itWE MAKE HAPPEN H A R T E - H A N K S , I N C . 2 0 0 0 A N N U A L R E P O R T WE MAKE itThe right people, the right tools, the right attitude. HAPPEN Today’s business landscape is more firmly anchored by technology than ever. Yet the application and support of that technology — and the development of successful direct and interactive marketing programs — remain a challenge for many companies worldwide. The solution is Harte-Hanks. Through a variety of services — Web page design to e-care, desktop database capabilities to systems integration, personalized mail to e-mail, software products to hosting, both e- and traditional fulfillment to shopper ads on paper and the Internet — we offer clients fully integrated marketing solutions. In other words, at Harte-Hanks, we make it happen. Direct Marketing Customer Relationship Management (CRM) and Marketing Services CRM enables companies to enhance their relationships with customers by responding to customer needs. At Harte-Hanks, we helped define CRM. This includes building and maintaining databases, as well as providing access to and analysis of data. These services help us deliver full-spectrum direct and interactive marketing solutions. Our CRM efforts are closely aligned with our Marketing Services solutions — developing marketing plans that meet the specific needs of each client and providing customized services. Our people offer program planning and management, and the execution of integrated marketing programs via mail, telephone and the Internet. it Shopper Publications Harte-Hanks Shopper publications are delivered to nearly 10 million households each week in California and Southern Florida. Zoned into more than 800 separate editions, these publications offer advertisers a targeted, cost-effective local advertising system, with virtually 100% penetration in their areas of distribution. 1 Financial Highlights (in millions, except per share amounts) Operating Revenues Operating Income 98 99 00 $749 $830 $961 98 99 00 After-Tax Cash Flow Earnings Per Share 98 99 00 $96 $108 $126 98 99 00 $102 $118 $138 $0.88 $1.01 $1.18 2 0 0 0 A N N U A L R E P O R T Company Profile Harte-Hanks makes it happen Based in San Antonio, Texas, and with facilities around the world, Harte-Hanks is a direct and interactive services company that provides end-to-end CRM and related solutions for businesses and organizations in both consumer and business-to-business markets. Harte-Hanks Direct Marketing has the tools to capture, analyze and disseminate business-to- business and business-to-consumer data at all points of contact. Our services help clients identify and reach their best customers and prospects — 2 and direct them to contact centers, retail locations and Web sites, while gaining knowledge about them in the process. Our client base is comprised of many Fortune 1,000 companies — some of the most recognizable names in retail, financial services, high-tech, pharmaceuticals, telecommunications and healthcare. Harte-Hanks also owns and operates shopper publications that target households based on geography, reaching nearly 10 million households in California and Southern Florida each week. Financial Highlights (in thousands, except per share amounts) 2000 1999 1998 Operating revenues Operating income Depreciation $960,773 $829,752 $748,546 138,221 118,228 101,958 28,494 24,126 21,087 Goodwill and intangible amortization 15,226 10,662 7,890 Operating cash flow (operating income plus depreciation and goodwill amortization) After-tax cash flow (net income plus depreciation and goodwill amortization) Interest expense 181,941 153,016 130,935 125,606 107,729 96,036 1,678 349 193 Income before non-recurring items 81,886 72,941 67,059 Earnings per share Capital expenditures Average common and common equivalent shares outstanding (diluted) 1.18 1.01 0.88 36,465 28,928 24,443 69,653 72,144 76,057 Highlights above exclude 1998 pension curtailment gain. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” H A R T E - H A N K S , I N C . it IS ALL ABOUT SOLUTIONS… 3 Gathering information, building partnerships and better serving our clients As we settle into a new century, technology continues to revolutionize the way we live and the way we work. From a business standpoint, technology enables a company to communicate with and serve clients in many different ways. But do we control technology — or does technology control us? At Harte-Hanks, our approach has always centered on serving our clients with interactive and technologically- driven solutions. Our success is built on the industry-specific expertise of our people and our ability to harness technology and use it as a tool to develop customized solutions to accomplish the goals of our clients. While many companies are only now recognizing the possibilities of customer relationship management (CRM), we’ve been building solutions based on this concept for more than 25 years, identifying and reaching the most desirable customers through faster and more flexible approaches. With a deep understanding of the markets we serve, and people who understand both the technology and its applications, we continue to explore purchase patterns, channel preference and the best growth opportunities for our clients. With an eye toward exceeding our clients’ expectations, we’ve realigned our organization. CRM brings together the CRM/Response Management and CRM/Database groups, and a Technology Services group has been created to ensure a focus on a more standardized approach to information technology throughout the company. This structure allows us to provide a more complete and integrated set of solutions. At Harte-Hanks, we’re excited about the future and the promise it holds. As the marketplace continues to evolve, Harte-Hanks will remain a leader, partnering with clients in a wide range of industry groups and providing them with technology-based solutions that help them keep customers — and find not just new customers, but the best customers. 2 0 0 0 A N N U A L R E P O R T 4 To Our Shareholders CRM — or customer relationship management — is something we heard a lot about in 2000. While nearly everyone in business believes CRM is important, many companies are having a hard time making it work. In fact, we conducted a study in 2000 among 448 companies selected from our Market Intelligence database and learned that 83% of these companies do not yet have a CRM solution in place. And although there are many different definitions of CRM, these definitions often leave out an important element — execution. Yet this is where we shine, it is our “sweet spot” and it is a value added benefit we offer — because at Harte-Hanks, “we make it happen!” In the direct marketing area, where we’ve recently organized into two operational groups — CRM and Marketing Services — “making it happen” is our worldwide go-to-market strategy. With a solid technology services foundation and people who truly understand the business of our clients, we offer customized, results-oriented solutions. “Making it happen” in our Shoppers group means using technology, a robust sales organization and a strong readership product that helps local and regional advertisers deliver targeted messages to customers and prospects. Across Harte-Hanks, we believe an important part of making it happen for clients is seamlessly integrating all touch points. We continue to integrate the telephone medium with mail — and today we are successfully expanding our integration efforts to include the Internet. Yes, all are viable stand-alone media, but each works best when integrated with others. What’s more, we have expanded our channel development and alliance network to deliver the best direct marketing solutions for each client — and often these solutions are quite different. In order to satisfy the needs of our clients, we combine software from our partners with our own, add our customer care and database building products and processes and draw on our understanding of relevant solutions in various vertical markets. In other words, we make it happen with best-of-breed solutions: Web design to e-care, desktop database products to systems integration, traditional to on-demand print, direct mail to e-mail, data quality software to hosting solutions, graphics to full direct agency services, traditional to electronic fulfillment. Plus, our customer-centric model allows us to be an overall solution provider for clients who need to drive traffic to a contact center, Web site or brick-and-mortar location. We truly believe — and have for some time — that blending and integrating all touch points is the right business model for a services company. While our work remains mostly centered on traditional approaches, our ability to offer and integrate e-capabilities helps us win new business. Not only do customers realize the importance of this new channel, they are confident in our ability to “make it happen” for them. We also believe that it is people who make things happen. In 2000 we promoted Gary Skidmore and Charles Dall’Acqua to senior vice presidents, leading the CRM and Marketing Services operational groups respectively. Craig Combest was also promoted to senior vice president, taking on the increased responsibility for sales in all vertical markets. Also promoted to vice president were Bob Brown, Kathy Calta, Jim Davis, Bill Goldberg, Spencer Joyner and Tann Tueller. This organizational realignment recognizes the contribution these people have made to Harte-Hanks for many years and represents the next evolution of management structure that supports the aggressive execution of our direct and interactive marketing strategy. In 1999 we acquired Market Intelligence, and in 2000 we complemented this strategic business-to-business database compiler with the acquisition of IRG. In 2001 we will combine the two capabilities and offer a range of niche products in addition to an even more robust high-tech database. Our worldwide presence was expanded with the opening of a 62,000 square foot facility in Hasselt, Belgium, and the acquisition of Hi-Tech Marketing in the United Kingdom. We also compiled a Latin American high-tech database. Once again we had good financial performance. Diluted earnings per share were up 16.8% to $1.18 on a revenue increase of 15.8% to $960.8 million. Even with some softness in retail, our direct marketing business extended its streak to 11 consecutive years of good growth — revenue was up 18.4% while operating cash flow increased 20.1%. Shoppers had another terrific year with revenue up 10.4% and operating cash flow increasing by 15.7%. We added 300,000 of additional Shopper circulation through internal circulation growth. During 2000 we repurchased 3.9 million shares of our own stock under the repurchase program first authorized in January 1997. Since inception, we have repurchased 14 million shares and have 4.6 million shares remaining under authorization at the end of 2000. Looking ahead. While the general softening of the economy in the second half of 2000 is continuing into the start of 2001, we are enthusiastic about our business and the industries in which we work. And we remain excited about our company’s position as a leader in both direct and interactive marketing and Shoppers. Our ability to deliver end-to-end solutions that help our clients target their best customers and prospects is even more valuable during times of economic uncertainty. As we consider the future, there are many reasons to be proud. Our strong CRM capabilities. Our continuing history as a high-quality service provider. Our financial strength and the investments we continue to make in our people. Our ability to provide solutions for our clients. These are the things that make us confident that 2001 will be another successful year. We understand that we are constantly measured — by our customers, our shareholders and our own people. We will continue to make it happen for all of you. 5 Larry Franklin Chairman and Chief Executive Officer Richard M. Hochhauser (left) President and Chief Operating Officer 2 0 0 0 A N N U A L R E P O R T Direct Marketing CONSTRUCT AND UPDATE THE DATABASE Both for business-to-business and business-to-customer ACCESS THE DATA Flexible hosting capabilities EXECUTE THE PROGRAMS Customer and prospect communications and delivery 6 We are vertical market experts dedicated to quality and service ANALYZE THE DATA Relevant research and evaluation APPLY THE KNOWLEDGE Putting data to work through effective multi-channel marketing programs How we make it happen for our customers During the past 25 years, technology has evolved to provide true one-to-one marketing to customers — the basis of CRM. And Harte-Hanks has the worldwide direct and interactive CRM and marketing services capabilities to provide complete end-to-end solutions. Making it happen takes more than just a software application. Our people offer much more than a set of capabilities — we provide guidance and insight to help clients focus on the possibilities that hold the greatest potential. From brick-and-mortar to “dot-coms,” from e-channels to traditional channels, we know the unique CRM challenges our clients face in their respective industries. We’ve made the investment in many products and services over the years, and we’ve also developed staff who are experts. Not only do we understand direct mail, e-marketing and telemarketing channels, we are CRM focused, we understand the business of direct and interactive marketing, and we are industry experts. H A R T E - H A N K S , I N C . Direct Marketing — CRM itWE MAKE HAPPEN 