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HARTE HANKS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Cautionary Note Regarding Forward-Looking Statements This report, including this 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 and Section 21E of the Securities Exchange Act of 1934. 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 with regard to the negative performance trends in our Shoppers business and the adverse impact of continuing economic uncertainty in the United States and other economies on the marketing expenditures and activities of our Direct Marketing clients and prospects, (5) competitive factors, (6) acquisition and development plans, (7) our stock repurchase program, (8) expectations regarding legal proceedings and other contingent liabilities, and (9) 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 our Annual Report on Form 10-K for the year ended December 31, 2010 (2010 Form 10-K) and in the "Cautionary Note Regarding Forward-Looking Statements" in our second quarter 2011 earnings release issued on July 28, 2011. 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. 18 -------------------------------------------------------------------------------- Table of Contents Overview The following MD&A section is intended to help the reader understand the results of operations and financial condition of Harte-Hanks, Inc. (Harte-Hanks). This section is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes to the financial statements contained elsewhere in this report and our MD&A section, financial statements and accompanying notes to financial statements in our 2010 Form 10-K. Our 2010 Form 10-K contains a discussion of other matters not included herein, such as disclosures regarding critical accounting policies and estimates, and contractual obligations. Harte-Hanks® is a worldwide direct and targeted marketing company that provides multichannel direct and digital marketing services and shopper advertising opportunities to a wide range of local, regional, national and international consumer and business-to-business marketers. We manage our operations through two operating segments: Direct Marketing and Shoppers. Our Direct Marketing services offer a wide variety of integrated, multichannel, data-driven solutions for top brands around the globe. We help our customers gain insight into their customers' behaviors from their data and use that insight to create innovative multichannel marketing programs to deliver a return on marketing investment. We believe our customers' 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. We offer a full complement of capabilities and resources to provide a broad range of marketing services and data management software, in media from direct mail to e-mail, including: • agency and creative services; • database marketing solutions; • data quality software and services with Trillium Software; • digital marketing and social networking services; • direct mail and supply chain management; • fulfillment and contact centers; and • lead generation. Revenues from the Direct Marketing segment represented approximately 72% and 71% of our total revenue for the three months and six months ended June 30, 2011, respectively. Harte-Hanks Shoppers is North America's largest owner, operator and distributor of shopper publications, based on weekly circulation and revenues. Shoppers are weekly advertising publications delivered free by mail to households and businesses in a particular geographic area. Through print and digital offerings, Shoppers is a trusted local source for saving customers money and helping businesses grow. Shoppers offer advertisers a geographically targeted, cost-effective local advertising system, with virtually 100% penetration in their area of distribution. Shoppers are particularly effective in large markets with high media fragmentation in which major metropolitan newspapers generally have low penetration. Our Shoppers business also provides advertising and other services online through our websites, PennySaverUSA.com and TheFlyer.com. These sites are online advertising portals, bringing buyers and sellers together through our online offerings, such as local classifieds, business listings, coupons, special offers and PowerSites®. PowerSites are templated websites for our customers, optimized to help small and medium sized business owners establish a web presence and improve their lead generation. At June 30, 2011, we are publishing approximately 6,500 PowerSites weekly. At June 30, 2011, our Shoppers publications were zoned into approximately 950 separate editions with total circulation of approximately 11.2 million shopper packages in California and Florida each week. Revenues from the Shoppers segment represented approximately 28% and 29% of our total revenue for the three months and six months ended June 30, 2011, respectively. 