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Executives

Dan Hucko - Investor Relations

Gregory Novak - President and CEO

Ron Salluzzo - CFO

Analysts

Abhijit Chakrabortti - JP Morgan

Randy Hugen - Piper Jaffray

Jim Boyle - CL King

Todd Van Fleet - First Analysis

Clark Brown - Needham & Company

Dan Stom - ZF Partners

Harris Interactive Inc. (HPOL) F2Q08 (Qtr End 12/31/07) Earnings Call February 1, 2008 8:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2008 Harris Interactive Earnings Call. My name is Tanya and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions).

I would now like to turn the presentation over to your host for today’s call, Mr. Dan Hucko. Please proceed sir.

Dan Hucko

Thanks Tanya. Good day and thank you everyone for joining us. With me today are Mr. Gregory Novak, our President and Chief Executive Officer, and Mr. Ron Salluzzo, our Chief Financial Officer. At the conclusion of their formal remarks, Mr. Novak and Mr. Salluzzo will be happy to answer your questions.

A webcast replay of this entire call will be accessible via the Investor Relations section of our corporate website later this morning, and will be archived there for at least 30 days. However, no telephone replay of this call will be provided.

During this call, we will make a number of forward-looking statements. These statements are based on current expectations that are subject to known and unknown risks and uncertainties that could make actual results differ from those discussed today.

Additional factors that could cause the actual results to differ from the expectations discussed on this call are readily available in the risk factors section of our latest Annual Report filed on Form 10-K with the Securities and Exchange Commission. The company assumes no obligation to update this information provided here today, and unless otherwise indicated, or results have been reclassified for continuing operations only.

Today, in addition to discussing results by country, we will also be reporting results of our three regions, North America, which is comprised of Canada and the United States; Europe, which is comprised of France, Germany, and the UK; and Asia, which is comprised of Hong Kong and Singapore.

I would also like to mention that we will be discussing non-GAAP financial measures today. These items are reconciled to GAAP financial data in the press release we issued this morning and are also posted on the Investor Relations section of our website at, HarrisInteractive.com.

Now, let me turn the call over to Mr. Gregory Novak, our President and CEO. Please go ahead, Greg.

Gregory Novak

Thank you, Dan. Good morning, North America. Good afternoon to Europe and good evening to Asia. Q2 and in general the first half has been truly a tale of two cities for our company. The very rapid deterioration in the US economy, negatively affected our North American performance in the quarter, in fact dramatically in the final months of the quarter. That was somewhat offset by strong performances in the region, driven by specific and successful growth based initiatives.

On the other hand, our international units performed well, with our most recent acquisitions or harmonization efforts experiencing double and triple digit growth rates, which is in stark contrast to prior history, accounted to loose revenue, as opposed to growing it.

The more did I travel and the more did I speak to customers, to potential, partners and the competitors, the more clearly our imperative to grow this company globally becomes. We recently investigated a market, where we had nearly zero market penetration. Yet the market has one of the highest broadband penetration rates in the world and very small Internet research of revenues. That market is a perfect opportunity for the technology transfer we’ve been speaking about on behalf of Harris clients and shareholders. The strategy is clear. The challenge has been perceived, and rightly so, as one of execution. Today, we can and we'll continue to discuss the successful execution of that strategy.

First, we do remain thoughtful and diligent as we perceive in this impenetrable globalization. A solid evidence that our strategy is working demonstrates that we can and we'll leverage our capabilities, our methodology and our technology around the world for the benefits of our clients, our employees and our shareholders. And it reinforces our confidence in the model and the execution of the plan, and in some sense, creates an urgency for accelerating our expansion where and when we intelligently can.

At the same time, we need to be realistic. In response to current macroeconomic and competitive conditions, the company has already started to implement a series of changes designed to streamline our structure, increase our operating efficiency and to reallocate resources to expand and strengthen our client-facing ability worldwide. We must accelerate those changes to effectively capture the opportunity available to us.

Although Ron will go through the details in a minute, I'm going to quickly hit on a few key points from our fiscal second quarter. The effects of the downturn in the US has hit us relatively quickly. At the end of November, we had achieved a 5% consolidated organic revenue growth globally. The downturn in US revenue in December down 15% relative to December of last year caused a 7 point swing in our global growth performance.

These dramatic changes were driven mainly by our healthcare and financial services groups in the US and our Canadian groups that serve US-based customers. In fact, US healthcare sales dropped 14% in the period. So the question is what are we doing about it?

First, we've added people in the UK to expand our business with clients. We've transferred very capable people to the region to help grow our intellectual capital, and we intend to face those clients that already know and appreciate our outstanding capabilities. One major former customer has recently named us a global supplier for brand research. What we have to do is be there to support them globally.

We've also added new healthcare capabilities in Canada who will work jointly with the US team to build business in both regions as they enter into new business. We're hiring healthcare specialists in both France and Asia. In short, we are following the revenue. We know the market is down in the US. We must take our capabilities rapidly around the globe to access those budgets. And we must do it even faster than we are doing it today.

