Earnings Call Transcript - HHS Q2 2020

Operator, Operator

Thank you, Paula. And good afternoon, everyone. Thanks for joining us. Hosting the call today are Andrew Benett, Executive Chairman and CEO of Harte Hanks; and CFO Lauri Kearnes. Before I begin, I'd like to tell everyone that the information provided during this call may contain forward-looking statements such as statements about the company's strategy, adjustments to its cost structure, financial outlook and capital resources, competitive factors, business and industry expectations, anticipated performance and outcomes, future effects of acquisitions, disposition, litigation and regulatory changes; economic forecast for markets served, expectations related to cost savings measures, and the availability of tax refunds and other statements that are not historical fact. Actual results may differ materially from those projected or implied in these statements because of various risks and uncertainties, including those described in the company's forms 10-K and 10-Q and other filings with the SEC and the cautionary statement in today's press release. The call may also reference non-GAAP financial measures. Please refer to the earnings release that was issued after the close for reconciliation and other related disclosures. The company's earnings release is available on the Investors section of its website at hartehanks.com. And with that, I'd like to now turn the call over to Andrew Benett. Andrew, the call is yours.

Andrew Benett, CEO

Thank you very much, Sheila. Before we get started, I want to express my sincere hope that everyone on today's call is being safe and healthy during these challenging times. I also want to thank the entire Harte Hanks team for their professionalism, resiliency and constant drive to serve and support each other and our clients. Our culture and commitment are among the key assets that attracted me as a company. Our employees' response to the upheaval of the last several months only amplified these attributes, and I couldn't be prouder. As we operate through the pandemic, we're carefully evaluating expenses and business functions to ensure we add value to our customers and to position Harte Hanks for sustainable profitability. As we've explained over the past year, we continually evaluate expenses and improve operational efficiency. Although the pandemic creates new challenges, the process for operational efficiency and excellence has not materially changed, and we're well on our way to creating a more relevant, efficient and streamlined Harte Hanks. Before commencing our second quarter update, I want to take a moment to look at what we accomplished during the first half of 2020. To begin with, we believe we've stabilized our quarterly revenue run rate. We implemented cost reductions across every aspect of the company, reducing overall costs in 2020 by over $20 million. We enhanced our management team, bringing industry-leading talent and promoting internal talent. We are focused on engineering cost savings and engineering growth. To that end, we moved swiftly to significantly reduce our real estate footprint that is aligned with our go-forward strategy. We're also beginning to recognize incremental revenue from new products and services in our efforts to productize how we go to market as we discussed on last call. Through these efforts, we remain confident that we will be adjusted EBITDA positive for the year and are on track to be free cash flow positive for the second half of 2021. We remain on plan for 2020 despite the difficult headwinds that our category faces due to COVID-19. When I hosted my first earnings call as CEO in March, I outlined a 3-pillar strategy to return the company to profitability and growth. First, optimize the business and the way we work; second, grow our current services with existing and new clients; and third, transform the business for the future. We are executing on all three of these pillars simultaneously. And while our operating environment has been drastically changed due to COVID-19, we believe we will emerge from 2020 a stronger, better company by helping our customers embrace new marketing imperatives more effectively and efficiently. I'd like to begin with our first pillar, optimizing our organization. Capitalizing on Harte Hanks' many unique assets is critical to our successful transformation. We're aligning our overall cost structure to meet industry benchmarks while modernizing our tanks at the same time. I'd like to cover a few themes in this area. The first is our IT infrastructure and our move to the cloud to enable value-added data and data-driven services to our customers, in conjunction with reducing our space in Austin and consolidating the data center operations with our data from Austin to our data center in Pennsylvania. As part of the data center consolidation, our IT team reviewed our applications, system and data needs that enable Harte Hanks to simplify our server requirements by 30%, and we anticipate further reducing server requirements by another 20% before moving most of our