HARTE HANKS INC
10-Ks and 10-Qs
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U.S.
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
ý
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
March 31, 2019
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-07120
HARTE HANKS, INC.
(Exact name of registrant as specified in its charter)
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Delaware
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74-1677284
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(State or other jurisdiction of
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(I.R.S. Employer
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incorporation or organization)
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Identification Number)
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9601 McAllister Freeway, Suite 610, San Antonio, Texas 78216
(Address of principal executive offices, including zip code)
(210) 829-9000
(Registrant’s telephone number including area code)
None
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes
ý
No
o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes
ý
No
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
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Large accelerated filer
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o
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Accelerated filer
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o
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Non-accelerated filer
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ý
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Smaller reporting company
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ý
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Emerging growth company
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o
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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
o
Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes
o
No
ý
The number of shares outstanding of each of the issuer's classes of common stock as of
April 15, 2019
was
6,271,669
shares of common stock, all of one class.
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Title of Each Class
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Trading Symbol(s)
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Name of each exchange on which registered
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Common Stock
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HHS
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New York Stock Exchange (“NYSE”)
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HARTE HANKS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
FORM 10-Q REPORT
For the Quarterly Period Ended
March 31, 2019
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2
Item 1. Financial Statements
Harte Hanks, Inc. and Subsidiaries Condensed Consolidated Balance Sheets
(Unaudited)
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In thousands, except per share and share amounts
|
March 31,
2019 |
December 31,
2018 |
||||||
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ASSETS
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||||
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Current assets
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||||
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Cash and cash equivalents
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$
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20,942
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$
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20,882
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Accounts receivable (less allowance for doubtful accounts of $ 466 at March 31, 2019
and $430 at December 31, 2018)
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47,258
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54,240
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||||
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Contract assets
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1,598
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2,362
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Inventory
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386
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448
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Prepaid expenses
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4,566
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4,088
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Prepaid taxes and income tax receivable
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15,650
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20,436
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||||
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Other current assets
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2,464
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2,536
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||||
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Total current assets
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92,864
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104,992
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||||
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Property, plant and equipment (less accumulated depreciation of $130,114 at March 31, 2019 and $133,559 at December 31, 2018)
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11,658
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13,592
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||||
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Right-of-use assets
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23,471
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—
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|||
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Other assets
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5,588
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6,591
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Total assets
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$
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133,581
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$
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125,175
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||||||||
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LIABILITIES AND STOCKHOLDERS’ DEFICIT
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||||
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Current liabilities
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||||
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Accounts payable
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$
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25,602
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$
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31,052
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Accrued payroll and related expenses
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5,999
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6,783
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||||
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Deferred revenue and customer advances
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6,402
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6,034
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||||
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Customer postage and program deposits
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5,066
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6,729
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Short-term lease liabilities
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8,451
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—
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Other current liabilities
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3,254
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3,564
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Total current liabilities
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54,774
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54,162
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Long-term debt
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18,700
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14,200
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Pensions
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62,494
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62,214
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Long-term lease liabilities
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15,922
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—
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Other long-term liabilities
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3,968
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4,060
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Total liabilities
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155,858
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134,636
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Preferred stock, $1 par value, 1,000,000 shares authorized; 9,926 designated as Series A Convertible Preferred Stock; 9,926 shares of Series A Convertible Preferred Stock authorized, issued and outstanding
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9,723
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9,723
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Stockholders’ deficit
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Common stock, $1 par value, 25,000,000 shares authorized;12,115,055 shares issued, 6,269,356 and 6,260,075 shares outstanding at March 31, 2019 and December 31, 2018, respectively
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12,115
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12,115
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Additional paid-in capital
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452,051
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453,868
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Retained earnings
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810,554
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812,704
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Less treasury stock, 5,845,699 shares at cost at March 31, 2019 and 5,854,980 shares at cost at December 31, 2018
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(1,249,404
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)
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(1,251,388
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)
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Accumulated other comprehensive loss
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(57,316
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)
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(46,483
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)
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Total stockholders’ deficit
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(32,000
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)
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(19,184
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)
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Total liabilities, preferred stock and stockholders’ deficit
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$
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133,581
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$
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125,175
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||
See Accompanying Notes to Condensed Consolidated Financial Statements
Harte Hanks, Inc. and Subsidiaries Condensed Consolidated Statements of Comprehensive (Loss) Income
(Unaudited)
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Three Months Ended March 31,
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In thousands, except per share amounts
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2019
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2018
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Operating revenues
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$
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59,150
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$
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81,198
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Operating expenses
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Labor
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33,815
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50,656
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Production and distribution
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23,000
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24,149
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Advertising, selling, general and administrative
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7,475
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9,277
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Impairment of assets and contract termination
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4,358
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—
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Depreciation, software and intangible asset amortization
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1,442
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2,151
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Total operating expenses
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70,090
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86,233
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Operating loss
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(10,940
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)
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(5,035
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)
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Other expenses (income)
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Interest expense, net
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220
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929
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Gain on sale
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—
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(30,954
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)
|
||
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Other, net
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1,577
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1,141
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||||
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Total other expenses (income)
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1,797
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(28,884
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)
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||||
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(Loss) income before income taxes
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(12,737
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)
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23,849
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||||
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Income tax expense (benefit)
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790
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(8,780
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)
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||||
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Net (loss) income
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$
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(13,527
|
)
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$
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32,629
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Less: Preferred stock dividends
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122
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—
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||||
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(Loss) income attributable to common stockholders
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$
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(13,649
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)
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$
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32,629
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(Loss) Earnings per common share
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||||||||
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Basic
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$
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(2.18
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)
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$
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5.24
|
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Diluted
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$
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(2.18
|
)
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$
|
4.67
|
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||
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||||||||
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Weighted average shares used to compute earnings (loss) per share attributable to common shares
|
||||||||
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Basic
|
6,268
|
|
6,213
|
|
||||
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Diluted
|
6,268
|
|
6,990
|
|
||||
|
Comprehensive (loss) income:
|
|
|
|
|
||||
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Net (loss) income
|
$
|
(13,527
|
)
|
$
|
32,629
|
|
||
|
Adjustment to pension liability
|
550
|
|
518
|
|
||||
|
Foreign currency translation adjustment
|
(28
|
)
|
(154
|
)
|
||||
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Adoption of ASU 2018-02
|
(11,355
|
)
|
—
|
|
||||
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Total other comprehensive (loss) income, net of tax
|
(10,833
|
)
|
364
|
|
||||
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Comprehensive (loss) income
|
$
|
(24,360
|
)
|
$
|
32,993
|
|
||
|
Less: Preferred stock dividends
|
122
|
|
|
—
|
|
|||
|
Comprehensive (loss) income attributable to common stockholders
|
$
|
(24,482
|
)
|
$
|
32,993
|
|
||
See Accompanying Notes to Condensed Consolidated Financial Statements
3
(Harte Hanks, Inc. and Subsidiaries Condensed Consolidated Statements of Changes in Stockholder's Equity (Deficit)
(Unaudited)
|
In thousands
|
Preferred Stock
|
Common
Stock |
Additional
Paid-in Capital |
Retained
Earnings |
Treasury
Stock |
Accumulated Other
Comprehensive Loss |
Total
Stockholders’ Deficit |
||||||||||||||||||||
|
Balance at December 31, 2017
|
$
|
—
|
|
$
|
12,075
|
|
$
|
457,186
|
|
$
|
794,583
|
|
$
|
(1,254,176
|
)
|
$
|
(44,303
|
)
|
$
|
(34,635
|
)
|
||||||
|
Cumulative effect of accounting change
|
—
|
|
—
|
|
—
|
|
571
|
|
—
|
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—
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571
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|||||||||||||
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Preferred stock issued
|
9,723
|
|
—
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|
|
—
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|
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—
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—
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—
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|
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—
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|
||||||||
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Stock Option activities
|
—
|
|
38
|
|
(38
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)
|
—
|
|
(1
|
)
|
—
|
|
(1
|
)
|
|||||||||||||
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Rounding from reverse stock split
|
|
—
|
|
(38
|
)
|
|
38
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|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|||||||
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Stock-based compensation
|
—
|
|
—
|
|
433
|
|
—
|
|
—
|
|
—
|
|
433
|
|
|||||||||||||
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Treasury stock issued
|
—
|
|
—
|
|
(50
|
)
|
—
|
|
53
|
|
—
|
|
3
|
|
|||||||||||||
|
Net income
|
—
|
|
—
|
|
—
|
|
32,629
|
|
—
|
|
—
|
|
32,629
|
|
|||||||||||||
|
Other comprehensive income
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
364
|
|
364
|
|
|||||||||||||
|
Balance at March 31, 2018
|
$
|
9,723
|
|
$
|
12,075
|
|
$
|
457,569
|
|
$
|
827,783
|
|
$
|
(1,254,124
|
)
|
$
|
(43,939
|
)
|
$
|
(636
|
)
|
||||||
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In thousands
|
Preferred Stock
|
Common
Stock |
Additional
Paid-in Capital |
Retained
Earnings |
Treasury
Stock |
Accumulated Other
Comprehensive Loss |
Total
Stockholders’ Deficit |
||||||||||||||||||||
|
Balance at December 31, 2018
|
$
|
9,723
|
|
$
|
12,115
|
|
$
|
453,868
|
|
$
|
812,704
|
|
$
|
(1,251,388
|
)
|
$
|
(46,483
|
)
|
$
|
(19,184
|
)
|
||||||
|
Cumulative effect of accounting change
|
—
|
|
—
|
|
—
|
|
11,377
|
|
—
|
|
(11,355
|
)
|
22
|
|
|||||||||||||
|
Stock-based compensation
|
—
|
|
—
|
|
151
|
|
—
|
|
—
|
|
—
|
|
151
|
|
|||||||||||||
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Treasury stock issued
|
—
|
|
—
|
|
(1,968
|
)
|
—
|
|
1,984
|
|
—
|
|
16
|
|
|||||||||||||
|
Net loss
|
—
|
|
—
|
|
—
|
|
(13,527
|
)
|
—
|
|
—
|
|
(13,527
|
)
|
|||||||||||||
|
Other comprehensive income
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
522
|
|
522
|
|
|||||||||||||
|
Balance at March 31, 2019
|
$
|
9,723
|
|
$
|
12,115
|
|
$
|
452,051
|
|
$
|
810,554
|
|
$
|
(1,249,404
|
)
|
$
|
(57,316
|
)
|
$
|
(32,000
|
)
|
||||||
See Accompanying Notes to Condensed Consolidated Financial Statements
4
Harte Hanks, Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows
(Unaudited)
|
|
Three Months Ended March 31,
|
|||||||
|
In thousands
|
2019
|
2018
|
||||||
|
Cash flows from operating activities
|
|
|
|
|
||||
|
Net (loss) income
|
$
|
(13,527
|
)
|
$
|
32,629
|
|
||
|
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities
|
||||||||
|
Depreciation, software amortization
|
1,442
|
|
2,151
|
|
||||
|
Intangible asset amortization
|
—
|
|
|
113
|
|
|||
|
Impairment of assets
|
2,190
|
|
|
—
|
|
|||
|
Stock-based compensation
|
150
|
|
551
|
|
||||
|
Net pension cost
|
1,013
|
|
429
|
|
||||
|
Interest accretion on contingent consideration
|
—
|
|
742
|
|
||||
|
Deferred income taxes
|
584
|
|
(457
|
)
|
||||
|
Gain on sale
|
—
|
|
(32,760
|
)
|
||||
|
Other, net
|
—
|
|
|
614
|
|
|||
|
Changes in assets and liabilities:
|
|
|
||||||
|
Decrease in accounts receivable, net and contract assets
|
7,746
|
|
7,043
|
|
||||
|
Decrease in inventory
|
62
|
|
114
|
|
||||
|
Decrease (increase) in prepaid expenses, income tax receivable and other assets
|
2,689
|
|
(10,468
|
)
|
||||
|
Increase (decrease) in accounts payable
|
(5,152
|
)
|
5,106
|
|
||||
|
Decrease in other accrued expenses and liabilities
|
(68
|
)
|
(3,006
|
)
|
||||
|
Net cash (used in) provided by operating activities
|
(2,871
|
)
|
2,801
|
|
||||
|
Cash flows from investing activities
|
0
|
|
|
|
||||
|
Dispositions, net of cash transferred
|
—
|
|
3,929
|
|
||||
|
Purchases of property, plant and equipment
|
(1,106
|
)
|
(1,618
|
)
|
||||
|
Proceeds from sale of property, plant and equipment
|
5
|
|
—
|
|
||||
|
Net cash (used in) provided by investing activities
|
(1,101
|
)
|
2,311
|
|
||||
|
|
||||||||
|
Cash flows from financing activities
|
|
|
|
|
||||
|
Borrowings
|
4,500
|
|
9,000
|
|
||||
|
Repayment of borrowings
|
—
|
|
(9,000
|
)
|
||||
|
Debt financing costs
|
(248
|
)
|
(106
|
)
|
||||
|
Issuance of preferred stock, net of transaction fees
|
|
—
|
|
|
9,723
|
|
||
|
Issuance of common stock
|
—
|
|
(1
|
)
|
||||
|
Issuance of treasury stock
|
16
|
|
3
|
|
||||
|
Payment of finance leases
|
(208
|
)
|
(126
|
)
|
||||
|
Net cash provided by financing activities
|
4,060
|
|
9,493
|
|
||||
|
|
||||||||
|
Effect of exchange rate changes on cash and cash equivalents
|
(28
|
)
|
(156
|
)
|
||||
|
Net increase in cash and cash equivalents
|
60
|
|
14,449
|
|
||||
|
Cash and cash equivalents at beginning of period
|
20,882
|
|
8,397
|
|
||||
|
Cash and cash equivalents at end of period
|
$
|
20,942
|
|
$
|
22,846
|
|
||
|
Supplemental disclosures
|
||||||||
|
Cash paid for interest
|
$
|
186
|
|
$
|
45
|
|
||
|
Cash received for income taxes
|
$
|
4,565
|
|
$
|
592
|
|
||
|
Non-cash investing and financing activities
|
||||||||
|
Purchases of property, plant and equipment included in accounts payable
|
$
|
685
|
|
$
|
88
|
|
||
See Accompanying Notes to Condensed Consolidated Financial Statements
5
Harte Hanks, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note A
- Overview and Significant Accounting Policies
Background
Harte Hanks, Inc. ("Harte Hanks," "we," "our," or "us") is a purveyor of data-driven, omni-channel marketing and customer relationship solutions and logistics. The Company has robust capabilities that offer clients the strategic guidance they need across the customer data landscape as well as the executional know-how in database build and management, data analytics, digital media, direct mail, customer contact, client fulfillment and marketing and product logistics. Harte Hanks solves marketing, commerce and logistical challenges for some of the world's leading brands in North America, Asia-Pacific and Europe.