Other US units for the most part are doing relatively well with bookings and revenue up in the quarter. One especially bright spot, CPG, an area we've been concentrating on and have communicated to you in the past, grew bookings 52% in the period and revenue 23%. And technology and loyalty, two units you heard about negatively in the past, are continuing to improve their businesses.

In Canada, unfortunately we lost 1 million in telephone work for US customers because of rapid rises in prices due to a surge in the value of the Canadian dollar. That has mostly stabilized. The clients in Canada's forestry products business who supply materials to -- yes, you guessed it -- the US home industry were down. And the Canadian government has put a temporary moratorium on buying MR who is a big client of Harris/Decima business.

Our team in Canada is strong, it is motivated and they have a plan to recover. Most of all, they are real professionals. They know the goal, they understand the challenges, they accept the responsibility and they're added with a good look at third quarter performance.

Turning to Europe, we have really great results in Germany 103% organic revenue growth in the period. Good results in France, which in fact we talk about as a harmonization candidate. They have just come off, of a three year earn out, we are now able to help them build their business by transferring our technology and methodology.

We are now applying our harmonization model in France, share the resources and transferring those capabilities would result in their solid management performance at 7% revenue growth and a 100% increase in bookings for them in the quarter.

In UK, revenue for the period was down a bit, but we had good bookings performance at plus 22%, great internet growth at plus 74% and a good look and a solid second half in the region.

And finally turning to Asia, while they are a small unit and they are small and growth is easier that way. They have managed to consume and leverage Harris capabilities at an incredible rate and grow their business in an astonishing 285% this quarter alone. Simply put the globalization strategy is working.

More than revenue is book to measure and the cause. Across these businesses we have nearly zero employee attrition a critical measure of forwarding looking success. These very productive revenue results are large part delivered by the common vision of the future that we share and a productive attitude towards achieving results.

Now I am going to turn it over Ron for details on the period. Ron?

Ron Salluzzo

Thanks, Greg. Good morning, afternoon and evening as well. I am going to review the financial results for the quarter as well as comment on specific items driving these results. During this discussion I recommend that you refer to the financial statements and key operating metrics we included in this morning's press release. If you did not received the press release this morning and the updated key operating metrics table and the key operating metrics table are available on our website.

Operating results for Q2 were driven by a shortfall in bookings leading to a shortfall in revenue. The main drivers of bookings reduction in the quarter included financial services, healthcare in Canada, as Greg summarized a moment ago. And from his summary, let me take into a bit more detail.

Our US Financial Services division is $2.2 million or 24% behind fiscal year 2007 on a year-to-date basis. In the US, we have impacted by $4.6 million in sales directly related to the sub-prime issues in a series of our clients. Some maybe renewable in Q3 or Q4 as clients reassess needs, but we expect the US Financial Services bookings issues to continue into Q3 and have an unfavorable impact on revenue in the second half of our fiscal year. We also add an adverse impact on UK and Canadian results of approximately $700,000 in bookings and revenue in the quarter.

Healthcare bookings in the US are behind last year by 26%, which at the end of the first quarter were basically flat and down as Greg mentioned earlier 40% in Q2. These are caused by several factors, which include healthcare businesses reconsidering their business models and strategies for the US market and while doing so focusing on cost containment including reductions in market research budgets. These adjustments contributed significantly to the volatility in our own US business unit.

An analysis of significant accounts shows that 37 accounts had reductions equaling $16 million in the half, while 22 accounts had increases equaling $8.2 million for a net drop of 7.8.

This is all part of the strategy to expand the base business and the base clients to include not only large pharma, but to expand into smaller and middle pharmaceuticals, as well as medical devices, as well as providers of healthcare services. While we've seen some real growth in those areas, they clearly were not enough to make up for some of the drops that we saw in our legacy accounts.

The industry is seeing continued globalization of research and redistribution of that research outside the US, which is why Greg mentioned the movement of resource and the building of resources in other regions of the world.

Greg also mentioned the Canadian bookings and revenue impact by the change in the US versus Canadian dollar. That effect was approximately $1 million as a result of less phone work conducted for US clients due to the weakening of the US dollar.

In Q2 '08, the average currency exchange rate was 101 and it hit a peak in October of $10 against the US dollar, and in the prior year, the Canadian dollar priced at $0.88. The exchange rate relationship is now more manageable and the phone work is recovering in Q3. In fact, for all the business units in Canada, total backlog at the end of January was 97% of expected Q3 revenue.

For the half year, new opportunities entering the pipeline reduced by 10% in the US; no surprise for the things that we talked about, with the largest debt in healthcare at $9.6 million, down 14%.

In healthcare, as I mentioned earlier, we have broaden the field of potential clients we are approaching, but this activity has not made up for the shortfall in our legacy client base. We have made and are making progress in several changes in an effort to reverse unfavorable sales growth.