applications to the cloud. In addition, we're evaluating software solutions to eliminate any legacy mainframe needs that we currently have. We anticipate finalizing our IT transformation by the second quarter of 2021 with over $2 million in annual savings while delivering new mission-critical services to our customers. We appreciate our IT team's diligent efforts to facilitate seamless continuity of operations and deliver material cost savings in this work-from-home pandemic-driven environment. Secondly, optimizing our operating footprint to align with customer requirements. In June 2020, we're excited to announce that we executed a long-term lease in Kansas City to build a new, state-of-the-art fulfillment facility, which will be 300,000 square feet. During the first half of 2021, this new turnkey facility will consolidate fulfillment operations currently performed in multiple locations. We will help optimize our FDA-approved and traditional fulfillment operational layout to best serve our current and future customers. The new facility is being designed in conjunction with our efforts — with our investment in our upgraded order entry and warehouse management systems that will leverage technology and automation to create new products and solutions for our customers. We're excited to grow our sampling product offering and expand our direct-to-consumer solutions through this facility, and I'll talk more about that later. We continue to implement our asset-light strategy by exiting direct mail production facilities, culminating in the asset sale of our Jacksonville direct mail facility at the end of June to Summit Direct Mail. We entered a partnership with Summit that allows us to make our cost structure more variable and provide a full suite of marketing solutions more efficiently while reallocating resources to our marketing services, fulfillment, logistics and contact center businesses. As a result of our exit from direct mail in Jacksonville and Grand Prairie, we eliminated nearly $5 million in labor costs and millions more in operating maintenance and capital costs. We also significantly reduced costs associated with our closed and underutilized facilities. We terminated our Wilkes-Barre lease and eliminated all future obligations after May 31, 2020. With respect to our Fullerton, California and Jacksonville trade park locations that we closed at the end of 2019, we executed sublease agreements through the end of the lease term to mitigate the vast majority of the lease carrying cost liabilities. In response to the current pandemic, our contact center business, as I mentioned before, effectively converted its operations to a work-from-home environment. Although we anticipate a return to offices at some point, we believe our future operating environment and customer needs will likely require less lease office space as we embrace more of a hybrid model. As a result, we undertook two initiatives to reduce lease and operating expenses. First, with respect to our Austin lease, which was to expire on June 30, 2020, we negotiated an over 60% reduction in lease space and secured an extension through December 31, 2021. Second, we executed a sublease of one of our two Manila facilities to eliminate the associated lease and facility costs through the lease term ending Q1 2021. Our other Manila location will accommodate all agents and support required to service our clients. We anticipate continued margin improvement from our contact center business as a result of these material cost-saving initiatives. Through the termination of leases, subleasing of closed facilities, and optimization of our current operating footprint, we expect to achieve annual savings of over $3 million in lease and facility operating expenses. Thirdly, operating our labor force to drive profitable growth. Throughout 2020, we've reviewed our labor needs. We both assessed the talent and skill set throughout the organization and realigned our resources to better facilitate collaboration, communication and efficiency to best serve our customers, leveraging the decades of experience and resident in our key business segment leaders, who continue to deliver value-added services while also improving our technology capability and optimizing our labor through process reengineering to meet current and future customer needs. As one example, our — for example, with our technology development and data rig skill sets across Harte Hanks through consolidated functions, streamlined management and migrated certain functions to lower-cost resources, thereby yielding more than $2 million in annualized savings. In addition, we reorganized certain productions, client service planning and reporting functions within our fulfillment organization to drive an incremental $1 million of labor savings. We anticipate $13 million in cost reduction, including variable labor costs as a result of these 2020 initiatives. With regard to our second pillar, we continue to make strong progress growing our current services with both existing and new clients. Our operating model and realigned leadership