Harte Hanks Inc Q2 FY2023 Earnings Call

Greetings and welcome to the Harte Hanks Second Quarter 2023 Earnings Call. Please note, this conference is being recorded. I will now turn the conference over to your host, Mr. Tom Baumann. Sir, the floor is yours.

Thank you. Hosting the call today are Kirk Davis, 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 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 10, 2023, and the company assumes no obligation to update these projections in the future as market conditions change. This webcast and certain financial information provided in 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 disclosure 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 Kirk. Kirk, welcome to Harte Hanks.

Thank you, Tom, and good afternoon. This is my first earnings call as CEO of Harte Hanks, having joined the company just 8 weeks ago. However, I have long been aware of Harte Hanks as a key player in the industry. My familiarity with the company and the findings from my due diligence completed before accepting this opportunity were largely confirmed in my first month. Harte Hanks has a world-class team, significant expertise, and valuable offerings that are well aligned with the needs of our global customers. My predecessor did an excellent job in materially improving our balance sheet. He also effectively aligned the business with its current opportunities, eliminating unprofitable business lines and rationalizing the cost structure. The business today is profitable on an EBITDA-generating basis with relatively stable revenues, solid relationships with a customer base comprised of global brands, and offerings that are well positioned to grow. I've come to Harte Hanks with 25 years of CEO experience in publishing and digital transformation. I've had the privilege of leading or advising C-level executives, boards, investors, and key decision-makers within publicly held and private equity-backed publishing and digital media verticals. I understand the needs of a modern corporation, the areas where Harte Hanks can provide value in the digital world, and the pain points of our customers. I also bring significant experience in business development, M&A, and B2B and B2C revenue-generating activities. Harte Hanks has a solid platform for sustainable profitability. My job is to evolve the organization so it becomes a solid platform for long-term growth while preserving and, in fact, expanding its profitability over time. For the last few years, Harte Hanks, like many companies, faced changes directly resulting from the pandemic. During the pandemic, as our customers had to change their business practices and find new digital ways to interact and engage with customers, we saw new opportunities that led to meaningful and incremental growth. We picked up call center projects, logistics projects, and marketing services projects that all helped our customers navigate the pandemic. As my predecessor said for the last few quarters, much of the business was going to naturally run off as a new normal was defined and our customers adapted to the environment. However, that runoff occurred at a slower pace than we projected which benefited our results over the past few years but is now fully wound down. Over the past few quarters, we've also experienced the macro pressures that are prevalent in the market, and as a result, have seen spending slowed and program re-evaluations from existing customers who are more cognizant of their expense structures than they were in the past. The result has been modest headwinds on revenue. We haven't yet seen signals that this behavior is changing. So we believe the third and fourth quarters of 2023 will look, by and large, like the second quarter from a revenue standpoint. Effectively, from a revenue standpoint, we think the Q2 results we are reporting today should serve as our near-term baseline. My focus today is on accelerating the organic growth opportunities we're built for. We know demand for digital solutions is growing. Companies are looking to enhance their marketing service capabilities, especially lead generation, and companies are looking to tie fulfillment services to marketing to better engage and care for their customers so that we can better capitalize on these opportunities. We need to market our company more effectively and improve our sales and marketing functions. Initially, we will reallocate costs