Harte Hanks Inc (HHS) 2010 Q4 法說會逐字稿

Welcome anti- three for joining the fourth quarter 2010 earnings call. (Operator Instructions)I will turn the meeting over to Mr. Larry Franklin, President and CEO of Harte-Hanks.

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 our Vice President of Finance and Controller, and also on the phone is Gary Skidmore, who is President of Harte-Hanks Direct Marketing. Before I begin my remarks, Robert will make a few comments.

Thanks, Larry. 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 of the United States and other economies and other statements that are not historical facts. Actual results may defer materially from those projected or implied by 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 earning release. Our call may also include non-GAAP financial measures. Please refer to today's earning 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 turn to call back over to Larry.

Our fourth quarter was outstanding. Our revenue grew 8.5%; operating income up 26.6%; net income up 15.7%, and earnings per share up 14.3%. We had a much stronger top and bottom line than we anticipated when we were discussing our third-quarter results with you back in October. Both Doug and I will provide some color on that when we talk about the two individual businesses. First, let me talk about direct marketing. I am very pleased with our Direct Marketing fourth-quarter revenue performance. As we said in the release about half of the 14.2% increase was from the one-time project in pharma, which was more than we had expected as Doug indicated in the press release.

We also had strong performance in our software and data businesses. Trillium, our Data Quality Software Company, had it largest revenue quarter in history. We also had terrific growth in our B2C agency, which is the agency inside Harte-Hanks, and Mason Zimbler our B2B digital agency. As we said in Q3, we are adding people in our agencies to develop and deliver digital solutions and to onboard those that we have already won. We sold approximately 20 new digital projects this past quarter. Most of those were to existing clients.

As we have said, most are not big dollar deals but very important to the long-term relationship, so that as dollars are reallocated to different channels, we will get those dollars. A couple of these projects are listed in the highlighted section of the press release. We continue to add additional resources to product management, which will allow us to more quickly and consistently deliver solutions to our clients. These also help in the sales process and on boarding. Examples of some recent new products are Quickstart and Momentium, which I described in our last earnings call. We are continuing to add people to our Customer Insight teams. We continue to evolve the way we go to market with a more integrated solutions approach using all of the capabilities we had with all of the capabilities we have.

For our B2B customers we leverage; Aberdeen; Mason Zimbler; Information Arts, and Market Intelligence. For our B2C customers, the agency inside Harte-Hanks integrates all we have to offer these customers. Database services and Trillium our core offerings that we provide for both B2B and a B2C customers. We believe coupling these more digital capabilities with our best of breed traditional services gives us a unique opportunity to deliver on our insight-driven, multi-channel direct and digital solutions approach. There are also examples of these in the highlights section. We are excited about the progress we made and are making, but we know there is a lot more to be done.

Direct Marketing operating income declined 3.7% in the quarter resulting in 15.4% operating income margins for Q4, 2010. That compared to 18.3% in Q4 of 2009. The Q4 2009 margin was our highest quarterly-margin percentage since 2000 and was in the face of revenue declines. About 2.5% of the margin percentage decline in the quarter was from incentive compensation resulting from the strong fourth-quarter results. As we said in the press release, we are very pleased with this fourth-quarter revenue performance, but do not expect that level of growth over the next few quarters. We do, however, expect to see margin improvement during 2011. Doug will have some additional details in his comments.

Looking at Shoppers, Shoppers had good performance in Q4, although the 5% revenue decline was larger than the 4.2% revenue decline in Q3. Operating income was $900,000, down $700,000 from Q4 of 2009, after eliminating the $6.95 million legal settlement in 2009. We had an outstanding profit performance for the year with $10 million increase in operating income. That is after adjusting for the legal disputes that I just mentioned. Account penetration is improving in California and Florida, with California performing better than Florida. But revenue per account is still down.

