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HHS > SEC Filings for HHS > Form 10-K on 12-Mar-2014All Recent SEC Filings

Show all filings for HARTE HANKS INC

Form 10-K for HARTE HANKS INC


12-Mar-2014

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 one of the world's leading, insight-driven multi-channel marketing organizations, delivering impactful business results for some of the world's best-known brands. Through strategic agencies and our core marketing services, we develop integrated solutions that connect brands with prospects and customers, moving them beyond awareness to transactions and brand loyalty.

We 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


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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 and business-to-business lead
generation;

data quality software and services with Trillium Software;

direct mail; and

contact centers.

Previously, Harte Hanks also provided shopper advertising opportunities through our Shoppers segment, which operated in certain California and Florida markets. On December 31, 2012 we sold the assets of our Florida Shoppers operations, The Flyer, for gross proceeds of $2.0 million. This transaction resulted in an after-tax loss of $2.7 million. On September 27, 2013 we sold the assets of our California Shoppers operations, The Pennysaver, for gross proceeds of $22.5 million. This transaction resulted in an after-tax loss of $12.4 million. Because Shoppers represented 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, the results of the Shoppers operations are reported as discontinued operations for all periods presented. Results of the remaining Harte Hanks business are reported as continuing operations. After these sales, Harte Hanks no longer has any Shoppers operations or circulation.

With business operations in several countries, we are affected by the general local, national and international economic and business conditions in the markets where we and our customers operate. 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. Our 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.

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

Results of Continuing Operations

As discussed in Note N, Discontinued Operations, we sold the assets of our Florida Shoppers operations on December 31, 2012 and the assets of our California Shoppers operations on September 27, 2013. Therefore, the operating results of both our Florida and California Shoppers, including the losses on the sales, 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.


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Operating results from our continuing operations were as follows:

In thousands, except per
share amounts                      2013       % Change      2012       % Change      2011
Revenues                         $ 559,609        -3.7 %  $ 581,091        -5.4 %  $ 614,270
Operating expenses                 516,948        -0.3 %    518,422        -4.4 %    542,011
Operating income                 $  42,661       -31.9 %  $  62,669       -13.3 %  $  72,259

Income from continuing
operations                       $  24,441       -30.9 %  $  35,396       -15.8 %  $  42,060

Diluted EPS from continuing
operations                       $    0.39       -30.6 %  $    0.56       -16.3 %  $    0.67

Year ended December 31, 2013 vs. Year ended December 31, 2012

Revenues

Revenues decreased $21.5 million, to $559.6 million, in 2013 compared to 2012. These results reflect the impact of decreased revenues from all of our verticals except for financial, with the retail vertical representing the largest dollar decrease. Revenues from our retail vertical declined 5% compared to the prior year, reflecting changes by two large customers to less expensive mailing formats. Our select markets vertical decreased 8%, primarily due to the loss of two customers. Compared to 2012, our pharmaceutical vertical decreased 6%, high-tech declined 4% and automotive and consumer brands decreased 3%. Our financial vertical increased 3% over the prior year.

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.

Operating Expenses

Overall operating expenses were $516.9 million in 2013, compared to $518.4 million in 2012. The $1.5 million decrease includes the impact of an impairment loss of $2.8 million related to other intangible assets associated with our Aberdeen business recorded in the third quarter of 2013, offset by a decrease of $4.3 million, or 0.8% in other operating expenses, compared to 2012.

Labor costs increased $3.3 million, or 1.2%, primarily due to an increase in headcount and $2.0 million of increased compensation expense related to the retirement of our former Chairman and CEO in the second quarter of 2013 and hiring of his successor in the third quarter of 2013. Production and distribution costs decreased $10.5 million, or 6.1%, due to decreased mail supply chain costs resulting from decreased fuel costs and decreased outsourced costs resulting from decreased outsourced volumes. General and administrative expense, excluding the impairment charge, increased $3.2 million, or 6.2%, compared to prior year, reflecting $2.5 million related to a legal settlement and associated fees and $1.7 million of professional consulting services related to strategy development. Promotional expenses also increased related to a new rebranding launch. Depreciation and intangible asset and software amortization expense decreased slightly compared to the prior year.


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Our 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 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 our total production costs and total operating expenses, and may have an impact on future demand for our supply chain management.

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

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

Revenues

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 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 2011, 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 12% and our financial vertical declined 3%. Our automobile and consumer brands vertical remained consistent year over year.

