Harte Hanks Annual Report 2004

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FY2004 Annual Report · Harte Hanks

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F u n d a m e ntals

Custom e r S u c c e

H a r t e - H a n k s , I n c . | 2 0 0 4 A n n u a l R e p o r t

Table of Contents

1 The Fundamentals of Customer Success

2 Expertise Grounded in the Fundamentals

3 Fundamentals of Harte-Hanks

5 Fundamental Goals

6 Fundamental Results

8 2004 Financial Information Table of Contents

The Fundamentals of Customer Success

Harte-Hanks people have earned a reputation as trusted advisors because we help our

clients achieve and exceed their marketing goals. We come to work every day with

unsurpassed expertise and a zest for excellence. Grounded in the highest ethical

standards, we live and breathe direct marketing and targeted media as science

and art. We demonstrate our commitment to our clients by:

• Connecting businesses and individuals from highly diverse and

dynamic demographic groups through our widely read, cost-effective
shopper publications;

• Earning trust with our thorough, expert and candid review of each client’s

unique market situation;

• Applying our intimate knowledge of the benchmarks, regulations and industry

standards that govern the client’s vertical market;

• Developing and recommending integrated programs that exceed the client’s return

on investment (ROI) expectations;

• Executing programs for clients with the speed and efficiency made possible by

our expertise and experience;

• Analyzing results to refine strategy in partnership with clients, to help them achieve

success; and

• Making it simple for clients to satisfy all their direct and targeted marketing needs

through a single point of contact.

This is how we do business. This is how we’ve set standards for the shoppers publishing and

direct marketing fields. It’s the way we crystallize the common carbon of marketing potential

into the diamond of client success. This annual report is a summary of how we made it

happen for our clients in 2004.

Financial Highlights (in millions, except per-share amount)

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Expertise Grounded in the Fundamentals

Fundamentals of Harte-Hanks

Originally a West Texas newspaper company founded in the 1920s, Harte-Hanks today is a

leading worldwide direct marketing and targeted media company that offers direct marketing

solutions and shopper advertising opportunities to a wide range of local, regional, national

and international consumer and business-to-business marketers. Our success, and that of our

clients, springs from our marketing mastery and its applications—with finesse gained from

decades of experience and innovation.

Our two business lines, shopper publications and direct marketing, reflect where we excel.

They also reflect the targeting needs of our global, national, regional and local clients.

National firms, along with thousands of smaller retailers, service firms and individuals, use

the effective audience targeting of our shopper publications in California and Florida. And

from our 35 locations around the world, Harte-Hanks has built direct marketing partnerships

with clients ranging from mid-sized to Fortune 1000 companies across North America,

Europe, South America and the Pacific Rim. These diverse corporations rely on Harte-Hanks

for integrated communication programs that are targeted, created, produced, delivered,

tracked, analyzed and refined by our vertical market experts.

Whether a client needs a complex multi-media program to launch a new pharmaceutical

or a PennySaver ad to increase traffic at a local chain of restaurants, every service we

perform is based on fundamental trust. How does Harte-Hanks earn that trust? With candor,

transparency, expertise, efficiency and results. In each vertical market we serve, our teams

of specialists earn our clients’ respect by demonstrating unsurpassed knowledge and insight.

Financial Highlights
(in thousands, except per share amount)

Revenues

Operating income

Depreciation and amortization

Interest expense

Net income

Diluted earnings per share1

Capital expenditures

Average common and common
equivalent shares outstanding – diluted1

2004

2003

2002

$ 1,030,461

$ 944,576

$ 908,777

165,295

28,769

1,020

97,568

1.11

35,146

87,806

146,487

30,033

855

87,362

0.97

31,915

89,982

150,288

32,728

1,208

90,745

0.96

17,358

94,872

1 Harte-Hanks completed a three-for-two split of its common stock in the form of a 50 percent stock dividend in

May 2002. All share and per share amounts presented have been adjusted to reflect this three-for-two split.

Direct Marketing
The range of Harte-Hanks Direct Marketing solutions

can be conceptualized by our five fundamental solution
points: Construct and update the database ➞ Access the
data ➞ Analyze the data ➞ Apply the knowledge ➞
Execute the programs.

Shoppers
Harte-Hanks Shoppers is North America’s largest

owner, operator and distributor of shopper publications,

with shoppers that are zoned into more than 900

separate editions with direct mail circulation in excess

of 11 million in California and Florida each week.

Harte-Hanks Direct Marketing

A broad spectrum of residential

advertisers and local, regional and

national businesses depend on our

publications for extremely cost-

effective, flexible marketing. We

target readers by geographic zone,

or clusters of zones surrounding an

advertiser location, and we apply

demographic, language and lifestyle

criteria for targeting. We offer

advertisers not just a variety of print

options, but also the opportunity to

take advantage of interactive search

functions in our online versions.

Plus, our print publications receive

the reliability, deliverability and

At each point in this process, solutions are tailored by

comprehensive coverage provided only by the United

market for the client’s evolving needs. Once the data-

States Postal Service.

driven programs have been executed, their results are

read, analyzed and applied to update the database and

refine marketing programs. The knowledge gained

enables the cycle to continue more effectively,

achieving the strategic goal of the process—increasing

the client’s return on marketing investment.

This kind of end-to-end relationship is made easier by a

true partnership with the client. We are candid with our

clients, which facilitates the teamwork necessary to

create and implement strategies that meet the

challenges of today’s markets.

Always with an eye on the fundamentals, our Harte-

Hanks shoppers business continues to set the bar for

success in reaching and influencing targeted consumers.

Harte-Hanks Shoppers

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Fundamental value delivery
The pressure to deliver value—better results at lower

Let’s examine the five integrated solution points of

direct marketing in more detail:

costs—has never been higher. We deliver value to our

Constructing and updating the database

clients by doing the fundamentals better, by innovating,

by understanding our clients and their vertical markets

and buyers, and by providing a return on each client’s

marketing investments.

Shoppers: value for clients
For our shopper publications, both in direct mail and

online, our value offering gets delivered many ways.

First, Harte-Hanks is vertically integrated as a shopper

publisher: we sell, produce, and see the advertising

through to delivery. We offer a range of ways for clients

to advertise—in the book, in inserts, on Web sites and

with detached cards. We offer a variety of placement

options and formats, such as front cover, back cover

and in color. We target with average circulations of

approximately 12,000, and we enable sub-zone inserts.

Plus, we accept advertising within as few as three

business days prior to delivery.

To influence future purchase behavior, a marketer must

understand previous purchase behavior—what, how,

when and at what price people buy. Companies that

need to know partner with Harte-Hanks for our world-

class technology and people. Data are gathered, stored,

verified, cleansed, enhanced and organized into an

accessible repository.

Three examples of Harte-Hanks leadership in data

technology and services are our Advanced Data

Quality (ADQ) offering for customer/prospect contact

information quality; a proprietary component of ADQ,

the Trillium Software System®; and the CI Technology

Database for business market intelligence.

Accessing the data

Once the database is built, the information it contains

has value only to the extent that it can be accessed to

solve business problems and improve marketing

Our PennySaver and Flyer titles are highly recognized,

cost-effectiveness.

powerful brands in their communities. Audited

readership consistently places us among the most

highly read publications. Our impact is measured right

at the client’s cash register. We saturate in areas of

coverage—reaching nearly everyone in the targeted

geography. No other print publication achieves this

mark at our level of circulation. It’s a 40-year formula

that, with innovation, continues to produce results even

as we invest to ensure tomorrow’s success.

Direct Marketing: value for clients
It takes highly skilled professionals equipped with

the best tools to transform disparate customer data

into patterns that prompt smart marketing action.

Premier among the industry’s tools to enable more

smart, strategic and cost-effective direct marketing

is our range of vertically focused Allink® solutions.

The Allink suite of products and services is based on

more than 30 years of successful database construction,

and consists of fully relational, Web-based, privacy-

compliant, operational and analytic customer-

management systems.

Our nexTouch suite enables marketers to manage leads

and subsequent prospect and customer “touch points”

in database-driven multichannel communications. We

provide Web-based support for online meetings and

event management, order processing, customer care,

tech support/help desk and fulfillment.

W e c a n n e v er be satisfied or complacent, because today’s “standard”

Analyzing the data

Our consultants, researchers, modelers and analysts

provide consultation, campaign support, segmentation and

modeling that are data-based, analysis-driven and grounded in a

sophisticated understanding of direct marketing, customer relationship

management and vertical markets. Our analytics professionals improve the

effectiveness of marketing efforts by translating data into information and

information into knowledge. That enables them to identify likely responders.

Applying the knowledge

Our expertise allows us to put knowledge to work in customer acquisition and retention; cross-sell,

up-sell and loyalty programs; privacy initiatives; customer-care services; merger and acquisition

communications; sales and lead-management systems; and company-specific promotional

campaigns. Our agency team provides both the strategic and creative insights to design award-

winning and results-driven campaigns to capitalize on this extracted knowledge.

Executing the programs

Our front-line vertical implementation teams help deliver personalized mail campaigns, on-demand

production, fulfillment (electronic and traditional), e-mail programs, teleservices, Web site

development and support, and logistics.

As one of the largest and most focused providers in each of these areas, we implement each step

with the ultimate aim of increasing client growth and ROI.

Fundamental Goals

Underlying everything we do is the goal of exceeding the expectations of each customer. That’s the

way we define success. Our fundamental values, attitudes, philosophy and style are at the root of the

Harte-Hanks insight, expertise and productivity that enable our customers to achieve their goals.

Harte-Hanks employees respond proactively and flexibly to opportunities and challenges. And we

accept individual responsibility for doing the right things and doing them right.

We value:

• Mutual trust and candor;

• Respect, teamwork and a strong work ethic;

• Pride and excellence;

• A willingness to take risks, to change and to grow;

• An emphasis on action and a sense of urgency toward our goals; and

• A spirit of fun in our work.

The people of Harte-Hanks place the highest value on our responsibilities to our customers

and stakeholders. By conducting business ethically, we fulfill our commitment to help

the communities we serve and to help lead our industry.

always has proven to become t o m o r r o w ’s “ p r i c e o f e n t r y . ” — R i c h a r d H o c h h a u s e r

Fundamental Results

We started the year with momentum in
both our Direct Marketing and Shoppers
businesses, yet much needed to be
accomplished for 2004 to achieve its
potential as a growth year. This
letter describes, in brief, the many
achievements of Harte-Hanks in
what turned out to be a very
exciting year.

Technologies Ltd., a leading provider of data profiling
technology. We have fully integrated its Discovery
software into the Trillium Software System® and now
have a more complete offering. In December, we
acquired Postfuture, an e-mail marketing company,
which offers us many opportunities to integrate e-mail
more fully into true multichannel programs for our
clients. In Shoppers, we acquired a shopper publication

in the fast-growing Hemet, California area and

T h e q u a l i t y o f a p e r s o n ’s lif e is in direct proportion to their co

We see two components
in delivering “The

integrated the publication with
our PennySaver brand.

Fundamentals of Customer

Success.” First is moving our
clients from a good place to a better

one—with the help of Harte-Hanks. And

second is the underlying culture of Harte-Hanks,
which facilitates the results we deliver for our clients.
We take much pride in both, and each component
differentiates us.

We continued to perform solidly in Shoppers and laid
the groundwork for sustaining this trend. We extended
our growth streak in this business to eight years. We
posted solid revenue and profit growth, as we built
circulation and enhanced our publications. In Direct
Marketing, revenue continued to grow, and each of our
vertical markets experienced growth. We translated this
increased revenue into profits—our return on sales
gained ground. We said that this would be a focus for
us this year, and we made it happen.

In 2004, our diluted earnings per share increased to
$1.11 on revenues of $1.03 billion—the first time
Harte-Hanks has surpassed the billion-dollar revenue
mark. Direct Marketing, which comprised 62% of total
revenue, achieved all of the key financial metric goals
that we established for this business. We continued
positive revenue momentum—posting a 9.6% revenue
gain—at the same time we drove up profit percentages.
Shoppers performance generated revenue growth of
8.2% and operating income posted a 10.1% increase.
This achievement is particularly noteworthy in that
paper costs ended 2004 at their highest point in
three years.