19 -------------------------------------------------------------------------------- Table of Contents We derive revenues from the sale of direct marketing services and shopper advertising services. As a worldwide business, Direct Marketing is affected by general national and international economic trends. Direct Marketing revenues are also affected by 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. The second quarter of 2011 was the fourth consecutive quarter that Direct Marketing has shown good year-over-year growth. We remain committed to making the investments necessary to execute our multichannel strategy while also adjusting our cost structure to reduce costs in the parts of the business that are not growing as fast. We believe these actions will improve our profitability in future periods. Our Shoppers operate in regional markets in California and Florida and are greatly affected by the strength of the state and local economies. Revenues from our Shoppers business are largely dependent on local advertising expenditures in the areas of California and Florida in which we operate. During the second quarter of 2011, the negative trends and economic conditions that we have experienced since the second half of 2007 in California and Florida continued. These conditions were initially created by weakness in the real estate and associated financing markets and have spread and persist across virtually all categories. We see no noticeable improvement in the California and Florida economies and we expect to have further challenges before performance improves. In response, during the second quarter, we incurred $3.3 million of charges through our efforts to reduce expenses in the Shoppers business, primarily through organizational restructuring and headcount reductions. Of these charges, $3.1 million were related to the recently announced retirement of our Shoppers President, Pete Gorman and severance due to the headcount reductions. The remaining charges were related to facilities and other miscellaneous items. We continue to invest in our digital strategy where we are seeing good revenue growth and are adding capabilities that add value for our readers and advertisers. We believe the steps we are taking to improve overall efficiency, combined with our digital strategy, will make our Shoppers business well positioned when the economies in California and Florida improve. Our principal operating expense items are labor, postage and transportation. Results of Operations Operating results were as follows: Three months ended Six months ended In thousands, except June 30, June 30, June 30, June 30, per share amounts 2011 2010 Change 2011 2010 Change Revenues $ 213,047 $ 207,609 2.6 % $ 413,353 $ 407,788 1.4 % Operating expenses 196,501 185,036 6.2 % 382,488 366,899 4.2 % Operating income $ 16,546 $ 22,573 -26.7 % $ 30,865 $ 40,889 -24.5 % Net income $ 9,425 $ 13,416 -29.7 % $ 17,342 $ 24,185 -28.3 % Diluted earnings per share $ 0.15 $ 0.21 -28.6 % $ 0.27 $ 0.38 -28.9 % 2nd Quarter 2011 vs. 2nd Quarter 2010 Revenues Consolidated revenues increased 2.6%, to $213.0 million, and operating income decreased 26.7% to $16.5 million in the second quarter of 2011 compared to the second quarter of 2010. Our overall results reflect increased revenues of $11.8 million, or 8.4%, from our Direct Marketing segment and decreased revenues of $6.4 million, 20 -------------------------------------------------------------------------------- Table of Contents or 9.5%, from our Shoppers segment. Direct Marketing experienced increased revenues from our select, retail, financial and healthcare verticals, which were partially offset by decreased revenues from our high-tech vertical market. The August 31, 2010 acquisition of Information Arts also contributed to Direct Marketing's second quarter revenue growth. Shoppers revenue performance reflects the continued impact that the difficult economic environments in California and Florida are having on our Shoppers business. The decrease in revenues was the result of decreased sales in established markets, including declines in most revenue categories. Operating Expenses Overall operating expenses increased 6.2%, to $196.5 million, in the second quarter of 2011 compared to the second quarter of 2010. The overall increase in operating expenses was driven by increased operating expenses in Direct Marketing of $11.4 million, or 9.5%. The increase at Direct Marketing was primarily due to increased headcount to support revenues, increased outsourced costs resulting from increased outsourced volumes, and higher mail supply chain costs on higher transportation volumes. The acquisition of Information Arts also contributed to the second quarter increase in Direct Marketing operating expenses. Shoppers operating expenses were up slightly, 0.1%, due to $3.3 million of charges recognized in the second quarter of 2011 related to our efforts to reduce expenses in the Shoppers business. Of these charges, $3.1 million were related to the recently announced retirement of our Shoppers President and severance due to headcount reductions. These charges were partially offset by lower variable payroll costs, decreased postage, decreased outsourced costs and a $0.5 million reduction of a legal accrual. Excluding the retirement, severance and other charges, and the legal accrual reduction, Shoppers operating expenses decreased $2.8 million, or 4.5%, and consolidated operating expenses increased $8.7 million, or 4.7%. Net Income/Earnings Per Share Net income decreased 29.7%, to $9.4 million, and diluted earnings per share