is gaining positive momentum with a mission to drive significant and sustained profitable growth. The silos we have broken down have revealed opportunities in both our bottom line as I've shared, as well as our top line which I'll now detail. We focus on categories where we have a proven track record and an offering relevant to market demand. In the second quarter, we began to see stabilization and growth across these categories. Categories we focus include healthcare, financial services, automotive, B2B tax and consumer DTC, a new frontier that I will discuss later and an area where we're seeing early signs of success from new products that we've launched. To deliver value to these key target markets, we've organized category practices across the company with a path to driving differences in each of these categories, agnostic to the services that we sell. Our capabilities in marketing services and our operational services, be that contact center, fulfillment, logistics and mail, provide a unique full-service offering to the market. All of this activity is resulting in more meetings, albeit virtual today, and a higher conversion rate, which I'll talk about in a moment. With respect to new business, our current weighted pipeline is 10.3 million and unweighted is 31.2 million. Our plan, as I've mentioned before, for 2020 requires $13 million of new business sold and delivered in that calendar year. As of quarter end, we've secured $10.1 million or 78% of our annual goal. These new wins include an insurance brand, a B2B tech brand, a pharma brand, a big 3 consulting company, a CPG brand for biotech, and an e-commerce company. We believe our new business pipeline remains healthy and diverse and will continue to promote our new product offerings where the demand is strong. It's also important to note that we're taking our new product offerings to both our existing clients as well as our net new ones. Last Q, we continue to invest in our growth team with new hires who have deep category experience that we believe will both open doors as well as help drive the overall business. I'm pleased to share that John Cook has joined our business development team to lead our automotive practice. John brings nearly 20 years of automotive experience working both on the client side and the agency side, where he's led teams in developing tier 1, tier 2 and tier 3 CRM solutions. His deep knowledge of the category and strong relationships will add significant momentum in one of our top focus areas. Our third strategic pillar is to transform our business model. Harte Hanks has extraordinary assets that we believe are ready to be optimized. Our roots and expertise lie in the convergence of data and marketing, and more specifically in engaging the customer directly through digital and what's been called direct marketing. We manage and model customer behavior. We listen to and counsel customers through our customer care centers around the world. We use our deep data capability to build customer engagement strategies and plans, and we design and manage customer marketing programs. Through this, we have a unique competitive advantage in that we can design and deliver multichannel marketing programs that reach customers from their fingertips to their front doors or across both the digital spectrum as well as the physical. Our renewed customer-centric focus is adding more value to clients and enabling us to capture more market share by developing broader marketing programs and offering more of our services. Let me share two examples of work recently won that illustrate the success of our customer-focused capability and our ability to now sell more broadly across the portfolio. Our first example of this is a program that we developed and deployed for a leading European automotive brand. The program is in support of one of their largest dealer groups and flows as follows. By simply placing a pixel as the consumer interacted with the dealer's website, we were able to identify and validate home addresses, anonymous visitors to the website, mask their email addresses, track the website activity and understand the model of interest. The digital data enables us to develop personalized messaging based on their models of interest and send physical assets to their home, which could include personalized high-end direct mail or custom packages like the GoBox, which we've discussed on the prior call, within 48 hours of the visit to the dealer site. The ability to connect the digital experience with a personalized physical engagement in a timely manner resulted in significantly higher conversion rate versus a capital control tab. The program remains for the automotive brand having higher conversion than any prior mail and physical campaign run before. Our second example is for a leading direct-to-consumer company. In this engagement, we're developing a customer win-back program designed to recapture lost or lapsed customers. We're utilizing analytics to interpret signals that lead to attrition or customer lapses and determine the right messaging and offers across