Harte Hanks Inc (HHS) 2011 Q3 法說會逐字稿

Welcome and thank you for joining the third-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.

Now I'll turn the meeting over to Mr. Larry Franklin, President and CEO of Harte-Hanks.

Good morning. Thank you. On the call with me today is Doug Shepard, our Executive Vice President and Chief Financial Officer; Robert Munden, Senior VP and General Counsel; and Jessica Huff, our VP of Finance and Controller. Also on the phone is Gary Skidmore, our Executive Vice President and President of Harte-Hanks Direct Marketing. Before I begin with my remarks, Robert will make a few statements.

Our call may include forward-looking statements. Examples may include statements about our strategies, initiatives and business plans, adjustment to our cost structure, financial outlook and capital resources, competitive factors, business and industry expectations, legal settlements, the economic condition of 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 SEC 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.

Thanks, Robert. Before talking about the individual businesses, a couple of comments about the Company's results. Revenues decreased 1.8%, operating income was down 17.3%, net income down 12.2%, and earnings per-share of $0.19 down 13.6%. I will add some more detail about the performance in the discussion of each of the businesses and then, when I'm finished, Doug will provide some additional detail.

Let's look first at Shoppers. On the second-quarter call we announced a significant senior management transition with Pete Gorman's retirement after 30 years with our Shopper business, and Mike Paulsin's promotion to President of Shoppers, as well as a restructuring of the sales organization in California under Loren Dalton. Both Mike and Loren are longtime veterans with the Company.

These leadership changes are going extremely well. We also talked about another -- a number of other initiatives underway to increase our efficiency and performance in light of the continued difficult economic climate. And I will update you on those activities in just a moment.

Shopper revenues of $60.8 million for the quarter was down 7.4%, slightly better than the 9.5% decline in each of the two previous quarters. Our operating income for the quarter was $3.1 million compared to $5.3 million in the same quarter of last year.

If we look at our revenue from some of the more important SIC codes, real estate continues to struggle with double-digit declines. However, the decline in quarter three is slightly less than in the previous quarters. And then, in the broad services category, health and educational services are doing better than the category as a whole.

After four consecutive quarters in which the consumer spending categories had declined from the previous quarters, they were nearly flat this quarter with some excellent performance in furniture and retail. And that's on the strength of some recent wins. Grocery showed the biggest decline, reflecting the loss of the large account that we have discussed in the previous quarters.

Automotive, driven by dealers, had good results for the quarter. Distribution revenue declined at a slightly faster pace than the [end] book or ROP advertising. And on the digital front, we continued to show good performance in PowerSites, the centerpiece of our Web strategy. The number of PowerSites grew by almost 18% compared to the third quarter of 2010. During the quarter we also introduced a garage sale and coupons phone app during the quarter.

Turning to costs, consistent with recent trends we experienced a mid-teens increase in paper cost. The USPS recently announced proposed postage increases which, if approved, would be effective January of 2012. And at the current postal distribution levels this would add approximately $2 million annually to our cost. Periodically we are asked if we are anticipating circulation reductions. The answer has been and still is that we are not anticipating circulation cuts.

A few comments about the initiatives from quarter two. Our work on developing order entry and prepress systems in California is nearing completion. They are already partially implemented and expected to be fully operational by 12-31-2011. As discussed on the Q2 call, this will allow us to reduce both variable and fixed cost going forward.

The inside sales consolidation in Florida is complete. We continue to estimate $7 million to $8 million of annualized savings in 2012 from these initiatives that are underway. As we have said, we do not expect to see any measurable improvement in the California and Florida economies in the near-term. Unemployment remains high in both states and have not improved, which really hurts the consumers of the small- to medium-sized businesses that the PennySaver targets.

But with the changes that we are making and those being planned, we are building a very, very solid foundation for our Shopper business going forward. None of us underestimates the enormity of the job ahead, but I'm confident of this leadership group and our abilities and our people's ability, dedication and determination to improving our financial performance in 2012, and I am excited about our prospects.

Next, Direct Marketing. Our Direct Marketing business had a good revenue growth, up mid-single digits excluding nonrecurring pharma revenue from 2010. This was the fifth consecutive quarter of growth. Direct Marketing operating income decreased 10.8%. But again, eliminating or excluding the profits from the nonrecurring revenue, our OI declined in the mid-single digits -- not where it should be or where it will be.

The decline in profit in the quarter was largely driven by recruiting and training costs associated with some new and growing contact center clients and significant additional resources for our database products and services, where we are adding people, capacity, processes and products that are negatively influencing our profit in the short term, but have high hopes for growth in the future. These costs will continue into the fourth quarter, causing Direct Marketing margins for the 2011, we believe, to be slightly below our 2010 margins. We do expect to see margin improvement in 2012, and we are making progress toward that.