7 Comprehensive, reliable database services Our professional services team, which has expertise in the design, construction and support of marketing databases, continues to help our clients successfully compete in their respective marketplaces. In addition to database hosting, Harte-Hanks maintains a full suite of data production and enhancement solutions. Service bureau processing includes preparing data feeds, developing and maintaining a customer database, preparing marketing lists and files, and accessing and understanding data. Best-of-breed software and services We’ve developed some of the most advanced e-care, e-marketing and traditional response management programs in business today. With nTouch Quick Reply, clients can automate their e-mail response systems, enabling quick and personal response to high-volume customer e-mail. nTouch CommCenter enhances clients’ Web sites by incorporating a searchable knowledge base that customers can access anytime, with real-time chat, live operator services and e-mail support. In addition, our campaign management systems enable clients to view the status of programs, assign tasks to Harte-Hanks program managers and generate reports for program analysis all via the Web. Our proprietary TrilliumTM software provides industrial-strength data cleansing, conversion and reengineering capabilities for valuable data — allowing accurate, standardized and consolidated views of legacy, operational and customer data. Trillium was rated the leader for excellence, quality and overall value to the enterprise, winning a DM Review Reader’s Award for 2000. Our AllinkTM solution set, which includes best-of-breed partner products as well as Harte-Hanks TrilliumTM, Relationship BuilderTM and AgentTM, delivers end-to-end database solutions. A new acquisition, a stronger offering To further enhance our database offering, Harte-Hanks acquired Information Resource Group (IRG) in November 2000. IRG develops databases and related solutions that provide information on buyers and suppliers of technology products and services. These capabilities complement the database products and solutions currently offered to technology and communications organizations by Market Intelligence, which Harte-Hanks acquired in 1999. The end result is a powerful database offering that provides clients and prospects with even more technology-related intelligence on more businesses to enhance their sales, marketing and research initiatives. 2 0 0 0 A N N U A L R E P O R T Direct Marketing — Marketing Services Fulfillment Services Fulfillment services go beyond traditional services and include print-on-demand, Web-based inventory manage- ment and order processing tools, on-demand marketing and e-fulfillment. Telemarketing Our inbound and outbound telemarketing services ensure the lines of communication stay open between clients and their customers. Contact centers are staffed by teleservicing experts with experience in results- oriented customer acquisition, retention programs and partner support programs. itWE MAKE HAPPEN 8 How we make it happen for our customers With more than 20 years experience executing large- and medium-scale projects and programs, we have specialized implementation teams for each of the vertical industries we serve. That means our people are at home in a wide variety of work environments, fulfilling marketing needs including campaign planning and management, customer acquisition programs, loyalty programs, customer retention programs, privacy initiatives, merger and acquisition communications, strategic planning, customer care and customized solutions. What’s more, we deliver it all: proprietary systems, resources, locations, expertise, capacity, experience and volume. We create, produce and mail promotional pieces; we make and take customer and prospect telemarketing calls; we build Web sites and create and receive e-mail; and we are one of the largest and most-focused providers in each of these areas. We offer fulfillment both electronically and traditionally. We do more than execute these functions — we own them. Direct Marketing Agency Services We offer full-service direct marketing agency services that combine information-based strategy and brand-building creative across traditional and interactive media. Personalized Mail and Logistics As one of the largest mailers in the United States, we have the experience to handle direct mail jobs of any size. Services include state-of-the-art printing, laser customization, mail engineering processes, logistics services and mail tracking. H A R T E - H A N K S , I N C . How we make it happen for our customers The Harte-Hanks Shoppers forge a vital link between buyers and sellers of goods and services. In 2000 we expanded the reach and geographic boundaries of our Shopper publications by over 300,000 households. Zoned into more than 800 separate editions, Shoppers reach nearly 10 million households in California and South Florida. In California, Harte-Hanks Shoppers reach over 70% of the households in the state every week with the PennySaver publication. In South Florida, Miami and Fort Lauderdale, area residents shop with The Flyer. These publications are delivered by mail, free of charge to readers. Over 2,000 combinations of geographic and demographic coverage allow for extensive targeting. Single-location, local advertisers can saturate a specific geographic zone, while multiple-location advertisers can saturate multiple zones. Further targeting helps advertisers connect with customers based on lifestyles, behavior and language. Advertisers benefit from a selection of cost-effective advertising products and services, including pre-printed inserts, print and deliver flyers, detached cards, rack products, VIP card and MARQUEETM, as well as traditional classified, display and in-column ads and Web-based products. Shopper Publications itWE MAKE HAPPEN 9 We make it happen in our minds, in our hearts and for our clients At Harte-Hanks, our solutions are securely supported by an extremely valuable resource: our people. We understand the technology, we recognize marketing opportunities and we know the business areas in which our clients compete. We also share a commitment to excellence and a strong desire not only to meet client expectations, but to exceed them. That’s why it’s no surprise that when a client calls, we make it happen. 2 0 0 0 A N N U A L R E P O R T Financial Contents 10 Financial Contents Management’s Discussion and Analysis................................12 Consolidated Balance Sheets ................................................18 Consolidated Statements of Operations ..............................19 Consolidated Statements of Cash Flows ..............................20 Consolidated Statements of Stockholders’ Equity................21 Notes to Consolidated Financial Statements........................22 Five-Year Financial Summary ................................................31 Independent Auditors’ Report..............................................32 Corporate Information........................................................32 Directors, Officers and Harte-Hanks Operations..................33 11 2 0 0 0 A N N U A L R E P O R T 12 Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview The Company’s overall performance reflects its commitment to its growth strategy of being a market leader in the targeted media industry, introducing new products and entering new markets, investing in technology and people, and increasing shareholder value. Harte-Hanks now operates as an international direct and interactive marketing services company that provides end-to-end CRM and related solutions to a wide range of industries serving both consumer and business-to-business markets. The Company also publishes highly targeted advertising shopper publications which reach nearly 10 million households each week. Since December 31, 1998, Harte-Hanks has grown revenues 29.2% and operating income 35.2%, excluding the results of operations sold by the Company during that time. Harte-Hanks has grown internally by adding new customers and products, cross-selling existing products, entering new markets and expanding its international presence. The Company also used proceeds from the sales of its newspaper and television operations and its excess cash flows to fund several acquisitions in 1998, 1999 and 2000. These acquisitions, as well as several previous acquisitions, have enhanced the Company’s growth over the past three years. Harte-Hanks has funded $240.4 million in acquisitions during the period 1998 through 2000. These acquisitions have all been in the Company’s direct and interactive marketing segment, which now comprises 69% of the Company’s revenues. Harte-Hanks derives the majority of its revenues from the sale of direct and interactive marketing and advertising services. As a national business, direct and interactive marketing is affected by general national economic trends. The Company’s shoppers operate in local markets and are affected by the strength of the local economies. The Company’s principal expense items are payroll, postage, transportation and paper. H A R T E - H A N K S , I N C . Results of Operations Operating results were as follows: In thousands 2000 % Change 1999 % Change 1998 Revenues $ 960,773 Operating expenses 822,552 Operating income $ 138,221 15.8 15.6 16.9 $ 829,752 711,524 $ 118,228 10.8 10.0 16.0 $ 748,546 646,588 $ 101,958 Consolidated revenues grew 15.8% to $960.8 million and operating income grew 16.9% to $138.2 million in 2000 compared to 1999. The Company’s overall growth resulted from acquisitions, increased business with both new and existing customers and from the sale of new products and services. Overall operating expenses increased 15.6% to $822.6 million as a result of the acquisitions and overall revenue growth. Overall growth in the Company’s 1999 revenues and operating income resulted from acquisitions and increased business from both new and existing customers. Overall operating expenses increased as a result of the overall revenue growth, including the acquisitions, and the hiring of additional personnel to support the growth. Direct Marketing Direct marketing operating results were as follows: 13 In thousands 2000 % Change 1999 % Change 1998 Revenues $ 662,044 Operating expenses 570,594 Operating income $ 91,450 18.4 18.8 15.5 $ 559,262 480,098 $ 79,164 13.2 13.2 13.7 $ 493,898 424,250 $ 69,648 Direct and interactive marketing revenues increased $102.8 million, or 18.4%, in 2000 compared to 1999. CRM experienced significant revenue growth in 2000 due to increased data processing, Internet and fulfillment business with both new and existing customers. Also contributing to the CRM revenue growth was the October 1999 acquisition of ZD Market Intelligence, renamed Harte-Hanks Market Intelligence, and to a much lesser extent the November 2000 acquisition of Information Resource Group and the June 2000 acquisition of Hi-Tech Marketing Limited. The traditional growth oriented business-to-business activities of CRM had significant growth. The high-tech, mutual fund, non-bank finance, telecommunications and healthcare industry sectors contributed significantly to overall CRM revenue growth, offsetting slowdowns in the insurance industry. Marketing Services also experienced good revenue growth in 2000, led by its targeted mail operations. Marketing Services revenues increased due to increased product sales to both new and existing customers, primarily in the non-bank finance, banking and pharmaceutical industry sectors, offsetting slowdowns in the retail industry. The May 1999 acquisition of Direct Marketing Associates, Inc. also contributed to the Marketing Services revenue growth. Overall, revenue growth for direct and interactive marketing increased as a result of increased business with both new and existing customers across several industry sectors including high-tech, non-bank finance, mutual fund, healthcare, banking, telecommunications and pharmaceutical, as well as the acquisitions noted above. Operating expenses rose $90.5 million, or 18.8%, in 2000 compared to 1999 due primarily to revenue growth contributed by acquisitions, which accounted for approximately 58% of this increase. Excluding these acquisitions, operating expenses increased 8.3%. This remaining increase was due to increased production costs directly associated with increased product volumes, increased payroll costs due to expanded hiring to support revenue growth and increased general and administrative expense from professional and business service fees and employee expenses. Depreciation and amortization expense increased $8.8 million due to goodwill associated with acquisitions and higher levels of capital investment to support growth. Direct and interactive marketing revenues increased $65.4 million, or 13.2%, in 1999 compared to 1998. CRM and Marketing Services both experienced significant revenue growth in 1999. CRM revenues increased due to increased Internet, consulting, data processing and fulfillment business with both new and existing customers, the October 1999 acqui- sition of ZD Market Intelligence, renamed Harte-Hanks Market Intelligence, and to a lesser extent the August 1998 acquisition of Cornerstone Integrated Services. The traditional growth oriented business-to-business activities of CRM had significant growth during the year. The high-tech, non-bank finance, retail and mutual fund industry sectors contributed significantly to overall CRM revenue growth. This growth was partially offset by softness in the healthcare, managed care, business services and publishing industries as well as revenue declines in the outbound credit card business. Marketing Services revenues, led by its targeted mail and logistics operations, increased due to increased product sales, including sales of new products, to new and existing customers, primarily in the retail, government/not-for-profit, and non-bank finance industry sectors. The November 1998 acquisition of Printing Management Systems, Inc. and the May 1999 acquisition of Direct Marketing Associates, Inc. also contributed to the Marketing Services revenue growth. Overall, revenue growth for direct and interactive marketing increased as a result of increased business with both new and existing customers across several industry sectors including retail, financial services, high-tech, pharmaceutical, automotive and telecommunications industries, as well as the acquisitions noted above. Operating expenses rose $55.8 million, or 13.2%, in 1999 compared to 1998 due primarily to revenue growth contributed by acquisitions, which accounted for $43.0 million of the increase. Excluding these acquisitions, operating expenses increased 3.1%. This remaining increase was due to increased production costs directly associated with the increased product volumes, increased payroll costs due to expanded hiring to support revenue growth and increased general and administrative expense from professional and outside service fees. Depreciation and amortization expense increased $5.7 million due to goodwill associated with acquisitions and higher levels of capital investment to support growth. 