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 September 30, 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)

Delaware	74-1677284
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification Number)

2800 Wells Branch Parkway, Austin, Texas 78728

(Address of principal executive offices, including zip code)

(512) 434-1100

(Registrant’s telephone number including area code)

None

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock	HHS	New York Stock Exchange (“NYSE”)

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.

Large accelerated filer	o	Accelerated filer	o
Non-accelerated filer	ý	Smaller reporting company	ý
		Emerging growth company	o

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).

Yeso  No ý

The number of shares outstanding of each of the issuer's classes of common stock as of October 15, 2019 was 6,300,381 shares of common stock, all of one class.

HARTE HANKS, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

FORM 10-Q REPORT

For the Quarterly Period Ended September 30, 2019

				Page
Part I.		Financial Information
	Item 1.		Financial Statements
			(Unaudited)
			Condensed Consolidated Balance Sheets — September 30, 2019 and December 31, 2018	3
			Condensed Consolidated Statements of Comprehensive (Loss) Income — Three months ended September 30, 2019 and 2018	5
			Condensed Consolidated Statements of Comprehensive (Loss) Income — Nine months ended September 30, 2019 and 2018	5
			Condensed Consolidated Statements of Changes in Deficit — Nine months ended September 30, 2019 and 2018	6
			Condensed Consolidated Statements of Cash Flows — Nine months ended September 30, 2019 and 2018
			Notes to Condensed Consolidated Financial Statements	8
	Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
	Item 3.		Quantitative and Qualitative Disclosures About Market Risk	31
	Item 4.		Controls and Procedures	31
Part II.		Other Information
	Item 1.		Legal Proceedings	33
	Item 1A.		Risk Factors	33
	Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds	33
	Item 3.		Defaults Upon Senior Securities	33
	Item 4.		Mine Safety Disclosure	33
	Item 5.		Other Information	33
	Item 6.		Exhibits	33

2

Item 1.  Financial Statements

Harte Hanks, Inc. and Subsidiaries Condensed Consolidated Balance Sheets

(Unaudited)

In thousands, except per share and share amounts	September 30, 2019			December 31, 2018
ASSETS
Current assets
Cash and cash equivalents	$	31,738		$	20,882
Accounts receivable (less allowance for doubtful accounts of $971 at September 30, 2019and $430 at December 31, 2018)	40,577			54,240
Contract assets	986			2,362
Inventory	407			448
Prepaid expenses	2,896			4,088
Prepaid taxes and income tax receivable	447			20,436
Other current assets	1,738			2,536
Total current assets	78,789			104,992
Property, plant and equipment (less accumulated depreciation of $130,799 at September 30, 2019 and $133,559 at December 31, 2018)	8,780			13,592
Right-of-use assets	20,684			—
Other assets	3,897			6,591
Total assets	$	112,150		$	125,175
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities
Accounts payable	$	18,131		$	31,052
Accrued payroll and related expenses	5,508			6,783
Deferred revenue and customer advances	4,286			6,034
Customer postage and program deposits	6,003			6,729
Short-term lease liabilities	8,048			—
Other current liabilities	2,984			3,564
Total current liabilities	44,960			54,162
Long-term debt	18,700			14,200
Pensions	61,518			62,214
Deferred tax liabilities, net	223			—
Long-term lease liabilities	14,578			—
Other long-term liabilities	2,877			4,060
Total liabilities	142,856			134,636
Preferred stock, $1 par value, 1,000,000 shares authorized; 9,926 shares of Series A Convertible Preferred Stock, issued and outstanding	9,723			9,723
Stockholders’ deficit
Common stock, $1 par value, 25,000,000 shares authorized;12,121,484 and 12,115,055 shares issued, 6,300,381 and 6,260,075 shares outstanding at September 30, 2019 and December 31, 2018, respectively	12,121			12,115
Additional paid-in capital	447,244			453,868
Retained earnings	800,763			812,704
Less treasury stock, 5,821,103 shares at cost at September 30, 2019 and 5,854,980 shares at cost at December 31, 2018	(1,244,056		)	(1,251,388		)
Accumulated other comprehensive loss	(56,501		)	(46,483		)
Total stockholders’ deficit	(40,429		)	(19,184		)
Total liabilities, preferred stock and stockholders’ deficit	$	112,150		$	125,175

See Accompanying Notes to Condensed Consolidated Financial Statements

3

Harte Hanks, Inc. and Subsidiaries Condensed Consolidated Statements of Comprehensive (Loss) Income

(Unaudited)

	Three Months Ended September 30,
In thousands, except per share amounts	2019			2018
Operating revenues	$	51,414		$	63,588
Operating expenses
Labor	28,589			35,619
Production and distribution	17,314			23,016
Advertising, selling, general and administrative	5,623			9,658
Restructuring Expense	3,080			—
Impairment of Assets	—			3,822
Depreciation, software and intangible asset amortization	1,283			1,826
Total operating expenses	55,889			73,941
Operating loss	(4,475		)	(10,353		)
Other expenses, net
Interest expense, net	330			177
Other, net	1,081			891
Total other expenses, net	1,411			1,068
Loss before income taxes	(5,886		)	(11,421		)
Income tax expense (benefit)	102			(1,437		)
Net loss	(5,988		)	(9,984		)
Less: Preferred stock dividends	125			125
Loss attributable to common stockholders	$	(6,113	)	$	(10,109	)
Loss per common share
Basic	$	(0.97	)	$	(1.62	)
Diluted	$	(0.97	)	$	(1.62	)
Weighted average shares used to compute loss per share attributable to common shares
Basic	6,291			6,250
Diluted	6,291			6,250
Comprehensive loss, net of tax:
Net loss	$	(5,988	)	$	(9,984	)
Adjustment to pension liability, net:	549			517
Foreign currency translation adjustment	(660		)	(248		)
Total other comprehensive (loss) income, net of tax	$	(111	)	$	269
Comprehensive loss	$	(6,099	)	$	(9,715	)
Less: Preferred stock dividends	125			125
Comprehensive loss attributable to common stockholders	$	(6,224	)	$	(9,840	)

