Harte Hanks
Annual Report 2001

Plain-text annual report

P.O. Box 269 San Antonio, TX 78291-0269 (210) 829-9000 www.harte-hanks.com 1235-AR-02 Our People Make It Happen Harte-Hanks, Inc. • 2001 Annual Report Experienced. Dedicated. Poised for the future. OUR PEOPLE MAKE IT HAPPEN. JAMES DAVIS B I L L C A R M A N F E D E R I C O O R T I Z S P E N C E R J OY N E R , J R . B I L L G O L D B E R G J E S S I C A H U F F TA N N T U E L L E R K AT H Y C A LTA D E A N B LY T H E These days, the business world is engaged in a tough round of “survival of the fittest.” Obstacles and uncer- tainties surprise even the most seasoned players. In the end, it is not merely the strongest company that wins, but the one that remains focused, is directed with clarity and vision, and adapts to a demanding, changing environment. Harte-Hanks is that company. As we navigate this difficult economic climate, Harte-Hanks is guided firmly by experienced leaders, a strong command of technology applications and the dedication of our people. We remain unwavering in our commitment to provide our clients with world-class, end-to-end customer relationship management (CRM), related direct and interactive marketing solutions, and targeted advertising vehicles. Our full-service approach — CRM professional services to implementation to ongoing support; strong product and service brands including AllinkTM, TrilliumTM, nTouch and PennySaver; the use of targeted media from mail to Internet to Web to telephone; end-to-end execution from design and print to personalized mail and e-mail production; and shopper ads that are highly targeted by geography and all other cluster groupings that are driven by geography — continues to support our client-centric beliefs at all times. DIRECT MARKETING We make it happen for our customers. Customer Relationship Management (CRM) and Marketing Services Our CRM capabilities strengthen the relationships between our clients and their customers. We construct and update business-to-business and business-to-consumer databases. We access the data through flexible hosting capabilities and analyze information to help make it relevant. We apply the knowledge by putting data to work via multi-channel marketing programs, and we execute those programs through our Marketing Services delivery programs. This is the Harte-Hanks definition of direct and interactive marketing services, which we customize to meet individual client needs. Our clients choose one or many of our offerings — and over time have the opportunity to add additional offerings as needed. SHOPPER PUBLICATIONS Each week, nearly 10 million households in California and South Florida receive Harte-Hanks Shopper publications. With more than 800 separate editions, these publications offer flexible zoning and virtually 100% market penetration in their areas of distribution. Also available in searchable, online editions, shopper publications provide a powerful local advertising system. S T H G I L H G I H L A I C N A N I F ) s t n u o m a e r a h s r e p t p e c x e , s n o i l l i m n i ( Operating Revenues Operating Income $961 $918 $830 $140 $138 $118 99 00 01 99 00 01 After-Tax Cash Flow Earnings Per Share $129 $126 $1.23 $1.18 $108 $1.01 99 00 01 99 00 01 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 2 0 0 1 A N N U A L R E P O R T Company Profile A SOLID HISTORY. A BRIGHT FUTURE. Based in San Antonio, TX, Harte-Hanks is a worldwide marketing company that provides end-to-end customer relationship management (CRM) and related solutions for businesses and organizations in both consumer and business-to-business markets across North America, Europe, South America and the Pacific Rim. retail locations while gaining knowledge about their customers in the process. Our client roster includes many Fortune 1,000 companies, including industry leaders in retail, financial services, pharmaceuticals/healthcare, high-tech/telecommunications and automotive, among others. The people at Harte-Hanks make it happen for our clients. Our firm grasp of technology enables us to capture, analyze and disseminate customer and prospect data at all points of contact. Our services help clients generate traffic to Web sites, call/contact centers and In addition, Harte-Hanks owns and operates shopper publications that target households based on geography and other demographic criteria. Zoned into more than 800 editions, our shopper publications reach nearly 10 million households in California and South Florida each week. S T H G I L H G I H L A I C N A N I F ) s t n u o m a e r a h s r e p t p e c x e , s d n a s u o h t n i ( Operating revenues $917,928 $960,773 $829,752 2001 2000 1999 Operating income Depreciation 139,630 138,221 118,228 32,079 28,494 15,226 24,126 10,662 Goodwill and intangible amortization 16,841 Operating cash flow (operating income plus depreciation and goodwill and intangible amortization) After-tax cash flow (net income plus depreciation and goodwill and intangible amortization) Interest expense Net income 188,550 181,941 153,016 128,604 125,606 107,729 3,076 1,678 349 79,684 81,886 72,941 Earnings per share (diluted) 1.23 1.18 1.01 Capital expenditures 26,445 36,465 28,928 Average common and common equivalent shares outstanding (diluted) 64,783 69,653 72,144 Even in this age of technology, nothing is more important than PEOPLE MAKING IT HAPPEN. Understanding client needs and providing the right solutions At Harte-Hanks, our solutions begin with a definitive understanding of our clients, the unique issues they face in their individual markets, and the challenges presented by their own financial realities. Led by top talent in the direct marketing industry, our people work closely with clients to define specific needs and develop goals. By combining extensive knowledge of our clients’ industries and a solid understanding of technology and its applications, we provide meaningful, measurable solutions. Our leadership role in the CRM arena further helps us close the loop between our clients and their customers. Employing proven direct and interactive techniques helps us develop effective contact strategies based on purchase patterns, channel preferences and market environments. Facing adversities, challenging ourselves — and winning In 2001, we heard words like “economic uncertainty” and “recession.” We witnessed unspeakable horror as America came under attack and prepared a defense unlike any before in our history. Throughout this difficult time, the people of Harte-Hanks have banded together as one company with a stronger understanding of the principles we hold dear. In this unpredictable economy, we continue our dedication to our clients, and we continue to hold ourselves accountable to our shareholders. We believe healing and recovery are on the horizon. With strong people and a comforting range of competitive advantages, we are confident in our ability to overcome today’s challenges. We are equally confident as we plan to face tomorrow’s challenges with renewed purpose and enthusiasm. GA R Y S K I D M O R E JAC Q U E S K E R R E S T D O N A L D C R E W S C H A R L E S DA L L’AC Q UA C R A I G C O M B E S T P E T E R G O R M A N 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 H A R T E - H A N K S , I N C . 2 0 0 1 A N N U A L R E P O R T To Our Shareholders To meet and to overcome challenges is why many clients turn to Harte-Hanks. Our people make solutions happen. applications, as well as partnerships with best-of-breed companies; and a “make it happen” attitude that permeates our delivery. This year, the United States entered its first recession in a decade, ending its longest peacetime economic expansion. The uncertain times were exacerbated by September 11. We are thankful that no one at Harte-Hanks personally experienced a loss in their immediate families as a result of this terror. Some client companies were not so fortunate. Yet we were all deeply affected. “Getting back to normal” has been our nation’s and our business’s mantra. In this difficult economy, the approximately 7,500 people of Harte-Hanks distinguished themselves by delivering extraordinary results. Throughout this report you see names and faces of some great people who “made it happen” in 2001. They are among many contributors, leaders and performers — too many to feature — who dedicate themselves to clients, shareholders and our culture. We thank them every bit as much as we do those who are shown in this Annual Report. In 2001, diluted earnings per share were up 4.2% to $1.23 on a revenue decrease of 4.5% to $917.9 million. Direct Marketing experienced lower revenue from many clients, as they slowed their marketing and customer relationship management (CRM) investments — even as these investments are important to their future financial success. Direct Marketing revenue declined 9.1%, yet operating cash flow was down only 0.9%. This was the first year in 11 that Direct Marketing experienced a decline in either revenue or operating cash flow. Shoppers had outstanding financial performance: revenue up 5.8% and operating cash flow up 11.6%. Going into 2001, our Direct Marketing business in retail had slowed significantly and the high technology sector started an even steeper slump. We worked on how to deal with revenue declines, and to balance the cost structure with the reality of ’01 revenues. We focused on cost control. We achieved success. With cost issues still top-of-mind, we further highlighted revenue growth. Our focus is on the basics, making the most of our competitive advantages: financial health; deep experience in what we do and the markets we serve; high-performance proprietary software and In Direct Marketing, we have taken advantage of synergies within our company, and rolled out several new products and services to capitalize on our clients’ needs for data quality, data management, data analysis, information application, and direct and interactive marketing services execution. Helped by these new products and services — Trillium Software System® Version 5.0, with Customer Key Manager; Allink™ Connect; Allink Xpert; Allink Customer Data Management; Allink Retail Daily Sales Builder; Allink Daily Deposit Builder; Harte-Hanks M/CIS; and CI Technology Database for CRM and for E-Business — both Harte-Hanks and its Trillium Software division were named to the DM Review 100 as leading “business intelligence vendors for CRM.” This double citation is a first-time achievement for our company. Our CRM business in Europe was also streamlined to facilitate client capabilities. A Latin American version of our CI Technology Database was launched. International business now accounts for 4% of total revenues. Our Shoppers also kept a watchful eye on cost control, while successfully delivering outstanding revenue growth for the third year in a row. We completed the rollout of process four-color printing capability to our entire shopper publications’ circulation of nearly 10 million. To capitalize on the strong brand name “PennySaver,” as well as to enhance services to businesses wanting to get their advertising message out later in the week, a second edition of PennySaver was started, reaching a circulation of 250,000 in Orange County, CA. During 2001, we repurchased 3.6 million shares of our own stock under the repurchase program first authorized in January 1997. Since inception we have repurchased 17.7 million shares, and have 4.9 million shares remaining under authorization at the end of 2001. In November 2001, we acquired Sales Support Services, Inc, a leading business-to-business lead generation, order processing and fulfillment services company with a history of long-lasting client relationships in energy, automotive and other industries. We believe this company will provide an excellent complement to our CRM Services offerings and help us capitalize on opportunities in these strategic markets. Harte-Hanks continues to invest in its people, as the caliber of our professional expertise is our most important competitive advantage. During the year, we filled three key positions through internal promotions — Kathy Calta to group president, CRM Database; Bill Goldberg to president, national sales and strategic markets; and Dave LaGreca to chief information officer, Direct Marketing. Additionally, Dean Blythe was named vice president, legal and secretary, replacing Don Crews who retired at the beginning of 2002 after a long and distinguished career at Harte-Hanks. In November, William K. Gayden was elected to our Board of Directors. Bill is chairman and chief executive officer of Merit Energy Company in Dallas, TX. Before forming Merit Energy in 1989, he was president of Petrus Oil Company, and previously held various positions with Electronic Data Systems Corporation. Bill’s capabilities will be valuable to our company. Looking ahead. The difficult economic climate continues in 2002. Our people remain committed to delivering excellent performance as they have in the past. As you see throughout this report, Harte-Hanks is a very sound company. We have the financial strength to invest, regardless of the economic climate, in people, systems, solutions, capital expenditures and acquisitions. That is why we are confident we will deliver on our vision: “To be the provider of premier direct and interactive marketing solutions, and to provide outstanding returns to all stakeholders.” On April 1, 2002, we begin the next evolution of our management team as one of us, Richard Hochhauser, replaces the other, Larry Franklin, as CEO. With more than 30 years with the company, Larry will continue to be involved as chairman of the board. The two of us have worked together for years, along with our very capable senior management team. All have been deeply involved in key corporate decisions that have made Harte-Hanks successful. We could not be more excited and confident about the prospects for the company. All our people take our responsibilities to our clients and to our shareholders very seriously. We will continue to make it happen for all of you. L A R R Y F R A N K L I N Chairman and Chief Executive Officer R I C H A R D H O C H H AU S E R President and Chief Operating Officer 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 H A R T E - H A N K S , I N C . 