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HHS > SEC Filings for HHS > Form 10-K on 13-Mar-2013All Recent SEC Filings

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Form 10-K for HARTE HANKS INC


13-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

Cautionary Note About Forward-Looking Statements

This report, including this Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A), contains "forward-looking statements" within the meaning of the federal securities laws. All such statements are qualified by the cautionary note included under Item 1A above, which is provided pursuant to the safe harbor provisions of Section 27A of the 1933 Act and Section 21E of the 1934 Act. Actual results may vary materially from what is expressed in or indicated by the forward-looking statements.

Overview

The following MD&A section is intended to help the reader understand the results of operations and financial condition of Harte-Hanks, Inc. (Harte-Hanks). This section is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes to the financial statements.

Harte-Hanks is a worldwide direct and targeted marketing company that provides multichannel direct and digital marketing services and shopper advertising opportunities to a wide range of local, regional, national and international consumer and business-to-business marketers. We manage our operations through two operating segments: Direct Marketing and Shoppers.

Our Direct Marketing services offer a wide variety of integrated, multichannel, data-driven solutions for top brands around the globe. We help our clients gain insight into their customers' behaviors from their data and use that insight to create innovative multichannel marketing programs to deliver a return on marketing investment. We believe our clients' success is determined not only by how good their tools are, but how well we help them use the tools to gain insight and analyze their consumers. This results in a strong and enduring relationship between our clients and their customers.

We offer a full complement of capabilities and resources to provide a broad range of marketing services and data management software, in media from direct mail to email, including:

†          agency and digital services;

†          database marketing solutions;

†          data quality software and services with Trillium Software;

†          business-to-business lead generation;

†          direct mail and fulfillment; and

†          contact centers.

In 2012, our Direct Marketing segment had revenues of $581.1 million, which represented 76% of our total revenues.

Harte-Hanks Shoppers is North America's largest owner, operator and distributor of shopper publications, based on weekly circulation and revenues. Shoppers are weekly advertising publications, 7 by 10 inches in size, distributed free by Standard Mail to households and businesses in a particular geographic area. Through print and digital offerings, Shoppers is a trusted local source for saving customers money and helping businesses grow. Shoppers offer advertisers a geographically targeted, cost-effective local advertising system, with virtually 100% penetration in their area of distribution. Shoppers are particularly effective in large markets with high media fragmentation in which major metropolitan newspapers generally have low penetration. Our Shoppers segment also provides online advertising and other services through our website, PennySaverUSA.com®, as well as business websites and search-engine marketing. Our websites are online advertising portals, bringing buyers and sellers together through our online offerings, such as local classifieds, business listings, coupons, special offers and PowerSites. PowerSites are templated websites for our customers, optimized to help small and medium-sized business owners establish a web presence and improve their lead generation. At December 31, 2011, we were publishing approximately 5,600 PowerSites weekly.


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On December 31, 2012 we sold the assets of our Florida Shoppers operations, The Flyer®, for gross proceeds of $2.0 million, subject to working capital adjustments. This transaction resulted in an after-tax loss of $2.7 million. Because the Florida Shoppers represent a distinct business unit with operations and cash flows that can clearly be distinguished, both operationally and for financial purposes, from the rest of Harte-Hanks, Inc., the results of the Florida Shoppers operations are reported as discontinued operations for all periods presented. Results of the remaining Harte-Hanks, Inc. business segments are reported as continuing operations.

After this sale, Harte-Hanks Shoppers no longer has any operations or circulation in the state of Florida. All of our Shopper operations are now located in California, and our California publications now account for all of Shoppers weekly circulation. As of December 31, 2012, Shoppers delivered approximately 9.1 million shopper packages in six major markets each week, covering Southern, Central and Northern California.

In 2012, our Shoppers segment, excluding the Florida Shoppers, had revenues of $186.6 million, which represented 24% of our total revenues.

We derive revenues from the sale of direct marketing services and shopper advertising services.

As a worldwide business, Direct Marketing is affected by general national and international economic and business conditions. Marketing budgets are often more discretionary in nature, and are easier to reduce in the short-term than other expenses in response to weak economic conditions. Direct Marketing revenues are also affected by the economic fundamentals of each industry that we serve, various market factors, including the demand for services by our clients, and the financial condition of and budgets available to specific clients, among other factors. We remain committed to making the investments necessary to execute our multichannel strategy while also continuing to adjust our cost structure to reduce costs in the parts of the business that are not growing as fast. We believe these actions will improve our profitability in future periods.