See Accompanying Notes to Condensed Consolidated Financial Statements

4

Harte Hanks, Inc. and Subsidiaries Condensed Consolidated Statements of Comprehensive (Loss) Income

(Unaudited)

	Nine Months Ended September 30,
In thousands, except per share amounts	2019			2018
Operating revenues	$	165,250		$	214,417
Operating expenses
Labor	94,034			125,999
Production and distribution	58,130			73,523
Advertising, selling, general and administrative	20,225			26,891
Restructuring Expense	10,867			—
Impairment of Assets	—			3,822
Depreciation, software and intangible asset amortization	4,022			5,879
Total operating expenses	187,278			236,114
Operating loss	(22,028		)	(21,697		)
Other expenses and (income)
Interest expense, net	938			1,289
Gain on sale from 3Q Digital	(5,000		)	(30,954		)
Other, net	4,512			2,859
Total other expenses and (income)	450			(26,806		)
(Loss) income before income taxes	(22,478		)	5,109
Income tax expense (benefit)	840			(10,800		)
Net (loss) income	(23,318		)	15,909
Less: Earnings attributable to participating securities	—			1,957
Less: Preferred stock dividends	371			332
(Loss) income attributable to common stockholders	$	(23,689	)	$	13,620
(Loss) earnings per common share
Basic	$	(3.77	)	$	2.19
Diluted	$	(3.77	)	$	2.18
Weighted-average shares used to compute (loss) earnings per share attributable to common shares
Basic	6,277			6,230
Diluted	6,277			6,251
Comprehensive (loss) income
Net (loss) income	$	(23,318	)	$	15,909
Adjustment to pension liability	1,648			1,552
Foreign currency translation adjustment	(311		)	(1,207		)
Adoption of ASU 2018-02	(11,355		)	—
Total other comprehensive (loss) income, net of tax	$	(10,018	)	$	345
Comprehensive (loss) income	$	(33,336	)	$	16,254
Less: Earnings attributable to participating securities	—			1,957
Less: Preferred stock dividends	371			332
Comprehensive (loss) income attributable to common stockholders	$	(33,707	)	$	13,965

See Accompanying Notes to Condensed Consolidated Financial Statements

5

Harte Hanks, Inc. and Subsidiaries Condensed Consolidated Statements of Changes in Stockholders' 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			—			—			571
Preferred stock issued	9,723		—			—			—			—			—			—
Stock Option activities	—		38			(38		)	—			(1		)	—			(1		)
Rounding from reverse stock split	—		(38		)	38			—			—			—			—
Stock-based compensation	—		—			433			—			—			—			433
Treasury stock issued	—		—			(50		)	—			53			—			3
Net income	—		—			—			32,627			—			—			32,627
Other comprehensive income	—		—			—			—			—			364			364
Balance at March 31, 2018	$	9,723	$	12,075		$	457,569		$	827,781		$	(1,254,124	)	$	(43,939	)	$	(638	)
Stock Option activities	—		33			(33		)	—			(69		)	—			(69		)
Stock-based compensation	—		—			425			—			—			—			425
Treasury stock issued	—		—			(755		)	—			789			—			34
Net loss	—		—			—			(6,734		)	—			—			(6,734		)
Other comprehensive loss	—		—			—			—			—			(288		)	(288		)
Balance at June 30, 2018	$	9,723	$	12,108		$	457,206		$	821,047		$	(1,253,404	)	$	(44,227	)	$	(7,270	)
Stock Option activities	—		7			(78		)	—			36			—			(35		)
Stock-based compensation	—		—			(1,461		)	—			—			—			(1,461		)
Treasury stock issued	—		—			(659		)	—			687			—			28
Net loss	—		—			—			(9,984		)	—			—			(9,984		)
Other comprehensive loss	—		—			—			—			—			269			269
Balance at September 30, 2018	$	9,723	$	12,115		$	455,008		$	811,063		$	(1,252,681	)	$	(43,958	)	$	(18,453	)

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
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	)
Stock Option activities	—		6		(8		)	—			—			—			(2		)
Stock-based compensation	—		—		239			—			—			—			239
Treasury stock issued	—		—		(345		)	—			343			—			(2		)
Net loss	—		—		—			(3,803		)	—			—			(3,803		)
Other comprehensive income	—		—		—			—			—			926			926
Balance at June 30, 2019	$	9,723	$	12,121	$	451,937		$	806,751		$	(1,249,061	)	$	(56,390	)	$	(34,642	)
Stock-based compensation	—		—		312			—			—			—			312
Treasury stock issued	—		—		(5,005		)	—			5,005			—			—
Net loss	—		—		—			(5,988		)	—			—			(5,988		)
Other comprehensive income	—		—		—			—			—			(111		)	(111		)
Balance at September 30, 2019	$	9,723	$	12,121	$	447,244		$	800,763		$	(1,244,056	)	$	(56,501	)	$	(40,429	)