The Company operates as
one
reportable segment. Our Chief Executive Officer is considered to be our chief operating decision maker. He reviews our operating results on an aggregate basis for purposes of allocating resources and evaluating financial performance.
Securities Purchase Agreement
On January 23, 2018, we entered into a Securities Purchase Agreement with Wipro, LLC ("Wipro"), pursuant to which on January 30, 2018 we issued
9,926
shares of Series A Convertible Preferred Stock, par value
$1.00
per share (the “Series A Preferred Stock”), for aggregate consideration of
$9.9 million
. Dividends on the Series A Preferred Stock accrue at a rate of
5.0%
per year or the rate that cash dividends were paid in respect to shares of Common Stock if such rate is greater than
5.0%
. The aggregate shares issued under the Securities Purchase Agreement are convertible into
1,001,614
shares of our Common Stock. Dividends are payable solely upon a Liquidation (as defined in the Certificate of Designation), but only if prior to such Liquidation such shares of Series A Preferred Stock have not been converted to Common Stock.
Along with customary protective provisions, Wipro, LLC has designated an observer to the Board of Directors. We are using the proceeds for general corporate purposes including for working capital purposes.
See Note E,
Convertible Preferred Stock
, for further information.
Related Party Transactions
Since 2016, we have conducted (and we continue to conduct) business with Wipro, whereby Wipro provides us with a variety of technology-related services, including database and software development, database support and analytics, IT infrastructure support, and digital campaign management. Additionally, we also provide Wipro with agency services and consulting services.
Effective January 30, 2018, Wipro became a related party when it purchased
9,926
shares of our Series A Preferred Stock (which are convertible at Wipro's option into
1,001,614
shares, or
16%
of our Common Stock as of January 30, 2018), for aggregate consideration of
$9.9 million
. For information pertaining to the Company’s preferred stock, See Note E,
Convertible Preferred Stock
.
Accounting Principles
Our unaudited interim condensed consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). In the opinion of management, the unaudited interim condensed consolidated financial statements reflect all adjustments of a normal recurring nature that are necessary for a fair presentation of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with information included in the Harte Hanks Annual Report on Form 10-K for the fiscal year ended December 31, 2018 (the "2018 10-K") filed with the U.S. Securities and Exchange Commission on March 18, 2019.
Consolidation
The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of Harte Hanks, Inc. and subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. As used in this report, the terms “Harte Hanks,” “the Company,” “we,” “us,” or “our” may refer to Harte Hanks, Inc., one or more of its consolidated subsidiaries, or all of them taken as a whole, as the context may require.
6
Interim Financial Information
The financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Rule 8-01 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the
three months ended
March 31, 2019
are not necessarily indicative of the results that may be expected for the year ending
December 31, 2019
. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the condensed consolidated financial statements and notes thereto included in our 2018 10-K.
Reverse Stock Split
On January 31, 2018, we executed a 1-for-10 reverse stock split (the "Reverse Stock Split"). Pursuant to the Reverse Stock Split, every
10
pre-split shares of our common stock were exchanged for one post-split share of the Company's Common Stock. No fractional shares were issued in connection with the Reverse Stock Split. Stockholders who would otherwise have held a fractional share of the Common Stock received (or are entitled to receive) a cash payment in lieu thereof. Pursuant to the Reverse Stock Split, our authorized Common Stock was reduced from
250 million
to
25 million
shares. The number of authorized shares of preferred stock remained unchanged at
one million
shares.
Use of Estimates
The preparation of Condensed Consolidated Financial Statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. Actual results and outcomes could differ from those estimates and assumptions. Such estimates include, but are not limited to, estimates related to lease accounting, pension accounting; fair value for purposes of assessing long-lived assets for impairment; income taxes; stock-based compensation; and contingencies. On an ongoing basis, management reviews its estimates based on currently available information. Changes in facts and circumstances could result in revised estimates and assumptions.
Operating Expense Presentation in Condensed Consolidated Statements of Comprehensive (Loss) Income
The “Labor” line in the Condensed Consolidated Statements of Comprehensive (Loss) income includes all employee payroll and benefits, including stock-based compensation, along with temporary labor costs. The “Production and distribution” and “Advertising, selling, general and administrative” lines do not include labor, depreciation, or amortization.
Revenue Recognition
We recognize revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to be entitled to receive in exchange for those products or services. We apply the following five-step revenue recognition model:
|
•
|
Identification of the contract, or contracts, with a customer
|
|
•
|
Identification of the performance obligations in the contract
|
|
•
|
Determination of the transaction price
|
|
•
|
Allocation of the transaction price to the performance obligations in the contract
|
|
•
|
Recognition of revenue when (or as) we satisfy the performance obligation
|
Certain client programs provide for adjustments to billings based upon whether we achieve certain performance criteria. In these circumstances, revenue is recognized when the foregoing conditions are met. We record revenue net of any taxes collected from customers and subsequently remitted to governmental authorities. Any payments received in advance of the performance of services or delivery of the product are recorded as deferred revenue until such time as the services are performed or the product is delivered. Costs incurred for search engine marketing solutions and postage costs of mailings are billed to our clients and are not directly reflected in our revenue.
Revenue from agency and digital services, direct mail, logistics, fulfillment and contact center is recognized as the work is performed. Fees for these services are determined by the terms set forth in the contract with the client. These are typically set at a fixed price or rate by transaction occurrence, service provided, time spent, or product delivered.
7
For arrangements requiring design and build of a database, revenue is not recognized until client acceptance occurs. Up-front fees billed during the setup phase for these arrangements are deferred and direct build costs are capitalized. Pricing for these types of arrangements are typically based on a fixed price determined in the contract. Revenue from other database marketing solutions is recognized ratably over the contractual service period. Pricing for these services are typically based on a fixed price per month or per contract.
Fair Value of Financial Instruments
FASB ASC 820,
Fair Value Measurements and Disclosures
, ("ASC 820") defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 also establishes a fair value hierarchy that prioritizes the inputs used in valuation methodologies into three levels:
|
Level 1
|
Quoted prices in active markets for identical assets or liabilities.
|
|
|
Level 2
|
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
|
|
|
Level 3
|
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
|
|
Because of their maturities and/or variable interest rates, certain financial instruments have fair values approximating their carrying values. These instruments include cash and cash equivalents, accounts receivable, and trade payables.
Leases
We determine if an arrangement is a lease at inception. Operating and finance leases are included in the lease right-of-use (“ROU”) assets, current portion and long-term portion of lease obligations on our condensed consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease, which are included in the lease ROU asset when it is reasonably certain that we will exercise that option. Lease expense for lease payments is recognized on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, which are generally accounted for separately. For certain real estate leases, we account for the lease and non-lease components as a single lease component.
See Note B,
Recent Accounting Pronouncements - Recently adopted accounting pronouncements.
Note B - Recent Accounting Pronouncements
Recently issued accounting pronouncements not yet adopted
In August 2018, the FASB issued ASU 2018-14, Compensation—Retirement Benefits—Defined Benefit Plans—General (Topic 715-20): Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans ("ASU 2018-14"), which modifies the disclosure requirements for defined benefit pension plans and other postretirement plans. ASU 2018-14 is effective for fiscal years ending after December 15, 2020, and earlier adoption is permitted. We are currently evaluating the impact of our pending adoption of ASU 2018-14 on our condensed consolidated financial statements.
Recently adopted accounting pronouncements
Income taxes
In March 2018, the FASB issued ASU 2018-05,
Income Taxes (Topic 740)—Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 ("SAB 118").
This ASU amends certain Securities and Exchange Commission (SEC) guidance in Topic 740 for the income tax accounting implications of the recently issued Tax Reform. This guidance clarifies the application of Topic 740 in situations where a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting under Topic 740 for certain income tax effects of Tax Reform for the reporting period in which Tax Reform was enacted. We adopted it in the fourth quarter 2017.
In February 2018, the FASB issued ASU 2018-02,
Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income
. This ASU allows for reclassification of stranded tax effects on items resulting from the change in the
8
corporate tax rate as a result of H.R. 1, originally known as the Tax Cuts and Jobs Act of 2017, from accumulated other comprehensive income to retained earnings. Tax effects unrelated to H.R. 1 are permitted to be released from accumulated other comprehensive income using either the specific identification approach or the portfolio approach, based on the nature of the underlying item. ASU 2018-02 is effective for interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted. We adopted ASU 2018-02 in the first quarter of 2019. See Note I,
Income Taxes,
for a discussion of the impacts of this ASU.