from within the company for any additional investment we deem appropriate. Toward this end, we expect to name a new Senior Vice President of Sales before year-end, replacing a sales leader who recently retired. This is an opportunity to tap an executive with skills and experience for our near- and long-term opportunities. Specifically, we expect to hire sales leadership and sales talent with deep experience in digital solutions, cross-selling, and expertise in executing land-and-expand strategies to take advantage of our rich client base. Simultaneously, to create more expansive customer relationships, we are cross-training our existing sales team to become enterprise-wide sellers as opposed to representing select services that we offer. We have undertaken an audit of all elements of our lead generation and go-to-market strategies. We are hyper-focused on this. As a result, we expect to have a more capital-efficient go-to-market strategy that supports our growth ambitions. To augment our internal focus on growth, we are launching a partnership next week with a business development company that will facilitate opportunities for us with Fortune 1000 clientele. Think of the engagement as sales-as-a-service, designed to mirror a team of direct sales resources that will be additive to our internal efforts. They bring an extensive strategic rolodex and deep industry insights. In turn, we offer attractive services that they are eager to promote within their network. And speaking of Sales-as-a-Service, I'd like to highlight my enthusiasm for the company InsideOut that we acquired late last year. Working closely with the dynamic founder of this business, we will incorporate and market this division as part of an end-to-end revenue generation solution for mid and large enterprises grappling with revenue and growth challenges. Historically, we've excelled in combining powerful data solutions with our marketing services capabilities to deliver marketing qualified leads for our customers. We'll now be featuring our ability from end-to-end, a full-cycle offering that leverages data, creates demand for a product or service, and closes deals. This strikes us as a highly scalable solution. The enhancements to our sales and marketing functions will take some time, at least a couple of quarters. Absent a recession, we expect to see benefits in 2024. I believe that once these investments are in place, we can step up our growth rate, and achieve more effective cross-selling, and higher revenue should result in expanded EBITDA margins. I'd now like to discuss how we're thinking about our cost structure. I'm confident we can further lower costs in our business without hindering our ability to delight customers. We need to quickly evolve our culture around this aspect of our company. As I get started here, there are a couple of targeted cost-out efforts going on that are timely and important. Last quarter, we announced the convergence of our Customer Care and Marketing Services segments. We are also focused on reducing costs associated with customer churn. Also, in the normal course of business, we operate with annual budgets and if we're behind, it's generally expected that incremental steps be taken throughout the year to bridge the gaps. That's what's happening today. As of now, we're in the early stages of thinking about how we formally assess our full potential for material improvement in our cost structure and how we organize and incentivize our teams to achieve it. We'll provide an update on these initiatives next quarter. I'll just add that maintaining our profitability is a key goal of this management team and the Board of Directors. Last, I'd be remiss if I didn't acknowledge that we, too, recognize that generative artificial intelligence represents an important opportunity for our business. As a customer of companies such as Microsoft and Amazon, we will benefit from the investment these market leaders are making through the technologies deployed with us. Of course, we need a road map for how we plan to incorporate end-market AI capabilities as part of our services, along with other emerging technologies. So this will be a recurring theme for our discussions with you. We are focused on both short-term and long-term opportunities and we're confident we can build a stronger company and a more profitable company. And now I will turn the call over to Lauri to walk through our results.

