Harte Hanks Inc Q2 FY2022 Earnings Call

Good day, everyone, and welcome to the Harte Hanks Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later, you’ll have the opportunity to ask questions during the question-and-answer session. It is now my pleasure to turn the conference over to Mr. Tom Baumann of FNK IR. Please go ahead Mr. Baumann.

Thank you. Hosting the call today are Brian Linscott, Chief Executive Officer; and Lauri Kearnes, Chief Financial Officer. Before we begin, I want to remind participants that during the call management's prepared remarks may contain forward-looking statements that are subject to risks and uncertainties. Management may also make additional forward-looking statements in response to your questions today. Therefore the company claims protection under the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from results discussed today and therefore we refer you to a more detailed discussion of these risks and uncertainties in the company's filings with the SEC. In addition, any projections as to the company's future performance represented by management include estimates as of today, August 11, 2022, and the company assumes no obligation to update these projections in the future as market conditions change. This webcast and certain financial information provided on the call, including reconciliations of non-GAAP financial measures to comparable GAAP financial measures, are available in the earnings press release that was issued shortly after the market closed. A copy of that press release and other corporate disclosures is available on the Investor Relations section of Harte Hanks website at hartehanks.com. With that, I would now like to turn the call over to Brian. Brian, the floor is yours.

Thank you, Tom, and good afternoon. The changes we have implemented at Harte Hanks are clearly yielding results, as evidenced by significant improvements in operating income and EBITDA, despite a modest decrease in revenues due to the conclusion of some pandemic-related projects, which we anticipated. This increased profitability stems directly from our strategic decision to adopt an asset-light business model and concentrate on profitable sectors to enhance our margins. Our operating margins have improved by over 8% compared to less than 3% in the same quarter last year. Harte Hanks is now operating sustainably profitably, with a stronger balance sheet and a business model that generates cash. Our restructuring is complete, but we will maintain our focus on operational enhancements and seek to further expand revenues and margins. As we entered 2022, we expected revenues to align with those of 2021, given the conclusion of several pandemic-related projects onboarded in previous years. The 1.4% revenue decline in the second quarter, particularly the $3.8 million drop in customer care revenue, aligns with this projection. However, we have successfully secured new client relationships and expanded our work with existing prominent clients. Even amid the documented economic slowdown, we are confident in our outlook, with a clear path to grow our revenues year-over-year. For instance, we have started increasing our customer care staffing to prepare for the August 21 release of House of the Dragon, the Game of Thrones prequel. This event, along with a significant logistics win and other new business successes, boosts our confidence in surpassing a strong third-quarter comparison with 2021. We anticipate a challenging comparison again in the fourth quarter, but looking towards 2023, we see plentiful opportunities to drive growth across all three business segments by continuing to invest in sales, marketing, and partnerships while enhancing existing client relationships. Strengthening our existing customer relationships remains a priority. Our offerings are in demand, and we are increasingly deepening relationships beyond single business segments, thanks to the sophisticated nature of our clientele who regard Harte Hanks as a valued and trusted partner. We emphasize data-driven, industry-leading solutions that foster optimal customer experiences. Additionally, we are integrating technology solutions to improve our customers' workflows, which further fortifies these relationships. We are consistently investing in our business to enhance growth, boost profitability, and maximize shareholder value. Recruiting and retaining talent, along with upgrading our technology platforms and expanding third-party partnerships, will enhance our market opportunities and facilitate cross-segment sales of our integrated offerings. We believe these investments will lead to additional revenue growth through improved cross-functional collaboration and deeper engagement with our customer base. We are committed to strengthening our balance sheet while effectively managing our free cash flow and capital allocation decisions. By the end of the second quarter, we had an agreement to repurchase all preferred shares held by Wipro, which will eliminate dilution for common shareholders and provide greater flexibility in our capital structure moving forward. A recent improvement in our balance sheet during the third quarter resulted from our transition to a cloud-based infrastructure platform, during which we identified over 52,000 unused IP addresses acquired in the early 1990s. In July, we successfully sold these unused IP address blocks through several transactions for total proceeds of $2.5 million. This sale also led to a one-time improvement of roughly $2.5 million in our third-quarter cash and non-operating earnings. While our long-term debt stood at $10 million as of June 30, we currently have no long-term debt and are accumulating cash. Now let's discuss our results. Our three segments are: Customer Care, focused on providing full-service customer care solutions that are tech-enabled and people-driven; Fulfillment & Logistics, which handles B2B product