channels of choice to win them back or ideally prevent them from leaving. We're currently developing win-back journeys that send personalized communications with relevant offers and choices based on specific personal preferences of the customer. In addition, we will be piloting a sampling program to integrate it to drive renew trials among the same lapsed users. In summary, I believe we're building a new type of customer experience company. We are driven by data and applying that data to everything we do. What makes us further differentiated is our ability to work deeply with that data to drive all the way through to engaging the customer, again both digitally and physically. It's the quality of our existing services that enables us to rapidly transform our business. We believe that we're well-positioned to gain market share through our existing offerings, digital marketing, B2B fulfillment, customer care, while expanding to closed-end services that leverage our existing assets, our people, our places, our marketing. These areas include sampling, which I'll talk about in a moment, DTC services, e-commerce services and data-driven customer care as well as outsourced marketing, which I shared on last quarter's call. A great example of our enhanced customer experience is our new sampling offer. We have the ability to build this business off of the asset base of our fulfillment operations and the active piece of our marketing services business or the marriage of processes. It's this macro extension of our current business that neatly marries our services together in a way that adds value to the clients and provides differentiated offers. Sampling, as you most know, is an extremely high ROI-driven marketing activity, similar to many of the activities we perform on behalf of our clients. Despite this, the conversion rate in the industry has historically not performed as well, and the industry is highly fragmented with few players who offer end-to-end solutions or even data-driven sampling. Our ability to leverage our capabilities in data with our expertise in fulfillment and the ability to reach a consumer at any point wherever they are, allows us to deliver what we are calling smart sampling. Smart sampling is much more than sending out product samples to consumers. It's a complete strategic marketing approach that puts the brand right in the hands of those consumers who are most likely to become loyal repeat buyers as well as influencers. We do this by leveraging our analytics expertise, analyzing first-, second- and third-party data to create a distribution strategy that has the highest propensity to convert prospects who have the greatest predisposition to then become profitable customers. Our smart sampling approach also includes follow-up reporting and analytics intelligence to help continually improve future acquisition efforts. We believe the combination of our data and analytics expertise and flawless fulfillment execution is a major differentiator in the market and is key to building our momentum. One example of progress with this new offering is a sampling business that we've just won from a leading top 5 CPG company that showcases our early success in entering this market. In the program, we work closely with our client to analyze the data and develop a targeted list of consumers who may be likely to be high-value customers or users of competing brands for essentially experience may lead to capturing marketing share. Traditional sampling programs have been much more spray and pray, which are no longer sustainable. Understanding the data, performing the analytics and measuring performance in real time is critical to optimizing sampling programs as well as sampling programs for the future, and we're confident that our combined service will benefit our DTC sampling clients in the future. Our efforts in this area will go beyond sampling and into DTC or direct-to-consumer commerce services. Moving a consumer from a sampler of your product to a subscriber of your products or services has become the next frontier for brands. Building a direct relationship with consumers is critical. But there are few end-to-end options that help marketers build direct relationships with consumers or, in the case of B2B, with their customers. We believe we're uniquely positioned to get our clients there starting from point A, a deep understanding of their customer; to point B, delivering a product sample or a service to a customer's home or office; to point C, converting that consumer or customer into a subscriber or a subscriber-like relationship with our customers. To deliver on our ambitious plans for this business, we're proud to announce that we've brought in Drew Rayman to lead our DTC e-commerce practice. With a focus on creative and strategy, Drew has built several leading agencies in the digital and e-commerce space and sold his last agency to Accenture. Also joining us is Craig Wishner, who worked with Drew at the three agencies he grew and sold. Craig is a strategic sales leader with a proven track record of delivering growth.