We continued to evaluate numerous acquisition
opportunities and acted upon three small ones—all
strategic. In February, we purchased Avellino

mit

Other uses of
capital included the
repurchase of approximately
3.6 million shares during 2004,
making a total of approximately 39.3
million shares repurchased since the
company initiated this activity in 1997. During
the year, the board authorized an increase of five
million additional shares for buyback, making the
year-end total of approximately 5.6 million shares
available for repurchase through this program. We
also invested in a range of client-focused software,
hardware and equipment aimed at creating new
revenue opportunities. In total, we spent $35.1 million
on capital projects in 2004.

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We made some significant changes among company
officers throughout Harte-Hanks. On our Direct
Marketing team, Kathy Calta, Jim Davis and Bill
Goldberg were promoted to senior vice president and
Robert Colucci, Frank Harvey and Dave LaGreca were
made vice presidents. In the corporate office, Steve
Hacker was hired as vice president, legal and secretary.

Shoppers achieved much in 2004:

• Significant circulation growth in contiguous

expansion of approximately 600,000;

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• Improved customer service via Internet-based

technology for primary accounts;

• Programming mostly completed on a major

common systems project that supports multi-unit
advertising, market pricing, common billing, and
media scheduling;

• Introduction of new shopper insert packages

including Local Living and Pensando en Ti; and

• Improved readership, based on independent

survey research.

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These “corporate governance” policies are posted
plainly on our Web site home page. Regarding
Sarbanes-Oxley, I am pleased to say that management
has completed its assessment of internal controls over
financial reporting as required by Section 404, and
neither we nor our independent auditor, KPMG LLP,
have identified any material weaknesses. Accordingly,
our external auditor has concluded that our internal
control over financial reporting is effective.

These achievements collectively reflect our energy, our
culture, our vision and our dedication to customer
success. Fundamentally, the people of Harte-Hanks are
special; they made it happen in 2004.

Richard Hochhauser

And in 2004, among our accomplishments in
Direct Marketing were:

• Revenue growth in all vertical markets;

• Improved margin;

• Expanded number of facilities, while others

were consolidated;

• A gain in awareness, recognition and client base

in our Allink® database offerings; and

• A number of prestigious awards. Among them
Trillium Software® receiving the highest score
awarded for customer satisfaction among data
quality vendors in Customer Relationship
Management magazine, as well as tops in market
share according to Forrester. Harte-Hanks was
chosen by Microsoft as one of its six top vendors,
and its best for customer service, noting that
Harte-Hanks has “come to be regarded as an
indispensable contributor to Microsoft.”

During the year, we celebrated the 25th anniversary of
Forum, our Direct Marketing customer event held both
in New York and in San Francisco. Our 2004 theme was
“Defying Gravity: Customer Growth Under Pressure.”

For our more than 7,000 employees, we launched an
internal Online Learning Center to provide for more
uniform employee training, and a way for professionals
in the company to communicate more easily with
peers across locations using an intranet. The OLC
complements prior continuing employee education
initiatives. We also are in the process of implementing a
newly acquired human capital management system to
aid in numerous workplace management activities.

In 2004, we also developed and posted corporate
governance policies and notices, approved by the
Board of Directors, as we prepared to meet new federal
Sarbanes-Oxley Act financial reporting and New York
Stock Exchange listing requirements. These policies
and notices pertained to audits, business practice,
ethics, executive compensation, nominations to the
Board of Directors and shareholder communication.

R i c h a r d H o c h h a u s e r
P r e s i d e n t & C h i e f E x e c u t i v e O f f i c e r

I k n o w t h e price of succes

Financial Contents

9 Management’s Discussion and Analysis

18 Consolidated Balance Sheets

19 Consolidated Statements of Operations

20 Consolidated Statements of Cash Flows

21 Consolidated Statements of Stockholders’ Equity and Comprehensive Income

22 Notes to Consolidated Financial Statements

32 Report of Independent Registered Public Accounting Firm

on Financial Statements

33 Management’s Report on Internal Control Over Financial Reporting

34 Report of Independent Registered Public Accounting Firm

on Internal Control Over Financial Reporting

35 Five-Year Financial Summary

36 Corporate Information

37 Directors, Officers and Harte-Hanks Offices

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

Overview

Harte-Hanks is a worldwide direct and targeted marketing company that provides direct marketing services and
shopper advertising opportunities to a wide range of local, regional, national and international consumer and
business-to-business marketers. The Company manages its operations through two operating segments: Direct
Marketing and Shoppers.

Harte-Hanks Direct Marketing improves the return on its clients’ marketing investment with a range of services
organized around five solution points: Construct and update the database➝Access the data➝Analyze the
data➝Apply the knowledge➝Execute the programs. The services and software products offered by Direct
Marketing are tailored to specific industries or markets. In 2004, revenue from the Direct Marketing segment
represented 62% of the Company’s total revenue.

Harte-Hanks Shoppers is North America’s largest owner, operator and distributor of shopper publications, based
on weekly circulation and revenues. Shoppers are weekly advertising publications delivered free by Standard
Mail to households and businesses in a particular geographic area. As of December 31, 2004, the Company’s
shoppers are zoned into 952 separate editions with total circulation of more than 11 million in California and
Florida each week. In 2004, revenue from the Shoppers segment represented 38% of the Company’s total
revenue.

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 derives its revenues from the sale of direct marketing services and shopper advertising services. As
a worldwide business, direct marketing is affected by general national and international economic trends.
Shoppers operate in local markets and are largely affected by the strength of the local economies. The Company’s
principal expense items are payroll, postage and transportation.

Results of Operations
Operating results were as follows:

In thousands

Revenues

Operating expenses

Operating income

2004

% Change

2003

% Change

$1,030,461

865,166

$ 165,295

9.1

8.4

12.8

$ 944,576

798,089

$ 146,487

3.9

5.2

-2.5

2002

$ 908,777

758,489

$ 150,288

The Company’s overall 2003 results reflect increased revenue
from its Direct Marketing and Shoppers segments, and an
operating income decrease from the Direct Marketing segment,
partially offset by increased operating income from the
Shoppers segment.

Consolidated revenues increased 9.1%, to $1,030.5 million,
while operating income increased 12.8%, to $165.3 million, in
2004 compared to 2003. Overall operating expenses increased
8.4% to $865.2 million. The Company’s overall results reflect
revenue increases in both its Direct Marketing and Shoppers
segments. Increases in operating income in the Company’s
Direct Marketing and Shoppers segments were partially offset
by increased general corporate operating expenses.

Direct Marketing
Direct Marketing operating results were as follows:

first half of 2003, as the war in Iraq and a sluggish U.S.
economy negatively impacted Direct Marketing’s business.
This slow start was difficult to recover from and is reflected in
the full year 2003 results. Direct Marketing revenues stabilized
in the second quarter of 2003, and this performance was
followed by modest growth in the second half of the year.

From a vertical market perspective, revenues from the high-
tech/telecom vertical had double-digit growth in 2003 compared
to 2002. The company’s select market group also had double-
digit growth for the year over 2002, particularly from the
government/non-profit and manufacturing sectors. Revenues
from the pharmaceutical/healthcare vertical market were flat
in 2003 compared to 2002. Revenues from the retail vertical
market, Direct Marketing’s largest vertical market in terms of
annual revenue, were down compared to 2002. Revenues from
the financial services vertical market were also down in 2003
compared to 2002.

Shoppers
Shoppers operating results were as follows:

increased revenues

From a service-offering perspective, Direct Marketing
experienced
in business-to-business
telesales,
support, consulting projects and
personalized direct mail. These increases were partially offset
by revenue declines in data processing, fulfillment, data sales,
logistics operations and internet services.

technical

Operating expenses increased $18.2 million, or 3.7%, in 2003
compared to 2002. Labor costs increased $4.6 million, as a
result of higher payrolls, due to higher volumes, and higher
healthcare costs. Production and distribution costs increased
$16.7 million, primarily due to higher temporary labor costs and
outsourcing costs. General and administrative expenses
increased $0.1 million, due to an increase in professional
services, partially offset by a decrease in business services.
Depreciation expense decreased $3.2 million, due to lower
capital expenditures in 2002 than in recent prior years.

In thousands

Revenues

Operating expenses

Operating income

2004

$ 641,214

550,358

$ 90,856

% Change

9.6

8.3

18.5

2003

$ 584,804

508,163

$ 76,641

% Change

1.9

3.7

-8.6

2002

$ 573,826

489,954

83,872

In thousands

Revenues

Operating expenses

Operating income

2004

$ 389,247

303,390

$ 85,857

% Change

8.2

7.7

10.1

2003

$ 359,772

281,765

$ 78,007

% Change

7.4

8.2

4.6

2002

$ 334,951

260,387

$ 74,564

Direct Marketing revenues increased $56.4 million, or 9.6%, in
2004 compared to 2003. These results reflect increased revenues
in all of the Company’s vertical markets. Revenues from the
high-tech/telecom and pharmaceutical/healthcare vertical
markets had double-digit growth in 2004 compared to 2003.
Revenues from the financial services vertical market increased
near double-digits in 2004 compared to 2003. Revenues from
the retail vertical market, Direct Marketing’s largest vertical
market in terms of annual revenue, were up in the mid-single
digits. The company’s select markets group also experienced
mid-single digit growth in 2004 over 2003, with the majority of
the growth coming from the manufacturing and business
services industries.

From a service offering perspective, Direct Marketing
experienced increased revenues from customer care, analytics,
software, fulfillment, logistics, targeted mail, telesales and
agency-related business.

The Company has not seen any material change in the
competitive landscape during 2004. Revenues from the
Company’s vertical markets are impacted by the economic
fundamentals of each vertical market as well as the financial
condition of specific customers.

Operating expenses increased $42.2 million, or 8.3%, in 2004
compared to 2003. Labor costs increased $28.7 million, or

11.4%, as a result of increased incentive compensation due to
Direct Marketing’s financial performance, higher payroll
costs due to higher volumes and increased headcount, and
higher unemployment taxes. Labor costs were partially offset
by lower healthcare costs and pension expense. Production and
distribution costs increased $13.1 million, or 6.9%, primarily
due to higher logistics-related transportation costs, outsourcing
costs, and production services expense, which were partially
offset by decreased lease expense. General and administrative
expenses increased $1.8 million, or 4.3%, due to increased
insurance expense, employee expense, and bad debt expense,
partially offset by decreased royalties and professional services.
Depreciation and amortization expense decreased $1.4 million,
or 5.7%, due to lower capital expenditures starting in 2001 and
continuing into 2002 and assets becoming fully depreciated.
Direct Marketing’s largest cost component is labor, and these
costs are primarily variable and tend to fluctuate with revenues
and the demand for the Company’s Direct Marketing services.
Although total Company healthcare costs decreased in 2004,
healthcare costs in general are expected to continue to increase,
and this increase is likely to impact Direct Marketing’s total
labor costs and total operating expenses.

Direct Marketing revenues increased $11.0 million, or 1.9%, in
2003 compared to 2002. Direct Marketing had a challenging

Shoppers revenues increased $29.5 million, or 8.2%, in 2004
compared to 2003. Revenue increases were the result of
improved sales in established markets and geographic
expansions into new neighborhoods in California and Florida.
Total Shoppers circulation increased by approximately 600,000
during 2004 and at December 31, 2004, Shoppers circulation
reached more than 11 million (including 240,000 in South
Orange County, California, where Shoppers publishes two
editions each week). During the year, the Harte-Hanks Shoppers
PennySaver publication in Northern California expanded
circulation by 323,500. The Harte-Hanks Shoppers PennySaver
publication in Southern California increased geographic
coverage by adding 150,000 circulation. The Harte-Hanks
Shoppers publication The Flyer,
located in South Florida,
expanded geographically by 129,500 circulation. The Company
believes
revenue
opportunities and plans to cover an additional circulation of
approximately 1.1 million over the next three years in Northern
California, Southern California and South Florida. Newer areas
initially tend to contribute less from a revenue-per-thousand
perspective than existing areas, and in fact are typically
expected to be less profitable or even unprofitable until the
publications in those areas mature.

that expansions provide

increased

From a product-line perspective, Shoppers had growth in both
run-of-press (ROP, or in-book) advertising, and its distribution

products. These increases were partially offset by decreased
coupon book revenues.