See Accompanying Notes to Condensed Consolidated Financial Statements

6

Harte Hanks, Inc. and Subsidiaries Condensed Consolidated Statements of Cash Flows

(Unaudited)

	Nine Months Ended September 30,
In thousands	2019			2018
Cash flows from operating activities
Net (loss) income	$	(23,318	)	$	15,909
Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities
Depreciation, software amortization	4,022			5,767
Intangible asset amortization	—			113
Restructuring	5,812			—
Impairment of Assets	—			3,822
Stock-based compensation	739			(706		)
Net pension cost	1,501			1,284
Interest accretion on contingent consideration	—			742
Deferred income taxes	426			(978		)
Gain on sale	—			(32,760		)
Other, net	—			(238		)
Changes in assets and liabilities:
Decrease in accounts receivable, net and contract assets	15,039			10,021
Decrease in inventory	41			60
Decrease (increase) in prepaid expenses, income tax receivable and other assets	20,131			(10,632		)
(Decrease) increase in accounts payable	(12,591		)	9,693
Decrease in other accrued expenses and liabilities	(2,427		)	(9,110		)
Net cash provided by (used in) operating activities	9,375			(7,013		)
Cash flows from investing activities	0
Dispositions, net of cash transferred	—			3,929
Purchases of property, plant and equipment	(1,655		)	(2,834		)
Proceeds from sale of property, plant and equipment	15			225
Net cash (used in) provided by investing activities	(1,640		)	1,320
Cash flows from financing activities
Borrowings	4,500			9,000
Repayment of borrowings	—			(9,000		)
Debt financing costs	(477		)	(425		)
Issuance of preferred stock, net of transaction fees	—			9,723
Issuance of common stock	(2		)	(105		)
Issuance of treasury stock	14			65
Payment of finance leases	(603		)	(377		)
Net cash provided by financing activities	3,432			8,881
Effect of exchange rate changes on cash and cash equivalents	(311		)	(1,207		)
Net increase in cash and cash equivalents	10,856			1,981
Cash and cash equivalents at beginning of period	20,882			8,397
Cash and cash equivalents at end of period	$	31,738		$	10,378
Supplemental disclosures
Cash paid for interest	$	643		$	113
Cash received for income taxes	$	19,329		$	41
Non-cash investing and financing activities
Purchases of property, plant and equipment included in accounts payable	$	489		$	36

See Accompanying Notes to Condensed Consolidated Financial Statements

7

Harte Hanks, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note A - Overview and Significant Accounting Policies

Background

Harte Hanks, Inc., together with its Subsidiaries ("Harte Hanks," "Company", "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 Principal Executive Officer 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 (“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 Preferred Stock 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), and 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 used the proceeds from the issuance for general corporate purposes including 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 provide Wipro with agency 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 interim 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.

8

Interim Financial Information

The condensed consolidated 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.

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.

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.

9

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, trade payables and long-term debt.

Leases

We determine if an arrangement is a lease at its inception. Operating and finance leases are included in the lease right-of-use (“ROU”) assets and the 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 interest 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 April 2019, the Financial Accounting Standards Board ("FASB") issued guidance to amend or clarify certain areas within three previously issued standards related to financial instruments which includes clarification for fair value using the measurement alternative, measuring credit losses and accounting for derivatives and hedging. The amendments in this guidance are largely effective for fiscal years beginning after December 15, 2019 with early adoption permitted. We have not elected early adoption and do not anticipate that this guidance will have a material impact on our condensed consolidated financial statements.

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 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 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,

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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 unless the practical expedient is elected for short-term operating leases. 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 statements of comprehensive (loss) income or cash flows from operations. The cumulative effect of the changes on our retained earnings was $22 thousand 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. 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 terms can vary by contract, but the period between invoicing and when payment is due is not significant. At September 30, 2019 and December 31, 2018, our contracts do not include any significant financing components.

Consistent with legacy GAAP, we present sales taxes assessed on revenue-producing transactions on a net basis.

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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 and nine months endedSeptember 30, 2019 and 2018 by our key vertical markets:

In thousands	Three Months Ended				Nine Months Ended
	Sep 30, 2019		Sep 30, 2018		Sep 30, 2019		Sep 30, 2018
B2B	$	11,290	$	14,069	$	35,149	$	47,673
Consumer Brands	11,171		12,642		35,222		47,893
Financial Services	11,635		13,185		36,850		42,185
Healthcare	5,257		4,382		14,946		12,800
Retail	8,803		14,933		31,752		46,884
Transportation	3,258		4,377		11,331		16,982
Total Revenues	$	51,414	$	63,588	$	165,250	$	214,417

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 and nine months endedSeptember 30, 2019 by our four major revenue streams and the pattern of revenue recognition:

	For the Three Months Ended September 30, 2019
In thousands	Revenue for performance obligations recognized over time		Revenue for performance obligations recognized at a point in time		Total
Agency & Digital Services	$	6,286	$	276	$	6,562
Contact Centers	14,618		—		14,618
Database Marketing Solutions	5,272		1,170		6,442
Direct Mail, Logistics, and Fulfillment	20,775		3,017		23,792
Total Revenues	$	46,951	$	4,463	$	51,414

	For the Nine Months Ended September 30, 2019
In thousands	Revenue for performance obligations recognized over time		Revenue for performance obligations recognized at a point in time		Total
Agency & Digital Services	$	18,793	$	407	$	19,200
Contact Centers	46,688		—		46,688
Database Marketing Solutions	16,745		2,537		19,282
Direct Mail, Logistics, and Fulfillment	67,853		12,227		80,080
Total Revenues	$	150,079	$	15,171	$	165,250

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

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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.