Let me talk about each of the units for a moment. In healthcare, we are leveraging our US experience to grow healthcare accounts and particularly to globalize our healthcare business.

In Canada, we added resources who specialize in secondary data analysis and the integration of primary and secondary research to improve sales and marketing performance for biopharmaceutical companies. They will enable us to provide a new roster of capabilities to our clients in Canada and in the US.

In financial services, we have a new leader with 20 years of research, consulting and management experience with notable concentration in the financial services industry. We believe there are opportunities in financial services, and we are addressing active sectors such as investment companies, banks not hit with CDO issues and investors focusing on retirement assets.

Throughout the company, we are going to invest carefully to protect market share in growing our business units. We will continue to focus on critical collaboration between our research staff and our sales force to offer insights to our clients that will address emerging business needs.

We are in the process of scaling the business units to our expectations in the market over the next several quarters where our view of the economic indicators would imply volatility. We are leveraging our expanding footprint to develop a global infrastructure to support global account development.

With those points as the causes of our results and some discussion of our actions and plans, let me now turn a bit more to the numbers. Bookings for the second quarter were $68.2 million, up 4% from $65.7 million in the prior year. Our recently acquired operations in Germany, Canada and Asia, contributed $9.5 million to those bookings.

Bookings increased 45% in Europe, and US bookings decreased 17%, driven by the factors just discussed, much of which occurred in late November and December. We will continue to invest in sales and marketing activities to support future growth.

Our backlog as of December 31, increased to $72.8 million, compared to $64.6 million at the same time last year for a total increase of 13%, which of course is attributed mainly to acquisitions.

Overall sales and marketing spend was 9.8% of revenue in Q2 '08, which is up compared to last year from 9.5%. As stated, we will continue to invest in sales and marketing in order to drive sales growth and raise awareness of the Harris Interactive brand in the global marketplace.

We do expect our full year marketing and sales spend to be in the 9.5% range as volume increases over the year and the fixed components of sales cost are spread over a larger base.

Sales headcount is virtually flat versus the last year, and we do expect to add further sales staff as well as balance the research staff to sales staff ratio to optimize selling efforts.

Turning to revenue, our consolidated revenue for the second fiscal quarter was $62.7 million, up 13% from the prior year. Revenue from our recent acquisitions was $9.5 million; consolidated pro forma organic revenue decreased 2%, driven by a 5% organic revenue decline in the US.

All pro forma organic growth numbers include the prior year amounts from the acquired companies to ensure comparability. European revenue growth of 12% and pro forma organic growth of 4% driven by revenue growth of over 100% in Germany, where we saw a return of a significant prior period client in this past quarter. European revenue included $900,000 of favorable impact of currency fluctuations.

We continue to take multiple actions to grow bookings and revenue activity in Europe, including rolling out presentation skills and solution portfolio training to sale staff, with client facings, researchers receiving training in the third quarter, improving resource allocation of business development inside sales resources across teams, placing strong solution staff to support sales activities in key growth markets, hiring a new UK marketing manager, recruiting sales staff actively. All those actions are intended to keep driving market share and growing our revenue base in each of these growing market places.

Although down on a pro forma organic basis in Q2 and basically flat with the first half of fiscal 2008, North America did see strong revenue growth in US consumer goods and curiously financial services. Consumer goods growth is a result of brand development and product innovation work despite the loss of a large tracker from a prior year. And while we remain cautious about the macro economic impact on future work in the financial services industry as evidenced by the decline in bookings, this research group has begun successfully partnering with our internal solutions group to fulfill client needs on a basis we had not done in prior years and we saw the result of that in first half before the slowdown principally driven by the subprime problem affected us.

Technology industry research was down 19% due to the timing and a reduced contract for the large client, but our relationships remain strong and bookings projections for the second half of the year are good. As discussed previously, Canadian revenue and bookings were adversely affected by the weakened US dollar throughout the quarter and we now believe are on track for a solid second half. Revenue growth in Asia is explosive at 285% for the quarter and 122% for the first half of the year on a pro forma organic basis.

One key metric that I know interest many of you is our Internet revenue was up 21% year-over-year. European Internet revenue was up 92%, driven by strong contributions from all European units.

Operating income for the quarter was $3.5 million or 5.5%, down 39% from the prior year. Net income for the first quarter was $2.1 million or $0.04 per diluted share, down 42% compared to Q1 of '07. Operating margin year-over-year changed by approximately 2 points due to some specific items.

First, the integration-related costs including amortization of intangibles at $400,000, and integration of implementation activities $200,000, our non-cash stock based compensation is $200,000, and in '07 we had a gain on the sale of real estate in the UK, which was $400,000. In addition, interest expense related to acquisitions of about $0.5 million was a further drag on net income. Interest expense plus the amortization plus the integration reduced our earnings per share by more than $0.01 in the quarter.