Account penetration has been and will continue to be a key area of focus for us. Looking at revenue from the more important industry SIC codes we serve real estate continues to be a significant challenge with no real sign of improvement. In the services area, we saw the best overall growth in several quarters, primarily driven by health services and from both new and existing customers. Educational services have continued growth, but at a slightly lower rate. Personal services continue to decline, again, although at a slightly lower rate.

Consumer spending categories continues to be difficult; furniture and groceries were down, with retail basically flat and improving. Automotive was down slightly. Communications continued to do very well. In our first-quarter call for 2010, we talked about two large accounts that had been spending at accelerated levels. These two accounts are still very good customers, but in the first part of 2011, they are not spending at the rates that they were in the 2010 first quarter.

In Q4, we made outstanding progress in all areas of our digital initiatives. We have exceeded 6000 PowerSites per week, which is a 58% increase since the beginning of 2010. 61% of our territory accounts buy Power Sites each week and that is up 34% from the beginning of the year. And 41% of our commercial accounts are PowerSite customers as well.

Additionally we continue to make product improvements and with new features. We have been aggressively investing in digital and our Shopper business during 2010, and we have an even more aggressive plan for 2011 both in terms of new people and product development. We have a very strong team leading this initiative and are making great progress. As we look to 2011 for Shoppers, we expect the economic environment to remain difficult. Unemployment levels did not change appreciably in California and Florida in 2010, and we do not expect significant improvements for 2011.

We will be facing increased costs in paper and postage, postage in the April/May time frame and we will continue to execute the digital strategy, drive account penetration and look for ways to increase efficiency in all of our production processes and the way we run our business. Our leadership challenge is to invest in each of these businesses at the same time that we are carefully managing everything that we do. I am confident our people are capable and committed to doing just that and I am excited about 2011. Doug?

Here is a Company-wide overview of the fourth-quarter and full-year 2010. Consolidated revenues increased 8.5% for the quarter and was flat for the year. Direct Marketing increased 14.2% and 2.6% for the year. Shoppers decreased 5% for the quarter and 5.4% for the year. Consolidated operating income increased 26.6% for the quarter and 10.5% for the year. For the quarter, Direct Marketing declined 3.7% while Shoppers increased $6.3 million. For the year, Direct Marketing decreased 9.5% and Shoppers increased $17 million.

Excluding last year's fourth-quarter $6.95 million legal settlement, Harte-Hanks' operating income would have decreased 6.2% for the quarter and increased 1.9% for the year. Excluding the same legal settlement, Shoppers' operating income would have decreased $700,000 for the quarter and increased $10 million for the year. For the quarter, our free cash flow was $17.3 million versus $19.2 million in 2009. For the year, free cash flow was $62 million as compared to $71.3 million in 2009. We ended the year with $17.5 million in capital expenditures, $8.5 million more than the $9 million spent in 2009. For 2011, we expect our capital spending to be, approximately $20 million.

Turning to the two businesses. In the quarter, Direct Marketing revenue increased 14.2% and operating income decreased 3.7%, resulting in an operating income margin of 15.4%, compared to a record margin of 18.3% in the 2009 fourth quarter. For the year, operating income margin finished at 14.4%, a decrease from the 2009 margin of 16.4%. About 50% of the revenue increase is due to the one-time project for a long-standing customer involving consumer communications related to a voluntary recall. The revenue related to this project was larger in the fourth quarter than what we communicated in the third quarter earnings call, because the client decided late in the fourth quarter to distribute more communications than originally planned. Our increase in production and distribution cost is largely due to this event. The margin decline was primarily driven by additional incentive compensation expense, continuing investment in project management and insights staff, and an increase in our mail supply chain expense.

In the quarter, our retail vertical market represented 27% of Direct Marketing revenue. High-tech was 26%, select markets were 20%, helathcare/pharma was 15%, and financial was 12%. For the year, high-tech telecom represented 27% of Direct Marketing revenues, retail was 26%, financial was 13%, select markets 21%, and healthcare/pharma, 13%. Our top 25 Direct Marketing customers represented 48% of direct marketing revenue for the quarter and 43% for the year.