and literature fulfillment, B2C e-commerce, sampling, and comprehensive supply chain and logistics services; and Marketing Services, aimed at strategic planning, data-driven insights, performance analytics, creative design, technology enablement, and program execution to optimize business outcomes and enhance customers' ROI. Our segment reporting aims to ensure clarity in the company's financials while offering insights into the value and dynamics of each business. Overall, revenues in the quarter fell by 1.4% to $48.6 million, but operating income rose by $2.6 million, nearly 180% compared to the same quarter last year. Our EBITDA more than doubled, reaching $4.6 million from $2.1 million in the second quarter of the prior year. Net income for the quarter was $4.5 million, indicating that Harte Hanks is now firmly profitable on a GAAP basis. We anticipate continued profitability in EBITDA and GAAP net income for every quarter of 2022. Each operating segment showed strong performance in the second quarter. Customer Care revenue dropped 19.8% compared to the previous year, and year-over-year EBITDA fell by 25% to $2.5 million from $3.4 million in the same quarter last year. This decline was influenced by the completion of COVID-related projects, as expected. Nonetheless, we look forward to strong sequential results in the third quarter as we onboard agents to support the House of the Dragon premiere and grow the business with new and existing clients. The Customer Care pipeline looks promising with current and returning customers. We are also discussing options to extend our offerings beyond Customer Care into marketing services, fulfillment, and technology development. Customer Care continues to invest in sales and marketing efforts, attending conferences, and enhancing talent and partnerships to bolster growth in 2023. Notable new business wins this quarter included an existing client that utilized Harte Hanks for back-office ticket processing and sharing, awarding us all customer-facing functions including phone, email, and chat, driven by our consistent delivery and high customer satisfaction. Additionally, we secured new business with a leading employee screening service to provide a comprehensive suite of B2B sales and marketing support services, selected for our strong track record of seamless integration with B2B sales operations aiming to accelerate growth. As part of this program, we will deliver various services to enhance client sales efforts, such as lead generation, appointment setting, education and nurturing, and sales performance tracking. Moving to Fulfillment & Logistics, revenue grew by approximately $3.9 million or 24.3% year-over-year, while EBITDA surged by 91.7% to $3.2 million. We are witnessing benefits from consolidating operations into our Kansas City and Boston locations, and with an EBITDA margin surpassing 16%, performance exceeded expectations. Demand for our Fulfillment & Logistics services remains robust even as larger logistics companies and e-commerce giants have reported a slowdown in spending. We continue to secure new contracts in both Fulfillment & Logistics, with revenue opportunities remaining strong. While we aim to improve margins through investments in light automation at both the Boston and Kansas City fulfillment centers, we expect EBITDA margins to moderate due to a revenue mix of growth in lower-margin logistics contracts. Early in the third quarter, we secured a contract to handle Middle Mile logistics for a provider offering low-cost delivery services to retailers, anticipating significant growth in freight managed by Harte Hanks Logistics in the latter half of 2022 and into 2023. New growth for the quarter included a major branding firm selecting Harte Hanks to manage production, kitting, and distribution of over 600,000 holiday sample kits for a Fortune 50 retail partner, already resulting in multiple follow-up production runs across their kitting and fulfillment network. Additionally, an existing client in Customer Care leveraged our fulfillment expertise to create and deliver thousands of promotional kits to high-value customers, coinciding with and promoting their monthly televised events. Lastly, regarding our Marketing Services division, revenues experienced a slight decline to $13.5 million, but EBITDA improved to $1.8 million, from $1.7 million in the previous year quarter. We are driving enhanced profitability in the Marketing Services segment by realigning resources, minimizing expenses, and investing in technology and infrastructure to better serve our customers. We remain highly focused on our delivery model and operational improvements to enhance profitability. Significant advancements have been made in our product offerings and marketing initiatives emphasizing targeted solutions for demanding segments. We remain committed to attracting new clients within key market categories such as healthcare, finance, B2B technology, and consumer products. Our pipeline for Marketing Services revenue remains strong. To further bolster growth, we have increased our marketing budget and are hiring sales and marketing talent in the third quarter. A recent business win in Marketing Services was a regional bank choosing Harte Hanks for digital media planning and buying, creative strategy, and content development, leveraging our expertise and comprehensive service array. In conclusion, Harte Hanks has clearly established a new profitable baseline and a foundation for ongoing growth. Our long-standing relationships with blue-chip customers and our talented workforce are invaluable assets. Our optimism for revenue growth has increased, and we are more confident in our sustainable profitability, even amid a challenging macroeconomic environment. We anticipate continued positive net income and a substantial year-over-year improvement in full-year EBITDA, enhancing free cash flows throughout 2022.