I'm pleased with our Direct Marketing third-quarter revenue growth performance. If you look in the highlights, there are some important multichannel wins in high tech and consumer products verticals. These are multichannel deals that normally include, as these did, data, analytics and Insight strategy and executing campaigns across multiple channels, and those channels include digital.

A little bit more color to the Q3 growth. We had two vertical markets with double-digit growth -- financial, which was driven by our credit card and diversified financial customers through our mail services; our select market verticals, which includes automotive, business services and manufacturing. We had growth in each of those markets with increased spending in our agency, database and contact centers.

We had single-digit growth in retail, which was driven by growth of our specialty retail customers with growth in both mail and contact center. Pharma/healthcare, which had growth from our [insty] businesses excluding last year's recall project.

The decline in tech, which was mid-single digits, like the quarter two was driven by an account loss with one of our largest tech contact center customers. And this customer continues to be, after this loss, our largest tech customer. That was partially offset by growth from agency and database customers. And much of that growth in the tech vertical is global.

Our three agencies, The Agency Inside Harte-Hanks, our B2C agency, and Mason Zimbler UK and Mason Zimbler US, our BTB digital agencies, all had terrific quarters. Most of our agency customers engage us to help them with multichannel programs. For example, during the quarter our agencies worked on 26 new digital projects in addition to our ongoing digital and off-line work. The average revenue for these engagements continue to grow, although smaller than our normal programs. The mix of our revenue towards digital continues to increase with digital comprising about 40% of our revenues.

During the quarter Demand Curve was released at the recent BMA show in Boston. The Demand Curve from Harte-Hanks leverages our 3 decades of experience growing demand and revenue for leading technology brands around the world. Demand Curve is built on Insight CiTDB data, Aberdeen content, agency strategy and cost center, where we help B2B marketers do three things extremely well.

First, focus more clearly on the right customers, markets and opportunities; then enable the fact-based strategies and tactics. And, third, engage efficiently with the people who matter. Those people are the buyers, the influencers, the customers and the partners.

In another very important part of our Company we are really excited about Trillium's two new business solutions. The first is for the banking industry, called Regulatory Capital Recovery. And the second is for the insurance industry, expected to be released soon, and is temporarily called Trillium Claims Data Analytics.

Finally, three products -- Momentium, Market Opportunity Analysis and QuickStart, that have all been developed in the past year by our database group, are getting excellent traction with our customers. I am pleased with the progress that we are making on multiple fronts in Direct Marketing and confident that our teams' focus on profit improvement with continued revenue growth will pay significant dividends. Doug?

Thank you, Larry, and good morning. Here's a Companywide overview of the third quarter. Consolidated revenues decreased 1.8% for the quarter to $212.8 million. Direct Marketing increased 0.6% for the quarter, and Shoppers decreased 7.4%.

Consolidated operating income decreased 17.3% for the quarter to $20.7 million. Direct Marketing operating income decreased 10.8%, while Shoppers decreased $2.2 million. Consolidated operating income margin declined to 9.7% for the quarter versus 11.6% last year.

For the quarter, our free cash flow was $12.8 million versus $15.9 million in 2010. We ended the quarter with $5 million in capital expenditures, $700,000 more than the $4.3 million spent in 2010. Now to the businesses.

In the quarter, Direct Marketing revenue, excluding the nonrecurring pharmaceutical recall last year, increased in the mid-single digit range, and operating income decreased in the mid-single-digit range.

Operating income margin was 13.5% compared to 15.2% in the third quarter of 2010. Our margin decline continues to be a result of two factors -- additional costs for new and growing contact center accounts and additional resources to increase our capacity and add processes in our database business to meet the needs of current and new customers.

Our retail vertical market represented 27% of Direct Marketing revenue. (inaudible) markets were 25%; high-tech telecom were 24%; financial was 14%; and healthcare was 10%. Our top 25 Direct Marketing customers represented 43% of Direct Marketing revenue and our largest customer represented approximately 6% of revenues.

Shoppers first-quarter revenue decreased by 7.4%, and operating income decreased $2.2 million. Our postal rates were relatively flat for the quarter, and paper rates continue to increase in the mid-teens range. Based on recent U.S. Postal Service announcement we expect postage to increase about 2% early next year.

During the quarter Shoppers' revenue decline from distribution products was slightly greater than the decline from the end book or our ROP. By sector, revenues were relatively flat in automotive and consumer spending, and decreased in the real estate, service and the restaurant sectors compared to the third quarter of last year.

The third-quarter effective tax rate was 40.6%, which was higher than the 2010 third-quarter rate of 38.7%. Higher state taxes drove the increase. In prior years our 4th quarter effective tax rate was noticeably lower than the other years. We believe that trend will not occur this year or in subsequent years.