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 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.

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 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.

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.

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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.

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 to five years for database solutions contracts and six months to one year for contact center contracts). The balance of upfront non-refundable fees collected from customers were immaterial as of September 30, 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 September 30, 2019 totaled $0.2 million, which is expected to be recognized over the next 2 years as follows: $0.1 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 September 30, 2019 and December 31, 2018:

In thousands	September 30, 2019		December 31, 2018
Contract assets	$	986	$	2,362
Deferred revenue and customer advances	4,286		6,034
Deferred revenue, included in other long-term liabilities	904		578

Revenue recognized during the nine months ended September 30, 2019 from amounts included in deferred revenue at December 31, 2018 was approximately $4.1 million. We recognized no revenues during the nine months ended September 30, 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

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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 $2.1 million as of September 30, 2019. For the periods presented, no impairment was recognized.

Note D - Leases

On January 1, 2019, the Company adopted Topic 842 using the modified retrospective approach with optional transition method. 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 September 30, 2019, assets recorded under finance and operating leases were approximately $1.0 million and $19.6 million respectively, and accumulated depreciation associated with finance leases was $0.3 million. 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 September 30, 2019
	Operating Leases		Finance Leases		Total
Right-of-use Assets	19,647		1,037		$	20,684
Liabilities
Short-term lease liabilities	7,625		423		8,048
Long-term lease liabilities	14,105		473		14,578
Total Lease Liabilities	$	21,730	$	896	$	22,626

For the three and nine months ended September 30, 2019, the components of lease expense were as follows:

In thousands	Three Months Ended September 30, 2019		Nine Months Ended September 30, 2019
Operating lease cost	$	2,347	$	6,940
Finance lease cost
Amortization of right-of-use assets	75		225
Interest on lease liabilities	16		54
Total Finance lease cost	91		279
Variable lease cost	614		1,991
Total lease cost	$	3,052	$	9,210

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Other information related to leases was as follows:

In thousands	Nine Months Ended September 30, 2019
Supplemental Cash Flows Information
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	13,076
Operating cash flows from finance leases	63
Financing cash flows from finance leases	344
Weighted Average Remaining Lease term
Operating leases	3.46
Finance leases	2.90
Weighted Average Discount Rate
Operating leases	4.71		%
Finance leases	6.68		%

The maturities of the Company’s finance and operating lease liabilities as of September 30, 2019 are as follows: 

In thousands	Operating Leases		Finance Leases
Year Ending December 31,
Remainder of 2019	$	2,359	$	459
2020	7,867		200
2021	5,794		160
2022	3,941		141
2023	2,188		3
2024	1,397		—
Total future minimum lease payments	23,546		963
Less: Imputed interest	1,816		67
Total lease liabilities	$	21,730	$	896

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:

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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 September 30, 2019, wehave no additional operating leases that have not yet commenced.

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 Series A 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), and only if prior to such Liquidation such shares of Series A Preferred Stock have not been converted to Common Stock. As of September 30, 2019, cumulative dividends payable to the holders of Series A Preferred Stock upon a Liquidation totaled $0.8 million or $83.43 per share of Series A Preferred Stock.

Conversion

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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 September 30, 2019.

Note F — Long-Term Debt

As of September 30, 2019 and December 31, 2018, we had $18.7 million and $14.2 million of borrowings outstanding under the Texas Capital Facility (as defined herein). As of September 30, 2019, we had the ability to borrow an additional $0.5 million under the facility.

Credit Facilities

On April 17, 2017, we entered into a secured credit facility with Texas Capital Bank, N.A., that provided a $20.0 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 commitment balances accrue interest at 0.50%. We are required to pay a quarterly fee of $0.1 million as consideration for the guarantee 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 Company has been in compliance of all the requirements.

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 $22.0 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 September 30, 2019, we had letters of credit outstanding in the amount of $2.8 million. No amounts were drawn against these letters of credit at September 30, 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.

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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 (Loss) Income. We recognized $0.3 million and $(2.0) million of stock-based compensation expense (benefit) during the three months ended September 30, 2019 and 2018, respectively. We recognized $0.7 million and $(0.7) million of stock-based compensation expense (benefit) during the nine months ended September 30, 2019 and 2018, respectively. The stock-based compensation expense for 2018 was a credit due to forfeitures resulting from departures by officers of the Company.

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 September 30,						Nine Months Ended September 30,
In thousands	2019			2018			2019			2018
Interest cost	$	1,813		$	1,685		$	5,439		$	5,055
Expected return on plan assets	(1,111		)	(1,524		)	(3,333		)	(4,571		)
Recognized actuarial loss	732			689			2,197			2,068
Net periodic benefit cost	$	1,434		$	850		$	4,303		$	2,552

We made $2.2 million minimum 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 and $1.3 million in the three and nine months endedSeptember 30, 2019, respectively.

Note I - Income Taxes

Our income tax expense of $0.1 million for the three months ended September 30, 2019 resulted in a negative effective income tax rate of 1.7%. Our nine months ended September 30, 2019 income tax expense of $0.8 million resulted in a negative effective income tax rate of 3.7%. The effective income tax rate for the three and nine months ended September 30, 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.