Thank you, Brian. As Brian said, this quarter unfolded as we anticipated, with a modest decrease in revenue, but a significant improvement in operating income and EBITDA. The June quarter was our fifth quarter in a row of positive EBITDA at $4.6 million. And perhaps more importantly, we are delivering solid GAAP profitability, with fully diluted earnings per share of $0.52 compared to $1.27 in the second quarter last year, which included a $10 million or $1.39 per share onetime gain related to the extinguishment of our PPP loan. This year's GAAP result does not include any nonrecurring adjustments or benefits. Our performance included new business wins, growth within our customer base and the benefits of our asset-light model. Our focus for 2022 is to expand revenue and margins. Longer term we have a solid platform with differentiated offerings that should enable sustainable growth and solid profitability. The large nonoperational restructuring charges are behind us. I'd now like to walk through the results in more detail. Second quarter revenue was $48.6 million, down 1.4% or $0.7 million from $49.3 million in the same period last year. Revenue growth was led by our Fulfillment & Logistics segment which was up $3.9 million or 24.3% year-over-year. Customer Care was down $3.8 million or 19.8% year-over-year and Marketing Services was down 5.3% or $758,000 from the prior year quarter. From a contribution margin perspective, our Customer Care segment delivered $2.5 million in EBITDA, down $857,000 or 25.6%. Our Fulfillment & Logistics segment delivered $3.2 million in EBITDA, up approximately $1.5 million or nearly double from the year-ago quarter. Marketing Services EBITDA grew by $100,000 or 5.1%. We believe each of our three operating segments are operating efficiently and should generate positive EBITDA levels for the foreseeable future. Our operating expenses for the second quarter were $44.5 million, down 6.9% from $47.8 million in the year-ago quarter due to labor, advertising and SG&A expenses as well as the absence of $1.7 million in restructuring expense in the second quarter last year. This was partially offset by modestly higher production and distribution expenses due to the increased revenue in our Fulfillment & Logistics segment. Operating income was $4 million, up $2.6 million compared to operating income of $1.4 million in the year-ago quarter. This improvement is attributed primarily to margin expansion and sustained expense management efforts. We posted net income of $4.5 million or $0.54 per basic and $0.52 per diluted share in the second quarter, compared to net income of $10.6 million or $1.36 per basic and $1.27 per diluted share in the second quarter last year. We recognize that onetime gain of $10 million or approximately $1.39 per diluted share related to the extinguishment of our PPP loan in the second quarter last year. EBITDA for the second quarter was $4.6 million compared to EBITDA of $2.1 million in the year-ago quarter. Now turning to our balance sheet. As of June 30, 2022, we had cash and cash equivalents of $10.6 million compared to $11.9 million at December 31, 2021. As of June 30, we had $6.8 million in net income tax receivable. This is due to our net operating loss carrybacks for 2020 of $7.6 million, which are partially offset with state tax payables. Our combined long-term pension liability on the balance sheet as of June 30th was $50.7 million. As a reminder, we have both qualified and nonqualified pension plans. We continue to monitor the impacts of rising interest rates and changes in asset values that are impacting our pension liability. While the pension liability is formally revalued on the balance sheet only at year-end, we have evaluated our net pension obligation as of the end of July and our net pension liability has declined approximately $10 million since year-end 2021. Additionally, as Brian mentioned, we reached an agreement with Wipro at the end of the quarter, in which we will acquire all of the outstanding preferred shares for a onetime cash payment of $9.9 million and 100,000 common stock shares. Please note that under GAAP at closing, this transaction will result in adjustments to our earnings per share but not our net income. This is likely to close during the third quarter. The elimination of the preferred stock dividend accrual and the earnings attributable to preferred shareholders will be offset by a onetime accounting charge based on the fair value of the common shares. We funded the cash portion of the repurchase consideration with a combination of cash and cash equivalents on hand and an additional $5 million borrowing under our credit facility. As of June 30, 2022, we had a total of $10 million drawn against our $25 million credit facility. As of today, the full $10 million has been repaid and we have no amounts drawn on the credit facility. With that, I will turn it back over to the operator to take your questions. Thank you.