Shoppers operating expenses rose $21.6 million, or 7.7%, in
2004 compared to 2003. Labor costs increased $6.3 million, or
6.2%, due to higher payroll costs as a result of higher volumes
and circulation expansions, and higher unemployment taxes,
partially offset by lower pension and health care expense.
Production costs increased $13.8 million, or 9.6%, including
additional postage of $6.6 million due to increased volumes,
and increased paper costs due to increased volumes and rates.
General and administrative costs increased $1.4 million, or
4.4%, due to increased business services and bad debt expense,
partially offset by decreased promotion expense. Depreciation
expense increased $0.1 million, or 2.3%, due to new capital
investments to support future growth. Shoppers’ largest cost
components are labor, postage and paper. Shoppers’ labor costs
are variable and tend to fluctuate with the number of zones,
circulation, volumes and revenues. Although total Company
healthcare costs decreased in 2004, healthcare costs in general
are expected to continue to increase, and this increase is likely
to impact Shoppers’ total labor costs and total operating
expenses. Standard postage rates have been unchanged since the
beginning of the third quarter of 2002, and it is anticipated that
the next increase in postage rates will occur in 2006. Increased
postage rates would impact Shoppers’ total production costs.

Newsprint prices increased throughout 2004 and are expected to
continue to increase in 2005, which will impact Shoppers’ total
production costs in 2005 and 2006.

Shoppers revenues increased $24.8 million, or 7.4%, in 2003
compared to 2002. Revenue increases were the result of
improved sales in established markets, geographic expansions
into new neighborhoods, household growth in existing
neighborhoods in California and Florida, and the once every six
year occurrence of one extra publication week in 2003. Total
Shoppers circulation increased by approximately 485,000
during 2003, and at December 31, 2003, Shoppers circulation
reached approximately 10.5 million (including 220,000 in South
Orange County, California, where Shoppers publishes two
editions each week).

From a product-line perspective, Shoppers had growth in both
ROP advertising, primarily core sales and real estate-related
advertising, and its distribution products. These increases
were partially offset by declines in automotive-related ROP
advertising and decreased coupon book revenues.

Excluding the extra publication week mentioned above,
Shoppers revenue increased 6.0% over 2002.

Shoppers operating expenses rose $21.4 million, or 8.2%, in
2003 compared to 2002. Labor costs increased $7.3 million, due
to increased staff, higher volumes and higher benefit costs.
Production costs increased $9.9 million, including additional
postage of $5.2 million, due to higher postage rates in the first
half of 2003 than in the first half of 2002, and increased
volumes for the full year. General and administrative costs
increased $3.7 million, due to increased insurance costs
(including workers’ compensation), promotion costs and bad
debt expense. Depreciation expense increased $0.5 million, due
to new capital investments to support future growth. Shoppers
operating expenses were also affected by the move into the new
facility in Northern California and the once every six year
occurrence of one extra publication week in 2003.

General Corporate Expense
General corporate operating expense increased $3.3 million, or
39.9%, to $11.4 million in 2004 compared to 2003. The increase
in general corporate expense in 2004 was primarily a result
of increased incentive compensation due to the Company’s
financial performance and increased professional services.

Interest Expense/Interest Income
Interest expense increased $0.2 million in 2004 over 2003, due
primarily to higher interest rates. Interest expense decreased
$0.4 million in 2003 over 2002, primarily due to lower
outstanding debt levels of the Company’s revolving credit
facilities. The decrease in interest expense in 2003 was also a
result of lower rates in 2003 compared to 2002. The Company’s
debt at December 31, 2004 and 2003 is described in Note C of
the “Notes to Consolidated Financial Statements,” included
herein.

Interest income increased $0.2 million in 2004 compared to
2003, primarily due to interest related to a tax refund the
Company received in the first quarter of 2004. Interest income
decreased $0.1 million in 2003 compared to 2002, primarily due
to lower interest rates and lower average investment balances in
2003 compared to 2002.

Other Income and Expense
Other net expense for 2004 and 2003 primarily consists of
balance-based bank charges and stockholders expenses.

Income Taxes
Income taxes increased $8.9 million in 2004 and decreased
$0.1 million in 2003, primarily due to the respective changes in
income levels. The effective income tax rate was 40.1%, 39.3%
and 38.4% in 2004, 2003 and 2002, respectively. The effective
income tax rate calculated is higher than the federal statutory
rate of 35%, due to the addition of state taxes.

Acquisitions
As described in Note B of the “Notes to Consolidated Financial
Statements” included herein, the Company made three
acquisitions in 2004.

In December 2004, the Company acquired Postfuture, Inc., an
e-mail service provider located in Richardson, Texas, that
provides both e-mail technology and services, among them a
platform that automates campaign and transactional e-mail
delivery to support e-commerce, customer service, event
communication and lead nurturing. Postfuture’s offerings are
being integrated into several existing Harte-Hanks solution
offerings, including Allink on Demand®, CI Technology
Database and Allink Agent®, among others.

In April 2004, Harte-Hanks acquired Dollar Saver, a local
shopper publication in the fast-growing Hemet area in Southern
California, and converted it to the PennySaver brand.

In February 2004, Harte-Hanks acquired Avellino Technologies
Ltd., a leading provider of data profiling technology. Harte-
Hanks has integrated Trillium Software System® and the
Avellino Discovery software solution. Joining these two
solutions allows organizations to take advantage, for the first
time, of a single solutions provider to define, assess, improve
and monitor the utility of data for their business processes.
Harte-Hanks still offers Trillium Software and Avellino
Discovery as stand-alone products as well as an integrated
solution within the Trillium Software System. Founded in 1997,
Avellino Technologies Ltd. is located in Aldermaston, UK.

The Company did not make any acquisitions in 2003 or 2002.

Liquidity and Capital Resources
Cash provided by operating activities for 2004 was $153.3
million, a $29.3 million increase compared to 2003. The
increase in 2004 primarily relates to an increase in net income
and an increase in other accrued expenses, income taxes and
payroll at December 31, 2004 over December 31, 2003. In

addition, the Company made a $12.6 million pension plan
funding payment in 2003.

Net cash outflows from investing activities were $64.6 million
for 2004, compared to net cash outflows of $31.6 million in
2003. The increase in 2004 primarily relates to a higher amount
spent on acquisitions and capital investments in 2004 than
in 2003.

Net cash used in investing activities for 2004 included
$35.1 million for capital expenditures and $29.7 million for
acquisitions. The Direct Marketing segment’s capital
expenditures consisted primarily of product development and
enhancement, additional computer capacity, computer and
communication systems and equipment upgrades. The Shoppers
segment’s capital expenditures were primarily related to the
Southern California color capacity expansion, common system
software, additional computers and other production equipment.
$28.0 million of the acquisition-related payments were made in
the Direct Marketing segment, and the remaining $1.7 million
were made in the Shoppers segment.

Net cash used in investing activities for 2003 included $31.9
million for capital expenditures and $0.3 million for acquisition-
related payments. The capital expenditures consisted
primarily of product development and enhancement, additional
computer capacity, systems, new press equipment and
equipment upgrades for the Direct Marketing segment. The
Shoppers segment’s capital expenditures were primarily related
to the Northern California facility expansion, common system

software, additional computers and other production equipment.
The acquisition-related payments, which all relate
to
acquisitions completed prior to 2003, were made in the Direct
Marketing segment.

Net cash outflows from financing activities in 2004 were $82.1
million, compared to $85.3 million in 2003. The decrease in
2004 primarily relates to $5.0 million net borrowings compared
to $11.3 million net repayment of debt in 2003. This was
partially offset by a higher amount spent repurchasing stock in
2004 than in 2003.

Capital resources are available from, and provided through, the
Company’s unsecured credit facility. This credit facility, a three-
year $125 million variable rate revolving loan commitment, was
put in place on October 18, 2002. All borrowings under this
credit agreement are to be repaid by October 17, 2005. The
Company intends to secure new financing prior to this date.

Management considers such factors as current assets, current
liabilities, total debt, revenues, operating income and cash flows
from operations, investing activities and financing activities
when assessing the Company’s liquidity.

Management believes that its credit facility, together with cash
provided by operating activities, will be sufficient to fund
operations and anticipated acquisitions, stock repurchases,
capital expenditures and dividends for the foreseeable future.
As of December 31, 2004, the Company had $115.0 million of
unused borrowing capacity under its credit facility.

The Company’s contractual obligations at December 31, 2004 are as follows:

In thousands

Total

2005

2006

2007

2008

2009

Thereafter

Debt....................................................

$ 10,000

—

$ —

—

Operating leases ................................

88,002

22,372

17,359

14,260

9,968

7,322

Deferred compensation liability ..........

Other long-term obligations ..............

6,820

8,052

650

3,708

650

2,832

650

1,506

623

600

16,721

3,647

—

Total contractual cash obligations ......

$ 112,874

$ 36,730

$ 20,841

$ 16,416

$ 10,595

$ 7,924

$ 20,368

At December 31, 2004, the Company had outstanding letters of
credit in the amount of $20.3 million. These letters of credit
renew annually and exist to support the Company’s insurance
programs relating to workers’ compensation, automobile and
general liability, and leases. The Company had no other off-
balance sheet arrangements at December 31, 2004.

The company paid a quarterly dividend of $0.04 per common
share and $0.03 per common share in each of the quarters in the
years ended December 31, 2004 and 2003, respectively.

During 2004 the Company repurchased approximately 3.6
million shares of its common stock for $85.7 million under its
stock repurchase program. In addition, the Company received
approximately 0.2 million shares of its common stock, with an

estimated market value of $4.3 million, in exchange for
proceeds related to stock option exercises. As of December 31,
2004, the Company has repurchased approximately 39.3 million
shares since the beginning of its stock repurchase program in
January 1997. During this period the Company has also received
approximately 1.3 million shares in exchange for proceeds
related to stock option exercises. Under this program, the
Company had authorization to repurchase approximately 5.6
million additional shares at December 31, 2004.

Critical Accounting Policies
Financial Reporting Release No. 60, released by the Securities
and Exchange Commission, requires all companies 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.

The Company’s accounting policy for revenue recognition has
an impact on its reported results and relies on certain estimates
that require judgments on the part of management. The portion
of the Company’s revenue that is most subject to estimates
and judgments is revenue recognized using the percentage-of-
completion method, as discussed below.

Specifically, Direct Marketing revenue from certain projects
and certain services such as database build services, internet
web design, market research and analytical services may be
billed at 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. Management estimates and
judgments are used in connection with the revenue recognized
in these instances. Should actual costs differ significantly from
the original estimated costs, the timing of revenues and overall
profitability of the contract could be impacted. Contracts
accounted for under the percentage-of-completion method
comprised less than 7% of total Direct Marketing revenue and
less than 5% of total Harte-Hanks revenue for the years ended
December 31, 2004, 2003 and 2002.

For all sales the Company requires either a purchase order, a
statement of work signed by the customer, a written contract, or
some other form of written authorization from the customer.

Direct Marketing revenue is derived from a variety of services.
Revenue from services such as creative and graphics, printing,
personalization of communication pieces using laser and
inkjet printing, targeted mail, fulfillment, agency services
and transportation logistics are recognized as the work is
performed. Revenue is typically based on a set price or rate
given to the customer.

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 at 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, software licenses with undelivered post-contract
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
equal 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.

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 arrangement. 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.

Shoppers services are considered rendered, and the revenue
recognized, when all printing, sorting, labeling and ancillary
services have been provided and the mailing material has been
received by the United States Postal Service.

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 $3.0 million, $1.6
million and $1.2 million for the years ended December 31,
2004, 2003 and 2002, respectively. While the Company believes
its reserve estimate to be appropriate, the Company may find
it necessary to adjust its allowance for doubtful accounts if
future bad debt expense exceeds the estimated reserve. Given
the significance of accounts receivable to the Company’s
consolidated financial statements, the determination of net
realizable values is considered to be a critical accounting
estimate.

Reserve for Healthcare, Workers’ Compensation,
Automobile and General Liability
The Company has a $150,000 deductible for individual
healthcare claims, with an aggregate claims deductible of 125%
of the expected claims for a given year. The Company has a
$250,000 deductible for automobile and general liability claims.
The Company’s deductible for workers’ compensation
decreased from $1.0 million to $500,000 in October 2003.
Management makes various subjective judgments about a
number of factors in determining the Company’s reserve for
healthcare, workers’ compensation, automobile and general
liability insurance, and the related expense. If ultimate losses
were 10% higher than the Company’s estimate at December 31,
2004, earnings would be impacted by up to $815,000, net of
taxes. The amount that earnings would be impacted is dependent
on the claim year and the Company’s deductible levels for that
plan year. 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 to the extent that the purchase price
exceeds the fair value of the assets acquired in accordance with
Statement of Financial Accounting Standards (SFAS) No. 142.
Prior to the adoption of SFAS No. 142 on January 1, 2002,
goodwill was being amortized on a straight-line basis over 15 to
40 year periods. Beginning January 1, 2002, goodwill is no
longer being amortized, but instead is tested for impairment as
discussed below.