2 0 0 1 A N N U A L R E P O R T Direct Marketing HOW OUR PEOPLE MAKE IT HAPPEN… 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 ANALYZE THE DATA Relevant research and evaluation We are vertical market experts dedicated to quality and service APPLY THE KNOWLEDGE Putting data to work through effective multi-channel marketing programs Construct and update the database Harte-Hanks offers a wide array of database construction tools and services, including design, consulting, construction and management. Our professional services teams use these industry-leading tools, such as Relationship Builder, to provide systems integration and support to clients in a variety of industries. Because Harte-Hanks has been executing these processes for more than 20 years, they are “production proofed.” Harte-Hanks offers a full range of business-to-business and business-to-consumer service bureau processing, including data capture and the preparation of data feeds, marketing lists and files. TrilliumTM, our proprietary software, remains the industry’s leading global data quality tool for cleansing, standardization and relationship matching solutions. It is designed to cleanse all types of data in both legacy and operational online environments for CRM, e-business and data warehouse applications. Our leadership in database solutions enabled Harte-Hanks to partner successfully with important new clients in 2001, including some of the most recognizable names in the financial, pharmaceutical, retail, automotive and high-tech industries. Access the data The Harte-Hanks AllinkTM Suite provides a continually growing portfolio of data access tools, such as AllinkTM Transact, Xpert and Connect, that can stand alone or work in an integrated fashion to give clients fast and accurate access to customer information, campaign management and analytics. Our AllinkTM Agent software and marketing solutions, such as Retail Daily Sales Builder, are real-time CRM database systems that blend customer transaction data and professional and marketing services with the sophistication of real-time personalization. Used heavily in the retail and financial services industries, P/CISTM is our industry-leading data access tool that ensures fast data access using a simple GUI. Using Desktop Direct, clients can track promotional history and measure results on their P/CIS database. The new multi-channel version, M/CIS, was released at the end of the year. Analyze the data Our team of analysis and research professionals provides clients with a clear understanding of their customers and their markets, turning data into actionable information. Customized services include market research, Web site analysis, database analysis and modeling, and direct marketing response analysis. PAU L K A M M A N N M AT T H E W P O L L O C K B R A D WA M S L E Y D E B O R A H S U L L I VA N N ATAC H A H O SY R A N DY W U S S L E R W E N DY TA B E N S K E SY D N E Y H O F F M A N L A R R Y H AW K S K E V I N K E R N E R D O N A I C K L E N J I M C O R R E L L G R E G G H A R P E R S E D R I C K P E R R Y T E R R Y O L S O N JOHN NICOLI J O E L BA K A L B E L I N DA C A S P E R A N D R E W R U T B E R G C A R O LY N D E L U C A C A R O LY N S C H R A D E R M A R I E D O N A P E E L E R 1 5 2 H A R T E - H A N K S , 6 7 4 3 9 8 I N C . 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 H A R T E - H A N K S , I N C . 6 8 7 5 4 3 2 1 2 0 0 0 A N N U A L R E P O R T 2 0 0 1 A N N U A L R E P O R T Execute the programs Harte-Hanks is well-equipped to execute the most complex direct marketing programs, whether traditional or Web-based, helping clients reach customers with the right message, via the right media channel, at the right time. One of the largest non-government solo mailers in the United States, Harte-Hanks offers services that range from state-of-the-art printing and laser personalization to logistics and mail delivery confirmation. Fulfillment services include print-on-demand, Web-based inventory management and ordering tools, and e-fulfillment, as well as more traditional functions. Our worldwide network supports these capabilities, giving Harte-Hanks a true competitive advantage. We initiate and receive outbound and inbound telemarketing calls on behalf of clients to provide lead generation, telesales, customer care and technical support. We also provide customized sales lead management solutions. In addition, Harte-Hanks interactive solutions provide the ultimate in one-to-one targeting, unparalleled reach and sound ROI. Webinars, Web site design and management, computer-based education and online direct marketing program management complement and extend traditional avenues of customer contact. Direct Marketing Apply the knowledge Harte-Hanks has more than 30 years’ experience managing intricate direct marketing programs, 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. Full-service direct marketing agency services combine information-based strategy and brand-building creative to develop and deliver promotional pieces. Expert media planning and management ensure that the most appropriate and most cost-effective media channels are utilized. The nTouch suite of CRM tools enables customers to provide highly personalized e-marketing campaigns, Web-based lead management and multi-channel customer care. L U C Y O R M E - S M I T H J O VA N SA M A N G M I K E S M I T H J I L L L I N S E N B E R G DA N R U B I N L I SAU L T H O M A S C O L L I N S L I N W E L L S K E V I N C U LV E R B R U N O C AT R A M B O N E S H A R R O N A M E S J E R R Y F E R G U S O N JA N H O GA N S T E V E N G R AY E R W I N VA N S PAU W E N WAY N E R O S E N B E R G E R F R A N K H A R V E Y J I M N E U M A N N J O H N D E N N I S O N M I C H A E L F I T Z G E R A L D S U SA N WA R D M I C H E L E F I T Z PAT R I C K K E V I N S W E E N E Y K A R E N R AVA S P E T E R D E T R E M P E H E AT H E R C O S T E L L O DAV I D L AG R E C A A N D R E W H A R R I S O N J E N N I F E R B O H A N N O N E V E T E C O P E L A N D J U L I E D O N OVA N K Y L E K E N N E DY N O R M A N SA L L I T T B I L L I E G R AY R O B E R T M A S O N R I C K K E G L E Y 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 H A R T E - H A N K S , I N C . 2 0 0 1 A N N U A L R E P O R T K E N L A M B E R T C R A I G M E U R E R M I K E WAT S O N K I M S M I T H B E T T I E H E N D R I C K X R O B E R T C O L U C C I Shopper Publications Winning in a tough economy Harte-Hanks shopper publications continue to provide an effective, cost-efficient advertising channel in California and South Florida. Led by a strong management team, our shoppers experienced healthy growth in both in-book and distribution product sales in 2001, despite a slower economy. Zoned into more than 800 separate editions, the shoppers reach nearly 10 million households. More than 2,000 combinations of geographic and demographic coverage provide flexibility in targeting and messaging, allowing advertisers to focus on a particular neighborhood or demographic group within a specific area. In California, PennySaver reaches more than 70% of the households in the state, while more than a million households in South Florida receive The Flyer. Mailed weekly, these publications are free of charge to readers. Advertisers can choose a full range of options including pre-printed inserts, print and deliver flyers, detached cards, rack products, VIP cards and MARQUEETM, as well as traditional classified, display and in-column ads and Web-based products. O R L A N D O BA R O T I M R Y C H E L JA M I D E L P E R DA N G L I SA D E L M O N T E D E B R A WAT S O N Financial Contents Managing today’s challenges, exploring tomorrow’s opportunities Throughout our history, our successes can be traced to strong leadership across the Harte-Hanks organization. Given the current economic challenges, strong leaders — those who provide guidance, motivation and direction — are more valuable than ever. The breadth and depth of experience the Harte-Hanks team brings to the table is rare. It is what will see us through difficult times and guide us toward a bright future. As a result, every Harte-Hanks employee shares common bonds: we understand clients and their marketplace challenges, we embrace technology, and we commit to winning. Now more than ever, our people make it happen. Management’s Discussion and Analysis..............12 Consolidated Statements of Cash Flows ............................20 Consolidated Balance Sheets ..........................18 Consolidated Statements of Operations ............................19 Consolidated Statements of Stockholders’ Equity and Comprehensive Income ........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 O R E S T E S BA E Z K E N N E T H D U R R U M R OY FA I R BA N K S JAC K C O L O P Y M I K E PAU L S I N GAY L E P I T T S L O R E N DA LTO N B O B FA L K S T E P H E N C A R A Z O C A R L O S G U Z M A N DAV E C L A R K T I M OT H Y S H E R M A N PAU L GAG L I A R D I E L A I N E B U C K L E Y R I C K C L U F F G R E G S N Y D E R H OWA R D YO U N G 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 H A R T E - H A N K S , I N C . 7 8 6 5 9 2 0 0 0 A N N U A L R E P O R T 2 0 0 1 A N N U A L R E P O R T 4 2 1 3 Overview Management’s Discussion and Analysis of Financial Condition and Results of Operations The Company’s overall performance reflects its commitment to its strategy of remaining 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 is an international direct and interactive marketing services company that provides end-to-end customer relationship management (CRM), related marketing services and shopper publications to a wide range of industries serving both consumer and business-to- business markets. The Company’s solutions use technology as the enabler to capture, analyze and disseminate customer and prospect data at all points of contact. The Harte-Hanks customer-centric models allow it to be the overall solutions provider for driving traffic to brick-and-mortar locations, Web sites or call/contact centers. A full-service approach — CRM professional services to implementation to ongoing support; strong product and service brands including AllinkTM, TrilliumTM, nTouch and PennySaver; the use of targeted media from mail to Internet to Web to telephone; end-to-end execution from design and print to personal- ized mail and e-mail production; and shopper ads that are highly targeted by geography and other cluster groupings that are driven by geography — supports Harte-Hanks customer-centric beliefs. As of December 31, 2001, the Company’s highly targeted advertising shopper publications covered 800 geographic zones and reached nearly 10 million households each week. 