Lauri Kearnes, CFO

Thank you, Andrew. I want to highlight that despite the challenges posed by COVID-19, we are securing business and noticing increasing demand in our B2B sector, particularly in our contact center services. We anticipate continued growth in this area for 2020. While COVID-19 has created short-term obstacles, we remain focused on streamlining and restructuring to align with current market needs. We are starting to see stabilization and growth in areas where we are investing. Compared to the same quarter last year, we decreased expenses by nearly $14 million, and our spending was down over $38 million in the first half of 2020 versus last year. These cost reductions, along with revenue growth this quarter compared to last quarter, are evident in our positive adjusted EBITDA, which increased by $2.25 million from negative $1.77 million last year, indicating that our turnaround strategy is working. Now, I’ll outline the results in more detail. Second quarter revenues were $41.6 million, up over $1 million from the previous quarter. This is a decline of $13.1 million compared to last year’s revenue of $54.7 million. We anticipated a more significant impact from COVID-19 on our earnings this quarter compared to Q1 but are optimistic about recent business wins. Revenues increased in both our B2B and consumer brands segments this quarter. Our B2B revenue rose by $3.1 million, or 28.2%, driven by strong demand for contact center services. As in the last quarter, the biggest dollar decline was in retail, down $7.3 million, primarily due to COVID-19 effects. The transportation segment saw the largest percentage decline, over 80%, as a major contact center client did not renew. The growth in our B2B division compensated for the revenue declines in our other segments, and we expect the demand for B2B services to persist. We are committed to maintaining a balanced revenue mix with an emphasis on higher-margin businesses during our restructuring. As Andrew mentioned, we completely exited our direct mail production business at the end of June. We incurred noncash impairment charges and disposal losses of $3.2 million during the quarter associated with closing our Jacksonville facility. Looking ahead, this change is expected to reduce quarterly losses related to this business by nearly $1 million, mostly in fixed costs. Our operating expenses for the second quarter were $47.5 million, down from $61.3 million in the same quarter last year. We managed to lower operating expenses across all categories including labor, production, distribution, advertising, and administrative costs. Some of these expenses were mitigated by participation in COVID-19 stimulus programs that helped retain employees critical to our growing higher-margin business lines. Our operating loss was $5.9 million for the second quarter, which is slightly higher than last quarter but an improvement from the $6.6 million operating loss in the same quarter last year, thanks to our effective cost reduction strategies. When adjusting for nonrecurring restructuring and impairment costs, our adjusted operating loss was $563,000 compared to a loss of $3.1 million last year, reflecting our continued efforts in cost-cutting and focus on higher-margin sectors. This quarter, we recognized a $1.5 million one-time tax benefit primarily related to NOL carrybacks and the removal of the 80% taxable income limitation on NOLs due to the CARES Act. Including this benefit, we had a GAAP net loss of $6.2 million or $0.99 per share in the second quarter, compared to a GAAP net loss of $3.8 million or $0.63 per share in the same quarter last year. Second quarter adjusted EBITDA was $480,000, a significant improvement from negative $1.8 million last year, especially considering the lower revenue levels. Regarding our balance sheet and liquidity, as of June 30, 2020, we had cash and cash equivalents of $30.1 million, compared to $23.5 million at the end of March 31, 2020. We had $22.2 million in long-term debt, reflecting the current draw on our $19 million revolving credit facility and the long-term portion of our PPP notes. On May 11, we extended the revolving credit facility through April 2022 and reduced the amount to $19 million. We believe our balance sheet is strong enough to continue our transformation plan effectively.

Andrew Benett, CEO

Thanks, Lauri. In summary, although we are facing near-term challenges, as with everyone, as a result of the pandemic and declining client marketing spend within our category, we're well in the process of modernizing our business through our existing client relationships as well as new relationships as we've discussed. Companies are undergoing accelerated digital transformation in the face of the pandemic, and we're making changes now that we believe would place us at a competitive advantage and position for the long term. While we're committed to continuing to align our expenses with expected near-term revenue levels, we're also making important progress towards aligning our capabilities with emerging customer needs. We've strengthened our cash balances, and we believe we have the necessary liquidity to execute our turnaround plan and regain our position as a leading customer experience company for years to come. With that, operator, if you could please open the line for questions. Thank you.

Michael Kupinski, Analyst

First of all, congratulations on achieving positive adjusted EBITDA in the quarter. I think that was the first time you had positive cash flow in the second quarter since at least 2017. So congrats on that. Revenue showed sequential improvement from the first quarter. This was a little bit better than what I was thinking for. And I was just wondering if you can add a little bit of color on that because you did say you had some client wins. But did the pace of client losses year-over-year decrease as well? I'm just trying to understand that. And then since July is already over, could you talk about how you started the third quarter? And then maybe if you anticipate that there will be sequential improvement in revenues from the second quarter and the third quarter as well?