Stock-based Compensation
In June 2018, the FASB issued ASU 2018-07,
Compensation-Stock Compensation (Topic 718): Improvements to nonemployee share-based payment accounting,
which supersedes ASC 505-50,
Accounting for Distributions to Shareholders with Components of Stock and Cash,
and expands the scope of ASC 718 to include all share-based payment arrangements related to the acquisition of goods and services from both non-employees and employees. As a result, most of the guidance in ASC 718 associated with employee share-based payments, including most of its requirements related to classification and measurement, applies to non-employee share-based payment arrangements. The ASU is effective for annual periods beginning after December 15, 2018, and the interim periods within those fiscal years with early adoption permitted after the entity has adopted ASC 606. This standard was adopted as of January 1, 2019 and did not have a material impact on our condensed consolidated financial statements and related disclosures.
Leases
In February 2016, the FASB issued ASU 2016-02,
Leases (Topic 842)
and subsequent amendment ASU 2018-11, which requires all operating leases to be recorded on the balance sheet. The lessee will record a liability for its lease obligations (initially measured at the present value of the future lease payments not yet paid over the lease term, and an asset for its right to use the underlying asset equal to the lease liability, adjusted for lease payments made at or before lease commencement). This ASU is effective for interim and annual periods beginning after December 15, 2018, with early adoption permitted. This change is required to be applied using a modified retrospective approach for leases that exist or are entered after the beginning of the earliest comparative period in the financial statements. Full retrospective application is prohibited. In July 2018, the FASB approved an optional transition method to initially account for the impact of the adoption with a cumulative-effect adjustment to the January 1, 2019, rather than the January 1, 2017, financial statements. This will eliminate the need to restate amounts presented prior to January 1, 2019.
We adopted the standard effective January 1, 2019, and we elected the optional transition method and the practical expedients permitted under the transition guidance within the standard. Accordingly, we accounted for our existing operating leases as operating leases under the new guidance, without reassessing (a) whether the contracts contain a lease under ASC Topic 842, (b) whether classification of the operating leases would be different in accordance with ASC Topic 842, or (c) whether the unamortized initial direct costs before transition adjustments (as of December 31, 2018) would have met the definition of initial direct costs in ASC Topic 842 at lease commencement.
The standard had a material impact on our condensed consolidated balance sheets, but did not have an impact on our condensed consolidated income statements or cash flows from operations. The cumulative effect of the changes on our retained earnings was
$22,000
associated with capital gain. The most significant impact was the recognition of right-of-use (ROU) assets and lease liabilities for operating leases. Our accounting for finance leases remained substantially unchanged. See Note D,
Leases
for further discussion.
Note C - Revenue from Contracts with Customers
In May 2014, the FASB issued ASU 2014-09,
Revenue from Contracts with Customers
, related to revenue recognition. Under ASC 606,
Revenue from Contracts with Customers,
an entity recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that are within the scope of the new standard, the entity performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The new standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new standard also includes criteria for the capitalization and amortization of certain contract acquisition and fulfillment costs.
Under ASC 606, revenue is recognized when control of the promised goods or services is transferred to the customer, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. Our contracts with customers state the terms of sale, including the description, quantity, and price of the product or service purchased. Payment
9
terms can vary by contract, but the period between invoicing and when payment is due is not significant. At
March 31, 2019
and December 31, 2018, our contracts do not include any significant financing components.
Consistent with legacy GAAP, we present taxes assessed on revenue-producing transactions on a net basis.
Disaggregation of Revenue
We disaggregate revenue by vertical market and key revenue stream. The following table summarizes revenue from contracts with customers for the
three months ended
March 31, 2019
by our key vertical markets:
|
In thousands
|
For the three months ended March 31, 2019
|
For the three months ended March 31, 2018
|
||||||
|
B2B
|
$
|
12,785
|
|
18,882
|
|
|||
|
Consumer Brands
|
12,163
|
|
19,556
|
|
||||
|
Financial Services
|
12,965
|
|
14,645
|
|
||||
|
Healthcare
|
4,627
|
|
4,426
|
|
||||
|
Retail
|
12,311
|
|
15,673
|
|
||||
|
Transportation
|
4,299
|
|
8,016
|
|
||||
|
Total Revenues
|
$
|
59,150
|
|
$
|
81,198
|
|
||
The nature of the services offered by each key revenue stream are different. The following tables summarize revenue from contracts with customers for the
three months ended
March 31, 2019
and 2018 by our four major revenue streams and the pattern of revenue recognition:
|
For the three months ended March 31, 2019
|
||||||||||||
|
In thousands
|
Revenue for performance obligations recognized
over time |
Revenue for performance obligations recognized at a point in time
|
Total
|
|||||||||
|
Agency & Digital Services
|
$
|
6,193
|
|
$
|
39
|
|
$
|
6,232
|
|
|||
|
Database Marketing Solutions
|
6,106
|
|
786
|
|
6,892
|
|
||||||
|
Direct Mail, Logistics, and Fulfillment
|
24,739
|
|
5,549
|
|
30,288
|
|
||||||
|
Contact Centers
|
15,738
|
|
—
|
|
15,738
|
|
||||||
|
Total Revenues
|
$
|
52,776
|
|
$
|
6,374
|
|
$
|
59,150
|
|
|||
Our contracts with customers may consist of multiple performance obligations. If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price ("SSP") basis unless the transaction price is variable and meets the criteria to be allocated entirely to a performance obligation or to a distinct good or service that forms part of a single performance obligation. For most performance obligations, we determine SSP based on the price at which the performance obligation is sold separately. Although uncommon, if the SSP is not observable through past transactions, we estimate the SSP taking into account available information such as market conditions and internally approved pricing guidelines related to the performance obligations. Further discussion of other performance obligations in each of our major revenue streams follows:
Agency & Digital Services
Our agency services are full-service, customer engagement agencies specializing in direct and digital communications for both consumer and business-to-business markets. Our digital solutions integrate online services within the marketing mix and include: search engine management, display, digital analytics, website development and design, digital strategy, social media, email, e-commerce, and interactive relationship management. Our contracts may include a promise to purchase media or acquire search engine marketing solutions on behalf of our clients; in such cases, we have determined we are an agent, rather than principal and therefore recognize the net consideration as revenue (consistent with legacy GAAP).
Agency and digital services performance obligations are satisfied over time and often offered on a project basis. We have concluded that the best approach of measuring the progress toward completion of the project-based performance obligations
10
is the input method based on costs or labor hours incurred to date dependent upon whether costs or labor hours more accurately depict the transfer of value to the customer.
The variable consideration in these contracts primarily relates to time and material-based services and reimbursable out-of-pocket travel costs, both of which are estimated using the expected value method. For time and material-based contracts, we use the “as invoiced” practical expedient.
Database Marketing Solutions
Our solutions are built around centralized marketing databases with services rendered to build custom database, database hosting services, customer or target marketing lists and data processing services.
These performance obligations, including services rendered to build a custom database, database hosting services, professional services, customer or target marketing lists and data processing services, may be satisfied over time or at a point in time. We provide software as a service ("SaaS") solutions to host data for customers and have concluded that they are stand-ready obligations to be recognized over time on a monthly basis. Our promise to provide certain data related services meets the over-time recognition criteria because our services do not create an asset with an alternative use and we have an enforceable right to payment. For performance obligations recognized over time, we choose either the input (i.e. labor hour) or output method (
i.e.
number of customer records) to measure the progress toward completion depending on the nature of the services provided. Some of our other data-related services do not meet the over-time criteria and are therefore, recognized at a point-in-time, typically upon the delivery of a specific deliverable.
We charge our customers for certain data-related services at a fixed transaction-based rate,
e.g.,
per thousand customer records processed. Because the quantity of transactions is unknown at the onset of a contract, our transaction price is variable, and we use the expected value method to estimate the transaction price. The uncertainty associated with the variable consideration generally resolves within a short period of time since the duration of these contracts is generally
less than two months
.
Direct Mail, Logistics, and Fulfillment
Our services include: digital printing, print on demand, advanced mail optimization, logistics and transportation optimization, tracking, commingling, shrink wrapping, and specialized mailings. We also maintain fulfillment centers where we provide custom kitting services, print on demand, product recalls, and freight optimization allowing our customers to distribute literature and other marketing materials.
The majority of performance obligations offered within this revenue stream are satisfied over time and utilize the input or output method, depending on the nature of the service, to measure progress toward satisfying the performance obligation. For performance obligations where we charge customers a transaction-based fee, we utilize the output method based on the quantities fulfilled. Services provided through our fulfillment centers are typically priced at a per transaction basis and our contracts provide us the right to invoice for services provided and reflects the value to the customer of the services transferred to date. In most cases, we use the “as invoiced” practical expedient to recognize revenue associated with these performance obligations unless significant discounts are offered in a contract and prices for services do not represent their standalone selling prices. For our direct mail revenue stream, our contracts may include a promise to purchase postage on behalf of our clients; in such cases, we have determined we are an agent, rather than principal and therefore recognize net consideration as revenue (consistent with legacy GAAP).
The variable consideration in our contracts results primarily from the transaction-based fee structure of some performance obligations with their total transaction quantities to be provided unknown at the onset of a contract, which is estimated using the expected value method
.
Contact Centers
We operate tele-service workstations in the U.S., Asia, and Europe to provide advanced contact center solutions such as: speech, voice and video chat, integrated voice response, analytics, social cloud monitoring, and web self-service.
Performance obligations are stand-ready obligations and satisfied over time. With regard to account management and SaaS, we use a time-elapsed output method. For performance obligations where we charge customers a transaction-based fee, we use the output method based on transaction quantities. In most cases, our contracts provide us the right to invoice for services provided, therefore, we generally use the “as invoiced” practical expedient to recognize revenue associated with these
11
performance obligations unless significant discounts are offered in a contract and prices for services do not represent their standalone selling prices.
The variable consideration in our contracts results primarily from the transaction-based fee structure of some performance obligations with their total transaction quantities to be provided unknown at the onset of a contract, which is estimated using the expected value method
.
Upfront Non-Refundable Fees
We may receive non-refundable upfront fees from customers for implementation of our SaaS database solutions products or for providing training in connection with our contact center solutions. These activities are not deemed to transfer a separate promised service and therefore, represent advanced payments. Where customers have an option to renew a contract, the customer is not required to pay similar upfront fees upon renewal. As a result, we have determined that these renewal options provide for the purchase of future services at a reduced rate and therefore, provide a material right. These upfront non-refundable fees are recognized over the period of benefit which is generally consistent with estimated customer life (
four and five years
for database solutions contracts and
six months to one year
for contact center contracts). The upfront non-refundable fees collected from customers were immaterial as of
March 31, 2019
and 2018.
Transaction Price Allocated to Future Performance Obligations
We have elected to apply certain optional exemptions that limit the disclosure requirements over remaining performance obligations at period end to exclude: performance obligations that have an original expected duration of one year or less, transactions using the “as invoiced” practical expedient, or when a performance obligation is a series and we have allocated the variable consideration directly to the services performed. After considering the above exemptions, the transaction prices allocated to unsatisfied or partially satisfied performance obligations as of
March 31, 2019
totaled
$0.5 million
, which is expected to be recognized over the next
2
years as follows:
$0.4 million
in 2019 and
$0.1 million
in 2020.