decreased 28.6%, to $0.15 per share, in the second quarter of 2011 when compared to the second quarter of 2010. The decrease in net income was a result of decreased operating income from Shoppers, changes in net foreign currency transaction gains and losses and a higher effective tax rate. First Half 2011 vs. First Half 2010 Revenues Consolidated revenues increased 1.4%, to $413.4 million, while operating income decreased 24.5% to $30.9 million in the first half of 2011 compared to the first half of 2010. Our overall results reflect increased revenues of $18.4 million, or 6.7%, from our Direct Marketing segment and decreased revenues of $12.8 million, or 9.7%, from our Shoppers segment. Direct Marketing experienced increased revenues from our select, retail and financial verticals, which were partially offset by decreased revenues from our high-tech and healthcare vertical markets. The acquisition of Information Arts also contributed to Direct Marketing's first half revenue growth. Shoppers revenue performance reflects the continued impact that the difficult economic environments in California and Florida are having on our Shoppers business. The decrease in revenues was the result of decreased sales in established markets, including declines in most revenue categories. Operating Expenses Overall operating expenses increased 4.2%, to $382.5 million, in the first half of 2011 compared to the first half of 2010. The overall increase in operating expenses was driven by increased operating expenses in Direct Marketing of $18.9 million, or 7.9%, and increased general corporate expense of $0.2 million, or 0.4%, partially offset by decreased operating expenses in Shoppers of $3.5 million, or 2.8%. The Direct Marketing increase was primarily due to increased headcount to support revenues, increased outsourced costs resulting from increased outsourced volumes, higher mail supply chain costs on higher transportation volumes, increased travel and increased employee recruiting. The acquisition of Information Arts also contributed to the first half increase in Direct Marketing operating expenses. The decrease at Shoppers was primarily due to lower variable payroll costs, decreased postage due to lower distribution volumes and the elimination of the second day edition, decreased outsourced costs on lower volumes, and a $1.3 million reduction of a legal accrual. The decrease at Shoppers was 21 -------------------------------------------------------------------------------- Table of Contents partially offset by $4.1 million of charges recognized in the first half of 2011 related to our efforts to reduce expenses in the Shoppers business. Of these charges, $3.9 million were related to the recently announced retirement of our Shoppers President and severance due to headcount reductions. The decrease at Shoppers was also partially offset by increased newsprint expense and outside printing costs, both a result of higher paper rates. The increase in general corporate expense was driven by higher stock-based compensation, partially offset by lower incentive-based compensation and acquisition-related expenses. Excluding the retirement, severance and other charges, and the legal accrual reduction, Shoppers operating expenses decreased $6.3 million, or 5.1%, and consolidated operating expenses increased $12.8 million, or 3.5%. Net Income/Earnings Per Share Net income decreased 28.3%, to $17.3 million, and diluted earnings per share decreased 28.9%, to $0.27 per share, in the first half of 2011 when compared to the first half of 2010. The decrease in net income was a result of decreased operating income from Shoppers and Direct Marketing, increased general corporate expense and changes in net foreign currency transaction gains and losses. Direct Marketing Direct Marketing operating results were as follows: Three months ended Six months ended June 30, June 30, June 30, June 30, In thousands 2011 2010 Change 2011 2010 Change Revenues $ 152,721 $ 140,926 8.4 % $ 293,802 $ 275,421 6.7 % Operating expenses 132,365 120,926 9.5 % 257,466 238,569 7.9 % Operating income $ 20,356 $ 20,000 1.8 % $ 36,336 $ 36,852 -1.4 % 2nd Quarter 2011 vs. 2nd Quarter 2010 Revenues Direct Marketing revenues increased $11.8 million, or 8.4%, in the second quarter of 2011 compared to the second quarter of 2010. These results reflect an increase (as a percentage) in the high teens from our select vertical compared to the second quarter of 2010. Our retail and financial verticals experienced revenue growth in the low double digits, while our healthcare vertical was up slightly. Our high-tech vertical declined in the low single digits. Revenues from our vertical markets are impacted by, among other things, the economic fundamentals of each industry, various market factors, including the demand for services by our clients, and the financial condition of and budgets available to specific clients. The acquisition of Information Arts also contributed to the second quarter revenue growth. Future revenue performance will depend on, among other factors, the overall strength of the national and international economies and how successful we are at maintaining and growing business with existing clients, acquiring new clients and meeting