Operating Expenses

Operating expenses decreased $23.6 million, or 4.4%, in 2012 compared to 2011. Labor costs decreased $5.8 million, or 2.0%, 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 $1.2 million, or 2.5%, 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 intangible asset and software amortization expense increased $0.5 million, or 3.1%, due to increased capital expenditures in 2011.

Interest Expense

Year ended December 31, 2013 vs. Year ended December 31, 2012

Interest expense decreased $0.5 million, or 13.9%, in 2013 compared to 2012, due to a lower interest rate spread and a decreased debt balance as a result of scheduled principal payments on the 2011 Term Loan Facility.

Our debt at December 31, 2013 and 2012 is described in Note C, Long-Term Debt, in the Notes to Consolidated Financial Statements.

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

Interest expense increased $0.5 million, or 18.5%, in 2012 compared to 2011, due to a higher interest rate spread as a result of the 2011 Term Loan Facility, which replaced the 2006 Term Loan Facility in August 2011. Interest Expense also increased due to lower average balances and lower returns on


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invested cash and cash equivalents in 2012. This increase was partially offset by lower average debt balances in 2012 due to the maturity and $60.0 million payoff of the 2008 Term Loan in March of 2012.

Other Income and Expense

Year ended December 31, 2013 vs. Year ended December 31, 2012

Other expense, net, declined 98.5% from $2.9 million in 2012. This change was primarily due to a $0.9 million gain on the sale of our facility in Belgium in the first quarter of 2013, and a $1.1 million change in net foreign currency transaction gains and losses.

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

Other expense, net, was $2.9 million in 2012, a $2.2 million change from other income, net of $0.8 million in 2011. This change was primarily due to a $2.3 million change in net foreign currency transaction gains and losses.

Income Taxes

Year ended December 31, 2013 vs. Year ended December 31, 2012

Our income tax expense of $15.2 million for 2013 resulted in an effective income tax rate of 38.3%. Benefiting our expense were various state-enacted legislation changes to our effective state income tax rates. The federal tax effected benefit of these changes was $1.5 million. Unfavorably impacting our expense was our limitation on using foreign tax credits to fully offset the incremental tax resulting from dividends paid by a foreign subsidiary to our U.S. operations. The impact of this limitation was an increase to expense of $1.1 million. Excluding the federal tax effected state tax benefit of enacted legislation and the foreign tax credit limitation, 2013 tax expense would have been $15.6 million with an effective tax rate of 39.4%. This compares to an income tax expense of $20.8 million for 2012 that resulted in an effective income tax rate of 37.0%. Our 2012 results reflect the benefit of a Florida Shoppers state net operating loss being attributed to continuing operations. Excluding the benefit related to the Florida net operating loss, 2012 tax expense would have been $21.8 million with an effective tax rate of 38.8%.

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

Our income tax expense of $20.8 million for 2012 resulted in an effective income tax rate of 37.0%. The income tax expense for 2012 reflects the January 1, 2012 net operating loss related to the Florida Shoppers operations now attributed to and being utilized by continuing operations. Excluding the benefit related to the Florida net operating loss, 2012 tax expense would have been $21.8 million with an effective tax rate of 38.8%. This compares to an income tax expense of $26.5 million and an effective tax rate 38.6% for 2011.

Income/Earnings Per Share from Continuing Operations

Year ended December 31, 2013 vs. Year ended December 31, 2012

We recorded income from continuing operations of $24.4 million and diluted earnings per share from continuing operations of $0.39. Excluding the pretax impairment charge, income and diluted earnings per share from continuing operations in 2013 would have been $26.1 million and $0.42, respectively. These results compare to income from continuing operations of $35.4 million and diluted earnings per share from continuing operations of $0.56 per share in 2012. The decrease in income from continuing operations, excluding the impairment charge, is primarily a result of decreased operating income and general corporate expense.

Year ended December 31, 2012 vs. Year ended December 31, 2011We recorded income from continuing operations of $35.4 million and diluted earnings per share from continuing operations of $0.56 in 2012. These results compare to income from continuing operations of $42.1 million and


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diluted earnings per share from continuing operations of $0.67 per share in 2011. The decrease in income from continuing operations is primarily a result of decreased operating income and tax expense, changes in net foreign currency transaction gains and losses, and increased general corporate expense.