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, borrowings against its credit facilities and its excess cash flows to fund several acquisitions in 1999, 2000 and 2001. These acquisitions, as well as several previous acquisitions, have enhanced the Company’s growth over the past three years. Harte-Hanks has funded $209.6 million in acquisitions during the period 1999 through 2001. These acquisitions have all been in the Company’s direct and interactive marketing segment, which now comprises approximately 66% of the Company’s revenues. Harte-Hanks derives its revenues from the sale of direct and interactive marketing and advertising services. As a worldwide business, direct and interactive marketing is affected by general national and international economic trends. 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. Results of Operations Operating results were as follows: In thousands 2001 % Change 2000 % Change 1999 Revenues $ 917,928 Operating expenses 778,298 Operating income $ 139,630 -4.5 -5.4 1.0 $ 960,773 822,552 $ 138,221 15.8 15.6 16.9 $ 829,752 711,524 $ 118,228 Consolidated revenues declined 4.5% to $917.9 million while operating income grew 1.0% to $139.6 million in 2001 compared to 2000. Overall operating expenses decreased 5.4% to $778.3 million. The Company’s overall results reflect revenue and operating income declines in its direct and interactive marketing segment, partially offset by increased revenue and operating income in the shopper segment. Overall growth in 2000 revenues and operating income resulted from acquisitions, increased business from both new and existing customers and from the sale of new products and services. 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: In thousands 2001 % Change 2000 % Change 1999 Revenues $ 601,901 Operating expenses 516,881 Operating income $ 85,020 -9.1 -9.4 -7.0 $ 662,044 570,594 $ 91,450 18.4 18.8 15.5 $ 559,262 480,098 $ 79,164 Direct and interactive marketing revenues decreased $60.1 million, or 9.1%, in 2001 compared to 2000. These results reflect declines in almost all of direct and interactive marketing’s vertical markets, including declines in the segment’s largest vertical markets, retail, financial services and high-tech/telcom. The overall decline was partially offset by strong growth in revenues from the pharmaceutical and healthcare Both Customer Relationship Management (CRM) and Marketing Services revenues declined from the prior year. CRM experienced revenue declines in data processing, agency, consulting, fulfillment, telesales and brokered customer list business, partially offset by increased software revenue and revenue attributable to 2001 and 2000 acquisitions. Marketing Services experienced revenue declines in its personalized direct mail, targeted mail and logistics operations. industries. Operating expenses decreased $53.7 million, or 9.4%, in 2001 compared to 2000. The overall decrease in operating expenses was primarily due to the Company’s efforts to manage its cost structure during the current economic environment, as well as reduced variable expenses resulting from lower revenue levels. Production and distribution costs decreased $28.4 million due primarily to decreased volumes and better pricing obtained from vendors. Labor costs declined $16.2 million due to lower volumes and staff reduc- tions. General and administrative expense decreased $14.4 million due to employee and professional services expenses. Depreciation expense increased $3.7 million due to new capital investments to support future growth and improve efficiencies. Goodwill and intangible amortization expense increased $1.6 million due to prior year acquisitions. Operating expenses were also impacted by 2001 and 2000 acquisitions. 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 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 H A R T E - H A N K S , I N C . 2 0 0 1 A N N U A L R E P O R T 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. Shoppers Shopper operating results were as follows: In thousands 2001 % Change 2000 % Change 1999 Revenues $ 316,027 Operating expenses 252,629 Operating income $ 63,398 5.8 4.0 13.8 $ 298,729 243,019 $ 55,710 10.4 8.7 18.5 $ 270,490 223,475 $ 47,015 Shopper revenues increased $17.3 million, or 5.8%, in 2001 when compared to 2000. 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 distribution products and in-book products, primarily core sales and real estate related advertising. These increases were partially offset by declines in employment advertising, print-and-deliver and coupon book revenues. Shopper operating expenses rose $9.6 million, or 4.0%, in 2001 compared to 2000. The increase in operating expenses was primarily due to increases in production costs of $5.6 million, including increased postage of $3.5 million due to higher postage rates and increased circulation and volumes. Promotion costs also increased $2.9 million, labor costs increased $2.0 million, and insurance costs were up $1.0 million. 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. Acquisitions As described in Note B of the “Notes to Consolidated Financial Statements” included herein, the Company made several acquisi- tions in the past three years. In November 2001, the Company acquired Sales Support Services, Inc. (SSS), a leading business-to-business lead generation, order processing and fulfillment services company to the automotive, energy and other industries. 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 (HTM), a London based leading pan-European provider of CRM services to the hightech, 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. Interest Expense/Interest Income Interest expense increased $1.4 million in 2001 over 2000 due primarily to higher outstanding debt levels during 2001 of the Company’s three-year revolving credit facility, the proceeds of which were used to repurchase the Company’s stock and fund the November 2001 acquisition of SSS. Interest relating to the Company’s unsecured credit facility obtained for the purpose of constructing a new building in Belgium, and a note payable issued in connection with the Company’s June 2000 acquisition of HTM, also contributed to the increase in interest expense during the year. The increase in interest expense in 2001 was partially offset by lower interest rates in 2001 compared to 2000. Total interest expense increased in 2000 when compared to 1999 primarily due to interest, commitment charges and the amortization of financing costs from the two unsecured revolving credit facilities. Interest related to the Company’s unsecured credit facility obtained for the purpose of constructing a new building in Belgium, and the note payable issued in connection with the June 2000 acquisition of HTM, also contributed to the increase in interest expense. The Company’s debt at December 31, 2001 and 2000 is described in Note D of the “Notes to Consolidated Financial Statements,” included herein. Interest income decreased $1.6 million in 2001 over 2000 due to lower interest rates and lower overall cash balances during the year. 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 acquisitions and repur- chase the Company’s stock, and lower overall cash balances during the year. Other Income and Expense During 2001 the Company realized $2.5 million in losses on the sales of investments that were classified as available for sale and $.9 million on the sales of investments that were accounted for under the cost method. Income Taxes Income taxes decreased $2.2 million in 2001 due to lower income levels. Income taxes increased $5.1 million in 2000 due to higher income levels. The effective income tax rate was 39.8%, 40.2%, and 40.6% in 2001, 2000 and 1999, respectively. The effective income tax rate calculated is higher than the federal statutory rate of 35% due to the addition of state taxes and certain expenses recorded for financial reporting purposes (primarily goodwill amortization) that are not deductible for federal income tax purposes. Capital Investments Net cash used in investing activities for 2001 included $28.2 million for acquisitions and $26.4 million for capital expenditures. The acquisition investments, which were made in the direct and interactive marketing segment, are discussed under “Acquisitions.” The capital expenditures consisted primarily of additional computer capacity, technology, systems, new press equipment and equipment upgrades for the direct and interactive marketing segment to support its growth in all sectors. The Company also invested in facility expansion in its CRM sector. The shopper segment’s capital expenditures were primarily related to facility improvements and additional computer and other production equipment. Net cash used in investing activities for 2000 included $43.9 million for acquisitions and $36.5 million for capital expenditures. The acquisition investments, which were made in the direct and interactive marketing segment, are discussed under “Acquisitions.” The capital expenditures consisted primarily of the construction of a new building to expand and support the Company’s CRM oper- ations 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. Critical Accounting Policies Financial Reporting Release No. 60, which was recently released by the Securities and Exchange Commission, requires all compa- nies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. Note A of the “Notes to Consolidated Financial Statements,” includes a summary of the significant accounting policies and methods used in the preparation of the Company’s Consolidated Financial Statements. The following is a discussion of the more significant accounting policies and methods. 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 or delivery of the product are recorded as deferred revenue until such time as the services are performed or the product is delivered. As described below, significant management judgments and estimates must sometimes be made and used in connection with the revenue recognized in any accounting period. For all sales the Company requires either a purchase order, a state- ment of work signed by the customer, a written contract, or some other form of written authorization from the customer. Direct and interactive marketing revenue is derived from a variety of CRM and marketing services solutions. Revenue from marketing services such as creative and graphics, printing, personalization of communication pieces using laser and inkjet printing, target mail, fulfillment, agency services and transporta- tion logistics are recognized as the work is performed. Revenue is typically based on a set price or rate given to the customer. CRM revenue from the ongoing production and delivery of data is recognized upon completion and delivery of the work and is typically based on a set price or rate. Revenue from time-based subscriptions is based on a set price and is recognized ratably over the term of the subscription. Revenue from database build services may be billed based on hourly rates or at a set price. If billed at a set price, the database build revenue 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. Revenue from market research and analytical services may be billed based on hourly rates or a set price. If billed at a set price, the revenue 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 related to e-marketing, lead management, multi-channel customer care, inbound and outbound teleservices and technical support is typically billed based on a set price per transaction or service provided. Revenue from these services is recognized as the service or activity is performed. 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 “Modification of SOP 97-2, Software Revenue Recognition.” 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. For software sales with multiple elements (for example, undelivered postcontract customer support or “PCS”), the Company allocates revenue to each component of the arrangement using the residual value method based on the fair value of the undelivered elements. This means the Company defers revenue from the software sale equivalent to the fair value of the undelivered elements. The fair value of PCS is based upon separate sales of renewals to other customers or upon renewal rates quoted in the contracts. The fair value of services, such as training and consulting, is based upon separate sales of these services to other customers. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 H A R T E - H A N K S , I N C . 2 0 0 1 A N N U A L R E P O R T The revenue allocated to PCS is recognized ratably over the term of the support period. Revenue allocated to professional services is recognized as the services are performed. The revenue allocated to software products, including time-based software licenses, is recognized, if collection is probable, 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 arrange- ment. If the licensing agreement is for a term of one year or less and includes PCS, the company recognizes the software and the PCS revenue ratably over the term of the license. The Company applies the provisions of Emerging Issues Task Force Issue No. 00-03 “Application of AICPA Statement of Position 97-2 to Arrangements that Include the Right to Use Software Stored on Another Entity’s Hardware” to its hosted software service transactions. Revenue under hosted service transactions is typically recognized over the service period unless the customer is able to take possession of the software during the service period. In such situations, revenue is recognized pursuant to SOP 97-2, as described above. Shopper services are considered rendered, and the revenue recog- nized, when all printing, sorting, labeling and ancillary services have been provided and the mailing material has been received by the United States Postal Service. The methodology used Allowance for Doubtful Accounts — The Company maintains its allowance for doubtful accounts at a balance adequate to reduce accounts receivable to the amount of cash expected to be realized upon collection. to determine the minimum allowance balance is based on the Company’s prior collection experience and is generally related to the accounts receivable balance in various aging categories. The balance is also influenced by specific customers’ financial strength and circum- stance. Accounts that are determined to be uncollectible are written off in the period in which they are determined to be uncollectible. Periodic changes to the allowance balance are recorded as increases or decreases to bad debt expense, which is included in the “Advertising, selling, general and administrative” line of the Company’s Consolidated Statements of Operations. The Company recorded bad debt expense of $4.4 million, $4.6 million, and $1.8 million for the years ended December 31, 2001, 2000 and 1999, respectively. Reserve for Workers Compensation, Automobile and General Liability — The Company has a $250,000 deductible for worker's compensation, automobile and general liability. The estimate of loss reserves necessary for claims is based on the Company’s estimate of claims incurred as of the end of the year. The Company uses detail loss-run claim reports provided by the insurance adminis- trator and applies actuarial development factors to the claim loss balance to determine an appropriate reserve balance. The loss-run claim reports show all claims and an estimate of what the claim will cost. This estimate is provided by the insurance administrator based upon their experience dealing with similar type claims. The Company uses the loss-run claim reports as a basis for its reserve balance. Periodic changes to the reserve are recorded as increases or decreases to insurance expense, which is included in the “Advertising, selling, general and administrative” line of the Company’s Consolidated Statement of Operations. Goodwill — Goodwill is recorded in purchase business combina- tions as the excess of the purchase price over the fair value of assets acquired and liabilities assumed. Recorded goodwill is amortized on a straight-line basis over periods of 15 to 40 years. The Company assesses the recoverability of its goodwill by determining whether the recorded goodwill balance can be recovered through projected undiscounted future cash flows over the remaining amortization period. If projected undiscounted future cash flows indicate that unamortized goodwill 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. This assessment is typically done on an annual basis, but can be done more frequently whenever events or changes in circumstances indi- cate that the unamortized goodwill balance may not be recoverable. The Company has not recorded an impairment loss in any of the three years ended December 31, 2001. The Company will adopt Statement of Financial Account Standards (“SFAS”) No. 142 on January 1, 2002, except that goodwill associ- ated with the November acquisition of SSS was not amortized during 2001 in accordance with SFAS No. 141, “Business Combinations.” SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually. As a result of the adoption of SFAS No. 142, the Company will cease to amortize $434.4 million of goodwill. The company recorded $16.2 million, $14.8 million and $10.6 million of goodwill amortization expense for the years ended December 31, 2001, 2000 and 1999. In lieu of amortization, the Company is required to perform an initial impair- ment assessment of its goodwill in 2002 and an annual impairment assessment thereafter. SFAS No. 142 is described in more detail in Note A of the “Notes to Consolidated Financial Statements,” included herein. Liquidity and Capital Resources Cash provided by operating activities for 2001 was $152.9 million. Net cash outflows from investing activities were $53.4 million for 2001, resulting primarily from the acquisitions and capital investments described above. Net cash outflows from financing activities in 2001 were $92.0 million. The cash outflow from financing activities is attributable primarily to the repurchase of stock throughout 2001 totaling $83.7 million. The acquisitions and repurchases of stock in 2001 were funded through the Company’s cash flows and borrowings under the Company’s credit facilities. 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 stock throughout 2000 totaling $92.7 million. The acquisitions and repurchases of stock in 2000 were funded through the Company’s cash flows and borrowings under the Company’s credit facilities. 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 Agreement are to be repaid by November 4, 2002. On October 26, 2001 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 October 25, 2002. The Company has classified its debt at December 31, 2001 as long- term as it is the Company's intent to refinance all outstanding balances under these credit facilities at the time they expire. The Company believes it will be able to obtain additional credit facilities at comparable amounts and terms based on the Company's financial position and relationships with its existing lenders. 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, 2001, the Company had $155.0 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 statements 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 that could affect the Company’s future performance, including its revenues, net income and earnings per share; the risks described below, however, are not the only ones the Company faces. Additional risks and uncertainties that are not presently known, or that the Company currently considers immaterial, could also impair the Company’s business operations. 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 business 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. 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 compe- tition 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 are, in large part, determined by the location and demographics of the markets targeted by a particular advertiser, and the number of media alternatives in those markets. Failure continually to improve the Company’s current processes and to develop new products and services could result in the 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 administra- tive personnel. While dependent on employment levels and general economic conditions, qualified personnel historically have been in great demand and from time to time in the foreseeable future will likely remain a limited resource. Postal Rates — The Company’s shoppers and direct and interactive marketing services depend on the United States Postal Service (“USPS”) to deliver products. The Company’s shoppers are delivered by standard mail, and postage is the second largest expense, behind payroll, in the Company’s shopper business. The present standard postage rates went into effect in the third quarter of 2001 and are expected to increase in the second half of 2002. Future postage rates may also be impacted by the USPS’s response to recent threats to the postal system. 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. 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, such as events following the September 11, 2001 attacks, can affect levels of advertising expenditures generally, and such changes can affect each of the Company’s businesses. In addition, 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. Interest Rates — Interest rate movements in Europe and the United States can affect the amount of interest the Company pays related to its debt and the amount it earns on cash equivalents. The Company’s primary interest rate exposure is to interest rate fluctuations in Europe, specifically EUROLIBOR rates due to their impact on two $100 to million credit facilities. The Company also has exposure to interest rate fluctuations in the United States, specifically commercial paper and overnight time deposit rates as these affect the Company’s earnings on its excess cash. interest related the Company’s 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 H A R T E - H A N K S , I N C . 2 0 0 1 A N N U A L R E P O R T Harte-Hanks, Inc. and Subsidiaries Consolidated Balance Sheets Harte-Hanks, Inc. and Subsidiaries Consolidated Statements of Operations December 31, Year Ended December 31, In thousands, except per share and share amounts 2001 2000 In thousands, except per share amounts 2001 2000 1999 Revenues .............................................................................................................. $ 917,928 $ 960,773 $ 829,752 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 .................................................................................................... 335,913 313,639 79,826 32,079 16,841 778,298 139,630 3,076 (498) 4,614 7,192 Income before income taxes ................................................................................ 132,438 Income tax expense ................................................................................................ 52,754 350,058 336,444 92,330 28,494 15,226 822,552 138,221 1,678 (2,062) 1,746 1,362 136,859 54,973 300,336 306,340 70,060 24,126 10,662 711,524 118,228 349 (5,662) 730 (4,583) 122,811 49,870 Net income ............................................................................................................ $ 79,684 $ 81,886 $ 72,941 Basic earnings per common share ........................................................................ $ 1.26 $ 1.21 $ 1.04 Weighted-average common shares outstanding .......................................... 63,206 67,517 69,914 Diluted earnings per common share ...................................................................... $ 1.23 $ 1.18 $ 1.01 Weighted-average common and common equivalent shares outstanding...................................................... 64,783 69,653 72,144 See Notes to Consolidated Financial Statements ASSETS Current assets Cash and cash equivalents.................................................................................................. $ 30,468 $ 22,928 Accounts receivable (less allowance for doubtful accounts of $5,463 in 2001 and $4,644 in 2000)...... 138,409 179,838 Inventory ........................................................................................................................ Prepaid expenses ................................................................................................................ Current deferred income tax asset .................................................................................... Other current assets.......................................................................................................... 5,835 13,411 8,378 6,306 6,260 14,072 7,648 5,127 Total current assets........................................................................................................... 