Shoppers fourth-quarter revenue decreased 5% and 5.4% for the year. Shoppers operating income for the quarter decreased $6.3 million to 1.4% as compared to 2.5% for the prior year quarter adjusted for the 2009 fourth-quarter legal settlement. For the year, operating income was 6%, as compared to 2% in 2009, adjusted for the 2009 fourth-quarter legal settlement. Revenues were positive in the health and educational service sectors and were offset by negative performances in real estate, grocery and automotive.

Our fourth-quarter effective tax rate was 34.6%, which was higher than the 2009 fourth-quarter effective tax rate of 28.2%. Lower state taxes in 2009 drove the increase. Our 2010 effective tax rate was 37.9%, compared to 33.7% for 2009. The rate increase is primarily due to favorable state tax settlements we received in 2009. For 2011, we expect our effective tax rate to be approximately 37% to 38%. On the balance sheet, net-accounts receivables were $151 million versus $140.1 million at year-end 2009. Day sales outstanding at the end of December was 59 days, identical to December of 2009.

At December 31, we reduced our total-debt balance by $46.7 million to $193 million, compared to $239.7 million at the end of 2009. Our net-debt balance was $107 million versus $153.1 million at 12/31/09, a reduction of $46.1 million. We currently have $70 million available under our revolver, excluding outstanding layers of credit in addition to a cash balance of $86 million at the end of the year. With that, operator, we will turn the call over to questions.

(Operator Instructions)Will Slabaugh, from Stephens, Inc.

Congratulations on the quarter there. Curious on the one-time client, can we expect that that is going to be wrapped up and no more revenues from there going forward? Do you expect some of that to drag into 1Q?

The project we are talking about is complete now, right?

It is.

They are an ongoing client, absolutely. Long-term client.

The voluntary recall they had to do -- volunteered to do is over with.

On the labor costs going forward, can we expect that incentive comp to stay at an elevated level as, you talked about, as revenues continue to increase here? And then, how much of that pickup, sequentially, in labor, can we contribute to hiring verses an increase in incentive comp?

The first part of the question about will it continue at that rate, no, unless there is a big move in performance towards the end of next year or during the year. It was driven by the fourth quarter increase, primarily in revenue, but also in some of our businesses and profits, as well. The other question about how much of the sequential increase is hiring versus the incentive comp. We continue to manage the overall payroll level, if not down reasonably flat, although as the environment improves, there is more dollars attributed to increases. And, we are, as I said a number of times, we are adding people in those selected areas. But it would be more from the increase -- what was the labor for the quarter? What was that up in total?

It was up over fourth quarter last year -- the fourth quarter last year was up $8 million.

It would be hiring and the sequential -- the increase in the comps.

Okay. And then in the other category you guys show some nice growth there of 14%. I wonder if you could break out what that was, what went on there, and what were the strengths in that vertical?

Select markets?

Right, in the select markets.

We have strong growth in our automotive category. We have some very strong customers there that are not domestic customers that we do work in the US and our business services category also grew very nicely during the quarter.

Lastly, kind of housekeeping here, what was the contribution from Information Arts for the quarter?

We do not usually disclose that. The revenue is in the 1% to 2% range of the $175 million that Direct Marketing did for the quarter and from a profitability standpoint, it is in line with the total Direct Marketing business.

Great. Thank you, guys.

Alexia Quadrani, JPMorgan Chase & Co.

Larry, I was hoping you could give us more color on the Shoppers revenue decline in the quarter? You gave us a bunch of examples of verticals or segments that, the way I scribbled it down, tend to be less bad or stabilizing. I am wondering what got incrementally worse in the quarter because the comparisons do not look that much different than the previous quarter, yet the decline seemed a bit weaker.

