Harte Hanks Inc (HHS) 2011 Q2 法說會逐字稿

Welcome and thank you for joining the second quarter 2011 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. I'll turn the meeting over to Mr. Larry Franklin, President and CEO of Harte-Hanks. Sir, you may begin.

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

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

Thanks, Larry. 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, legal settlements, the economic downturn in the United States 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 filings 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 Harte-Hanks.com. I will now turn the call back over to Larry.

Thank you. Quarter two was an extremely important quarter, in many respects and very busy. Before we talk about those items, the results -- revenue was up 2.6%. Operating income was down 26%, net income down 29%, earnings per share down 28%; that was reported $0.21 last year versus the $0.15 the share. The $0.15 this year included a net $2.8 million Shoppers charge that we said would be coming on this call back into the end of Q1.

If you eliminate these charges, which we will discuss in detail later, our earnings per share would have been $0.18 rather than the $0.15 we reported. I will talk about the two businesses; and when I finish, then Doug will add some additional comments.

First, Direct Marketing -- our Direct Marketing business had very good revenue growth, up 8.4%, our fourth consecutive quarter of growth. Direct Marketing income was up 1.8%, our best growth in several quarters.

I'm please, obviously, extremely pleased with the revenue performance. And again, we had very strong performance from Trillium Software, which Gartner just announced as a leader in the data quality software space. In our earnings release, in the highlights section we also noted several significant wins in the quarter. Our Trillium team continues to add new capabilities to the Trillium Software System, which makes us the best choice for global data quality.

Also, our three agencies, The Agency Inside Harte-Hanks, which is our B2C agency; Mason Zimbler UK, Mason Zimbler US, our B2B digital agencies, all had great quarters. Most of our agency customers engage us to help them with multi-channel programs. For example, during the quarter, our three agencies worked on 37 new digital projects in addition to our ongoing digital and off-line work. And a good sign is that the average revenue from these engagements continues to grow. And in fact, digital revenue for the quarter increased 18% over last year.

Also, our mail business had good growth in the quarter, and that was on the strength of retail and the financial verticals. We had -- four of the five vertical markets that we serve showed growth. Doug will add some details on that. And let me just add a little color as well.

The financial performance was driven by our credit card and diversified financial services customers with growth in Trillium and direct mail. Retail, which includes consumer markets, was driven by the growth of our department store specialty retail customers and growth in database mail and contact centers. Select markets, which includes automotive, business services, energy and manufacturing -- we had growth in each of those markets with increased spending in our agencies database and contact centers.

The decline in tech, which was mid-single digits, was driven by the reduction in spending of one of our largest tech contact center customers, which continues to be one of our largest tech customers. That was in part offset by very good growth from agency and database customers, and much of the growth in tech is global growth.

The investments that we are making in multi-channel are showing good results, as are the momentum in quick start solutions that we released over the past few quarters. This quarter we mentioned in the press release that we released Demand Curve, which is our solution for the tech market. Demand Curve leverages the capabilities of our insight team. It leverages Mason Zimbler, our installed tech database, which is CiTDB; our Aberdeen content and our call center team. Demand Curve helps our tech clients increase demand for their products through multi-channel communications with their most qualified prospects. And during the quarter we had 13 engagements for Demand Curve.

We had 1.8% operating growth, as I mentioned. There were three factors that negatively affected our margins there, and I will go through these. Doug will add a little more context. In Europe we integrated our tech data base business with Information Arts, the database analytics company that we acquired last year. This effort will help us be more competitive in the European B2B data business and will improve our global database marketing capability.

In the first quarter highlights, we announced a new relationship with Barnes & Noble. In the highlights section in this report, the second quarter. We're announcing an expansion of that relationship in additional products and service lines related to their e-reader device resulting in some additional contact center cost as this and another new client wraps up.

We are incurring expense to increase our capacity and improve processes in our database marketing business. This is helping us respond better to needs of new customers and meet the demand for new customers, including global database customers.

