HARTE HANKS INC - Quarter Report: 2013 March (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

(Mark One)

 

 

For the quarterly period ended March 31, 2013

 

or

 

 

For the transition period from                      to                    

 

Commission File Number 001-7120

 

HARTE-HANKS, INC.

(Exact name of registrant as specified in its charter)

 

 

9601 McAllister Freeway, Suite 610, San Antonio, Texas  78216

(Address of principal executive offices)  (Zip Code)

 

Registrant’s telephone number including area code — 210/829-9000

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer.  See definitions of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act

 

 

Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes  o  No x

 

The number of shares outstanding of each of the registrant’s classes of common stock as of April 15, 2013 was 62,439,311 shares of common stock, all of one class.

 

 

Table of Contents

 

HARTE-HANKS, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

FORM 10-Q REPORT

March 31, 2013

 

		Page
Part I.	Financial Information
Item 1.	Interim Condensed Consolidated Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets - March 31, 2013 and December 31, 2012	3
	Consolidated Statements of Comprehensive Income — Three months ended March 31, 2013 and 2012	4
	Consolidated Statements of Cash Flows - Three months ended March 31, 2013 and 2012	5
	Consolidated Statements of Changes in Equity - Three months ended March 31, 2013 and year ended December 31, 2012	6
	Notes to Unaudited Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24
Item 4.	Controls and Procedures	25
Part II.	Other Information
Item 1.	Legal Proceedings	25
Item 1A.	Risk Factors	26
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	26
Item 6.	Exhibits	26

 

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Item 1.  Interim Condensed Consolidated Financial Statements

Harte-Hanks, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets (in thousands, except share amounts)

 

		March 31,			December 31,
		2013			2012
		(Unaudited)			(Audited)
Assets
Current assets
Cash and cash equivalents		$	61,011		$	49,648
Accounts receivable (less allowance for doubtful accounts of $2,931 at March 31, 2013 and $3,402 at December 31, 2012)		126,579			141,347
Inventory		4,975			5,067
Prepaid expenses		10,854			9,178
Current deferred income tax asset		7,052			8,181
Prepaid income tax		1,583			4,491
Other current assets		10,344			7,588
Total current assets		222,398			225,500
Property, plant and equipment (less accumulated depreciation of $232,170 at March 31, 2013 and $231,167 at December 31, 2012)		57,646			61,971
Goodwill		408,715			408,715
Other intangible assets (less accumulated amortization of $9,596 at March 31, 2013 and $9,541 at December 31, 2012)		5,204			5,259
Other assets		5,018			4,767
Total assets		$	698,981		$	706,212
Liabilities and Stockholders’ Equity
Current liabilities
Current maturities of long-term debt		$	12,250		$	12,250
Accounts payable		41,510			42,187
Accrued payroll and related expenses		13,438			16,777
Deferred revenue and customer advances		35,381			36,924
Income taxes payable		1,987			1,518
Customer postage and program deposits		15,111			19,892
Other current liabilities		8,294			10,649
Total current liabilities		127,971			140,197
Long-term debt		94,938			98,000
Other long-term liabilities (including deferred income taxes of $57,056 at March 31, 2013 and $53,935 at December 31, 2012)		141,593			139,851
Total liabilities		364,502			378,048
Stockholders’ equity
Common stock, $1 par value per share, 250,000,000 shares authorized. 118,956,799 shares issued at March 31, 2013 and 118,737,456 shares issued at December 31, 2012		118,957			118,737
Additional paid-in capital		341,837			341,586
Retained earnings		1,172,619			1,165,952
Less treasury stock: 56,451,821 shares at cost at March 31, 2013 and 56,348,026 shares at cost at December 31, 2012		(1,249,073		)	(1,248,377		)
Accumulated other comprehensive loss		(49,861		)	(49,734		)
Total stockholders’ equity		334,479			328,164
Total liabilities and stockholders’ equity		$	698,981		$	706,212

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

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Harte-Hanks, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (in thousands, except per share amounts)

(Unaudited)

 

