Harte-Hanks Management Discusses Q4 2013 Results - Earnings Call Transcript

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 |  About: Harte Hanks Inc. (HHS)
by: SA Transcripts

Operator

Good day, and welcome to the Harte-Hanks Fourth Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Robert Munden, General Counsel. Please go ahead, sir.

Robert L. R. Munden

Thank you very much. Our call may include forward-looking statements, such as statements about our strategies, adjustments to our cost structure, financial outlook and capital resources, competitive factors, business and industry expectations, litigation developments and regulatory changes, economic forecasts for the markets we serve 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 reference non-GAAP financial measures. Please refer to today's earnings release for the required reconciliations and other related disclosures. Our earnings release is available in the Investor section of our website at harte-hanks.com. I'll now turn the call back over to Whitney.

Operator

And I will now pass the call over to Robert Philpott, CEO.

Robert Philpott

Thank you, Whitney. Good morning, everyone, and welcome to Harte-Hanks Fourth Quarter Earnings Call. As usual, Doug Shepard, our CFO, joins me on today's call. In a few minutes, he will take you through the details of our earnings release. But to begin with, let me set the tone for today's call by saying right up front that although our final quarter in fiscal 2013 remained challenging and we continue to see a decline on our business, it was less dramatic than we had forecasted. There were parts of our business that had a strong end to the year, and if contract renewals are taken into consideration, there are reasons why we enter 2014 with a degree of optimism that we can arrest the decline in our performance.

Overall, as I've said, 2013 was a disappointing year for Harte-Hanks. The expected second half pickup in business did not materialize due to multiple factors. First, the traditional peak season, such as back-to-school and holiday, did not generate the increases in revenue we had anticipated at the start of the year. Second, there were various microeconomic factors that combined to disrupt our forecast. For example, the budget wrangling in Washington which depressed business optimism during the critical September and October period. And then the announcement of the significant postal rate increase late in the year which caused many of the larger users of traditional mail Direct Marketing to reevaluate their campaign strategies. And finally, we had an inconsistent performance of our client base across a number of industry verticals. The retail and technology sectors, in particular, had uneven performance. It was highly variable within these sectors depending on individual brands. And these -- don't forget are 2 verticals where Harte-Hanks has traditionally been overweight. And even the pickup in health care, largely due to the Obamacare effect, couldn't make up for the reduction in spending from several of our larger retail and technology clients. But much work was done behind the scenes at Harte-Hanks to prepare us for 2014 and beyond. Clearly, we ended the debate about the role of shoppers in Harte-Hanks. We now have a more focused organization, albeit one which still has a number of distinct business strengths, some of which include: software, data and analytics, mail fulfillment and our agency businesses. And we have taken the opportunity to tidy up a range of other outstanding issues in the business, including a third quarter impairment charge and a notable litigation settlement in quarter 4. My onboarding is now complete, as is my review of the business, but before I go into that and give more specific comments on our fourth quarter performance, let me first have Doug walk you through the detailed financial results. I will then rejoin the discussion a little later. Doug?

Douglas C. Shepard

Thank you, Robert, and good morning. Revenues for the fourth quarter decreased 3.5% which was a better performance than what we had expected at the end of the third quarter. Operating income decreased 20.9% after excluding $1.6 million for severance, $1.4 million in consulting fees and $1.2 million for legal settlement and related legal fees for a total of $4.2 million in charges. Excluding these items, fourth quarter diluted earnings per share from continuing operations were $0.15 per share compared to $0.19 per share for 2012.

First, I will focus on revenue from our industry verticals where we have the following results: Healthcare increased 26% or $3.5 million. The increase was largely driven by health care plan enrollment activity. Needs from various state Blue Cross Blue Shield organizations contributed to this increase in activity for our agency and call centers. Automotive and consumer brands increased 3.4% or $900,000, primarily from increased call center services from a worldwide transportation and business services company. In addition, we were able to implement an e-mail campaign strategy along with the content for a well-known national membership association. Financial services increased 2.6% or $500,000. This increase was led by Trillium Software and its continued success in implementing its previously announced finance industry solutions. This success offset the client loss we discussed in the third quarter.