Thank you, Kirk. Second quarter revenues were $47.8 million, down 1.6% compared to $48.6 million in the second quarter last year and up 1.4% sequentially compared to the first quarter. Revenue growth was led by our Customer Care segment which largely offset declines in our other two segments. Operating income was $1.7 million compared to $4 million in the second quarter last year. We reported positive net income of $0.6 million or $0.08 per diluted share compared to net income of $4.5 million or $0.52 per diluted share in the prior year. Results this quarter included $1.2 million of pension expense as well as $503,000 in stock-based compensation and $1.2 million in severance, largely related to the CEO transition. Our operating expenses for the second quarter were $46.1 million, essentially flat on a sequential basis and up 3% from $44.5 million in the year ago quarter due to the change in the revenue mix, resulting in higher transportation costs in our Fulfillment & Logistics segment. Our EBITDA was $2.7 million compared to $4.6 million last year. Due to higher severance expense and the nonrecurring charges related to the CEO transition, we are providing adjusted EBITDA as well. Our adjusted EBITDA was $4.4 million compared to $5.2 million. From a segment contribution margin perspective, our Customer Care segment delivered $3 million in EBITDA, up 18.3%. Our Fulfillment & Logistics Services segment delivered $1.9 million in EBITDA, down $1.2 million or 39% year-over-year. Marketing Services EBITDA was $1.3 million, declining by approximately $500,000 or 27%. As long as currency adjustments don't negatively impact net income, we expect profitability both in terms of EBITDA and GAAP net income for each quarter of 2023. Turning to our operating segments. Customer Care revenue increased by $1.8 million or 11.9% from the previous year and year-over-year EBITDA increased 18.3% to $3 million. Our InsideOut business performed well and it contributed $2.3 million in revenue and $246,000 in EBITDA. The Customer Care pipeline is improving with opportunities, including in the verticals: pharma, government, healthcare, technology, and consumer products. New business wins for the quarter included a multinational pharmaceutical company which has engaged Harte Hanks to develop the strategy for their long-term customer service experience. The scope includes the analysis and validation of their customer service vision, benchmarking, gap analysis and a blueprint with an implementation road map to inform their 2024 plans and to optimize their customer care strategy and delivery. Also, one of the largest consultancy firms in the world has selected Harte Hanks to support a government's rollout of Medicaid renewal support for its constituents. This program helps Medicaid users renew for services as well as provide education on how to engage and leverage the online systems to improve the use of these systems. Fulfillment & Logistics revenue decreased slightly to $19.6 million, and EBITDA decreased 39% to $1.9 million. While we continue to expect operational leverage and further benefits from consolidating our operations into the Kansas City and Boston facilities, we have experienced EBITDA margin compression resulting from a higher concentration of growth in our lower-margin logistics revenue. New business wins for the quarter included a new logo business with a major international manufacturer, providing fulfillment support for a new program of direct-to-customer hearing aid sales. As a major player in the industry, the manufacturer is well positioned for growth as the hearing aid market pivots from prescription-only into the over-the-counter space. Also, a leading branding company selected Harte Hanks' Fulfillment to manage the production, kitting, and distribution of over 150,000 curated food and beverage product gift boxes for a Fortune 50 retail partner. After producing several million kits on this partner's behalf over the past year, this represents the first instance where the relationship has fully leveraged our FDA-approved climate-controlled facility for food grade items. Marketing Services revenue decreased 18.8% to $10.9 million, and EBITDA decreased 27% to $1.3 million. The largest driver of the year-over-year revenue decline related to direct mail campaigns not continuing in the current quarter. We also had project work conclude last year in financial services and CPG verticals and we continue to face challenges in growth given the macro environment. We are working to expand our pipeline of near-term opportunities across all verticals. New business wins for the quarter included a major insurance carrier supporting government employees which has selected Harte Hanks to facilitate their e-mail transition to a new CRM. While this organization is an existing customer for our Customer Care and Fulfillment & Logistics segments, this is the first engagement for this client with our Marketing Services team. Also, one of the largest online travel agencies has expanded its services with Harte Hanks to support an Always On nurture program for their global business customers. Each of our three segments continued to deliver positive operating income and EBITDA. Now turning to our balance sheet. As of June 30, 2023, we had cash and cash equivalents of $13.4 million compared to $10.4 million at December 31, 2022. Our combined long-term pension liability on the balance sheet as of June 30 was $36.7 million. As we announced in our Q4 earnings call, we are moving forward with the termination of our largest qualified pension plan. We are on track to have that completed in the first half of 2024. As of June 30, 2023, we have no debt and maintain a $25 million credit facility. With that, I will turn this back over to the operator to take your questions.

