Harte-Hanks, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Unaudited consolidated results; comparisons are to the same 2013 periods. Shoppers was sold in September 2013 and is reported as discontinued operations, so continuing-operations comparisons exclude it.
Business context
Harte-Hanks provides multichannel marketing services through Customer Interaction (about 90% of revenue) and data-quality software and services through Trillium Software (about 10%). In Q2 2014, the company reorganized around these two reportable segments as part of a new strategy to optimize its operating structure.
Key financial metrics
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $134.1 million | $135.0 million | $407.2 million | $407.4 million |
| Operating income | $10.5 million | $8.4 million | $26.1 million | $30.2 million |
| Operating margin | 7.9% | 6.2% | 6.4% | 7.4% |
| Continuing-operations income | $6.4 million | $4.5 million | $13.9 million | $17.7 million |
| Diluted continuing-operations EPS | $0.10 | $0.07 | $0.22 | $0.28 |
| Net income | $6.4 million | $(8.2) million | $13.9 million | $6.8 million |
| Cash from operating activities | Not separately reported | Not separately reported | $18.0 million | $34.7 million |
Q3 operating income rose 26.1%, despite slightly lower revenue, mainly because operating expenses fell 2.4%. For the first nine months, operating income fell 13.5% as expenses increased 1.0% while revenue was nearly flat. Q3 net income in 2013 included a $12.6 million after-tax loss from discontinued operations; nine-month 2013 net income included a $10.9 million discontinued-operations loss.
Segments: Q3 Customer Interaction revenue was $121.1 million, down 0.2%, while operating income increased to $7.6 million from $5.6 million. Trillium revenue was $13.0 million, down 4.3%, and operating income declined to $3.3 million from $3.9 million. For the nine months, Customer Interaction revenue was down 0.2% and operating income down 17.1%; Trillium revenue increased 1.3% but operating income fell 11.9%.
Balance sheet and liquidity: At September 30, cash was $67.2 million, down from $88.7 million at year-end 2013. Total debt was $87.3 million, down from $98.0 million; all was outstanding under the term loan, with no revolver borrowings. Current assets were $201.2 million and current liabilities $117.9 million. Stockholders’ equity was $344.6 million.
Cash uses: Nine-month investing cash outflow was $6.2 million, including $6.8 million of capital expenditures. Financing cash outflow was $32.5 million, including $10.7 million of debt repayments, $16.2 million of dividends, and $5.4 million of treasury-stock purchases. Operating cash flow fell from $34.7 million, with the filing citing working-capital changes and lower earnings excluding the prior-year sale loss. Days sales outstanding increased to about 73 from 71 at year-end.
Margins and taxes: Q3 effective tax rate was 38.7%; the nine-month rate was 39.4%, primarily reflecting state taxes. Nine-month 2013 benefited from tax-accrual reductions and tax credits. Interest expense declined year over year as scheduled term-loan principal payments reduced average debt.
Material changes and unusual items
- Retail-market revenue was a notable weakness: down $5.0 million, or 13.1%, in Q3, primarily due to lower department-store and specialty-client direct-mail work. Financial services and select markets partly offset the decline.
- Nine-month select-markets growth included non-recurring streaming enrollment services under a large contact-center contract. Management also cited growth in auto/consumer brands and healthcare, while retail remained weaker.
- 2013 comparisons include a $2.75 million Aberdeen intangible-asset impairment in Q3 and, for the nine months, a $0.9 million gain on sale of a Belgium facility. No impairment charge was recorded in 2014.
- Q3 2014 other income included a foreign-currency transaction gain; the filing reports a $0.4 million pretax currency transaction loss for the quarter elsewhere in its market-risk discussion. Nine-month other expense was $1.2 million, versus $0.6 million of other income in 2013, reflecting currency movements and the prior-year Belgium gain.
- The company froze its unfunded supplemental pension plan effective April 1, 2014. Management said this reduced the projected benefit obligation by $1.2 million and is expected to lower remaining-2014 plan expense by $0.4 million. It contributed $4.4 million to its funded frozen pension plan through September and planned no further 2014 contributions.
Outlook, risks and contingencies
No numerical revenue or earnings guidance is provided. Management believes cash on hand, operating cash flow, and available revolver capacity will be sufficient for operations, expected capital spending, debt service, dividends, and pension contributions over the next 12 months. At September 30, unused revolver capacity was $72.8 million; the facility matures August 16, 2016.
The company was in compliance with its credit covenants, including minimum interest coverage of 2.75 to 1 and maximum total debt-to-EBITDA of 2.25 to 1. Management cautioned that a prolonged recession could materially harm results and liquidity. Marketing budgets are discretionary; revenue also depends on client demand, customer retention and acquisition, and industry conditions. Other risks include rising mail-supply-chain costs, foreign-exchange movements, variable interest rates, and potential future goodwill impairment. Goodwill was $398.2 million; a Step 0 assessment found no impairment indication at September 30, but the company continues to monitor triggers.
Management considers pending legal matters unlikely to have a material adverse effect, but certain client indemnification commitments have no stated maximum exposure and cannot be reasonably estimated. Disclosure controls were judged effective at the reasonable-assurance level, and no material change in internal control over financial reporting was reported. Management said there were no material changes to the risk factors disclosed in the 2013 Form 10-K.
Important facts for investors to verify
- Whether retail-client losses continue and whether growth in other verticals can offset them, especially as some select-markets revenue was non-recurring.
- Whether cost actions and the new two-segment strategy improve sustained operating performance, particularly in Customer Interaction and Trillium.
- Cash conversion and working-capital trends, including the decline in operating cash flow and increase in days sales outstanding.
- Debt repayment capacity, covenant headroom, revolver availability, and the sustainability of dividends and share repurchases.
- Potential goodwill impairment, currency exposure, mail-supply-chain cost pressures, and the effect of economic conditions on clients’ marketing spending.
- The filing reports both a Q3 currency transaction gain in the MD&A and a $0.4 million pretax currency transaction loss in market-risk disclosure; verify the detailed reconciliation in the company’s filing.