Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Harte-Hanks, Inc. (NYSE:HHS)

Q3 2008 Earnings Call

October 27, 2008 11:00 am ET

Executives

David Blythe – President, CEO

Douglas Shepard – Executive Vice President, CFO

Analysts

Matt Chesler – Deutsche Bank

Troy Baskin – William Blair & Co.

Townsend Buckles – J. P. Morgan

Daniel Leben – Robert W. Baird

Dan Salmon – Bank of Montreal

Michael Kupinski – Global Financial

[Andrew Cash – Point Clear Value Management]

Operator

Thank you for joining the Q3 2008 earnings call. (Operator Instructions) Now I will turn the meeting over to Mr. David Blythe, President, and CEO of Harte-Hanks.

David Blythe

Good morning everyone. On the call with me today is Doug Shepard, our Executive Vice President, and Chief Financial Officer, [Jessica Huff] our Vice President and Financial Controller and [Brian Saturski] our Senior Vice President, General Council, and Secretary.

Before I begin with my remarks, Brian will make a few statements.

[Brian Satarski]

Our call may include forward-looking statements. Examples made include statements of our strategies, initiatives, and business plans, adjustments to our cost structure, financial outlook and capital resources, competitive factors, business and industry expectations, economic downturns in the U.S. and other economies and other statements that are not historical facts.

Actual results may differ materially from those projected or implied in these statements because of various risks and uncertainties including those described in our most recent Form 10-K and other documents filed with the Securities and Exchange Commission and 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 web site at www.harte-hank.com. I'll now turn the call back over to Dean.

David Blythe

As noted in the press release today, we released our second quarter results 90 days ago and we said that our customers were "becoming cautious with their spending plans in the face of extreme economic uncertainty."

Well, 90 days later the extent we have any lessening of uncertainty in the external economic environment has been replaced by bad news. Today, it is difficult to know with any degree of confidence what impact the current economic upheaval will have on our businesses for the remainder of this year and into 2009. Uncertainty is the prevailing description we are hearing from our customers regarding their spending plans in the coming quarter.

Our operating assumption therefore is that the revenue environment will be difficult and we will operate our businesses accordingly. We firmly believe in the fundamental effectiveness and efficiency our businesses provide. We provide tremendous value to our thousands of business customers whether they're Fortune 100 companies, midsize, private businesses, or small entrepreneurial businesses.

And these are across a wide range of industries that operate in our international market, nationwide, domestically and in local markets. Precisely because we operate across such a wide range of industries and sizes of customers, there is no doubt that the external economic environment will negatively impact our performance.

As for the length of this impact, we simply cannot predict this until there is a return to some stability in the markets. We do know that in direct marketing we saw some impact in the third quarter and that we will be impacted in the current quarter. Our expectation is that the environment will certainly continue into 2009.

This external outlook dictates our internal response. We are aggressively reshaping and reducing our infrastructure costs to reflect reduced levels of economic activity and we will relentlessly focus on flawlessly delivering our products and service to continue to provide value to our customers.

Doug will now give you some more detail on our results.

Douglas Shepard

Here is a company wide overview of the third quarter. Revenues decreased 5.9% for the quarter with an increase of revenues for direct marketing and a decrease of shoppers. Direct marketing revenue increased 0.7%. Shoppers' revenues decreased 17.1%.

Moving to operating income it decreased 21.9% for the quarter. The quarter's Direct Marketing had an operating income decrease of 3.9% while Shoppers declined 68.6%. Direct Marketing operating margin was 14.5% and Shoppers operating margin was 8.5% for the third quarter.

Free cash flow was $22.3 million versus $25.6 million in the third quarter of 2007. We spent $4.1 million in capital expenditures compared to $6.6 million in the third quarter of 2007.

Turning to our two businesses; for the third quarter of 2008, our Direct Marketing revenue increased 0.7% and operating income decreased 3.9% resulting in an operating income margin of 14.5% for the third quarter of 2008 which is a decreased compared to an operating margin of 15.2% for the third quarter of 2007.