Andrew Benett, CEO

Thank you for the question. I'll start and Lauri can add as well. To address the first part regarding revenue, we believe we’ve stabilized the top line. We're seeing an improvement compared to Q1. In relation to your second question about July, we are observing a resurgence in parts of our business that had weakened due to COVID. We've experienced a decline in volumes in our fulfillment business, not losses of clients, but a softening. In our marketing services, clients have delayed activities as they were determining how to communicate with consumers during COVID. Overall, we feel confident that our revenue is at a solid run rate right now. For the growth this quarter, especially in July, we’re noticing an increase in our contact center due to COVID-related services, which is showing a spike. Additionally, we’re seeing an uptick in new business activity and pipeline, along with improved conversion rates. This increase in activity has been occurring over the last six weeks. However, the sales cycle is longer due to COVID, making things take more time. While growing services with existing clients tends to be quicker and more efficient, the effects of COVID are still present. Nonetheless, we are starting to see positive outcomes. Lastly, with consumer engagement rising and our aim to expand into the B2C space, we're seeing early successes, such as a sampling program for a leading CPG company. Lauri, do you have anything to add?

Lauri Kearnes, CFO

No. I mean I think you've covered it. I mean we definitely see some increased business with our contact center, specifically COVID-related as well as entertainment services-related. And the other part of your question, Michael, we have seen certainly a decrease and as we said, stabilized the revenue, so we're not seeing those same customer losses that we were experiencing previously.

Michael Kupinski, Analyst

Great. And then in terms of the $13 million in annualized savings, is that for the full year 2020? Or what timeframe are you talking about in terms of the $13 million?

Andrew Benett, CEO

In terms of the $13 million...

Lauri Kearnes, CFO

Yes, the $13 million is...

Michael Kupinski, Analyst

And can you break that down by quarter? Is that possible? I mean of that $13 million, did you see some of that already in the first quarter? And how much was achieved in the second quarter?

Lauri Kearnes, CFO

Yes. I would say that it's probably more started in the second quarter. So you're going to see it across the second, third and fourth quarters. It's going to be at a higher level in the third and fourth quarter.

Michael Kupinski, Analyst

In regard to the increase in employee expenses, I understand that you have implemented cost reductions and that production costs were lower than anticipated. However, we did notice an upward trend in employee expenses as a percentage of revenues compared to both the first quarter and year-over-year. I'm curious if there were any specific factors impacting employee expenses in the second quarter, or if this marks a new baseline moving forward. How should we approach this line item in future assessments?

Lauri Kearnes, CFO

Are you looking at labor, Michael?

Michael Kupinski, Analyst

Yes. Yes. Yes. I was looking at labor.

Lauri Kearnes, CFO

So I just want to make sure I’m on the right—on the labor line.

Michael Kupinski, Analyst

Yes, I'm sorry.

Lauri Kearnes, CFO

Yes, I mean some of the increase that we've had of revenue in our contact services business, that is — I mean their labor is a higher percentage of revenue with some of the other businesses. So you see some increase there, where some of the other businesses may have higher production and distribution costs.

Michael Kupinski, Analyst

Okay. And then in terms of...

Lauri Kearnes, CFO

Revenue, it's a revenue mix.

Michael Kupinski, Analyst

It's just a revenue mix. Okay.

Lauri Kearnes, CFO

Yes.

Michael Kupinski, Analyst

As we look toward the second half, should we expect increases? You're suggesting that your contact center is performing at a higher level, so should we consider this current run rate or something higher? I'm trying to grasp where that figure should be headed.

Lauri Kearnes, CFO

Yes. I think in Q3, you're going to see about the same percentage. And in Q4, it will probably dip slightly.

Andrew Benett, CEO

Perfect. Well, thank you all for joining the call today. We appreciate your time and do stay safe. Thank you.

Operator, Operator

We'll go to Michael Kupinski with Noble Capital Markets.

Michael Kupinski, Analyst

Thank you.

Andrew Benett, CEO

Thank you.

Operator, Operator

And that does conclude today's conference. We'd like to thank everyone for their participation. You may now disconnect.