HHS

Harte-Hanks, Inc. 10-Q Summary

Business Context and Reporting Period

This is a Quarterly Report (Form 10-Q) for Harte-Hanks, Inc., a worldwide direct and targeted marketing company, for the period ended September 30, 2006. The company operates through two primary segments: Direct Marketing (data collection, analysis, and program execution) and Shoppers (owner and distributor of weekly advertising publications). The company is a large accelerated filer incorporated in Delaware.

Key Financial Metrics

Segment Performance (9 Months): Direct Marketing revenues were $512.2 million (1.0% increase YoY); Shoppers revenues were $359.2 million (9.9% increase YoY).

Material Changes vs. Prior Period

• Revenue Growth: Consolidated revenues increased 4.6% in Q3 and 4.5% for the nine-month period compared to 2005. The Shoppers segment drove growth (6.8% in Q3, 9.9% YTD) due to geographic expansions in California and Florida and improved sales. Direct Marketing grew modestly (3.1% in Q3, 1.0% YTD).
• Profitability Decline: Despite revenue growth, Operating Income decreased 8.2% in Q3 and 2.2% YTD. Net Income decreased 4.0% in Q3 and 1.7% YTD.
• Expense Increases: Operating expenses rose 7.3% in Q3 and 5.8% YTD. Key drivers included higher postage costs (due to Jan 2006 rate hikes), increased paper costs, higher labor costs to support expansion, and the adoption of SFAS No. 123R (stock-based compensation), which added $1.9 million in Q3 and $5.6 million YTD to expenses.
• Debt Levels: Long-term debt increased significantly from $62.0 million (Dec 31, 2005) to $167.0 million (Sep 30, 2006), driven by borrowings to fund acquisitions and share repurchases. Consequently, interest expense increased 168% in Q3 and 166% YTD.

Guidance, Outlook, and Risks

• Acquisitions: The company acquired AberdeenGroup, Inc. (technology market research) and Global Address (postal data software) in 2006 for a total cash cost of approximately $50.8 million. These are expected to provide synergy with existing data services.
• Cost Pressures: Management anticipates continued pressure from rising fuel costs, newsprint prices, and potential future postal rate increases in mid-2007. These factors are expected to impact production costs for the remainder of 2006 and into 2007.
• Expansion Strategy: The company does not anticipate additional geographic expansions for the remainder of 2006 and plans to moderate the pace of expansion in 2007 to allow new areas to mature.
• Accounting Changes: The adoption of SFAS No. 123R in 2006 resulted in the expensing of stock options, impacting diluted EPS by approximately $0.015 in Q3 and $0.04 YTD. The company is also assessing the impact of FIN 48 (income tax uncertainty) effective Jan 1, 2007.
• Liquidity: The company maintains a $125 million revolving credit facility and a new $200 million term loan facility. As of Sep 30, 2006, $158 million of unused borrowing capacity remained available.

Investor Verification Checklist

• Debt Servicing: Verify the impact of the increased debt load ($167M) on future interest expenses and cash flow, given the variable interest rate structure of the new Term Loan Facility.
• Margin Compression: Monitor the Shoppers segment's ability to pass on increased postage and paper costs to advertisers to protect operating margins.
• Stock-Based Compensation: Review the ongoing impact of SFAS No. 123R on reported earnings and cash flow, noting the $13.5 million of unrecognized compensation cost related to unvested options.
• Acquisition Integration: Assess the revenue contribution and synergy realization from the AberdeenGroup and Global Address acquisitions.
• Share Repurchases: Note the significant cash outflow for treasury stock purchases ($132.8 million YTD) and the remaining authorization under the repurchase plan.