The Company assesses the impairment of its goodwill in
accordance with SFAS No. 142, by determining the fair value of
each of its reporting units and comparing the fair value to the
carrying value for each reporting unit. The Company has
identified its reporting units as Direct Marketing and Shoppers.
Fair value is determined using projected discounted future cash
flows and cash flow multiple models, based on historical
performance and management’s estimate of future performance,
giving consideration to existing and anticipated competitive and
economic conditions. If a reporting unit’s carrying amount
exceeds its fair value, the Company must calculate the implied
fair value of the reporting unit’s goodwill 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, and then compare this implied fair
value to its carrying amount. To the extent that the carrying
amount of goodwill exceeds its implied fair value, an
impairment loss is recorded.

Both the Direct Marketing and Shoppers segments are tested for
impairment as of November 30 of each year, after the annual
forecasting process for the upcoming fiscal year has been
completed. The Company has not recorded an impairment loss
in any of the three years ended December 31, 2004. Significant
estimates utilized in the Company’s discounted cash flow model
include weighted average cost of capital and the long-term rate
of growth for each of the Company’s reporting segments. These
estimates require management’s judgment. Any significant
changes in key assumptions about the Company’s businesses
and their prospects, or changes in market conditions, could have
an impact on this annual analysis.

At December 31, 2004 and 2003, the Company’s goodwill
balance was $458.2 million, net of $82.0 million of accumulated
amortization, and $437.2 million, net of $82.0 million of
accumulated amortization, respectively. Based upon the
Company’s analysis, the estimated fair values of the Company’s
reporting units as of December 31, 2004 was well in excess of
the reporting units’ carrying values.

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; however, the risks
described below 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.

International Operations
Harte-Hanks Direct Marketing conducts business outside of
the United States. During 2004, approximately 8.8% of Harte-
Hanks Direct Marketing’s revenues was derived from business
outside the United States. Accordingly, the Company’s future
operating results could be negatively affected by a variety of
factors, some of which are beyond its control. In addition,
exchange rate movements may have an impact on the
Company’s future costs or on future cash flows from foreign
investments. The Company has not entered into any foreign
currency forward exchange contracts or other derivative
instruments to hedge the effects of adverse fluctuations in
foreign currency exchange rates. Additional risks inherent in
the Company’s non-U.S. business activities generally include,
among others, potentially longer accounts receivable payment
cycles, the costs and difficulties of managing international
operations, potentially adverse tax consequences, and greater
difficulty enforcing intellectual property rights. The various
risks that are inherent in doing business in the United States are
also generally applicable to doing business outside of the
United States, and may be exaggerated by the difficulty of
doing business in numerous sovereign jurisdictions due to
differences in culture, laws and regulations.

War
War and/or terrorism or the threat of war and/or terrorism
involving the United States could have a significant impact on
the Company’s operations. War or the threat of war could
substantially affect the levels of advertising expenditures by
clients in each of the Company’s businesses. In addition, each
of the Company’s businesses could be affected by operation
disruptions and a shortage of supplies and labor related to such
a war or threat of war.

Legislation, Judicial Interpretations,
Consumer Environment
There could be a material adverse impact on the Company’s
business due to the enactment of legislation or industry
regulations, the issuance of judicial interpretations, or simply a
change in customs, arising from public concern over consumer
privacy issues. Restrictions could be placed upon the collection,
management, aggregation and use of information that is legally
available, which could result in a material increase in the cost of
collecting some kinds of data. It is also possible that we could
be prohibited from collecting or disseminating certain types of
data, which could in turn materially adversely affect our ability
to meet our clients’ requirements.

Data Suppliers
There could be a material adverse impact on the Company’s
Direct 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 additional
legislation is passed restricting the use of the data.

Acquisitions
The Company continues to pursue 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 would
be achieved. The Company believes that it will be able to
successfully integrate recently acquired businesses into existing
operations, but there is no certainty that future acquisitions
will be consummated on acceptable terms or that any acquired
assets, data or businesses will be successfully integrated into the
Company’s operations. The failure to identify appropriate
candidates, to negotiate favorable terms, or to successfully
integrate future acquisitions into existing operations could result
in decreased revenues, net income and earnings per share.

Competition
Direct 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
Marketing business faces competition in all of its offerings and
within each of its vertical markets. The Company’s Shoppers
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, other communications media and other
advertising printers 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 to continually 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 administrative personnel.
While dependent on employment levels and general economic
conditions, qualified personnel historically have been in great
demand and from time to time and in the foreseeable future will
likely remain a limited resource.

Postal Rates
The Company’s Shoppers and Direct Marketing services depend
on the United States Postal Service 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. Standard postage rates have been
unchanged since the beginning of the third quarter of 2002, and
it is anticipated the next increase in postage rates will occur in
2006. Overall Shoppers postage costs are expected to grow as a
result of anticipated increases in circulation and insert volumes.
Postal rates also influence the demand for the Company’s Direct
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
Shoppers operations. In recent years newsprint prices have
fluctuated widely, and such fluctuations can materially affect the
results of the Company’s operations.

Economic Conditions
Changes in national economic conditions can affect levels of
advertising expenditures generally, and such changes can affect
each of the Company’s businesses. In addition, revenues from
the Company’s Shoppers 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
Marketing revenues are dependent on national and international
economies.

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 interest related to the Company’s $125 million
credit facility. The Company also has exposure to interest rate
fluctuations in the United States, specifically money market,
commercial paper and overnight time deposit rates as these
affect the Company’s earnings on its excess cash.

Harte-Hanks, Inc. and Subsidiaries Consolidated Balance Sheets

Harte-Hanks, Inc. and Subsidiaries Consolidated Statements of Operations

In thousands, except per share and share amounts

ASSETS
Current assets

Cash and cash equivalents ................................................................................................
Accounts receivable (less allowance for doubtful accounts of $1,892

in 2004 and $1,240 in 2003)....................................................................................
Inventory ..........................................................................................................................
Prepaid expenses ..............................................................................................................
Deferred income tax asset ................................................................................................
Other current assets ..........................................................................................................
Total current assets ..................................................................................................

Property, plant and equipment

Land ................................................................................................................................
Buildings and improvements ............................................................................................
Software ............................................................................................................................
Equipment and furniture ....................................................................................................

Less accumulated depreciation and amortization ..............................................................

Software development and equipment installations in progress ......................................
Net property, plant and equipment ..........................................................................

Intangible and other assets

Goodwill (less accumulated amortization of $81,973 in 2004

December 31,

2004

2003

$ 38,807

$ 32,151

168,755
6,086
16,664
13,812
6,373
250,497

3,463
37,312
76,347
190,522
307,644
(204,669)
102,975
10,795
113,770

152,703
5,213
13,816
7,682
5,732
217,297

3,423
36,817
62,955
183,744
286,939
(194,987)
91,952
5,795
97,747

In thousands, except per share amounts

Revenues ........................................................................................................
Operating expenses

Payroll........................................................................................................
Production and distribution ......................................................................
Advertising, selling, general and administrative ........................................
Depreciation ..............................................................................................
Intangible amortization ..............................................................................
Total operating expenses ..................................................................
Operating income ............................................................................................
Other expenses (income)

Interest expense ........................................................................................
Interest income ..........................................................................................
Other, net ..................................................................................................

Income before income taxes ............................................................................
Income tax expense..........................................................................................
Net income ......................................................................................................

Basic earnings per common share ..................................................................

Weighted-average common shares outstanding........................................

Diluted earnings per common share ................................................................

Weighted-average common and common equivalent

Year Ended December 31,

2004

2003

2002

$ 1,030,461

$ 944,576

$ 908,777

394,417
361,298
80,682
28,169
600
865,166
165,295

1,020
(341)
1,648
2,327
162,968
65,400
97,568

1.13

86,169

1.11

357,811
334,359
75,886
29,433
600
798,089
146,487

855
(168)
1,895
2,582
143,905
56,543
$ 87,362

0.99

88,541

0.97

340,703
311,540
73,518
32,128
600
758,489
150,288

1,208
(274)
2,004
2,938
147,350
56,605
$ 90,745

0.98

92,648

0.96

and 2003) ................................................................................................................

458,171

437,156

shares outstanding ..........................................................................

87,806

89,982

94,872

See Notes to Consolidated Financial Statements.

Other intangible assets (less accumulated amortization of $2,933

in 2004 and $2,333 in 2003)....................................................................................
Other assets ......................................................................................................................
Total intangible and other assets ..............................................................................
Total assets ..............................................................................................................

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities

Current maturities of long-term debt ................................................................................
Accounts payable ..............................................................................................................
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 $48,201

in 2004 and $35,853 in 2003) ..........................................................................................
Total liabilities ..........................................................................................................

Stockholders’ equity

Common stock, $1 par value, authorized: 250,000,000 shares

Issued 2004: 114,505,329; issued 2003: 113,280,794 shares ................................
Additional paid-in capital ..................................................................................................
Retained earnings ..............................................................................................................
Less treasury stock, 2004: 29,524,064; 2003: 25,788,502 shares at cost........................
Accumulated other comprehensive loss ............................................................................
Total stockholders’ equity ........................................................................................
Total liabilities and stockholders’ equity ..................................................................

2,067
3,848
464,086
$ 828,353

$ 10,000
55,632
36,539
53,707
17,239
9,075
182,192

—

74,362
256,554

114,505
253,515
882,750
(663,779)
(15,192)
571,799
$ 828,353

2,667
4,263
444,086
$ 759,130

—
47,891
22,808
48,658
7,776
6,939
134,072

5,000

64,460
203,532

113,281
235,996
798,974
(573,863)
(18,790)
555,598
$ 759,130

See Notes to Consolidated Financial Statements.

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

Harte-Hanks, Inc. and Subsidiaries Consolidated Statements of

Stockholders’ Equity and Comprehensive Income

Year Ended December 31,

2004

2003

2002

$ 97,568

$ 87,362

$ 90,745

In thousands

Common
Stock

Additional
Paid-in
Capital

Retained
Earnings

Treasury
Stock

2003

Accumulated
Other
Comprehensive
Income (Loss)

Total
Stockholders’
Equity

In thousands

Cash Flows from Operating Activities

Net income ................................................................................................
Adjustments to reconcile net income to net
cash provided by operations:

Depreciation ............................................................................
Intangible amortization ............................................................
Amortization of option-related compensation ..........................
Deferred income taxes..............................................................
Other, net..................................................................................

Changes in operating assets and liabilities,

net of effects from acquisitions and divestitures:

(Increase) decrease in accounts receivable, net ......................
(Increase) decrease in inventory ..............................................
(Increase) decrease in prepaid expenses and other

current assets ......................................................................
Increase (decrease) in accounts payable..................................
Increase in other accrued expenses and other liabilities ..........
Other, net..................................................................................
Net cash provided by operating activities ........................

Cash Flows from Investing Activities

Acquisitions ..............................................................................................
Purchases of property, plant and equipment ............................................
Proceeds from the sale of property, plant and equipment ........................
Net cash used in investing activities ................................

Cash Flows from Financing Activities

Long-term borrowings ..............................................................................
Payments on debt ......................................................................................
Issuance of common stock........................................................................
Issuance of treasury stock ........................................................................
Purchase of treasury stock ........................................................................
Dividends paid ..........................................................................................
Net cash used in financing activities ................................

28,169
600
101
6,963
534

(14,215)
(873)

(3,233)
7,442
26,232
4,029
153,317

(29,705)
(35,146)
268
(64,583)

55,000
(50,000)
12,287
165
(85,738)
(13,792)
(82,078)

Net increase (decrease) in cash and cash equivalents......................................
Cash and cash equivalents at beginning of year ..............................................
Cash and cash equivalents at end of year ........................................................

6,656
32,151
$ 38,807

See Notes to Consolidated Financial Statements.

