Index to Financial Statements

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 20032004

For the transition period from            toto            

Commission File Number 1-7120

HARTE-HANKS, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code — 210-829-9000

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

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

None

(Title of class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yesx    No  ¨

Indicate by check mark if disclosure of delinquent filings pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    Yesx    No  ¨

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).    Yes  x    No  ¨

State the aggregate market value of the voting and non-voting common equity held by non-affiliates based on the $19.00$24.41 per share closing price for the Company’s Common Stock on the New York Stock Exchange as of the last business day of the registrant’s most recently completed second fiscal quarter (June 30, 2003)2004): approximately $1,109,000,000.$1,473,000,000.

Indicate the number of shares outstanding of each of the registrant’s classes of Common Stock as of January 31, 2004: 87,530,704February 28, 2005: 84,622,749

Documents incorporated by reference:

Portions of the Proxy Statement for the Company’s May 18, 200417, 2005 Annual Meeting of Stockholders are incorporated by reference in Part III of this report.

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Harte-Hanks, Inc.

Table of Contents

Form 10-K Report

December 31, 20032004

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ITEM 1. BUSINESS

INTRODUCTION

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’s direct marketing business operates both nationally and internationally, while its shopper business operates in selected local and regional markets in California and Florida. The Company believes that marketing continues to undergo a transition from traditional mass media marketing to direct and targeted marketing. The transition is being driven by the increasing sophistication and efficiency of technology and a growing need among marketers to customize the products and services they offer to customers.customers and to demonstrate a return on their marketing invesments. Direct marketing, which represented 62% of the Company’s revenues in 2003,2004, is a leader in the movement toward highly targeted marketing. The Company’s shopper business applies similargeographic targeting principles. Harte-Hanks strategy is based on fiveseven key elements: being a market leader in each of its businesses; increasing revenues through growing its base businesses; introducing new products; entering new markets and making acquisitions; using technology to create competitive advantages; employing people who understand its clients business and markets and delight its clients; and creating shareholder value.

Harte-Hanks is the successor to a newspaper business begun in Texas in the early 1920’s by Houston Harte and Bernard Hanks. In 1972, the Company went public and was listed on the New York Stock Exchange. The Company became private in a leveraged buyout initiated by management in 1984. In 1993, the Company again went public and listed its common stock on the NYSE. In 1997, the Company sold all of its remaining traditional media operations (consisting of newspapers, television and radio companies) in order to focus all of its efforts on two business segments - direct marketing services and shoppers operations.

Harte-Hanks provides public access to all reports filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the “1934 Act”). These documents may be accessed free of charge on Harte-Hanks’the Company’s website at the following address: http://www.harte-hanks.com. Since November 15, 2002, these documents have been provided as soon as practical after they are filed with the SEC. The documents may also be found at the SEC’s website at http://www.sec.gov. Additionally, the Corporation has adopted and posted on its website a code of ethics that applies to its principal executive officer, principal financial officer and principal accounting officer. The Corporation’s website also includes its corporate governance guidelines and the charters for its audit committee, its compensation committee, and its corporate governance and nominating committee. The address for the Corporation’s website ishttp://www.harte-hanks.com. The Corporation will provide a printed copy of any of the aforementioned documents to any requesting shareholder.

DIRECT MARKETING

General

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. Direct marketing services are targeted to specific industries or markets with services and software products tailored to each industry or market. Currently, the Company’s vertical markets include retail, high-tech/telecom, financial services, pharmaceutical/healthcare, and a wide range of selected markets. The Company believes that it has the ability to provide services to new industries and markets by modifying its existing technology and information applications as opportunities are presented. In 2004, Harte-Hanks Direct Marketing had revenues of $641.2 million, which accounted for approximately 62% of the Company’s total revenues.

Depending on the needs of its clients, Harte-Hanks Direct Marketing capabilities are provided in an integrated approach through 35 facilities worldwide. Each of these centers possess some industry specialization and are linked together to support certain clients that experience volume spikes or seek high-growth needs. The Company also provides direct marketing services internationally through nine offices located outside of the United States.