On an as-reported basis, revenue increased 13% and billable FTEs were up 14%. We did see some inefficiency due to the volatile economic conditions in healthcare in US across the board and with limited visibility into our Canadian operations, who are now fully integrated, onto our forecasting process.

Utilization for the quarter was 62%, up 1 point from the prior period. But we think that we could have done a bit better with better visibility into the late changes that affected us.

Adjusted EBITDA was $7.1 million or 11.3% of revenue. That is down 14% compared to Q2 '07, but the full year original guidance would have said that we were looking for a margin of 11.7%, so that the performance of the adjusted EBITDA line is relatively in line with our expectation, at least on a margin basis.

As of December 31, '07, cash, cash equivalents and marketable securities are at $33.3 million, up from $24.1 million as of September and down from $54 million as of the prior year, the largest change, of course, being the process of stock buybacks. CapEx for Q2 was approximately $1.6 million.

Looking at where we see the rest of the year and based on the results of the first half in the rapidly changing and uncertain macroeconomic outlook, we continue to drive toward the low-end of revenue guidance. With the expectation of continued volatility, we will invest at a higher rate to ensure capturing market share which will impact our profitability. While we’ll continue to invest in high growth areas to drive sales growth we’ll focus on the appropriate level of costs required to fulfill revenue expectations. We expect to implement a plan that will reduce cost by $5 million over the next 12 months with the most of the savings beginning in Q4.

We anticipate incurring a charge of between $1 million and $1.5 million equating to earnings per share of more than a penny related to the closing of our US phone center in [Orem] and properly sizing our business to meet current productivity and profitability standards. We have implemented changes in and continue to review certain outside services to be sure these services deliver appropriate value to our customers as well as cost efficient solutions for the company. All over head costs continue to be carefully monitored to be sure that they are client focused and move us towards our bookings growth expectations.

Thank you and now I would like turn it back to Greg.

Gregory Novak

Thanks Ron. Before we go to Q&A I am going to talk about just a couple of things. While the success of the globalization strategy is also to be measured in revenue growth, there are milestones or checkpoints along the way that are critical to recognizing the potential for this success. Things like employee retention and employee feedback, a common understanding of the goals and the strategy that we’ve agreed to, a shared vision and implementation of best practices and a healthy ability to make a decision, implement it, and move on. In all cases we’ve seen great evidence that these conditions exist and are the bedrock of our success today and thank you to all you involved in making that happen.

Second, in addition to all of the critical reasons we discussed and we described that it is necessary to recreate and globalize this company. This quarter we can focus on yet another, that is the increased ability to mitigate dynamic regional and structural market risk with a more diversified portfolio for the benefit of shareholders and finally this globalization strategy and actual implementation can and does work.

And this company must redouble its efforts not only acquisitively but as importantly organically to rapidly globalize our client support network. We must use our current assets to build a stronger company and we must do it immediately.

And I am going to open it up for questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Barton Crockett with JP Morgan. Please proceed.

Abhijit Chakrabortti - JP Morgan

Hi good morning. This is Abhijit actually stepping in for Barton. Thanks for taking the question. I did not see any color on guidance, EPS guidance or EBITDA guidance in the press release. I was just wondering if you could reiterate, whether you still expect to stick to your originally provided guidance at the beginning of the year.

Gregory Novak

I think where we are right now is taking a hard look at that. We expect -- we did not speak to that, because we are still assessing the impact of what occurred to us starting in December and bleeding a bit into January. And we are assessing right now how much we need to invest to ensure market shares, our first priority. Secondly how much do we need to take out of costs in our base in units that are not growing to ensure that we scale those businesses properly; and third, taking a look at how long the US business, which of course is our largest unit by far is going to impacted by the current [roiling] that's going on.

When we put all those together, we felt uncomfortable telling you something until we had better visibility. Our expectation would be that we are going to follow this over the next 30 to 60 days. And at the point where we have a stronger sense of it, we will come to you and reissue.

And it may take us till the quarter, but I think the thing we want to leave you with is that the incremental costs that we are taking are going to affect profitability over the second half that's $1 million to $1.5 million and that we are going to have to invest in order to grow the businesses. And we are seeing some good results in the other areas.

I will also say that when we came out of the blocks last year, we did point out to everyone that we were going to have some impact on earnings as a result of the costs associated with the acquisitions, particularly in the earliest quarters, the first, second and third.

They would have dampening impact on earnings for the year that was being fairly sizable, and I believe we talked in terms of $0.05. So, we are looking at that right now. And I know everybody likes to hear specifically our thinking, but rather than precede the thought with the facts, we thought we should get the facts first.

Abhijit Chakrabortti - JP Morgan

Okay. And also just a question on internet revenue growth, which, in both geographies, seem to be holding up a lot better than your traditional revenue growth. I was just wondering if you are seeing any signs that internet-based research is actually holding up better in the current economic environment than traditional research.