We're pleased with the progress that we are making on multiple fronts, and we are confident that the steps being taken will support continued revenue growth and improving profits.

On the Q1 call, we said that we believed our Direct Marketing margins would improve throughout the year and for the year would be slightly better than in 2010. We now believe that our margins for 2011 will be slightly below 2010.

Turning now to Shoppers, for Shoppers revenue of $60.3 million for the quarter was down 9.5%, about the same as the first quarter decline. OI for the quarter was a loss of $1,118,000 compared to a profit of $5,275,000 last year in the same quarter. Eliminating the effect of the net $2.8 million of charges, there would have been a profit of $1,682,000 in quarter two.

Before adding more detail about the performance in the quarter, let me talk a little bit about the leadership transition that is underway. Pete Gorman has been a terrific leader for our Shoppers business since 1996. He has also been a terrific partner and a friend, and he and I are very excited about the team that will lead to Shoppers in the next era. As we stated in the highlights section of the release, these are all veterans with our Company. They are uniquely qualified for their roles, having operated in all different economic climates and through our evolution to becoming the largest prepublication in North America.

Mike Paulsin is President of Shoppers, [Warren Dalton] is Senior Vice President of Sales and Marketing for the California Shoppers, in addition to being President of the Shoppers digital business; Carlos Guzman, President of Florida shoppers. And [So Young Park], in her expanded role of Executive Vice President and General Manager for the digital business -- this is a very talented leadership team. While none of us underestimate the size of the challenges ahead and that we will miss Pete, our business is in good hands.

Now some additional details on the charges. In the press release, we said we incurred $3.3 million of charges related to our efforts to reduce expense through, primarily, organizational restructuring and staff reductions. These charges consist of severance, including [VIEF] and miscellaneous facility reductions from consolidations of some operational functions that we mentioned on our Q1 call. The charges are reduced by an expected refund of $500,000 related to the fourth quarter of 2009 legal settlement.

The annualized savings from the $3.3 million of charges will be somewhere between $7 million and $8 million. Some of the savings will begin to be realized immediately, while the majority of the savings will be realized during late third quarter and fourth quarters, as we continue to consolidate work processes and various functions. And specifically, the savings from consolidation will show up in improved labor and facilities cost as we reduce both fixed and variable headcount and minimize the need for facility space.

Not being able to predict the exact timing of some of these events makes it difficult to give guidance on Q3 and 4. However, the savings related to this $3.3 million will be, obviously, included in our 2012 performance that of the reduction that we actually realize in 2011. During the second half we are also completing some production systems development and installation that will lead to additional savings and will have some additional charges associated with them. We are making enormous progress to improve our Shoppers financial performance.

More discussion about the second quarter -- periodically, we are asked, are we anticipating circulation reductions? The answer has been and still is that we are not anticipating circulation reductions. In the last couple of days there has been a lot of press about the USPS closing facilities and possibly reducing service to five days a week. We certainly support their efforts to reduce cost and become more efficient.

Based on the information that we have today of these proposed changes, we do not expect any material impact on the delivery of our products. With that said, we continue to be thoughtful about rates, stability and service levels.

Now looking at the revenue from some of our important [SIC] codes, real estate continues with double-digit declines, but slightly less declined than the previous quarter. In the service area, where we have performed well, health services continues to be a bright spot, and educational services has been a good sector until last quarter, when it declined. And this quarter, the decline was at a slightly lower rate than the previous quarter. This is the fourth consecutive quarter that consumer spending categories declined from the previous quarter. Grocery showed the biggest decline, reflecting the loss of the large account that we mentioned last week. We recently won a large furniture retailer account, and we hope to turn this trend in subsequent quarters.

Retail showed good growth; automotive had good growth, driven by dealers. Communication was down for the first time in several quarters, in the first quarter of 2011, and the decline continued in the second quarter. The decline reflects a general reduction in spending and not loss of accounts. Just recently there has been some slight recovery in the communications category.