On the balance sheet net accounts receivable were $147.6 million versus $151 million at December 31. Days sales outstanding at the end of September were 64 days compared to 63 days outstanding in June and 63 days outstanding in September 2010.

We ended the quarter with approximately $72 million in cash on the balance sheet. Our net debt leverage ratio at the end of the quarter was 1.3 times. In August we entered into a 5-year unsecured term loan facility of $122.5 million. We are currently paying LIBOR plus 2% under this new facility compared to the retired the debt cost of LIBOR plus 0.6%. Financial covenants for the new term facility match those of the retired facility.

Simultaneous with the closing of the new term facility, we paid $97.5 million under one of our outstanding term facilities which was scheduled to mature in September. This leaves us at the end of the quarter with two term facilities outstanding and an unused revolver. One of the term facilities matures in March, and we anticipate using cash on hand and cash generated over the next two quarters to retire that facility.

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

(Operator instructions). Carter Malloy, Stevens.

So first off, in the Direct Marketing business and the incremental expenses being made there on some of the investments in the database and in processing, as well as your recruiting and training costs, you said those are going to continue into Q4 2011. Do those continue into 2012 as well? Should we run out this current run rate? Or how do you think about and how should we think about the ROI expected on those investments or the NPV in those projects?

On the training costs and the onboarding cost, those will continue in the fourth quarter, but they shouldn't continue into next year, other than just from normal growth of the account. But this is in the initial onboarding and ramping up rather rapidly of a significant customer.

On the database investments and products that we are developing, which we really started heavily into that in the first quarter of this year, so we will cycle against that going into the first quarter of next year. And the investments from that point on will be more normalized, or the expenses will be more normalized, just based on revenue and new customers and onboarding of new customers.

So it should, in the first, second quarter -- well, actually, the first quarter should be different from what we are experiencing now and in the fourth quarter. But by the second, third quarter of next year it ought to be pretty stable and normal.

And when you speak to onboarding of the new customers or potentially one large one, it sounds like, ex that tough year-over-year comp on the pharma deal the run rate in your Direct marketing business on a revenue basis should continue or maybe even improve?

Oh, from where it is now -- well, we believe that it will continue about in the mid-single digits. We are a little -- our clients have given us no indication at this point that there will be any significant change in what they are spending. But just the overall economy makes us a little bit cautious, but we feel pretty comfortable going forward with about where we are, ex-ing out those one-time. Anything to add to that, Doug?

No. We've been pretty consistent telling folks that our clients haven't really given us any noticeable changes on volume commitments, things of that nature. But we -- with all the outside noise you stay very cautious at this point.

Good, that's actually very encouraging to hear. And then, lastly, just any change as far as the guidance, or coming to the table, or the aggression with which they come to the table in the Direct Marketing competitive environment?

You're talking about competition?

Sure. We were all at BMA just a couple weeks ago, and it seems like there's an increasing number of new names there. So I am just curious what you guys see as you go to the table on new RFPs?

Gary, anything new?

We actually -- we see the same companies typically in our different service lines and our multichannel competitive situations. We saw no real significant changes from our competition. Our competitors are good, and we pay close attention to them.

Well, on the digital side there are a lot of newer, smaller ins and outs, but generally, what Gary said (multiple speakers).

Okay, sounds good. Thanks (inaudible).

Michael Kupinski with Noble Financial.

I have a couple of quick ones. Can you break out between California and Florida what your experience was in the Shoppers business?

On the revenue side, the performance against last year was better in Florida than in California, which has been most of this year. It was not the case two years ago. The difference is that Florida is much, much, much smaller, as you know, in terms of revenue from California.

Right. And so by the end of the quarter was Florida revenue up year-over-year?

No.

Okay. And are you seeing improving trends there going into the fourth quarter?

In Shoppers or in --?

In Shoppers.

Not enough to really get excited about.

Okay. And in terms of the cash flow prospect for Shoppers, do you think that you are on track to deliver $10 million in cash flow for the full year for 2011?

We'll tell you in early [January].

Okay. And in spite of the cost pressures that you are seeing in Shoppers, are you anticipating margin improvement in 2012?

Yes. And you are talking in Shoppers?

In Shoppers, yes.

Yes.

Okay. And that's in spite of the postage rate increases and so forth?

Yes.

And then, if you -- just turning to Direct Marketing, given the ramp of your new account wins, and obviously that you are spending money now, that should help margins in 2012. Do you think the margins in Direct Marketing could return to 2010 levels?

2010? We will improve on -- there will be some improvement in 2012.

The type of scale, the type of improvement are you looking for like 100 basis points, 150 basis points? Can you give us the magnitude?

We are not -- we are starting into some really detailed reviews of plans, and so we will have a better sense of that over the next few weeks. But we are committed to improving margins in 2012 over 2011.