29,433
600
100
12,047
379

(15,024)
86

2,931
7,145
7,186
(8,181)
124,064

(343)
(31,915)
621
(31,637)

45,000
(56,300)
12,885
125
(76,393)
(10,619)
(85,302)

7,125
25,026
$ 32,151

32,128
600
99
8,878
741

730
536

(2,762)
(2,244)
8,884
3,302
141,637

(3,791)
(17,358)
439
(20,710)

34,000
(66,531)
14,113
110
(98,912)
(9,149)
(126,369)

(5,442)
30,468
$ 25,026

Balance at January 1, 2002 ....................................

$109,352

$188,158

$640,635

$(384,486)

$ (1,293)

$552,366

Common stock issued—employee benefit plans....
Exercise of stock options for cash and by

surrender of shares..........................................
Tax benefit of options exercised..............................
Dividends paid ($0.098 per share) ........................
Treasury stock issued ............................................
Treasury stock repurchased....................................
Comprehensive income, net of tax:

Net income ......................................................
Adjustment for minimum pension liability

(net of tax of $17,121)............................
Foreign currency translation adjustment..........
Total comprehensive income ..................................

202

3,131

—

2,282
—
—
—
(301)

—

—
—

13,787
10,765
—
7
301

—

—
—

—
—
(9,149)
—
—

90,745

—
—

(8,498)
—
—
103
(98,912)

—

—
—

—

—
—
—
—
—

—

(26,169)
1,873

3,333

7,571
10,765
(9,149)
110
(98,912)

90,745

(26,169)
1,873
66,449

Balance at December 31, 2002 ..............................

$111,535

$216,149

$722,231

$(491,793)

$(25,589)

$532,533

Common stock issued—employee benefit plans....
Exercise of stock options for cash and by

surrender of shares..........................................
Tax benefit of options exercised..............................
Dividends paid ($0.12 per share) ..........................
Treasury stock issued ............................................
Treasury stock repurchased....................................
Comprehensive income, net of tax:

Net income ......................................................
Adjustment for minimum pension liability

(net of tax of $2,652)..............................
Foreign currency translation adjustment..........
Total comprehensive income ..................................

213

3,199

—

1,533
—
—
—
—

—

—
—

10,392
6,282
—
(26)
—

—

—
—

—
—
(10,619)
—
—

87,362

—
—

(5,828)
—
—
151
(76,393)

—

—
—

—

—
—
—
—
—

—

4,053
2,746

3,412

6,097
6,282
(10,619)
125
(76,393)

87,362

4,053
2,746
94,161

Balance at December 31, 2003......................

$113,281

$235,996

$798,974

$(573,863)

$(18,790)

$555,598

Common stock issued—employee benefit plans
Exercise of stock options for cash and by

surrender of shares ..............................
Tax benefit of options exercised ....................
Dividends paid ($0.16 per share) ..................
Treasury stock issued ................................
Treasury stock repurchased ..........................
Comprehensive income, net of tax:

Net income ........................................
Adjustment for minimum pension liability

(net of tax of $1,519)......................
Foreign currency translation adjustment ....
Total comprehensive income ........................

175

3,347

—

1,049
—
—
—
—

—

—
—

10,345
3,818
—
9
—

—

—
—

—
—
(13,792)
—
—

97,568

—
—

(4,334)
—
—
156
(85,738)

—

—
—

—

—
—
—
—
—

—

2,322
1,276

3,522

7,060
3,818
(13,792)
165
(85,738)

97,568

2,322
1,276
101,166

Balance at December 31, 2004......................

$114,505

$253,515

$882,750

$(663,779)

$(15,192)

$571,799

See Notes to Consolidated Financial Statements.

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
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.

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 $3.0 million, $1.6
million and $1.2 million for the years ended December 31,
2004, 2003 and 2002, 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 is recorded to the extent that the purchase price
exceeds the fair value of the assets acquired in accordance
with Statement of Financial Accounting Standards (SFAS)
No. 142, “Goodwill and Other Intangible Assets.” Prior to the
adoption of SFAS No. 142 on January 1, 2002, goodwill was
being amortized on a straight-line basis over 15 to 40 year
periods. Beginning January 1, 2002, goodwill is no longer
being amortized, but instead is tested for impairment as
discussed below.

Both the Direct Marketing and Shoppers segments are tested for
impairment as of November 30 of each year, after the annual
forecasting process for the upcoming fiscal year has been
completed. Based on the results of the Company’s impairment
test, the Company has not recorded an impairment loss in any of
the three years ended December 31, 2004.

The changes in the carrying amount of goodwill for the year
ended December 31, 2004, are as follows:

In thousands,
except per share amounts

Direct

Marketing Shoppers

Total

Balance at

December 31, 2003 .............. $ 312,810 $124,346 $437,156

Additional purchase

consideration........................

19,430

1,585

21,015

Balance at

December 31, 2004 .............. $ 332,240 $125,931 $458,171

As of December 31, 2004 and 2003, the Company does not have
any intangibles with indefinite useful lives other than goodwill.

Other intangibles with definite useful lives are recorded on
the basis of cost in accordance with SFAS No. 142 and are
amortized on a straight-line basis over a period of 5 to 10 years.
The Company assesses the recoverability of its other intangibles
with definite lives 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, 2004 and 2003, all of the Company’s other
intangibles with definite useful lives are related to the
Company’s Direct Marketing segment. At December 31, 2004
and 2003, the balance of other intangibles was $2.1 million, net
of $2.9 million of accumulated amortization, and $2.7 million,
net of $2.3 million of accumulated amortization. Amortization
expense related to other intangibles with definite useful lives
was $0.6 million for each of the years in the three year period
ended December 31, 2004. Expected amortization expense is
$0.6 million for the year ending December 31, 2005, $0.4
million for the years ending December 31, 2006, 2007 and
2008, and $0.3 million for the year ending December 31, 2009.

Income Taxes
Income taxes are calculated using the asset and liability
method required by SFAS No. 109. Deferred income taxes are
recognized for the tax consequences resulting from “timing
differences” by applying enacted statutory tax rates applicable
to future years. These “timing differences” are associated with
differences between the financial and the tax basis of existing
assets and liabilities. Under SFAS No. 109, a statutory change
in tax rates will be recognized immediately in deferred taxes
and income.

Earnings Per Share
Basic earnings per common share are based upon the weighted-
average number of common shares outstanding. Diluted
earnings per common share are based upon the weighted-
average number of common shares outstanding and dilutive
common stock equivalents from the assumed exercise of stock
options using the treasury stock method.

Stock-Based Compensation
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
determined based on the fair value at the grant date for awards
since January 1, 1995, consistent with the provisions of SFAS
No. 123, the Company’s net income and diluted earnings per
share would have been reduced to the pro forma amounts
indicated below:

Year Ended December 31,

In thousands,
except per share amounts

2004

2003

2002

Net income—as reported ...... $ 97,568
Stock-based employee

$ 87,362

$ 90,745

compensation expense,
included in reported net
income, net of related
tax effects ..........................

Stock-based employee

compensation expense
determined under fair
value based methods
for all awards, net of
related tax effects ..............

(3,798)
Net income—pro forma ........ $ 93,831
Basic earnings per share—

(3,899)
$ 83,524

(4,411)
$ 86,395

as reported ........................ $

1.13

Basic earnings per share—

pro forma .......................... $

1.09

Diluted earnings per share—

as reported ........................ $

1.11

Diluted earnings per share—

pro forma .......................... $

1.07

0.99

0.94

0.97

0.93

0.98

0.93

0.96

0.91

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
2004, 2003 and 2002:

Year Ended December 31,

2004

2003

2002

Expected dividend yield............

0.7%

0.6%

0.5%

Expected stock price

volatility................................

Risk free interest rate ..............

26.3%

3.8%

27.2%

3.6%

27.8%

5.4%

Expected life of options............ 3-10 years 3-10 years 3-10 years

Direct 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 determined that it has
Company-specific objective evidence of fair value to allocate
revenue to the license and post-contract customer support (PCS)
component of its software license arrangements. 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 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 Healthcare, Workers’ Compensation,
Automobile and General Liability
The Company has a $150,000 deductible for individual
healthcare claims with an aggregate claims deductible of 125%
of the expected claims for a given year. The Company has a
$250,000 deductible for automobile and general liability claims.
The Company’s deductible for workers’ compensation
decreased from $1.0 million to $500,000 in October 2003. The
Company’s insurance administrator provides the Company with
estimated loss reserves, based upon its experience dealing with
similar types of claims, as well as amounts paid to date against
these claims. The Company applies actuarial factors to both
insurance estimated loss reserves and to paid claims and then
determines
these
calculations. 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.

into account

reserve

levels,

taking

Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards
Board (FAS) revised SFAS No. 123, “Accounting for Stock-
Based Compensation.” SFAS No. 123 focuses primarily on
accounting for transactions in which an entity obtains employee

services in exchange for share-based payment transactions. This
revised Statement requires public entities to measure the cost of
employee services received in exchange for an award of equity
instruments based on the grant-date fair value of the award.
That cost is then recognized over the period during which an
employee is required to provide service in exchange for the
award—the requisite service period (typically the vesting
period). No compensation cost is recognized for equity
instruments for which employees do not render the requisite
service. The grant-date fair value of employee share options and
similar instruments is to be estimated using option-pricing
models adjusted for the unique characteristics of those
instruments. This revised Statement supercedes APB Opinion
No. 25, “Accounting for Stock Issued to Employees,” and
eliminates the alternative to use the intrinsic value method of
accounting prescribed by APB No. 25. Under APB No. 25,
issuing stock options to employees with an exercise price equal
to the market price on the date of grant generally resulted in
recognition of no compensation cost. SFAS No. 123, as revised,
is effective for interim periods beginning after June 15, 2005.
The Company currently follows the disclosure-only provisions
of SFAS No. 123 as originally issued, and accordingly no
compensation expense has been recognized in the financial
statements for options granted where the exercise price is equal
to the market price of the underlying stock at the date of grant.
The adoption of SFAS No. 123, as revised, in the Company’s
third fiscal quarter of 2005 will have an impact on the
Company’s financial position and results of operations, but at
this time the Company has not determined that impact.

In December 2004, the Financial Accounting Standards Board
issued Staff Positions 109-1 (FAS 109-1) and 109-2 (FAS 109-
2). FAS 109-1, “Application of FASB Statement No. 109,
‘Accounting for Income Taxes,’ to the Tax Deduction on
Qualified Production Activities provided by the American Jobs
Creation Act of 2004,” gives guidance on applying FASB 109 to
the tax deduction on qualified production activities provided by
the Act. FAS 109-2, “Accounting and Disclosure Guidance for
the Foreign Earnings Repatriation Provision within the
American Jobs Creation Act of 2004,” gives guidance on the
Act’s repatriation provision. The Company is in the process of
determining the impact the American Jobs Creation Act of 2004
and the guidance from FAS 109-1 and FAS 109-2 will have on
the Company’s financial position and results of operations.

In November 2004, the Financial Accounting Standards
Board (FAS) issued SFAS No. 151, “Inventory Costs.” This
Statement amended the guidance in Accounting Research
Bulletin (ARB) No. 43, Chapter 4, “Inventory Pricing,” to
clarify the accounting for abnormal amounts of idle facility
expense, freight, handling costs and wasted material (spoilage).
ARB 43 previously required that such items be treated as
current period charges only if they were considered abnormal.
SFAS No. 151 requires that those items be recognized as
current-period charges regardless of whether they meet the
criteria for abnormal. In addition, this Statement requires the
allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production

facilities. SFAS No. 151 is effective for inventory costs incurred
during fiscal years beginning after June 15, 2005. The adoption
of SFAS No. 151 for the fiscal year beginning January 1, 2005
is not expected to have a material impact on the Company’s
financial position or results of operations.

Note B — Acquisitions
In December 2004, the Company acquired Postfuture, Inc., an
e-mail service provider that provides both e-mail technology
and services.

In April 2004, Harte-Hanks acquired Dollar Saver, a local
shopper publication in the Hemet area in Southern California.

In February 2004, the Company acquired Avellino Technologies
Ltd., a leading provider of data profiling technology.

The total cash outlay in 2004 related to acquisitions was
$29.7 million. The total cash outlay in 2003 for acquisitions was
$0.3 million. The total cash outlay in 2002 for acquisitions was
$3.8 million.