When we had this conversation back in the third quarter when you asked me if I thought the sequential quarterly declines would continue to be less, and I said I did not think so in the fourth quarter, and no, the 5% is not as much as I had thought that it would be. It is close and in line. I think the answer to the question is why is it continuing at that level. It is spread across those categories that I mentioned where we e are selling -- we are being successful in selling additional accounts. The key comment that I made was that still, today, the newer accounts are buying at a lower-revenue per ad than what we have experienced in the past, and in fact it's still declining. Each ad that we sell is less revenue, just not declining as much as it had in the previous quarters. The fact that we are selling -- increase in the number of ads, those come on, generally, at a lower rate than what the existing advertisers are buying. So, it is a dampening effect on the revenue.

Should we assume -- I know it is January, or the first of February, early in the year, but you, obviously, are budgeting as well. Should we assume a single digit decline in 2011 in terms of the Shoppers revenue?

What?

Would a low single-digit decline be an appropriate starting point for the Shoppers revenue in 2011?

For there not being a lot of viability, that's probably not a bad place to start, I guess.

Then just on the direct marketing side, I think you mentioned in your comments that you should see margin improvement in 2011. Did you mean for the full year, year-over-year or at some time during the year.

During the year. We want to improve margins during the year.

They will not, necessarily beat last year's margins, obviously, which were so high?

No.

Okay. Thank you.

Dan Leben, from Robert W. Baird.

Just to follow-up on Alexia's question on the Shoppers business, is it just pure pricing with the new customers that is a problem, or are they selecting less appealing locations of ads, deeper in the pages? Talk us through the dynamics of what is going on there.

The real value to our Shoppers business is the way that you can buy the ads, depending on what your market is, where your customers are. They can buy more zones, less zones. They can buy larger ads, smaller ads. They can buy combinations of advertisements. Example, an eight page ad in a small flyer to supplement that ad, and what has happened over the last three to, years, is that they are buying either lesser, smaller ads. Whereas, in the past when business was good if you had a three location serving shop, you would advertise heavily in your direct market and you would send some into the adjacent zones.

That is not happening as much, obviously, as it did in the past. The combination of size -- frequency is not as big of an issue. Obviously, with the combination of the in-book advertising and the PowerSites, which have the tracking numbers on them, it is really easy to demonstrate to the advertiser where the business is coming from and what is working and what is not. The answer is that it is buying down and generally a lower cirque. We are talking about for the in-book advertising, the ROP?

That is helpful. Then on the direct marketing business, some nice growth in the agency and Trillium and some of those other areas. Can you give us an update on what the mix of the business looks like in direct marketing now with some of the growth in those areas?

You mean by service line?

Yes.

There is no substantial change between what we've talked about in traditional versus nontraditional and the software. Obviously, in this quarter there's a couple points change, but nothing material--.

If you look at the more digital parts of the product line, when you talk about agency and also the Trilliums, andAberdeens, and those, and the digital projects that we mentioned, that segment of the business is growing at about twice the rate of the more traditional services. Now, that is not the case when we have that one project, which was -- that drove the big revenue increase. That is primarily fulfillment, where we are communicating directly with their customers. I am not putting that into the mix when I say they are growing at twice that rate. The rate of growth is higher in the more digital areas.

Okay. So just--?

We have really good growth in the agency part and then in the Trillium and the related service offerings there.

Excluding the one-time project, is it safe to assume that every business within Direct Marketing grew year-over-year in the fourth quarter?

In the fourth quarter? Mail was either flat or maybe down a percent. Other than that, yes.

Thanks.

Thank you. Michael Kupinski, Noble financial.

Thank you and congrats on your quarter. The pacing of the Direct Marketing business in the first quarter, is it continuing on the pace as the fourth quarter ex the one-time special project? You had mentioned that you're certainly not going to grow where you were going to grow in the fourth quarter at 14%, but exing out that nonrecurring special item, are we looking at more high single digital type of growth, or more midsingle digits or what is it looking like in that Direct Marketing?