		Three Months Ended March 31,
		2013			2012
Operating revenues		$	178,332		$	186,042
Operating expenses
Labor		80,308			83,879
Production and distribution		67,587			67,669
Advertising, selling, general and administrative		15,326			15,313
Depreciation and software amortization		4,882			5,145
Intangible asset amortization		55			60
Total operating expenses		168,158			172,066
Operating income		10,174			13,976
Other expenses (income)
Interest expense		803			1,019
Interest income		(35		)	(29		)
Other, net		(1,218		)	655
Total other expenses (income)		(450		)	1,645
Income from continuing operations before income taxes		10,624			12,331
Income tax expense		3,957			4,896
Income from continuing operations		6,667			7,435
Loss from discontinued operations, net of income taxes		0			(642		)
Net income		$	6,667		$	6,793
Basic earnings (loss) per common share
Continuing operations		$	0.11		$	0.12
Discontinued operations		$	0.00		$	(0.01	)
Basic earnings per common share		$	0.11		$	0.11
Weighted-average common shares outstanding		62,471			62,910
Diluted earnings (loss) per common share
Continuing operations		$	0.11		$	0.12
Discontinued operations		$	0.00		$	(0.01	)
Diluted earnings per common share		$	0.11		$	0.11
Weighted-average common and common equivalent shares outstanding		62,669			63,273
Other comprehensive income (loss), net of tax
Adjustment to pension liability		$	1,003		$	901
Foreign currency translation adjustments		(1,130		)	886
Total other comprehensive income (loss), net of tax		(127		)	1,787
Comprehensive income		$	6,540		$	8,580

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

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Harte-Hanks, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (in thousands)

(Unaudited)

 

		Three Months Ended March 31,
		2013			2012
Cash Flows from Operating Activities
Net income		$	6,667		$	6,793
Adjustments to reconcile net income to net cash provided by operating activities:
Loss from discontinued operations		0			642
Depreciation and software amortization		4,882			5,145
Intangible asset amortization		55			60
Stock-based compensation		1,288			993
Excess tax benefits from stock-based compensation		(5		)	(42		)
Net pension cost		346			506
Deferred income taxes		2,769			3,018
Other, net		(851		)	3
Changes in operating assets and liabilities, net of acquisitions:
Decrease in accounts receivable, net		14,768			22,414
Decrease in inventory		92			475
Increase in prepaid expenses and other current assets		(647		)	(2,215		)
Decrease in accounts payable		(4,462		)	(6,987		)
Decrease in other accrued expenses and other current liabilities		(9,031		)	(17,828		)
Other, net		(945		)	(196		)
Net cash provided by continuing operations		14,926			12,781
Net cash provided by discontinued operations		0			171
Net cash provided by operating activities		14,926			12,952
Cash Flows from Investing Activities
Purchases of property, plant and equipment		(4,631		)	(3,054		)
Proceeds from sale of property, plant and equipment		4,781			8
Net cash provided by (used in) investing activities		150			(3,046		)
Cash Flows from Financing Activities
Repayment of borrowings		(3,062		)	(61,532		)
Issuance of common stock		82			361
Excess tax benefits from stock-based compensation		5			42
Purchase of treasury stock		(436		)	0
Dividends paid		0			(5,405		)
Net cash used in financing activities		(3,411		)	(66,534		)
Effect of exchange rate changes on cash and cash equivalents		(302		)	217
Net increase (decrease) in cash and cash equivalents		11,363			(56,411		)
Cash and cash equivalents at beginning of year		49,648			86,778
Cash and cash equivalents at end of period		$	61,011		$	30,367

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

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Harte-Hanks, Inc. and Subsidiaries

Consolidated Statements of Changes in Equity (in thousands, except per share amounts)

(2013 Unaudited)

 