Goodwill recognized in 2004 acquisitions totaled $21.6 million,
$20.0 million of which was assigned to the Direct Marketing
segment. The remaining $1.6 million was assigned to the
Shoppers segment.

The operating results of the acquired companies have been
included
the accompanying Consolidated Financial
Statements from the date of acquisition under the purchase
method of accounting. The Company has not disclosed pro
forma amounts including the operating results of prior years’
acquisitions as they are not considered material to the Company
as a whole.

Note C — Long-Term Debt
Cash payments for interest were $1.0 million, $0.9 million, and
$1.3 million for the years ended December 31, 2004, 2003 and
2002, respectively.

December 31,

In thousands

2004

2003

facility contains both affirmative and negative covenants, the
most significant of which are that the Company’s leverage ratio,
as defined in the credit facility, must not exceed 3.00 to 1.00,
and that the Company’s interest coverage ratio, as defined,
cannot be less than 2.75 to 1.00. If the Company were not in
compliance with any of these affirmative or negative covenants,
a default would occur and the lenders could terminate their
commitments under the credit facility and declare all
outstanding borrowings, interest and fees due. The Company
has been in compliance with all covenants since obtaining the
credit facility. The credit facility does not contain any cross-
default provisions.

Note D — Income Taxes
The components of income tax expense (benefit) are as follows:

In thousands

Current

Year Ended December 31,

2004

2003

2002

Federal .............................. $ 47,081
State and local ..................
10,539
Foreign ..............................
818
Total current .................. $ 58,438

$ 37,820
6,376
300
$ 44,496

$ 41,602
6,026
99
$ 47,727

Deferred

Federal .............................. $ 7,498
State and local ..................
801
Foreign ..............................
(1,337)
Total deferred ................ $ 6,962

$ 10,825
2,435
(1,213)
$ 12,047

$ 7,087
1,791
—
$ 8,878

Total income tax expense ...... $ 65,400

$ 56,543

$ 56,605

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:

In thousands

Computed expected

Year Ended December 31,

2004

2003

2002

Revolving loan commitment,

various interest rates based on
EUROLIBOR (effective rate of
2.91% at December 31, 2004),
due October 17, 2005 ..................

$ 10,000

$ 5,000

income taxes ..................

7,371 5% 5,717 4% 4,922 3%

income tax expense........ $57,039 35% $50,367 35% $51,572 35%

Net effect of state

Less current maturities ....................

10,000

—

$ —

$ 5,000

Credit Facilities
On October 18, 2002, the Company obtained a three-year
$125 million variable rate unsecured revolving credit facility.
All borrowings under this $125 million credit agreement are to
be repaid by October 17, 2005. Commitment fees on the total
credit facility 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
.125% to .175%. Interest rates on drawn amounts range from
EUROLIBOR plus .5% to EUROLIBOR plus .7%. As of
December 31, 2004, the Company had $115 million of unused
borrowing capacity under this credit agreement. This credit

Change in the beginning
of the year balance of
the valuation allowance ..
Other, net ..........................

Income tax expense

39 0%
951 1%

10 0%
449 0%

159 0%
(48) 0%

for the period.................. $65,400 40% $56,543 38% $56,605 38%

Total income tax expense (benefit) was allocated as follows:

Year Ended December 31,

In thousands

2004

2003

2002

Results of operations .......... $65,400
Stockholders’ equity............
(2,299)
Total ................................ $63,101

$56,543
(3,630)
$52,913

$ 56,605
(27,886)
$ 28,719

The tax effects of temporary differences that gave rise to
significant portions of the deferred tax assets and deferred tax
liabilities were as follows:

December 31,

In thousands

2004

2003

Deferred tax assets
Deferred compensation and

retirement plan ..............................

$ 10,291

$ 10,598

4,451
343
211
—

1,214

597
492
17,906
(1,089)
16,817

Accrued expenses

not deductible until paid ................
Accounts receivable, net ....................
Other, net ............................................
State income tax ................................
Foreign net operating loss

5,114
662
211
3,236

carryforwards ................................

2,201

State net operating loss

carryforwards ................................
Capital loss carryforward ..................
Total gross deferred tax assets ..........
Less valuation allowance....................
Net deferred tax assets ......................

Deferred tax liabilities
Property, plant and equipment ..........
Goodwill..............................................
State income tax ................................
Total gross deferred tax liabilities ......
Net deferred tax liabilities ..................

682
492
22,889
(1,174)
21,715

(16,830)
(39,274)
—
(56,104)
$ (34,389)

(12,819)
(31,299)
(870)
(44,988)
$(28,171)

Net deferred taxes are recorded both as a current deferred
income tax asset and as other long-term liabilities based upon
the classification of the related timing difference. There are
approximately $7.9 million and $9.1 million of deferred tax
assets related to non-current items that are netted with long-
term deferred tax liabilities at December 31, 2004 and 2003,
respectively.

As of December 31, 2004 and 2003, the Company had net
operating loss and capital loss carryforwards that are available
to reduce future taxable income and that will begin to expire
in 2006.

In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or
all of the deferred tax assets will not be realized. Based on the
expectation of future taxable income, and that the deductible
temporary differences will offset existing taxable temporary
differences, management believes it is more likely than not
that the Company will realize the benefits of these deductible
differences, net of the existing valuation allowances, at
December 31, 2004.

The valuation allowance for deferred tax assets as of January 1,
2003, was $1,277,000. The valuation allowance at December 31,
2004, relates to state net operating losses of $682,000 and
capital losses of $492,000, which are not expected to be
realized. The valuation allowance at December 31, 2003, related
to state net operating losses of $597,000 and capital losses of
$492,000 that are not expected to be realized.

Cash payments for income taxes were $50.1 million, $39.9
million and $37.8 million in 2004, 2003 and 2002, respectively.

Note E — 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 were it not for limitations
imposed by income tax regulation. The benefits under this
supplemental pension plan, which is an unfunded 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:

Year Ended December 31,

In thousands

2004

2003

Change in benefit obligation
Benefit obligation at

beginning of year ..............................
Service cost ..........................................
Interest cost ..........................................
Actuarial loss ........................................
Benefits paid..........................................
Benefit obligation at end of year............

$ 109,171
561
6,568
1,973
(4,741)
113,532

$ 102,151
523
6,561
4,363
(4,427)
109,171

Change in plan assets
Fair value of plan assets

at beginning of year ..........................
Actual return on plan assets..................
Contributions ........................................
Benefits paid..........................................
Fair value of plan assets

89,210
10,918
51
(4,741)

64,660
16,366
12,611
(4,427)

at end of year ....................................

95,438

89,210

Funded status ........................................
Unrecognized actuarial loss ..................
Unrecognized prior service cost............
Net amount recognized ........................

(18,094)
35,062
426
$ 17,394

(19,961)
38,670
491
$ 19,200

The following amounts have been recognized
Consolidated Balance Sheets:

the

Year Ended December 31,

In thousands

2004

2003

Accrued benefit liability ......................
Intangible asset ..................................
Accumulated other

$ (16,175)
824

$ (18,370)
984

comprehensive loss ........................
Net amount recognized ......................

32,745
$ 17,394

36,586
$ 19,200

The minimum pension liability included in other comprehensive
income decreased $3.8 million during the year ended December
31, 2004, and decreased $6.7 million during the year ended
December 31, 2003.

The Company is not required to make and does not intend to
make a contribution to either pension plan in 2005 other than to
the extent needed to cover benefit payments related to the
unfunded plan.

The following information is presented for pension plans with
an accumulated benefit obligation in excess of plan assets:

Years Ended December 31,

In thousands

2004

2003

Projected benefit obligation ................
Accumulated benefit obligation ..........
Fair value of plan assets ......................

$ 113,532
111,614
$ 95,438

$ 109,171
107,580
$ 89,210

The Company’s non-qualified, unfunded pension plan had an
accumulated benefit obligation of $10.8 million and $10.0
million at December 31, 2004 and 2003, respectively.

Net pension cost for both plans included the following
components:

Years Ended December 31,

In thousands

2004

2003

2002

The discount rate assumptions are based on current yields
of investment-grade corporate long-term bonds. The expected
long-term return on plan assets is based on the expected future
average annual return for each major asset class within the
plan’s portfolio (which is principally comprised of equity
investments) over a long-term horizon. In determining the
expected long-term rate of return on plan assets, the Company
evaluated input from its investment consultants, actuaries, and
investment management firms including their review of asset
class return expectations, as well as long-term historical asset
class returns. Projected returns by such consultants and
economists are based on broad equity and bond indices.
Additionally, the Company considered its historical 15-year
compounded returns, which have been in excess of the
Company’s forward-looking return expectations.

The Company’s funded pension plan assets as of December 31,
2004 and 2003, by asset category are as follows:

In thousands

December 31,

2004

2003

Equity securities ..................................
Debt securities ....................................
Other ..................................................
Total plan assets..................................

$ 67,815
26,516
1,107
$ 95,438

$ 63,962
23,768
1,480
$ 89,210

561
6,568

523
6,561

581
6,662

The expected future pension benefit payments as of December
31, 2004 are as follows:

Service cost ..........................
Interest cost..........................
Expected return

on plan assets ..................

(7,396)

(5,964)

(6,931)

Amortization of

prior service cost..............

Recognized actuarial

loss (gain) ........................

2,060

2,477

1,066

Net periodic

benefit cost (income)........

$ 1,857

$ 3,662

$ 1,443

The weighted-average assumptions used for measurement of the
defined pension plans were as follows:

Years Ended December 31,

In thousands

2004

2003

2002

Weighted-average assumptions used to determine

net periodic benefit cost

Discount rate ........................
Expected return on

6.25%

6.85%

7.40%

plan assets........................

8.50%

9.00%

Rate of compensation

increase ............................

4.00%

December 31,

2004

2003

Weighted-average assumptions used to determine

benefit obligations

Discount rate ........................
Rate of compensation

6.00%

6.25%

increase ............................

4.00%

In thousands

2005..........................................................................
2006..........................................................................
2007..........................................................................
2008..........................................................................
2009..........................................................................
2010–2014................................................................

$ 4,507
4,580
4,736
5,338
5,714
35,349
$ 60,224

The investment policy for the Harte-Hanks, Inc. Pension Plan
focuses on the preservation and enhancement of the plan’s assets
through prudent asset allocation, quarterly monitoring and
evaluation of investment results, and periodic meetings with
investment managers.

The investment policy’s goals and objectives are to meet or
exceed the representative indices over a full market cycle (3-5
years). The policy establishes the following investment mix,
which is intended to subject the principal to an acceptable level
of volatility while still meeting the desired return objectives:

Target

Acceptable
Range

Benchmark Index

Domestic Equities ........
Large Cap Growth ....
Large Cap Value........
Mid Cap Value ..........
Domestic Fixed Income
International Equities ....

S&P 500

55.0% 35%-75%
22.5% 15%-30% Russell 1000 Growth
22.5% 15%-30%
Russell 1000 Value
10.0% 5%-15% Russell Mid Cap Value
30.0% 20%-50%
15.0% 10%-25%

LB Aggregate
MSCI EAFE

To address the issue of risk, the investment policy places high
priority on the preservation of the value of capital (in real terms)
over a market cycle. Investments are made in companies with a
minimum five-year operating history and sufficient trading
volume to facilitate, under most market conditions, prompt sale
without severe market effect. Investments are diversified;
reasonable concentration in any one issue, issuer, industry or
geographic area is allowed if the potential reward is worth
the risk.

Investment managers are evaluated by the performance of the
representative indices over a full market cycle for each class of
assets. The Pension Plan Committee reviews, on a quarterly
basis, the investment portfolio of each manager, which includes
rates of return, performance comparisons with the most
appropriate indices, and comparisons of each manager’s
performance with a universe of other portfolio managers that
employ the same investment style.

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 2004, 2003 and 2002
was $6.3 million, $6.1 million and $6.4 million, respectively.

The 1994 Employee Stock Purchase Plan provides for a
total of 6,000,000 shares to be sold to participating
employees at 85% of the fair market value at specified quarterly
investment dates. Shares available for sale totaled 2,826,290 at
December 31, 2004.

Note F — Stockholders’ Equity
In January 2005, the Company announced an increase in the
regular quarterly dividend from 4.0 cents per share to 5.0 cents
per share, payable March 15, 2005, to holders of record on
March 1, 2005.