Retail declined 13.6% or $7.1 million. We continue to see clients changing to less-expensive print formats. They, in turn, use the savings to mail higher quantities or add additional mailings to reach more customers. The January 6% U.S. Postal Service rate increase remains a concern for retailers as many are not increasing their marketing spend. Postage rate increase has a potential to drive retailers to continue their trends to less expensive formats and alternative marketing strategies as they try to offset the impact of the rate increase. Technology declined 4.3% or $1.5 million. Declines with our lead generation businesses, agency work and volume reductions for contact center support led to the quarterly decline. Our smallest revenue vertical, select markets, declined 16.2% or $1.8 million. Select markets were impacted by a onetime Trillium software sale last year that was offset this year by Trillium's success in our financial services vertical.

Operating income, excluding the severance charges, consulting fees and legal settlement charges decreased 20.9% during the quarter. Their operating income declined as a result of revenue declines in businesses with labor cost that aren't variable in the short term in proportion to revenue changes. We continue to closely monitor our expense structure. During the quarter, we made decisions that eliminated several million in annual payroll expenses and, of course, the $1.4 million of consulting fees and $1.2 million in legal expenses are nonrecurring.

Moving down the income statement. Our fourth quarter effective tax rate was 39.3% which is consistent with our 38.7% in the fourth quarter of 2012. For 2013, our effective tax rate was 38.3%, and we expect that for 2012, our effective tax rate will be in the 38% to 40% range. Our net debt balance is $9.3 million versus $60.9 million at year end, a reduction of $51.6 million. We currently have $80 million available under our revolver, excluding outstanding letters of credit, in addition to a cash balance of approximately $88.7 million at the end of the quarter. We continue to have a strong balance sheet with low leverage and plenty of liquidity. For the quarter, we spent $3.1 million on capital expenditures compared to $5.3 million on fourth quarter 2012. For the year, we spent almost $16 million on capital expenditures versus $13.5 million last year. The 2013 capital expenditures included new digital printing capabilities, the annual Trillium software update and maintenance of our facilities.

We repurchased almost 80,000 shares during the fourth quarter for a total of a little over $600,000. For the year, we repurchased about 220,000 shares for a total amount of about $1.7 million. Our ability to repurchase was restricted during most of the year due to our knowledge of the CEO change and the potential sale of shoppers. This leaves us with approximately $3.5 million in remaining repurchase authorization.

With that, I'll turn the call back to Robert.

Robert Philpott

Okay. Thank you for that, Doug. But first, let me focus on the positive developments at Harte-Hanks during the fourth quarter. We closed out several major sales opportunities late in the year, which comprised a mix of new business wins and also securing renewals on a number of expiring contracts. These wins, each of which was an excess of $1 million, took place in multiple industry verticals, including our healthcare business, finance, automotive, consumer electronics and business services.

Well, let me look at some of these industries in a little more detail. In healthcare, the individual mandate for health insurance created a buying wave of enrollment support services as insurers tried to anticipate the demand from individual healthcare consumers. As a result, healthcare revenues rose across our business. This growth was especially marked in contact centers, where revenues grew $2.7 million in 2013 over the prior year. Most of this business ended on December 31, although some will continue through March of 2014. Continued demand for seasonal enrollment support late in 2014 is expected, but healthcare growth was not restricted to Obamacare or to the domestic health care industry. For example, during the later stages of 2013, we expanded a client's patient support program to cover 9 countries, and we expect further rollout of this program to occur this year. We also had significant healthcare contract renewals and wins in our fulfillment, software and agency divisions.

The automotive industry is experiencing something of a renaissance, and we saw evidence of this in project renewals in the fourth quarter. As Doug has already mentioned, we won automotive projects in the agency and database teams, including multiyear contract extensions. These long-term commitments from blue-chip clients give us confidence to invest in our future plans here.