Contract Balances
We record a receivable when revenue is recognized prior to invoicing when we have an unconditional right to consideration (only the passage of time is required before payment of that consideration is due) and a contract asset when the right to payment is conditional upon our future performance such as delivery of an additional good or service (e.g. customer contract requires customer's final acceptance of custom database solution or delivery of final marketing strategy delivery presentation before customer payment is required). If invoicing occurs prior to revenue recognition, the unearned revenue is presented on our Condensed Consolidated Balance Sheet as a contract liability, referred to as deferred revenue. The following table summarizes our contract balances as of
March 31, 2019
and December 31, 2018:
|
In thousands
|
March 31, 2019
|
December 31, 2018
|
||||||
|
Contract assets
|
$
|
1,598
|
|
$
|
2,362
|
|
||
|
Deferred revenue and customer advances
|
6,402
|
|
6,034
|
|
||||
|
Deferred revenue, included in other long-term liabilities
|
1,023
|
|
578
|
|
||||
Revenue recognized during the
three months ended March 31, 2019
from amounts included in deferred revenue at December 31, 2018 was approximately
$3.0 million
. We recognized
no
revenues during the
three months ended March 31, 2019
from performance obligations satisfied or partially satisfied in previous periods.
Costs to Obtain and Fulfill a Contract
We recognize an asset for the direct costs incurred to obtain and fulfill our contracts with customers to the extent that we expect to recover these costs and if the benefit is longer than one year. These costs are amortized to expense over the expected period of benefit in a manner that is consistent with the transfer of the related goods or services to which the asset relates. We capitalized a portion of commission expense that represents the cost to obtain a contract. The remaining unamortized contract costs were
$3.2 million
as of
March 31, 2019
. For the periods presented,
no
impairment was recognized.
12
Note D
- Leases
On January 1, 2019, the Company adopted Topic 842 using the modified retrospective approach. The Company recorded operating lease assets (right-of-use assets) of
$22.8 million
and operating lease liabilities of
23.9 million
. There was minimal impact to retained earnings upon adoption of Topic 842.
We have operating and finance leases for corporate and business offices, service facilities, call centers and certain equipment. Leases with an initial term of 12 months or less are generally not recorded on the balance sheet, unless the arrangement includes an option to purchase the underlying asset, or an option to renew the arrangement, that we are reasonably certain to exercise (short-term leases). Our leases have remaining lease terms of
1
year to
6 years
, some of which may include options to extend the leases for up to
5
years, and some of which may include options to terminate the leases within
1
year.
As of March 31, 2019, assets recorded under finance and operating leases were approximately
$1.2 million
and
$22.3 million
respectively, and accumulated depreciation associated with finance leases was $
63,800
. Operating lease right of use assets and lease liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. The discount rate used to determine the commencement date present value of lease payment is the interest rate implicit in the lease, or when that is not readily determinable, we utilized our incremental borrowing rate, which is the rate incurred to borrow on a collateralized basis over a similar term at an amount equal to the lease payments in a similar economic environment. Certain adjustments to the right-of-use asset may be required for items such as initial direct costs paid or incentives received.
The following table presents supplemental balance sheet information related to our financing and operating leases:
|
in thousands
|
As of March 31, 2019
|
|||||||
|
Financing Leases
|
|
Operating Leases
|
|
|||||
|
Right-of-use Assets
|
$
|
1,187
|
|
$
|
22,284
|
|
||
|
Liabilities
|
||||||||
|
Short-term operating lease liabilities
|
421
|
|
8,030
|
|
||||
|
Long-term operating lease liabilities
|
680
|
|
15,242
|
|
||||
|
Total Liabilities
|
$
|
1,101
|
|
$
|
23,272
|
|
||
For the three months ended March 31, 2019, the components of lease expense were as follows:
|
in thousands
|
|
Three Months Ended March 31, 2019
|
||
|
Operating lease cost
|
|
$
|
2,215
|
|
|
|
|
|
||
|
Finance lease cost
|
|
|
||
|
Amortization of right-of-use assets
|
|
64
|
||
|
Interest on lease liabilities
|
|
19
|
||
|
Total Finance lease cost
|
|
83
|
|
|
|
Variable lease cost
|
|
537
|
|
|
|
Total lease cost
|
|
$
|
2,835
|
|
13
Other information related to leases was as follows:
|
in thousands
|
|
Three Months Ended March 31, 2019
|
||
|
Supplemental Cash Flows Information
|
|
|
||
|
|
|
|
||
|
Cash paid for amounts included in the measurement of lease liabilities:
|
|
|
||
|
Operating cash flows from operating leases
|
|
$
|
4,285
|
|
|
Operating cash flows from finance leases
|
|
22
|
|
|
|
Financing cash flows from finance leases
|
|
101
|
|
|
|
|
|
|
||
|
Weighted Average Remaining Lease term
|
|
|
||
|
|
|
|
||
|
Operating leases
|
|
3.5
|
|
|
|
Finance leases
|
|
3.3
|
|
|
|
|
|
|
||
|
Weighted Average Discount Rate
|
|
|
||
|
Operating leases
|
|
4.71
|
%
|
|
|
Finance leases
|
|
7.16
|
%
|
|
The maturity of the Company’s finance and operating lease liabilities as of March 31, 2019 are as follows:
|
in thousands
|
Operating Leases
|
|
Finance Leases
|
|
||||
|
Year Ending December 31,
|
||||||||
|
2019 (excluding the quarter ended March 31, 2019)
|
$
|
8,882
|
|
$
|
475
|
|
||
|
2020
|
7,076
|
|
325
|
|
||||
|
2021
|
4,664
|
|
186
|
|
||||
|
2022
|
2,783
|
|
141
|
|
||||
|
2023
|
1,113
|
|
74
|
|
||||
|
2024
|
706
|
|
—
|
|
||||
|
Total future minimum lease payments
|
25,224
|
|
1,201
|
|
||||
|
Less: Imputed interest
|
1,952
|
|
100
|
|
||||
|
Total lease liabilities
|
$
|
23,272
|
|
$
|
1,101
|
|
||
As previously disclosed in our 2018 10-K and under the previous lease accounting standard, ASC 840, Leases, the total commitment for non-cancelable operating and finance leases was
$35.0 million
and
$1.3 million
as of December 31, 2018:
14
|
in thousands
|
|
Operating Leases
|
|
Finance Leases
|
||||
|
Year Ending December 31,
|
|
|
|
|||||
|
2019
|
|
$
|
9,645
|
|
|
$
|
748
|
|
|
2020
|
|
8,815
|
|
|
307
|
|
||
|
2021
|
|
7,425
|
|
|
131
|
|
||
|
2022
|
|
5,456
|
|
|
133
|
|
||
|
2023
|
|
2,349
|
|
|
104
|
|
||
|
Thereafter
|
|
1,328
|
|
|
—
|
|
||
|
Total future minimum lease payments
|
|
$
|
35,018
|
|
|
$
|
1,423
|
|
|
|
|
|
|
|
||||
|
Less: imputed interest
|
|
|
|
120
|
|
|||
|
|
|
|
|
|
||||
|
Total
|
|
|
|
$
|
1,303
|
|
||
|
|
|
|
|
|
||||
As of March 31, 2019, we
have additional operating leases, that have not yet commenced of
$2.9 million
. These operating and finance leases
will commence between fiscal year 2019 and fiscal year 2020 with lease terms of
1 year
to
5 years
.
Note E - Convertible Preferred Stock
Our Amended and Restated Certificate of Incorporation authorizes us to issue
1.0 million
shares of preferred stock (“Preferred Stock”). On January 30, 2018, we issued
9,926
shares of our Series A Preferred Stock to Wipro, LLC (as further described in Note A above under the heading "Securities Purchase Agreement") at an issue price of
$1,000
per share, for gross proceeds of
$9.9 million
pursuant to a Certificate of Designation filed with the State of Delaware on January 29, 2018. We incurred
$0.2 million
of transaction fees in connection with the issuance of the Preferred Stock which are netted against the gross proceeds of
$9.9 million
on our Condensed Consolidated Financial Statements.
Series A Preferred Stock has the following rights and privileges:
Liquidation Rights
In the event of a liquidation, dissolution or winding down of the company or a Fundamental Transaction (defined in the Certificate of Designation for the Series A Preferred Stock), whether voluntary or involuntary, the holders of the Series A Preferred Stock are entitled to receive, prior to and in preference to the holders of common stock, from the assets of the company available for distribution, an amount equal to the greater of (i) the original issue price, plus any dividends accrued but unpaid thereon, and (ii) such amount per share as would have been payable had all shares of Series A Preferred Stock been converted into Common Stock immediately before such liquidation.
Upon liquidation, after the payment of all preferential amounts required to be paid to the holders of Series A Preferred Stock, the remaining assets of the Company available for distribution to its stockholders shall be distributed among the holders of common stock.
Dividends
Upon liquidation, dissolution or winding down of the company, or a Fundamental Transaction, shares of Series A Preferred Stock which have not been otherwise converted to Common Stock, shall be entitled to receive dividends that accrue at a rate of (i)
5%
each year, or (ii) the rate that cash dividends were paid in respect of common stock (with Series A Preferred Stock being paid on an as-converted basis in such case) for such year if such rate is greater than
5%
. Dividends on the Series A Preferred Stock are cumulative and accrue to the holders thereof whether or not declared by the Board of Directors. Dividends are payable solely upon a Liquidation (as defined in the Certificate of Designation), but only if prior to such Liquidation such shares of Series A Preferred Stock have not been converted to Common Stock. As of
March 31, 2019
, cumulative dividends payable to the holders of Series A Preferred Stock upon a Liquidation totaled
$0.1 million
, or
$12.33
per share of Series A Preferred Stock.
Conversion
15
At the option of the holders of Series A Preferred Stock, shares of Series A Preferred Stock may be converted into Common Stock at a rate of
100.90817
shares of Common Stock for
one
share of Series A Preferred Stock, subject to certain future adjustments.
Voting and Other Rights
The Series A Preferred Stock does not have voting rights, except as otherwise required by law. Other rights afforded the holders of Series A Preferred Stock, under defined circumstances, include the election and removal of one member of the Board of Directors as a separate voting class, the ability to approve certain actions of the Company prior to execution, and preemptive rights to participate in any future issuances of new securities. In addition, under certain circumstances, the holder of the Series A Preferred Stock is entitled to appoint an observer to our Board of Directors. The holder of the Series A Preferred Stock has elected to exercise its observer appointment rights but not its right to appoint the board member.
We determined that the Series A Preferred Stock has contingent redemption provisions allowing redemption by the holder upon certain defined events. As the event that may trigger the redemption of the Series A Preferred Stock is not solely within our control, the Series A Preferred Stock is classified as mezzanine equity (temporary equity) in the Condensed Consolidated Balance Sheet as of
March 31, 2019
.
Note F
— Long-Term Debt
As of
March 31, 2019
and
December 31, 2018
, we had
$18.7 million
and
$14.2 million
of borrowings outstanding under the Texas Capital Facility.
Credit Facilities
On April 17, 2017, we entered into a secured credit facility with Texas Capital Bank, N.A., that provided a
$20 million
revolving credit facility (the "Texas Capital Credit Facility") and letters of credit issued by Texas Capital Bank up to
$5.0 million
. The Texas Capital Credit Facility will be used for general corporate purposes. The Texas Capital Credit Facility is secured by substantially all of the company's assets and its material domestic subsidiaries. The Texas Capital Credit Facility is guaranteed by HHS Guaranty, LLC, an entity formed to provide credit support for Harte Hanks by certain members of the Shelton family (descendants of one of our founders).
Under the Texas Capital Credit Facility, we can elect to accrue interest on outstanding principal balances at either
LIBOR
plus
1.95%
or
prime
plus
0.75%
. Unused credit balances accrue interest at
0.50%
. We are required to pay a quarterly fee of
$0.1 million
as consideration for the collateral balances provided by HHS Guaranty, LLC.
The Texas Capital Credit Facility is subject to customary covenants requiring insurance, legal compliance, payment of taxes, prohibition of second liens, and secondary indebtedness, as well as the filing of quarterly and annual financial statements.