Gregory Novak

Well, certainly, we're pleased with the internet revenue growth in almost all of our regions. And that's a positive sign overall. Every customer evaluates the capability, the quality and the deliverable every single time. So, I suppose if there is a sense of internet holding up better, the answer is internet is growing for us, and in fact, growing a bit faster than it had in the past.

In fact, in Europe, we're doing nicely. We're really getting to the market today. And in some cases, that's as much about having talented people facing the markets with the capabilities and introducing and growing into those markets. So, I guess the short answer is yes.

Abhijit Chakrabortti - JP Morgan

Okay, great. And just one last question, if I may, is there any update you can provide us with regard to the status of your discussions with your large shareholders?

Gregory Novak

I think the answer is going to be no. We kind of go through this every quarter. We actually are working with two of our large shareholders, growing the business quite frankly, and we're very excited about that. But in general, we're not going to talk about that very much, because it sends signals that are inappropriate, no matter which way we are talking.

Abhijit Chakrabortti - JP Morgan

Okay, great. Thank you very much.

Operator

Our next question comes from the line of Randy Hugen with Piper Jaffray. Please proceed.

Randy Hugen - Piper Jaffray

Thanks. At this point, what sort of economic assumptions are implied in your second half revenue expectations and what is the sensitivity of that if US economy continues to decline?

Ron Salluzzo

Randy, this is Ron. Right now, our expectation is that we're going to see a protracted, but stable at the level we are at, economy in the second half. We do expect by the expansion, for instance, of our client base in healthcare that we will be able to hold on to revenue, but we are not planning for growth in either the healthcare nor the financial services industries.

Randy Hugen - Piper Jaffray

All right. And then have the weakening trends that you've been confined to the healthcare financial services and then also Canada, and could you give us revenue breakdown there?

Gregory Novak

Let me talk a little bit about trends, and in the US as we said struggling in healthcare and financial services both market chips and economic issues. On the other hand, we mitigate that somewhat having fixed or repaired some of the businesses that were struggling a year ago and those businesses whether new products or new growth initiatives or new leadership are growing and are setting some of those declines. And as Ron said, you should put your money where you are winning and we'll ride those horses even harder in the future.

In Canada, Ron can you I think talk a little bit about backlogs in a moment. But they took a really short term hit; sort of a triple witching thing. We met with them and their view is, "Listen we're on this, we own this one, we have it and we're going to take care of it" and that’s pretty positive, so we don’t see that as a permanent locked in. I won't call that one a trend. If we can rapidly access these tremendous client relationships that we have in healthcare around the globe, we can also offset some of those capabilities and we're running this as fast as we can in that direction right now.

Ron Salluzzo

I think to add a bit of color to that Randy, the phone issue in Canada cost them $1 million in the quarter. And it was truly a result of almost overnight the cost of doing phone work with our Canadian sub by US companies went up about 17%, which made them short term pretty non-competitive.

Now that we've seen a little more balancing of the relationships between the US and Canadian dollars and they've had a chance to react and make some modest adjustment in pricing, they are seeing a recovery and they are back to their traditional levels. We also will think to improve profitability of that unit, because as we mentioned, we closed our last US phone center and we expect to be pushing work there, which should leverage off the fixed cost that associated with the phone centers. So we have some real confidence there.

Another bit of information is that the UK, while the first half they struggled a bit with revenue, have shown substantial growth in sales and are projecting pretty comfortable growth for the second half that we think is real for two reasons. One is, the relationships with the clients they have and secondly, they are moving more of their revenue online, and that online revenue is our sweet spot and is where we think we can compete thus. So we have some confidence there.

Again in the US obviously as always our biggest unit is healthcare. So for us to grow as a group without healthcare growing is pretty hard, and we've recognized at we are willing to acknowledge that we are not going to hit our hedge against a wall, we are going to scale it to be a successful business unit.

Randy Hugen - Piper Jaffray

And then what's the size of financial services group?

Ron Salluzzo

It's relatively small, around $10 million for the full year, may be a bit under that. But they interestingly had growth, had substantial revenue growth in the first half. It just isn't going to continue in the second half, because there was a case where they were going along nicely with growth and they've been working pretty hard again to expand the base of clients out of institutions affected by subprime, but that takes a little time. And we are expecting that it will take us a bit longer to get there, so that we have the opportunity to build the business in the non-subprime areas, and then as people affected by subprime come back, then we get it.

I also misspoke on revenue. They are actually at about $14 million all-in. I was giving you a number that didn't include all of the solutions, I believe, but all-in we do about $14 million.

Randy Hugen - Piper Jaffray

All right, thanks. And then, outside of restructuring costs, what are the high growth areas that you're going to be investing in? And do you have any idea of how much incremental costs you might be expecting from the investments?