We'll take our first question from Julio Romero with Sidoti & Company.

Good afternoon. Thank you for taking my question. Lauri, in your prepared remarks, you seemed more confident about year-over-year revenue growth compared to your comments during the first quarter call. Could you elaborate on what has contributed to this increased confidence regarding the sales outlook for the year?

Sure. I think as we've said there's certainly been a focus on some cross-segment selling and we're definitely seeing some results from that. Brian mentioned the ramp-up to support the Game of Thrones release is providing some additional revenue for us in Q3. Overall, I think we're just seeing strength in the business and some of these new contracts coming to fruition. Brian, did you have anything else to add?

Yeah. No, I think the only other real significant increase in the second half that is worth highlighting I mentioned it in my comments, but the platform that we have under our logistics business should generate some material increases in revenues as well.

Got you. And that, kind of, dovetails into my next question on that Fulfillment & Logistics segment. You had really strong sales margins. The incremental margins were really strong. If you could just talk about what went right for the segment in the quarter, maybe what the mix was of fulfillment versus logistics and how you see margins for that segment trending for the remainder of the year?

Yeah. So sequentially, I will say that we posted a pretty strong second quarter that makes it a little bit more challenging sequentially for us. That said, I think the revenue mix concept is important to note. Our logistics business in the second quarter produced double-digit EBITDA margins. That strong performance there, along with the revenue mix of both print and kitting fulfillment that we had in both Boston and Kansas City really helped the business drive forward, including some ongoing project work that we got as a result of a recall that I think we talked about on our first-quarter call that continued into the second quarter. I still think we're improving operationally because we're fully into the new facility, but we're still racking out the additional 100,000 square feet that might actually be done in the next week or two. But with that, I think it's going to allow us to hopefully gain some additional incremental opportunities from operational efficiencies. That said, I think it should be noted that the revenue mix because I think we're going to have a stronger increased performance out of logistics is probably going to push the margins down just a little bit sequentially.

Okay. That makes sense. And then just staying on that segment, you mentioned you're seeing healthy demand for Fulfillment & Logistics even as some of the larger logistics players and e-commerce giants may be slowing some spend there. Just would love to hear you expand on that? And what are you seeing in the demand pipeline that's maybe giving you some confidence there?

So I think there's three areas. We obviously have a nice opportunity within logistics as I mentioned. There's a lot of really positive momentum with some of our existing clients. A good example there is us leveraging technology and electronic data exchange with some of our large customer contracts. When we sat in front of them and met with them, it really identified opportunities to not only make their life easier but find ways to expand some of what we do for these large clients. I think that organic growth as an example with leveraging tech is going to be a continued catalyst for us just within the existing customer base. I do think that the branding company that I talked about in the new business section is a great example of just a completely new opportunity, no relationship we ever had in the past, but some of our marketing efforts came to fruition and now we're ramping up as we speak. I'm heading out to Boston next week to meet with the customer to talk about additional opportunities as we've invested in some light automation to increase the speed of our pick pack and hopefully improve some of the performance and the margins within Bridgewater.

That’s helpful. Thanks very much for taking the questions and I’ll pass it on.

Thanks, Julio.

Thanks, Julio.

Our next question comes from Michael Kupinski with Noble Capital Markets.

Thank you. Congratulations on your solid quarter. I was just wondering now that you've paid off your debt, are you planning to find traditional financing options at this point, or is that still in the future?

