HARTE HANKS INC quarterly report, Q2 FY2016

Harte Hanks, Inc. — Q2 2016 Form 10-Q

Reporting period: Three and six months ended June 30, 2016. Unaudited results are presented for continuing operations separately from Trillium Software, which was classified as discontinued operations and held for sale.

Financial performance and position

Metric	Q2 2016	Q2 2015	Six months 2016	Six months 2015
Continuing-operations revenue	$97.3 million	$109.2 million	$196.9 million	$218.5 million
Operating income (loss), continuing operations	$(7.2) million	$3.0 million	$(16.2) million	$2.8 million
Operating margin, continuing operations	(7.4)%	2.8%	(8.2)%	1.3%
Net income (loss), including discontinued operations	$(4.3) million	$(4.2) million	$(9.9) million	$(2.6) million
Diluted loss per share, continuing operations	$(0.11)	$(0.11)	$(0.23)	$(0.11)

Q2 continuing-operations revenue fell 10.9%; first-half revenue fell 9.9%. Operating expenses declined only 1.5% in Q2 and 1.2% for the half, so the revenue decline was accompanied by a sharp deterioration in operating results.
Q2 continuing-operations loss was $6.9 million versus $6.7 million a year earlier; first-half loss was $13.9 million versus $7.1 million. Higher interest expense and lower revenue weighed on results.
Cash and cash equivalents were $12.9 million at June 30, down from $16.6 million at year-end 2015. Six-month operating cash flow was $21.8 million, including $16.7 million from continuing operations; investing cash use was $10.9 million and financing cash use was $13.1 million.
Debt totaled $69.7 million: $27.5 million drawn on the revolving facility and $44.3 million on the term loan, net of debt discount and issuance costs. Because of covenant issues, the full balance was classified as current. The company reported $10.4 million of unused revolver capacity.
Current assets were $274.6 million and current liabilities $159.0 million; both include amounts classified as held for sale. Assets held for sale totaled $169.0 million and related liabilities $23.7 million.
Trillium’s Q2 revenue was $12.7 million and net income was $2.6 million, compared with $13.2 million and $2.5 million, respectively, a year earlier. Its operating margin declined to 27.0% from 38.1%.

Material changes and management commentary

Continuing-operations revenue weakness was attributed to lost clients, reduced client marketing spending, and the sale of the B2B research business. Q2 declines were particularly notable in healthcare and pharmaceuticals, retail, financial services, and select markets.
Labor costs rose, reflecting severance and non-recurring database-development expense. Lower outsourced services and job-production costs reduced production and distribution expense, partly offsetting those increases.
On June 7, the company announced it was exploring strategic alternatives for Trillium, began marketing the business, and expected a sale within one year. Management said a divestiture would allow greater focus on Customer Interaction services.
Management said cash, operating cash flow, and available revolver capacity were expected to fund operations, planned capital expenditures, and debt service, subject to facility terms and the ability to extend or replace financing. No specific earnings or revenue guidance was provided.

Credit risks, contingencies, and unusual items

The company failed its fixed-charge coverage and leverage covenants for the period ending April 30, 2016. An August 5, 2016 amendment waived the relevant covenant violations through September 30, 2016, replaced those tests temporarily with minimum adjusted EBITDA requirements that rise over time, and increased applicable interest rates by 1 percentage point effective May 31.
The filing says it is not probable the company can cure all defaults by meeting future covenants within 12 months; absent the amendment, the lender could have called the debt. The company therefore classified all secured debt as current. The facilities are secured by substantially all company assets and contain restrictions, including on dividends and share repurchases.
Management anticipated no dividends or stock repurchases for the foreseeable future. Q2 dividends were zero per share, compared with $0.09 in Q2 2015; first-half declared dividends were $0.09 per share versus $0.17.
The filing gives inconsistent April leverage-ratio figures: the debt note reports 2.28 against a 2.25 maximum, while MD&A reports 2.15 against the same limit. Investors should verify the correct calculation.
Management identified a goodwill impairment trigger due to continued revenue declines and a sustained stock-price decline, but its interim tests found no impairment. Future events could require further testing and potentially an impairment charge.
The company disclosed ordinary-course legal matters and client indemnification obligations; management did not consider pending matters reasonably likely to materially adversely affect results or financial position. It stated that maximum exposure under certain indemnities could not be reasonably estimated.
Variable-rate debt and foreign currency movements create market exposure. The company reported no interest-rate or foreign-currency hedges; a one-percentage-point change in borrowing rates was estimated to affect Q2 net income by approximately $0.1 million.

Key facts for investors to verify

Compliance with the amended credit agreement’s monthly adjusted EBITDA requirements, availability under the borrowing base, and any further lender waivers or amendments.
The company’s ability to generate sufficient cash and maintain financing access, given declining revenue, current debt classification, and covenant-related restrictions.
Progress, terms, and timing of a potential Trillium sale, including the effect of proceeds on debt and future continuing results.
The conflicting leverage-ratio disclosures and the assumptions underlying goodwill impairment tests.
Whether client losses, reduced marketing budgets, cost actions, and severance expenses continue to affect revenue and margins.