In the third quarter, our retail vertical represented 26% of Direct Marketing revenue. High/tech Telecom was 26%, select markets were 22%, financial 16% and healthcare/pharma was 10%. Our top 25 direct marketing customers represented approximately 43% of direct marketing revenue in the third quarter. Our largest customer in the quarter represented almost 8% of our total direct marketing revenue.

Turning to Shoppers; our third quarter total revenue decreased by 17.1%, about half of the revenue decrease was attributable to abandoning circulation of approximately 250,000 in August. Operating income for the quarter declined 8.5% as compared with 17% with the third quarter of 2007. The decrease in operating income margin was primarily driven by a 490-basis increase in postage. Since postal costs are directly tied to circulation, the increases resulted in declining revenues; we saw a slight decrease in circulation in the third quarter compared to 2007.

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

Our third quarter effective tax rate was 39.6% compared to 39.8% in the third quarter of 2007. On the balance sheet of September 30, we were showing a debt balance of $295.5 million and a cash balance of $23.8 million bringing net debt balance to $271.7 million compared to a net balance net debt of $286.4 million at June 30.

Net accounts receivable were $178.1 million versus $199.2 million as of December 31, 2007. Days outstanding at the end of September was 61 days, consistent with our days outstanding at the end of June.

In the second quarter earnings call we stated our stock repurchase activity would dependant on the deteriorating economy and credit markets. Both further deteriorated during the third quarter and we did not repurchase any stock. During the first nine months of 2008 we have spent $76.6 million on stock repurchases compared to $121.6 million in the first nine months of 2007.

We reduced our net debt by $14.7 million during the quarter, and ended the quarter with a leverage ratio of 1.7 times. We currently have $110 million available under our revolver.

Our balance sheet remains conservatively leveraged with strong free cash flow giving us good flexibility.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Matt Chesler – Deutsche Bank.

Matt Chesler – Deutsche Bank

You commented that you saw an impact in the third quarter and continuing into the fourth quarter. Can you give us some more commentary on the progression of the trends that you're seeing in your businesses as the months rolled out in the third quarter?

David Blythe

I think you can say that September 15, which is the day I believe that Lehman Brothers filed for bankruptcy and Bank of American announced that it had taken over Merrill Lynch, I think, was a [seminole] date in the quarter. I think from that date forward with some of our financial customers we saw very erratic volume on a going forward basis. With a lot of our retail customers, we saw increasing caution about their outlook for the fourth quarter.

This is relatively new. It's less than six weeks old so I don't think I can give you any progressive trends throughout the quarter other than we have seen volumes and events not roll out as anticipated as volumes declines.

Matt Chesler – Deutsche Bank

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

David Blythe

I part of the problem is, what's the definition? We do a series of projects for our customers and we've been doing them for some of these customers for 20 years. For retailers as an example, our historical fourth quarter experience is that we end up with more money spent by retailers than we "have known" going into the fourth quarter. It's been a historical trend and it's based on the behavior of retailers to adjust their plan on a real time basis during the holidays.

We are certainly not seeing that as much this year. We're not seeing incremental retail dollars being spent yet, and we're already toward the end of October. So that is a change from what we've seen in the past. This is not about customers going away, and this is not about customers shutting down, but a lot of what we do is volume based, and volumes are down.

Matt Chesler – Deutsche Bank

What can you say about the nature of the type of work that you're doing for your clients and that [inaudible] confront their new reality. Any differences in services that you're providing?

David Blythe

No. It's not people leaving one service and going to another.

Matt Chesler – Deutsche Bank

It's hard to follow you placing highest priority on leveraging in the current environment, but where your leverage is at and where you stock is at, [inaudible] as a historic opportunity to buy back some shares.

David Blythe

I think we view it as an historic time.

Matt Chesler – Deutsche Bank

How much did Masons [inaudible] contribute to direct marketing growth for the quarter?

David Blythe

Mason's was a little over a point of gross. So it was all of our growth in the quarter.

Matt Chesler – Deutsche Bank

So that explains why you described your direct marketing growth as flat.

David Blythe

0.7% was what we reported. We describe that as flat whether it came from acquisition or organic.

Operator

Your next call comes from Troy Mastin – William Blair & Co.