client demands. We believe that in the long-term an increasing portion of overall marketing and advertising expenditures will be moved from other advertising media to the targeted media space, and that our business will benefit as a result. Targeted media advertising results can be more effectively tracked, enabling measurement of the return on marketing investment. Operating Expenses Operating expenses increased $11.4 million, or 9.5%, in the second quarter of 2011 compared to the second quarter of 2010. Labor costs increased $5.1 million, or 8.2%, due to increased headcounts to support revenues and increased commissions due to increased revenues. Production and distribution costs increased $4.9 million, or 11.3%, due to increased outsourced costs resulting from increased outsourced volumes, and higher mail supply chain costs on higher transportation volumes. General and administrative expense increased $1.7 million, or 15.5%, due primarily to an increase in travel, employee recruiting and bad debt expense. Depreciation and software amortization expense decreased $0.3 million, or 7.1%, due to decreased capital expenditures over the last few years. Intangible asset amortization was up slightly due to the Information Arts acquisition. The acquisition of Information Arts also contributed to the total increase in operating expenses in Direct Marketing in the second quarter of 2011. 22 -------------------------------------------------------------------------------- Table of Contents Direct Marketing's largest cost components are labor, outsourced costs and mail supply chain costs. Each of these costs is somewhat variable and tends to fluctuate with revenues and the demand for our direct marketing services. Mail supply chain costs have increased significantly over the last several quarters due to demand and supply issues within the transportation industry, contributing to the overall increase in operating expenses. Future changes in mail supply chain costs will continue to impact Direct Marketing's total production costs and total operating expenses, and may have an impact on future demand for our supply chain management. Postage costs of mailings in our Direct Marketing business are borne by our clients and are not directly reflected in our revenues or expenses. First Half 2011 vs. First Half 2010 Revenues Direct Marketing revenues increased $18.4 million, or 6.7%, in the first half of 2011 compared to the first half of 2010. These results reflect an increase of 20% from our select vertical compared to the first half of 2010. Our retail vertical experienced revenue growth (as a percentage) in the low double digits and our financial vertical grew in the high single digits. Our high-tech and healthcare verticals both declined in the mid single digits. The acquisition of Information Arts also contributed to the first half revenue growth. Operating Expenses Operating expenses increased $18.9 million, or 7.9%, in the first half of 2011 compared to the first half of 2010. Labor costs increased $8.6 million, or 6.8%, due to increased headcounts to support revenues. Production and distribution costs increased $8.9 million, or 10.8%, due to increased outsourced costs resulting from increased outsourced volumes, and higher mail supply chain costs on higher transportation volumes. General and administrative expense increased $2.0 million, or 9.0%, due primarily to an increase in travel, employee recruiting and outside sales commissions. Depreciation and software amortization expense decreased $0.6 million, or 7.2%, due to decreased capital expenditures over the last few years. Intangible asset amortization was up slightly due to the Information Arts acquisition. The acquisition of Information Arts also contributed to the total increase in operating expenses in Direct Marketing in the first half of 2011. Shoppers Three months ended Six months ended In thousands June 30, 2011 June 30, 2010 Change June 30, 2011 June 30, 2010 Change Revenues $ 60,326 $ 66,683 -9.5 % $ 119,551 $ 132,367 -9.7 % Operating expenses 61,444 61,408 0.1 % 119,422 122,924 -2.8 % Operating income $ (1,118 ) $ 5,275 -121.2 % $ 129 $ 9,443 -98.6 % 2nd Quarter 2011 vs. 2nd Quarter 2010 Revenues Shoppers revenues decreased $6.4 million, or 9.5%, in the second quarter of 2011 compared to the second quarter of 2010. These results reflect the continued impact that the difficult economic environments in California and Florida are having on our Shoppers business. The decrease in revenues was the result of decreased sales in established markets, including declines in most revenue categories. At June 30, 2011, our Shoppers circulation reached approximately 11.2 million addresses each week. While we have not made any significant changes to our circulation since the first quarter of 2009, we continue to evaluate all of our circulation performance and may make further circulation reductions in the future as part of our efforts to address the difficult economic conditions in California and Florida. Future revenue performance will depend on, among other factors, the overall strength of the California and Florida economies, as well as how successful we are at maintaining and growing business with existing clients, and acquiring new clients. 