Prior to the sale of our Florida Shoppers in 2012, our Shoppers business operated in regional markets in both California and Florida and was greatly affected by the strength of the state and local economies. Revenues from our Shoppers business were largely dependent on local advertising expenditures in the areas of California and Florida in which we operated. During 2012, the poor economic conditions that we have experienced since the second half of 2007 in California and Florida continued. These conditions were initially created by weakness in the real estate and associated financing markets and have spread and persist across virtually all categories. As a result of management's evaluation of the Shoppers business, we recorded a $165.3 million impairment loss in the second quarter of 2012 related to Shoppers' goodwill and other intangible assets. Excluding the Florida Shoppers operations, the total impairment charge related to our Shoppers business was $156.9 million. We see some improvement in the California economy, but we expect to have further challenges before our performance improves. In response, during 2012, we continued our efforts to reduce expenses in the Shoppers business, primarily through organizational restructuring, and the discontinuance of a number of unprofitable digital initiatives, including SaverTime and mobile apps. We also made plans to close our production facility in Northern California in 2013. We continue to invest in online offerings, particularly our PowerSites, where we are seeing good revenue growth and are adding capabilities that provide value for our readers and advertisers, and in other profitable digital initiatives. We believe the steps we are taking to improve overall efficiency, combined with our continued investments in digital initiatives, will improve our Shoppers performance in the long term.

Our principal operating expense items are labor, postage and transportation.


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Results of Continuing Operations

As discussed in Note P, Discontinued Operations, we sold the assets of our Florida Shoppers operations on December 31, 2012. Therefore, the operating results of our Florida Shoppers, including the loss on the sale, are being reported as discontinued operations in the Consolidated Financial Statements, and are excluded from management's discussion and analysis of financial condition and results of operations below.

Operating results from continuing operations, direct marketing and California shoppers, were as follows:

In thousands except
per share amounts              2012       % Change      2011       % Change      2010
Revenues                     $ 767,709        -5.4    $ 811,636        -1.1    $ 820,720
Operating expenses             857,649        16.9      733,538         0.8      727,474
Operating income (loss)      $ (89,940 )    -215.2    $  78,098       -16.2    $  93,246

Income (loss) from
continuing operations        $ (73,104 )    -259.3    $  45,877       -16.9    $  55,194

Diluted EPS from
continuing operations        $   (1.16 )    -261.1    $    0.72       -16.3    $    0.86

Year ended December 31, 2012 vs. Year ended December 31, 2011

Revenues

Consolidated revenues decreased $43.9 million, to $767.7 million, in 2012 compared to 2011. Our overall results reflect decreased revenues of $33.2 million, or 5.4%, from our Direct Marketing segment and decreased revenues of $10.7 million, or 5.4%, from our Shoppers segment. Direct Marketing results reflect the impact of a large, long standing retail customer which changed its marketing strategy to emphasize broadcast at the expense of direct mail. Direct Marketing experienced decreased revenues from all of our verticals, with the high-tech vertical representing the largest dollar decrease. Shoppers' revenue performance reflects the continued impact that the difficult economic environment in California is having on our Shoppers business. The decrease in revenues was the result of decreased sales in established markets, including declines from most revenue categories. Revenues from in-book advertising decreased at a higher rate than revenues from distribution products. Shoppers revenues increased from the automotive, consumer spending and communications sectors, and decreased from the services and real estate sectors.