Troy Mastin – William Blair & Co.

A question about production and distribution expenses, costs were up substantially as a percentage of revenue. I'm curious if there's anything abnormal in there, if there's a heavy energy related component that might go down in time or is this primarily just the effective [inaudible]

David Blythe

I don't think it's necessarily the energy pricing. I think postage is in that line. Our out source services, we out source some services for capacity and specialty stuff that's in that line. A lot of costs were increasing. Transportation is in that line. Despite our labor line which we dropped during the quarter and our SG&A line which dropped during the quarter, the production line did actually increase.

Troy Baskin – William Blair & Co.

Is this a line item you can have an affect on in the immediate term but it's very difficult to affect in the short term like the quarter.

David Blythe

It also depends on revenue distribution because some of the revenues we produce has a larger production component and some of the production we produce has a larger labor component. What you're seeing in that line is some of that being revenue distribution. Perhaps the increase looks bigger than if all the revenue had the same distribution throughout the period of time you're looking at.

Troy Baskin – William Blair & Co.

On the Direct Marketing business, has there been any affect in the quarter or are you seeing an affect in the very near term due to any bankruptcies, reorganizations, consolidations that have occurred in the financial services or retail or other industries?

David Blythe

Yes. Our bad debt and write offs associated with those type of events in the quarter, if we had not had those, we would have improved margin in Direct Marketing. We have had retail customers who have filed for Chapter 11 and are now in the process of liquidating, and we believe that with the outlook for the fourth quarter for retail sales, we have a lot of retail customers. It would not surprise us if the fourth quarter is as soft as people are saying. Some of our existing customers may have trouble as we move into the next quarter and 2009.

Troy Baskin – William Blair & Co.

Can you quantify the affect that those had on the costs of bad debt or whatever else?

David Blythe

I think I gave you some indicators that our margins would have gone up if we hadn't had that. I think we're down about $1 million in operating income in the quarter on $1 million of revenue growth. We'd say it's definitely more than a seven-figure impact in Q3.

Troy Baskin – William Blair & Co.

In the Shoppers business, if you think about your mix of clients, I'm sure some categories are very weak, certainly real estate would be in that group, and I'm sure some other categories are relatively strong. Have you done any mix analysis that might tell you there's a floor somewhere if you let the mix run out that you would potentially bottom at current trends in the several quarters of next year?

David Blythe

We certainly have categories of mortgage brokers as an example that can't decline any more because they don't have any revenue or we have $1.98 of revenue a week. So there are certain categories that have been hurting us that have reached virtually zero, so we're not going to suffer on a going forward basis those trends.

So that gives us some comfort and hope that we're going to start seeing stability in the revenues, but I do have to say that if consumer spending has seized up, which everything we read and see says consumer spending has absolutely fallen off a cliff, that ultimately impacts our advertisers in Shoppers.

We haven't seen it yet, but we do look at external data to try to judge what our business is going to be like and a shut down in consumer spending will not help us.

Troy Baskin – William Blair & Co.

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

David Blythe

I can't speculate on that.

Troy Baskin – William Blair & Co.

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

David Blythe

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

Operator

Your next question comes from Townsend Buckles – J. P. Morgan.

Townsend Buckles – J. P. Morgan

In Direct Marketing, can you talk about what drove the strong growth in the select verticals and how auto fit into that? And where you've seen declines in the pharma/healthcare, do you expect that to continue?

David Blythe

In the select group, automotive was one of the big drivers of that. Part of that was a new customer win for us that was significant. Remember auto was a relatively small piece. It's not even a third of the vertical itself, so one customer win can drive some very good growth. But auto was the driver of that increase for us. We had some travel and leisure that was a very small piece but it was an increase for us.

In terms of healthcare and pharmaceutical, healthcare continues to be the larger decline within that vertical. Those are really two very different businesses. They're similar obviously to put into a similar vertical but the pharmaceutical customers are manufacturers of drugs or marketers of drugs, and the healthcare customers that we have are principally health care organizations that have members.

So what you're doing are pretty different things and the healthcare piece of that vertical has been hurt more. Part of that I think is as we described the last quarter, some of the health care plans that people had out there, they were actually losing money every time they got a member so they stopped member marketing.