														Accumulated
					Additional									Other			Total
		Common			Paid-In			Retained			Treasury			Comprehensive			Stockholders’
		Stock			Capital			Earnings			Stock			Income (Loss)			Equity
Balance at December 31, 2011		118,487			341,149			1,276,266			(1,244,224		)	(45,323		)	446,355
Exercise of stock options and release of nonvested shares		250			410			0			(205		)	0			455
Net tax effect of options exercised and release of nonvested shares		0			(3,082		)	0			0			0			(3,082		)
Stock-based compensation		0			3,412			0			0			0			3,412
Dividends paid ($0.43 per share)		0			0			(26,961		)	0			0			(26,961		)
Treasury stock issued		0			(303		)	0			454			0			151
Purchase of treasury stock		0			0			0			(4,402		)	0			(4,402		)
Net loss		0			0			(83,353		)	0			0			(83,353		)
Other comprehensive income		0			0			0			0			(4,411		)	(4,411		)
Balance at December 31, 2012		$	118,737		$	341,586		$	1,165,952		$	(1,248,377	)	$	(49,734	)	$	328,164
Exercise of stock options and release of nonvested shares		220			(138		)	0			(395		)	0			(313		)
Net tax effect of options exercised and release of nonvested shares		0			(801		)	0			0			0			(801		)
Stock-based compensation		0			1,288			0			0			0			1,288
Treasury stock issued		0			(98		)	0			135			0			37
Purchase of treasury stock		0			0			0			(436		)	0			(436		)
Net income		0			0			6,667			0			0			6,667
Other comprehensive income		0			0			0			0			(127		)	(127		)
Balance at March 31, 2013		$	118,957		$	341,837		$	1,172,619		$	(1,249,073	)	$	(49,861	)	$	334,479

 

See Notes to Unaudited Condensed Consolidated Financial Statements.

 

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Harte-Hanks, Inc. and Subsidiaries

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

Note A - Basis of Presentation

 

Consolidation

 

The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of Harte-Hanks, Inc. and its subsidiaries (the “Company”).  All intercompany accounts and transactions have been eliminated in consolidation.

 

As used in this report, the terms “Harte-Hanks,” “we,” “us” or “our” may refer to Harte-Hanks, one or more of its consolidated subsidiaries, or all of them taken as a whole.

 

Interim Financial Information

 

The financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  Operating results for the three months ended March 31, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.  The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2012.

 

Discontinued Operations

 

As discussed in Note M, Discontinued Operations, we sold the assets of our Florida Shoppers operations on December 31, 2012.  The operating results of our Florida Shoppers are being reported as discontinued operations in the Consolidated Financial Statements.  Unless otherwise stated, amounts related to the Florida Shoppers operations are excluded from the Notes to Consolidated Financial Statements for all periods presented.

 

Sale of Belgium Facility

 

In the first quarter of 2013, we sold the facility where our Hasselt, Belgium direct marketing business was located for net proceeds of $4.6 million.  At the time of the sale, the book value of this facility was $3.7 million, and the transaction resulted in a $0.9 million gain.  This gain is included in “Other, net” in the Consolidated Statements of Comprehensive Income.  This direct marketing business now operates in leased space in Hasselt, Belgium.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.  Actual results and outcomes could differ from those estimates and assumptions.  On an ongoing basis management reviews its estimates based on currently available information.  Changes in facts and circumstances could result in revised estimates and assumptions.

 

Operating Expense Presentation in Consolidated Statements of Comprehensive Income

 

“Labor” in the Consolidated Statements of Comprehensive Income includes all employee payroll and benefits, including stock-based compensation, along with temporary labor costs.  “Production and distribution” and “Advertising, selling, general and administrative” do not include labor, depreciation or amortization.

 

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Note B - Recent Accounting Pronouncements

 

In the first quarter of 2013, we adopted Accounting Standards Update (ASU) 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.  ASU 2013-02 addresses the presentation of reclassification adjustments, which was deferred in the initial issuance of ASU 2011-05, Presentation of Comprehensive Income.  ASU 2013-02 requires entities to disclose:

 

·                  For items reclassified out of accumulated other comprehensive income and into net income in their entirety, the effect of the reclassification on each affected net income line item, and

 

·                  For accumulated other comprehensive income reclassification items that are not reclassified in their entirety into net income, a cross reference to other required U.S. GAAP disclosures.

 

In connection with this adoption we have added the required disclosures in Note J, Comprehensive Income.  The adoption of ASU 2013-02 did not affect our operating results, cash flows or financial position.

 

Note C - Fair Value of Financial Instruments

 

ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  ASC 820 also establishes a fair value hierarchy that prioritizes the inputs used in valuation methodologies into three levels:

 

Level 1                        Quoted prices in active markets for identical assets or liabilities.

 

Level 2                        Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3                        Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

Because of their maturities and/or variable interest rates, certain financial instruments have fair values approximating their carrying values.  These instruments include cash and cash equivalents, accounts receivable and trade payables.  The fair value of our outstanding debt is disclosed in Note E, Long-Term Debt.