Our income tax benefit of $1.4 million for the three months ended September 30, 2018 resulted in an effective income tax rate of 12.6%. Our nine months ended September 30, 2018 income tax benefit of $10.8 million resulted in a negative effective income tax rate of 211.4%. The effective income tax benefit calculated for the three months ended September 30, 2018 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. The effective income tax benefit for the nine months ended September 30, 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 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 and nine months ended September 30, 2019 and September 30, 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.

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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

U.S. state returns, we are no longer subject to tax examinations for tax years prior to 2014. For U.S. federal and foreign returns, we are no longer subject to tax examinations for tax years prior to 2016.

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 (Loss) Income. We did not have a significant amount of interest or penalties accrued at September 30, 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 Series A Preferred Stock is considered a participating security with objectively determinable and non-discretionary dividend participation rights. Series A 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 September 30,
In thousands, except per share amounts	2019			2018
Net loss	$	(5,988	)	$	(9,984	)
Less: Preferred stock dividends	125			125
Loss attributable to common stockholders	$	(6,113	)	$	(10,109	)
Basic loss per Common Share
Weighted-average common shares outstanding	6,291			6,250
Basic loss per common share	$	(0.97	)	$	(1.62	)
Diluted Loss per Common Share
Weighted-average shares used to compute earnings/(loss) per share attributable to common shares	6,291			6,250
Diluted Loss per common share	$	(0.97	)	$	(1.62	)
Computation of Shares Used in Diluted Loss Per Common Share
Weighted-average common shares outstanding	6,291			6,250
Shares used in diluted loss per common share computations	6,291			6,250

For the three months ended September 30, 2019 and 2018, respectively, the following shares have been excluded from the calculation of shares used in the diluted EPS calculation: 0.1 million and 0.2 million shares of anti-dilutive market price options; 0.2 million and 0.1 million of anti-dilutive unvested shares; and 1.0 million and 0 shares of anti-dilutive preferred stock (as if converted).

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	Nine Months Ended September 30,
In thousands, except per share amounts	2019			2018
Numerator:
Net (loss) income	$	(23,318	)	$	15,909
Less: Preferred stock dividend	371			332
Less: Earnings attributable to participating securities	—			1,957
Numerator for basic EPS: (loss) income attributable to common stockholders	$	(23,689	)	$	13,620
Effect of dilutive securities:
Add back: Allocation of earnings to participating securities	—			1,957
Less: Re-allocation of earnings to participating securities considering potentially dilutive securities	—			(1,951		)
Numerator for diluted EPS	$	(23,689	)	$	13,626
Denominator:
Basic EPS denominator: weighted-average common shares outstanding	6,277			6,230
Effect of dilutive securities:
Unvested shares	—			21
Diluted EPS denominator	6,277			6,251
Basic (loss) earnings per common share	$	(3.77	)	$	2.19
Diluted (loss) earnings per common share	$	(3.77	)	$	2.18

For the nine months ended September 30, 2019 and 2018, respectively, the following shares have been excluded from the calculation of shares used in the diluted EPS calculation: 0.1 million and 0.3 million of anti-dilutive market price options; 0.2 million and 0.1 million anti-dilutive unvested shares; and 1.0 million and 0 shares of anti-dilutive preferred stock (as if converted).

Note K — Comprehensive (Loss) Income

Comprehensive (loss) income for a period encompasses net (loss) income and all other changes in equity other than from transactions with our stockholders. Our comprehensive (loss) income was as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
In thousands	2019			2018			2019			2018
Net (loss) Income	$	(5,988	)	$	(9,984	)	(23,318		)	$	15,909
Other comprehensive income (loss):
Adjustment to pension liability	732			689			2,197			2,068
Tax expense	(183		)	(172		)	(549		)	(516		)
	549			517			1,648			1,552
Foreign currency translation adjustment, net of tax	(660		)	(248		)	(311		)	(1,207		)
Adoption of ASU 2018-2	—			—			(11,355		)	—
Total other comprehensive income (loss), net of tax	(111		)	269			(10,018		)	345
Total comprehensive (loss) income	$	(6,099	)	$	(9,715	)	$	(33,336	)	$	16,254

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Changes in accumulated other comprehensive 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	—			(311		)	(311		)
Amounts reclassified from accumulated other comprehensive income (loss), net of tax, to other, net, on the condensed consolidated statements of comprehensive (loss) income	1,648			—			1,648
Adoption of ASU 2018-02	(11,355		)	—			(11,355		)
Net current period other comprehensive income (loss), net of tax	(9,707		)	(311		)	(10,018		)
Balance at September 30, 2019	$	(56,291	)	$	(210	)	$	(56,501	)

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	—			(1,207		)	(1,207		)
Amounts reclassified from accumulated other comprehensive income (loss), net of tax, to other, net, on the condensed consolidated statements of comprehensive (loss) income	1,552			—			1,552
Net current period other comprehensive income (loss), net of tax	1,552			(1,207		)	345
Balance at September 30, 2018	$	(43,866	)	$	(92	)	$	(43,958	)

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 ordinary 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.

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.

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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 (“Contingent Payment”) if the 3Q Digital business is sold again (provided certain value thresholds are met) ("Qualified Sale"). 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 September 30, 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 N — 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 and nine months endedSeptember 30, 2019 and 2018, we recorded an immaterial amount of revenue for services we provided to Wipro.