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

Townsend Buckles – J. P. Morgan

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

David Blythe

It's not a one off project. It's a new client relationship that we would expect would continue.

Townsend Buckles – J. P. Morgan

Can we expect further substantial cost cutting initiatives probably in the layoff category, particularly in direct marketing if you're beginning to see a prolonged downturn in the business? And in the Shoppers side, outside of trimming circulation further, is there room to cut more or are you getting closer to the bone at this point?

David Blythe

I just want to repeat what I've said. We are aggressively reshaping our infrastructure costs. So yes, we will adjust our costs based on the level of economic activity we see. Circulation is one area we'll look at in Shoppers. There are other areas available. Are we getting closer to the bone? Well, that's logically true. If you cut before and you cut again, you get closer to the bone.

Townsend Buckles – J. P. Morgan

You do have a strong balance sheet and positive free cash flow. Can we assume that your dividend is in pay shape for next year going forward?

David Blythe

We consider the dividends on an annual toward the end of the year and we will consider that again, and we always take all kinds of factor into effect. I have no comment on that. We have no plan at this point to do anything different than we've done.

Operator

Your next question comes from Daniel Leben – Robert W. Baird.

Daniel Leben – Robert W. Baird

You mentioned September 15 as the seminole event when things slowed down, kind of a very similar situation to what we had the last time we were going into a recession in 2001 with 9/11. Just looking back at the growth rates in the direct marketing business, it fell off about 10% from June to December. Is that the kind of environment we could think about the current environment in the same type of context or have there been some fundamental changes in the business that make it less fateful from that point?

David Blythe

As we said in the press release and in my prepared comments, anything I told you would be pure speculation.

Daniel Leben – Robert W. Baird

I was trying to get a sense of are there ways the business has changed the different verticals; you've gotten into within the mix that makes the business different than the last cycle?

David Blythe

A couple of things I think. We're a larger company in terms of revenue and probably a little bit more diverse in terms of distribution revenues between our verticals so I think that would be a good thing compared to 2001. I believe that we have seen a change in the advertising environment where advertising measurable media such as our Direct Marketing business and even our Shopper business is more favored than traditional mass media.

Therefore, if people are going to cut, they're going to less likely to cut programs have a measurable [inaudible]. I think that's a favorable trend. We had revenue growth in the first two quarters and the last quarter of 2007. September 15 was a seminole event, the economic pressure has been here longer than that, and our revenue is holding up very good.

That gave us proof points to the hypothetical that people are going to spend to measurable media where they see an ROI, and we believe that people understand that better today than they did in September so we think that's a positive event.

Daniel Leben – Robert W. Baird

I was out at the D&A trade show last week and one of the things that came out of there is the theme that some retailers, in advance of what they thought was going to be a pretty awful Christmas season had actually done some things to pull some mailings and spending forward into the third quarter to try to get out into the customer's wallets a little bit earlier and try to gain some share that way. Do you see any of that in the Direct Marketing business?

David Blythe

No.

Daniel Leben – Robert W. Baird

On the paper cost side, are you anticipating getting any relief from falling gas prices, the Canadian dollar is about $0.80 today. Any help there as we look at ‘09.

David Blythe

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

Operator

Your next question comes from Dan Salmon – Bank of Montreal.

Dan Salmon – Bank of Montreal

In the tech vertical, I know in the past you've seen some nice growth from a handful of five or six main clients and leveled off this quarter. Can you comment if that was across the board in that category or maybe that was focused on a couple of clients?

David Blythe

The lower rate was actually in the telecommunications part of that vertical and that was more client specific as opposed to anything across the board. The high tech maintained some respectable growth.

Dan Salmon – Bank of Montreal

Could you just remind us of any of the relevant covenants for the credit facility?

Douglas Shepard

There's two covenants. One is a leverage and the other is interest. The leverage ratio, the covenant is three times for 1.7 so there's plenty of flexibility there and the interest coverage is not even close, it's 2.75% and we're at 12.7%, 12.8$, so plenty of flexibility in addition to the revolver is almost fully available.