Operating Expenses

Overall operating expenses were $857.6 million in 2012, compared to $733.5 million in 2011. This $124.1 million increase was a result of the impairment charge of $156.9 million discussed above. Excluding this impairment charge, operating expenses decreased $32.8 million, or 4.5%, compared to 2011. This $32.8 million decrease in operating expenses was driven by decreased operating expenses in Direct Marketing of $25.1 million, or 4.7%, and decreased operating expenses of $9.2 million, or 4.8%, in Shoppers , partially offset by an increase in general corporate expense of $1.5 million, or 13.3%. The decrease at Direct Marketing was primarily due to decreased outsourced costs resulting from decreased outsourced volumes, decreased mail supply chain costs resulting from decreased volumes, and reductions in headcount, temporary labor, incentive compensation and commissions, all as a result of revenue performance. The decrease at Shoppers was due to decreased severance costs, decreased stock-based compensation, lower payroll costs due to lower ad sales and headcount reductions, decreases in newsprint and job paper expenses due to declines in volumes, decreased bad debt expense and decreased facility lease expense. The overall decrease at Shoppers was partially offset by costs accrued for the closure of the Northern California production facility, legal accrual reductions in 2011, an increase in offload printing costs due to an increase in heatset volumes, an increase in postage costs due to the January 2012 postage rate increase, an increase in outsourced costs due to increased outsourced volumes, and the write-off of software related to various digital initiatives. The increase in general corporate expense was attributable to increased pension expense resulting from using a lower discount rate to calculate the projected pension benefit obligation.


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Income/Earnings Per Share from Continuing Operations

We recorded a loss from continuing operations of $73.1 million, and diluted loss per share from continuing operations of $1.16, in 2012. Excluding the impairment loss, income from continuing operations and diluted earnings per share from continuing operations for 2012 would have been $39.0 million and $0.62, respectively. These results, excluding the impairment loss, compare to income from continuing operations of $45.9 million, and diluted earnings per share from continuing operations of $0.72 in 2011. The decrease in income from continuing operations, excluding the impairment loss, is primarily a result of decreased operating income from both Direct Marketing and Shoppers, a gain on the sale of land in 2011, changes in net foreign currency transaction gains and losses, and an increase in general corporate expense.

Year ended December 31, 2011 vs. Year ended December 31, 2010

Revenues

Consolidated revenues decreased $9.1 million, to $811.6 million, in 2011 compared to 2010. Our overall results reflect increased revenues of $13.0 million, or 2.2%, from our Direct Marketing segment and decreased revenues of $22.1 million, or 10.1%, from our Shoppers segment. The Direct Marketing results were affected by a large, one-time, voluntary recall project performed for a long-time pharmaceutical customer during the second half of 2010. Excluding the results from this project, total Direct Marketing revenues increased $29.1 million, or 5.0% in 2011 compared to 2010. Direct Marketing experienced increased revenues from our select, retail and financial verticals, which were partially offset by decreased revenues from our healthcare and high-tech vertical. The August 2010 acquisition of Information Arts also contributed to the 2011 revenue growth. Shoppers revenue performance reflects the continued impact that the difficult economic environment in California is having on our Shoppers business. The decrease in revenues was the result of decreased sales in established markets, including declines in most revenue categories.

Operating Expenses

Overall operating expenses increased 0.8%, to $733.5 million, in 2011 compared to 2010. The overall increase in operating expenses was driven by increased operating expenses in Direct Marketing of $16.2 million, or 3.2%. The Direct Marketing increase was primarily due to increased headcount to support revenues and improve our database service capabilities, higher mail supply chain costs on higher transportation volumes, increased travel and increased employee recruiting. The acquisition of Information Arts also contributed to the increase in Direct Marketing operating expenses. Shoppers operating expenses decreased $10.1 million, or 5.0%, due to lower variable payroll costs, decreased postage due to lower distribution volumes and the elimination of the second day edition, decreased outsourced costs on lower volumes, decreased lease expense due to facility consolidations, and a $1.3 million reduction of a legal accrual. The overall decrease at Shoppers was partially offset by $4.1 million of charges recognized in the first half of 2011 related to our efforts to reduce expenses in the Shoppers business. Of these charges, $3.9 million related to the retirement of the President of our Shoppers business and severance due to headcount reductions. The remaining charges related to facilities and other miscellaneous items. The decrease at Shoppers was also partially offset by an increase in newsprint expense due to higher paper rates. Excluding the retirement, severance and other charges, and the legal accrual reduction, Shoppers operating expenses decreased $12.9 million, or 6.4%.

Income/Earnings Per Share from Continuing Operations

Income from continuing operations decreased 16.9%, to $45.9 million, and diluted earnings per share from continuing operations decreased 16.3%, to $0.72 per share, in 2011 compared to 2010. These decreases were the result of decreased operating income from both Shoppers and Direct Marketing, higher interest expense, and a higher effective tax rate in 2011 compared to 2010. These decreases were partially offset by a $2.3 million gain on the sale of land adjacent to our Shopper's Brea facility, and a $1.3 million change in net foreign currency transaction gains and losses.