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:

Harte-Hanks Direct Marketing uses technology as an enabler to capture, analyze and disseminate customer and prospect data across all points of customer contact. Using both proprietary software and open software solutions, the Company builds contact databases for its clients using the information gained from the client’s marketing activities across different media such as mail, websites, e-mail, toll-free numbers, trade shows and other sources. The Company believes that these databases enable clients to measure the return on their marketing communications and make more informed decisions about future marketing efforts. The Company helps clients manage the inquiries they receive from their marketing efforts, whether from Web sites,websites, e-mail, toll-free numbers, trade

Index to Financial Statements

shows or other sources. These inquiries, or leads, are qualified, tracked and distributed both to appropriate sales channels and to client management for analysis, decision-making and/or additional interaction in order for clients to more effectively manage their customer and prospect relationships.Using proprietary software and open software solutions, the Company also builds contact databases for its clients using the information gained from these activities. These databases help clients measure the return on their marketing communications and make more informed decisions about future marketing efforts.relationships.

The Company also builds customized marketing databases for specific clients and provides them with easy-to-use tools to perform analysis and to target their best customers and prospects. Using its proprietary name and address matching software, the Trillium Software System®, the Company standardizes large numbers of customer records from multiple sources, integrates them into a single database for each client and, if needed, appends demographic and lifestyle information.

RelationalThe Company’s Allink® databases are built for clients from a range of facilities, each specializing in specific market segments. These databases are moved to the client’s site or maintained at Harte-Hanks with online access tofrom client locations. In addition to building a client’s database and providing software solutions for analytics and campaign management, Harte-Hanks performs regular database updates. Harte-Hanks also offers its software module, the Trillium Software System®, for clients who want to integrate data quality capabilities into their data warehouse or operational systems.

In addition, the Company operates as a service bureau, preparing list selections, maximizing deliverability and reducing clients’ mailing costs through its Advanced Data Quality services which includes sophisticated postal coding, hygiene and address updates through a non-exclusive National Change of Address license with the U.S. Postal Service.

As a further extension of the client’s marketing arm, Harte-Hanks provides marketing research and analytics services. Specific capabilities include tracking and reporting, media analysis, modeling, database profiling, primary data collection, marketing applications, consulting and program development.

Harte-Hanks also offers direct marketing agency services to create the plan to manage direct marketing communication efforts. These services combine information-based strategy and brand-building creative efforts across both traditional direct and interactive media.

Harte-Hanks also provides a variety of services to help clients develop and execute targeted marketing communication programs. These include such upfront services as creative and graphics, along with back-end services such as printing,telephone, email, website development, personalization of communication pieces using laser and inkjet printing, target mail and fulfillment, transportation logistics, and transportation logistics.printing.

The Company’s mail tracking capability and long-standing relationshipsrelationship with the U.S. Postal Service help ensure that customer mailings reach their destinations on time. By controlling the final stage of the print distribution process through its logistics operations, the Company facilitates the delivery of its clients’ materials while holding costs to a minimum.

Direct marketing services are marketed to specific industries or markets with services and software products tailored to each industry or market. Having established the basic technological foundation, the Company is able to provide services to new industries and markets by modifying its existing technology and information applications. The Company currently provides direct marketing services to all of its primary markets in addition to a range of select markets.

The Company continued to develop new solutions and enhance its products through several new strategic initiatives during 2003. Harte-Hanks expanded its CI Technology Database^™, a market intelligence tool that profiles technology platforms at hundreds of thousands of business locations on three continents, to

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include data on small and medium-sized businesses. Over the past year, Harte-Hanks has added comprehensive data on 220,000 small and medium-sized business locations in North America. The Company released Trillium Software System® Version 6 Unicode Edition for the Chinese and Korean markets. The Company also had two mail processing facilities certified by the United States Postal Service for compliance with its Mail Preparation Total Quality Management (MPTQM) program, making the facilities the first of their kind in the country to earn this quality distinction. MPTQM is a systematic prevention-based approach for managing the quality of the mail preparation process.