 

Note D - Goodwill

 

As of March 31, 2013 and December 31, 2012, we had goodwill of $408.7 million.  Under the provisions of FASB ASC 350, Intangibles-Goodwill and Other, goodwill is tested for impairment at least annually, or more frequently if events or circumstances indicate that it is “more likely than not” that goodwill might be impaired.  Such events could include a significant change in business conditions, a significant negative regulatory outcome or other events that could negatively affect our business and financial performance.  We perform our annual goodwill impairment assessment as of November 30th of each year.

 

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Note E - Long-Term Debt

 

Our long-term debt obligations were as follows:

 

		March 31,			December 31,
In thousands		2013			2012
2010 Revolving Credit Facility, various interest rates based on LIBOR, due August 12, 2013 ($60.5 million capacity at March 31, 2013)		0			0
2011 Term Loan Facility, various interest rates based on LIBOR (effective rate of 2.20% at March 31, 2013), due August 16, 2016		107,188			110,250
Total debt		107,188			110,250
Less current maturities		12,250			12,250
Total long-term debt		$	94,938		$	98,000

 

The carrying values and estimated fair values of our outstanding debt were as follows:

 

		March 31,						December 31,
		2013						2012
		Carrying			Fair			Carrying			Fair
In thousands		Value			Value			Value			Value
Total debt		$	107,188		$	107,188		$	110,250		$	110,250

 

The estimated fair values were calculated using current rates provided to us by our bankers for debt of the same remaining maturity and characteristics.  These current rates are considered Level 2 inputs under the fair value hierarchy established by FASB ASC 820, Fair Value Measurements and Disclosures, (ASC 820).

 

Note F - Stock-Based Compensation

 

We recognized $1.3 million and $1.0 million of stock-based compensation during the three months ended March 31, 2013 and 2012, respectively.

 

Our annual grant of stock-based awards occurred in the first quarter of 2013, consistent with the timing of previous annual grants.  All stock-based awards granted in the first quarter of 2013 were granted under the 2005 Omnibus Incentive Plan (2005 Plan).  These grants consisted of:

 

				Weighted-
				Average
		Number		Grant-Date
		of Shares		Fair Value
Stock options		668,600		$	2.09
Non-vested shares		461,210		$	7.73
Performance stock units		183,000		$	7.10

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model.  These options become exercisable in 25% increments on the first, second, third and fourth anniversaries of their date of grant, and expire on the tenth anniversary of their date of grant.  All stock options granted in the first quarter of 2013 have exercise prices equal to the market value of the common stock on the date of grant.  Market value is defined by the 2005 Plan as the closing price on the previous trading day.  The weighted-average exercise price of options granted in the first quarter of 2013 was $7.72.

 

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The fair value of each non-vested share is estimated on the date of grant as the closing market price of our common stock on the date of grant.  All non-vested shares granted in the first quarter of 2013 vest in three equal increments on the first, second and third anniversaries of their date of grant.

 

The fair value of each performance stock unit is estimated on the date of grant as the closing market price of our common stock on the date of grant, minus the present value of anticipated dividend payments.  Performance stock units are a form of share-based awards similar to non-vested shares, except that the number of shares ultimately issued is based on our performance against specific performance goals over a three-year period.  At the end of the performance period, the number of shares of stock issued will be determined by adjusting upward or downward from the maximum in a range between 0% and 100%.

 

Note G - Components of Net Periodic Pension Benefit Cost

 

Prior to January 1, 1999, we maintained a defined benefit pension plan for which most of our employees were eligible.  We elected to freeze benefits under this defined benefit pension plan as of December 31, 1998.

 

In 1994, we adopted a non-qualified, unfunded, supplemental pension plan covering certain employees, which provides for incremental pension payments so that total pension payments equal those amounts that would have been payable from our principal pension plan if it were not for limitations imposed by income tax regulations.  The benefits under this supplemental pension plan continue to accrue as if the principal pension plan had not been frozen.

