HHS

Harte-Hanks, Inc. 10-Q Summary

Business Context and Reporting Period

This filing is a Quarterly Report (Form 10-Q) for Harte-Hanks, Inc., a worldwide direct and targeted marketing company, for the period ended September 30, 2007. The company operates through two primary segments: Direct Marketing (data management, analytics, and program execution) and Shoppers (owner and operator of weekly advertising publications in California and Florida).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Consolidated revenues decreased 2.7% in Q3 and 1.3% year-to-date (YTD) compared to 2006. The Shoppers segment drove this decline with a 12.6% revenue drop in Q3 due to challenging real estate markets in California and Florida, circulation reductions, and the discontinuation of commercial printing in Tampa. The Direct Marketing segment grew 4.1% in Q3, offsetting some of the Shoppers decline.
• Profitability Pressure: Operating income fell 10.3% in Q3 and 13.3% YTD. Net income decreased 20.9% in Q3 and 20.2% YTD. Margins were compressed by higher labor costs in Direct Marketing and significant restructuring expenses.
• Restructuring Costs: The company incurred $4.6 million in restructuring and transition costs in Q3 and over $7.0 million YTD. These costs relate to flattening the organizational structure in Direct Marketing and consolidating Shoppers operating units to reduce fixed costs.
• Interest Expense: Interest expense surged 125.3% in Q3 and 186.4% YTD due to higher debt levels (used for acquisitions and stock buybacks) and rising interest rates.
• Executive Transition: The retirement of CEO Richard Hochhauser resulted in $0.8 million of accelerated stock-based compensation expense in Q3.

Outlook, Risks, and Management Commentary

• Restructuring Impact: Management expects restructuring costs to exceed benefits in 2007 but anticipates a $14 million reduction in the cost base for 2008.
• Shoppers Outlook: The difficult economic environment in real estate and financing markets is expected to continue impacting the Shoppers segment into at least the first part of 2008. The company reduced unprofitable circulation by 600,000 units in June 2007.
• Liquidity: The company maintains $100 million of unused capacity under its Revolving Credit Facility. Management believes current cash and operating cash flows are sufficient to fund operations and capital expenditures for the next 12 months.
• Interest Rate Risk: To mitigate variable rate exposure, the company entered a $150 million interest rate swap in September 2007 to fix rates on a portion of its debt.
• Tax Rate: The effective tax rate for the first nine months of 2007 was 39.6%, higher than the prior year due to the absence of favorable state tax resolutions and manufacturing deductions present in 2006.

Investor Verification Checklist

• Shoppers Segment Recovery: Verify if the circulation reductions and cost-cutting measures in the Shoppers segment are stabilizing revenue trends given the ongoing real estate market weakness.
• Restructuring ROI: Monitor the realization of the projected $14 million annual cost savings in 2008 to ensure the 2007 restructuring expenses yield the intended margin improvement.
• Debt Service Capacity: Assess the impact of rising interest rates on future earnings, noting the significant increase in interest expense despite the new interest rate swap.
• Direct Marketing Growth: Confirm if the growth in the Direct Marketing segment (specifically high-tech/telecom) can continue to offset the structural decline in the Shoppers business.
• CEO Succession: Evaluate the impact of the CEO transition on strategic execution and the integration of the new leadership team.