And finally, it was encouraging to see the uplift in new business from the finance sector. Again, the wins came from across our organization, most notably Trillium, mail and the agencies. Trillium, in particular, had a strong final quarter, winning new client domestic and international business in excess of $3 million, which represents double-digit year-on-year growth. We're now also witnessing a broadening of the Trillium offering from pure software subscription and maintenance to include data quality consulting support.

Turning now to investments to support the long-term growth of the business. We have continued to support and develop our base of customer solutions. We've made solid progress with our digital print solution, which offers new opportunities via integrated campaigns using a combination of data analytics, content management and digital print technology. In quarter 4, our Aberdeen business, which has struggled for competitiveness in recent years, launched content access, a new subscription-based product to address high-tech and business-to-business marketers, increasing demand for relevant, high-quality and impactful marketing content. Content access provides availability of and distribution of licenses for 3 years of industry research. It offers the ability to exert and repurpose content from available research assets and advisory, and it provides insight services from our research analysts and content marketing experts. And although it's early in the life cycle of content access, the product has exceeded initial launch expectations and it's performing well in the market.

I'd like to actually quote Outsell Inc., it is a research and advisory firm focused on media information and technology, who said, on the launch of content access, "Aberdeen having grown up as an IT research firm, has taken an innovative approach to carving out its future path and is providing a great example of what information firms, those that own and create content, can do to shape their new reality." I think that's really encouraging to see that the industry is reacting so positively to Aberdeen's new approach. In fact, we're doing our earnings call from Aberdeen's office in Boston here this morning.

Increased business on our contact centers has resulted in an expansion of our Philippines location, which will soon house more than 1,500 highly trained agents. We've also established a partnership with a third-party contact center operator in Latin America that will now provide us with almost 100 new seats, a number we hope to steadily increase this year. Each of these expansions is underwritten by long-term client contracts.

We continue to focus attention on our senior leadership team during the quarter. In December, Gavin Pommernelle joined as Chief Human Resources Officer, a role that's critical to our ability to compete for the brightest and best talent in our industry. Gavin will be based in our New York office. We've also begun a search for a new CEO to lead our Trillium business. I feel very strongly that Trillium has enormous potential, especially in its international markets, and we'll put a priority on finding an outstanding candidate who can lead the Trillium business across the globe.

Now let me turn to some of the more challenging aspects of the fourth quarter performance. Doug has already mentioned in his comments about the margin impact of fixed labor costs in businesses with declining revenues. We recognize this challenge, and I mentioned in our last earnings call that we would examine closely the cost base in the business. We started this in quarter 4, and the result was a targeted workforce reduction which will result in annualized savings of $2 million in 2014. Now this process is not complete and nor will it concentrate only on labor. I believe that there's further scope for cost reduction, and we have a number of specific teams targeting areas where I believe we can become more efficient without sacrificing client service standards or our ambitions to grow our business.

Also, I wanted to update you on the progress we're making in the development of our strategic plan. As you may recall, I appointed external strategic consultants, specializing in marketing and data sectors, to assist us in our review of the business. That review has been completed and has given us a solid base of information upon which we can now plan for change.

In late November, I presented the findings to our board. The review focused on the reasons underlying the lack of revenue growth. And on the basis of this analysis, the Board has approved the second phase of work, involving the development of a detailed 5-year strategic plan. This work is currently underway and involves teams from Harte-Hanks. It involves input from clients and from industry experts and, of course, there's direction from the board itself. We still anticipate this work to be completed before the end of the first quarter of 2014, and we expect to roll out our plans before the end of quarter 2.

Now looking ahead to 2014. The goal of the Harte-Hanks' leadership team is to arrest the decline in our revenues. Given the disappointment of 2013, we will endeavor to stabilize our performance by focusing attention on our core clients, who offer the greatest potential for significant revenue growth, and in winning our fair share of major new business pitches, something that we have underperformed in recently. We're helped by the fact that many of the industry that we work in have forecasts for growth in 2014, and we're determined to take advantage of these opportunities.