Economic Climate and Impact on our Financial Statements

As discussed above, we sold the assets of the California Shoppers operations on September 27, 2013. The business and economic climate in California had a negative impact on our Shoppers' operations and cash flows, and therefore, the cash proceeds received at sale. The loss on sale of these assets is reflected in the discontinued operations results throughout our financial statements. In addition, as a result of a significant decrease in forecasted revenues, management completed an evaluation of the Aberdeen trade name intangible asset as of September 30, 2013. A discounted cash flow model was used to calculate the fair value of the Aberdeen trade name. The significant assumptions used in this method included the (i) revenue growth rates for the Aberdeen Group,
(ii) discount rate, (iii) tax rate and (iv) royalty rate. Harte Hanks recorded a non-cash trade name intangible asset impairment charge of $2.8 million. The impairment charge is included in Intangible impairment in the Consolidated Statements of Comprehensive Income (Loss) for the year ended December 31, 2013.

Liquidity and Capital Resources

Sources and Uses of Cash

As of December 31, 2013, cash and cash equivalents were $88.7 million, increasing from $49.4 million from cash and cash equivalents at December 31, 2012. This net decrease was a result of net cash provided by operating activities of $59.6 million and net cash provided by investing activities of $10.4 million, offset by net cash used in financing activities of $30.0 million.

Operating Activities

Net cash provided by operating activities in 2013 was $59.6 million, compared to $76.4 million in 2012. The $16.8 million year-over-year decrease was attributable to the changes within working capital assets and liabilities.

In 2013, our principal working capital changes, which directly affected net cash provided by operating activities, were as follows:

A decrease in accounts receivable attributable to collection of the December 31, 2012 receivables as well as lower revenues in the fourth quarter of 2013 compared to the fourth quarter of 2012. Days sales outstanding were approximately 72 days at December 31, 2013, which decreased from 74 days at December 31, 2012;

An increase in inventory due to purchasing and holding higher levels of print material inventory in current periods in advance of increases in print material prices;

An increase in prepaid expenses and other current assets due to timing of payments;

A decrease in accounts payable due to lower overall production and distribution expense in the fourth quarter of 2013 than in the fourth quarter of 2012;

An increase in accrued payroll and related expenses due to higher severance expenses accrued at December 31, 2013 than at December 31, 2012;

An increase in customer postage and program deposits due to the timing of customer deposits;


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An increase in income taxes payable due to overpayment of estimated taxes payments in 2012 that drove down the liability in that year. The overpayment was the result of the loss on the sale of Florida Shoppers operations at the end of 2012; and,

An decrease in cash provided by discontinued ops as a result of the sale of Shoppers.

Investing Activities

Net cash provided by investing activities was $10.4 million in 2013, compared to net cash used in investing activities of $13.3 million in 2012. The $23.7 million increase is primarily the result of the $22.5 million proceeds from the sale of Shoppers in 2013.

Financing Activities

Net cash used in financing activities was $30.0 million in 2013 compared to $99.8 million in 2012. The $69.8 million decrease is attributable to $56.9 million in lower net debt repayments in 2013 than in 2012. The additional dividend in the fourth quarter of 2012 also contributed to this decrease.

Credit Facilities

On March 7, 2008, we entered into a four-year $100 million term loan facility (2008 Term Loan Facility) with Wells Fargo Bank, N.A., as Administrative Agent. The 2008 Term Loan Facility matured on March 7, 2012, at which time we paid the remaining outstanding principal of $60.0 million using cash on hand.

On August 12, 2010, we entered into a three-year $70 million revolving credit facility (2010 Revolving Credit Facility) with Bank of America, N.A., as Administrative Agent. The 2010 Revolving Credit Facility matured on August 12, 2013.

On August 16, 2011, we entered into a five-year $122.5 million term loan facility (2011 Term Loan Facility) with Bank of America, N.A., as Administrative Agent. The 2011 Term Loan Facility matures on August 16, 2016. For each borrowing under the 2011 Term Loan Facility, we can generally choose to have the interest rate for that borrowing calculated based on either (i) the LIBOR rate (as defined in the 2011 Term Loan Facility) for the applicable interest period, plus a spread (ranging from 2.00% to 2.75% per annum) based on our total net funded debt-to-EBITDA ratio (as defined in the 2011 Term Loan Facility) then in effect; or (ii) the highest of (a) the Agent's prime rate, (b) the BBA daily floating rate LIBOR, as determined by Agent for such date, plus 1.00%, and
(c) the Federal Funds Rate plus 0.50%, plus a spread (ranging from 1.00% to 1.75% per annum) based on our total net funded debt-to-EBITDA ratio then in effect. We may elect to prepay the 2011 Term Loan Facility at any time without incurring any prepayment penalties. At December 31, 2013, we had $98.0 million outstanding under the 2011 Term Loan Facility.

