our retail vertical market represented 27% of Direct Marketing revenue. High-tech telecom markets were 25%. Select markets were 22%. Financials 12% and healthcare/pharma was 14%. Our top 25 Direct Marketing customers were up, Technical difficulty 36% of Direct Marketing revenue and our largest customer represented approximately 7% of revenues.

Shoppers third-quarter revenue decreased by 4.2% and operating income increased 58.4%, resulting in an operating income margin of 8% compared to 4.9% in the third quarter of 2009. This was Shoppers best revenue performance since the first quarter of 2007. Revenues were positive in the communications, automotive and services sectors. These were offset by declining performances in the real estate, grocery and restaurant sectors.

Our third-quarter effective tax rate was 38.7%, which was higher than the 2009 third-quarter rate of 33.2%. In 2009, we settled a state tax dispute, which resulted in a lower-than-ordinary quarterly effective tax rate. As a reminder, our fourth-quarter 2009 effective tax rate was also lower than normal due to state tax issues and that will not repeat in 2010. For the full year, we still expect our effective tax rate to be approximately 37% to 38%.

Below operating income, we incurred a $1.4 million loss related to foreign currency translations in the quarter due to the dollar weakening against the euro and pound.

On the balance sheet, net accounts receivable were $149.8 million versus $140.1 million at December 31, 2009. Days sales outstanding at the end of September was 63 days compared to 59 days outstanding at June 2010 and 57 days outstanding at September 2009.

At September 30, we have a total debt balance of $206.5 million compared to $239.7 million at the end of 2009. Our net debt balance was $130.2 million versus $153.1 million at December 31, a reduction of almost $23 million.

During the quarter, we replaced our expiring revolver with a $70 million facility. When our 10-Q is filed on Monday, you will note we have negative working capital due to the maturity of one of our term loan facilities in September 2011. Our current plans are to pay that obligation with our existing cash on hand, our unused revolver facility and cash generated over the next 12 months. We ended the quarter with a cash balance of $76.3 million. With that, operator, we will turn the call over for questions.

(Operator Instructions). Dan Salmon, BMO Capital Markets.

Hi, guys. Thanks for taking the question. Larry, I wanted to ask a little bit more about the details on client penetration and revenue per client in the Shoppers business. You mentioned that penetration is good, but that revenue per client is still coming down. You spoke obviously about the economic situation there and particularly related to the housing situation. But I guess what gives you confidence that the weakness there in revenue per client is just economic versus perhaps competitive threats?

Well, that's a good question. If you look at the customer base and the consistency of that base over many years, including even in this economic recession that we have been in for the last few years out there, the customers -- what we track is how much revenue per add we get. We are with those people, with our field sale force every single week and so we have some real-time insight into where they are spending their money and how much money they have to spend.

And so I don't believe that the continuing decline -- I think it is more out of the uncertainty of what is going to happen to their business in January if they have increased taxes and what is going to happen to insurance. And those are the things that we hear when we talk directly with our clients.

Now could there be some competitive change in the landscape? Possibly, but what I am really talking about here are the small to midsized businesses. These are the people that are marketing with multiple zones, obviously or single zones around locations and to targeted groups based on the products that they are selling. So we have some pretty good insight, market insight, again, just based on the fact that we are there every week. And I don't think that is so much the issue as just the general climate.

Okay, and then just one follow-up on the real estate.

And the fact that we are -- we are increasing the account penetration, so we are selling to more businesses each and every week. It is just --

Okay. And then just a question on the real estate element to that business. In particular, obviously, I think what took place there through the past decade was relatively unprecedented. And so when you look ahead to that sort of core vertical for the next few years, even with some assumption for an economic stabilization and hopefully some type of recovery, is it fair to say that that business, from real estate in particular, may not come back to the levels where it once was simply because it was a bit of a one-time bubble in that business?