So to conclude, I commented last time that we still have a great deal of work to do. We've made a solid start and it's -- but it is still a work in progress. We'll continue to act decisively to address underperformance in some of our businesses and to ensure that we capitalize on the marketing opportunities in others. But I'm confident that we're putting in place the necessary foundation in the business in order to position ourselves for future growth.

And with that, I want to thank everyone on today's call for your continued interest in our business and for your ongoing support to the ambitions that we have. I'll now hand the call back to our operator, Whitney, who will give you details of how you may participate in the Q&A session with Doug and myself. Over to you, Whitney.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Michael Kupinski with Noble Financial.

Michael A. Kupinski - Noble Financial Group, Inc., Research Division

I was wondering if you can talk a little bit about what things you can talk about in terms of your strategic plan.

Robert Philpott

I don't want to be too premature on this, Michael, because we are about halfway through the development of the strategy work at this stage. So all that I can really say is that it's my expectation that the new strategy will be evolutionary rather than revolutionary. It's involving the gathering of a great amount of details from clients. Some non-clients in the industry and, clearly, from industry experts and rolling that together with our own internal knowledge base of our business. But the point that I'd really like to stress is it's now built off of the back of a very solid review of the business, a very factual review of the business that has taken place. And therefore, I'm confident that we're building on a solid platform of knowledge. It's our intention to be very clear and very public about what that strategy is going to look like when we roll it out in the second quarter of 2014. So at this stage, I can really just talk about the -- give you an update on the process we're using rather than the outcome of the strategy itself.

Michael A. Kupinski - Noble Financial Group, Inc., Research Division

Okay. And then in terms of the strategy, does it include making acquisitions? I mean, can you give us a little color on that part of the strategy in terms of whatever technology needs you might need or capabilities that you might need? Can you just give a little color on that?

Robert Philpott

Sure, I can comment on that. And I think I've been very clear on my previous 2 earnings calls that I certainly see M&A as being a tool that management can and should use when the opportunity arises. Until we actually develop the strategy, I can't determine yet whether M&A is a core part of that. But it's something that we recognize as a tool that we have in our toolbox, and we'll use it if the opportunity arises. We -- I think it will be premature to suggest that we've got specific acquisition targets at this point. We'll wait for the outcome of the strategy, and then if acquisition is part of how we deliver that strategic goal, then we will use that as a tool.

Michael A. Kupinski - Noble Financial Group, Inc., Research Division

And I was just wondering, in terms -- I may have missed this, but did you talk about what your capital expenditure plans were for 2014?

Douglas C. Shepard

Kind of could guess, Mike. We expect it to be in the $20 million range.

Michael A. Kupinski - Noble Financial Group, Inc., Research Division

Okay. And then have you identified where you plan to spend most of that $20 million?

Douglas C. Shepard

It will be in prior years -- it will be consistent with what we have done in prior years. We always have an annual Trillium update. There are needs of our database clients. We'll have, as we renew, refresh contracts, things of that nature, so a lot of it is technology-based. And some of it will continue to be in what I'll call product development with the digital printing that has gone -- been successful for us. Those type of things.

Michael A. Kupinski - Noble Financial Group, Inc., Research Division

And you mentioned that postal rate increases may have caused a little bit of some issues. Do you -- newspapers, TMC products become an alternative to Direct Mail during these types of periods? I mean, have you seen shifts in advertising, maybe to newspapers? Or can you just talk about the competitive landscape?

Robert Philpott

Really, the change that we are noticing is, on the makeup of the Direct Mail pieces themselves, rather than seeing spend going from Direct Mail across to other channels. We know people use Direct Mail and many other marketing channels combined. But the change that we are seeing is, for example, changes in the weight of the paper products that they're using, the frequency in which they're mailing, et cetera. So it's that change we're referring to rather than a change out of mail into some other communication avenue.