Gregory Novak

If it's acquisitive, that will be a different sort of model. We're not spending a lot of money on a lot of incremental dollars you would point out on integration. We're not slashing our costs in these acquired businesses. We are spending management time on transferring technology and methodology and capability.

The costs for more organically growing our businesses and switching will be captured within the business units. And as Ron said, we got a bunch of complex moving parts going on right now. We don't see a [singular big trough], what we're already talking about is telling to people in place around the globe to serve these clients. And that will get us some costs ahead of revenues as we try to globalize these businesses.

Ron Salluzzo

Yeah. The types of people that we would be getting, we clearly need more sales people, and we'll be investing in them as we clearly need people who have industry expertise at fairly senior levels that can go upscale at clients, talking to more senior people about their business issues. We're investing in those. And we're also investing in the kinds of training we do for everybody to prepare them better for the marketplaces they face.

Randy Hugen - Piper Jaffray

All right. Thanks.

Ron Salluzzo

Okay.

Operator

Our next question comes from the line of Jim Boyle with CL King, you may proceed.

Jim Boyle - CL King

Good morning. What happened to Harris's bookings and sales and margins in the last two recessions, if you can kind of give us quantifiable drop-offs if possible? And how far ahead of those last two recessions did the Harris number start to flash warning signals of the macroeconomic problems to come?

Ron Salluzzo

Jim, I wasn't here, but let me start since I've looked at some of these trends. I don't think we have a comparative that's as good, because in the last recessions the company was riding on uptick on Internet wave in the US at the same time the recession was occurring. So we were still gaining, but I think gaining at a slower rate because of the recession.

Now, we're global so we have disparate results in different places, and because we've already gotten to 66% of our revenue in the US, we're not going to get the continued path that comes from the Internet.

Gregory Novak

A more generic question is the historical commentary has mostly gone one direction, but actually it cuts the other way. Advertising revenues decline proceeding a recession, research follows that but with less volatility, and then advertising revenues increase. I actually have taken a look at the most recent forecast on advertising revenues but it is little a curious thing and this is certainly before what happened in December.

Ron Salluzzo

It’s 3% or 4% domestic overall advertising growth given political and Olympics.

Jim Boyle - CL King

Is that -- that’s from September right?

Gregory Novak

That is the last two months work of various ad agency gurus and madams, yeah that’s a so much of -- they actually had predicted an up tick in advertising revenues for 2008 and we'll see whether that maintains or not.

Jim Boyle - CL King

Okay, Ron any updates please on the buyback?

Ron Salluzzo

On the buyback program expired 12/31 and we've been looking at how we deploy resources I think I've said that in the past and right now we think we can fully commit resources to the company otherwise.

Jim Boyle - CL King

And what was done in Q4?

Ron Salluzzo

Well nothing.

Jim Boyle - CL King

Okay and could you just give us a feel with that foreign currency impact, what the growth was in the international segments?

Ron Salluzzo

For the impact on a dollar basis was $900,000 on revenue. I didn’t do the math on percent.

Jim Boyle - CL King

Okay and finally given the volatility of the macro environment which of course is out of your direct control what probability would you approximately think it is of Harris getting to the low end of your revenue guidance range?

Gregory Novak

Well I think right now that’s where we believe we can get. We clearly got a lot of hard work to do and as I said a minute ago we really want to look at this for another month or two before I actually answer your question directly.

Jim Boyle - CL King

So it’s better than a 50-50 jump off?

Gregory Novak

In my opinion, yes, but I have to tell you that if there is even more down check from where we are I might -- my discomfort level gets higher. Jim maybe you can come out how many more banks. You can do that then we will give a bit more.

Jim Boyle - CL King

Yes, okay thank you very much.

Operator

Our next question comes from the line of Todd Van Fleet with First Analysis. Please proceed.

Todd Van Fleet - First Analysis

Good morning guys, I have to confess I am having a hard time getting in my arms around all the different moving parts and pieces here that are the issue that you guys are dealing with. I am just -- in terms of understanding what's the priority to the company is at this point and trying to put together some reasonable forecast toward the back half for this year is going to look like. I guess I'd now some just kind of asking for your assistance in this regard.

Let me start with, observation is that you could have made, you could have made the consensus EPS estimate had SG&A expenses been more inline with the revenue level that came in for the quarter. So that being the starting point, refer just say a couple of things I guess regarding the back half of the year and what's assumed in the economy of your outlook for the back half of the year? Really on the revenue side no change in kind of the current macro environment that would cause the downturn in the healthcare and financial services verticals that turnaround that's correct?

Gregory Novak

I would say yes to that.

Todd Van Fleet - First Analysis

Okay, and so then we could still probably expect a sequential reduction in revenue just based on seasonality and sales force is that correct?

Ron Salluzzo

Yes, Q2, Q3 tend to be about the same, most years yes.

Todd Van Fleet - First Analysis

So last year was anomaly then, where we saw the downturn from Q2 to Q3 from a revenue standpoint?