The Texas Capital Credit Facility originally had an expiration date of April 17, 2019, at which point all outstanding amounts would have been due. On January 9, 2018, we entered into an amendment to the Texas Capital Credit Facility that increased the borrowing capacity to
$22 million
and extended the maturity by one year to April 17, 2020. On May 7, 2019, we entered into an amendment to the Texas Capital Credit Facility which further extended the maturity of the facility by
one
year to April 17, 2021. The Texas Capital Credit Facility remains secured by substantially all of our assets and continues to be guaranteed by HHS Guaranty, LLC.
At
March 31, 2019
, we had letters of credit outstanding in the amount of
$2.8 million
.
No
amounts were drawn against these letters of credit at
March 31, 2019
. These letters of credit exist to support insurance programs relating to workers’ compensation, automobile, and general liability.
Note G
— Stock-Based Compensation
We maintain stock incentive plans for the benefit of certain officers, directors, and employees, including the 2013 Omnibus Incentive Plan. Our stock incentive plans include stock options, cash stock appreciation rights, performance stock units, phantom stock units and cash performance stock units. Our cash stock appreciation rights, phantom stock units and cash performance stock units settle solely in cash and are treated as a liability, which are adjusted each reporting period based on changes in our stock price.
16
Compensation expense for stock-based awards is based on the fair values of the awards on the date of grant and is recognized on a straight-line basis over the vesting period of the entire award in the “Labor” line of the Condensed Consolidated Statements of Comprehensive Income (Loss). We recognized
$0.2 million
and
$0.6 million
of stock-based compensation expense during the
three months ended March 31, 2019
and
2018
, respectively.
Note H
— Components of Net Periodic Benefit Cost
Prior to January 1, 1999, we maintained a defined benefit pension plan for which most of our employees were eligible (the "Qualified Pension Plan"). We elected to freeze benefits under the Qualified Pension Plan as of December 31, 1998.
In 1994, we adopted a non-qualified, unfunded, supplemental pension plan (the "Restoration Pension Plan") covering certain employees, which provides for incremental pension payments so that total pension payments equal those amounts that would have been payable from our Qualified Pension Plan were it not for limitations imposed by income tax regulation. The Restoration Pension Plan was intended to provide benefits equivalent to our Qualified Pension Plan as if such plan had not been frozen. We elected to freeze benefits under the Restoration Pension Plan as of April 1, 2014.
Net pension cost for both plans included the following components:
|
|
Three Months Ended March 31,
|
||||||
|
In thousands
|
2019
|
2018
|
|||||
|
Interest cost
|
$
|
1,813
|
|
$
|
1,685
|
|
|
|
Expected return on plan assets
|
(1,111
|
)
|
(1,524
|
)
|
|||
|
Recognized actuarial loss
|
733
|
|
689
|
|
|||
|
Net periodic benefit cost
|
$
|
1,435
|
|
$
|
850
|
|
|
We are required to make a minimum of
$2.2 million
contribution to our Qualified Pension Plan in
2019
.
We are not required to make, and do not intend to make, any contributions to our Restoration Pension Plan other than to the extent needed to cover benefit payments. We made benefit payments under this supplemental plan of
$0.4 million
in the
three months ended
March 31, 2019
.
Note I
- Income Taxes
Our income tax expense of
$0.8 million
for the three months ended March 31, 2019 resulted in a negative effective income tax rate of
6.2%
. The effective income tax rate for the three months ended March 31, 2019 differs from the federal statutory rate of 21.0%, primarily due to valuation allowances recorded on our deferred tax assets for current period federal net operating losses incurred, as we have concluded that it is more likely than not that these deferred tax assets will not be realized. We have in general historically calculated the provision for income taxes during interim reporting periods by applying an estimate of the annual effective tax rate for the full calendar year to ordinary income or loss for the reporting period. However, we have used a discrete effective tax rate method to calculate income taxes for the three months ended March 31, 2019 because we determined that our ordinary income or loss cannot be reliably estimated and small changes in estimated ordinary income would result in significant changes in the estimated annual effective tax rate.
Our income tax benefit of
$8.8 million
for the three months ended March 31, 2018 resulted in an effective income tax rate of
106.2%
. The effective income tax benefit calculated for the three months ended March 31, 2018 differs from the federal statutory rate of 21.0%, primarily due to the capital loss generated from the sale of 3Q Digital which will be available for carryback. We used a discrete effective tax rate method to calculate income taxes for the three months ended March 31, 2018, because we determined that small changes in estimated ordinary income would result in significant changes in the estimated annual effective tax rate, such that the historical method would not provide a reliable estimate for the three months ended March 31, 2018.
Effective January 1, 2019 we adopted ASU 2018-02 which allows a reclassification from accumulated other comprehensive
income to retained earnings for stranded tax effects resulting from the reduction of the U.S. federal statutory income tax rate
from 35% to 21% due to the enactment of the U.S. Tax Cuts and Jobs Act of 2017 (the "Tax Reform Act”). As a result of the adoption, we reclassified
$11.4 million
of stranded tax effects from accumulated other comprehensive income to retained earnings.
Harte Hanks, or one of our subsidiaries, files income tax returns in the U.S. federal, U.S. state, and foreign jurisdictions. For
17
U.S. state returns, we are no longer subject to tax examinations for tax years prior to 2013. For U.S. federal and foreign returns, we are no longer subject to tax examinations for tax years prior to 2015.
We have elected to classify any interest expense and penalties related to income taxes within income tax expense in our Condensed Consolidated Statements of Comprehensive Income (Loss). We did not have a significant amount of interest or penalties accrued at March 31, 2019 or December 31, 2018.
Note J
- Earnings Per Share
In periods in which the company has net income, the company is required to calculate earnings per share ("EPS") using the two-class method. The two-class method is required because the company's preferred stock is considered a participating security with objectively determinable and non-discretionary dividend participation rights. Preferred stockholders have the right to participate in dividends above their
five
percent dividend rate should the company declare dividends on its Common Stock at a dividend rate higher than the five percent (on an as-converted basis). Under the two-class method, undistributed and distributed earnings are allocated on a pro-rata basis to the common and the preferred stockholders. The weighted-average number of common and preferred stock outstanding during the period is then used to calculate EPS for each class of shares.
In periods in which the company has a net loss, basic loss per share is calculated using the treasury stock method. The treasury stock method is calculated by dividing the net loss by the weighted-average number of common shares outstanding during the period. The two-class method is not used, because the calculation would be anti-dilutive.
Reconciliations of basic and diluted EPS were as follows:
|
|
Three Months Ended March 31,
|
|||||||
|
In thousands, except per share amounts
|
2019
|
2018
|
||||||
|
Net (loss) Income
|
$
|
(13,527
|
)
|
$
|
32,629
|
|
||
|
Less: Preferred stock dividends
|
122
|
|
—
|
|
||||
|
(Loss) income attributable to common stockholders
|
$
|
(13,649
|
)
|
$
|
32,629
|
|
||
|
Basic loss per Common Share
|
||||||||
|
Weighted-average common shares outstanding
|
6,268
|
|
6,213
|
|
||||
|
Basic (loss) income per common share
|
$
|
(2.18
|
)
|
$
|
5.24
|
|
||
|
Diluted Earnings (Loss) per Common Share
|
|
|
|
|
||||
|
Weighted-average shares used to compute earnings/(loss) per share attributable to common shares
|
6,268
|
|
6,990
|
|
||||
|
Diluted (loss) income per common share
|
$
|
(2.18
|
)
|
$
|
4.67
|
|
||
|
Computation of Shares Used in Diluted Earnings (Loss) Per Common Share
|
|
|
|
|
||||
|
Weighted-average common shares outstanding
|
6,268
|
|
6,213
|
|
||||
|
Shares used in diluted earnings (loss) per common share computations
|
6,268
|
|
6,990
|
|
||||
0.1 million
and
0.3 million
shares of anti-dilutive market price options have been excluded from the calculation of shares used in the diluted EPS calculation for the
three months ended March 31, 2019
and
2018
, respectively.
0.1 million
and
0.2 million
of anti-dilutive unvested shares were excluded from the calculation of shares used in the diluted EPS calculation for the
three months ended
March 31, 2019
and
2018
, respectively.
1.0 million
shares of anti-dilutive preferred stock (as if converted) have been excluded from the calculation of shares used in the diluted EPS calculation for the
three months ended March 31, 2019
.
18
Note K
— Comprehensive (Loss) Income
Comprehensive income (loss) for a period encompasses net income (loss) and all other changes in equity other than from transactions with our stockholders. Our comprehensive (loss) income was as follows:
|
|
Three Months Ended March 31,
|
|||||||
|
In thousands
|
2019
|
2018
|
||||||
|
Net (loss) Income
|
$
|
(13,527
|
)
|
$
|
32,629
|
|
||
|
|
||||||||
|
Other comprehensive income (loss):
|
|
|
|
|
||||
|
Adjustment to pension liability
|
733
|
|
691
|
|
||||
|
Tax expense
|
(183
|
)
|
(173
|
)
|
||||
|
Adoption of ASC 2018-02
|
(11,355
|
)
|
—
|
|
||||
|
Adjustment to pension liability, net of tax
|
(10,805
|
)
|
518
|
|
||||
|
Foreign currency translation adjustment, net of tax
|
(28
|
)
|
(154
|
)
|
||||
|
Total other comprehensive (loss) income, net of tax
|
(10,833
|
)
|
364
|
|
||||
|
|
||||||||
|
Total comprehensive (loss) income
|
$
|
(24,360
|
)
|
$
|
32,993
|
|
||
Changes in accumulated other comprehensive income (loss) by component were as follows:
|
In thousands
|
Defined Benefit
Pension Items |
Foreign Currency Items
|
Total
|
|||||||||
|
Balance at December 31, 2018
|
$
|
(46,584
|
)
|
$
|
101
|
|
$
|
(46,483
|
)
|
|||
|
Other comprehensive income (loss), net of tax, before reclassifications
|
—
|
|
(28
|
)
|
(28
|
)
|
||||||
|
Amounts reclassified from accumulated other comprehensive income (loss), net of tax, to other, net, on the condensed consolidated statements of comprehensive (loss) income
|
550
|
|
—
|
|
550
|
|
||||||
|
Adoption of ASU 2018-02
|
(11,355
|
)
|
|
—
|
|
|
(11,355
|
)
|
||||
|
Balance at March 31, 2019
|
$
|
(57,389
|
)
|
$
|
73
|
|
$
|
(57,316
|
)
|
|||
|
In thousands
|
Defined Benefit
Pension Items |
Foreign Currency Items
|
Total
|
|||||||||
|
Balance at December 31, 2017
|
$
|
(45,418
|
)
|
$
|
1,115
|
|
$
|
(44,303
|
)
|
|||
|
Other comprehensive (loss), net of tax, before reclassifications
|
—
|
|
(154
|
)
|
(154
|
)
|
||||||
|
Amounts reclassified from accumulated other comprehensive income (loss), net of tax, to other, net, on the condensed consolidated statements of comprehensive (loss) income
|
518
|
|
—
|
|
518
|
|
||||||
|
Net current period other comprehensive income (loss), net of tax
|
518
|
|
(154
|
)
|
364
|
|
||||||
|
Balance at March 31, 2018
|
$
|
(44,900
|
)
|
$
|
961
|
|
$
|
(43,939
|
)
|
|||
Reclassification amounts related to the defined pension plans are included in the computation of net periodic pension benefit cost (see
Note H
,
Components of Net Periodic Benefit Cost
).