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Direct Marketing



Direct Marketing operating results were as follows:



In thousands           2012      % Change     2011      % Change     2010
Revenues             $ 581,091       -5.4   $ 614,270        2.2   $ 601,283
Operating expenses     505,693       -4.7     530,780        3.2     514,535
Operating income     $  75,398       -9.7   $  83,490       -3.8   $  86,748

Year ended December 31, 2012 vs. Year ended December 31, 2011

Revenues

Direct Marketing revenues decreased $33.2 million, or 5.4%, in 2012 compared to 2011. These results reflect the impact of a large, long standing retail customer which changed its marketing strategy to emphasize broadcast at the expense of direct mail. Despite the shift in strategy and reduced direct mail volumes, this company remains one of our largest customers. Reduced revenues from this customer represented a little less than half of the overall decline in Direct Marketing revenues. Revenues from our retail vertical declined 1% compared to the prior year as increased spending by other existing retail customers somewhat offset the reduced spending by this customer. Revenues from our pharmaceutical vertical decreased 16% compared to 2012, reflecting the effect of volume reductions from one long standing customer beginning in the second quarter of 2012, and the loss of another long standing customer in the third quarter of 2012. Our high-tech vertical declined 9%, representing the largest dollar decrease from the prior year. Our select vertical declined 4% and our financial vertical declined 3%.

Future revenue performance will depend on, among other factors, the overall strength of the national and international economies and how successful we are at maintaining and growing business with existing clients, acquiring new clients and meeting client demands. We believe that, in the long-term, an increasing portion of overall marketing and advertising expenditures will be moved from other advertising media to the targeted media space, and that our business will benefit as a result. Targeted media advertising results can be more effectively tracked, enabling measurement of the return on marketing investment.

Postage costs of mailings in our Direct Marketing business are borne by our clients and are not directly reflected in our revenues or expenses.

Operating Expenses

Operating expenses decreased $25.1 million, or 4.7%, in 2012 compared to 2011. Labor costs decreased $7.0 million, or 2.5%, primarily due to reductions in headcount and temporary labor, decreased incentive compensation and decreased commissions, all as a result of revenue performance. Production and distribution costs decreased $19.5 million, or 10.2%, due to decreased outsourced costs resulting from decreased outsourced volumes, decreased mail supply chain costs resulting from decreased volumes, and decreased lease costs due to costs recognized in 2011 to terminate a lease. General and administrative expense increased $0.9 million, or 2.0%, due primarily to an increase in legal fees, increased royalties and increased employee travel and training, partially offset by decreased promotion expense and facilities costs. Depreciation and software amortization expense increased $0.5 million, or 3.1%, due to increased capital expenditures in 2011. Intangible asset amortization was up slightly.

Direct Marketing's largest cost components are labor, outsourced costs and mail supply chain costs. Each of these costs is somewhat variable and tends to fluctuate with revenues and the demand for our direct marketing services. Mail supply chain rates have increased over the last few years due to demand and supply issues within the transportation industry. Future changes in mail supply chain rates will continue to impact Direct Marketing's total production costs and total operating expenses, and may have an impact on future demand for our supply chain management.


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Year ended December 31, 2011 vs. Year ended December 31, 2010

Revenues

Direct Marketing revenues increased $13.0 million, or 2.2%, in 2011 compared to 2010. These results were affected by a large, one-time, voluntary recall project performed for a long-time pharmaceutical customer during the second half of 2010. Excluding the results from this project, total Direct Marketing revenues increased $29.1 million, or 5.0%, in 2011 compared to 2010. Revenues from our select vertical increased 17%, representing the largest dollar increase from the prior year. Our retail vertical increased 9% and our financial vertical increased 4%. Revenues from our pharmaceutical vertical declined 18% due to the recall project discussed above, and our high-tech vertical declined 7%. Revenues from our vertical markets are impacted by, among other things, the economic fundamentals of each industry, various market factors, including the demand for services by our clients, and the financial condition of and budgets available to specific clients. The August 2010 acquisition of Information Arts also contributed to the 2010 revenue growth.