Ron Salluzzo

No that was I think in '06, and I don't have in front of me, but '06, I believe, we went up a little bit. Last year, we went down. With what's being going on here, it may not be unreasonable to assume down in Q3, although we are certainly working not to have that.

Todd Van Fleet - First Analysis

Okay. If I just look at the model here, so if I assume flat revenue in Q2, Q3 and they say even a 10% uptick sequentially from Q3 to Q4, that puts you maybe $10 million below the low end of your revenue guidance range for the full year. So, it would seem that Q4 would have to be a pretty much a blowout in every sense of the word 'quarter' to get to that low end to the guidance range.

So, I see that or observe that and then I take into consideration what you are saying on the expense side of things where I'm hearing a couple of things; one, you are going to be investing in personnel and increase in the sales force and looking at going into new markets and exploring your solutions and your offerings in those markets.

So, it doesn't seem that maybe there would be a downtick in kind of the SG&A levels in the back half of the year, because it sounds like really you're investing for future growth when things kind of turn around and start working your way. Is that right?

Ron Salluzzo

We are doing some shifting. As we said, we're going to take the charge of the $1 million to $1.5 million. So, we'll see some savings in the charges that we're taking, and then we're going to invest that, whether we invest past that will depend on where we see opportunities for growth.

Gregory Novak

Todd, you remember, in our income statement, a large part of what I would call the structural unutilized time of researchers is in the SG&A portion. It's actually on the G&A portion. And it's a big chunk. And so, as an example, in our second quarter, we have 5% organic growth rate and the bottom falls out in December.

All those folks are here. Okay? And so, that's a big number moving in the wrong direction. We get that one sorted out. The investments that we are putting in are around to grow the business may not be 100% offset to that.

Ron Salluzzo

Okay.

Todd Van Fleet - First Analysis

Yes.

Ron Salluzzo

The SG&A, there is a couple of things that worked there. Greg mentioned probably the biggest individual item, which was the unutilized time. And we mentioned that even though our utilization is up one point, it's really below where we needed to be and where we scale to be, especially because the revenues fell out so late in the quarter.

But there is some other things in there that are relatively fixed. So, they won't ride up or down with revenue, because they represent fixed costs, things like stock-based comp, amortization of intangibles, interest expense, which affects earnings per share down below. Those things are to be fairly fixed to us. So, as revenues ride up, we would expect to see positive results in earnings.

But your point on growth in revenue, it is not unreasonable to have substantial growth from Q2 to Q3, 5 to 15, and we have, don't forget, some units that are added this year that were not with us last year. So, the theory being that their ability to grow and plus the plans that we established jointly would indicate sizable growth patterns, partly because they are integrating the Harris Solutions sets and we are trying to exports some people as well. This should take constraints off their growth rate to some extent. So, all of that's in the mix as well.

Gregory Novak

Their sales pipelines are talk full of new capabilities, larger orders, global projects and to the extent they win them, there's a lot of value there for our company.

Todd Van Fleet - First Analysis

Right. I think we understand that everyone needs to be optimistic and that's great, but the same time the thing we could probably be a little bit realistic regarding the current environment that we find ourselves then in, and that, you said that the downturn, you really didn't started seeing the downturn in financial services for example until the December quarter. And you look at last year for example, last fiscal year, the revenue downturn from Q2 to Q3 was pretty meaningful and given the new environment macroeconomic environment that exists this year, it deteriorated of course in December. Why would anyone think that your third fiscal quarter this year is going to be better in --?

Ron Salluzzo

Last year almost 80% of our revenue was produced in the US, today it makes up a significantly lower amount, and we are seeing growth in the non-US units. By the way, the concept of optimistic and realistic, I think I have said, when we get a better handle we will come back to you, because we clearly saw the impact December, we see something happening in January, but we don't even have January fully closed at this point being yesterday. So, I think rather than tell you what's going to be X, Y or Z, we believe we need a bit more time to get visibility into this. I mean a good example is, it's not just the sales piece, but how much of the sales get modified or cancelled or pushed to other quarters. There is a change that represents some volatility to us, and it effects us in substantially all of our business units. So, one thing that can happen to us that results in no revenue or little revenue is just the constant push of a project.

So, we're looking at all of these factors and when we get our arms around all of it, we will come back. But having said that, we do have a math, and a plan that gets us to the bottom guidance.

Gregory Novak

Todd, this is Greg. Our goal is not to be overly optimistic. I said, we've got to be realistic in the United States, we have to make the actions that make that work right. But to put it in perspective, from a shareholder perspective, I worry about two things on Harris, worry about organic growth as you so appropriately mentioned, but let's be honest people have been very fearful about whether or not this globalization strategy make sense; number one, given our past history, and whether or not, we can execute it.

The optimism is about those successes and that opportunity and how that will mitigate some of the [dollar] risk that we have in the US. So, I appreciate it. We are never going to be optimistic, but we also think that we've got a plan going that helps our company be better, rather than just leaves us with the [wins] of the US market.