Note L
— Litigation and Contingencies
In the normal course of our business, we are obligated under some agreements to indemnify our clients as a result of claims that we infringe on the proprietary rights of third parties. The terms and duration of these commitments vary and, in some cases, may be indefinite, and certain of these commitments do not limit the maximum amount of future payments we could become obligated to make thereunder; accordingly, our actual aggregate maximum exposure related to these types of commitments is not reasonably estimable. Historically, we have not been obligated to make significant payments for obligations of this nature, and
no
liabilities have been recorded for these obligations in our condensed consolidated financial statements.
We are also subject to various claims and legal proceedings in the course of conducting our businesses and, from time to time, we may become involved in additional claims and lawsuits incidental to our businesses. We routinely assess the likelihood of adverse judgments or outcomes to these matters, as well as ranges of probable losses; to the extent losses are reasonably estimable. Accruals are recorded for these matters to the extent that management concludes a loss is probable and the financial impact, should an adverse outcome occur, is reasonable estimable.
19
In the opinion of management, appropriate and adequate accruals for legal matters have been made, and management believes that the probability of a material loss beyond the amounts accrued is remote. Nevertheless, we cannot predict the impact of future developments affecting our pending or future claims and lawsuits. We expense legal costs as incurred, and all recorded legal liabilities are adjusted as required as better information becomes available to us. The factors we consider when recording an accrual for contingencies include, among others: (i) the opinions and views of our legal counsel; (ii) our previous experience; and (iii) the decision of our management as to how we intend to respond to the complaints.
Note M
— Disposition
On February 28, 2018, we sold our 3Q Digital, Inc. subsidiary ("3Q Digital") to an entity owned by certain former owners of the 3Q Digital business. Consideration for the sale included
$5.0 million
in cash proceeds, subject to certain working capital adjustments, and up to
$5.0 million
in additional consideration if the 3Q Digital business is sold again (provided certain value thresholds are met). The
$35.0 million
contingent consideration obligation of the company that related to our acquisition of 3Q Digital in 2015 was assigned to the buyer, thereby relieving us of the obligation. In addition, the identified intangible assets with definite lives for client relationships and non-compete agreements were written-off as a component of the gain on sale.
The 3Q Digital business represented less than
10%
of our total 2017 revenues. As a result of the sale, the company recognized a pre-tax gain of
$31.0 million
in the first quarter of 2018. The assets of 3Q Digital included net intangible assets and the liabilities (including contingent consideration) were removed from our balance sheet as a result of the disposition.
A reconciliation of accrued balances of the contingent consideration using significant unobservable inputs (Level 3) is as follows:
|
In thousands
|
Fair Value
|
|||
|
Accrued contingent consideration liability as of December 31, 2017
|
$
|
33,887
|
|
|
|
Accretion of interest
|
742
|
|
||
|
Disposition
|
(34,629
|
)
|
||
|
Accrued contingent consideration liability as of March 31, 2018
|
$
|
—
|
|
|
On May 7, 2019, we received the
$5 million
Contingent Payment related to the Qualified Sale of 3Q Digital as defined in the Purchase and Sale Agreement dated February 28, 2018.
Note O — Certain Relationships and Related Party Transactions
Since 2016, we have conducted (and we continue to conduct) business with Wipro, whereby Wipro provides us with a variety of technology-related services, including database and software development, database support and analytics, IT infrastructure support, leased facilities and digital campaign management. Additionally, we also provide Wipro with agency services and consulting services.
Effective January 30, 2018, Wipro became a related party when it purchased
9,926
shares of our Series A Preferred Stock (which are convertible at Wipro's option into
1,001,614
shares, or
16%
of our Common Stock), for aggregate consideration of
$9.9 million
. For information pertaining to the Company’s preferred stock, See Note E,
Convertible Preferred Stock
.
During the
three months ended
March 31, 2019
, we recorded an immaterial amount of revenue for services we provided to Wipro. During the three months ended March 31, 2018, we recorded
no
revenue from services we provided to Wipro.
During the
three months ended
March 31, 2019
and
2018
, we recorded
$6.3 million
and
$2.8 million
of expense, respectively, in technology-related services and lease expense for a facility Wipro provided to us. Included in the first quarter 2019
$6.3 million
expense was also a one-time termination charge of $
2.1 million
as in the first quarter of 2019, we terminated several contracts with Wipro and entered into new agreements resulting in
$3.3 million
of annual savings.
During the
three months ended
March 31, 2019
and 2018, we capitalized
$0.8 million
and $
1.1 million
, respectively, for internally developed software services received from Wipro. These remaining capitalized costs are included in Property, Plant and Equipment on the Condensed Consolidated Balance Sheet as of March 31, 2019 and 2018.
As of
March 31, 2019
and
December 31, 2018
, we had a trade payable due to Wipro of
$5.3 million
and
$5.0 million
, respectively. As of
March 31, 2019
and
December 31, 2018
, we had an immaterial amount in trade receivables due from Wipro for services provided in 2017 but invoiced in 2018
.
20
As described in “Note F- Long-Term Debt", the Company’s Texas Capital Credit Facility is secured by HHS Guaranty, LLC, an entity formed to provide credit support for the Company by certain members of the Shelton family (descendants of one of our founders). Pursuant to the Amended and Restated Fee, Reimbursement and Indemnity Agreement, dated January 9, 2018, between HHS Guaranty, LLC and the Company, HHS Guaranty, LLC has the right to appoint one representative director to the Board of Directors. Currently, David L. Copeland serves as the HHS Guaranty, LLC representative on the Board of Directors.
Note P — Restructuring Activities
On September 21, 2018, our Board of Directors approved a reduction in our workforce for certain employees performing sales and corporate marketing functions. In addition, in the fourth quarter of 2018 we identified additional reduction opportunities which resulted in an additional reduction of our workforce in other functions. The workforce reductions resulted in a restructuring charge of approximately
$0.9 million
for employee severance and related costs and we anticipate that this action will result in annualized cost savings of approximately
$7.5 million
.
We continue to reduce our workforce in response to the declining revenue. To date in 2019, we have recognized severance expense in the amount of
$0.5 million
in relation to this termination which resulted in
$5.7 million
of annual savings. We plan to make further reductions in the workforce which will result in an additional
$0.5 million
severance expense and
$3.4 million
of annual cost savings.
In the first quarter of 2019, we terminated several contracts with Wipro and entered into new agreements resulting in
$3.3 million
of annual savings. As a result, we incurred a one-time termination charge of
$2.1 million
which was included in our operating expense for the first quarter of 2019. We also recorded an impairment charge of
$2.3 million
on our long-term other assets, the majority of which were related to capitalized labor to build customer databases. A decision was made to not move forward with this database platform.
We are in the process of advancing initiatives to remove an additional
$3 million
in annualized vendor-related savings. In addition, subsequent to the end of the first quarter, we reduced the size and expense of our executive team. Going forward, we will maintain our aggressive pursuit of additional cost cutting opportunities throughout the organization.
Note Q — Subsequent Events
On May 8, 2019, the Company announced that, in order to focus on his role as Chairman of Qnary LLC, Bant Breen will step down as Chief Executive Officer, as well as resign from his membership on the Company’s Board of Directors and any officer and director positions with the Company’s subsidiaries on May 10, 2019 (“Separation Date”). The Company and Mr. Breen have entered into a separation agreement memorializing the terms of his transition and eventual separation of employment (the “Separation Agreement”). Mr. Breen has agreed to provide consulting services following the Separation Date until November 10, 2019 or such other earlier date as determined by the Board of Directors. During the consulting period, Mr. Breen will receive a monthly fee of
$31,667
. Additionally, the Separation Agreement contains a release, as well as a non-disparagement provision, and ratifies the confidentiality and non-solicitation covenants in Mr. Breen’s employment restrictions agreement with the Company, dated January 4, 2019.
Andrew Harrison, the Company’s President, will assume the role of the Principal Executive Officer of the Company effective as of the Separation Date.
On May 7, 2019, we entered into an amendment to the Texas Capital Credit Facility which further extended the maturity of the facility by
one
year to April 17, 2021. The Texas Capital Credit Facility remains secured by substantially all of our assets and continues to be guaranteed by HHS Guaranty, LLC.
On May 7, 2019, we received a
$5 million
Contingent Payment related to the Qualified Sale of 3Q Digital as defined in the Purchase and Sale Agreement dated February 28, 2018.
21
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Note Regarding Forward-Looking Statements
This report, including the Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A"), contains “forward-looking statements” within the meaning of the federal securities laws. All such statements are qualified by this cautionary note, which is provided pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933 (the "1933 Act") and Section 21E of the 1934 Act. Forward-looking statements may also be included in our other public filings, press releases, our website, and oral and written presentations by management. Statements other than historical facts are forward-looking and may be identified by words such as “may,” “will,” “expects,” “believes,” “anticipates,” “plans,” “estimates,” “seeks,” “could,” “intends,” or words of similar meaning. Examples include statements regarding (1) our strategies and initiatives, (2) adjustments to our cost structure and other actions designed to respond to market conditions and improve our performance, and the anticipated effectiveness and expenses associated with these actions, (3) our financial outlook for revenues, earnings per share, operating income, expense related to equity-based compensation, capital resources and other financial items, (4) expectations for our businesses and for the industries in which we operate, including the impact of economic conditions of the markets we serve on the marketing expenditures and activities of our clients and prospects, (5) competitive factors, (6) acquisition, disposition, and development plans, (7) our stock repurchase program, (8) expectations regarding legal proceedings and other contingent liabilities, (9) the impact of recent tax reform legislation on our results of operations, and (10) other statements regarding future events, conditions, or outcomes.
These forward-looking statements are based on current information, expectations, and estimates and involve risks, uncertainties, assumptions, and other factors that are difficult to predict and that could cause actual results to vary materially from what is expressed in or indicated by the forward-looking statements. In that event, our business, financial condition, results of operations, or liquidity could be materially adversely affected and investors in our securities could lose part or all of their investments. Some of these risks, uncertainties, assumptions, and other factors can be found in our filings with the Securities and Exchange Commission, including the factors discussed under “Item 1A. Risk Factors” in the 2018 10-K, and in the “Cautionary Note Regarding Forward-Looking Statements” in our first quarter 2019 earnings release issued on May 8, 2019. The forward-looking statements included in this report and those included in our other public filings, press releases, our website, and oral and written presentations by management are made only as of the respective dates thereof, and we undertake no obligation to update publicly any forward-looking statement in this report or in other documents, our website, or oral statements for any reason, even if new information becomes available or other events occur in the future, except as required by law.
Overview
The following MD&A section is intended to help the reader understand the results of operations and financial condition of Harte Hanks, Inc. This section is provided as a supplement to, and should be read in conjunction with, our condensed consolidated financial statements and the accompanying notes to the Condensed Consolidated Financial Statements as well as our
2018
10-K. Our
2018
10-K contains a discussion of other matters not included herein, such as disclosures regarding critical accounting policies and estimates, and contractual obligations. The following MD&A of Financial Condition and Results of Operations gives retroactive effect to the Reverse Stock Split for all periods presented, unless otherwise noted. See Note A,
Overview and Significant Accounting Polici
es, in the Notes to Condensed Consolidated Financial Statements for further information.
Harte Hanks partners with clients to deliver relevant, connected, and quality customer interactions. Our approach starts with discovery and learning, which leads to customer journey mapping, creative and content development, analytics, and data management, and ends with execution and support in a variety of digital and traditional channels. We do something powerful: we produce engaging and memorable customer interactions to drive business results for our clients, which is why Harte Hanks is known for developing better customer relationships and experiences and defining interaction-led marketing.