14 Shoppers Shopper operating results were as follows: In thousands 2000 % Change 1999 % Change 1998 Revenues $ 298,729 Operating expenses 243,019 Operating income $ 55,710 10.4 8.7 18.5 $ 270,490 223,475 $ 47,015 6.2 4.4 16.1 $ 254,648 214,141 $ 40,507 Shopper revenues increased $28.2 million, or 10.4%, in 2000 when compared to 1999. Revenue increases were the result of improved sales in established markets as well as geographic expansions into new neighborhoods in both California and Florida. On a product basis, revenues increased due to growth in in-book products, primarily employment and automotive related advertising and core sales, and distribution products, primarily pre-printed inserts and four-color glossy flyers. Shoppers also experienced growth from up-selling ads onto its Web site. Shopper operating expenses rose $19.5 million, or 8.7%, in 2000 compared to 1999. The increase in operating expenses was primarily due to increases in labor costs of $6.5 million and additional production costs of $8.8 million, including increased postage of $5.3 million due to increased circulation and insert volume growth. Shopper revenues increased $15.8 million, or 6.2%, in 1999 when compared to 1998. Excluding the effects of the sale of the Dallas-Fort Worth Shoppers Guide and the Wichita, Kansas and Springfield, Missouri PennyPower in May 1998, revenues increased $20.7 million, or 8.3%. Revenue increases were the result of improved sales in established markets as well as geographic expansions into new neighborhoods in both Northern and Southern California. On a product basis, revenues increased due to growth in in-book products, primarily employment and core sales, and distribution products, primarily four-color glossy flyers and pre-printed inserts. These increases were partially offset by declining revenues in the personals advertising segment. Shopper operating expenses rose $9.3 million, or 4.4%, in 1999 compared to 1998. Excluding the divestiture mentioned above, the increase in operating expenses was primarily due to increases in labor costs of $4.8 million and additional produc- tion costs of $6.9 million, including increased postage of $4.0 million due to increased circulation and insert volume growth. Acquisitions/Divestitures As described in Note B of the “Notes to Consolidated Financial Statements” included herein, the Company made several acquisitions in the past three years. The Company acquired Detroit-based Information Resource Group, a leading provider of business-to-business intelligence solutions to the high-tech, telecommunications and other industries in November 2000 and Hi-Tech Marketing Limited, a London based leading pan-European provider of CRM services to the high-tech, telecommunications and financial services industries in June 2000. In October 1999, the Company acquired ZD Market Intelligence, renamed Harte-Hanks Market Intelligence, for $101 million in cash from Ziff-Davis, Inc. Harte-Hanks Market Intelligence is a leading provider of database products and solutions to the high-tech and telecommunications industries in the United States, Canada and Europe. The Company acquired Direct Marketing Associates, Inc. of Baltimore, Maryland, a leading provider of integrated direct marketing services to commercial, government and non-profit organizations in May 1999 and LYNQS Newmedia of Kansas City, Missouri, a developer of new media applications for the financial services, pharmaceutical and other industries in June 1999. The Company acquired Cornerstone Integrated Services of Austin, Texas, a leading provider of technical and marketing support services to major computer hardware and software manufacturers, as well as other manufacturers in the high-tech industry in August 1998; Printing Management Systems, Inc. of Bellmawr, New Jersey, a leading provider of direct marketing services geared to addressing clients’ needs in database marketing, inventory control, information processing, fulfillment and direct mail in November 1998; and Spectral Resources, Inc. of Woodstock, New York, a leading provider of interactive solutions to the pharmaceutical industry in December 1998. The Company sold three of its smallest shopper publica- tions, located in Dallas, Texas, Wichita, Kansas and Springfield, Missouri, in May 1998. Interest Expense/Interest Income Interest expense increased $1.3 million in 2000 over 1999 due primarily to interest, commitment charges and the amorti- zation of financing costs associated with the Company’s two unsecured revolving credit facilities. Interest relating to the Company’s unsecured credit facility obtained for the purpose of constructing a new building in Belgium to expand and support the Company’s CRM operations, and a note payable issued in connection with the Company’s June 2000 acquisition of Hi-Tech Marketing Limited also contributed to the increase in interest expense. Total interest expense increased in 1999 when compared to 1998 primarily due to interest and commitment charges from the two unsecured revolving credit facilities the Company obtained in November 1999. The Company’s debt at December 31, 2000 and 1999 is described in Note D of the “Notes to Consolidated Financial Statements” included herein. Interest income decreased $3.6 million in 2000 over 1999 due to the sale of all of the Company’s short-term investments during 1999, the proceeds of which were used to fund acquisi- tions and repurchase the Company’s stock, and lower overall cash balances. Interest income decreased $7.8 million in 1999 over 1998 for the same reasons. Pension Curtailment Gain The Company recognized a pension curtailment gain of $2.15 million and related income tax expense of $0.8 million in 1998. This non-recurring gain resulted from the freezing of benefits under its defined benefit plan. (See Note F of the “Notes to Consolidated Financial Statements” included herein.) Excluding the non-recurring gain and related tax, net income was $67.1 million for the year ended December 31, 1998. 15 Income Taxes Income taxes increased $5.1 million in 2000 due to higher income levels. Excluding income taxes related to the 1998 pension curtailment gain, income taxes increased $2.9 million in 1999 due to higher income levels. The effective income tax rate (excluding the unusual item) was 40.2%, 40.6% and 41.2% in 2000, 1999 and 1998, respectively. Capital Investments Net cash used in investing activities for 2000 included $43.9 million for acquisitions and $36.5 million for capital expenditures. The acquisition investments were made in the direct and interactive marketing segment, discussed under “Direct Marketing.” The capital expenditures consisted primarily of the construction of a new building to expand and support the Company’s CRM operations in Belgium, additional computer capacity, technology, systems and equipment upgrades for the direct and interactive marketing segment to support its growth in all sectors. The Company also invested in facility expansions in its CRM and Marketing Services sectors. The shopper segment’s capital expenditures were primarily related to new press, computer and other production equipment. Net cash used in investing activities for 1999 included $136.5 million for acquisitions and $28.9 million for capital expenditures. The acquisition investments were made in the direct and interactive marketing segment, discussed under “Direct Marketing.” In addition, the Company made equity investments totaling $4.0 million in three companies in order to further strengthen its CRM capabilities. The capital expendi- tures consisted primarily of additional computer capacity, technology, systems and equipment upgrades for the direct and interactive segment to support its growth in all sectors. The Company also invested in facility expansions in its CRM and Marketing Services sectors. The shopper segment’s capital expenditures were primarily related to the Northern California operations consolidation, replacement of Southern California’s order entry and related accounting applications and new press and computer equipment. Additionally, the Company continued with its implementation of new accounting systems software begun in December 1997. 16 Liquidity and Capital Resources Cash provided by operating activities for 2000 was $110.9 million. Net cash outflows from investing activities were $79.5 million for 2000, resulting primarily from the acquisitions and capital investments described above. Net cash outflows from financing activities in 2000 were $43.7 million. The cash outflow from financing activities is attributable primarily to the repurchase of treasury stock throughout 2000 totaling $92.7 million. The acquisitions and repurchases of treasury stock in 2000 were funded through the Company’s cash flows and borrowings under the Company’s credit facilities. Cash provided by operating activities for 1999 was $115.4 million. Net cash outflows from investing activities were $29.6 million for 1999, resulting primarily from the acquisitions described above and funded by the sale and maturity of short- term investments. Net cash outflows from financing activities in 1999 were $81.0 million. The cash outflow from financing activities is attributable primarily to the repurchase of treasury stock throughout 1999 totaling $87.6 million. Capital resources are available from, and provided through, the Company’s two unsecured credit facilities. These credit facilities, two $100 million variable rate, revolving loan commitments, were put in place on November 4, 1999. All borrowings under the $100 million revolving Three-Year Credit to be repaid by November 4, 2002. Agreement are On November 2, 2000 the Company was granted a 364-day extension to its $100 million revolving 364-Day Credit Agreement. All borrowings under the $100 million revolving 364-Day Credit Agreement are to be repaid by November 1, 2001. Management believes that its credit facilities, together with cash provided by operating activities, will be sufficient to fund operations and anticipated acquisitions and capital expenditures needs for the foreseeable future. As of December 31, 2000, the Company had $145.0 million of unused borrowing capacity under its credit facilities. Factors That May Affect Future Results and Financial Condition From time to time, in both written reports and oral state- ments by senior management, the Company may express its expectations regarding its future performance. These “forward- looking statements” are inherently uncertain, and investors should realize that events could turn out to be other than what senior management expected. Set forth below are some key factors which could affect the Company’s future performance. Legislation — There could be a material adverse impact on the Company’s direct and interactive marketing business due to the enactment of legislation or industry regulations arising from public concern over consumer privacy issues. Restrictions or prohibitions could be placed upon the collection and use of information that is currently legally available. Data Suppliers — There could be a material adverse impact on the Company’s direct and interactive marketing busi- ness if owners of the data the Company uses were to withdraw the data. Data providers could withdraw their data if there is a competitive reason to do so or if legislation is passed restricting the use of the data. Acquisitions — In recent years the Company has made a number of acquisitions in its direct and interactive marketing segment, and it expects to pursue additional acquisition opportunities. Acquisition activities, even if not consummated, require substantial amounts of management time and can distract from normal operations. In addition, there can be no assurance that the synergies and other objectives sought in acquisitions will be achieved. 