Our first question will come from Julio Romero with Sidoti & Company.

Congratulations on the role. I wanted to start by maybe digging more into some of your thoughts on strategy. You identified some items in the prepared remarks. If you could just speak more to what does Harte Hanks need to maybe do differently or adjust from an operational perspective and maybe just a rank order of thoughts there.

We've encountered some revenue difficulties this year, and the management team is focusing on establishing a stable revenue base. Our goal is to model our expenses to achieve a 10% margin in the business. This is a long-term commitment, but it's our objective, and we believe it will provide us with several options moving forward. Additionally, we see potential for more strategic acquisitions, similar to what we accomplished last year, which remains our top priority. In the meantime, our immediate focus is on revitalizing our revenue operations, including sales and marketing. I believe that Harte Hanks needs to be its own best customer, which isn't the case right now. We serve our clients exceptionally well, fostering strong loyalty and long-term relationships. However, upon reviewing our internal processes to enhance revenue growth, I feel we're not fully capitalizing on our opportunities. In the short term, that will be our focus. Once we align our costs effectively, we'll have a range of strategic options available, and I'm eager to see that progress. Currently, we are actively working to align our costs.

That's good color there. And maybe if you could just talk to the response you've received from the Harte Hanks' team and the employees and how that has gone?

It's been an incredible experience. I've had the opportunity to hold town halls and large conference calls, receiving a lot of feedback and energy. A marketing company like ours tends to thrive under a growth directive, and we are committed to that. However, our immediate priority is to ensure our costs are aligned and provide stability to our outlook, which we will achieve. I've spent several days with the senior management team, and it has been fantastic. They are a talented group. We are currently conducting a marketing audit that I initiated to identify areas we are not addressing that could generate more leads and ultimately drive growth. Many of our opportunities arise from requests for proposals, and it's essential to engage in prospecting as well. Companies tend to conduct thorough evaluations when considering switching vendors or outsourcing services, which involves a formal assessment process. We invest a significant amount of time in this process, leading to a sales cycle that can last six months. Our goal is to excel in this area by generating more leads and being noticed by procurement officers, executives, and C-suite individuals while they assess potential companies for outsourcing services. The past eight weeks have been productive, and in a couple of weeks, I will be heading to Florida to spend time with the team at InsideOut, the acquisition we made last year. I've reached out to employees a few times to keep them informed and engaged in our journey, and the reception has been positive. Everyone understands that we are making progress, which seems to resonate well. We are determined to succeed, and a lot of preparation is necessary to achieve that, which is our focus.

Got it. That's really helpful. And then just wanted to ask about the revenue trends. You talked to some customers curtailing budgets for '23. Did revenue trends improve as you progress throughout the quarter? In other words, how is June trending relative to May and April?

Yes. I would like to refer back to what the company communicated in May, which was that there has been significant re-evaluation of marketing and logistics spending, especially in financial services and B2B tech. This has impacted visibility. It seems fair to say that last quarter was effectively a reset in terms of expectations. Here's the situation: Most of our largest, long-standing customers have cut back on spending this year, and this trend will likely continue for the remainder of the year. We are observing a widespread reaction to the uncertainty and caution in the market, as many companies have reduced their expenditures. This has been a notable theme this year. On a positive note, our customer satisfaction and loyalty remain strong, which is encouraging. We maintain close relationships with our customers and understand their actions and motivations. We have experienced some significant accounts reducing their spending significantly, often due to major strategic changes within those companies. When that happens, we need to evaluate our resource allocation and the staff dedicated to those accounts, which sometimes leads to staff reductions. We hire to support accounts that are experiencing growth or for seasonal needs, but we need to keep a flexible staffing approach when we face setbacks or account losses. While we work to ramp up our revenue operations and activities, which we will do, it’s not a major challenge; rather, it presents a remarkable opportunity. During this time, we also have the chance to align our expenses, which is something everyone is looking for, and we are committed to achieving that.

Our next question is coming from Michael Kupinski with NOBLE Capital Markets.

Kirk, welcome to Harte Hanks.

Thanks. Nice to meet you.

A couple of questions. You mentioned the cost structure is too high. Can you kind of give us some thoughts and I know that you've only been there 8 weeks, but can you kind of give us some thoughts on the cost-cutting? Were these initiatives started before you joined? And is there a particular division that needs to align cost?

So yes, the company is impressively focused on costs, and trying to size that opportunity gets more challenging when it's been iterative and you've been at that quarter after quarter. So what I'm really talking about here is dedicating resources and talent that brings objectivity to looking broadly across the entire globe and portfolio with a lens of prioritizing those services that have the best trajectory and/or best margins. And keeping in mind the target margin that we'd like to achieve, which is to have a 10% margin. So that's what we want to get to. And I don't think there's one particular area that I go into the exercise with more concern about or another. I'm gaining a deep understanding of how to augment and accelerate growth uniquely in our Fulfillment & Logistics division, for example, juxtaposed to Customer Care or Marketing Services. So and I think over time, as both those divisions get stronger, they afford the company a lot of strategic optionality. But everything is in scope, our overhead, our field. And this is something that you can track with us over the next quarter or maybe two because we're going to be very excited to talk about what we discovered but I can't prescribe it exactly 8 weeks in here. I just know the results of an effort as comprehensive as I’m thinking about are not incremental.