Our services offer a wide variety of integrated, multi-channel, data-driven solutions for top brands around the globe. We help our clients gain insight into their customers’ behaviors from their data and use that insight to create innovative multi-channel marketing programs that deliver greater return on marketing investment. We believe our clients’ success is determined not only by how good their tools are, but how well we help them use the tools to gain insight and analyze their consumers. This results in a strong and enduring relationship between our clients and their customers which is key to being leaders in customer interaction. We offer a full complement of capabilities and resources to provide a broad range of marketing services, in media from direct mail to email, including:
|
•
|
Agency
|
|
•
|
Digital Solutions
|
|
•
|
Database Marketing Solutions
|
|
•
|
Direct mail
|
22
|
•
|
Mail and Product Fulfillment
|
|
•
|
Logistics
|
|
•
|
Contact centers.
|
We are affected by the general, national, and international economic and business conditions in the markets where we and our customers operate. Marketing budgets are largely discretionary in nature, and as a consequence are easier for our clients to reduce in the short-term than other expenses. Our revenues are also affected by the economic fundamentals of each industry that we serve, various market factors, including the demand for services by our clients, and the financial condition of and budgets available to specific clients, among other factors. We remain committed to making the investments necessary to execute our multichannel strategy while also continuing to adjust our cost structure to reduce costs in the parts of the business that are not growing as fast.
We continued to face a challenging competitive environment in 2019. The sale of 3Q Digital in 2018, together with our restructuring efforts that are meant to decrease recurring expenses, are all parts of our efforts to prioritize our investments and focus on our core business of optimizing our clients' customer journey across an omni-channel delivery platform. We expect these actions will enhance our liquidity and financial flexibility. For additional information, see Liquidity and Capital Resources section. We have taken actions to return the business to profitability and improve our cash, liquidity, and financial position. This includes workforce restructuring, making investments targeted at improving product offerings, and implementing expense reductions.
Recent Developments
Management Changes
On May 8, 2019, the Company announced that, in order to focus on his role as Chairman of Qnary LLC, Bant Breen will step down as Chief Executive Officer, as well as resign from his membership on the Company's Board of Directors. Mr. Breen was initially appointed as our CEO on January 4, 2019. Andrew Harrison, the Company's President, will assume the role of the Principal Executive Officer of the Company. Mr. Harrison was initially promoted to President and Chief Operating Officer on January 4, 2019 and has been with the company for over 20 years.
On February 1, 2019, Martin Reidy took the helm of our marketing services division which covers our agency, digital solutions and database marketing solutions. Martin was a Harte Hanks board member and has significant experience in direct marketing, digital advertising, predictive marketing and data-driven results marketing. Most recently, Martin served as the President and CEO of Ansira Partners, a data and digital marketing agency. Prior to that he was CEO and President of Meredith Xcelerated Marketing (a marketing services division within Meredith Publishing Inc.), Publicis Modem and R/GA (leading digital advertising and relationship marketing services firms).
On January 16, 2019, Mark Del Priore was appointed as Chief Financial Officer to succeed Jon Biro who chose to leave the Company. Mark has more than 15 years of media experience, most recently as CFO for the publicly traded advertising company, SITO Mobile. Mark began working with Harte Hanks as an advisor in October 2018.
Restructuring Activities
We continue our restructuring efforts to reduce operating expenses. In the first quarter of 2019, we terminated several contracts with Wipro and entered into new agreements resulting in $3.3 million of annual savings. As a result, we incurred a one-time termination charge of $2.1 million which was included in our operating expense for the first quarter of 2019. We also recorded an impairment charge of $2.3 million on our long-term other assets, the majority of which were related to capitalized labor to build customer databases. A decision was made to not move forward with this database platform.
On September 21, 2018, our Board of Directors approved a reduction in our workforce for certain employees performing sales and corporate marketing functions. In addition, in the fourth quarter of 2018 we identified additional reduction opportunities which resulted in an additional reduction of our workforce in other functions. The workforce reductions resulted in a restructuring charge of approximately $0.9 million for employee severance and related costs and we anticipate that this action will result in annualized cost savings of approximately $7.5 million. In addition, beginning in 2019 we expect to reduce certain non-labor discretionary expenses, with the aim of reducing expenses by approximately an additional $2.0 million per year
.
Results of Operations
23
Operating results were as follows:
|
|
Three Months Ended March 31,
|
|
|||||||||
|
In thousands
|
2019
|
2018
|
% Change
|
||||||||
|
Revenues
|
$
|
59,150
|
|
$
|
81,198
|
|
(27.2
|
)%
|
|||
|
Operating expenses
|
70,090
|
|
86,233
|
|
(18.7
|
)%
|
|||||
|
Operating Loss
|
$
|
(10,940
|
)
|
$
|
(5,035
|
)
|
117.3
|
%
|
|||
|
|
|
|
|||||||||
|
Operating margin
|
(18.5
|
)%
|
(6.2
|
)%
|
|||||||
|
Income (Loss) before taxes
|
$
|
(12,737
|
)
|
$
|
23,849
|
|
(153.4
|
)%
|
|||
|
Diluted Income (loss) per common share from operations
|
$
|
(2.18
|
)
|
$
|
4.67
|
|
(146.7
|
)%
|
|||
Revenues
Three months ended March 31,
2019
vs. Three months ended March 31,
2018
Revenues declined
$22.0 million
, or
27.2%
, in the
first
quarter of
2019
compared to the
first
quarter of
2018
. These results reflect the impact of declines in almost all of our industry verticals. Revenues declined in our retail, B2B, financial services, consumer and transportation verticals by
$3.3 million
, or
21.5%
,
$6.1 million
, or
32.3%
,
$1.7 million
, or
11.5%
,
$7.4 million
, or
37.8%
, and
$3.7 million
, or
46.4%
, respectively. Healthcare increased slightly by
$0.2 million
, or
4.6%
. These declines were partially due to the sale of 3Q Digital at the end of February 2018, which led to
$6.9 million
of the revenue reduction quarter-over-quarter and primarily impacted the B2B and Consumer verticals. Additionally, lost clients and lower volumes from existing clients caused the further decrease in revenues.
Among other factors, our revenue performance will depend on general economic conditions in the markets we serve and how successful we are at maintaining and growing business with existing clients and acquiring new clients. We believe that, in the long-term, an increasing portion of overall marketing and advertising expenditures will be shifted from other advertising media to targeted media advertising resulting in a benefit to our business. Targeted media advertising results can be more effectively tracked, enabling measurement of the return on marketing investment.
Operating Expenses
Three months ended March 31,
2019
vs. Three months ended March 31,
2018
Operating expenses were
$70.1 million
in the
first
quarter of
2019
, compared to
$86.2 million
in the
first
quarter of
2018
. This decline was partially caused by the sale of 3Q Digital (
$5.8 million
total operating expense reduction quarter-over-quarter). Labor costs declined
$16.8 million
, or
33.2%
, compared to the
first
quarter of
2018
, primarily due to lower payroll expense, our expense reduction efforts, and the sale of 3Q Digital (
$4.8 million
expense reduction) which was partially offset by higher severance expense. Production and distribution expenses declined
$1.1 million
, compared to the first quarter of 2018 primarily due to $0.7 million lower repairs and maintenance expense for IT and the sale of 3Q Digital resulting in
$0.4 million
lower expense compared to the prior year quarter. Advertising, Selling and General expense decreased
$1.8 million
, or
19.4%
, compared to the first quarter of 2018, primarily due to $0.6 million lower employee expense, $0.5 million lower business services expense and the sale of 3Q Digital (
$0.6 million
reduction). Depreciation, software and intangible asset amortization expense declined
$0.7 million
, or 28.5%, compared to the prior year quarter, primarily due to lower capital expenditure and the elimination of the intangible assets upon the sale of 3Q Digital.
The largest components of our operating expenses are labor, outsourced costs, and mail transportation expenses. Each of these costs is, at least in part, variable and tends to fluctuate in line with revenues and the demand for our services. Mail transportation rates have increased over the last few years due to demand and supply fluctuations within the transportation industry. Future changes in mail transportation expenses will continue to impact our total production costs and total operating expenses and may have an impact on future demand for our supply chain management services.
Postage costs for mailings are borne by our clients and are not directly reflected in our revenues or expenses.
Operating Loss
24
Three months ended March 31,
2019
vs. Three months ended March 31,
2018
Operating loss was
$10.9 million
in the first quarter of
2019
, compared to $5.0 million operating loss in the first quarter of
2018
. The
$5.9 million
decline reflected the impact of lower revenues of
$22.0 million
, partially offset by a
$16.1 million
decline in operating expenses. The sale of 3Q Digital in late February 2018 reduced operating income by
$1.1 million
, as compared to three months ended March 31, 2018.
Interest Expense
Three months ended March 31,
2019
vs. Three months ended March 31,
2018
Interest expense, net, in the first quarter of
2019
declined
$0.7 million
compared to the first quarter of
2018
. This decline was due to the elimination of interest accretion expense related to the 3Q Digital contingent consideration liability as of February 2018.
Other Income and Expense
Three months ended March 31,
2019
vs. Three months ended March 31,
2018
Other expense, net, increased
$0.4 million
in the first quarter of
2019
, compared to the first quarter of
2018
.
Income Taxes
Three months ended March 31,
2019
vs. Three months ended March 31,
2018
The income tax expense of $0.8 million in the first quarter of 2019 represents an increase in expense of $9.6 million
when compared to the first quarter of 2018. Our effective tax rate was negative 6.2% for the first quarter of 2019, decreasing
from a rate of 106.2% for the first quarter of 2018. We have in general historically calculated the provision for
income taxes during interim reporting periods by applying an estimate of the annual effective tax rate for the full calendar
year to ordinary income or loss for the reporting period. However, we used a discrete effective tax rate method to calculate
income taxes for the three months ended March 31, 2019 and March 31, 2018, because we determined that our ordinary
income or loss cannot be reliably estimated and small changes in estimated ordinary income would result in significant
changes in the estimated annual effective tax rate. The effective income tax rate calculated for the three months ended
March 31, 2019 differs from the federal statutory rate of 21.0%, primarily due to valuation allowances recorded on our
deferred tax assets for current period federal net operating losses incurred, as we have concluded that it is more likely than
not that these deferred tax assets will not be realized.
Liquidity and Capital Resources
Sources and Uses of Cash
Our cash and cash equivalent balances were
$20.9 million
at
March 31, 2019
and
December 31, 2018
. Our principal sources of liquidity are cash on hand, cash provided by operating activities, and borrowings. Our cash is primarily used for general corporate purposes, working capital requirements, and capital expenditures.
On May 7, 2019, we received a
$5
million Contingent Payment related to the Qualified Sale of 3Q Digital as defined in the Purchase and Sale Agreement dated February 28, 2018.
At this time, we believe that we will be able to continue to meet our liquidity requirements and fund our fixed obligations (such as debt services and operating leases) and other cash needs for our operations for at least the next twelve months through a combination of cash on hand, cash flow from operations, and borrowings under the Texas Capital Credit Facility. Although the Company believes that it will be able to meet its cash needs for the foreseeable future, if unforeseen circumstances arise the company may need to seek alternative sources of liquidity.
Operating Activities
Net cash used in operating activities for the
three months ended
March 31, 2019
was
$2.9 million
, compared to net cash provided by operating activities of
$2.8 million
for the
three months ended
March 31, 2018
. The
$5.7 million
year-over-year decrease was primarily the result of a decrease in net income in three months ended March 31, 2019 as compared to 2018.
25
Investing Activities
Net cash used in investing activities was
$1.1 million
for the
three months ended
March 31, 2019
, compared to the net cash provided by investing activities of
$2.3 million
for the
three months ended
March 31, 2018
. This change was mainly due to the sale of 3Q Digital in late February 2018.