When I was saying that we do not expect that level of growth for the next few quarters that was after exing out the one-time. So no, it is not pacing it at the level of revenue ex the one-time.

The CapEx Outlook for 2011 of $20 million. That's still at an elevated level relative to your prior years. Can you break out the CapEx between the two divisions and any color on how that money is going to be spent?

It is not different from what has traditionally happened in a majority of that number, simply because of the buzz between the two businesses will go to Direct Marketing. There our investments in Shoppers. It has increased a little bit over last year. That is mainly to support the additional digital initiatives that we have going out there and supporting the website and the new features, et cetera that are in the plans for 2011.

And at this time, Doug, not adding any distribution in Shoppers, correct?

Right.

In the Shoppers, in terms of the distribution year-over-year in the fourth quarter what were the changes? Were there any changes in the year-over-year distribution?

No, nothing appreciable.

Certainly not then from the third quarter then?

Correct.

Does the Company need to make acquisitions in Direct Marketing business for any digital enabling or does the Company have the tools to do it yourself? I am mostly interested in, are your customers pushing more aggressively for any capability that you may or may not currently have or maybe the staff too and ability to do yourself at this point?

We have a broad array of partner relationships that in the short-term that can combine with our existing capabilities. I don't know, Gary, that is not a competitive disadvantage at all.

We meet the service requirements of our customers, the capabilities. We are not lacking in what they want us to do. The acquisition might help us go faster. We are not getting customers--.

We see a lot of acquisitions and deals. There is a high level of deal flow. We are trying to figure out how they support what we do at a reasonable price is sometimes a little difficult.

Still throwing up a lot of free cash flow here, the best uses of your cash at this point, what are your plans?

The immediate need is our current facilities are coming up. A big chunk of it in September and then the remainder in March of '11. That is the first priority, and we will deal with that, part of that would be with our existing cash. We will be in a better position to make some future plans, et cetera after we have dealt with the renewal of those terms facilities. In addition, don't forget we just increased our dividends.

Right, Doug. As soon as you finalize your plans for your financing at this point, what is your best thought at how you plan to capitalize the Company?

We have all of the traditional ways to do it. Certainly, we can support debt because we have great cash flows. We will be putting together a more detailed plan, as Doug said, over the next several months here is what our thoughts are on the best way to use the cash in the short-to-intermediate term.

Assuming that you do refinance, you have a big cash balance. Are you contemplating any types of share repurchase, stock buyback, or special dividend? What are your thoughts?

Again, we would have the flexibility to do any of those. We have not discussed, recently, any of those, right?

No.

Fair enough. Thanks, guys.

Thank you.

Dan Salmon, from BMO Capital Markets.

Good morning, guys. Two questions. One on Direct Marketing and one on Shoppers. You mentioned in the press release in the highlights, a couple things that bounced out to me were some compliance work on Basel II compliance measures for financial institutions and heard a little bit about that business from companies in the IT services area recently, but not so much out of the traditional database marketing. Is that an area where you expect to see more business? Do you see a different set of competitors there? I would just like to hear a little bit more about it.

Is being driven by our Trillium software capabilities and it is a great opportunity for us. The two institutions that we helped with that issue in the fourth quarter are among the world's largest financial institutions and we do expect that there is more opportunity there. But is driven by our Trillium software capability not a database marketing capability.

Do you tend to see a bit different competitive set there, than in maybe some of your broader assignments that do bring in the database and agency services more?

It is a combination of both software and consulting services. We do see some different competition, but the need for data quality to address those issues gives you the same players.

Then, just on the Shoppers side, we have had some questions about the revenue and I just wanted to ask a bit more about the costs. It sounds like -- you mentioned postage and paper, specifically. It sounds like a larger footprint of advertisers, it sounds like sales costs will be a little bit more difficult to manage, as well, for your own sales force. When you are looking at that this year and trying to maintain margins on some revenue that you think may be down a little bit, what are some of the techniques you are going to try to look at to maintain it?