2000. Fluctuations in paper prices, such as those experienced in recent years, can materially affect the results of the Company’s operations. Economic Conditions — Changes in national economic conditions can affect levels of advertising expenditures generally, and such changes can affect each of the Company’s businesses. Revenues from the Company’s shopper business are dependent to a large extent on local advertising expenditures in the markets in which they operate. Such expenditures are substantially affected by the strength of the local economies in those markets. Direct and interactive marketing revenues are dependent on national and international economics. 17 Competition — Direct and interactive marketing is a rapidly evolving business, subject to periodic technological advancements, high turnover of customer personnel who make buying decisions, and changing customer needs and preferences. Consequently, the Company’s direct and interactive marketing business faces competition in both of its sectors — CRM and Marketing Services. The Company’s shopper business competes for advertising, as well as for readers, with other print and electronic media. Competition comes from local and regional newspapers, magazines, radio, broadcast and cable television, shoppers and other communications media that operate in the Company’s markets. The extent and nature of such competition is, in large part, determined by the location and demographics of the markets targeted by a particular adver- tiser, and the number of media alternatives in those markets. Failure to continually improve the Company’s current processes and to develop new products and services could result in loss of the Company’s customers to current or future competitors. In addition, failure to gain market acceptance of new products and services could adversely affect the Company’s growth. Qualified Personnel — The Company believes that its future prospects will depend, in large part, upon its ability to attract, train and retain highly skilled technical, client services and administrative personnel. Qualified personnel are in great demand and are likely to remain a limited resource for the foreseeable future. Postal Rates — The Company’s shoppers are delivered by standard mail, and postage is the second largest expense, behind payroll, in the Company’s shopper business. Overall postal rates, which typically increase every 3 to 4 years, increased in January 1999. Shopper postal costs were relatively unaffected by this increase as base rates remained flat and overweight rates changed very little. Postal rates again increased in January 2001. Overall shopper postage costs are expected to grow moderately as a result of this increase as well as anticipated increases in circulation and insert volumes. Postal rates also influence the demand for the Company’s direct and interactive marketing services even though the cost of mailings is borne by the Company’s customers and is not directly reflected in the Company’s revenues or expenses. Paper Prices — Paper represents a substantial expense in the Company’s shopper operations. Paper prices increased slightly at the beginning of 1998, but leveled out toward the end of 1998. The Company benefited from decreasing paper prices throughout 1999, although prices increased in the fourth quarter. Paper prices continued to increase throughout Harte-Hanks, Inc. and Subsidiaries Consolidated Balance Sheets December 31, In thousands, except per share and share amounts 2000 1999 ASSETS Current assets Cash and cash equivalents.................................................................................................. $ 22,928 $ 35,196 Accounts receivable (less allowance for doubtful accounts of $4,644 in 2000 and $3,751 in 1999)...... Inventory ........................................................................................................................ Prepaid expenses ................................................................................................................ Current deferred income tax asset .................................................................................... Other current assets.......................................................................................................... 179,838 154,030 6,260 14,072 7,648 5,127 7,099 12,651 6,848 4,309 Total current assets........................................................................................................... 235,873 220,133 Property, plant and equipment Land.................................................................................................................................. Buildings and improvements ................................................................................................ Software............................................................................................................................ Equipment and furniture..................................................................................................... 3,428 28,374 34,966 171,560 238,328 3,302 23,863 22,736 163,848 213,749 Less accumulated depreciation.......................................................................................... (130,544) (113,376) 18 Construction and equipment installations in progress....................................................... Net property, plant and equipment ........................................................................ 107,784 4,281 112,065 100,373 5,877 106,250 Intangible and other assets Goodwill and other intangibles (less accumulated amortization of $66,344 in 2000 and $51,118 in 1999)............ Other assets ...................................................................................................................... Total intangible and other assets........................................................................... 439,148 20,019 459,167 409,791 33,253 443,044 Total assets .............................................................................................................. $ 807,105 $ 769,427 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities Accounts payable .............................................................................................................. $ 60,069 $ 64,812 Accrued payroll and related expenses.................................................................................. Customer deposits and unearned revenue .......................................................................... Income taxes payable................................................................................................................ Other current liabilities..................................................................................................... Total current liabilities .............................................................................................. Long-term debt.............................................................................................................................. Other long-term liabilities (including deferred income taxes of $26,007 in 2000 and $20,180 in 1999) .................... Total liabilities ....................................................................................................... Stockholders’ equity Common stock, $1 par value, authorized 250,000,000 shares Issued 2000: 76,916,339; 1999: 76,392,063 shares .............................................. Additional paid-in capital ........................................................................................................ 31,429 42,712 5,135 10,619 149,964 65,370 40,768 256,102 76,916 202,222 Accumulated other comprehensive income (loss) .............................................................. (2,105) Retained earnings ............................................................................................................... 568,512 845,545 Less treasury stock, 2000: 12,230,388; 1999: 8,285,966 shares at cost........................................................................................................... (294,542) Total stockholders’ equity........................................................................................... 551,003 25,511 35,622 13,667 14,405 154,017 5,000 32,792 191,809 76,392 197,454 12,316 493,362 779,524 (201,906) 577,618 Total liabilities and stockholders’ equity................................................................ $ 807,105 $ 769,427 See Notes to Consolidated Financial Statements Harte-Hanks, Inc. and Subsidiaries Consolidated Statements of Operations Year Ended December 31, In thousands, except per share amounts 2000 1999 1998 Revenues .............................................................................................................. $ 960,773 $ 829,752 $ 748,546 Operating expenses Payroll........................................................................................................ Production and distribution .......................................................................... Advertising, selling, general and administrative........................................ Depreciation .................................................................................................. Goodwill and intangible amortization ........................................................ Operating income .................................................................................................. Other expenses (income) Interest expense ........................................................................................ Interest income ............................................................................................ Other, net .................................................................................................... Pension curtailment gain.............................................................................. 350,058 336,444 92,330 28,494 15,226 822,552 138,221 1,678 (2,062) 1,746 – 1,362 Income before income taxes ................................................................................ 136,859 Income tax expense ................................................................................................ 54,973 300,336 306,340 70,060 24,126 10,662 711,524 118,228 268,957 284,572 64,082 21,087 7,890 646,588 101,958 349 193 (5,662) (13,474) 730 – (4,583) 122,811 49,870 1,230 (2,150) (14,201) 116,159 47,788 Net income ............................................................................................................ $ 81,886 $ 72,941 $ 68,371 Basic earnings per common share ........................................................................ $ 1.21 $ 1.04 $ 0.94 19 Weighted-average common shares outstanding .......................................... 67,517 69,914 72,716 Diluted earnings per common share ...................................................................... $ 1.18 $ 1.01 $ 0.90 Weighted-average common and common equivalent shares outstanding...................................................... 69,653 72,144 76,057 See Notes to Consolidated Financial Statements Harte-Hanks, Inc. and Subsidiaries Consolidated Statements of Cash Flows In thousands Cash Flows from Operating Activities Year Ended December 31, 2000 1999 1998 Net income .................................................................................... $ 81,886 $ 72,941 $ 68,371 Adjustments to reconcile net income to net cash provided by continuing operations: Depreciation............................................................................ Goodwill and intangible amortization ........................................ Amortization of option-related compensation ............................ Deferred income taxes .............................................................. Pension curtailment gain ........................................................ Other, net .............................................................................. 28,494 15,226 441 5,942 – 424 24,126 10,662 430 10,572 – 224 21,087 7,890 592 4,130 (2,150) 534 Changes in operating assets and liabilities, net of effects from acquisitions and divestitures: Increase in accounts receivable, net .......................................... (22,514) (13,827) (12,415) (Increase) decrease in inventory ................................................ 839 Increase in prepaid expenses and other current assets ................ (1,848) Increase (decrease) in accounts payable .................................... Increase in other accrued expenses and other liabilities .............. 1,451 5,095 Other, net .............................................................................. (4,511) (848) (2,058) 5,597 10,826 (3,281) Net cash provided by continuing operations...................... 110,925 115,364 20 Net cash used in discontinued operating activities................................ – – Net cash provided by (used in) operating activities .......... 110,925 115,364 Cash Flows from Investing Activities Acquisitions ...................................................................................... Purchases of property, plant and equipment ........................................ Proceeds from the sale of property, plant and equipment ...................... Proceeds from divestiture .................................................................. Net sales and maturities of available-for-sale short-term investments .................................................................... (43,873) (36,465) 432 – – Other investing activities .................................................................. 