Financing Activities
Net cash provided by financing activities was
$4.1 million
for the
three months ended
March 31, 2019
, compared to net cash provided of
$9.5 million
for the
three months ended
March 31, 2018
. The
$5.4 million
decrease
was primarily due to the issuance of the Series A Preferred Stock in the first quarter of 2018 which was partially offset by $4.5 million of borrowings under the Company’s credit facilities in the first quarter of 2019.
Foreign Holdings of Cash
Consolidated foreign holdings of cash as of
March 31, 2019
and
2018
were $2.3 million and $3.6 million, respectively.
Credit Facilities
On January 9, 2018, we entered into an amendment to the Texas Capital Credit Facility that increased the borrowing capacity to
$22 million
and extended the maturity by one year to April 17, 2020. On May 7, 2019, we entered into an amendment to the Texas Capital Credit Facility which further extended the maturity of the facility by one year to April 17, 2021. The Texas Capital Credit Facility remains secured by substantially all of our assets and continues to be guaranteed by HHS Guaranty, LLC.
At
March 31, 2019
, we had letters of credit in the amount of $2.8 million. No amounts were drawn against these letters of credit at
March 31, 2019
. These letters of credit exist to support insurance programs relating to workers’ compensation, automobile, and general liability.
As of
March 31, 2019
and
December 31, 2018
, we had $18.7 million and $14.2 million of borrowings outstanding under the Texas Capital Facility.
Outlook
We consider such factors as total cash and cash equivalents, current assets, current liabilities, total debt, revenues, operating income, cash flows from operations, investing activities, and financing activities when assessing our liquidity. Our management of cash is designed to optimize returns on cash balances and to ensure that it is readily available to meet our operating, investing, and financing requirements as they arise. We believe that there are no conditions or events, considered in the aggregate, that raise substantial doubt about our ability to continue as a going concern for the 12 months following the issuance of the Condensed Consolidated Financial Statements.
Critical Accounting Policies
Critical accounting policies are defined as those that, in our judgment, are most important to the portrayal of our company’s financial condition and results of operations and which require complex or subjective judgments or estimates. Refer to the 2018 10-K for a discussion of our critical accounting policies.
The following represent changes to our critical accounting policies as described in detail in our
2018
10-K:
|
•
|
The adoption of ASC 842,
Leases - t
he impact of this change in accounting policy is described in detail in Note D of the Notes to Unaudited Condensed Consolidated Financial Statements in this 10Q; and
|
|
•
|
Goodwill and intangible assets are no longer included as a critical accounting policy as we no longer have these assets on our condensed consolidated balance sheet
|
See Recent Accounting Pronouncements under Note B, of the Notes to Condensed Consolidated Financial Statements for a discussion of certain accounting standards that have been recently issued.
26
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk includes the risk of loss arising from adverse changes in market rates and prices. We face market risks related to interest rate variations and to foreign exchange rate variations. From time to time, we may utilize derivative financial instruments to manage our exposure to such risks.
As of
March 31, 2019
, we had
$18.7 million
of borrowings outstanding under the Texas Capital Facility. A hypothetical one percentage point change in average interest rates would not have a significant impact on our earnings for the three months ended March 31, 2019.
On April 17, 2017, we entered into the Texas Capital Credit Facility. On January 9, 2018, we entered an amendment to the Texas Capital Credit Facility that increased the borrowing capacity to $22 million and extended the maturity by one year to April 17, 2020.
On May 7, 2019, we entered into an amendment to the Texas Capital Credit Facility which further extended the maturity of the facility by
one
year to April 17, 2021. The credit facility increased exposure to market risks relating to changes in interest rates because borrowings under the facility bear interest at a variable rate. We do not believe that a one percentage point change in average interest rates would have a material impact on our interest expense. As such, we do not believe that we currently have significant exposure to market risks associated with changing interest rates.
Our earnings are also affected by fluctuations in foreign currency exchange rates as a result of our operations in foreign countries. Our primary exchange rate exposure is to the Euro, British Pound, and Philippine Peso. We monitor these risks throughout the normal course of business. The majority of the transactions of our U.S. and foreign operations are denominated in the respective local currencies. Changes in exchange rates related to these types of transactions are reflected in the applicable line items making up operating income (loss) in our Condensed Consolidated Statements of Comprehensive Income/(Loss). Due to the current level of operations conducted in foreign currencies, we do not believe that the impact of fluctuations in foreign currency exchange rates on these types of transactions is significant to our overall annual earnings. A smaller portion of our transactions are denominated in currencies other than the respective local currencies. For example, intercompany transactions that are expected to be settled in the near-term are denominated in U.S. Dollars. Since the accounting records of our foreign operations are kept in the respective local currency, any transactions denominated in other currencies are accounted for in the respective local currency at the time of the transaction. Any foreign currency gain or loss from these transactions, whether realized or unrealized, results in an adjustment to income, which is recorded in “Other, net” in our Condensed Consolidated Statements of Comprehensive Income (Loss). Transactions such as these amounted to $28,000 in pre-tax currency transaction gains in the first three months of 2019. At this time, we are not entered into any foreign currency forward exchange contracts or other derivative instruments to hedge the effects of adverse fluctuations in foreign currency exchange rates.
We do not enter into derivative instruments for any purpose other than cash flow hedging. We do not speculate using derivative instruments.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures are controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in such reports is accumulated and communicated to management, including our Chief Executive Officer, Chief Financial Officer, and Corporate Controller as appropriate to allow timely decisions regarding required disclosure.
Our management, including our Chief Executive Officer, Chief Financial Officer, and Corporate Controller, evaluated the effectiveness of our disclosure controls and procedures pursuant to Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of March 31, 2019, the end of the period covered by this Quarterly Report on Form 10-Q. Based upon such evaluation, our Chief Executive Officer, Chief Financial Officer and Corporate Controller concluded that our disclosure controls and procedures were not effective as of
March 31, 2019
solely due to the material weaknesses in internal control over financial reporting as described in Item 9A of the 2018 10-K.
Notwithstanding the material weaknesses described below, based on the additional analysis and other post-closing procedures performed, we believe the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q are fairly presented in all material respects, in conformity with GAAP.
27
Material Weakness in Internal Control over Financial Reporting
We identified material weaknesses in the following areas (i) the effectiveness of information and communication, and control activities, and (ii) the effectiveness of internal controls over revenue recognition.
Notwithstanding the material weaknesses, each of our Chief Executive Officer, Chief Financial Officer, and Corporate Controller concluded that the condensed consolidated financial statements included in this report present fairly, in all material respects, our financial position, results of operations, and cash flows as of the dates and for the periods presented, in conformity with U.S. GAAP.
Changes in Internal Control over Financial Reporting
Improvements in the design and operating effectiveness of internal controls over financial reporting that we have affected to date have led to the successful remediation of several previously disclosed material weaknesses including monitoring, control environment and risk assessment. Other than the material weaknesses discussed above, and the successful remediation of previously disclosed material weaknesses related to monitoring, control environment and risk assessment, there have been no changes in our internal controls over financial reporting during the quarter ended March 31, 2019 that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting.
Remediation Plan for Material Weaknesses in Internal Control over Financial Reporting
Management has been actively engaged in remediation efforts to address the material weaknesses throughout fiscal year 2018 and these efforts will continue into fiscal year 2019. We have made progress towards addressing the weakness in information and communication by preparing a comprehensive listing of applications and assessing each to determine its impact on financial reporting. We have identified and documented all the systems utilized as we redesigned processes and controls. We have documented which reports are used in the execution of controls.
Significant progress has been made towards addressing the weakness in revenue recognition. Walk throughs have been performed for all significant revenue streams and flow charts have been completed to document these processes. Current key controls have been assessed and mapped to risks within the process. Additional key controls have been identified and designed. We have begun implementing new controls and enhancing the reviews and documentation of currently implemented controls.
We continue to work with the third-party specialists we engaged to review, document, and (as needed) supplement our controls, with the goal of designing and implementing controls that not only better address both the accuracy and precision of management's review, but also enhance our ability to manage our business as it has evolved. In 2018 and the first three months of 2019, significant progress was made in relation to the design and implementation of controls, however, there is still additional work to be done to completely remediate the material weakness. While we have made improvements to many of our control activities, management may determine that additional steps may be necessary to remediate the material weaknesses.
While we intend to resolve all the material control deficiencies discussed above, we cannot provide any assurance that these remediation efforts will be successful, will be completed quickly, or that our internal control over financial reporting will be effective as a result of these efforts by any particular date.
28
PART II.
OTHER INFORMATION
Item 1. Legal Proceedings
Information regarding legal proceedings is set forth in
Note L
,
Litigation and Contingencies,
in the Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q, which information is incorporated herein by reference.
Item 1a. Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our
2018
10-K, which could materially affect our business, financial condition, or future results. The risks described in our
2018
10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, and operating results. There have been no material changes during the three months ended March 31, 2019 to the risk factors previously disclosed in the
2018
10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table contains information about our purchases of equity securities during the
first
quarter of
2019
:
|
Period
|
Total Number of
Shares
Purchased (1)
|
Average
Price Paid
per Share
|
Total Number of
Shares Purchased
as Part of a Publicly
Announced Plan (2)
|
Maximum Dollar
Amount that May
Yet Be Spent
Under the Plan
|
||||||||||
|
January 1-31, 2019
|
—
|
|
$
|
—
|
|
—
|
|
$
|
11,437,538
|
|
||||
|
February 1-28, 2019
|
—
|
|
$
|
—
|
|
—
|
|
$
|
11,437,538
|
|
||||
|
March 1-31, 2019
|
—
|
|
$
|
—
|
|
—
|
|
$
|
11,437,538
|
|
||||
|
Total
|
—
|
|
$
|
—
|
|
—
|
|
|
|
|||||
(1)
Represents shares withheld to offset withholding taxes upon the vesting of unvested shares.
(2)
The Board of Directors does not anticipate purchasing any shares of our Common Stock through our stock repurchase program that was publicly announced in August 2014 for the foreseeable future. Under this program, through which shares can be purchased in the open market, our Board of Directors has authorized us to spend up to $20.0 million to repurchase shares of our outstanding common stock. Through March 31, 2019, we had repurchased a total of 6.8 million shares at an average price of $18.10 per share under all current and previous repurchase programs.
29
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
On May 7, 2019, we entered into an amendment to the Texas Capital Credit Facility, which further extended the maturity of the facility by one year to April 17, 2021.
Item 6. Exhibits
|
Exhibit
No.
|
|
Description of Exhibit
|
|
|
|
|
|
*
31.1
|
||
|
|
||
|
|
|
|
|
*101
|
|
XBRL Instance Document.
|
*Filed or furnished herewith, as applicable.
**Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.
30
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
|
|
|
HARTE HANKS, INC.
|
|
|
|
|
|
May 9, 2019
|
|
/s/ Mark A. Del Priore
|
|
Date
|
|
Mark A. Del Priore
|
|
|
|
Executive Vice President and Chief Financial Officer
|
|
|
|
|
|
|
|
|
|
May 9, 2019
|
|
/s/ Lauri Kearnes
|
|
Date
|
|
Lauri Kearnes
|
|
|
|
Vice President, Finance and
|
|
|
|
Corporate Controller
|
31
TABLE OF CONTENTS
Item 1. Financial StatementsItem 2. Management S Discussion and Analysis Of Financial Condition and Results Of OperationsItem 3. Quantitative and Qualitative Disclosures About Market RiskItem 4. Controls and ProceduresPart II. Other InformationPart IIItem 1. Legal ProceedingsItem 1A. Risk FactorsItem 2. Unregistered Sales Of Equity Securities and Use Of ProceedsItem 3. Defaults Upon Senior SecuritiesItem 4. Mine Safety DisclosuresItem 5. Other InformationItem 6. Exhibits