Depending on the needs of its clients, Harte-Hanks Direct Marketing capabilities are provided in an integrated approach through 37 facilities worldwide. Each of these centers possess some industry specialization and are linked together to support certain clients that experience volume spikes or seek high-growth needs. The Company also provides direct marketing services internationally through nine offices located outside of the United States.

Sales and Marketing

The national direct marketing sales forces of Harte-Hanks are headquartered in Cincinnati, Ohio, with additional offices maintained throughout the United StatesStates. There are also product specific sales forces and sales groups in Europe, as well as office locations in Australia and South America. The sales forces, with industry-specific knowledge and experience, emphasize the cross-selling of a full range of direct marketing services and are supported by employees in each sector. The overall sales focus is to position Harte-Hanks as a marketing partner and a single-source solution for a client’s targeted marketing needs.

Direct Marketing Facilities

Direct marketing services are provided at the following facilities:

For more information please refer to Item 2 - Properties.

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Competition

The Harte-Hanks direct marketing business faces competition from other direct marketing companies in each sector, as well as from print and electronic media and other forms of advertising. Harte-Hanks believes that its capabilities, combined with its national production capability, industry focus and ability to offer a full range of integrated services, enable the Company to compete effectively.

SHOPPERS

General

Harte-Hanks Shoppers is theNorth America’s largest publisherowner, operator and distributor of advertising shoppers in North America,shopper publications, based on weekly circulation and revenues, and is the only national targeted media company that focuses on shoppers as a core business. Shoppers are weekly advertising publications delivered free by third-class mailStandard Mail to all households and businesses 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.

As of December 31, 2003,2004, Shoppers delivered more than 1011 million shopper packages in four major markets each week covering the greater Los Angeles market (Los Angeles County, Orange County, Riverside County, San Bernardino County, Ventura County and Kern County), the greater San Diego market, Northern California (San Jose, Sacramento, Stockton and Stockton)Modesto) and South Florida (Dade County and Broward County). Two editions of the shopper publication are delivered to approximately 220,000240,000 households and businesses in South Orange County where both an “early” and “late” editionPennySaver isare published each week. The Company’s California publications account for 88%87% of Shoppers’ weekly circulation.

Harte-Hanks publishes 877952 individual shopper editions each week distributed to zones with circulation of approximately 12,200 households12,000 each. This allows single-location, local advertisers to saturate a single geographic zone, while enabling multiple-location advertisers to saturate multiple zones. This unique delivery system gives large and small advertisers alike a cost-effective way to reach their target markets. The Company believes that its zoning capabilities and production technologies have enabled it to saturate and target areas in a number of ways including geographic, demographic, lifestyle, behavioral and language allowing its advertisers to effectively target their customers. The Company’s strategy is to increase its share of local advertising in its existing circulation areas, and, over time, to increase circulation through internal expansion into contiguous areas. In 2003,2004, Harte-Hanks Shoppers had revenues of $359.8$389.2 million, accounting for approximately 38% of the Company’s total revenues.

The Company continued to develop new solutions and enhance its products through several strategic initiatives during 2003.2004. Harte-Hanks Shoppers Northern CaliforniaPennySaverbegancompleted the transitionrelocation to its new manufacturing facility and is expected to complete its relocation by the end of March, 2004.in March. The new facility and associated equipment investment will provide Shoppers with the needed capacity for significant geographic expansion in Northern California. Shoppers continued to focus on the expanded use of in-book color advertising and on various multi-customer shared insert products printed by third party printers and then inserted in the shopper publications on a bi-monthly or monthly basis. Harte-Hanks Shoppers launchedDreams, “Pensando en Ti,” a four-color heatset magazine targeting travel, entertainmentmulti-page free-standing insert targeted to Hispanic households. “Pensando en Ti,” which means “thinking of you,” was created to market to the rising number of Hispanic consumer households. “Pensando en Ti” is designed as a monthly publication and lifestyle advertisers. The product is inserted intoappears as an insert inside thePennySaverin higher-income markets of Southern California. Harte-Hanks Shoppers investedCalifornia and the Flyer in color capacity for the San Diego market. The San DiegoPennySaver now has the capability of having spot color on every page including color classifieds. Shoppers also introduced computer-to-plate (CTP) equipment in its greater Los Angeles manufacturing plants resulting in film and labor savings.Florida.