 

Net pension cost for both plans included the following components:

 

		Three Months Ended March 31,
In thousands		2013			2012
Service cost		$	86		$	117
Interest cost		1,809			1,960
Expected return on plan assets		(1,846		)	(1,683		)
Amortization of prior service cost		0			1
Recognized actuarial loss		1,672			1,500
Net periodic benefit cost		$	1,721		$	1,895

 

We made contributions to our funded, frozen pension plan of $1.0 million in the first quarter of 2013.  We plan to make additional contributions of $3.6 million to this pension plan during the remainder of 2013.  These contributions to our funded, frozen pension plan are being made in order to obtain the Pension Protection Act of 2006 full funding limit exemption.

 

We are not required to make and do not intend to make any contributions to our unfunded, supplemental pension plan in 2013 other than to the extent needed to cover benefit payments.  We expect benefit payments under this supplemental pension plan to total $1.4 million in 2013.

 

Note H - Income Taxes

 

Our first quarter 2013 income tax expense of $4.0 million resulted in an effective income tax rate of 37.2%.  Our first quarter 2012 income tax provision of $4.9 million resulted in an effective income tax rate of 39.7%.  Our effective income tax rate is derived by estimating pretax income and income tax expense for the year ending December 31, 2013.  The effective income tax rate calculated for the first quarter of 2013 is higher than the federal statutory rate of 35.0%, primarily due to the addition of state income taxes.

 

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Harte-Hanks, or one of our subsidiaries, files income tax returns in the U.S. federal, U.S. state and foreign jurisdictions.  For U.S. state and foreign returns, we are no longer subject to tax examinations for tax years prior to 2008.  For U.S. federal returns, we are no longer subject to tax examinations for tax years prior to 2009.

 

We have elected to classify any interest expense and penalties related to income taxes within income tax expense in our Consolidated Statements of Comprehensive Income.  We did not have a significant amount of interest or penalties accrued at March 31, 2013 or December 31, 2012.

 

Note I - Earnings Per Share

 

Basic earnings per share is computed on the basis of the weighted average number of shares of common stock outstanding during the period.  Diluted earnings per share is computed on the basis of the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method.  Dilutive potential common shares include outstanding stock options and non-vested shares.

 

Reconciliations of basic and diluted earnings per share (EPS) are as follows:

 

		Three Months Ended March 31,
In thousands, except per share amounts		2013			2012
Net Income
Income from continuing operations		$	6,667		$	7,435
Loss from discontinued operations		0			(642		)
Net income		$	6,667		$	6,793
Basic EPS
Weighted-average common shares outstanding used in earnings per share computations		62,471			62,910
Basic earnings (loss) per share
Continuing operations		$	0.11		$	0.12
Discontinued operations		0.00			(0.01		)
Net income		$	0.11		$	0.11
Diluted EPS
Shares used in diluted earnings per share computations		62,669			63,273
Diluted earnings per common share
Continuing operations		$	0.11		$	0.12
Discontinued operations		0.00			(0.01		)
Net income		$	0.11		$	0.11
Computation of Shares Used in Earnings Per Share Computations
Weighted-average common shares outstanding		62,471			62,910
Weighted-average common equivalent shares - dilutive effect of stock options and awards		198			363
Shares used in diluted earnings per share computations		62,669			63,273

 

4.4 million and 5.1 million anti-dilutive market price options have been excluded from the calculation of shares used in the diluted EPS calculation for the three months ended March 31, 2013 and 2012, respectively.  0.4 million and 0.2 million anti-dilutive non-vested shares have been excluded from the calculation of shares used in

 

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the diluted EPS calculation for the three months ended March 31, 2013 and 2012, respectively.

 

Note J – Comprehensive Income

 

Comprehensive income for a period encompasses net income and all other changes in equity other than from transactions with our stockholders.  Our comprehensive income was as follows:

 

		Three Months Ended March 31,
In thousands		2013			2012
Net income		$	6,667		$	6,793
Other comprehensive income:
Adjustment to pension liability		1,672			1,501
Tax expense		(669		)	(600		)
Adjustment to pension liability, net of tax		1,003			901
Foreign currency translation adjustment		(1,130		)	886
Total other comprehensive income (loss), net of tax		(127		)	1,787
Total comprehensive income		$	6,540		$	8,580

 

Changes in accumulated other comprehensive income by component are as follows:

 