23 -------------------------------------------------------------------------------- Table of Contents Operating Expenses Operating expenses increased slightly, 0.1%, in the second quarter of 2011 compared to the second quarter of 2010. During the second quarter of 2011, we incurred $3.3 million of charges through our efforts to reduce expenses in the Shoppers business primarily through organizational restructuring and headcount reductions. Of these charges, $3.1 million were related to the recently announced retirement of our Shoppers President and severance due to headcount reductions. The remaining charges were related to facilities and other miscellaneous items. Total labor costs increased $1.2 million, or 5.7%, due to severance and the retirement charges. Excluding these charges, total labor costs decreased $1.9 million, or 9.3%, due to lower variable payroll costs from lower ad sales, headcount reductions and lower incentive compensation. Total production costs decreased $0.9 million, or 2.5%, due primarily to decreased postage costs as a result of a decline in distribution volumes and the elimination of the second day edition in southern California, and decreased outsourced costs resulting from decreased outsourced volumes. These decreases were partially offset by increased newsprint expense as a result of higher paper rates. Total general and administrative costs decreased $0.1 million, or 2.7%, due primarily to a $0.5 million reduction of a legal accrual, partially offset by an increase in bad debt expense. Depreciation and software amortization expense decreased $0.1 million, or 7.2%, due to decreased capital expenditures in the last few years. Intangible asset amortization decreased slightly, 14.2%, as certain intangible assets became fully amortized. Excluding the retirement, severance and other charges, and the legal accrual reduction, Shoppers operating expenses decreased $2.8 million, or 4.5% Shoppers' largest cost components are labor, postage and paper. Shoppers' labor costs are partially variable and tend to fluctuate with the number of zones, circulation, volumes and revenues. Standard postage rates have increased in recent years, and increased again in April 2011. Shoppers' postage rates increased by less than 1.0% as a result of the April 2011 rate increase. We believe the next postal rate increase will likely occur in the second quarter of 2012 and will be capped at the consumer price index level in accordance with the regulations in effect at that time. Any future changes in postage rates will affect Shoppers' production costs. The U. S. Postal Service has also proposed various changes in its services to address its financial performance, such as delivery frequency and facility access. We do not believe the proposed changes will have a material impact on our Shoppers business. Shoppers' newsprint prices increased in the second half of 2010 and continued to increase in the first half of 2011, causing the increase in Shoppers paper costs. Newsprint prices are expected to continue to increase in the second half of 2011. Any future changes in newsprint prices will affect Shoppers' production costs. First Half 2011 vs. First Half 2010 Revenues Shoppers revenues decreased $12.8 million, or 9.7%, in the first half of 2011 compared to the first half of 2010. These results reflect the continued impact that the difficult economic environments in California and Florida are having on our Shoppers business. The decrease in revenues was the result of decreased sales in established markets, including declines in most revenue categories. Operating Expenses Operating expenses decreased $3.5 million, or 2.8%, in the first half of 2011 compared to the first half of 2010. During the first half of 2011, we incurred $4.1 million of charges through our efforts to reduce expenses in the Shoppers business primarily through organizational restructuring and headcount reductions. Of these charges, $3.9 million were related to the recently announced retirement of our Shoppers President and severance due to headcount reductions. The remaining charges were related to facilities and other miscellaneous items. Total labor costs increased $0.7 million, or 1.7%, due to severance and retirement charges. Excluding these charges, total labor costs decreased $3.1 million, or 7.7%, due to lower variable payroll costs from lower ad sales, headcount reductions and lower incentive compensation. Total production costs decreased $1.6 million, or 2.3%, due primarily to decreased postage costs as a result of a 24-------------------------------------------------------------------------------- Table of Contents decline in distribution volumes and the elimination of the second day edition in southern California, and decreased outsourced costs resulting from decreased outsourced volumes. These decreases were partially offset by increased newsprint expense and outside printing costs, both a result of higher paper rates. Total general and administrative costs decreased $2.1 million, or 22.4%, due primarily to a $1.3 million reduction of a legal accrual and a decrease in bad debt expense. Depreciation and software amortization expense decreased $0.3 million, or 11.5%, due to decreased