Harte Hanks, Inc. (HHS) Q2 2023 Earnings Report, Transcript and Summary

Greetings and welcome to the Harte Hanks Second Quarter 2023 Earnings Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Mr. Tom Baumann of FNK IR. 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, new opportunities which led to meaningful and incremental growth. We picked up call center projects, logistics projects, 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 normal -- 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, so this 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 inside out 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 links leveraging data, creating demand for a product of service and closing 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 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 and there are others, 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 2 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, health care, 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 have 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 declined 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 3 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.

[Operator Instructions] Our first question will come from Julio Romero with Sidoti & Company.

Congratulations on the role. I wanted to start by maybe, Kirk, 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.

Sure. Well, as we've disclosed, we've had some revenue challenges this year. I think the management team is going to be focused on having an appreciation for a relatively stable revenue base, take that baseline and model our expenses around working toward a 10% margin in the business, that's what we'd like to do. That's going to take some time and a deep commitment but that's our objective. And then I think we have a lot of optionality at that point. I think we'll have a lot of support. I think there are opportunities to do more strategic acquisitions such as we did last year. But that's our highest priority. And while we're doing that because we can address at the fastest, I think the other thing that I've highlighted and I gave you a lot of specific actions around this is to rejuvenate the revenue operations here, sales and marketing. My view is that Harte-Hanks needs to be its own best customer and we're not today. We do a fantastic job for our clients which engenders amazing loyalty and support, many long-standing -- decade-long relationships. But when I look and audit, everything that we're doing for ourselves today to optimize our prospects for growing revenue, we're just leaving too much on the table. So in the near term, that's the focus. And I think when we get to that point, a lot of strategic options open up for the company and I'm looking forward to that. But right now, we're in hurry-up offense here to get our costs in line.

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?

Yes. It's been amazing. I have had a chance to do town halls, large-scale conference calls, a lot of feedback, a lot of energy. A marketing company that offers the services that we do to our clients responds very well to a growth mandate. And we will have a growth mandate. We do have a growth mandate. But the first thing that we need to do is make sure our costs are aligned and we provide some stability to our outlook and we'll do that. But I've had a chance to spend several days with the senior management team. That's been fantastic. It's a talented group. We were doing our marketing audit that I asked for to uncover what all are we not doing that we know we generate more leads that would ultimately fuel more growth. I mean many of our opportunities are the result of RFPs, right? I mean it's not -- you should be prospecting or cold calling as it's put. But the fact of the matter is that a lot of diligence is done in companies when they think about changing a vendor or outsourcing a service and they want to evaluate several options. And so they have a very formal process of doing that. We invest a lot of time in that process. It equates to a sales cycle that can be 6 months long. And so we want to excel at that but the key is to generate more leads and be discovered when those procurement officers and executives and C-suite folks are looking at viable companies to outsource these services to. So it's a great -- it's been a great 8 weeks here. And I'm going down to Florida in a couple of weeks and spend time with the team at InsideOut which is the acquisition we did last year. I've written to employees on a few occasions to tell them and make sure they're up for the journey and it's been a great reception. But everybody knows we're going to be on the move and it seems to be resonating. So I think we want to win. There's a lot of preparation that you have to put into winning and that's what we're all about.

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 was -- how is June trending relative to May and April?

Yes. So I would go back to what the company conveyed in May which was acknowledging that there's been a lot of re-evaluation of marketing spend, of logistics spend, particularly in financial services, B2B tech. And that was really clouding visibility. And, I guess, it's fair to say that it was essentially a reset last quarter on what to expect. Here's the lay of the land. The majority of our largest long-standing customers have reduced spending this year and that's going to persist for the balance of the year. We're seeing a fairly broad-based response to the uncertainty or cautiousness in the marketplace. I mean, many companies have reduced spending. I think broadly speaking, that's a predominant theme this year. On the plus side though, we have fantastic customer satisfaction and loyalty. They both remain intact and that's good. We stay close to our customers. And frankly, we understand what they're doing and why. Frankly, I'm discussing doing that here with you today. We have had a couple of large accounts, reduced spending substantially. That happens when there's a major change in the company's strategy. So when that occurs, we have to assess our resource allocation and staff devoted to those accounts. And regrettably, sometimes that means we have to reduce staff. We staff up accounts that are growing with us or sometimes for seasonal reasons. But we must -- we got to maintain a variable staffing model when we encounter a setback or an account loss. So while we get our revenue, operations and activities ramped up and we will, it's not -- that's not an incredible challenge here. It's really a phenomenal opportunity. But while we're doing that, we have an opportunity to get our expenses in line. And I think that's what everybody is looking for and that's what we're going to get done.

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 and that gets more challenging when you -- when it's been iterative and you've been at that quarter after quarter and we've been in that mode. 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. And that drives a very intense, extensive process that can take a few months to complete and scope. But I've done that before a few times and it's really not a drill and it's not a reaction to a tough month or a tough quarter. It's an extraordinarily deep dive into the business through all facets, unit level economics. And so I think it will be a combination of our team and we'll probably augment those resources somewhat to do as extensive job as I would like. But it does start with trying to have some target in mind and we do and that's 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 concerned about or another. I'm gaining a deep understanding of how to augment and accelerate growth uniquely in our Fulfillment & Logistics division, for example, juxtapose 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 we can -- you can track with us over the next quarter or maybe 2 because we're going to be very excited to talk about what we discovered but I don't -- 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. And in terms of the sales development partnership that you were talking about. Some investors and analysts like myself that have been around the company for some period of time recognize the problems that the company got into with some contracts with Wipro in the past which obviously turned the company negative into -- in earnings. So I was just wondering if you can maybe -- and maybe you don't have the history here, maybe Lauri can help out to talk about the type of relationship that you're referring to in terms of sales development? And if this relationship is more like a rev share or just kind of give us the basis of what type of arrangement you're looking for?

Yes. So Michael, let me start and then I'll let Kirk fill in a little bit more on what this opportunity is. It is very different from what we've done in the past and certainly different from Wipro. So this is a very not like -- we're not putting a lot of cost into this upfront. But it's an ongoing. It's incremental. Think of it as somewhat of an incremental to our sales team looking for opportunities for us. So there's only some commission on an ongoing basis if we get that revenue. So it's not any kind of large fixed cost like we had with the previous relationship with Wipro. And I'll let Kirk talk about it little more.

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 [ph] 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 provider or seek growth or it could be 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 they 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 over the course of the year if we extend engagement -- well, 45-or-so discussions with key decision makers. And we'll also have the opportunity actually 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. One other question. The customer care division was one of the areas that benefited from the pandemic. And so I was anticipating that maybe that portion of the business might be trailing off or have a little bit more weakness. But in the last quarter, it came in better than expected and showed some pretty decent growth. And I was just wondering if -- what -- if that business came in unexpected or it was a business that came in unexpectedly? Or is there an improving trend in Customer Care at this point?

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 -- I'm not sure I'd say them but they definitely had some 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 health care 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.

Thanks very much. And I just want to thank you all for joining the call. I appreciate the opportunity to speak on behalf of all of us here at Harte Hanks and our commitment to running a good business and performing for our shareholders. I want to be clear on how I see us propelling the business forward. We need to commit to and organize around an effort to take a comprehensive look at our costs and lowering them. We can address this much faster than we can expect revenue to grow at least net grow but I'll tell you, I'm very excited about that, too. It's just -- there's a sales cycle and there's a lot we need to put in place but we are all over it right now. So I'm looking forward to keeping you updated and we look forward to talking to you at Q3 results. So, thanks so much.

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