Todd Van Fleet - First Analysis

Thanks guys. I will follow-up offline.

Operator

Our next question comes from the line of [Clark Brown] with Needham & Company. Please proceed.

Clark Brown - Needham & Company

Hi, guys, thanks for taking my question. And I guess, most of my questions have been answered. But I have just a couple of quick ones. I think you guys mentioned a shortfall in bookings, for example, in finance line, when does that really play out on the revenue line? And second, can you just give me what the operating cash flow for the quarter was? Thanks.

Gregory Novak

Just first on the bookings scene. In the financial services business right now a booking shortfall can affect you tomorrow. We've had people call up and simply suspend data collection in the face of this banking crisis. The typical conversion might average more like 90 to 180 days depending on the kind of work that you are talking about.

We had a revenue growth in financial services in the period actually, but a downtick in bookings. We try to communicate our concerns about the business kind of looking out over the future, and certainly financial services is going to struggle some. That's all set by the fact that we got a strong leader in place who thinks there is other opportunities to use our capabilities.

Clark Brown - Needham & Company

And the operating cash flow number?

Ron Salluzzo

About $4 million for the quarter.

Clark Brown - Needham & Company

Thank you.

Operator

Our next question comes from the line of Steven Fingerhood with ZF Partners. Please proceed.

Dan Stom - ZF Partners

Yeah, hi guys this is [Dan Stom] on behalf of Steven.

Gregory Novak

Hi, Dan.

Dan Stom - ZF Partners

Hi. I had a question related to the acquisition, and you spoke about the harmonization efforts and issues around employee retention. Could you give us a little more color and perhaps some additional metrics that may help us understand and track that progress?

Gregory Novak

Sure. First is we're really sort of talking about four units currently globally; our German operation, our French operation, our Asian operation, which is really located in Hong Kong and Singapore, and our Canadian operation. And we had our French one in because the original acquisition of our French unit was done a bit differently. So we are trying to communicate a message that says if we are harmonizing and the cost of the harmonizing is we are transferring technology, methodology, product solutions, capability, intellectual capital and in some cases leadership in and around the globe and in both directions or in all directions, how well does that model work? Can you buy a firm, professional services firm and can you give it capabilities will then help it grow in its region and will grow on behalf of shareholders.

Our history is not being an [ingredient] of that and I think shareholders appropriately so, have been fearful of that strategy. What we are looking at now is three of the four units are having from good to exceptional growth characteristics, increased client retention. In Germany, in fact, we had legitimate and real fear that our largest client in Germany would actually reduce their commitment to our German operation and as that adding them to the Harris family they have increased that commitment, they like them being part of a global enterprise. We’d lost a couple of people here and there but its normal attrition it's not the kind of dramatic activity.

I have just made a tour all around the globe met everyone of our presidents and the bottom line is they are not worried about that they are not losing people they are connected in, as you can see in the results on revenues they are growing the business. If you look at some of these units are small and those gross rates are big, but for us $1 million or $2 million makes lot of difference in growth in a period quite frankly and these guys are able to consume these offerings that we provide and compete much more effectively in the market. And while we were making those towards what we find is more and more markets honestly that have really quite honestly opportunity that looks like the US did in 2001 or 2002, with no real capability from local companies to supply those markets on the internet, which we're just so good at. So, we're going to continue that path.

We are seeing great success. We probably could start to gather up, whether we have abnormal attrition data, but everywhere I go, everyone is saying we're on board and we're moving in the right direction.

Canada suffered some business issues, but as I said earlier, our guys in Canada are pros. They've got a good looking quarter ahead of them. They know what happened, and they're on it, and we don't see big problems there. In the past, people attrition leads revenue attrition, and we're not looking at that in Canada. We just got business issues.

Dan Stom - ZF Partners

Okay. Thanks, guys.

Gregory Novak

Okay.

Operator

(Operator Instruction)

There are no other questions at this time. I would now like to turn the call back over to Greg Novak, CEO.

Gregory Novak

Thank you, and thanks for listening. As I said before, Harris is at a dynamic and exciting new point in our history. We have historically and should continue to be judged on our organic revenue growth in our base business with some thoughtful consideration of the challenging economic times, and yes, our largest business.

Shareholders have, since the announcement of our globalization strategy, been concerned and appropriately so about our successful execution of that strategy. We're excited to talk about those possibilities. We're excited to talk about the opportunities.

We believe those are the two things you have to look at about our company. We'll continue to report on them independently as we have here today. And we'll continue to try to run this business for the benefit of employees and clients and shareholders.

And we thank you for listening, and we thank you for your ongoing support.

Operator

That concludes the presentation. You may now disconnect and have a great day.

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Source: Harris Interactive F2Q08 (Qtr End 12/31/07) Earnings Call Transcript
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