I think that is absolutely the case, but what I would add to that is, when I say the real estate market, I am talking about a lot of the peripheral services that go with that. It is the painters and the plumbers and the roofers and the patio people, pools, etc.

Now, in that bubble that you talked about, a big piece of our revenue was from mortgage brokers and that is obviously gone or basically gone. And I certainly don't see that we are going to be -- I guess this was -- I don't remember if it was '07 or '08 in February where we had 20 houses in Mission Viejo, I think it was, over $2 million advertised. We don't have many of those today. So I don't think it is going to come back to the same level, but I think when people have the resources to spend, they will start spending it on painting, on furniture replacement, on that category, I believe.

Okay, great. That's helpful detail. Thanks.

[Will Sleyboss], Stephens.

Thanks for taking my questions. Regarding Direct Marketing, the pharma, retail and high-tech seem to be growing along nicely there. Is there any indication from just conversations with clients what it will take to get these financial services guys to be moving in the same direction and maybe kind of how far out that might be?

Well, the pharma results -- I mean the outstanding pharma result in this quarter was primarily from the one-time or the nonrecurring large project that we mentioned that occurred. That was the voluntary recall by one of the pharma clients. But it is still a good question in that we are seeing -- in the financial markets, we had some good, although it is a very small vertical for us now, we had some good growth in the credit card. Mutual funds had very good growth. Retail bank was about flat. Diversified finance was down and that was generally from one account that dealt with student loans and then we have a small insurance vertical in the financial segment and that was down. That was from a loss of one account.

But that segment, we are seeing a little bit of increased volume. Gary, do you want to add anything?

The credit card mailers are back, especially the really large providers in that category. And we are seeing a lot of increased volume, as well as we are seeing a lot of agency activity and multichannel activity across the large brands that cover mortgage, credit card, retail banking. So we have excellent activity there.

Great, thanks. And on that multichannel [conversation] there, just broadly speaking, can you give us some sort of sense of what percent of your client base you would consider truly multichannel today versus where you think that can go maybe in the next couple of years and more or less kind of gauge that opportunity for you?

Well, there are very few -- well, all of our customers buy every service that is included in that multichannel diagram that we use. Very few, if any, buy them all from us. Our objective is to move them from the left side, which is a single point solution purchase, toward the right side and add additional services. And with our customer base, there is a lot of potential there.

We have found that when we go to market with a multichannel integrated solution that that is the time to really sell and get the buy-in to the multichannel approach. As opposed to some of our existing clients with our more traditional services, that takes a little longer. Gary, do you got --?

The multichannel opportunity is an enormous challenge for CMOs of all of our clients. That creates opportunity for us. That is why we created an assessment tool, Momentium, that helps our customers know how they are performing against best-in-class in their industry. All of our largest customers -- in fact, all of our customers have a lot of interest in getting help about how to engage multiple channels in their marketing efforts. It is a great opportunity for us.

Great, thanks.

Alexia Quadrani, JPMorgan.

Thank you. A couple of questions. First, I want to follow up on your comments about the profitability of that one-time project in the Direct Marketing business. In the quarter, you mentioned it was below average. Any more color you can give us on that just to get a better sense of how the underlying profitability of that business was doing and your core business was doing. And then I guess any color on that about how it would trend in the fourth quarter. Should the profitability be depressed by that project again in Q4 or were the costs maybe front-end loaded and therefore you won't have the same impact in Q4?

The reason why it was below normal margins, or our average Direct Marketing margins, this was really an FDA or government-required communication that had to occur in a certain manner. Therefore, the type of thing that occurred, the type of services that we were hired to do just simply was not the higher type margin stuff that we normally perform. It was below our what I call our average Direct Marketing OI performance, but it wasn't a huge variance either, but it was definitely below it. As we evaluate it for the fourth-quarter impact and what has happened, it is going to be about the same size in revenue and about the same margin impact.