Distribution revenue declined at a much faster rate than book ROP revenue, reflecting loss of the grocery account. We have talked a number of times about our initiative to increase account penetration. In quarter two we saw a slight drop-off in the average weekly territory accounts compared to last year, although it is still up slightly. We also saw a slight improvement in the revenue per account, although revenue per account is still down from the same quarter of last year. These changes probably as a result of a small price increase that we implemented in the second quarter.

For inside sales, the performance against last year has been more challenging, since this is a group that primarily sells to real estate and real estate services companies. In the second quarter, the decline in average weekly accounts was flat with the decline in quarter one, and the decline in revenue per account improved a little bit from the decline in quarter one, although it is still slightly down from last year.

Consistent with recent trends, we experienced an increase in the mid teens in paper cost during the quarter. And, while the increase will continue in Q3 and 4, it will be at a slightly lower percentage increase.

Quarter 2, another important initiative has been and continues to be to expand our digital capabilities. In quarter two, we again had excellent results in these digital initiatives. The success of our PowerSites continued with weekly average sites hosted increasing to over 6500 per week, an increase of over 20% from the same quarter last year. We've completed development and will be introducing two new iPhone and Android apps to the marketplace in the coming months, and we will share details about those in subsequent quarters.

Our recently launched SaverTime site continues to show progress, but it's way too early to get into any of the details. We launched Free Friday weekly e-mail, SMS and blog announcements that has become our most popular and best performing e-mail campaign. Our mobile site traffic has surpassed the double-digit mark as a percent of overall PennySaverUSA.com, and there are several more exciting developments in the works. We remain committed and excited about our digital performance and the strategy that we are pursuing.

We do not expect to see any improvement in the economy in the near-term in California and Florida. Unemployment rates remain high in both states and have not improved. Obviously, this hurts the consumers for the small to medium-sized businesses that PennySaver targets. With the changes we're making and those being planned, we are building a very solid foundation for our Shopper business going forward.

Again, none of us underestimate the enormity of the job ahead, but I'm confident of this leadership group and our people's ability, dedication and determination to improving our financial performance in 2012. And I'm excited about our prospects. Doug?

Thank you, Larry, and good morning. Here's a Company-wide overview of the second quarter.

Consolidated revenues increased 2.6% for the quarter to $213 million. Direct Marketing increased 8.4% for the quarter, and Shoppers decreased 9.5%. Consolidated operating income decreased 26.7% in the quarter, $16.5 million. Direct Marketing operating income increased 1.8% while Shoppers decreased $6.4 million. Consolidated operating income margin declined to 7.8% for the quarter versus 10.9% last year.

For the quarter, our free cash flow was $8.8 million versus $15.4 million in 2010. We ended the quarter with $7 million in capital expenditures, $2.7 million more than the $4.3 million spent in 2010.

Turning to the businesses -- in the quarter, Direct Marketing revenue increased 8.4% and operating income increased 1.8%, resulting in an operating income margin of 13.3% compared to 14.2% in the second quarter of 2010.

Our margin declined is the result of three factors -- the consolidation of two international business units, added cost for new and growing contact center accounts and additional resources to increase our capacity and add processes in our data business to meet the needs of current and new customers. These three factors are worth about $1.5 million during the quarter. Our retail vertical represented 26% of Direct Marketing revenue. Select markets were 25%, high-tech was 24%, financial was 15% and healthcare was 10%. Our top 25 Direct Marketing customers represented 43% of Direct Marketing revenue, and our largest customer represented approximately 6% of our revenues.

Shoppers' first-quarter revenue decreased by 9.5%, and operating income decreased $6.4 million. We incurred $3.3 million of charges related to our efforts to reduce expenses through organizational restructuring and staff reductions. These charges consists of severance, including the Shoppers President retirement and miscellaneous facility reductions from consolidations of some operational functions we mentioned on the last call.

The charges are offset by an expected refund of $500,000 related to a fourth-quarter 2009 legal settlement. Adjusting for these charges would have resulted in operating income of $1.7 million and an operating margin of 2.8%. Revenues were positive in the retail and automotive sectors. These were offset a decline performances in real estate, grocery and consumer spending.