During the three months endedSeptember 30, 2019 and 2018, we recorded $2.6 million and $3.2 million of expense, respectively, in technology-related services and lease expense for a facility Wipro provided to us. During the nine months ended September 30, 2019 and September 30, 2018, we recorded $9.5 million and $9.3 million of expense, respectively, in technology-related services and lease expense for a facility Wipro provided to us. Included in the $9.5 million of expense for the nine months ended September 30, 2019 was a one-time termination charge of $2.1 million because in the first quarter of 2019 we terminated several technology related service agreements with Wipro and entered into new agreements resulting in $3.3 million of annual savings. In Q3 2019, we terminated a portion of the new agreements with Wipro. We also incurred $0.7 million of termination charge related to an additional service agreement with Wipro.

During the three and nine months endedSeptember 30, 2019, we capitalized $0 and $1.7 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 September 30, 2019.

As of September 30, 2019 and December 31, 2018, we had trade payables due to Wipro of $1.4 million and $5.0 million, respectively. As of September 30, 2019 and December 31, 2018, we had an immaterial amount in trade receivables due from Wipro.

In the third quarter of 2019, we entered a business relationship with Snap Kitchen, the founder of which is a 7% owner of Harte Hanks.

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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 O — Restructuring Activities

Our management team along with members of the Board have formed a project committee focused on our cost-saving initiatives and other restructuring efforts. This committee has commenced a review of each of our business lines and other operational areas to identify both one-time and recurring cost-saving opportunities.

In the three and nine months endedSeptember 30, 2019, we recorded restructuring charges of $3.1 million and $10.9 million, respectively. This comprised charges mainly related to customer database build write offs, termination fees related to certain contracts with Wipro, severance agreements, asset impairment and facility related expense. The following table summarizes the restructuring charges which are recorded in "Restructuring Expense" in the Condensed Consolidated Statement of Comprehensive (Loss) Income.

In thousands	Three Months Ended September 30, 2019		Nine Months Ended September 30, 2019
Customer database build write off	$	—	$	4,036
Contract termination fee	667		2,767
Severance	1,116		1,760
Facility, asset impairment and other expense	1,297		2,304
Total	$	3,080	$	10,867

The following table summarizes the changes in liabilities related to restructuring activities:

In thousands	Three months Ended September 30, 2019
	Contract Termination Fee			Severance			Facility, asset impairment and other expense			Total
Beginning Balance:	$	2,100		$	231		$	76		$	2,407
Additions:	667			1,116			452			2,235
Payments	(700		)	(739		)	(387		)	(1,826		)
Ending Balance:	$	2,067		$	608		$	141		$	2,816

In thousands	Nine Months Ended September 30, 2019
	Contract Termination Fee			Severance			Facility, asset impairment and other expense			Total
Beginning balance:	$	—		$	—		$	—		$	—
Additions:	2,767			1,760			528			5,055
Payments	(700		)	(1,152		)	(387		)	(2,239		)
Ending balance:	$	2,067		$	608		$	141		$	2,816

We expect that in connection with our cost-saving and restructuring initiatives, we will incur total restructuring charges of approximately $14.0 million through 2020. One of the larger initiatives to combine sub-scale production environments received Board approval on August 1, 2019. This will result in the closing of three production facilities by the end of 2019 and consolidating the work currently performed at these facilities into other production facilities. The related lease impairment charge of $0.9 million was recorded in the three months ended September 30, 2019.

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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, as amended (the "1933 Act") and Section 21E of the 1934 Act, as amended. 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 "the negative thereof" or similar words of similar meaning. Examples include statements regarding (1) our strategies and initiatives, (2) restructuring activities and other 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) expectations regarding legal proceedings and other contingent liabilities, (8) the impact of recent tax reform legislation on our results of operations, 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 the 2018 10-K, Quarterly Report on Form 10-Q for the quarter ended September 30, 2019 and in the “Cautionary Note Regarding Forward-Looking Statements” in our second quarter 2019 earnings release issued on August 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. and its subsidiaries. This section is provided as a supplement to, and should be read in conjunction with, our Condensed Consolidated Financial Statements and the accompanying notes 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 Policies, 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

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• Direct mail

• 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. 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. For additional information, see "Liquidity and Capital Resources" section.

Recent Developments

Restructuring Activities

Our management team, along with members of the Board, have formed a project committee focused on our cost-saving initiatives and other restructuring efforts. This committee has commenced a review of each of our business lines and other operational areas to identify both one-time and recurring cost-saving opportunities. To date the committee has already identified over $20 million in potential annual savings, some of which we have already begun to recognize.

In the three and nine months endedSeptember 30, 2019, we recorded restructuring charges of $3.1 million and $10.9 million, respectively. These comprised mainly charges related to customer database build write offs, termination fees related to certain contracts with Wipro, severance agreements, asset impairment and facility related expenses.

We expect that in connection with our cost-saving and restructuring initiatives, we will incur total restructuring charges of approximately $14.0 million through 2020. One of the larger initiatives to combine sub-scale production environments received Board approval on August 1, 2019. This will result in the closing of three production facilities by the end of 2019 and consolidating the work currently performed in these facilities into other production facilities. The related lease impairment charge of $0.9 million was recorded in the three months ended September 30, 2019.