On August 8, 2013, we entered into a three-year $80 million revolving credit facility, a $25 million letter of credit sub-facility and a $5 million swing line loan sub-facility (2013 Revolving Credit Facility) by amending and restating the 2010 Revolving Credit Facility agreements. The 2013 Revolving Credit Facility permits us to request up to a $15 million increase in the total amount of the facility, and matures on August 16, 2016. The 2013 Revolving Credit Facility replaces the 2010 Revolving Credit Facility, under which Harte Hanks had no borrowings as of August 8, 2013, except for letters of credit totaling approximately $9.5 million. For each borrowing under the 2013 Revolving Credit Facility, we can generally choose to have the interest rate for that borrowing calculated on either (i) the Eurodollar rate for the applicable interest period plus a spread which is determined based on our total net debt-to-EBITDA ratio then in effect, which ranges from 2.25% to 3.00% per annum; or (ii) the highest of (a) the Agent's prime rate, (b) the Federal Funds Rate plus 0.50% per annum, (c) Eurodollar rate plus 1.00% per annum, plus a spread which is determined based on our total debt-to-EBITDA ratio then in effect, which spread ranges from 1.25% to 2% per annum. We are also required to pay a quarterly


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commitment fee under the 2013 Revolving Credit Facility. The rate of which is applied to the amount equal to the difference of the total commitment amount under the 2013 Revolving Credit Facility less the aggregate amount of outstanding obligations under such facility. The commitment fee rate ranges from 0.50% to 0.55% per annum, depending on our total net debt-to-EBITDA ratio then in effect. In addition, we pay a letter of credit fee with respect to outstanding letters of credit. That fee is calculated by applying a rate equal to the spread applicable to Eurodollar based loans plus a fronting fee of 0.125% per annum to the average daily undrawn amount of the outstanding letters of credit. We may elect to prepay the 2013 Revolving Credit Facility at any time without incurring any prepayment penalties.

Under all of our credit facilities we are required to maintain an interest coverage ratio of not less than 2.75 to 1 and a total debt-to-EBITDA ratio of not more than 2.25 to 1. The credit facilities also contain customary covenants restricting our and our subsidiaries' ability to:

authorize distributions, dividends, stock redemptions and repurchases if a payment event of default has occurred and is continuing;

enter into certain merger or liquidation transactions;

grant liens;

enter into certain sale and leaseback transactions;

have foreign subsidiaries account for more than 25% of the consolidated revenue, or 20% of the assets of Harte Hanks and its subsidiaries, in the aggregate;

enter into certain transactions with affiliates; and

allow the total indebtedness of Harte Hanks' subsidiaries to exceed $20.0 million.

The credit facilities each also include customary covenants regarding reporting obligations, delivery of notices regarding certain events, maintaining our corporate existence, payment of obligations, maintenance of our properties and insurance thereon at customary levels with financially sound and reputable insurance companies, maintaining books and records and compliance with applicable laws. The credit facilities each also provide for customary events of default including nonpayment of principal or interest, breach of representations and warranties, violations of covenants, failure to pay certain other indebtedness, bankruptcy and material judgments and liabilities, certain violations of environmental laws or ERISA or the occurrence of a change of control. Our material domestic subsidiaries have guaranteed the performance of Harte Hanks under our credit facilities. As of December 31, 2013, we were in compliance with all of the covenants of our credit facilities.

Contractual Obligations



Contractual obligations at December 31, 2013 are as follows:



In thousands             Total       2014       2015       2016      2017      2018      Thereafter
Debt                   $  98,000   $ 15,313   $ 18,375   $ 64,312   $     0   $     0   $          0
Interest on debt (1)       4,547      2,045      1,666        836         0         0              0
Operating leases          38,922     13,513      8,873      5,655     4,452     3,220          3,209
Capital leases               461        257         97         61        32        14              0
Deferred
compensation
liability                  2,162      1,811        351          0         0         0              0
Unfunded pension
plan benefit
payments                  16,305      1,572      1,536      1,530     1,601     1,593          8,473
Other long-term
obligations                  791        646         81         64         0         0              0
Total contractual
cash obligations       $ 161,188   $ 35,157   $ 30,979   $ 72,458   $ 6,085   $ 4,827   $     11,682

. . .

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