Second-quarter effective tax rate was 39.2%, which was slightly higher than the 2010 second quarter rate of 38.9%. Higher state taxes drove the increase. For the full year, we expect our effective tax rate to be approximately 39%.

On the balance sheet, we had accounts receivable for $147.2 million versus $142.9 million at March 31. Days sales outstanding at the end of June was 63 days compared to 65 days outstanding in March and 59 days outstanding in June of 2010.

At June 30 we reduced our total debt balance by $13.8 million to $165.5 million compared to $179.3 million at the end of March. We currently have $70 million available under our revolver excluding outstanding letters of credit in addition to a cash balance of $47.9 million at the end of the quarter. Our revolver also includes a $25 million accordion future. That consists of two term loan facilities, one that matures in September of this year and on that matures in March of 2012. We have been negotiating a new term facility and expect to have something to announce shortly.

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

(Operator instructions) Alexia Quadrani,

This is Townsend Buckles for Alexia with a few questions. First, on the revenue strength in Direct Marketing, can we assume this is mostly recurring type revenue that should continue in the second half?

Yes, yes. Whether it will -- we've got to remember, in the second half we had, in Q3 and Q4 last year, the nonrecurring or one-time, whatever we were calling it --

Special projects.

-- Special projects we will be coming against. But the revenue that we had, the majority of it is recurring revenue.

Okay, and then on the margin, looking into next year and beyond, do you see an ability for improvement where you could get back to maybe the 15% to 16% range you have seen in the past?

I don't know about the 15% to 16%. I hadn't focused on it, Townsend, really, but, yes.

I guess, just getting back to historical levels you have seen?

There are opportunities to improve margins, yes.

Okay. And then on the Shoppers side, on the restructuring, is there a strategy change implied at all with the new leadership that we could see perhaps in your sales or product strategy, or are your adjustments still very expense and cost focused?

Well, you know, I don't know that there will be any change in strategy on the sales side, other than the continued execution of the digital strategy, which is integrated with and supportive of and supported by the print side of the business. But we have the opportunity to -- I believe we have the opportunity to improve our sales performance over time.

And then, just lastly, has your longer-term commitment to Shoppers -- has it wavered at all, given the ongoing revenue challenges you're facing in that business and, as you have said, little hope for meaningful improvement for at least the rest of the year?

And the -- hope for improvement in the economy. And the answer is no; we are committed and we are working on it.

Is there a point at all in which you sort of wave the white flag on it?

Did you say will there be, or has there been?

Could there be a point, if, going even into 2012 and beyond, where you are just not seeing the revenue improvement that you would hope?

Yes. Could there be? I mean, if there were, we wouldn't be able to tell you, anyway.

Got it, thank you very much.

Michael Kupinski, Global Financial.

Turning back to Shoppers, Larry, I was just wondering, do you believe you finally have that business right-sized now, given the current revenue environment? And then, on that outlook, do you think the business has kind of stabilized now? Or do you think that -- to where, you know, we've kind of bottomed? Or -- I know that you didn't really give too much color on the revenue outlook. I was just wondering if you could talk a little bit about that.

And then are there other opportunities if, let's say, business does get a little bit worse that -- are there other opportunities for you to cut costs in Shoppers if things don't improve?

Well, there's -- you know, Mike, there's cost cutting and then there's efficiencies gained from doing things differently, which result in the same thing, meaning that you have lower cost to produce the ads, etc. And so one of the comments that I made was about the production systems and some of the consolidations of free press that we've mentioned in the past. There's still some of those opportunities there that will add to our efficiency in producing and delivering the products. So it's there.

Now, the other question, I guess, was about right-sizing based on the current level. There are a lot of moving parts in our Shopper operations today, just based on the actions that have been taken and that will be -- being implemented. Some obviously are already being implemented and have been concluded. But there are a lot of others that Mike and team and Pete and others are all working on that will be implemented over the next several months.