So Michael, we did actually do a new traditional financing arrangement that we closed on last December. So this is truly just an asset-base based on our accounts receivable, so a standard $25 million line.

Okay. Got you. I didn't know if you were looking at further financing options beyond what you've done then. Okay. In terms of the quarter, obviously you touched on it on the question earlier, the margins in fulfillment were a little better than expected. Did you have duplicative costs in the quarter related to the consolidation of your Kansas City facility? Would margins have been better, or how much impact did you have in terms of those costs?

So I wouldn't say we have duplicative costs, and Lauri can chime in if she can think of any at this point. But what I would say is until we have the building fully racked out, I don't think we're hitting on all cylinders, right? I think the Kansas City management team has done a phenomenal job improving operations, and obviously the results are shown there, but I still think that there's some room to grow as we finish out the racking of the additional 100,000 square feet we took on five, six, seven months ago.

I would agree. There's no duplicative costs, but there were in Q2 some last year as we were moving into that facility, and that's certainly part of what's driving that margin improvement.

Got you. And does the repurchase agreement with Wipro dissolve the vendor agreement that you had with them? Does it change the relationship in any way going forward? I was just wondering if you could just shed a little color on your relationship with them.

Sure. So we actually did dissolve the vendor agreements previously. This is the last transaction that we had with Wipro.

Got you. And then just in terms of the general environment, you touched on this with your individual businesses talking about the segments and so forth. Are there any particular businesses? I know you're close to your clients, and they – and you tend to have a business that is a little bit farther into the future, and they are more project-related in many cases. I was just wondering if you can give us a sense of what you're hearing from advertisers. Any concerns that they have at this point in terms of the general economic conditions and things going on with them, and how they're being influenced by the inflation and so forth?

Yes. So that Mike is a question that I ask my sales team on a weekly basis at the very least. To date, I've got – we've got no specific examples where spend has been reduced as a result of them pulling back spend, right? Now we've had some clients delay for other idiosyncratic issues within their company, but nothing has stopped as a result of the macroeconomic or inflationary pressures and advertising spend that they have. So I don't know if we're just lucky right now, but I ask that question just yesterday. To date, we still haven't had anything that has stopped our opportunities as a result of contraction in spend.

That's great. In terms of the unfunded pension liabilities, are you saying that by year end, the amount would be reduced by $10 million from current levels, which would be a total of $50 million?

No.

All right. I'm sorry, if you could just explain that a little bit.

Yes, let me explain. We officially revalue the pension liability on the balance sheet at the end of each year based on changes in asset value and interest rates. Other than the usual expense runoff for the year, there are no additional adjustments. We assessed it from December 31 when it was last revalued and again as of July 31. As of July 31, we have experienced approximately a $10 million decrease in the pension liability. There are still five months left in the year, so we will monitor what happens with asset values and interest rates during the remainder of the year. Although asset values are declining, rising interest rates have more than offset the changes in asset values.

For sure. And then what would be the best use of cash at this point? Are you looking at now that you're generating cash flow, your solid earnings what are your thoughts in terms of looking at acquisitions? What are the options uses of cash at this point?

Yes. So Mike, obviously, we have healthy discussions about the use of capital going forward. I will say I want to step back and say we just paid off $10 million of debt, right? And we paid off $10 million worth of preferred shares or we have it in escrow, as you can see on the balance sheet. So we're stepping through all what we think are the big items. The next set of potential use is going to be continued investment in the business whether it's technology or assets that are going to improve efficiency. I think I've mentioned it before if there are acquisition opportunities that help complement our capabilities and expand our revenue, we'll certainly look at that. And then it's a valuation. Is there other things from the balance sheet that we can do whether it's pension and/or deliver money to our shareholders? We’re evaluating all of those options, and I will say we haven't built a lot of cash yet because we just spent a whole bunch, but we certainly are planning and looking forward to making sure we do what's right for our shareholders and our business.

All right. Terrific. Thank you so much.

Thank you.

Thank you.

And there were no further questions at this time. I'll turn the floor back to our speakers for closing remarks.

And this is Brian. Thank you everybody for joining, and we'll see you in one quarter from now. Take care.

And thank you for joining the Harte Hanks second quarter earnings call. This does conclude today's program. You may now disconnect. Have a great day.