Results of Operations

Operating results were as follows:

	Three Months Ended September 30,								Nine Months Ended September 30,
In thousands, except percentages	2019			2018			% Change		2019			2018			% Change
Revenues	$	51,414		$	63,588		(19.1	)%	$	165,250		$	214,417		(22.9	)%
Operating expenses	55,889			73,941			(24.4	)%	187,278			236,114			(20.7	)%
Operating Loss	$	(4,475	)	$	(10,353	)	(56.8	)%	$	(22,028	)	$	(21,697	)	1.5	%
Operating margin	(8.7		)%	(16.3		)%			(13.3		)%	(10.1		)%
(Loss) income before taxes	$	(5,886	)	$	(11,421	)	(48.5	)%	$	(22,478	)	$	5,109		(540.0	)%
Diluted (Loss) income per common share from operations	$	(0.97	)	$	(1.62	)	(40.1	)%	$	(3.77	)	$	2.18		(272.9	)%

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Revenues

Three months ended September 30, 2019 vs. Three months ended September 30, 2018

Revenues declined $12.2 million, or 19.1%, in the three months ended September 30, 2019, compared to the three months ended September 30, 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 $6.1 million, or 41.1%, $2.8 million, or 19.8%, $1.6 million, or 11.8%, $1.5 million, or 11.6%, and $1.1 million, or 25.6%, respectively. These declines were primarily due to lost clients and lower volumes from existing clients. Healthcare increased slightly by $0.9 million, or 20.0%.

Nine months ended September 30, 2019 vs. Nine months ended September 30, 2018

Revenues declined $49.2 million, or 22.9%, in the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018. These results reflect the impact of declines in almost all of our industry verticals. Revenues declined in our retail, consumer, B2B, transportation, and financial services verticals by $15.1 million, or 32.2%, $12.7 million, or 26.5%, $12.5 million, or 26.2%, $5.7 million, or 33.6% and $5.3 million, or 12.6%, respectively. 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 in 2019 as compared to the nine months ended September 30, 2018 and primarily impacted the B2B and Consumer verticals. Additionally, non-renewing clients and lower volumes from existing clients caused the further decrease in revenues. Healthcare increased slightly by $2.1 million, or 16.4%.

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 September 30, 2019 vs. Three months ended September 30, 2018

Operating expenses were $55.9 million in the three months ended September 30, 2019, compared to $73.9 million in the three months ended September 30, 2018. Labor costs declined $7.0 million, or 19.7%, compared to the three months ended September 30, 2018, primarily due to lower payroll expense from lower revenue and our expense reduction efforts. Production and distribution expenses declined $5.7 million, or 24.8%, compared to the third quarter of 2018 primarily due to lower revenue and cost reduction initiatives. Advertising, Selling, General and Administrative expense decreased $4.0 million, or 41.8%, compared to the three months ended September 30, 2018, primarily due to $1.7 million lower professional services and $0.8 million lower employee expense and $0.4 million lower business services expense from lower revenue. Depreciation, software and intangible asset amortization expense declined $0.5 million, or (29.7)%, compared to the prior year quarter, primarily due to lower capital expenditure.

Nine months ended September 30, 2019 vs. Nine months ended September 30, 2018

Operating expenses were $187.3 million in the nine months ended September 30, 2019, compared to $236.1 million in the nine months ended September 30, 2018. This decline was partially caused by the sale of 3Q Digital (caused a $5.8 million total operating expense reduction to the nine-month period-over-period results). Labor costs declined $32.0 million, or 25.4%, compared to the nine months ended September 30, 2018, primarily due to lower payroll expense as a result of our expense reduction efforts and the sale of 3Q Digital (caused a $4.8 million expense reduction to the nine-month period-over-period results). Production and distribution expenses declined $15.4 million, or 20.9%, compared to the nine months ended September 30, 2018 primarily due to lower transportation service expense, lower broker production expense and lower production service expense due to lower revenue. The sale of 3Q Digital caused a $0.4 million expense reduction to the nine-month period-over-period results. Advertising, Selling and General expense declined $6.7 million, or 24.8%, compared to the nine months ended September 30, 2018, primarily due to a reduction in employee-related expenses and lower professional service expense as well as the sale of 3Q Digital (caused a $0.6 million expense reduction to the nine-month period-over-period results). Depreciation, software and intangible asset amortization expense declined $1.9 million, or 31.6%, compared to the nine months ended September 30, 2018, primarily due to the reduced capital expenditures and the elimination of the intangible assets on the sale of 3Q Digital.

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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

Three months ended September 30, 2019 vs. Three months ended September 30, 2018

Operating loss was $4.5 million in the three months ended September 30, 2019, compared to $10.4 million in three months ended September 30,2018. The $5.9 million improvement was primarily driven by the impact of the restructuring activities with a $18.1 million decline in operating expenses which was partially offset by $12.2 million lower revenue.

Nine months ended September 30, 2019 vs. Nine months ended September 30, 2018

Operating loss was $22.0 million in the nine months ended September 30, 2019, compared to $21.7 million in nine months ended September 30, 2018. The $0.3 million increase in loss was related to revenue of $49.2 million, which was offset by $48.8 million decline in operating expenses due to restructuring activities. The sale of 3Q Digital in late February 2018 resulted in $1.1 million of the lower operating income.

Interest Expense

Three months ended September 30, 2019 vs. Three months ended September 30, 2018

Interest expense, net, in the three months ended September 30, 2019 increased $0.2 million compared to the three months ended September 30, 2018. This increase was due to interest incurred under increased borrowings outstanding under the Texas Capital Facility as of September 30, 2019. As of September 30, 2019, $18.7 million was outstanding under the Facility.

Nine months ended September 30, 2019 vs. Nine months ended September 30, 2018

Interest expense, net, in the nine months ended September 30, 2019 decreased $0.4 million compared to the nine months ended September 30, 2018. The decline was due to the elimination of interest accretion expense related to the 3Q Digital contingent consideration liability as of February 2018 which was partially offset by higher interest expense associated with increased borrowings outstanding under the Texas Capital Facility as of September 30, 2019.