Operating Expenses

Operating expenses increased $16.2 million, or 3.2%, in 2011 compared to 2010. Labor costs increased $9.3 million, or 3.5%, due to increased headcounts to support revenues and improve our database service capabilities. Production and distribution costs increased $6.4 million, or 3.4%, due to higher mail supply chain costs on higher transportation volumes. General and administrative expense increased $2.2 million, or 4.8%, due primarily to an increase in travel and employee recruiting. Depreciation and software amortization expense decreased $1.6 million, or 9.5%, due to decreased capital expenditures over the last few years. Intangible asset amortization was down $0.1 million, or 20.9%, due to certain intangible assets becoming fully amortized.

Shoppers



Shoppers operating results were as follows:



In thousands                 2012      % Change     2011      % Change     2010
Revenues                  $  186,618       -5.4   $ 197,366      -10.1   $ 219,437
Operating expenses           339,228       77.1     191,527       -5.0     201,642

Operating income (loss) $ (152,610 ) -2,713.6 $ 5,839 -67.2 $ 17,795

Year ended December 31, 2012 vs. Year ended December 31, 2011

Revenues

Shoppers revenues decreased $10.7 million, or 5.4%, in 2012 compared to 2011. These results reflect the continued impact that the difficult economic environment in California is having on our Shoppers business. The decrease in revenues was the result of decreased sales in established markets, including declines from most revenue categories. Revenues from in-book advertising decreased at a higher rate than revenues from distribution products. Shoppers revenues increased from the automotive, consumer spending and communications sectors. Revenues from the services and real estate sectors decreased.

At December 31, 2012, our Shoppers circulation reached approximately 9.1 million addresses in California each week. While we have not made any significant changes to our circulation in the last several years, we continue to evaluate all of our circulation performance and may make circulation reductions in the future as part of our efforts to address the difficult economic conditions in California.

Future revenue performance will depend on, among other factors, the overall strength of the California economy, as well as how successful we are at maintaining and growing business with existing clients, and acquiring new clients.


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Operating Expenses

Shoppers operating expenses were $339.2 million in 2012, compared to $191.5 million in 2011. This $147.7 million year over year increase was primarily a result of the $156.9 million impairment loss recorded in the second quarter of 2012, as discussed above. This increase was also impacted by $1.3 million of costs recognized in the fourth quarter of 2012 relating to the closure of our production facility in Northern California. Excluding the impairment loss and facility closure costs, operating expenses decreased $10.5 million, or 5.5%, compared to 2011. Total labor costs decreased $10.1 million, or 15.7%, due to decreased severance costs (partially offset by severance costs related to the facility closure), decreased stock-based compensation, and lower payroll costs from lower ad sales, headcount reductions and pay rate reductions. Total production costs were up $1.6 million, or 1.4%, due to an increase in offload printing costs due to an increase in heatset volumes, an increase in postage costs resulting from the January 2012 postage rate increase, and an increase in outsourced costs due to increased outsourced volumes, partially offset by decreases in newsprint and job paper expenses due to declines in volumes, and a decrease in facility lease expense. Total general and administrative costs decreased $0.8 million, or 6.0%, due to a decrease in bad debt expense, lower credit card processing fees and lower costs associated with digital products, partially offset by a portion of the closing costs discussed above and legal accrual reductions in 2011. Depreciation and software amortization expense increased $0.1 million, or 2.0%, due to writing off software related to various digital initiatives in the second quarter of 2012.

Shoppers' largest cost components are postage, labor, and paper. Shoppers' labor costs are partially variable and tend to fluctuate with the number of zones, circulation, volumes and revenues. Standard postage rates have increased in recent years, most recently in April 2011, January 2012 and January 2013. Shoppers' postage rates increased by less than 1.0% as a result of the April 2011 rate increase, increased by approximately 2.1% as a result of the January 2012 rate increase, and will increase by approximately 2.8% as a result of the January 2013 rate increase. The January 2013 postage rate increase, and any additional future changes in postage rates will affect Shoppers' distribution costs. The U. S. Postal Service has also proposed various changes in its services to address its financial performance, such as delivery frequency and facility access. Recently, the USPS announced it would end household delivery on Saturdays starting in August 2013. At this point we do not believe the announced and proposed changes will have a material impact on our Shoppers business. Newsprint prices increased steadily over the last two years before leveling off in the second half of 2012. Newsprint prices are expected to . . .

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