During 2004 the Company repurchased 3.6 million shares of its
common stock for $85.7 million under its stock repurchase
program. In addition, the Company received 0.2 million shares
of its common stock, with an estimated market value of
$4.3 million, in exchange for proceeds related to stock option
exercises. As of December 31, 2004, the Company has
repurchased 39.3 million shares since the beginning of its stock
repurchase program in January 1997. During this period the
Company has also received 1.3 million shares in exchange for
proceeds related to stock option exercises. Under this program,
the Company had authorization to repurchase an additional 5.6
million shares at December 31, 2004.

On April 26, 2004, the Company purchased 744,000 shares of
its common stock for $24.00 per share ($0.24 below the closing
price per share of the Company’s common stock on April 26,
2004) from two trusts and a private foundation. Mr. Larry
Franklin, the Chairman of the Company’s Board, and Mr. David

L. Copeland, the Chairman of the Company’s Audit Committee,
serve as co-trustees on each of the trusts and are board members
of the private foundation. Each of Messrs. Franklin and
Copeland disclaim beneficial ownership of such shares.

On April 28, 2004, the Company purchased 100,000 shares of
its common stock for $24.00 per share (the closing price per
share of the Company’s common stock on April 28, 2004) from
Mr. Houston H. Harte. On August 11, 2004, the Company
purchased 100,000 shares of its common stock for $24.00 per
share (the closing price per share of the Company’s common
stock on August 10, 2004) from Mr. Houston H. Harte. In
addition, on September 15, 2004, the Company purchased
100,000 shares of its common stock for $24.49 per share (the
closing price per share of the Company’s common stock on
September 15, 2004) from Mr. Houston H. Harte. Mr. Harte is a
member of the Company’s Board of Directors.

Note G — Stock Option Plans
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 20,500,000 shares of common stock.
Options have been granted at exercise prices equal to the market
price of the common stock on the grant date (market price
options) and at exercise prices below market price of the
common stock (performance options). As of December 31,
2004, 2003 and 2002, market price options to purchase
7,099,685 shares, 7,216,659 shares and 8,659,127 shares,
respectively, were outstanding with exercise prices ranging from
$4.28 to $25.48 per share at December 31, 2004. Market price
options granted prior to January 1998 became 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, 2004 was
$16.29 and $13.44, respectively. The weighted-average
remaining life for outstanding market price options was
5.94 years.

At December 31, 2004, 2003 and 2002, performance options to
purchase 129,000 shares, 161,325 shares and 359,625 shares,
respectively, were outstanding with exercise prices ranging from
$0.22 to $1.33 per share at December 31, 2004. No performance
options have been granted since January 1999. The performance
options became exercisable in whole or in part after three years,
depending upon the extent to which the Company achieved
certain goals established at the time the options were granted.
That portion of the performance options that did not become
exercisable at an earlier date becomes exercisable after the ninth
anniversary of the date of grant. Compensation expense of $0.1
million was recognized for the performance options during each
of the three years ended December 31, 2004. The weighted-
average exercise price for outstanding performance options and
exercisable performance options at December 31, 2004, was
$0.71 and $0.61, respectively. The weighted-average remaining
life for outstanding performance options was 2.06 years.

The following summarizes all stock option plans activity during
2004, 2003 and 2002:

Number of Shares

Weighted Average
Option Price

Options outstanding at

January 1, 2002 ..............

9,801,656

10.06

Granted ................................
Exercised ............................
Cancelled ............................
Options outstanding at

2,054,825
(2,282,461)
(555,268)

December 31, 2002 ........

9,018,752

Granted ................................
Exercised ............................
Cancelled ............................
Options outstanding at

318,300
(1,533,296)
(425,772)

18.88
6.17
12.24

12.92

18.04
6.87
16.15

December 31, 2003 ........

7,377,984

14.21

Granted........................
Exercised ....................
Cancelled ....................
Options outstanding at

1,269,750
(1,051,038)
(368,011)

22.46
10.68
17.35

December 31, 2004 ......

7,228,685

16.01

Exercisable at

December 31, 2004 ......

3,700,964

13.17

The following table summarizes information about stock
options outstanding at December 31, 2004:

Note H – 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 and trade
payables.

Note I – Commitments and Contingencies
At December 31, 2004, the Company had outstanding letters of
credit in the amount of $20.3 million. These letters of credit
exist to support the Company’s insurance programs relating to
workers’ compensation, automobile and general liability, and
leases.

Note J – 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 $27.5 million, $29.2 million
and $29.7 million for the years ended December 31, 2004, 2003
and 2002, respectively.

Step rent provisions and escalation clauses, capital improvement
funding, and other lease concessions are taken into account in
computing the Company’s minimum lease payments. The
Company recognizes the minimum lease payments on a straight-
line basis over the minimum lease term.

The future minimum rental commitments for all non-cancelable
operating leases with terms in excess of one year as of
December 31, 2004 are as follows:

Outstanding

Exercisable

In thousands

2005..........................................................................
2006..........................................................................
2007..........................................................................
2008..........................................................................
2009..........................................................................
After 2009 ................................................................

$ 22,372
17,359
14,260
9,968
7,322
16,721
$ 88,002

Range of
Exercise
Prices

Number
Outstanding

Weighted
Average
Remaining
Life (Years)

Weighted
Average
Exercise
Price

Number
Exercisable

$ 0.22- 8.58

860,385

$10.25-14.50 1,404,624

$14.54-15.63

954,912

$15.75-17.45 1,027,457

$17.98-18.61 1,015,432

$18.79-21.23

722,125

$22.03-25.48 1,243,750

7,228,685

1.51

4.17

5.74

5.43

7.10

7.76

8.16

5.87

$ 6.43

805,635 $ 6.78

$ 12.96 1,240,627 $ 12.90

$ 14.81

540,473 $ 14.87

$ 16.60

737,708 $ 16.44

$ 18.21

218,146 $ 18.22

$ 19.87

158,375 $ 19.96

$ 22.47

—

$ 16.01 3,700,964 $ 13.17

The weighted-average fair value of market price options granted
during 2004, 2003 and 2002 was $7.26, $5.96 and $6.75,
respectively. The Company did not grant any performance
options during 2003, 2002 or 2001.

Note K – Selected Quarterly Data (Unaudited)

Note M — Business Segments (continued)

In thousands,
except per share amounts

2004 Quarter Ended

2003 Quarter Ended

2003

December 31 September 30

June 30

March 31

December 31 September 30

June 30

March 31

Revenues ....................................
Operating income ........................
Net income ..................................
Basic earnings per share ............
Diluted earnings per share ..........

$ 277,491
47,333
27,580
0.32
0.32

$
$

43,506
25,653

$ 262,566 $ 254,152 $ 236,252
31,558
18,789
0.21
0.21

0.30 $
0.29 $

42,898
25,546

$
$

$ 255,721
41,674
24,978
0.29
0.28

$
$

38,514
22,924

$ 239,366 $ 233,169 $ 216,320
27,833
16,378
0.18
0.18

0.26 $
0.26 $

38,466
23,082

$
$

Note L – Earnings Per Share
A reconciliation of basic and diluted earnings per share (EPS) is
as follows:

Year Ended December 31,

In thousands,
except per share amounts

Basic EPS

Net income............................
Weighted-average common
shares outstanding used
in earnings per share
computations....................
Earnings per share................

Diluted EPS

Net income............................
Shares used in diluted
earnings per share
computations....................
Earnings per share................

2004

2003

2002

$ 97,568

$ 87,362

$ 90,745

86,169
1.13

88,541
0.99

92,648
0.98

$ 97,568

$ 87,362

$ 90,745

87,806
1.11

89,982
0.97

94,872
0.96

Computation of Shares Used in Earnings
Per Share Computations

Average outstanding

common shares................
Average common equivalent
shares—dilutive effect of
option shares....................

Shares used in diluted
earnings per share
computations....................

86,169

88,541

92,648

1,637

1,441

2,224

87,806

89,982

94,872

For the purpose of calculating the shares used in the diluted EPS
calculations, 109,000, 56,000 and 781,000 anti-dilutive market
price options have been excluded from the EPS calculations for
the years ended December 31, 2004, 2003 and 2002,
respectively.

Note M – Business Segments
Harte-Hanks is a highly focused targeted media company with
operations in two segments—Direct Marketing and Shoppers.

Harte-Hanks operates a worldwide direct and targeted
marketing company that provides direct marketing services to a
wide range of local, regional, national and international
consumer and business-to-business marketers. The Company

utilizes advanced technologies to enable its clients to identify,
reach, influence and nurture their customers. The Company
believes that developments in technology and trends toward
more sophisticated marketing analysis and measurement will
continue to result in increased usage of direct marketing
services. Harte-Hanks Direct Marketing improves the return on
its clients’ marketing investment with a range of services
organized around five solution points: Construct and update the
database—Access the data—Analyze the data—Apply the
knowledge—Execute the programs. The Company’s Direct
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 Marketing
customers also include 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 Standard Mail to all
households in a particular geographic area. Shoppers offer
advertisers a targeted, cost-effective local advertising system,
with virtually 100% penetration in their area of distribution.
Shoppers are particularly effective in large markets with high
media fragmentation in which major metropolitan newspapers
generally have low penetration. The Company’s Shoppers
customers range from large national companies to local
neighborhood businesses to individuals with a single item for
sale. The segment’s core customers are local service businesses
and small retailers. Shoppers’ client base is entirely domestic.

Included in Corporate Activities are general corporate expenses.
Assets of Corporate Activities include unallocated cash and
investments and deferred income taxes.

Information about 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).

In thousands

Revenues

Year Ended December 31,

2004

2003

2002

$ 573,826
334,951
$ 908,777

$ 83,872
74,564
(8,148)
$ 150,288

$ 150,288
(1,208)
274
(2,004)
$ 147,350

$ 27,088
5,008
32
$ 32,128

600
—
600

$ 12,782
4,548
28
$ 17,358

Direct Marketing ........................................................................................
Shoppers ..................................................................................................
Total revenues ..................................................................................

641,214
389,247
$ 1,030,461

Operating income

Direct Marketing ........................................................................................
Shoppers ..................................................................................................
Corporate Activities....................................................................................
Total operating income ....................................................................

Income before income taxes

Operating income ......................................................................................
Interest expense ........................................................................................
Interest income ..........................................................................................
Other, net ..................................................................................................
Total income before income taxes ....................................................

Depreciation

Direct Marketing ........................................................................................
Shoppers ..................................................................................................
Corporate Activities....................................................................................
Total depreciation ............................................................................

Goodwill and intangible amortization

Direct Marketing ........................................................................................
Shoppers ..................................................................................................
Total goodwill and intangible amortization ......................................

Capital expenditures

Direct Marketing ........................................................................................
Shoppers ..................................................................................................
Corporate Activities....................................................................................
Total capital expenditures ................................................................

Total assets

Direct Marketing ........................................................................................
Shoppers ..................................................................................................
Corporate Activities....................................................................................
Total assets ......................................................................................

Goodwill

Direct Marketing ........................................................................................
Shoppers ..................................................................................................
Total goodwill ..................................................................................

Other intangible assets

Direct Marketing ........................................................................................
Shoppers ..................................................................................................
Total assets ......................................................................................

90,856
85,857
(11,418)
165,295

165,295
(1,020)
341
(1,648)
162,968

22,518
5,621
30
28,169

600
—
600

22,587
12,556
3
35,146

574,033
203,587
50,733
828,353

332,240
125,931
458,171

2,067
—
2,067

$ 584,804
359,772
$ 944,576

$ 76,641
78,007
(8,161)
$ 146,487

$ 146,487
(855)
168
(1,895)
$ 143,905

$ 23,908
5,493
32
$ 29,433

600
—
600

$ 18,526
13,365
24
$ 31,915

$ 527,733
188,301
43,096
$ 759,130

$ 312,810
124,346
$ 437,156

2,667
—
2,667

Information about the Company’s operations in different geographic areas:

Management’s Report on Internal Control Over Financial Reporting

In thousands

Revenuesa

Year Ended December 31,

2004

2003

2002

United States ............................................................................................
Other countries ..........................................................................................
Total revenues ..................................................................................

974,258
56,203
$ 1,030,461

Long-lived net assetsb

United States ............................................................................................
Other countries ..........................................................................................
Total long-lived assets ......................................................................