Got you. In regard to the sales development partnership you mentioned, some investors and analysts familiar with the company are aware of the challenges faced in the past with certain contracts, which negatively impacted earnings. I was wondering if you could discuss the nature of the relationship you’re referencing in terms of sales development. Is this relationship structured more like a revenue share, or could you provide some details about the type of arrangement you are pursuing?

Yes, Michael, let me start by explaining the opportunity, and then I’ll have Kirk provide additional details. This situation is quite different from our past experiences and certainly contrasts with previous relationships that were problematic. We are not investing heavily in upfront costs for this, but rather it is an ongoing and incremental approach. You can think of it as a boost to our sales team, as they seek new opportunities. There will only be some commission on an ongoing basis if we generate revenue from this, so it won’t involve any large fixed costs like we faced in previous relationships.

Sure. I'm not intimately familiar with that prior relationship. And I'm actually very familiar with the relationship that I talked about on this call. So the company we retained on a proof-of-concept basis is Landmark Ventures. I consulted for the Board of an agency in India for a couple of years and had the opportunity to meet the team at Landmark and work with them over a couple of years and I had a fantastic experience. Essentially, we'll be among hundreds of companies seeking to network, solve problems, to provide or seek growth or efficiency solutions. As I said, we'll start with a 90-day proof of concept. We've passed their test. I put our executive team in front of them, and they did a seasonally good job, and were very intrigued by the connections and success that this particular company has with their Fortune 1000 clients. So it will augment our pipeline. It will augment our staff's efforts. I would expect that we'll have 45 discussions with key decision makers over the course of the year if we extend engagement. We will also have the opportunity to host an event with Landmark Ventures with 18 to 25 major stakeholders from Fortune 1000 companies. So if we're successful and landing business together, then we share in the success of that with commissions. And there's a tail on those commissions if we decide to part company at some point down the road. But they are very good at what they do. And I think our company will meet the moment and we'll have some very, very exciting discussions. It's a month-to-month deal. So if at some point, we don't think it's worthwhile, then we have to wait 30 days. But this is happening fast. We're launching it next week. But I've had 2 years of experience with the company. I think we're going to have a good run.

Great. I have another question. The customer care division was one of the areas that benefited from the pandemic. I was expecting that this part of the business might be declining or showing some weakness. However, in the last quarter, it performed better than I anticipated and showed considerable growth. I am curious if that business exceeded expectations or if there is a positive trend in Customer Care at this time.

Yes. Michael, so Customer Care, obviously, is benefiting from our InsideOut acquisition. We did have in Q2, one of our streaming customers had, I would say, a bit more than expected additional support requirements during Q2 that certainly helped out the quarter and we saw some of that increase. So we did have a big ramp in May for that support and that led to a little bit higher revenues for the quarter.

And so that, at this point, doesn't look like that's going to continue into Q3 at this point?

Yes. I mean we have these ramps from time to time. I don't expect that similar type of ramp in Q3 but then in Q4, we'll have more of our healthcare open enrollment-type ramp. So we'll see a little bit of down into Q3 with some expected seasonality in Q4.

Thank you. We have no further questions in queue at this time. So I will hand it back to Mr. Davis for any closing remarks you may have.

Thank you all for joining the call. I appreciate the chance to speak on behalf of everyone at Harte Hanks and our dedication to operating a successful business and delivering for our shareholders. I want to emphasize my vision for advancing the business. We need to focus on thoroughly reviewing and reducing our costs. We can tackle this more quickly than we can anticipate revenue growth, at least in terms of net growth, but I am also very optimistic about that. There is a sales cycle and several elements we need to establish, but we are actively addressing it now. I'm eager to keep you informed and look forward to discussing our Q3 results with you. Thank you once again.

Thank you. This concludes today's conference and you may disconnect your lines at this time. We thank you for your participation.