So there's a lot going on. And we continue and will continue to look for ways to be more efficient.

Larry, I was just wondering, on the Shoppers, obviously you have a number of digital initiatives in the Shoppers business. Any competitive threats from daily deals, like Groupon, anything like that, that you're hearing from some of your customers on that front?

No. On the -- to the print competitors, no. Obviously, there are some -- you know, when people spend money they have less money to spend. But Groupon, as successful as it is -- it's not one -- at this point, it's not one of our competitive threats that we believe is driving our business at the moment. But we do not take any competitor -- we take all competitors seriously, none of them lightly.

And, Mike, we have talked about in the past that a lot of this stuff, when you talk about the daily deals, that market has really expanded there. Everybody is running it -- newspapers, all sorts of people. And the cost to entry, the barriers to entry, are pretty low. So yes, it is a competitive place out there. But it's an alternative product that the customers that we target want.

Yes. We still believe that -- and, you know, while -- again, huge competitor, or huge companies. But we still believe that our competitive advantage is the intensely local nature of what we do in Shoppers.

And just one final question -- in terms of Direct Marketing, the visibility of your revenues -- obviously, you've shied away from giving us any particular guidance in the third quarter, which we are already in. And can you just talk little bit about, if you were to X out the pharmaceutical nonrecurring whatever you call that, again, like what you said last year -- can you talk a little bit about maybe the pace of revenues in the quarter? Any thoughts on that?

And I would assume that, given that you have such a high hurdle rate with that nonrecurring revenues in the fourth quarter, that revenues should be or could be down in that quarter? Is that correct?

We said last quarter and continue to believe that in the mid-single digit range is where our revenues are likely to be.

In what we would call organic.

Yes.

Without that project, mid-single digit type revenue growth.

So with that said, then the fourth quarter is -- I guess it could be, could be down slightly.

Yes, so, as it stands right now, it looks like the third quarter could be up very modestly in revenues and the fourth quarter would be down just a little bit so that you would still have some growth year-over-year?

With the size of the projects that they were in the third and fourth quarter, that sounds consistent with what we are saying, yes.

Right, okay, perfect, thank you so much.

Dan Salmon, BMO Capital Markets.

Doug, in the quarter you sort of reestablished a balance in free cash flow use of continuing to pay down some debt and also adding some share repurchase, as expected. Looking out at your capital structure right now and leverage sort of continuing to come down, what are -- maybe with a bit of a longer-term view in mind, how do you think about your capital structure and things like tax shielding through interest expense and whatnot, and where the right balance is for you going forward?

We have -- we are very much in the midst of redoing our credit agreement. And like I said in my remarks, I expect to have something soon to announce. And we can get into some very specific details after that announcement. But from a general perspective, we have tried to say or be consistent with we are comfortable, we believe, in a leverage ratio, debt to EBITDA in the 1 to 1.5 to 1 range.

So it kind of gives you a feel there. That gives us the ability, if we need to expand our debt or get cash, we also have our revolver that is unused right now with an accordion feature so that, if there is a need for acquisition, something sizable of that nature, we believe we can access cash and react quickly.

We have a long history, and we expect to continue that, of supporting shareholders. We increased our dividend in the first quarter. We have, even through the financial crisis of '08-'09, we did not reduce our dividend, we did not cut it. We kept it flat and have recently increased it. It has a nice yield on it at this point, and during the second quarter we announced that we would buy back 1 million shares of stock, and we executed and did that during the second quarter.

So, even when we get the credit agreement done, redone, etc., we have been shareholder-friendly, and we continue to expect to take those actions.

Should we expect another one of those sort of 1 million sort of in the quarter type buybacks in the third quarter and in the second half? Would you expect that sort of level to keep up?

There has been nothing talked about with the Board beyond what we executed in this quarter.

Okay, great, thanks guys.

(Operator instructions) [Dan Hershberger], Stephens Inc.