		Defined
		Benefit			Foreign
		Pension			Currency
In thousands		Items			Items			Total
Balance at December 31, 2012		$	(54,431	)	$	4,697		$	(49,734	)
Other comprehensive loss, net of tax, before reclassifications		0			(1,130		)	(1,130		)
Amounts reclassified from accumulated other comprehensive income, net of tax		1,003			0			1,003
Net current period other comprehensive income (loss), net of tax		1,003			(1,130		)	(127		)
Balance at March 31, 2013		$	(53,428	)	$	3,567		$	(49,861	)

 

		Defined
		Benefit			Foreign
		Pension			Currency
In thousands		Items			Items			Total
Balance at December 31, 2011		$	(48,705	)	$	3,382		$	(45,323	)
Other comprehensive income, net of tax before reclassifications		0			886			886
Amounts reclassified from accumulated other comprehensive income, net of tax		901			0			901
Net current period other comprehensive income, net of tax		901			886			1,787
Balance at March 31, 2012		$	(47,804	)	$	4,268		$	(43,536	)

 

Reclassification amounts related to the defined pension plans are included in the computation of net period pension benefit cost (see Note G, Components of Net Periodic Pension Benefit Cost).

 

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Note K – Litigation Contingencies

 

In the normal course of our business, we are obligated under some agreements to indemnify our clients as a result of claims that we infringe on the proprietary rights of third parties.  The terms and duration of these commitments vary and, in some cases, may be indefinite, and certain of these commitments do not limit the maximum amount of future payments we could become obligated to make there under; accordingly, our actual aggregate maximum exposure related to these types of commitments cannot be reasonably estimated.  Historically, we have not been obligated to make significant payments for obligations of this nature, and no liabilities have been recorded for these obligations in our financial statements.

 

We are also currently subject to various other legal proceedings in the course of conducting our businesses and, from time to time, we may become involved in additional claims and lawsuits incidental to our businesses.  In the opinion of management, after consultation with counsel, none of these matters is currently considered to be reasonably possible of resulting in a material adverse effect on our consolidated financial position or results of operations.  Nevertheless, we cannot predict the impact of future developments affecting our pending or future claims and lawsuits and any resolution of a claim or lawsuit within a particular fiscal quarter may adversely impact our results of operations for that quarter.  We expense legal costs as incurred, and all recorded legal liabilities are adjusted as required as better information becomes available to us. The factors we consider when recording an accrual for contingencies include, among others: (i) the opinions and views of our legal counsel; (ii) our previous experience; and (iii) the decision of our management as to how we intend to respond to the complaints.

 

Note L – Business Segments

 

Harte-Hanks is a worldwide, direct and targeted marketing company with operations in two segments — Direct Marketing and Shoppers.

 

Information about the operations of our two business segments follows:

 

		Three Months Ended March 31,
In thousands		2013			2012
Operating revenues
Direct Marketing		$	132,352		$	139,456
Shoppers		45,980			46,586
Total operating revenues		$	178,332		$	186,042
Operating income
Direct Marketing		$	12,822		$	15,653
Shoppers		770			1,245
Corporate Activities		(3,418		)	(2,922		)
Total operating income		$	10,174		$	13,976
Income from continuing operations before income taxes
Operating income		$	10,174		$	13,976
Interest expense		(803		)	(1,019		)
Interest income		35			29
Other, net		1,218			(655		)
Total income from continuing operations before income taxes		$	10,624		$	12,331

 

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Note M – Discontinued Operations

 

We sold the assets of our Florida Shoppers operations to Coda Media Corp. on December 31, 2012.  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.

 

Summarized operating results for the Florida Shoppers discontinued operations are as follows:

 

		Three Months Ended March 31,
In thousands		2013			2012
Revenues		$	0		$	9,130
Loss from discontinued operations before income taxes		0			(1,045		)
Income tax benefit		0			403
Loss from discontinued operations		$	0		$	(642	)

 

The major components of cash flows for the Florida Shoppers discontinued operations are as follows;

 

		Three Months Ended March 31,
In thousands		2013			2012
Loss from discontinued operations		$	0		$	(642	)
Depreciation and software amortization		0			192
Intangible asset amortization		0			143
Other, net		0			478
Net cash provided by discontinued operations		$	0		$	171