Okay, thank you. And on the Shopper business, jumping there for a second, I know you probably don't have great visibility into Q4, but from what you're seeing, is that sort of a lessening of the declines that we saw in Q3, does that trend continue or is it continuing into Q4?

I don't expect it to.

Okay.

I don't expect it to.

But it is not necessarily getting worse?

Well, if it is not going to decline --

I mean it could stabilize (inaudible) I guess (inaudible).

It is plus or minus a percent or two.

Okay, okay.

Again, keep in mind, as you said, visibility is a difficult thing when you are dealing with that many customers, but that is where our expectations are at the moment.

Okay. And then just two other small ones.

And also, Alexia, I am sorry to interrupt you, but the fourth quarter I think -- isn't that our smallest?

Revenue-wise because of two holidays --

Yes.

-- it is a low-volume quarter for Shoppers.

Okay, that is good to know. And just sort of two housekeeping questions. The tax rate, any sense what we should expect for 2011 and then any thoughts on use of cash into next year?

Right now, we are not ready to deal with the tax rate for '11 because, like so many other companies, 30 days from now, we are hoping there is a lot more visibility than there is right now. In general, I think most people are expecting state tax rates to go up a tad, but we will see how that all works out.

The cash use right now and cash plans, there are no changes that are planned for now. We are sitting on a large amount, like I previously commented. We have our term facilities coming up in the fall of '11 and then another balloon payment in the spring of '12. We have our revolver, which is untapped. It gives us a lot of flexibility. We can meet those term maturities with a decent amount of comfort. Yet, at the same time, all the liquidity that we have out there allows us to be flexible and take care of opportunities as they arise.

Okay, thank you.

Dan Leben, Robert W. Baird.

Great, thank you. Just to clarify on the 4Q guidance you had in the press release of operating income up slightly, is that excluding the charge or on the $26.8 million base roughly or is that the GAAP number of $19.8 million?

That is the GAAP.

Okay, great. And then in the Direct Marketing business, was there any contribution from Information Arts to speak of in the quarter?

No, because we only owned them for 30 days and as you are aware, you have got to expense acquisition charges, etc. now immediately. So totally immaterial.

Okay. And then in the Direct Marketing business, retail was an area of relative strength. Is that Modell's and the other client you mentioned in the press release coming in or was there something else happening?

No, it was in our department stores. Really that is our big and successful category, so that was really good performance. And it is the best actual retail performance we have had in a number of quarters. But no, that was not the new business. That was our existing businesses or clients, existing clients.

Okay, great. And then last one from me, you talked about educational being an area of relative strength in Shoppers lately. Help us understand what the exposure is there and if you have seen any changes given what is going on in the kind of for-profit education space.

It is actually -- it is still positive, but it is not as positive as it was. And it is not a huge vertical, but when people are not employed and they started going back to school and some of that has obviously abated over the last several months, but it is still positive compared to the same quarter last year, but not at the rate that it was.

(inaudible). To give you a feel, it has had strong growth, but it is less than 10% of Shoppers total revenues.

Okay. And have you heard anything directionally from those companies that have talked a lot about kind of changing their models and they are not sure exactly how to move going forward? Have you got any indications of any changes coming there or is Shoppers still a pretty good medium for them to advertise?

Well, Shoppers is a wonderful medium for them to advertise again because of the targeting around campuses and that sort of thing. So we have heard nothing that would make us think they are going to change the way they go to market.

Great, thanks, guys.

Michael Kupinski, Noble Financial.

Thank you for taking the questions. Just want to drill down a little bit on the Direct Marketing one more time. If I look at that and factor out the acquisition of Information Arts and as well as the special project, did core Direct Marketing revenues, was that up like 2% then?

Close to 3%.

Closer to 3%? Okay. And then in terms of how -- if we look at the core revenues going to the fourth quarter, any thoughts about how core revenues are looking into the fourth quarter?

They are about the same.

About the same in terms of 3%? Okay.

Plus or minus, you know how.