Operator

Your next question comes from Michael Kupinski – Global Financial.

Michael Kupinski – Global Financial

In terms of the auto win, I know you have not focused on foreign manufacturers. Was the recent win a foreign manufacturer or is that still domestic?

David Blythe

Our automobile customers are almost exclusively foreign manufacturers but we do marketing for them in the United States. And the win fits in that category, a foreign manufacturer to be their marketing partner in the United States.

Michael Kupinski – Global Financial

I know the Direct Marketing business has been extremely fragmented with a lot of mom and pop's. Do you think this cycle might shake out a number of those to the point where you emerge a little stronger and potentially capture some share, and in particular to this recent win, I was wondering if it was a company getting out of business or just being able to support the client? How did you capture this client?

David Blythe

It wasn't a result of a vendor disappearing from that client. That wasn't why we won. It was more a new initiative for that customer that we were in front of them and won.

I think we're seeing that in the Shoppers side of the business where a lot of rack products and mailers and things like that, we're seeing exit the market and I think for sure you're going to see the same thing happen on the Direct Marketing side. It is a very fragmented business.

We are a brand name within the direct marketing business. We are known for our strength. The positive signs we are seeing here is, we are having our customers and other customers approach us because they're concerned about their vendors and they have comfort and faith that given our financial strength that we are a safe place.

It could be a contra event here where see a "people talk about a space of safety", we are that space in this environment or viewed as that space among our customers. We're not rolling up the awnings or anything, we're still aggressively doing business, but we just have to be realistic.

Unfortunately I read the paper every day and I watch TV and you just need to be realistic about economic activity.

Michael Kupinski – Global Financial

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

David Blythe

The circulation I believe was more in California than it was in Florida as a percentage, it may have been about the same because again we have 80% of our circulation in California and 20% in Florida.

If you look at some of the newspaper results, McClasky as an example, released yesterday or the day before. They break out their revenue by geography and Florida was worse this quarter and from a revenue perspective than California was and I think we're seeing the same thing.

Some of that may be seasonal. There were a couple of expected hurricanes in Florida that actually came over here to Texas instead and that did impact revenue. I would say that Florida is softer than California.

Michael Kupinski – Global Financial

What is the total distribution in California at this time?

David Blythe

I think it is slightly under 10 million.

Michael Kupinski – Global Financial

It seems like we've scaled back capital expenditures. Any update on CapEx for the fourth quarter, possibly thoughts on 2009.

David Blythe

I would expect given the environment that we will reduce capital spending on a going forward basis.

Michael Kupinski – Global Financial

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

David Blythe

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

Operator

Your next question comes from [Andrew Cash – Point Clear Value Management]

[Andrew Cash – Point Clear Value Management]

Could you explain the reasons behind the payroll reduction costs? Was it headcount reduction or was there something else involved? The payroll line was down 8% in the quarter versus a year ago.

David Blythe

It was a combination of head count reduction and to the extent that we have variable compensation based on performance so that was lower this period than a year ago.

[Andrew Cash – Point Clear Value Management]

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

David Blythe

Yes.

[Andrew Cash – Point Clear Value Management]

And will hourly reduction be something that would be easy for you get your hands on versus head count reduction?

David Blythe

It's different dependant on the business. Shoppers probably has the larger percentage of hourly workers where you adjust shifts and cut back shifts and things like that than the Direct Marketing. So there some availability there but that is not a primary driver on the labor line.

We manage that always based on volume.

[Andrew Cash – Point Clear Value Management]

Was there any severance or restructuring charges or unusual charges you had to take in the third quarter and do you expect any going forward that are related to your cost reduction efforts.

David Blythe

There was severance expense in the quarter and we would anticipate that we will have some to some extent going forward based on reshaping and reducing the size of our infrastructure.

[Andrew Cash – Point Clear Value Management]

Can you say if there was a significant number? Was it a penny? Was it $0.05?

Operator

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

David Blythe

We appreciate it. Thank you all very much and we look forward to speaking to you again in the future.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Harte-Hanks, Inc Q3 2008 Earnings Call Transcript
This Transcript
All Transcripts