It is a good question on both parts. Let me take them one at a time here. On the cost side, the paper cost, when we've have had over the last couple of years, we have had very favorable, we and everybody else that uses paper have had a very favorable pricing situation. That is going up. Now, paper is 10%, 12% of our--.

Yes (inaudible).

--of our cost. But still, when it was down 10% and it is going to be up mid teens, or down 5% and up midteens, then it makes a difference. On the postage side, this is a hard one to say. It is nothing like what we thought we were going to be talking about at this point in time. That simply didn't increase; they didn't add the 5% that they were talking about doing. It is probably somewhere between 1.5% and maybe 1.7%, and we are expecting it sometime in April/May is about right. Now, with those and when you have the economies that we are in, i.e., California, Florida, you have a little bit of maybe 1%, where you can get some of that back with price. You just have got headwinds. The selling expense part of the question, that one is not a -- our cost of sale -- our commission costs and selling costs, it will not go up. We will manage that one well.

That is really helpful. Thanks.

Ed Atorino, Benchmark.

Hello?

Hey, Ed.

I was going to ask about pricing in the Shoppers. It sounds like it isn't so much a rate issue, as sort of, let's call it mix of business that is resulting in the lower revenue per unit, whatever you call it, is that correct?

That is correct. When you look at the territory revenue, pricing is competitive. It is competitive and aggressive.

That's it.

Okay.

Thanks.

Will Slabaugh, Stephens Inc.

Just a quick follow-up here. I want to dig a little more on the digital side of Shoppers and trying to get a better feel for how big of a driver that piece is. Can you give us any sense of if that business is north of 5% of the segment revenues or so, and any sense growth would be helpful as well.

Which piece of the revenue?

The digital side of Shoppers.

Okay, digital. We will get to the point where we will tell you how much it is, but we are not there.

Okay.

It is growing, nicely. It is significant, and we are investing in it. We are investing very aggressively. We are able, with the people that we have running that, we manage those investments for speed to market, but also to build the solid business as we are doing. Today, it is less than 5% of our revenue.

Great. Thank you.

(Operator Instructions)Alexia Quadrani, JPMorgan Chase & Co.

Hi, Larry, I wanted to follow up on the Shoppers business with one more question. You talked a little about your expectations for this year on the cost side and the top line. How do you view the longer term profitability of the business? Obviously, we are not assuming it will get back to where it was, but do you feel that over time in a better economy, we can see a good margin in this business return? And then secondly, on the same topic, any changes in the competitive environment since before this cycle started, or is it really a question of the cyclical environment?

The answer to the first question is in a different economic environment, can we get the business back to a reasonable and good profit level? The answer is, yes. As you and I have had this conversation a number of times, it would have to be a very different environment for it to get back where it was. That is just not the way advertising and marketing is done today.

On the change in the competitive environment, the newspapers -- we used to think a lot about them in certain categories. Not that we do not think about them today, but they are not as big a piece by any means of the competitive environment as they used to be. There are fewer of the specialty publications that are out there that used to be a niche when it was high glossy real estate and cars and those sorts of things. That is down a little bit.

The basic fundamentals of how a -- the way we do Shopper businesses is, our primary customer is that small, medium-sized one-to-several location advertisers. We are extremely effective against those accounts. The franchise kinds of accounts where there are ways that you can segment their stores and provide the footprint that we can provide to them, plus the combination of the in-book advertising with the inserts into the book, couple that with the local of the digital space -- extremely effective. Very competitive when you start talking about covering very, very large geography.

Thank you, very much.

You bet.

Thank you. I am showing no other questions at this time. I would now like to turn the call back over to Mr. Larry Franklin for closing remarks.

Thank you, very much. We really do appreciate your interest in our Company and the questions that you ask. It makes us better. We appreciate that. To all of our people, we had a good 2010. Now we got to chalk up another one in 2011. Thanks .

That concludes today's conference.