capital expenditures in the last few years. Intangible asset amortization decreased $0.1 million, or 31.4%, as certain intangible assets became fully amortized. Excluding the retirement, severance and other charges, and the legal accrual reduction, Shoppers operating expenses decreased $6.3 million, or 5.1% General Corporate Expense General corporate expense was down slightly, 0.4%, in the second quarter of 2011 compared to the second quarter of 2010. This decrease was due to lower incentive-based compensation and acquisition-related expenses, partially offset by increased stock-based compensation. General corporate expense increased $0.2 million, or 3.6%, in the first half of 2011 compared to the first half of 2010. This increase was due to higher stock-based compensation, partially offset by lower incentive-based compensation and acquisition-related expenses. Interest Expense Interest expense decreased $0.1 million, or 8.5%, in the second quarter of 2011 and $0.1 million, or 9.7%, in the first half of 2011 compared to the same periods in 2010. These decreases were primarily due to lower outstanding debt levels during the second quarter and first half of 2011 compared to the same periods in 2010. Interest Income Interest income was up slightly in the second quarter of 2011 and increased $0.1 million, or 103.0%, in the first half of 2011 compared to the same periods in 2010 due to higher returns on invested cash and cash equivalents in 2011. Other Income and Expense Other expense, net, increased $0.5 million in the second quarter of 2011 and $1.5 million in the first half of 2011 compared to the same periods in 2010. These changes were primarily due to changes in net foreign currency transaction gains and losses. Income Taxes Income tax expense decreased $2.4 million in the second quarter of 2011 and $4.5 million in the first half of 2011 compared to the same periods in 2010. Our effective tax rate was 39.2% for the second quarter of 2011, increasing from 38.9% for the second quarter of 2010. The increase in the effective tax rate is primarily due to an increase in state income tax. Our effective tax rate was 39.4% for the first half of 2011 and the first half of 2010. Economic Climate and Impact on our Financial Statements The current economic climate in California and Florida has had a negative impact on our Shoppers' operations and cash flows for the three months and six months ended June 30, 2011, and our financial position at June 30, 2011. We cannot predict the timing, strength or duration of the current difficult economic environment in California and Florida or any subsequent improvement. If the economic climate and markets we serve continue to deteriorate, we may record charges related to restructuring costs and the impairment of goodwill, other intangibles and long-lived assets, and our operations, cash flows and financial position may be materially and adversely affected. 25-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Sources and Uses of Cash As of June 30, 2011, cash and cash equivalents were $47.9 million, decreasing $38.1 million from cash and cash equivalents at December 31, 2010. This net decrease was a result of net cash provided by operating activities of $18.0 million, net cash used in investing activities of $11.3 million, net cash used in financing activities of $45.2 million and $0.3 million from the effect of exchange rate changes. Operating Activities Net cash provided by operating activities in the second quarter of 2011 was $18.0 million, compared to net cash provided by operating activities of $37.7 million in the second quarter of 2010. The $19.7 million year-over-year decrease was primarily attributable to changes within working capital assets and liabilities and a decrease in net income. In the second quarter of 2011, our principal working capital changes, which directly affected net cash provided by operating activities, were as follows: • A decrease in accounts receivable attributable to higher revenues in the fourth quarter of 2010 than in the second quarter of 2011. Days sales outstanding of approximately 63 days at June 30, 2011 increased from 59 days at June 30, 2010 and 59 days at December 31, 2010; • An increase in inventory due to increased newsprint prices; • An increase in prepaid expenses and other current assets due to timing of payments; • A decrease in accounts payable due to higher overall operating expenses in the fourth quarter of 2010 than in the second quarter of 2011; • A decrease in accrued payroll and related expenses due to the payment of 2010 incentive compensation; • A decrease in customer deposits, unearned revenue and other current liabilities due to timing of receipts; and • A decrease in income taxes payable due to the timing of payments. Investing Activities Net cash used in investing activities was $11.3 million in the second quarter of 2011, compared to $8.1 million in the second quarter of 2010. The $3.2 million increase is the result of a $3.1 million increase in capital spending in the second quarter of 2011 compared to the second quarter of 2010. Financing Activities Net cash used in financing activities was $45.2 million in the second quarter of 2011 compared to $31.6 million in the second