It's actually [Ben Hearnsberger], in for Carter Molloy. I was wondering if you would talk a little bit about the investment in digital and where you see that going forward. I know, last call, you mentioned it was just, I think, 5% of the Shoppers business. Maybe just kind of talk about your outlook there?

Why don't you talk about the level of digital in Direct Marketing revenue, where that is?

We have digital investments in both businesses, and the Direct Marketing and on the Shoppers side.

Right. Specifically -- sorry to interrupt. Specifically focusing on the Shoppers side, I'm sorry, I wasn't very clear.

Oh, okay, I'm sorry. On the Shoppers, we had a plan that we developed two years ago. That obviously was updated at the end of last year as a part of our planning process, and we are continuing to execute against the original plan saying that we are -- the commitments that we made to that strategy are being fulfilled. We had people involved in that, and we have added people. Sometimes you can't find the person you want, but our commitment is to continue to invest in the digital part of our Shopper business.

And on the percentage side of the segment, it was, I think, at 5% last quarter. Do you see that growing to, say, X number by next year? Do you have some kind of color on that?

No, not really.

All right, and on the Direct Marketing side, maybe talk a little bit about customer acquisition and how that looks and maybe general competition in the market, pricing.

(multiple speakers) the price competition -- I mean, it's still there. We actually think we have some opportunities in certain areas, particularly with our multi-service accounts, where we might be able to get a little bit of a price increase. We're a lot more thoughtful about pricing at the time we win a new customer.

But it is still price sensitive and it's more so, obviously, as you would expect, in some of the single service areas and some of the more traditional parts of the business. Anything you want to add, Gary, or --

I will refer and make sure -- and the highlights to the release there are several good examples of what we have done with some recent customers in the last quarter, really supporting that revenue growth.

Okay, great, thanks. And just one last quick question, a little bit more specific. What are you specifically seeing in credit card mailers? Is that typically higher volume, lately?

Yes. We don't have big share, but yes, that volume is up substantially.

Okay, great, thanks guys.

Ed Atorino, Benchmark.

Most of my questions have been answered. One thing, Larry -- in the Shopper, is the weakness pretty well widespread, or are there sort of one or two areas that are driving the total down a lot?

Well, the weakness continues, Ed, in the areas that we talked about, and that's in the home services area and real estate. Now, we have -- obviously, where we lost the customer, that revenue is down. But we are also having some wins in that category as well.

But things that are discretionary to our target customer -- they are very careful in those two states at the moment.

And newspapers in those states are feeling the same thing. Thanks very much.

Michael Kupinski, Global Financial.

Yes, just one follow-up question. Obviously, you gave some thoughts about margins for the Direct Marketing side of the business for the balance of the year. I was just wondering if you wanted to give us your thoughts about the margins in the Shoppers business, given the fact that you have executed a lot of cost savings there and some efficiencies. And if you could just exclude the one-time charges that you are contemplating or had in the last quarter?

We are going to have to see, when we get the initiatives that we have announced and are working on, when we get those implemented. And then we will -- and when we get these other inefficiencies in the second half of the year from the new systems, then I will be able to give you a better -- or some better parameters about what we are thinking about as far as margins are concerned.

What we do believe is that, with the one-time costs and savings that we're going to get, that we ought to have a much improved bottom line in 2012 from what we will actually report in 2011. So I'll have to wait to give you that guidance.

Larry, theoretically, if you look to 2012, given these savings, do you think that you can get to the margins that you had in 2010 or higher?

Refresh my memory what 2010 was.

Like in the 6% range, 5%-6% range.

Yes, that's not out of the question.

Okay, perfect, thank you.

I would now like to turn the call back over to Mr. Larry Franklin for closing comments.

Okay. Just in conclusion, thank you all for your interest in our Company and for joining the call. We are in two businesses that we are excited about. We are convinced that we have the right focus and that our people are deeply committed to producing excellent performance. And we will look forward to talking to you in three months. Have a great day.

At this time, that will conclude today's conference. You may disconnect. Thank you for your attendance.