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Cautionary Note Regarding 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 this cautionary note, which is provided pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Forward-looking statements may also be included in our other public filings, press releases, our website and oral and written presentations by management.  Statements other than historical facts are forward-looking and may be identified by words such as “may,” “will,” “expects,” “believes,” “anticipates,” “plans,” “estimates,” “seeks,” “could,” “intends,” or words of similar meaning.  Examples include statements regarding (1) our strategies and initiatives, (2) adjustments to our cost structure and other actions designed to respond to market conditions and improve our performance, and the anticipated effectiveness and expenses associated with these actions, (3) our financial outlook for revenues, earnings per share, operating income, expense related to equity-based compensation, capital resources and other financial items, (4) expectations for our businesses and for the industries in which we operate, including with regard to the negative performance trends in our Shoppers business and the adverse impact of continuing economic uncertainty in the United States and other economies on the marketing expenditures and activities of our Direct Marketing clients and prospects, (5) competitive factors, (6) acquisition, disposition of assets and development plans, (7) our stock repurchase program, (8) expectations

 

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regarding legal proceedings and other contingent liabilities, and (9) other statements regarding future events, conditions or outcomes.

 

These forward-looking statements are based on current information, expectations and estimates and involve risks, uncertainties, assumptions and other factors that are difficult to predict and that could cause actual results to vary materially from what is expressed in or indicated by the forward-looking statements.  In that event, our business, financial condition, results of operations or liquidity could be materially adversely affected and investors in our securities could lose part or all of their investments. Some of these risks, uncertainties, assumptions and other factors can be found in our filings with the Securities and Exchange Commission, including the factors discussed under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2012 (2012 Form 10-K) and in the “Cautionary Note Regarding Forward-Looking Statements” in our first quarter 2013 earnings release issued on April 25, 2013.  The forward-looking statements included in this report and those included in our other public filings, press releases, our website and oral and written presentations by management are made only as of the respective dates thereof, and we undertake no obligation to update publicly any forward-looking statement in this report or in other documents, our website or oral statements for any reason, even if new information becomes available or other events occur in the future.

 

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 contained elsewhere in this report and our MD&A section, financial statements and accompanying notes to financial statements in our 2012 Form 10-K.  Our 2012 Form 10-K contains a discussion of other matters not included herein, such as disclosures regarding critical accounting policies and estimates, and contractual obligations.

 

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, which operates both nationally and internationally, and Shoppers, which operates in certain California markets.

 

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.

 

Revenues from the Direct Marketing segment represented approximately 74% of our total revenues for the three months ended March 31, 2013.

 

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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 March 31, 2013, we were publishing approximately 5,600 PowerSites weekly.

 

On December 31, 2012 we sold the assets of our Florida Shoppers operations, The Flyer®.  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.

 

At March 31, 2013 our Shoppers publications were zoned into approximately 780 separate editions with total circulation of approximately 9.1 million shopper packages in California each week.  Our distribution products can be zoned even tighter, into approximately 2,400 subzones.  Shoppers are delivered in six major markets each week, covering Southern, Central and Northern California.

 

Revenues from the Shoppers segment represented approximately 26% of our total revenues for the three months ended March 31, 2013.

 

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.

 

Our Shoppers business operates in regional markets in California and is greatly affected by the strength of the state and local economies.  Revenues from our Shoppers business are largely dependent on local advertising expenditures in the areas of California in which we operate.  During the first quarter of 2013, the poor economic conditions that we have experienced since the second half of 2007 in California 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.  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

 

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number of unprofitable digital initiatives, including SaverTime and mobile apps.  We are in the process of consolidating our production facilities from four plants to three plants and we expect to close our production facility in Northern California in mid 2013.  We continue to invest in online offerings, particularly our PowerSites, which 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.

 

Results of Continuing Operations

 

As discussed in Note M, Discontinued Operations, we sold the assets of our Florida Shoppers operations on December 31, 2012.  Therefore, the operating results of our Florida Shoppers, 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 our continuing operations, direct marketing and California shoppers, were as follows:

 

In thousands, except		Three months ended
per share amounts		March 31, 2013			March 31, 2012			Change
Revenues		$	178,332		$	186,042		-4.1	%
Operating expenses		168,158			172,066			-2.3	%
Operating income		$	10,174		$	13,976		-27.2	%
Income from continuing operations		$	6,667		$	7,435		-10.3	%
Diluted earnings per share from continuing operations		$	0.11		$	0.12		-8.3	%

 