quarter of 2010. The $13.6 million increase is attributable primarily to the repurchase of $8.4 of treasury stock in the second quarter of 2011, and $5.4 million more net debt repayments in the second quarter of 2011 than in the second quarter of 2010. Credit Facilities On September 6, 2006, we entered into a five-year $200 million term loan facility (2006 Term Loan Facility) with Wells Fargo Bank, N.A., as Administrative Agent. The 2006 Term Loan Facility matures on September 6, 2011. For each borrowing under the 2006 Term Loan Facility, we can generally choose to have the interest rate for that borrowing calculated based on either (i) a Eurodollar (as defined in the 2006 Term Loan Facility) rate, plus a spread which is determined based on our total debt-to-EBITDA ratio (as defined in the 2006 Term Loan Facility) 26 -------------------------------------------------------------------------------- Table of Contents then in effect, and ranges from 0.315% to 0.60% per annum, or (ii) the higher of Wells Fargo Bank's prime rate in effect on such date or the Federal Funds rate in effect on such date plus 0.50%. There is a facility fee that we are also required to pay under the 2006 Term Loan Facility that is based on a facility fee rate applied to the outstanding principal balance owed under the 2006 Term Loan Facility. The facility fee rate ranges from 0.085% to 0.15% per annum, depending on our total debt-to-EBITDA ratio then in effect. We may elect to prepay the 2006 Term Loan Facility at any time without incurring any prepayment penalties. At June 30, 2011, we had $97.5 million outstanding under the 2006 Term Loan Facility. On March 7, 2008, we entered into a four-year $100 million term loan facility (2008 Term Loan Facility) with Wells Fargo Bank, N.A., as Administrative Agent. The 2008 Term Loan Facility matures on March 7, 2012. For each borrowing under the 2008 Term Loan Facility, we can generally choose to have the interest rate for that borrowing calculated based on either (i) a Eurodollar (as defined in the 2008 Term Loan Facility) rate, plus a spread which is determined based on our total debt-to-EBITDA ratio (as defined in the 2008 Term Loan Facility) then in effect, and ranges from 0.40% to 0.75% per annum, or (ii) the higher of Wells Fargo Bank's prime rate in effect on such date or the Federal Funds rate in effect on such date plus 0.50%. There is a facility fee that we are also required to pay under the 2008 Term Loan Facility that is based on a rate applied to the outstanding principal balance owed under the 2008 Term Loan Facility. The facility fee rate ranges from 0.10% to 0.25% per annum, depending on our total debt-to-EBITDA ratio then in effect. We may elect to prepay the 2008 Term Loan Facility at any time without incurring any prepayment penalties. At June 30, 2011, we had $68.0 million outstanding under the 2008 Term Loan Facility. On August 12, 2010, we entered into a new three-year $70 million revolving credit facility, which includes a $25 million accordion feature, a $25 million letter of credit sub-facility and a $5 million swing line loan sub-facility (2010 Revolving Credit Facility), with Bank of America, N.A., as Administrative Agent. The 2010 Revolving Credit Facility permits us to request up to a $25 million increase in the total amount of the facility. The 2010 Revolving Credit Facility matures on August 12, 2013. For each borrowing under the 2010 Revolving Credit Facility, we can generally choose to have the interest rate for that borrowing calculated on either (i) the LIBOR rate for the applicable interest period, plus a spread which is determined based on our total net debt-to-EBITDA ratio then in effect, which ranges from 2.25% to 3.00% per annum; or (ii) the highest of (a) the Federal Funds Rate plus 0.50%, (b) the Agent's prime rate, and (c) the Eurodollar Rate plus 1.00%, plus a spread which is determined based on our total net debt-to-EBITDA ratio then in effect, which ranges from 1.25% to 2.00% per annum. There is a facility fee that we are also required to pay under the 2010 Revolving Credit Facility. The facility fee rate ranges from 0.40% to 0.45% per annum, depending on our total net debt-to-EBITDA ratio then in effect. In addition, there is a letter of credit fee with respect to outstanding letters of credit. That fee is calculated by applying a rate equal to the spread applicable to Eurodollar based loans plus a fronting fee of 0.125% per annum to the average daily undrawn amount of the outstanding letters of credit. We may elect to prepay the 2010 Revolving Credit Facility at any time. At June 30, 2011, we did not have any outstanding amounts drawn against our 2010 Revolving Credit Facility. At June 30, 2011 we had letters of credit totaling $11.8 million issued under the 2010 Revolving Credit Facility, decreasing the amount available for borrowing to $58.2 million. Under all of our credit facilities we are required to maintain an interest coverage ratio of not less than 2.75 to 1 and a total debt-to-EBITDA ratio of not more than 3.0 to 1. The credit facilities also contain covenants restricting our ability to grant liens and enter into certain transactions and limit the total amount of indebtedness of our subsidiaries. The