104,877
8,893
113,770

$ 896,788
47,788
$ 944,576

$ 89,733
8,014
$ 97,747

$ 870,700
38,077
$ 908,777

a Geographic revenues are based on the location of the customer.
b Long-lived assets are based on physical location.

Report of Independent Registered Public Accounting Firm on Financial Statements

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, 2004
and 2003, 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, 2004. 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 the standards of the
Public Company Accounting Oversight Board (United States).
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 financial statements referred to above
present fairly, in all material respects, the consolidated financial
position of Harte-Hanks, Inc. and subsidiaries as of December
31, 2004 and 2003, and the results of their operations and their
cash flows for each of the three years in the period ended
December 31, 2004, in conformity with U.S. generally accepted
accounting principles.

We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States),
the effectiveness of the Company’s internal control over
financial reporting as of December 31, 2004, based on criteria
established in “Internal Control—Integrated Framework” issued
by the Committee of Sponsoring Organizations of the Treadway
Commission, and our report dated March 15, 2005, expressed
an unqualified opinion thereon.

KPMG LLP
San Antonio, Texas
March 15, 2005

We are responsible for the preparation and integrity of the
consolidated financial statements appearing in our Annual
Report. The consolidated financial statements were prepared in
conformity with United States generally accepted accounting
principles and include amounts based on management’s
estimates and judgments. All other financial information in this
report has been presented on a basis consistent with the
information included in the financial statements.

We are also responsible for establishing and maintaining
adequate internal controls over financial reporting. We maintain
a system of internal controls that is designed to provide
reasonable assurance as to the fair and reliable preparation and
presentation of the consolidated financial statements, as well as
to safeguard assets from unauthorized use or disposition.

Our control environment is the foundation for our system of
internal controls over financial reporting. It sets the tone of our
organization and includes factors such as integrity and ethical
values. Our internal controls over financial reporting are
supported by formal policies and procedures that are reviewed,
modified and improved as changes occur in business conditions
and operations.

The Audit Committee of the Board of Directors, which is
composed solely of outside directors, meets periodically with
members of management, the internal auditors and the
independent auditors to review and discuss internal controls
over financial reporting and accounting and financial reporting
matters. The independent auditors and internal auditors report
to the Audit Committee and accordingly have full and free
access to the Audit Committee at any time.

We conducted an evaluation of the effectiveness of our internal
controls over financial reporting based on the framework in
“Internal Control—Integrated Framework” issued by the
Committee of Sponsoring Organizations of the Treadway
Commission. This evaluation
the
the design
documentation of controls, evaluation of
effectiveness of controls, testing of the operating effectiveness
of controls and a conclusion on this evaluation. Based on our
evaluation, we concluded that internal control over financial
reporting was effective as of December 31, 2004.

included review of

KPMG LLP, an independent registered public accounting
firm, has issued an attestation report on management’s
assessment of internal control over financial reporting, which
is included herein.

March 15, 2005

Richard Hochhauser
President and Chief Executive Officer

Dean Blythe
Senior Vice President and Chief Financial Officer

Jessica Huff
Vice President, Finance and Chief Accounting Officer

Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

Five-Year Financial Summary

The Board of Directors and Stockholders
Harte-Hanks, Inc.:

We have audited management’s assessment, included in the
accompanying Management’s Report on Internal Control
Over Financial Reporting, that Harte-Hanks, Inc. maintained
effective internal control over financial reporting as of
December 31, 2004, based on criteria established in “Internal
Control—Integrated Framework” issued by the Committee of
Sponsoring Organizations of the Treadway Commission (the
COSO criteria). The Company’s management is responsible for
maintaining effective internal control over financial reporting
and for its assessment about the effectiveness of internal control
over financial reporting. Our responsibility is to express an
opinion on management’s assessment and an opinion on the
effectiveness of the Company’s internal control over financial
reporting based on our audit.

We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in
all material respects. Our audit included obtaining an
understanding of internal control over financial reporting,
evaluating management’s assessment, testing and evaluating the
design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary
in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.

A company’s internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally
accepted accounting principles. A company’s internal control
over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary

to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance
with authorizations of management and directors of the
company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use,
or disposition of the company’s assets that could have a material
effect on the financial statements.

Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that the Company
maintained effective internal control over financial reporting as
of December 31, 2004, is fairly stated, in all material respects,
based on the COSO criteria. Also, in our opinion, the Company
maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2004, based on the
COSO criteria.

We also have audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States),
the consolidated balance sheet of Harte-Hanks, Inc. and
subsidiaries as of December 31, 2004 and 2003 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, 2004 and
our report dated March 15, 2005 expressed an unqualified
opinion thereon.

KPMG LLP
San Antonio, Texas
March 15, 2005

In thousands, except per share amounts

Statement of Operations Data
Revenues ........................................................................
Operating expenses

Payroll, production and distribution ........................
Advertising, selling, general and administrative ......
Depreciation ............................................................
Goodwill and intangible amortization ......................
Total operating expenses ............................................
Operating income ........................................................
Interest expense, net ..................................................
Net income ..................................................................
Earnings per common share—diluted ........................
Cash dividends per common share ............................
Weighted-average common and common

2004

2003

2002

2001

2000

$ 1,030,461

$ 944,576

$ 908,777

$ 917,928

$ 960,773

755,715
80,682
28,169
600
865,166
165,295
679
97,568
1.11
0.16

692,170
75,886
29,433
600
798,089
146,487
687
87,362
0.97
0.12

652,243
73,518
32,128
600
758,489
150,288
934
90,745
0.96
0.10

653,002
76,376
32,079
16,841
778,298
139,630
2,578
79,684
0.82
0.08

693,272
85,560
28,494
15,226
822,552
138,221
(384)
81,886
0.78
0.07

equivalent shares outstanding—diluted ..................

87,806

89,982

94,872

97,174

104,480

Adjusted data to exclude amortization of

goodwill, net of tax effecta

Net income ..................................................................
Earnings per common share—diluted ........................

97,568
1.11

87,362
0.97

90,745
0.96

91,700
0.94

92,638
0.89

Segment data
Revenues

Direct Marketing......................................................
Shoppers ................................................................
Total revenues ........................................................

641,214
389,247
$ 1,030,461

584,804
359,772
$ 944,576

573,826
334,951
$ 908,777

601,901
316,027
$ 917,928

662,044
298,729
$ 960,773

Operating income

Direct Marketing......................................................
Shoppers ................................................................
General corporate....................................................
Total operating income ..........................................

Operating income excluding
amortization of goodwilla
Direct Marketing......................................................
Shoppers ................................................................
General corporate....................................................
Total operating income ..........................................

Capital expenditures ........................................................
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............................................

90,856
85,857
(11,418)
165,295

$ 76,641
78,007
(8,161)
$ 146,487

$ 83,872
74,564
(8,148)
$ 150,288

$ 85,020
63,398
(8,788)
$ 139,630

$ 91,450
55,710
(8,939)
$ 138,221

90,856
85,857
(11,418)
165,295

$ 76,641
78,007
(8,161)
$ 146,487

$ 83,872
74,564
(8,148)
$ 150,288

$ 97,171
67,470
(8,788)
$ 155,853

$ 102,172
59,781
(8,939)
$ 153,014

35,146

$ 31,915

$ 17,358

$ 26,445

$ 36,465

113,770
460,238
828,353
—
571,799

$ 97,747
439,823
759,130
5,000
$ 555,598

$ 94,154
440,067
736,732
16,300
$ 532,533

$ 109,428
438,325
771,049
48,312
$ 552,366

$ 112,065
439,148
807,105
65,370
$ 551,003

a Effective January 1, 2002, the Company adopted the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets,” which established new

accounting and reporting requirements for goodwill and other intangible assets and eliminated the amortization of goodwill. See Note A of the “Notes
to Consolidated Financial Statements” for further discussion of SFAS No. 142.

CORPORATE INFORMATION

Common Stock
The Company’s common stock is listed on the New York Stock
Exchange (symbol: HHS). The reported high and low quarterly
sales price ranges for 2004 and 2003 were as follows:

2004

2003

High

Low

High

Low

First Quarter ..........

Second Quarter ....

Third Quarter ........

Fourth Quarter ......

23.42

24.88

25.68

27.00

21.38

22.51

23.56

24.13

19.56

19.65

19.98

22.15

17.10

17.19

18.35

18.41

In 2004, quarterly dividends were paid at the rate of 4.0 cents
per share. In 2003, quarterly dividends were paid at the rate of
3.0 cents per share.

As of January 1, 2005, there are approximately 2,600 holders
of record.

The certifications over the Company’s internal controls required
by Section 302 of the Sarbanes-Oxley Act of 2002 have been
filed as an exhibit to the Company’s Form 10-K. These
certifications have been submitted to the NYSE. The Company
also submitted the required certification to the NYSE pursuant
to NYSE Rule 303A.12(a) in 2004.

Transfer Agent and Registrar
EquiServe Trust Company, N.A.
PO Box 43023
Providence, RI 02940-3023
(781) 575-4593
www.equiserve.com

Annual Meeting of Stockholders
The annual meeting of stockholders will be held at 10:00 am
on May 17, 2005, 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:

Steve Hacker, Secretary
Harte-Hanks, Inc.
P.O. Box 269
San Antonio, Texas 78291-0269

DIRECTORS

David L. Copeland
President, SIPCO, Inc.
Chairman, Audit Committee

William F. Farley
Founder & Owner
Livingston Capital

Dr. Peter T. Flawn
President Emeritus
The University of Texas at Austin

OFFICERS
Larry Franklin
Chairman

Larry Franklin
Chairman

Houston H. Harte
Vice Chairman

William K. Gayden
Chairman & Chief Executive Officer
Merit Energy Company

Christopher M. Harte
Private Investor
Chairman, Nominating & Corporate
Governance Committee

Richard Hochhauser
President & Chief Executive Officer

Judy C. Odom
Private Investor
Co-Founder, Former Chairman &
Chief Executive Officer
Software Spectrum, Inc.
Chairman, Compensation Committee

Jessica Huff
Vice President, Finance &
Chief Accounting Officer

Spencer Joyner, Jr.
Vice President, Direct Marketing

Dave LaGreca
Vice President, Direct Marketing

Federico Ortiz
Vice President, Tax

Michael Paulsin
Vice President, Shoppers

Tann Tueller
Vice President, Direct Marketing

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

Gary Skidmore
Senior Vice President, Direct Marketing

Richard Hochhauser
President & Chief Executive Officer

Bill Carman
Vice President, Shoppers

Dean Blythe
Senior Vice President &
Chief Financial Officer

Kathy Calta
Senior Vice President, Direct Marketing

James Davis
Senior Vice President, Direct Marketing

Bill Goldberg
Senior Vice President, Direct Marketing

Peter Gorman
Senior Vice President, Shoppers

Robert J. Colucci
Vice President, Direct Marketing

Loren Dalton
Vice President, Shoppers

Carlos Guzman
Vice President, Shoppers

Steve Hacker
Vice President, Legal & Secretary

Frank Harvey
Vice President, Direct Marketing

CORPORATE OFFICE
San Antonio, Texas
http://www.harte-hanks.com

DIRECT MARKETING
Austin, Texas
Baltimore, Maryland
Billerica, Massachusetts
Bloomfield, Connecticut
Cincinnati, Ohio
Clearwater, Florida
Deerfield Beach, Florida
East Bridgewater, Massachusetts
Fort Worth, Texas
Fullerton, California
Glen Burnie, Maryland
Grand Prairie, Texas
Jacksonville, Florida
Lake Mary, Florida
Langhorne, Pennsylvania
Monroe Township, New Jersey
New York, New York
Ontario, California

Richardson, Texas
River Edge, New Jersey
San Diego, California
Shawnee, Kansas
Sterling Heights, Michigan
Vineland, New Jersey
Westville, New Jersey
Wilkes-Barre, Pennsylvania

NATIONAL MARKETS HEADQUARTERS
Cincinnati, Ohio

INTERNATIONAL OFFICES
Aldermaston, United Kingdom
Dublin, Ireland
Hasselt, Belgium
Madrid, Spain
Melbourne, Australia
São Paulo, Brazil
Sèvres, France
Stuttgart, Germany
Uxbridge, United Kingdom

HHA-AR-05

P.O. Box 269 • San Antonio, TX 78291-0269
(210) 829-9000 • www.harte-hanks.com