202,807 235,873 Property, plant and equipment Land.................................................................................................................................. Buildings and improvements ................................................................................................ Software............................................................................................................................ Equipment and furniture..................................................................................................... 3,325 31,045 45,806 178,842 259,018 3,428 28,374 34,966 171,560 238,328 Less accumulated depreciation and amortization.............................................................. (152,558) (130,544) Construction and equipment installations in progress....................................................... Net property, plant and equipment ........................................................................ Intangible and other assets Goodwill and other intangibles (less accumulated amortization of $83,092 in 2001 and $66,344 in 2000)............ Other assets ...................................................................................................................... Total intangible and other assets........................................................................... 106,460 2,968 109,428 438,325 20,489 458,814 107,784 4,281 112,065 439,148 20,019 459,167 Total assets .............................................................................................................. $ 771,049 $ 807,105 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities Accounts payable .............................................................................................................. $ 42,990 $ 60,069 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 $29,515 in 2001 and $26,007 in 2000) .................... Total liabilities ....................................................................................................... Stockholders’ equity Common stock, $1 par value, authorized 250,000,000 shares Issued 2001: 78,281,458; 2000: 76,916,339 shares .............................................. Additional paid-in capital ........................................................................................................ 21,550 38,617 10,531 8,086 121,774 48,312 48,597 218,683 78,281 219,229 Accumulated other comprehensive loss.............................................................................. (1,293) Retained earnings ............................................................................................................... 640,635 Less treasury stock, 2001: 16,139,795; 2000: 12,230,388 shares at cost ........................ (384,486) Total stockholders’ equity........................................................................................... 552,366 31,429 42,712 5,135 10,619 149,964 65,370 40,768 256,102 76,916 202,222 (2,105) 568,512 (294,542) 551,003 Total liabilities and stockholders’ equity................................................................ $ 771,049 $ 807,105 See Notes to Consolidated Financial Statements 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 H A R T E - H A N K S , I N C . 2 0 0 1 A N N U A L R E P O R T Harte-Hanks, Inc. and Subsidiaries Consolidated Statements of Cash Flows Harte-Hanks, Inc. and Subsidiaries Consolidated Statements of Stockholders’ Equity and Comprehensive Income In thousands Cash Flows from Operating Activities Year Ended December 31, 2001 2000 1999 Net income .................................................................................... $ 79,684 $ 81,886 $ 72,941 In thousands Common Stock Adjustments to reconcile net income to net cash provided by operations: Depreciation............................................................................ Goodwill and intangible amortization ........................................ Amortization of option-related compensation ............................ Deferred income taxes .............................................................. Other, net .............................................................................. 32,079 16,841 206 2,470 4,464 28,494 15,226 441 5,942 424 24,126 10,662 430 10,572 224 Changes in operating assets and liabilities, net of effects from acquisitions and divestitures: (Increase) decrease in accounts receivable, net .......................... 47,578 (22,514) (13,827) (Increase) decrease in inventory ................................................ Increase in prepaid expenses and other current assets ................ 425 (124) Increase (decrease) in accounts payable .................................... (17,054) Increase (decrease) in other accrued expenses and other liabilities ............................................................ (12,350) Other, net .............................................................................. (1,278) Net cash provided by operating activities ........................ 152,941 Cash Flows from Investing Activities Acquisitions ...................................................................................... Purchases of property, plant and equipment ........................................ Proceeds from the sale of property, plant and equipment ...................... Net sales and maturities of available-for-sale short-term investments .................................................................... Other investing activities .................................................................. (28,230) (26,445) 492 – 801 839 (1,848) 1,451 5,095 (4,511) 110,925 (43,873) (36,465) 432 – 391 Net cash used in investing activities .............................. (53,382) (79,515) Cash Flows from Financing Activities Long-term borrowings...................................................................... 282,000 Payments on debt .............................................................................. (292,000) Issuance of common stock................................................................ Issuance of treasury stock ................................................................ 9,131 75 58,494 (5,000) 6,506 81 (848) (2,058) 5,597 10,826 (3,281) 115,364 (136,469) (28,928) 976 138,874 (4,005) (29,552) 5,000 – 7,082 87 Balance at January 1, 1999 ...................................... $ 75,789 Common stock issued — employee benefit plans ...... 215 388 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...................................... – – Additional Paid-in Capital $ 189,698 4,172 2,307 1,253 – 24 – Accumulated Deficit Retained Earnings Accumulated Other Comprehensive Income (Loss) Treasury Stock $ 425,999 $ (114,395) – – – – 63 (87,574) – – – (5,578) – – $ – – – – – – – Total Stockholders’ Equity $ 577,091 4,387 2,695 1,253 (5,578) 87 (87,574) – – 72,941 – – – – 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 Purchase of treasury stock................................................................ (83,664) (92,706) (87,574) Balance at December 31, 2000.................................. 76,916 202,222 568,512 (294,542) (2,105) 551,003 Warrants repurchased ........................................................................ – Dividends paid................................................................................ (7,561) Net cash used in financing activities .............................. (92,019) Net increase (decrease) in cash.................................................................... Cash and cash equivalents at beginning of period........................................ 7,540 22,928 (4,317) (6,736) (43,678) (12,268) 35,196 – (5,578) (80,983) 4,829 30,367 Cash and cash equivalents at end of period................................................ $ 30,468 $ 22,928 $ 35,196 Supplemental Cash Flow Information: Non-cash investing and financing activities: Acquisitions — debt issued (2000) .................................................... $ – $ 6,876 $ – See Notes to Consolidated Financial Statements Common stock issued — employee benefit plans ...... Exercise of stock options............................................ Tax benefit of options exercised................................ Dividends paid ($0.12 per share).............................. Treasury stock issued ................................................ Treasury stock repurchase ........................................ 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 $481) .......... Total comprehensive income...................................... 177 1,188 – – – – – – – 3,275 7,311 6,416 – 5 – – – – – – – (7,561) – – 79,684 – – – (6,350) – – 70 (83,664) – – – – – – – – – 3,452 2,149 6,416 (7,561) 75 (83,664) – (85) 79,684 (85) 897 897 80,496 Balance at December 31, 2001.................................. $ 78,281 $ 219,229 $ 640,635 $ (384,486) $ (1,293) $ 552,366 See Notes to Consolidated Financial Statements 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 H A R T E - H A N K S , I N C . 2 0 0 1 A N N U A L R E P O R T 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 accounting principles generally accepted in the United States of America 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. All intercompany accounts and 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 an original maturity of 90 days or less at the time of purchase are considered to be cash equivalents. Cash equivalents are carried at cost, which approximates 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. Allowance for Doubtful Accounts The Company maintains its allowance for doubtful accounts at a balance adequate to reduce accounts receivable to the amount of cash expected to be realized upon collection. The methodology used to determine the minimum allowance balance is based on the Company’s prior collection experience and is generally related to the accounts receivable balance in various aging categories. The balance is also influenced by specific customers’ financial strength and circumstance. Accounts that are determined to be uncollectible are written off in the period in which they are determined to be uncollectible. Periodic changes to the allowance balance are recorded as increases or decreases to bad debt expense, which is included in the “Advertising, selling, general and administrative” line of the Company’s Consolidated Statements of Operations. The Company recorded bad debt expense of $4.4 million, $4.6 million and $1.8 million for the years ended December 31, 2001, 2000 and 1999, respectively. 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, 2001 and 2000 the Company’s goodwill balance was $434.4 million, net of $82.0 million of accumulated amortization, and $434.7 million, net of $65.7 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 conse- quences resulting from “timing differences” by applying enacted statutory tax rates applicable to future years. These “timing differ- ences” 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 or delivery of the product 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 “Modification of SOP 97-2, Software Revenue Recognition”. 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 deter- mined 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. Reserve for Workers Compensation, Automobile and General Liability The Company has a $250,000 deductible for worker's compensation, automobile and general liability. The estimate of loss reserves nec- essary for claims is based on the Company's estimate of claims incurred as of the end of the year. The Company uses detail loss-run claim reports provided by the insurance administrator and applies actuarial development factors to the claim loss balance to determine an appropriate reserve balance. The loss-run claim reports show all claims and an estimate of what the claim will cost. This estimate is provided by the insurance administrator based upon their experience dealing with similar type claims. The Company uses the loss-run claim reports as a basis for its reserve balance. Periodic changes to the reserve are recorded as increases or decreases to insurance expense, which is included in the “Advertising, selling, general and administrative” line of the Company's Consolidated Statement of Operations. Recent Accounting Pronouncement In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, “Business Combinations”, and SFAS No. 142, “Goodwill and Other Intangible Assets”. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. SFAS No. 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assem- bled workforce may not be accounted for separately. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 121, “Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of ”. The Company adopted the provisions of SFAS No. 141 on July 1, 2001. The Company is required to adopt the provisions of SFAS No. 142 effective January 1, 2002, except that goodwill and intangible assets that were acquired in a business combination completed after June 30, 2001, and were determined to have an indefinite useful life, will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate pre-SFAS No. 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 were continued to be amortized during the period July 1, 2001 through December 31, 2001. SFAS No. 141 requires, upon adoption of SFAS No. 142, that the Company evaluate its existing intangible assets and goodwill that were acquired in a prior purchase business combination, and make any necessary reclassifications in order to conform with the new criteria in SFAS No. 141 for recognition apart from goodwill. Upon adoption of SFAS No. 142, the Company will be required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the first interim period after adoption. In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company will be required to test the intan- gible asset for impairment in accordance with the provisions of SFAS No. 142 within the first interim period. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period. In connection with the transitional goodwill impairment evaluation, SFAS No. 142 will require the Company to perform an assessment of whether there is an indication that goodwill and equity-method goodwill is impaired as of the date of adoption. To accomplish this, the Company must identify its reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of the date of adoption. The Company will then have up to six months from the date of adoption to determine the fair value of each reporting unit and compare it to the reporting unit’s carrying amount. To the extent a reporting unit’s carrying amount exceeds its fair value, an indication exists that the reporting unit’s goodwill may be impaired and the Company must perform the second step of the transitional impairment test. In the second step, the Company must compare the implied fair value of the reporting unit’s goodwill, determined by allocating the reporting unit’s fair value to all of its assets and liabilities (recognized and unrecognized) in a manner similar to a purchase price allocation in accordance with SFAS No. 141, to its carrying amount, both of which would be measured as of the date of adoption. This second step is required to be completed as soon as possible, but no later than the end of the year of adoption. Any transitional impairment loss will be recog- nized as the cumulative effect of a change in accounting principle in the Company’s statement of operations. As of the date of adoption, the Company has unamortized goodwill in the amount of $434.4 million and unamortized identifiable intangible assets in the amount of $3.9 million, all of which will be subject to the transition provisions of SFAS No. 141 and 142. Amortization expense related to goodwill was $16.2 million, $14.8 million and $10.6 million for the years ended December 31, 2001, 2000 and 1999, respectively. The Company expects to complete its initial impairment assessment during the second quarter of 2002. Based on its preliminary review, the Company does not expect to record any transitional goodwill impairment upon the completion of its initial impairment assessment. Note B — Acquisitions/Divestitures In November 2001, the Company acquired Sales Support Services, Inc. (SSS), a leading business-to-business lead generation, order processing and fulfillment services company to the automotive, energy and other industries. The total cost of the transaction was approximately $21.9 million, which was paid in cash and with the assumption of SSS’s debt. Goodwill recognized in this transaction amounted to approximately $16.4 million, and was assigned to the direct and interactive marketing segment. 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. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 H A R T E - H A N K S , I N C . 2 0 0 1 A N N U A L R E P O R T In June 2000, the Company acquired the UK based Hi-Tech Marketing Limited (HTM), 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 telecommuni- cations 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. The total cash outlay in 2001 for acquisitions was $28.2 million. In addition, the Company held back $1.0 million of the purchase price related to its November acquisition of SSS pending the final settlement of the acquired company’s working capital amount. 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 of HTM. The total cash outlay in 1999 for acquisitions was $136.5 million. The operating results of the acquired companies have been included in the accompanying Consolidated Financial Statements from the date of acquisition under the purchase method of accounting. The Company has not disclosed proforma amounts including the operating results of SSS as they are not considered material to the Company as a whole. Note C — Investments Short-Term Investments In 1999 the Company sold all of its short-term investments and at December 31, 2001, 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 year ended December 31, 1999. Long-Term Investments The Company made equity investments totaling $0.7 million and $4.0 million in 2000 and 1999, respectively. These investments were classified as other assets. All such investments for which fair value was readily determinable were considered to be available-for-sale and were recorded at fair value. The related unrealized gains and losses were reported as a separate component of accumulated other comprehensive income. All other equity investments were 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 The Company sold all of these equity investments in 2001 and 2000, and owns no equity investments at December 31, 2001. Proceeds from the sale of long-term investments were $0.8 million and $1.1 million in 2001 and 2000, respectively. Gross realized losses included in 2001 income were $3.4 million and gross realized gains included in 2000 income were $0.5 million. Gross gains and losses were determined using the average cost method. Note D — Long-Term Debt Long-term debt consists of the following: In thousands Revolving loan commitment, various interest rates (effective rate of 2.36% at December 31, 2001), due November 4, 2002................ Revolving loan commitment, various interest rates (effective rate of 3.60% at December 31, 2001), $2.2 million due December 16, 2002, remaining $1.1 million due July 20, 2003........................ Acquisition note payable, various interest rates ............................ Less current maturities ...................... December 31, 2001 2000 $ 45,000 $ 55,000 3,312 3,493 – – 6,877 – Cash payments for interest were $3.4 million, $1.3 million and $0.1 million for the years ended December 31, 2001, 2000 and 1999, 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 October 26, 2001 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 October 25, 2002 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%. These credit facilities contain both affirmative and negative covenants and the Company has been in compliance with these covenants since obtaining the credit facilities in 1999. As of December 31, 2001, the Company had $55 million and $100 million of unused borrowing capacity under its Three-Year Credit Agreement and 364-Day Credit Agreement, respectively. It is the Company’s intent to obtain additional credit facilities at comparable amounts and terms at the time these two facilities expire. On November 29, 1999 the Company obtained an unsecured credit facility in the amount of 2.5 million Euros for the purpose of financing the construction of a new building in Hasselt, Belgium. This facility was increased to 3.7 million Euros 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, 2001, the Company had no unused borrowing capacity under this credit facility. It is the Company’s intent to repay this note with borrowings under the additional credit facilities the Company intends to obtain at the expiration of its three-year and 364-day revolving credit facilities. Acquisition Note Payable In June 2000, the Company issued a note payable of 4.6 million British Pounds in connection with an acquisition. Interest on this note was at LIBOR minus .75%. This note payable was due upon demand, and was paid during 2001 using borrowings obtained from the Company’s three-year revolving credit facility. Note E — Income Taxes The components of income tax expense (benefit) are as follows: In thousands Current Federal .............................. $ 43,010 $ 40,502 $ 32,099 State and local.................. Foreign.............................. 6,776 498 6,679 1,850 6,079 1,120 Total current................ $ 50,284 $ 49,031 $ 39,298 Federal .............................. $ 2,716 $ 5,321 $ 8,564 State and local.................. (246) 621 2,008 Total deferred.............. $ 2,470 $ 5,942 $ 10,572 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: Total income tax expense (benefit) was allocated as follows: In thousands Year Ended December 31, 2001 2000 1999 Results of operations.............. $ 52,754 $ 54,973 $ 49,870 Stockholders’ equity................ (5,935) (10,207) 5,379 Total ........................................ $ 46,819 $ 44,766 $ 55,249 The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and deferred tax liabilities were as follows: and retirement plans .............. $ 1,336 $ 2,430 Accrued expenses not deductible until paid.............. Accounts receivable, net.............. Other, net .................................... State net operating loss carryforwards.......................... Capital loss carryforward ............ Total gross deferred tax assets........................ Less valuation allowance ............ Net deferred tax assets .......... 4,327 1,674 162 759 492 8,750 (897) 7,853 2,979 1,264 806 455 – 7,934 (455) 7,479 Deferred tax liabilities: Property, plant and equipment...... (12,878) (13,646) Year Ended December 31, 2001 2000 1999 In thousands Deferred tax assets: Deferred compensation December 31, 2001 2000 In thousands 2001 2000 1999 State income tax.......................... (638) (566) Year Ended December 31, Goodwill ...................................... (15,474) (11,626) Computed expected income tax expense ................ $ 46,353 35% $ 47,900 35% $ 42,984 35% Net effect of state income taxes ........ 4,368 3% 4,857 4% 5,256 4% Effect of goodwill amortization.......... 1,607 1% 1,633 1% 1,344 1% Effect of non-taxable investment income .................. Change in the beginning of the year balance of the valuation allowance.............. – 0% – 0% (50) 0% (124) 0% (112) 0% – 0% Other, net .................. 550 0% 695 0% 336 0% Income tax expense for the period........ $ 52,754 40% $ 54,973 40% $ 49,870 41% Total gross deferred tax liabilities ................ (28,990) (25,838) Net deferred tax liabilities...... $ (21,137) $ (18,359) The valuation allowance for deferred tax assets as of January 1, 2000 was $475,000. The valuation allowance at December 31, 2001 relates to state net operating losses of $405,000 and capital losses of $492,000, which are not expected to be realized. The entire valuation allowance at December 31, 2000 related to state net operating losses that 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 timing difference. Cash payments for income taxes were $38.0 million, $47.8 million and $39.1 million in 2001, 2000 and 1999, respectively. $ 48,312 $ 65,370 Deferred 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 H A R T E - H A N K S , I N C . 2 0 0 1 A N N U A L R E P O R T 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. 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 supplemental 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: The weighted-average assumptions used for measurement of the defined pension plans were as follows: December 31, 2001 2000 1999 Weighted-average assumptions as of December 31 Discount rate ............................ 