Okay. And then how much of the increase in production and distribution expense is in the third quarter? How much of that increase was related to whether it be the acquisition or related to this special project?

The majority of it was the special project.

Okay. And then in terms of the Shoppers, as you look next year -- Larry, you mentioned the added expenses and I know that you guys just really cut a lot of expenses out of the Shoppers business. Is there anything left in that business where you can cut to kind of maintain your margins that have been slightly improving here?

The answer is that there is always a way to look at how you do business differently. Now when you have, as you point out, have made the changes that we have made, then there is certainly not anywhere near that number left. But when we are talking about these cost increases, my guess is that there will be some negative effect on the margin over the next few quarters, but we will still, I think, do reasonably well there.

And just going back to the Direct Marketing one more time --

And again, I called out I think the percent of our expenses that were attributable to those two cost items that I mentioned. And as I said, we don't have our plans finalized for 2011, but we are going to continue aggressively invest in the digital part of that business because it is working.

Okay, fair enough. And going back to Direct Marketing one more time, in terms of looking at that core revenue growth, typically you guys have kind of spent in advance of kind of seeing the revenues because there is usually some upfront loaded costs in some of these contracts that you get. Are we starting to see that now in terms of the third quarter, fourth quarter aside from the special project that you just had? But I am just looking at it from more of the core revenue growth perspective. Are we seeing some added costs just built in right now because of these contracts that are coming forward -- going forward?

It's is a number of things, but you have hit the point there because if you look at the third quarter of last year, our margins in Direct Marketing I believe was 17%. That was the highest third-quarter margins we have had in at least since 2000. So just as in these investments we are making where we are hiring ahead of some of the revenue streams, when we saw what was happening to revenue in late '08, early '09, then we very quickly addressed the cost structure that had been built up over a period of revenue growth. And we said last year, you can't keep doing that.

In fact, the 15.2% margin for the current quarter I think is -- well, it is obviously less than the 17% last year, but it was more than '07, more than '08 and I think about the same as '07 and a little more than '06, 0-6 I'm talking about here.

So there is still -- and I also want to emphasize, as we continue to pursue this whole multichannel digital initiative, we are going to incur some costs in how we go to market. We are going to continue to do -- I think I mentioned in my remarks about product development. Those have high returns, but you have got to do it first. And that was an example of Momentium and Quickstart and some of those sorts of things. So there is a whole confluence of things happening here that makes it a little difficult to sort out, but we think -- well, we know we are going in the right direction because our clients are telling us that.

Thanks for that color, by the way. But it is interesting that your payroll expenses actually came in line with my number, even though while you overachieved on the Direct Marketing revenues. And I am just kind of curious, as we look to the fourth quarter, I would have expected that you might be hiring a little bit more additionally there and trying to kind of support these new contracts that you are winning. What are your thoughts about the payroll expenses going to the fourth quarter?

Doug can talk about that, but one of the things about this one-time project is that that occurred -- I think it is over, isn't it?

It is done.

It is done.

It is done now.

So that occurred in less than a month and that obviously influenced the level of the revenue that we are comparing those costs against. But I don't know about Q4.

I mean we don't normally talk about individual line items, but we will here a little bit in that the Q4 labor, and yes, you are correct, it should reflect some of these investments, etc. that we have made in people that we are making ahead of some of the contracts that we are signing. So yes, it should be slightly up over the third quarter of 2010.

Okay, great. All right, thank you, guys. I appreciate it.

(Operator Instructions). Ed Atorino, Benchmark.

My question was answered, thanks.

Actually, at this time, we are showing no questions. I would now like to turn the call back over to Mr. Larry Franklin for closing comments. Go ahead, sir.

Thank you very much for the interest in the Company and for the questions and we look forward to communicating with you through the quarter and at the end of the year. Thanks a lot.

Thank you for your participation in today's conference. This concludes the presentation. You may disconnect at this time.