391 Net cash provided by (used in) investing activities .......... (79,515) Cash Flows from Financing Activities Long-term borrowings...................................................................... Payments on debt .............................................................................. Issuance of common stock................................................................ Issuance of treasury stock ................................................................ 58,494 (5,000) 6,506 81 (136,469) (28,928) 976 – 138,874 (4,005) (29,552) 5,000 – 7,082 87 900 (2,549) (2,206) 10,034 1,210 95,428 (265,650) (170,222) (47,386) (24,443) 1,385 5,769 249,840 – 185,165 – – 7,452 23 Purchase of treasury stock................................................................ (92,706) (87,574) (71,354) Warrants repurchased ........................................................................ Dividends paid................................................................................ (4,317) (6,736) Net cash used in financing activities .............................. (43,678) Net increase (decrease) in cash.................................................................... Cash and cash equivalents at beginning of period........................................ (12,268) 35,196 – (5,578) (80,983) 4,829 30,367 – (4,372) (68,251) (53,308) 83,675 Cash and cash equivalents at end of period................................................ $ 22,928 $ 35,196 $ 30,367 Supplemental Cash Flow Information: Non-cash investing and financing activities: Acquisitions — debt issued (2000) and stock issued (1998).................. $ 6,876 $ – $ 5,752 See Notes to Consolidated Financial Statements Harte-Hanks, Inc. and Subsidiaries Consolidated Statements of Stockholders’ Equity In thousands Common Stock Balance at January 1, 1998 ...................................... $ 74,843 Common stock issued — employee benefit plans ...... 218 728 Exercise of stock options .......................................... Tax benefit of options exercised................................ – – Dividends paid ($0.06 per share).............................. Treasury stock issued in conjunction with acquisition ................................................ Treasury stock issued ................................................ Treasury stock repurchase.......................................... Comprehensive income, net of tax: Net income ........................................................ Change in unrealized gain (loss) on short-term investments, net of reclassification adjustments (net of tax of $311)........ Total comprehensive income...................................... – – – – – Additional Paid-in Capital $ 177,238 4,018 2,862 4,031 – 1,545 4 – – – Retained Earnings Treasury Stock $ 362,000 – – – (4,372) $ (47,267) – – – – – – – 4,207 19 (71,354) 68,371 – – – Balance at December 31, 1998.................................. 75,789 189,698 425,999 (114,395) Common stock issued — employee benefit plans ...... Exercise of stock options............................................ Tax benefit of options exercised................................ Dividends paid ($0.08 per share).............................. Treasury stock issued ................................................ Treasury stock repurchase.......................................... Comprehensive income, net of tax: Net income ........................................................ Change in unrealized gain (loss) on long-term investments, net of reclassification adjustments (net of tax of $6,632) ............................ Total comprehensive income...................................... 215 388 – – – – – – 4,172 2,307 1,253 – 24 – – – – – – (5,578) – – 72,941 – – – – – 63 (87,574) – – Accumulated Other Comprehensive Income (Loss) $ (577) – – – – Total Stockholders’ Equity $ 566,237 4,236 3,590 4,031 (4,372) – – – – 577 – – – – – – – – 5,752 23 (71,354) 68,371 577 68,948 577,091 4,387 2,695 1,253 (5,578) 87 (87,574) 72,941 12,316 12,316 85,257 Balance at December 31, 1999.................................. 76,392 197,454 493,362 (201,906) 12,316 577,618 Common stock issued — employee benefit plans ...... Exercise of stock options............................................ Tax benefit of options exercised................................ Dividends paid ($0.10 per share).............................. Treasury stock issued ................................................ Treasury stock repurchase ........................................ Warrants repurchased (net of tax of $1,511) ............ Comprehensive income, net of tax: Net income ........................................................ Foreign currency translation adjustment .......... Change in unrealized gain (loss) on long-term investments, net of reclassification adjustments (net of tax of $7,115) ............................ Total comprehensive income...................................... 196 328 – – – – – – – – 3,809 2,173 1,581 – 11 – (2,806) – – – – – – (6,736) – – – 81,886 – – – – – – 70 (92,706) – – – – – – – – – – – 4,005 2,501 1,581 (6,736) 81 (92,706) (2,806) – (1,208) 81,886 (1,208) (13,213) (13,213) 67,465 Balance at December 31, 2000.................................. $ 76,916 $ 202,222 $ 568,512 $ (294,542) $ (2,105) $ 551,003 See Notes to Consolidated Financial Statements 21 Harte-Hanks, Inc. and Subsidiaries Notes to Consolidated Financial Statements Note A — Significant Accounting Policies Consolidation The accompanying Consolidated Financial Statements present the financial position of Harte-Hanks, Inc. and subsidiaries (the “Company”). The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. intercompany accounts and All transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified for comparative purposes. Cash Equivalents and Available-for-Sale Securities All highly liquid investments with a remaining maturity of 90 days or less at the time of purchase are considered to be cash equivalents. Cash equivalents are carried at cost, which approxi- mates fair value. The Company considers its investments to be available-for-sale and has recorded its investments at fair value, with the unrealized gain (loss) recognized as a component of accumulated other comprehensive income. 22 Inventory Inventory, consisting primarily of newsprint and operating supplies, is stated at the lower of cost (first-in, first-out method) or market. Property, Plant and Equipment Property, plant and equipment are stated on the basis of cost. Depreciation of buildings and equipment is computed generally on the straight-line method at rates calculated to amortize the cost of the assets over their useful lives. The general ranges of estimated useful lives are: Buildings and improvements Equipment and furniture Software 10 to 40 years 3 to 20 years 3 to 10 years Goodwill and Other Intangibles Goodwill and other intangibles are stated on the basis of cost, adjusted as discussed below. Goodwill is amortized on a straight-line basis over 15 to 40 year periods. Other intangibles are amortized on a straight-line basis over a period of 5 to 10 years. The Company assesses the recoverability of its goodwill and other intangibles by determining whether the amortization of the intangible balance over its remaining life can be recovered through projected undiscounted future cash flows over the remaining amortization period. If projected undiscounted future cash flows indicate that an unamortized intangible will not be recovered, an impairment loss is recognized based on projected discounted future cash flows. Cash flow projections are based on trends of historical performance and management’s estimate of future performance, giving consideration to existing and anticipated competitive and economic conditions. At December 31, 2000 and 1999 the Company’s goodwill balance was $434.7 million, net of $65.7 million of accumulated amortization, and $405.9 million, net of $51.0 million of accumulated amortization, respectively. Income Taxes Income taxes are calculated using the asset and liability method required by Statement of Financial Accounting Standards (“SFAS”) No. 109. Deferred income taxes are recognized for the tax consequences resulting from “temporary differences” by applying enacted statutory tax rates applicable to future years. These “temporary differences” are associated with differences between the financial and the tax basis of existing assets and liabilities. Under SFAS No. 109, a statutory change in tax rates will be recognized immediately in deferred taxes and income. Earnings Per Share Basic earnings per common share are based upon the weighted- average number of common shares outstanding. Diluted earnings per common share are based upon the weighted-average number of common shares outstanding and dilutive common stock equivalents from the assumed exercise of stock options using the treasury stock method. Revenue Recognition The Company recognizes revenue at the time the service is rendered or the product is delivered. Payments received in advance of the performance of services are recorded as deferred revenue until such time as the services are performed. Direct and interactive marketing revenue from the production and delivery of data is recognized upon completion and shipment of the work. Revenue from database subscriptions is recognized ratably over the term of the subscription. Service revenue from time-and-materials services is recognized as the services are provided. Revenue from certain service contracts is recognized over the contractual period, using the percentage-of-completion method based on individual costs incurred to date compared with total estimated contract costs. In other instances, progress toward completion is based on performance milestones specified in the contract where such milestones fairly reflect progress toward contract completion. Revenue from software is recognized in accordance with the American Institute of Certified Public Accountants’ (AICPA) Statement of Position (“SOP”) 97-2 “Software Revenue Recognition,” as amended by SOP 98-9. SOP 97-2 generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the vendor-specific objective evidence of fair values of the respective elements. In accordance with SOP 97-2, the Company has analyzed all of the elements included in its multiple-element arrangements and determined that it has Company-specific objective evidence of fair value to allocate revenue to the license and postcontract customer support (PCS) component of its software license arrangements. The revenue allocated to software products, including time-based software licenses, is recognized upon execution of a licensing agreement and shipment of the software or ratably over the term of the license, depending on the structure and terms of the arrangement. The revenue allocated to PCS is recognized ratably over the term of the support. Revenue allocated to professional services is recognized as the services are performed. Shopper services are considered rendered when all printing, sorting, labeling and ancillary services have been provided and the mailing material has been received by the United States Postal Service. Recent Accounting Pronouncement Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” issued in June 1998, establishes accounting and reporting standards for derivative instruments and hedging activities. This statement requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The Company will adopt SFAS No. 133, as amended, in the first quarter of 2001 and does not expect it to have a material effect on the Company’s financial position or results of operations. Note B — Acquisitions/Divestitures Purchases In November 2000, the Company acquired Detroit-based Information Resource Group, a leading provider of business-to- business intelligence solutions to the high-tech, telecommunications and other industries. In June 2000, the Company acquired the UK based Hi-Tech Marketing Limited, a leading pan-European provider of CRM services to the high-tech, telecommunications and financial services industries. In October 1999, the Company acquired ZD Market Intelligence, renamed Harte-Hanks Market Intelligence, for $101 million cash from Ziff-Davis, Inc. Harte-Hanks Market Intelligence is a leading provider of database products and solutions to the high- tech and telecommunications industries in the United States, Canada and Europe. In June 1999, the Company acquired LYNQS Newmedia of Kansas City, Missouri, a developer of new media applications for the financial services, pharmaceutical and other industries. In May 1999, the Company acquired Direct Marketing Associates, Inc. of Baltimore, Maryland, a leading provider of integrated direct marketing services to commercial, government and non-profit organizations. In December 1998, the Company acquired Spectral Resources, Inc. of Woodstock, New York, a leading provider of interactive solutions to the pharmaceutical industry. In November 1998, the Company acquired Printing Management Systems, Inc. of Bellmawr, New Jersey, a leading provider of direct marketing services geared to addressing clients’ needs in database marketing, inventory control, information processing, fulfillment and direct mail. In August 1998, the Company acquired Cornerstone Integrated Systems of Austin, Texas, a leading provider of technical and marketing support services to major computer hardware and software manufacturers, as well as other manufacturers in the high-tech industry. The total cash outlay in 2000 for acquisitions was $43.9 million. In addition, the Company incurred $6.9 million in notes payable for its June 2000 acquisition. The total cash outlay in 1999 for acquisitions was $136.5 million. The total cash outlay in 1998 for acquisitions was $47.4 million. In addition, the Company issued stock with a value of $5.8 million for its November 1998 acquisition. The operating results of the acquired companies have been includ- ed in the accompanying Consolidated Financial Statements from the date of acquisition under the purchase method of accounting. The following table summarizes, on an unaudited pro forma basis, the estimated combined results of operations of the Company and the 2000 and 1999 acquisitions (Information Resource Group, Hi-Tech Marketing Limited, ZD Market Intelligence, LYNQS Newmedia and Direct Marketing Associates) assuming the acqui- sitions had taken place at the beginning of the respective year. The pro forma information includes adjustments for a reduction in interest income on cash equivalents and increased interest expense on debt used to finance the acquisitions and amortization of the intangible assets acquired. The unaudited pro forma results of operations are not necessarily indicative of the results that actually would have occurred had the acquisitions been completed at the beginning of the respective year. In thousands except per share amounts For the years ended December 31, 2000 1999 Revenues...................................... $ 972,280 $ 891,576 Net income.................................... 