7.40% 7.50% 8.00% Expected return on plan assets .................. 9.00% 10.00% 10.00% Rate of compensation increase.............................. 4.00% 4.00% 4.00% Net pension cost for both plans included the following components: In thousands Change in benefit obligation Benefit obligation Year ended December 31, 2001 2000 In thousands 2001 2000 1999 December 31, Components of net periodic benefit cost (income) at beginning of year.................... $ 85,369 $ 68,685 Service cost.............................. $ 543 $ 338 Service cost ........................................ Interest cost...................................... Actuarial loss (gain) ...................... Benefits paid...................................... 543 6,045 (1,512) (4,453) Benefit obligation at end of year........ 85,992 338 5,373 15,729 (4,756) 85,369 Change in plan assets Fair value of plan assets at beginning of year.................... 90,356 101,679 Actual return on plan assets.............. Benefits paid ...................................... (6,662) (4,453) (6,567) (4,756) Fair value of plan assets at end of year .............................. 79,241 90,356 Funded status .................................... (6,751) Unrecognized actuarial loss .............. 17,825 Unrecognized prior service cost ........ 620 4,987 3,919 684 Net amount recognized...................... $ 11,694 $ 9,590 The Company’s non-qualified pension plan has an accumulated benefit obligation in excess of its assets of $8.4 million at December 31, 2001. $ 365 5,215 Interest cost ............................ 6,045 5,373 Expected return on plan assets.................... (8,820) (9,951) (8,351) Amortization of prior service cost .............. Recognized actuarial loss (gain).......................... 65 64 65 65 (1,575) 151 Net periodic benefit income...... $(2,103) $(5,750) $ (2,555) 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 2001, 2000 and 1999 was $6.3 million, $6.2 million and $5.1 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 276,367 at December 31, 2001. Note G — Stockholders’ Equity In January 2002, the Company announced an increase in the regular quarterly dividend from 3 cents per share to 3.5 cents per share, payable March 15, 2002 to holders of record on March 1, 2002. During 2001 the Company repurchased 3.6 million shares of its common stock for $83.7 million under its stock repurchase program. In addition, the Company received .3 million shares of its common stock, with an estimated market value of $6.3 million, in exchange for proceeds related to stock option exercises. In September 2001, the Company authorized an increase of four million shares in the Company’s stock repurchase program. As of December 31, 2001 the Company has repurchased 17.7 million shares since the beginning of its stock repurchase program in January 1997. During this period the Company has also received .3 million shares in exchange for proceeds related to stock option exercises. Under this program, the Company has authorization to repurchase an additional 4.9 million shares. million shares of Harte-Hanks common stock. There were no out- standing DiMark options as of December 31, 2001 and 2000. As of December 31, 1999, there were 54,792 DiMark options outstanding. The following summarizes all stock option plans activity during 2001, 2000 and 1999: 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 became exercisable five years after date of grant. There were no remaining options outstanding under the 1984 Plan at December 31, 2001. At December 31, 2000 and 1999, options to purchase 126,000 shares and 216,000 shares, respectively, were outstanding under the 1984 Plan. 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 (“perform- ance options”). As of December 31, 2001, 2000 and 1999, market price options to purchase 6,033,187 shares, 6,597,025 shares and 5,873,475 shares, respectively, were outstanding with exercise prices ranging from $3.33 to $26.19 per share at December 31, 2001. 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 market price options and exercisable market price options at December 31, 2001 was $16.49 and $10.86, respectively. The weighted-average remaining life for outstanding market price options was 5.94 years. At December 31, 2001, 2000 and 1999, performance options to purchase 501,250 shares, 716,600 shares and 739,400 shares, respectively, were outstanding with exercise prices ranging from $0.33 to $2.00 per share at December 31, 2001. 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 $0.2 million, $0.4 million and $0.4 million was recognized for the performance options for the years ended December 31, 2001, 2000 and 1999, respectively. The weighted- average exercise price for outstanding options and exercisable options at December 31, 2001 was $0.61 and $0.49, respectively. The weighted-average remaining life for outstanding performance options was 2.80 years. The Company did not grant any performance options during 2001 or 2000. DiMark In connection with the DiMark merger, DiMark’s outstanding stock options were converted into options to acquire approximately 3.0 Number Of Shares Weighted Average Option Price Options outstanding at January 1, 1999 ...................... 6,306,914 $ 9.72 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) Options outstanding at December 31, 2000................ 7,439,625 Granted.............................................. 821,100 Exercised .......................................... (1,188,288) Cancelled .......................................... (538,000) 22.29 6.76 17.88 12.04 22.01 7.37 20.20 13.50 22.21 7.26 21.29 Options outstanding at December 31, 2001 .............. 6,534,437 $ 17.73 Exercisable at December 31, 2001.................... 2,908,561 $ 9.30 The Company has adopted the disclosure-only provisions of SFAS 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 underlying 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 deter- mined 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, 2000 2001 1999 Net income — as reported...... $ 79,684 $ 81,866 $ 72,941 Net income — pro forma ........ 75,446 77,245 68,923 Diluted earnings per share — as reported.... 1.23 1.18 1.01 Diluted earnings per share — pro forma...... 1.16 1.11 0.95 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 H A R T E - H A N K S , I N C . 2 0 0 1 A N N U A L R E P O R T 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 2001, 2000 and 1999: Note L — Earnings Per Share A reconciliation of basic and diluted earnings per share (EPS) is as follows: Year ended December 31, 2000 2001 1999 In thousands Year ended December 31, except per share amounts 2001 2000 1999 Expected dividend yield .......... 0.5% 0.4% 0.3% BASIC EPS Net income.............................. $ 79,684 $ 81,886 $ 72,941 Weighted-average common shares outstanding used in earnings per share computations .................... 63,206 67,517 69,914 Earnings per share .................. $ 1.26 $ 1.21 $ 1.04 DILUTED EPS Net income.............................. $ 79,684 $ 81,886 $ 72,941 Shares used in diluted earnings per share computations...... 64,783 69,653 72,144 Earnings per share .................... $ 1.23 $ 1.18 $ 1.01 Computation of Shares Used in Earnings Per Share Computations Average outstanding common shares.................. 63,206 67,517 69,914 Average common equivalent shares — dilutive effect of option shares................ Shares used in diluted earnings per share computations ...... 1,577 2,136 2,230 64,783 69,653 72,144 As of December 31, 2001 the Company had 363,798 antidilutive market price options outstanding, which have been excluded from the EPS calculations Expected stock price volatility.................. 21.0% 23.0% 22.0% Risk free interest rate.............. 6.0% 6.0% 6.0% Expected life of options .......... 3-10 years 3-10 years 3-10 years The weighted-average fair value of market price options granted during 2001, 2000 and 1999 was $8.02, $9.66 and $9.24, respec- tively. The weighted-average fair value of performance options granted during 1999 was $22.54. The Company did not grant any performance options during 2001 or 2000. 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 approximating their carrying values. These instruments include revolving credit agreements, accounts receivable, trade payables, and miscellaneous notes receivable and payable. The Company’s equity securities that have a readily determinable fair value are recorded at fair value. (See Note C.) Note J — Commitments and Contingencies At December 31, 2001, the Company had outstanding letters of credit in the amount of $8.4 million. These letters of credit exist to support 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 $28.5 million, $26.3 million and $23.0 million for the years ended December 31, 2001, 2000 and 1999, respectively. The future minimum rental commitments for all non-cancelable operating leases with terms in excess of one year as of December 31, 2001 are as follows: In thousands 2002 .............................................................................. $ 26,696 2003 .............................................................................. 2004 .............................................................................. 2005 .............................................................................. 2006 .............................................................................. 21,313 15,344 11,170 6,913 After 2006 ...................................................................... 23,538 $ 104,974 Note M — Selected Quarterly Data (Unaudited) In thousands, except per share amounts 2001 Quarter Ended __________________________________________________ December 31 September 30 June 30 March 31 December 31 September 30 ________________________________________________ March 31 June 30 2000 Quarter Ended Revenues...................................... $ 233,024 $ 224,130 $ 228,654 $ 232,120 $ 255,818 $ 243,205 $ 235,693 $ 226,057 Operating income .......................... Net income .................................. Basic earnings per share ................ Diluted earnings per share .............. 35,173 20,572 0.33 0.32 36,046 36,559 31,852 19,913 20,836 18,363 0.32 0.31 0.33 0.32 0.28 0.28 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 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 acquisition of Sales Support Services, Inc. in November 2001. 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 $380.8 million, $419.5 million and $335.5 million in 2001, 2000 and 1999, respectively. Marketing Services’ revenues were $221.1 million, $242.5 million and $223.8 million in 2001, 2000 and 1999, respectively. The Company utilizes advanced technologies to enable its customers to identify, reach and influence specific consumers or businesses. The Company’s direct and interactive marketing capabilities also strengthen the relationship between its clients and their customers. The Company constructs and updates business-to-business and business-to-consumer databases; accesses the data through flexible hosting capabilities and analyzes it to help make it relevant; applies the knowledge by putting the data to work via multi-channel programs; and, executes those programs through marketing services delivery campaigns. The Company’s direct and interactive marketing customers include many of America’s largest retailers; financial companies including banks, financing companies, mutual funds and insurance companies; high-tech and telecommunications companies; and pharmaceutical companies and healthcare organizations. Direct and interactive marketing customers also include a growing number of customers in such selected markets as automotive, utilities, consumer packaged goods, hospitality, publishing, business services, energy and government/not-for-profit. The segment’s 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 adver- tisers 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. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 H A R T E - H A N K S , I N C . 2 0 0 1 A N N U A L R E P O R T Note N — Business Segments (continued) Information about the Company’s operations in different industry segments: Five-Year Financial Summary In thousands Revenues Year Ended December 31, 2001 2000 1999 Direct Marketing ............................................................................................ $ 601,901 $ 662,044 $ 559,262 Shoppers .................................................................................................... 316,027 298,729 270,490 Total Revenues........................................................................................ $ 917,928 $ 960,773 $ 829,752 Operating income Direct Marketing............................................................................................ $ 85,020 $ 91,450 $ 79,164 Shoppers .................................................................................................... Corporate Activities ...................................................................................... 63,398 (8,788) 55,710 (8,939) 47,015 (7,951) Total operating income........................................................................ $ 139,630 $ 138,221 $ 118,228 Income before income taxes Operating income.......................................................................................... $ 139,630 $ 138,221 $ 118,228 Interest expense ........................................................................................ (3,076) Interest income ................................................................................................ 498 Other, net ...................................................................................................... (4,614) (1,678) 2,062 (1,746) (349) 5,662 (730) Total income before income taxes ........................................................ $ 132,438 $ 136,859 $ 122,811 Depreciation Direct Marketing............................................................................................ $ 26,769 $ 23,022 $ 18,804 Shoppers .................................................................................................... Corporate Activities ........................................................................................ 5,235 75 5,393 79 5,235 87 Total depreciation................................................................................ $ 32,079 $ 28,494 $ 24,126 Goodwill and intangible amortization Direct Marketing............................................................................................ $ 12,769 $ 11,156 $ 6,593 Shoppers .................................................................................................... 4,072 4,070 4,069 Total goodwill and intangible amortization.......................................... $ 16,841 $ 15,226 $ 10,662 Total assets Direct Marketing............................................................................................ $ 536,270 $ 589,552 Shoppers .................................................................................................... 179,748 Corporate Activities ...................................................................................... 55,031 187,905 29,648 Total assets.......................................................................................... $ 771,049 $ 807,105 - - - - Capital expenditures Direct Marketing............................................................................................ $ 22,354 $ 34,030 $ 24,450 Shoppers .................................................................................................... Corporate Activities ...................................................................................... Total capital expenditures...................................................................... 4,085 6 $ 26,445 2,408 27 $ 36,465 4,434 44 $ 28,928 Information about the Company’s operations in different geographic areas: Year Ended December 31, In thousands Revenuesa 2001 2000 1999 United States .................................................................................................. $ 880,642 $ 917,160 $ 800,700 Other countries .......................................................................................... 37,286 43,613 29,052 Total revenues ........................................................................................ $ 917,928 $ 960,773 $ 829,752 Long-lived assetsb United States .................................................................................................. $ 101,785 $ 104,507 Other countries .......................................................................................... 7,643 7,558 Total long-lived assets ........................................................................ $ 109,428 $ 112,065 - - - a Geographic revenues are based on the location of the customer. b Long-lived assets are based on physical location. In thousands, except per share amounts 2001 2000 1999 1998 1997 Statement of Operations Data Revenues.............................................................................. $ 917,928 $ 960,773 $ 829,752 $ 748,546 $ 638,349 Operating expenses Payroll, production and distribution .......................... 649,552 686,502 606,676 553,529 479,742 Selling, general and administrative............................ Depreciation.................................................................. Goodwill and intangible amortization........................ Total operating expenses .................................... Operating income........................................................................ Interest expense, net.................................................................. Income from continuing operationsa............................................ Income from continuing operations 79,826 32,079 16,841 778,298 139,630 2,578 79,684 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) 68,371b after extraordinary items, net of taxes .............................. 79,684 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 1.23 1.23 0.12 1.18 1.18 0.10 1.01 1.01 0.08 0.90b 0.90b 0.06 59,054 17,327 5,134 561,257 77,092 1,777 44,271c 43,396d 0.57c 0.56d 0.04 equivalent shares outstanding — diluted.......................... 64,783 69,653 72,144 76,057 77,000 Segment Data Revenues Direct Marketing .......................................................... $ 601,901 $ 662,044 $ 559,262 $ 493,898 $ 425,489 Shoppers .................................................................... 316,027 298,729 270,490 254,648 212,860 Total revenues.............................................................. $ 917,928 $ 960,773 $ 829,752 $ 748,546 $ 638,349 Operating income Direct Marketing .......................................................... $ 85,020 $ 91,450 $ 79,164 $ 69,648 $ 54,360 Shoppers.................................................................... General corporate ...................................................... 63,398 (8,788) 55,710 (8,939) 47,015 (7,951) 40,507 (8,197) 31,089 (8,357) Total operating income.............................................. $ 139,630 $ 138,221 $ 118,228 $ 101,958 $ 77,092 Other Data Operating cash flow e.......................................................... Capital expenditures.......................................................... $ 188,550 $ 181,941 $ 153,016 $ 130,935 $ 99,553 26,445 36,465 28,928 24,443 28,396 Balance Sheet Data (at end of period) ...................................... Property, plant and equipment, net .................................. Goodwill and other intangibles, net.................................. Total assets.......................................................................... Total long term debt .......................................................... Total stockholders’ equity .................................................. $ 109,428 $ 112,065 $ 106,250 $ 92,274 $ 89,351 438,325 771,049 48,312 552,366 439,148 807,105 65,370 551,003 409,791 769,427 5,000 577,618 290,831 715,213 – 250,363 954,923 – 577,091 566,237 a Represents income and earnings from continuing operations per common share before extraordinary items. b 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. c 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. d Includes extraordinary loss from the early extinguishment of debt of $0.9 million, net of $0.6 million income tax benefit. e Operating cash flow is defined as operating income plus depreciation and goodwill and intangible amortization. Operating cash flow is not intended to represent cash flow or any other measure of performance in accordance with accounting principles generally accepted in the United States of America. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 32 31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 H A R T E - H A N K S , I N C . 2 0 0 1 A N N U A L R E P O R T 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, 2001 and 2000, and the related consolidated statements of operations, cash flows, and stockholders’ equity and comprehensive income for each of the years in the three-year period ended December 31, 2001. These consolidated 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, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. San Antonio, Texas January 29, 2002 Common Stock The Company’s common stock is listed on the New York Stock Exchange (symbol: HHS). The quarterly stock price ranges for 2001 and 2000 were as follows: First Quarter .............. Second Quarter.......... Third Quarter.............. Fourth Quarter............ 2001 2000 Low High Low 21.28 21.36 20.50 20.45 26.75 25.94 27.88 28.44 19.63 21.00 24.38 21.50 High 24.09 25.88 24.90 28.92 In 2001, quarterly dividends were paid at the rate of 3 cents per share. In 2000, quarterly dividends were paid at the rate of 2.5 cents per share. There are approximately 2,700 holders of record. Transfer Agent and Registrar EquiServe Trust Company, N.A. PO Box 43010 Providence, RI 02940-3010 Annual Meeting of Stockholders The annual meeting of stockholders will be held at 10:00 a.m. on May 7, 2002, 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: Dean Blythe, Secretary Harte-Hanks, Inc. P. O. Box 269 San Antonio, Texas 78291-0269 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 H A R T E - H A N K S , I N C . 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 HOCHHAUSER President and Chief Operating Officer JAMES L. JOHNSON Chairman Emeritus, GTE Corporation Chairman, Compensation Committee WILLIAM K. GAYDEN Chairman and Chief Executive Officer, Merit Energy Company CORPORATE OFFICE SAN ANTONIO, TEXAS http://www.harte-hanks.com DIRECT MARKETING CRM Austin, Texas Billerica, Massachusetts Clearwater, Florida Fort Worth, Texas Glen Burnie, Maryland La Jolla, California Lake Katrine, New York Lake Mary, Florida Monroe Township, New Jersey New York, New York Ontario, California River Edge, New Jersey San Diego, California Sterling Heights, Michigan Valencia, California West Bridgewater, Massachusetts LARRY FRANKLIN Chairman and Chief Executive Officer RICHARD HOCHHAUSER President and Chief Operating Officer CRAIG COMBEST Senior Vice President, Direct Marketing DONALD CREWS Senior Vice President, Legal and Secretary CHARLES DALL’ACQUA Senior Vice President, Direct Marketing PETER GORMAN Senior Vice President, Shoppers JACQUES KERREST Senior Vice President, Finance and Chief Financial Officer GARY SKIDMORE Senior Vice President, Direct Marketing MARKETING SERVICES Baltimore, Maryland Bellmawr, New Jersey Bloomfield, Connecticut Cherry Hill, New Jersey Cincinnati, Ohio Clearwater, Florida Deerfield Beach, Florida Forty Fort, Pennsylvania Fullerton, California Grand Prairie, Texas Jacksonville, Florida Langhorne, Pennsylvania Memphis, Tennessee Shawnee, Kansas Westville, New Jersey NATIONAL SALES HEADQUARTERS Cincinnati, Ohio INTERNATIONAL OFFICES Darmstadt, Germany Dublin, Ireland Hasselt, Belgium London, United Kingdom DEAN BLYTHE Vice President, Legal KATHY CALTA Vice President, Direct Marketing BILL CARMAN Vice President, Shoppers JAMES DAVIS Vice President, Direct Marketing BILL GOLDBERG Vice President, Direct Marketing SPENCER JOYNER, JR. Vice President, Direct Marketing FEDERICO ORTIZ Vice President, Tax TANN TUELLER Vice President, Direct Marketing JESSICA HUFF Controller and Chief Accounting Officer Madrid, Spain Melbourne, Australia São Paulo, Brazil Sevres, France Toronto, Canada Uxbridge, United Kingdom SHOPPERS THE FLYER South Florida http://www.theflyer.com PENNYSAVER Northern California Southern California — Greater Los Angeles Area 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-02 Our People Make It Happen Harte-Hanks, Inc. • 2001 Annual Report 

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