Michael A. Kupinski - Noble Financial Group, Inc., Research Division

Okay. And I just have one quick question, a further question. Doug, can you talk a little bit about the SG&A expenses? I know that there were obviously nonrecurring items that you identified. Can you just tell me what the SG&A expenses were, excluding some of those costs and if they were in line with the same types of percentage of revenues in the past quarters?

Douglas C. Shepard

Yes, they are in line with the past quarters in both the legal and the consulting fees that come together. About a little over $2.5 million hit that SG&A area.

Michael A. Kupinski - Noble Financial Group, Inc., Research Division

Okay. So if we backed out $2.5 million, it seems like SG&A was just a little higher. Is there any particular reasons for that then?

Douglas C. Shepard

No, it's -- I mean, it's -- our math is a little bit different. SG&A would be the same, if not, slightly lower than what it was fourth quarter of last year.

Operator

We'll take our next question from Dan Salmon with BMO Capital Markets.

Daniel Salmon - BMO Capital Markets U.S.

It sounds like you're still working through the details of your strategic plan, and we'll hear more about that later. But a couple of things that you mentioned were about the Trillium business, in particular, was sort of broadening the offering there around some data quality consulting, and then mentioning looking for a new CEO and perhaps some global expansion there. Are there maybe just some high-level thoughts on Trillium? I know in the past, we've talked a little bit about making that tool a bit more useful for Chief Marketing Officers, specifically. But maybe some just very high-level comments around where you think that asset could go over the medium to long term?

Robert Philpott

Sure. I actually have spent a reasonable amount of time with our Trillium business in my 6 or 7 months on board with the business, and that has included time, not just with the Trillium office, the major Trillium office here in the U.S., but also with our Trillium offices in the U.K., Germany, et cetera, and the reseller network that we have in other markets, particularly Japan. As I said in my comments, I'm particularly bullish about Trillium. I think there's great opportunity. The product is well-recognized, and that's not just the word of the CEO. I think the independent view of the data quality space, the Gartner analysis, reflects that as well. The thing that I'm struck with in Trillium is the -- in particular, is the international opportunity. I'll not comment on the specifics of the software itself. Trillium do more -- do a much better job on that than I would. But the thing that I noticed is that we have an inconsistent impact on the international landscape. We've got great business in the U.S., great business in -- with Trillium in the U.K. and Germany, and our reseller in Japan does an outstanding job there. But there are many other geographies where either we only have a very small amount of business, or actually, we're nonexistent. And it's really around that side of Trillium that I'm particularly focused, making sure that we have a much more consistent approach to rolling out that product into international markets and take a substantial share of those markets. So that's really the brief that we'd be handing to the new CEO, who we hope will come on-board relatively soon.

Daniel Salmon - BMO Capital Markets U.S.

Sounds like that new CEO is probably somebody who's going to have a little bit of international experience.

Robert Philpott

Absolutely. That's going to be critical for us. I think that the upside in Trillium is on that international side of the business. And the search criteria that we're using at the moment really emphasizes the fact that we're looking for leadership with international experience. Trillium is the -- it's the one business that's really within Harte-Hanks has a big international outlook. And I know that, that view is shared by the senior management team at Trillium. So we're all aligned with what we need to do now.

Operator

[Operator Instructions] And we will take our next question from Brad Evans with Heartland.

Bradford Alan Evans - Heartland Advisors, Inc.

Robert, you'd mentioned in your prepared remarks that you are -- the goal of the management team is to arrest the decline in the top line. If knowing what you know today, based upon your current view of the business, do you believe that revenues will grow in 2014?

