Harte Hanks, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Financial statements are unaudited. Unless noted otherwise, amounts below are in millions. Continuing operations are principally Customer Interaction services; Trillium Software is presented as discontinued operations and held for sale.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Continuing-operations revenue | $97.4 | $108.8 | $294.3 | $327.3 |
| Continuing-operations operating loss | $(4.6) | $(209.6) | $(20.8) | $(206.9) |
| Operating margin | (4.7)% | (192.7)% | (7.1)% | (63.2)% |
| Continuing-operations net loss | $(4.3) | $(172.9) | $(16.9) | $(180.0) |
| Consolidated net loss | $(3.0) | $(170.9) | $(12.9) | $(173.5) |
| Diluted loss per share, continuing operations | $(0.07) | $(2.80) | $(0.27) | $(2.91) |
Q3 discontinued operations contributed $1.2 million of net income; nine-month contribution was $4.0 million. These figures include Trillium, whose revenue was $11.7 million in Q3 and $35.6 million in the first nine months.
- Cash flow: Nine-month operating cash flow was $26.5 million ($21.8 million from continuing operations); investing cash use was $12.5 million and financing cash use was $21.8 million. Cash declined $9.7 million from year-end to $6.9 million.
- Liquidity and debt: At September 30, cash was $6.9 million, unused revolver capacity was $7.9 million, and debt was $61.2 million, all classified as current. Total current assets were $267.9 million and current liabilities $155.2 million; these totals include Trillium assets and liabilities held for sale.
- Debt terms: The secured facilities comprise a $65 million revolving facility and a $45 million term loan, secured by substantially all company assets. Outstanding balances were $19.9 million on the revolver and $43.1 million on the term loan. The term loan’s reported effective rate was 10.72%; the revolver’s was 6.00%.
- Other balance-sheet items: Pension liabilities were $53.7 million and 3Q Digital contingent consideration was $21.8 million. Stockholders’ equity was $122.6 million.
Material changes versus the prior comparable period
- Continuing revenue fell 10.4% in Q3 and 10.1% for the first nine months. Management cited client losses and reduced marketing spending, particularly in healthcare and pharmaceuticals, retail, and technology.
- Operating losses were substantially smaller than in 2015 largely because the prior-year periods included a $209.9 million goodwill impairment charge. The 2016 results remained loss-making; the improvement should not be read as an equivalent improvement in underlying operating performance.
- Production and distribution costs fell 20.0% in Q3 and 19.4% year to date, mainly from lower outsourced-services and mail-supply-chain costs. Year-to-date labor expense rose 5.0%; general and administrative expense rose 7.0%, including higher legal settlement costs.
- Trillium revenue declined 11.4% in Q3 and 7.0% year to date. Its operating margin was 34.1% in Q3 and 28.3% year to date.
- Year-to-date dividends were $0.09 per share versus $0.26 in 2015. The company said it did not anticipate share repurchases for the foreseeable future after entering the new credit facilities.
Outlook, risks, contingencies, and unusual items
- Credit covenant breaches: At September 30, the fixed-charge coverage ratio was 0.6:1 versus a 1.1:1 minimum, and leverage was 2.40:1 versus a 2.25:1 maximum. A November 8, 2016 waiver, after quarter-end, waived those period-end violations. The company must meet covenants after the waiver expires and said it intends to seek another waiver if needed. Debt was classified as current because management did not consider future covenant compliance within 12 months probable at the balance-sheet date.
- Liquidity and going concern: Management believed cash, operating cash flow, and available revolver capacity would fund planned operations, capital expenditures, and debt service, subject to financing availability. It also stated continued operations depend on generating cash flow or obtaining additional liquidity; if planned cost reductions do not deliver, current resources may be insufficient for at least 12 months without additional financing, which may not be available on favorable terms or at all.
- Trillium sale: The company was actively marketing Trillium and expected a sale within one year, but said there was no assurance of acceptable terms or completion. Proceeds from a disposal must be applied to repay secured debt. Trillium represented about 10% of total revenue in the periods presented.
- Cost and operating risks: Management described cost-reduction efforts and investment in its multichannel strategy, but provided no quantified earnings or revenue guidance. Marketing budgets are discretionary, and management warned that a lasting economic downturn could materially harm results. Mail-supply-chain rate increases may affect costs and demand.
- Unusual items and contingencies: Q3 continuing results included approximately $1.4 million of labor expense related to severance and other compensation and a $1.6 million legal settlement charge. Management said pending legal matters were not then considered reasonably likely to have a material adverse effect, while noting outcomes are uncertain. No goodwill impairment trigger was identified in Q3; future triggering events could result in impairment.
Important facts for investors to verify
- Read the November 8 credit waiver and subsequent disclosures for its duration, revised requirements, and consequences if covenants are missed again.
- Track cash generation, revolver availability, debt repayment obligations, and whether management secures additional liquidity; the company reported covenant noncompliance and conditional going-concern liquidity.
- Verify progress and terms of a potential Trillium sale, including the required debt repayment and the effect of the disposal on continuing operations.
- Assess whether continuing revenue declines and cost reductions change operating performance, rather than relying on comparisons distorted by the 2015 goodwill impairment.
- Monitor the $21.8 million contingent consideration liability, pension obligations, and legal exposures; the filing does not provide a clear estimate of maximum exposure for certain client-indemnification commitments.