In terms of the, obviously, uses of cash at this point, have you given any thoughts now that you are kind of winding down in terms of your debt refinancings and so forth, what you might do with the free cash flow?

We look at it frequently and discuss it in detail, and there's nothing at this point that we want to announce as to any difference in the way we are using our cash, which we've got one more debt payment coming up in March.

In the first week of March.

But certainly, with the refinancing behind us and on some reasonably good terms, it gives us some flexibility to look at the alternatives.

Edward Atorino, Benchmark.

To follow up on that call, you started to talk about the trend for Direct Marketing. Would you talk about the trend going into 4Q on Direct Marketing, unless you said earlier and I missed it? Sorry.

No. The only thing that we've said is that we think the roughly mid-single digit rate is what we are seeing at this point.

Got you. On Shoppers (multiple speakers).

Unless there is some significant changes in the environment or our customers. But our trends at this point, based on our conversation with our customers, is that it would continue to be in the mid-single digits.

Got you. Shoppers for three quarters in row here have been around $60 million, give or take a little. Is there a seasonal drop-off in the fourth quarter, or is this a base for a while here?

In the fourth quarter there is a seasonal drop off.

Yes, got you.

You have Thanksgiving and Christmas, those advertisers come back on.

Is there a pricing issue in your Direct Marketing business? I imagine it's really not a price-sensitive area for your valuable services. But is there any kind of pricing resistance or issue that you are up against there?

Pricing, there is -- we will have, in our opinion, from this point forward prices will be competitive. There will be competition on pricing. Now, we've also said and are experiencing that it's not like it was six, eight quarters ago, but our customers, they are all looking at pricing for everything (multiple speakers).

Yes, everybody is looking at everything. Thanks.

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

I mostly just wanted to hear about free cash flow uses. But I think it was covered there before, so I think I'm all set.

And with no further questions, I would like to -- I do apologize. We do have another question from Michael Kupinski with Noble Financial.

Yes, I was just wondering, Larry, if you can just expand a little bit what you are seeing in terms of your digital [quad] revenues out of your Direct Marketing side of the business. You indicated that that's now 40% of Direct Marketing. What type of trends are you seeing relative to your other businesses for that? Is it growing faster than mid-single digits, or what type of experience are you seeing there?

Yes, it has been growing faster than the other services and continues to, but not at the same rate it was in the previous few quarters. And part of that is because of the onboarding of some larger customers in the non-digital area. But it's still a growing part of our business. And it is growing at a rate faster than the traditional.

I would imagine at some point that the margins there are going to be better than the mail side of the business, or what are the margins there relative to the overall segment margins?

It varies among the multitude of digital services that we provide, from some of them being very low to some being very high. We have good margins in our mail and mail-related businesses. So the question is, would it become higher-margin business than the traditional services? Some of the traditional services, yes, and others, it will take a while.

And then just moving back to the Shoppers one more time, the prospect of seeing improved margins there -- what other venues -- I mean, you have production facilities that you could consolidate further? What other options do you have to improve margins there?

Well, some of the margin improvement in 2012 is going to be the rollout of the changes that we're making now and have announced and are in the process of implementing.

So, as I said in the opening remarks, this is a significant event -- this pre-press and data -- and order entry system that's being implemented there has been a lot of good work being done for a long period of time there. And that will allow us, over time, to be more efficient in those two key areas of our production process. And as it gets fully operational toward the end of the year and early into next year, and then we will start to build efficiencies even beyond that through just training and working with the system.

So we've got some opportunity there. And, while we don't know, we believe that these mid-teen increases in paper cost, we will cycle against some of that. And not sure yet what the forecast is for paper prices next year, but I would be surprised if for the year they were 15 on top of 15. So that will give us a little bit of opportunity to move the margins.

So there are -- it's the managing of all the details every day that makes these businesses -- can make these businesses more profitable than they are, and they are already good businesses in terms of profits.

And if we circle back to the Direct Marketing side, obviously you are ramping up for some of these new account wins. If we were just to factor that expense out, how much of an impact would that expense -- those expenses be to Direct Marketing in terms of magnitude of the expenses?

Well, what we are doing is we're factoring those expenses out. We have a number of service offerings that we have that are at various stages of their growth maturity. So it's not like everything else is going to stay static when we cycle against those.

With that said, our focus is on improving the profitability and our margins in our Direct Marketing business. And we think we will be able to do that and not hinder our ability to continue to grow revenues.

And with no further questions, I would now like to turn the call back over to Mr. Larry Franklin for closing comments.

Yes. In closing, I just want to thank all of our people that are on the phone for all the work that they do every day to make this a great company to work for, and one that we are very excited about the future of. So thanks a lot.

And with that, once again, ladies and gentlemen, that does conclude today's call. Thank you for your participation and have a great day.