1st Quarter 2013 vs. 1st Quarter 2012

 

Revenues

 

Consolidated revenues decreased 4.1%, to $178.3 million, in the first quarter of 2013 compared to the first quarter of 2012 due to decreased revenues of $7.1 million, or 5.1%, from our Direct Marketing segment and decreased revenues of $0.6 million, or 1.3%, from our Shoppers segment.  Direct Marketing results reflect the impact of a 32% decline in revenues from the pharmaceutical vertical, including the effect of volume reductions from a long standing customer beginning in the second quarter of 2012, and the loss of another long standing customer in the third quarter of 2012.  Direct Marketing experienced decreased revenues from our pharmaceutical, automotive and consumer brands, select and high-tech verticals, and increased revenues from our financial and retail verticals compared to the prior year quarter.  Shoppers revenue performance reflects decreased in-book advertising, partially offset by increased revenues from distribution products.  From an industry perspective, Shoppers revenues decreased from the services, automotive, real estate and communications sectors, and increased from the consumer spending sector.

 

Operating Expenses

 

Overall operating expenses decreased 2.3%, to $168.2 million, in the first quarter of 2013 compared to the first quarter of 2012.  This $3.9 million decrease was driven by decreased operating expenses in Direct Marketing of $4.3 million, or 3.5%, and decreased operating expenses of $0.1 million, or 0.3%, in Shoppers, partially offset by an increase in general corporate expense of $0.5 million, or 17.0%.  The decrease at Direct Marketing was primarily due to reductions in temporary labor, as a result of revenue performance, decreased mail supply chain costs resulting from decreased volumes, and decreased bad debt expense.  The overall decrease at Direct Marketing was partially offset by increased outsourced costs resulting from increased outsourced volumes, and increased promotion expense.  The decrease at Shoppers was due to lower payroll costs from lower ad sales and headcount reductions, decreases in newsprint and job paper expenses due to declines in volumes, and lower

 

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service fees related to our web products.  The overall decrease at Shoppers was partially offset by an increase in offload printing costs due to an increase in heatset volumes, an increase in outsourced costs due to increased outsourced volumes, and an increase in postage costs resulting from the January 2013 postage rate increase.

 

Income/Earnings Per Share from Continuing Operations

 

Income from continuing operations decreased 10.3%, to $6.7 million, and diluted earnings per share from continuing operations decreased 8.3%, to $0.11 per share, in the first quarter of 2013 when compared to the first quarter of 2012.  The decrease in income from continuing operations was a result of decreased operating income from both Direct Marketing and Shoppers, and increased general corporate expense.  This decrease was partially offset by a gain on the sale of our facility in Belgium, changes in net foreign currency transaction gains and losses and a lower effective tax rate.

 

Direct Marketing

 

Direct Marketing operating results were as follows:

 

In thousands, except		Three months ended
per share amounts		March 31, 2013			March 31, 2012			Change
Revenues		$	132,352		$	139,456		-5.1	%
Operating expenses		119,530			123,803			-3.5	%
Operating income		$	12,822		$	15,653		-18.1	%

 

1st Quarter 2013 vs. 1st Quarter 2012

 

Revenues

 

Direct Marketing revenues decreased $7.1 million, or 5.1%, in the first quarter of 2013 compared to the first quarter of 2012.  Revenues from our pharmaceutical vertical decreased 32% compared to 2012, reflecting the effect of volume reductions from a 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 automotive and consumer brands vertical experienced a 12% revenue decline, our select vertical declined 11% and our high-tech vertical declined 7%.  Our financial vertical increased 19% and our retail vertical increased 1%.  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.

 

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

 

Operating expenses decreased $4.3 million, or 3.5%, in the first quarter of 2013 compared to the first quarter of 2012.  Labor costs decreased $2.4 million, or 3.6%, primarily due to a reduction in temporary labor as a result of revenue performance.  Production and distribution costs decreased $1.6 million, or 4.0%, due to decreased mail supply chain costs resulting from decreased volumes, partially offset by increased outsourced costs resulting from increased outsourced volumes.  General and administrative expense decreased $0.2 million, or 1.8%, due primarily to decreased bad debt expense, partially offset by an increase in promotion expense.  Depreciation and software amortization expense and intangible asset amortization each decreased slightly compared to the prior year quarter.

 

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