credit facilities each also include customary covenants regarding reporting obligations, delivery of notices regarding certain events, maintaining our corporate existence, payment of obligations, maintenance of our properties and insurance thereon at customary levels with financially sound and reputable insurance companies, maintaining books and records and compliance with applicable laws. The credit facilities each also provide for customary events of default including nonpayment of principal or interest, breach of representations and warranties, violations of covenants, failure to pay certain other indebtedness, bankruptcy and material judgments and liabilities, certain violations of environmental laws or ERISA or the occurrence of a change of control. As of June 30, 2011, we were in compliance with all of the covenants of our credit facilities. 27 -------------------------------------------------------------------------------- Table of Contents 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 primary sources of liquidity have been cash and cash equivalents on hand and cash generated from operating activities. 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. Capital resources are also available from and provided through our 2010 Revolving Credit Facility, subject to the terms and conditions of that facility. The amount of cash on hand and borrowings available under our 2010 Revolving Credit Facility are influenced by a number of factors, including fluctuations in our operating results, revenue growth, accounts receivable collections, working capital changes, capital expenditures, tax payments, share repurchases, pension plan contributions, acquisitions and dividends. As of June 30, 2011, we had $58.2 million of unused borrowing capacity under our 2010 Revolving Credit Facility and a cash balance of $47.9 million. Based on our current operational plans, we believe that our cash on hand, cash provided by operating activities, and availability under the 2010 Revolving Credit Facility will be sufficient to fund operations, anticipated capital expenditures, payments of principal and interest on our borrowings, and dividends on our common stock through the end of 2011. Nevertheless, we cannot predict the impact on our business performance of the economic climate in the United States and other economies. A lasting economic recession in the United States and other economies could have a material adverse effect on our business, financial position or operating results. Both the 2006 Term Loan Facility and the 2008 Term Loan Facility mature in the next 9 months, and we are scheduled to make principal payments of $165.5 million during this period. We believe that we will be able to replace the 2006 Term Loan Facility prior to its maturity. However, if there are disruptions in the credit markets, we may be unable to obtain a replacement facility on acceptable terms or at all. In that event, depending on our ability to generate sufficient cash flow from operations, our overall liquidity and ability to make payments on our indebtedness under our 2006 Term Loan Facility (which matures in September 2011) and our 2008 Term Loan Facility (which matures in March 2012) may be adversely impacted, and we may be required to seek one or more alternatives, such as refinancing or restructuring our indebtedness, selling material assets or operations, or seeking to raise debt or equity capital. We cannot assure you that any of these actions could be affected on a timely basis or on satisfactory terms, if at all. In addition, our existing debt agreements contain restrictive covenants that may prohibit us from adopting one or more of these alternatives. To the extent that we do not refinance our current debt, we will make the scheduled principal payments using cash on hand, cash provided by operating activities and availability under the 2010 Revolving Credit Facility. Critical Accounting Policies Our financial statements and accompanying notes are prepared in accordance with U.S generally accepted accounting principles. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses. These estimates and assumptions are affected by management's application of accounting policies. We consider the following to be our critical accounting policies, as described in detail in our 2010 Form 10-K: • Revenue recognition; 28 -------------------------------------------------------------------------------- Table of Contents • Allowance for doubtful accounts; • Reserve for healthcare, workers' compensation, automobile and general liability; • Goodwill; and • Stock-based compensation. There have been no material changes to the critical accounting policies described in our 2010 Form 10-K. As discussed in Note B, Recent Accounting Pronouncements, of the Notes to Unaudited Condensed Consolidated Financial Statements, certain new financial accounting pronouncements have been issued which either have already been reflected in the accompanying consolidated financial statements, or will become effective for our financial statements at various dates in the future. The adoptions of these new accounting pronouncements have not and are not expected to have a material effect on our consolidated financial statements. |