81,530 72,580 Diluted earnings per common share ........................ 1.17 1.01 Divestitures In May 1998, the Company sold three of its smallest shopper publications, located in Dallas, Texas, Wichita, Kansas and Springfield, Missouri. Note C — Investments Short-Term Investments In 1999 the Company sold all of its short-term investments and at December 31, 2000 and 1999 held no such investments. The gross realized gains and losses on the sale of short-term available-for-sale securities were immaterial for the years ended December 31, 1999 and 1998. Long-Term Investments The Company made equity investments totaling $0.7 million and $4.0 in 2000 and 1999, respectively. These investments have been classified as other assets. All such investments for which fair value was readily determinable are considered to be available-for- sale and are recorded at fair value. The related unrealized gains 23 and losses have been reported as a separate component of accumulated other comprehensive income. All other equity investments have been recorded at cost. Long-term investments for which the fair value was readily determinable at December 31, 2000 and 1999 consisted of the following: In thousands December 31, 2000 Gross Unrealized Gain (Loss) Fair Value Original Cost Equity securities...................... $ 3,150 $ (1,380) $ 1,770 Total ........................................ $ 3,150 $ (1,380) $ 1,770 In thousands December 31, 1999 Gross Unrealized Gain (Loss) Fair Value Original Cost Equity securities...................... $ 2,003 $ 18,948 $ 20,951 Total ........................................ $ 2,003 $ 18,948 $ 20,951 Proceeds from the sale of long-term investments were $1.1 million in 2000. Gross realized gains included in 2000 income were $0.5 million, determined using the average cost method. 24 Note D — Long-Term Debt Long-term debt consists of the following: In thousands Revolving loan commitment, various interest rates (effective rate of 7.15% at December 31, 2000), due November 4, 2002................ Revolving loan commitment, various interest rates (effective rate of 5.09% at December 31, 2000), $2.3 million due December 16, 2002, remaining $1.2 million due July 20, 2003........................ Acquisition note payable, various interest rates (effective rate of 5.51% at December 31, 2000) .... Less current maturities ...................... December 31, 2000 1999 $ 55,000 $ 5,000 3,493 6,877 – – – – $ 65,370 $ 5,000 Cash payments for interest were $1.3 million, $0.1 million and $0.1 million for the years ended December 31, 2000, 1999 and 1998, respectively. Credit Facilities On November 4, 1999 the Company obtained two unsecured revolving credit facilities. All borrowings under the $100 million revolving Three-Year Credit Agreement are to be repaid by November 4, 2002. On November 2, 2000 the Company was granted a 364-day extension to its $100 million revolving 364-Day Credit Agreement. All borrowings under the $100 million revolving 364-Day Credit Agreement are to be repaid by November 1, 2001 unless the Company requests and is granted another 364-day extension. Commitment fees on the total credit and interest rates for drawn amounts are determined according to a grid based on the Company’s total debt to earnings ratio. Commitment fees range from .08% to .125% for the 364-day facility, and .1% to .15% for the three-year facility. Interest rates on drawn amounts range from EUROLIBOR plus .4% to EUROLIBOR plus .75%. As of December 31, 2000, the Company had $45 million and $100 million of unused borrowing capacity under its Three-Year Credit Agreement and 364-Day Credit Agreement, respectively. On November 29, 1999 the Company obtained an unsecured credit facility in the amount of 100 million Belgium Francs for the purpose of financing the construction of a new building in Hasselt, Belgium. This facility was increased to 150 million Belgium Francs on July 18, 2000. All borrowings under the original facility amount are to be repaid by December 16, 2002 and any remaining outstanding amounts are to be repaid by July 20, 2003. The Company pays a commitment fee of .1% on the undrawn portion of the commitment. Interest rates on drawn amounts are at EURIBOR plus .15%. As of December 21, 2000, the Company had no unused borrowing capacity under this credit facility. Acquisition Note Payable In June 2000, the Company issued a note payable of 4.6 million British Pounds in connection with an acquisition. This note payable is due upon demand, but must be repaid no later than December 31, 2001. Interest on the note is at LIBOR minus .75%. It is the Company’s intent to repay this note with borrowings under the Company’s three-year revolving credit facility. Note E — Income Taxes The components of income tax expense are as follows: In thousands Current Year Ended December 31, 2000 1999 1998 Federal .............................. $ 40,502 $ 32,099 $ 33,949 State and local.................. Foreign.............................. 6,679 1,850 6,079 1,120 9,012 697 Total current................ $ 49,031 $ 39,298 $ 43,658 Deferred Federal .............................. $ 5,321 $ 8,564 $ 4,175 State and local.................. 621 2,008 (45) Total deferred.............. $ 5,942 $ 10,572 $ 4,130 Included in income tax expense for 1998 is tax expense of $0.8 million related to the pension curtailment gain. The differences between total income tax expense and the amount computed by applying the statutory federal income tax rate to income before income taxes were as follows: The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and deferred tax liabilities were as follows: In thousands 2000 1999 1998 In thousands Year Ended December 31, December 31, 2000 1999 Computed expected income tax expense ................ $ 47,900 35% $ 42,984 35% $ 40,656 35% Net effect of state income taxes ........ 4,857 4% 5,256 4% 5,891 5% Effect of goodwill amortization.......... 1,633 1% 1,344 1% 1,230 1% Effect of non-taxable investment income .................. Change in the beginning of the year balance of the valuation allowance.............. – 0% (50) 0% (424) 0% Total gross deferred tax assets........................ Less valuation allowance ............ (112) 0% – 0% (63) 0% Net deferred tax assets .......... 7,934 (455) 7,479 Deferred tax assets: Deferred compensation and retirement plans .............. $ 2,430 $ 4,229 Accrued expenses not deductible until paid.............. Accounts receivable, net.............. Other, net .................................... State net operating loss 2,979 1,264 806 carryforwards.......................... 455 3,068 583 157 475 8,512 (475) 8,037 Other, net .................. 695 0% 336 0% 498 0% Deferred tax liabilities: Income tax expense for the period........ $ 54,973 40% $ 49,870 41% $ 47,788 41% Property, plant and equipment...... (13,646) (12,823) Goodwill ...................................... (11,626) (8,052) 25 Total income tax expense (benefit) was allocated as follows: Other, net .................................... – State income tax.......................... (566) (493) (1) In thousands Year Ended December 31, 2000 1999 1998 Results of operations.............. $ 54,973 $ 49,870 $ 47,788 Stockholders’ equity................ (10,207) 5,379 (3,720) Total ........................................ $ 44,766 $ 55,249 $ 44,068 Total gross deferred tax liabilities ................ (25,838) (21,369) Net deferred tax liabilities...... $ (18,359) $ (13,332) The valuation allowance for deferred tax assets as of January 1, 1999 was $188,650. The valuation allowance at December 31, 2000 and 1999 relate to state net operating losses, which are not expected to be realized. The net deferred tax asset (liability) is recorded both as a current deferred income tax asset and as other long-term liabilities based upon the classification of the related temporary difference. Cash payments for income taxes were $47.8 million, $39.1 million and $302.1 million ($265.7 million related to gain on sale of discontinued operations) in 2000, 1999 and 1998, respectively. Note F — Employee Benefit Plans Prior to January 1, 1999, the Company maintained a defined benefit pension plan for which most of its employees were eligible. In conjunction with significant enhancements to the Company’s 401(k) plan, the Company elected to freeze benefits under this defined benefit pension plan as of December 31, 1998, resulting in recognition of a curtailment gain of $2.15 million. In 1994, the Company adopted a non-qualified, supplemental 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 the Company’s principal pension plan if it were not for limitations imposed by income tax regulation. The benefits under this supple- mental pension plan will continue to accrue as if the principal pension plan had not been frozen. The status of the Company’s defined benefit pension plans at year-end was as follows: Net pension cost for both plans included the following components: In thousands Change in benefit obligation Benefit obligation Year ended December 31, 2000 1999 In thousands 2000 1999 1998 December 31, Components of net periodic benefit cost (income) at beginning of year.................... $ 68,685 $ 86,332 Service cost.............................. $ 338 $ 365 $ 4,207 26 Service cost ........................................ Interest cost...................................... 338 5,373 365 5,215 Actuarial loss (gain) .......................... 15,729 (18,708) Benefits paid...................................... (4,756) Benefit obligation at end of year........ 85,369 Change in plan assets Fair value of plan assets at beginning of year.................... 101,679 Actual return on plan assets.............. Benefits paid ...................................... (6,567) (4,756) (4,519) 68,685 85,548 20,650 (4,519) Fair value of plan assets at end of year .............................. 90,356 101,679 Funded status .................................... Unrecognized actuarial loss (gain) .... Unrecognized prior service cost ........ 4,987 3,919 684 32,994 (29,904) 750 Net amount recognized...................... $ 9,590 $ 3,840 The Company’s non-qualified pension plan has an accumulated benefit obligation in excess of its assets of $7.0 million at December 31, 2000. The weighted-average assumptions used for measurement of the defined pension plans were as follows: December 31, 2000 1999 1998 Weighted-average assumptions as of December 31 Discount rate ............................ 7.50% 8.00% 6.00% Expected return on plan assets .................. 10.00% 10.00% 10.00% Rate of compensation increase.............................. 4.00% 4.00% 4.00% Interest cost ............................ 5,373 5,215 5,759 Expected return on plan assets.................... (9,951) (8,351) (8,243) Amortization of prior service cost .............. 65 65 Recognized actuarial loss (gain).......................... (1,575) 151 4 27 Recognized curtailment (gain)................................ – – (2,150) Net periodic benefit income...... $(5,750) $(2,555) $ (396) Prior to January 1, 1999, the Company also sponsored several 401(k) plans to provide employees with additional income upon retirement. The Company generally matched a portion of employees’ voluntary before-tax contributions. Employees were fully vested in their own contributions and generally vested in the Company’s matching contributions upon three years of service. Effective January 1, 1999, changes were made that combined all 401(k) plans and allowed for immediate vesting of enhanced Company matching contributions. Total 401(k) expense recognized by the Company in 2000, 1999 and 1998 was $6.2 million, $5.1 million, and $1.4 million, respectively. The 1994 Employee Stock Purchase Plan provides for a total of 2,000,000 shares to be sold to participating employees at 85% of the fair market value at specified quarterly investment dates. Shares available for sale totaled 453,198 at December 31, 2000. Note G — Stockholders’ Equity In January 2001, the Company announced an increase in the regular quarterly dividend from 2.5 cents per share to 3 cents per share, payable March 15, 2001 to holders of record on March 1, 2001. During 2000 the Company repurchased 3,947,856 shares of its common stock for $92.7 million under its stock repurchase program. In December 2000, the Company authorized an increase of four million shares in the Company’s stock repurchase program. As of December 31, 2000 the Company has repurchased 14.0 million shares since the beginning of its stock repurchase program in January 1997. Under this program, the Company has authorization to repurchase an additional 4.6 million shares. Note H — Stock Option Plans 1984 Plan In 1984, the Company adopted a Stock Option Plan (“1984 Plan”) pursuant to which it issued to officers and key employees options to purchase shares of common stock at prices equal to the market price on the grant date. Market price was determined by the Board of Directors for purposes of granting stock options and making repurchase offers. Options granted under the 1984 Plan become exercisable five years after date of grant. At December 31, 2000, 1999 and 1998, options to purchase 126,000 shares, 216,000 shares and 340,800 shares, respectively, were outstanding under the 1984 Plan, with an exercise price of $3.33 per share at December 31, 2000. No additional options will be granted under the 1984 Plan. 1991 Plan The Company adopted the 1991 Stock Option Plan (“1991 Plan”) pursuant to which it may issue to officers and key employees options to purchase up to 8,000,000 shares of common stock. Options have been granted at prices equal to the market price on the grant date (“market price options”) and at prices below market price (“performance options”). As of December 31, 2000, 1999 and 1998, market price options to purchase 6,597,025 shares, 5,873,475 shares and 5,058,550 shares, respectively, were outstanding with exercise prices ranging from $3.33 to $26.19 per share at December 31, 2000. Market price options granted prior to January 1998 become exercisable after the fifth anniversary of their date of grant. Beginning January 1998, market price options generally become exercisable in 25% increments on the second, third, fourth and fifth anniversaries of their date of grant. The weighted-average exercise price for outstanding options and exercisable options at December 31, 2000 was $15.10 and $7.43, respectively. The weighted-average remaining life for outstanding options was 6.18 years. At December 31, 2000, 1999 and 1998, performance options to purchase 716,600 shares, 739,400 shares and 724,700 shares, respectively, were outstanding with exercise prices ranging from $0.33 to $2.00 per share at December 31, 2000. The performance options become exercisable in whole or in part after three years, and the extent to which they become exercisable at that time depends upon the extent to which the Company achieves certain goals established at the time the options are granted. That portion of the performance options which does not become exercisable at an earlier date becomes exercisable after the ninth anniversary of the date of grant. Compensation expense of $0.4 million, $0.4 million and $0.6 million was recognized for the performance options for the years ended December 31, 2000, 1999 and 1998, respectively. The weighted-average exercise price for outstanding options and exercisable options at December 31, 2000 was $0.54 and $0.41, respectively. The weighted-average remaining life for outstanding options was 3.09 years. DiMark In connection with the DiMark merger, DiMark’s outstanding stock options were converted into options to acquire approximately 3.0 million shares of Harte-Hanks common stock. There were no outstanding DiMark options as of December 31, 2000. As of December 31, 1999 and 1998, DiMark options to purchase 54,792 shares and 182,864 shares, respectively, were outstanding. The following summarizes all stock option plans activity during 2000, 1999 and 1998: Number Of Shares Weighted Average Option Price Options outstanding at January 1, 1998 ...................... 5,996,916 $ 7.13 Granted.............................................. 1,315,050 Exercised............................................ (727,980) Cancelled ............................................ (277,072) Options outstanding at December 31, 1998 ................ 6,306,914 Granted.............................................. 1,575,350 Exercised............................................ (388,097) Cancelled ............................................ (610,500) Options outstanding at December 31, 1999................ 6,883,667 Granted.............................................. 1,163,600 Exercised .......................................... (327,992) Cancelled .......................................... (279,650) 19.13 4.45 12.05 9.72 22.29 6.76 17.88 12.04 22.01 7.37 20.20 Options outstanding at December 31, 2000 .............. 7,439,625 $ 13.50 27 Exercisable at December 31, 2000.................... 2,852,831 $ 5.75 The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, “Accounting For Stock-Based Compensation.” Accordingly, no compensation expense has been recognized for options granted where the exercise price is equal to the market price of the under- lying stock at the date of grant. For options issued with an exercise price below the market price of the underlying stock on the date of grant, the Company recognizes compensation expense under the provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, as permitted under SFAS No. 123. Had compensation expense for the Company’s options been determined based on the fair value at the grant date for awards since January 1, 1995, consistent with the provisions of SFAS No. 123, the Company’s net income and diluted earnings per share would have been reduced to the pro forma amounts indicated below. In thousands except per share amounts Year ended December 31, 1999 2000 1998 Net income — as reported...... $ 81,866 $ 72,941 $ 68,371 Net income — pro forma ........ 77,245 68,923 65,636 Diluted earnings per share — as reported.... 1.18 1.01 0.90 Diluted earnings per share — pro forma...... 1.11 0.95 0.86 The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2000, 1999 and 1998: The future minimum rental commitments for all non-cancellable operating leases with terms in excess of one year as of December 31, 2000 are as follows: Year ended December 31, 1999 2000 1998 Expected dividend yield .......... 0.4% 0.3% 0.3% Expected stock price volatility.................. 23.0% 22.0% 21.0% Risk free interest rate.............. 6.0% 6.0% 6.0% Expected life of options .......... 3-10 years 3-10 years 3-10 years In thousands 2001 .............................................................................. $ 23,135 2002 .............................................................................. 2003 .............................................................................. 2004 .............................................................................. 2005 .............................................................................. 18,697 13,768 9,656 5,184 After 2005 ...................................................................... 21,613 $ 92,053 The weighted-average fair value of market price options granted during 2000, 1999 and 1998 was $9.66, $9.24 and $7.79, respec- tively. The weighted-average fair value of performance options granted during 1999 and 1998 was $22.54 and $16.82, respectively. The Company did not grant any performance options during 2000. Note L — Earnings Per Share A reconciliation of basic and diluted earnings per share is as follows: 28 Note I — Fair Value of Financial Instruments Because of their maturities and/or variable interest rates, certain financial instruments of the Company have fair values approxi- mating their carrying values. These instruments include revolving credit agreements, accounts receivable, trade payables, and miscellaneous notes receivable and payable. The Company’s equity securities which have a readily determinable fair value are recorded at fair value. (See Note C.) Note J — Commitments and Contingencies At December 31, 2000, the Company had outstanding letters of credit in the amount of $12.6 million. These letters of credit exist to support an acquisition related note, the Company’s insurance programs relating to worker’s compensation, automobile and general liability, and leases. Note K — Leases The Company leases certain real estate and equipment under various operating leases. Most of the leases contain renewal options for varying periods of time. The total rent expense applicable to operating leases was $26.3 million, $23.0 million and $18.5 million for the years ended December 31, 2000, 1999 and 1998, respectively. In thousands Year ended December 31, except per share amounts 2000 1999 1998 BASIC EPS Net income.............................. $ 81,886 $ 72,941 $ 68,371 Weighted-average common shares outstanding used in earnings per share computations .................... 67,517 69,914 72,716 Earnings per share .................. $ 1.21 $ 1.04 $ 0.94 DILUTED EPS Net income.............................. $ 81,886 $ 72,941 $ 68,371 Shares used in earnings per share computations............ 69,653 72,144 76,057 Earnings per share .................... $ 1.18 $ 1.01 $ 0.90 Computation of Shares Used in Earnings Per Share Computations Average outstanding common shares.................. 67,517 69,914 72,716 Average common equivalent shares — dilutive effect of option shares................ Shares used in net earnings 2,136 2,230 3,341 per share computations ...... 69,653 72,144 76,057 As of December 31, 2000 antidilutive market price options outstanding. the Company had 864,864 Note M — Selected Quarterly Data (Unaudited) In thousands, except per share amounts 2000 Quarter Ended __________________________________________________ December 31 September 30 June 30 March 31 December 31 September 30 ________________________________________________ March 31 June 30 1999 Quarter Ended Revenues.............................................. $ 255,818 $ 243,205 $ 235,693 $ 226,057 $ 236,959 $ 207,632 $ 197,033 $ 188,128 Operating income .............................. Net income........................................ Basic earnings per share .................... Diluted earnings per share ................ 36,824 21,605 0.33 0.32 35,400 35,846 30,151 21,132 21,395 17,754 0.31 0.30 0.31 0.30 0.26 0.25 33,423 20,236 0.30 0.29 30,263 30,441 24,101 18,603 18,768 15,334 0.27 0.26 0.27 0.26 0.22 0.21 Note N — Business Segments Harte-Hanks is a highly focused targeted media company with operations in two segments — direct and interactive marketing and shoppers. The Company’s direct and interactive marketing segment offers a complete range of specialized, coordinated and integrated direct marketing services from a single source. CRM and Marketing Services are provided in the direct and interactive marketing segment. CRM revenues were $419.5 million, $335.5 million and $301.3 million in 2000, 1999 and 1998, respectively. Marketing Services’ revenues were $242.5 million, $223.8 million and $192.6 million in 2000, 1999 and 1998, respectively. The Company utilizes advanced technologies to enable its customers to identify, reach, influence and nurture specific consumers or businesses. The Company’s direct and interactive marketing customers include many of America’s largest retailers, banks, mutual fund companies, pharmaceutical companies, healthcare organizations, insurance companies, high-tech firms and telecom- munications firms, along with a growing number of customers in such selected markets as automotive, utilities and hospitality. Its client base is both domestic and international. The Company’s shoppers segment produces weekly advertising publications primarily delivered free by third-class mail to all households in a particular geographic area. Shoppers offer advertisers a targeted, cost-effective local advertising system, with virtually 100% penetration in their area of distribution. Shoppers are particularly effective in large markets with high media fragmentation in which major metropolitan newspapers generally have low penetration. Included in Corporate Activities are general corporate expenses. Assets of Corporate Activities include unallocated cash and invest- ments and deferred income taxes. Information as to the operations of Harte-Hanks in different business segments is set forth below based on the nature of the products and services offered. Harte-Hanks evaluates performance based on several factors, of which the primary financial measures are segment revenues and operating income. The accounting policies of the business segments are the same as those described in the summary of significant accounting policies (Note A). The operating results of Harte-Hanks Direct Marketing include the acquisitions of Information Resource Group in November 2000 and Hi-Tech Marketing Limited in June 2000. 29 30 Note N — Business Segments (continued) Information about the Company’s operations in different industry segments: In thousands Revenues Year Ended December 31, 2000 1999 1998 Direct Marketing ............................................................................................ $ 662,044 $ 559,262 $ 493,898 Shoppers .................................................................................................... 298,729 270,490 254,648 Total revenues ........................................................................................ $ 960,773 $ 829,752 $ 748,546 Operating income Direct Marketing............................................................................................ $ 91,450 $ 79,164 $ 69,648 Shoppers .................................................................................................... Corporate Activities ...................................................................................... 55,710 (8,939) 47,015 (7,951) 40,507 (8,197) Total operating income........................................................................ $ 138,221 $ 118,228 $ 101,958 Income before income taxes Operating income.......................................................................................... $ 138,221 $ 118,228 $ 101,958 Interest expense ........................................................................................ Interest income ................................................................................................ Other, net ...................................................................................................... Pension curtailment gain ............................................................................ (1,678) 2,062 (1,746) – (349) 5,662 (730) – (193) 13,474 (1,230) 2,150 Total income before income taxes ........................................................ $ 136,859 $ 122,811 $ 116,159 Depreciation Direct Marketing............................................................................................ $ 23,022 $ 18,804 $ 15,977 Shoppers .................................................................................................... Corporate Activities ........................................................................................ 5,393 79 5,235 87 5,025 85 Total depreciation................................................................................ $ 28,494 $ 24,126 $ 21,087 Goodwill and intangible amortization Direct Marketing............................................................................................ $ 11,156 $ 6,593 $ 3,703 Shoppers .................................................................................................... 4,070 4,069 4,187 Total goodwill and intangible amortization.......................................... $ 15,226 $ 10,662 $ 7,890 Total assets Direct Marketing............................................................................................ $ 589,552 $ 512,066 $ 341,653 Shoppers .................................................................................................... 187,905 Corporate Activities ...................................................................................... 29,648 196,121 61,240 197,885 175,675 Total assets.......................................................................................... $ 807,105 $ 769,427 $ 715,213 Capital expenditures Direct Marketing............................................................................................ $ 34,030 $ 24,450 $ 18,655 Shoppers .................................................................................................... Corporate Activities ...................................................................................... 2,408 27 4,434 44 5,764 24 Total capital expenditures...................................................................... $ 36,465 $ 28,928 $ 24,443 Information about the Company’s operations in different geographic areas: Year Ended December 31, In thousands Revenuesa 2000 1999 1998 United States .................................................................................................. $ 917,160 $ 800,700 $ 724,659 Other countries .......................................................................................... 43,613 29,052 23,887 Total revenues ........................................................................................ $ 960,773 $ 829,752 $ 748,546 Long-lived assetsb United States .................................................................................................. $ 104,507 $ 102,630 $ 89,905 Other countries .......................................................................................... 7,558 3,620 2,369 Total long-lived assets ........................................................................ $ 112,065 $ 106,250 $ 92,274 a Geographic revenues are based on the location of the customer. b Long-lived assets are based on physical location. Five-Year Financial Summary In thousands, except per share amounts 2000 1999 1998 1997 1996 Statement of Operations Data Revenues.............................................................................. $ 960,773 $ 829,752 $ 748,546 $ 638,349 $ 515,460 Operating expenses Payroll, production and distribution .......................... 686,502 606,676 553,529 479,742 392,494 Selling, general and administrative............................ Depreciation.................................................................. Goodwill and intangible amortization........................ Merger costs.................................................................. Total operating expense ...................................... Operating income........................................................................ Interest expense, net.................................................................. Income from continuing operations b.......................................... Income from continuing operations 92,330 28,494 15,226 – 822,552 138,221 (384) 81,886 70,060 24,126 10,662 – 711,524 118,228 (5,313) 72,941 64,082 21,087 7,890 – 646,588 101,958 (13,281) 68,371c after extraordinary items, net of taxes .............................. 81,886 72,941 68,371 Earnings from continuing operations per common share — diluted ............................................ Earnings from continuing operations after extra- ordinary items per common share — diluted.................... Cash dividends per common share.............................................. Weighted-average common and common 1.18 1.18 0.10 1.01 1.01 0.08 0.90c 0.90c 0.06 59,054 17,327 5,134 – 561,257 77,092 1,777 44,271d 43,632 13,779 3,658 12,136 a 465,699 49,761 6,629 23,084e 43,396f 23,084 0.57d 0.56f 0.04 0.30e 0.30e 0.03 equivalent shares outstanding — diluted.......................... 69,653 72,144 76,057 77,000 77,154 Segment Data Revenues Direct Marketing .......................................................... $ 662,044 $ 559,262 $ 493,898 $ 425,489 $ 330,255 Shoppers .................................................................... 298,729 270,490 254,648 212,860 185,205 Total revenues.............................................................. $ 960,773 $ 829,752 $ 748,546 $ 638,349 $ 515,460 Operating income Direct Marketing .......................................................... $ 91,450 $ 79,164 $ 69,648 $ 54,360 $ 44,794 Shoppers.................................................................... General corporate ...................................................... 55,710 (8,939) 47,015 (7,951) 40,507 (8,197) 31,089 (8,357) 24,017 (19,050) Total operating income.............................................. $ 138,221 $ 118,228 $ 101,958 $ 77,092 $ 49,761 Other Data Operating cash flow g ........................................................ Capital expenditures.......................................................... $ 181,941 $ 153,016 $ 130,935 $ 99,553 36,465 28,928 24,443 28,396 $ 67,198h 23,885 Balance Sheet Data (at end of period) ...................................... Property, plant and equipment, net .................................. $ 112,065 $ 106,250 $ 92,274 $ 89,351 $ 72,195 Goodwill and other intangibles, net.................................. Total assets.......................................................................... Total long term debt .......................................................... Total stockholders’ equity .................................................. 439,148 807,105 65,370 551,003 409,791 769,427 5,000 290,831 715,213 – 250,363 954,923 – 577,618 577,091 566,237 142,053 343,005 218,005 252,692 a Merger costs of $12.1 million related to DiMark merger. b Represents income and earnings from continuing operations per common share before extraordinary items. c Includes non-recurring pension gain of $1.3 million, or two cents per share, net of $0.8 million income tax expense. Excluding this gain, earnings were $0.88 per share. d Includes non-recurring income of $0.4 million, or one-half cent per share, net of $0.4 million income tax expense related to the sale of stock in another company partially offset by other non-recurring items. Excluding this income, earnings were $0.57 per share. e Includes merger costs of $8.7 million, or 11 cents per share, net of $3.4 million income tax benefit. Excluding these costs, earnings were $0.41 per share. f g Operating cash flow is defined as operating income plus depreciation and goodwill amortization. Operating cash flow is not intended to represent cash Includes extraordinary loss from the early extinguishment of debt of $0.9 million, net of $0.6 million income tax benefit. flow or any other measure of performance in accordance with generally accepted accounting principles. h Excluding 1996 merger costs, operating cash flow was $79,334. 31 Independent Auditors’ Report Corporate Information The Board of Directors and Stockholders Harte-Hanks, Inc.: We have audited the accompanying consolidated balance sheets of Harte-Hanks, Inc. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of opera- tions, cash flows, and stockholders’ equity for each of the years in the three-year period ended December 31, 2000. These consoli- dated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Harte-Hanks, Inc. and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. 32 San Antonio, Texas January 29, 2001 Common Stock The Company’s common stock is listed on the New York Stock Exchange (symbol: HHS). The quarterly stock price ranges for 2000 and 1999 were as follows: 2000 1999 High Low High Low First Quarter .............. 26.7500 19.6250 29.2500 24.1250 Second Quarter.......... 25.9375 21.0000 28.0000 22.6250 Third Quarter.............. 27.8750 24.3750 27.4375 21.7500 Fourth Quarter............ 28.4375 21.5000 23.9375 19.5625 In 2000, quarterly dividends were paid at the rate of 2.5 cents per share. In 1999, quarterly dividends were paid at the rate of 2 cent per share. There are approximately 3,100 holders of record. Transfer Agent and Registrar State Street Bank and Trust Company c/o EquiServe Limited Partnership P. O. Box 8200 Boston, Massachusetts 02266-8200 Annual Meeting of Stockholders The annual meeting of stockholders will be held at 10:00 a.m. on May 8, 2001, at 200 Concord Plaza Drive, First Floor, San Antonio, Texas. Form 10-K Annual Report A copy of the Company’s annual report to the Securities and Exchange Commission on Form 10-K may be obtained, without charge, upon written request to: Donald R. Crews, Secretary Harte-Hanks, Inc. P. O. Box 269 San Antonio, Texas 78291-0269 Directors Officers David L. Copeland President, SIPCO, Inc. Dr. Peter T. Flawn President Emeritus The University of Texas at Austin Chairman, Audit Committee Larry Franklin Chairman and Chief Executive Officer Christopher M. Harte Private Investor Houston H. Harte Vice Chairman Richard M. Hochhauser President and Chief Operating Officer Larry Franklin Chairman and Chief Executive Officer Richard M. Hochhauser President and Chief Operating Officer Craig Combest Senior Vice President, Direct Marketing Donald R. Crews Senior Vice President, Legal and Secretary Charles Dall’Acqua Senior Vice President, Direct Marketing Gary J. Skidmore Senior Vice President, Direct Marketing Robert G. Brown Vice President, Direct Marketing Kathy S. Calta Vice President, Direct Marketing James S. Davis Vice President, Direct Marketing Bill Goldberg Vice President, Direct Marketing Spencer A. Joyner, Jr. Vice President, Direct Marketing Federico Ortiz Vice President, Tax Peter E. Gorman Senior Vice President, Shoppers R. Tann Tueller Vice President, Direct Marketing James L. Johnson Chairman Emeritus, GTE Corporation Chairman, Compensation Committee Jacques D. Kerrest Senior Vice President, Finance and Chief Financial Officer Jessica M. Huff Controller and Chief Accounting Officer 33 Harte-Hanks Operations Corporate Office San Antonio, Texas http://www.harte-hanks.com Direct and Interactive Marketing CRM Austin, Texas Billerica, Massachusetts Dallas, Texas Glen Burnie, Maryland La Jolla, California Lake Katrine, New York Lake Mary, Florida Los Angeles, California New York, New York River Edge, New Jersey Sterling Heights, Michigan Sunnyvale, California West Bridgewater, Massachusetts Marketing Services Baltimore, Maryland Bellmawr, New Jersey Bloomfield, Connecticut Cherry Hill, New Jersey Cincinnati, Ohio Clearwater, Florida Dallas/Grand Prairie, Texas Deerfield Beach, Florida Fullerton, California Jacksonville, Florida Kansas City, Kansas Langhorne, Pennsylvania Memphis, Tennessee New York, New York Sacramento, California Westville, New Jersey Wilkes-Barre, Pennsylvania National Sales Headquarters Cincinnati, Ohio Kansas City, Kansas La Jolla, California International Offices Dublin, Ireland Hasselt, Belgium London, England Madrid, Spain Melbourne, Australia S˜ao Paulo, Brazil Sevres, France Slough, England Thatcham, England Toronto, Canada Shoppers The Flyer South Florida http://www.theflyer.com PennySaver Northern California http://www.pennysaverusa.com PennySaver/South Coast Shopper Southern California — Greater Los Angeles Area http://www.pennysaverusa.com PennySaver/Bargain Bulletin Southern California — Greater San Diego Area http://www.pennysaverusa.com P.O. Box 269 San Antonio, TX 78291-0269 (210) 829-9000 www.harte-hanks.com 1235-AR-01