Gain on sale

The gain on sale for nine months ended September 30, 2019 is the result of $5 million Contingent Payment we received

related to the Qualified Sale of 3Q Digital as defined in the Purchase and Sales Agreement dated February 28, 2018.

The gain on sale for nine months ended September 30, 2018 is the result of the sale of 3Q Digital in late February 2018 whereby the sum of proceeds received plus net obligations eliminated resulted in a gain on sale of $31.0 million.

Other Income and Expense

Three months ended September 30, 2019 vs. Three months ended September 30, 2018

Other expense, net, increased $0.2 million in the three months ended September 30, 2019, compared to the three months ended September 30, 2018 mainly due to increased pension expenses.

Nine months ended September 30, 2019 vs. Nine months ended September 30, 2018

Other expense, net, increased $1.7 million in the nine months ended September 30, 2019, compared to the nine months ended September 30, 2018 mainly due to changes in pension expense and foreign currency revaluation.

Income Taxes

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Three months ended September 30, 2019 vs. Three months ended September 30, 2018

The income tax expense of $0.1 million in the third quarter of 2019 represents a decrease in benefit of $1.5 million when compared to the third quarter of 2018. Our effective tax rate was negative 1.7% for the third quarter of 2019, decreasing from a rate of 12.6% for the third quarter of 2018. The effective income tax rate calculated for the three months ended September 30, 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.

Nine months ended September 30, 2019 vs. Nine months ended September 30, 2018

The income tax expense of $0.8 million in the nine months ended September 30, 2019 represents a decrease in our income tax benefit of $11.6 million, as compared to nine months ended September 30, 2018. Our effective tax rate was negative 3.7% for the first nine months of 2019, increasing from a rate of negative 211.4% for the first nine months of 2018. The effective income tax rate for the first nine months of 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 used a discrete effective tax rate method to calculate income taxes for the three and nine month ended September 30, 2019 and September 30, 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 rates.

Liquidity and Capital Resources

Sources and Uses of Cash

Our cash and cash equivalent balances were $31.7 million and $20.9 million at September 30, 2019 and December 31, 2018, respectively. 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 June 26, 2019, we received $15.9 million in aggregate federal income tax refunds related to carryback of capital losses. On May 7, 2019, we received a $5 million Contingent Payment related to the Qualified Sale of 3Q Digital.

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 provided by operating activities for the nine months ended September 30, 2019 was $9.4 million, compared to net cash used by operating activities of $7.0 million for the nine months ended September 30, 2018. The $16.4 million year-over-year increase was primarily the result of $20.5 million tax refund received which was partially offset by decreases in accounts payable in the nine months ended September 30, 2019 as compared to 2018.

Investing Activities

Net cash used in investing activities was $1.6 million for the nine months ended September 30, 2019, compared to the net cash provided by investing activities of $1.3 million for the nine months ended September 30, 2018. This change was mainly due to the sale of 3Q Digital in late February 2018.

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Financing Activities

Net cash provided by financing activities was $3.4 million for the nine months ended September 30, 2019, compared to $8.9 million for the nine months ended September 30, 2018. The $5.4 milliondecrease 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 Texas Capital Credit Facility in the first quarter of 2019.

Foreign Holdings of Cash

Consolidated foreign holdings of cash as of September 30, 2019 and 2018 were $3.2 million and $2.3 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 $22.0 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 September 30, 2019, we had letters of credit in the amount of $2.8 million. No amounts were drawn against these letters of credit at September 30, 2019.  These letters of credit exist to support insurance programs relating to workers’ compensation, automobile, and general liability.

As of September 30, 2019 and December 31, 2018, we had $18.7 million and $14.2 million of borrowings outstanding under the Texas Capital Facility. As of September 30, 2019, we had the ability to borrow an additional $0.5 million under the 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 - the 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.

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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.

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. As of September 30, 2019, we had $18.7 million of borrowings outstanding under the Texas Capital Facility.

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 $0.3 million in pre-tax currency transaction gains in the nine months ended September 30, 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, as amended, 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 Principal Executive Officer, Chief Financial Officer, and Corporate Controller as appropriate to allow timely decisions regarding required disclosure.

Our management, including our Principal 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 September 30, 2019, the end of the period covered by this Quarterly Report on Form 10-Q. Based upon such evaluation, our Principal Executive Officer, Chief Financial Officer and Corporate Controller concluded that our disclosure controls and procedures were not effective as of September 30, 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.

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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 Principal 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 September 30, 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 have continued 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. A walk-through has 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 nine months ended September 30, 2019, significant progress was made in relation to the design and implementation of controls. There is still additional work to be done to completely remediate the material weaknesses. However, we expect all the material weaknesses to be remediated by the end of 2019.

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.

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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 September 30, 2019 to the risk factors previously disclosed in the 2018 10-K.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3.  Defaults Upon Senior Securities

Not applicable.

Item 4.  Mine Safety Disclosures

Not applicable.

Item 5.  Other Information

None.

Item 6.  Exhibits

Exhibit No.	Description of Exhibit
*10.1	Second Amendment to Credit Agreement
*10.2	Separation Agreement with Timothy E. Breen
*31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
*31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
*32.1	Furnished Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
*32.2	Furnished Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
*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.

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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.
November 12, 2019	/s/ Mark A. Del Priore
Date	Mark A. Del Priore
	Executive Vice President and Chief Financial Officer
November 12, 2019	/s/ Lauri Kearnes
Date	Lauri Kearnes
	Vice President, Finance and
	Corporate Controller

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