Robert Philpott

Certainly, that's the target I'm setting for the businesses. My first comment would be, it's quite a change when you move an organization from one that, for quite a number of years now, has been focused on internal cost side of its business, to asking people in the company to then refocus their attention externally. So I don't underestimate the -- if you like, something of the cultural change that's required to make a switch like that in our business, but that is very clearly the mantra that I'm using in our organization. I'm encouraged by the fact that within the markets that we operate in, that there is growth forecast by industry experts, by companies who work in those markets. So if you like, we've got a tailwind in many of the markets. So opportunity is there for us. Now we've got to balance that by the fact that within some of those markets, we have a pretty select group of clients, and therefore, we've got to have a view of the growth of those clients as well as the market itself. So I think there remains some challenge in getting growth. I've set it as a target. I wouldn't necessarily say it's a huge stretch target, but it's a target for us to get growth. And the main thing I'm focused on is making sure that we reverse the downward trend in revenue that we've noted over the last number of years.

Bradford Alan Evans - Heartland Advisors, Inc.

Very good. And this is more of a qualitative question. But, so I don't want you to have to, kind of, get into a terribly lengthy answer. But I sense that -- or I guess the question should be, as you have now been on-board since July, I guess, and now that you've done the first phase of the strategic plan, it sounds like you're fairly optimistic about the opportunity set in front of Harte-Hanks. Are you more optimistic than when you first -- first few months on-board?

Robert Philpott

I'm an optimist, full stop. So I was optimistic when I joined. Am I more optimistic now? No, I wouldn't say I'm more optimistic, but I'm not certainly not more pessimistic of the opportunity that's there. The things that I saw back in July when I started, which is the fact that we have some great client relationships which have extended over many years. And I mean, that still remains and holds true, and the rate of renewal of those contracts has been positive as far as I'm concerned. I haven't been here over December, January change or over a change into a new year. But I have been pleasantly surprised at the rate at which we're able to renew those contracts. So clients are still in a very good shape, and I like the profile of the client base that we have. We've got a team of very talented people. They continue to work very hard in the business. And I believe if we can just channel that, as I've said previously, in the right direction, then that gives us great opportunity as well. And we've got markets with growth in them. It's hard to ask for much more than that, and that's why I was optimistic at the start and why I'm optimistic going into 2014.

Bradford Alan Evans - Heartland Advisors, Inc.

Doug, it sounds like, absent perhaps the top line, surprising you to the upside that net income should be a pretty close approximation for free cash flow in 2014. Is that pretty close?

Douglas C. Shepard

That's a fair statement. Yes.

Bradford Alan Evans - Heartland Advisors, Inc.

I guess, with the stock where it is right now, I mean, do you -- Robert or Doug, do you feel like you have the ability to maybe be a little more aggressive on the share repurchase program and still have adequate liquidity to help you on your tuck-in M&A strategy?

Douglas C. Shepard

We -- as you're fully aware of, we have always been a strong supporter of our shareholders through share repurchase programs. We continue to believe in that. We have a very strong balance sheet at this point, and we are evaluating that. We have some money that we can still spend at this point, and we're evaluating our ongoing strategy as part of the overall strategical analysis and everything that's going on at this point. And we'll be able to more fully address that here in the second quarter when we talk about our long-term strategy.

Bradford Alan Evans - Heartland Advisors, Inc.

Notwithstanding the dividend, which, obviously, is much appreciated, I do think that, that would be a strong signal to have a balanced capital allocation framework that would accompany the dividend with share repurchases, while leaving management the ability to pursue tuck-in M&A when appropriate. So with the stock down here, it looks like it's a particularly good opportunity. So we'd appreciate you exercising that buyback.

Robert Philpott

Excellent. Thank you for that, and you've been pretty consistent with us on that point of view. And it's something that we're well aware of.

Operator

[Operator Instructions] At this time, we have no further questions in the queue.

Robert Philpott

Okay. Well, thank you for help with that, Whitney. I'd like to thank again, everyone, who has joined the call this morning. Thank you for your attention and your continued support to the business, and we look forward to bringing you more information, particularly, as we roll out our strategy through 2014. I'll talk to you, all, soon. Thank you.

Operator

This now concludes the presentation. Thank you for your participation.

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