During 2003, Shoppers’Total Shoppers circulation coverage increased by approximately 485,000 households600,000 through geographic expansion and household growth in the markets Shoppers already serves.expansion. During the year2004, distribution for the Harte-Hanks ShoppersPennysaverpublicationThe Flyerlocated in south Florida, geographicallyNorthern California expanded by 27,700 households in the south Broward County market, expanded by 15,000 homes in Fort

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Lauderdale, and added 66,000 homes to its circulation by expanding into the communities of Pompano Beach and Coconut Creek.323,500. The Harte-Hanks ShoppersPennysaverpublication in Southern California increased its geographic

coverage by adding 150,000 of circulation in 2004. The Harte-Hanks Shoppers publicationThe Flyerlocated in South Florida, expanded geographically by 129,500 circulation. The Company plans to cover an additional circulation of approximately 1.1 million over the Southeast Los Angeles market by 44,000 households, added 26,000 homesnext three years in the Silverlake neighborhoodNorthern California, Southern California and expanded into Bakersfield, adding 167,000 homes, during 2003.South Florida. The Company believes that expansions provide increased revenues and, ultimately, increased operating income as the publications in these new areas mature. The Company now reaches almost 9.2 million households in California, or nearly 77% of the state’s total.

Publications

The following table sets forth certain information with respect to shopper publications:

Shopper publications contain classified and display advertising and are primarily delivered to consumers’ homes by third-class saturation mail.Standard Mail saturation. The typical shopper publication contains approximately 4749 pages and is 7 by 9 ¹/9-1/2 inches in size. Each edition, or zone, is targeted around a natural neighborhood marketing pattern. Shoppers also serve as a distribution vehicle for multiple ads from national and regional advertisers; “print and deliver” single-sheet inserts designed and printed by the Company; coupon books; preprinted inserts,inserts; and four-color glossy flyers printed by third party printers. In addition, Shoppers offer advertising over its internet sites – www.pennysaverusa.com for its California publications and www.theflyer.com for its South Florida publication.

The Company has acquired, developed and applied innovative technology and customized equipment in the publication of its shoppers, contributing to efficiency and growth. A proprietary pagination system has made it possible for the hundreds of weekly zoned editions to be designed, built and output to plate-ready negatives in a paperless, digital environment. Automating the production process saves on labor, newsprint, and overweight postage. This software also allows for better ad tracking, immediate checks on individual zone and ad status, and more on-time press starts with less manpower.

Sales and Marketing

The Company maintains local Shoppers sales offices throughout its geographic markets and employs more than 620615 commissioned sales representatives who develop both targeted and saturation advertising programs for customers. The sales organization provides service to both national and local advertisers through its telemarketing departments and field sales representatives. Shopper customers vary from individuals with a single item for sale to local neighborhood advertisers to large multi-location advertisers. The core customers continue to be local service businesses and small retailers. The Company also focuses its marketing efforts on larger national accounts by emphasizing its ability to deliver saturation advertising in defined zones, or even partial zones for inserts, in combination with advertising in the shopper publication.

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Additional focus is placed on particular industries/categories through the use of sales specialists. These sales specialists are primarily used to target automotive, real estate and employment advertisers.

The Company utilizes proprietary sales and marketing systems to enter customer orders directly from the field, instantly checking space availability, ad costs and other pertinent information. These systems efficiently facilitate the placement of advertising into multiple-zoned editions and include built-in error-reducing safeguards that aid in minimizing costly sales adjustments. In addition to allowing advertising information to be entered for immediate publication, these systems feed a relational customer database enabling sales personnel to access customer history by designated variables to facilitate the identification of similar potential customers and to assist with timely follow-up on existing customers.

Shoppers Facilities

Harte-Hanks shoppers are produced at owned or leased facilities in the markets they serve. The Company has five production facilities – three in Southern California, one in Northern California and one in its Florida market – and 3031 sales offices.

For more information please refer to Item 2 - Properties.

Competition

Harte-Hanks shoppers compete primarily with metropolitan daily newspapers, shared mail packages and other local advertising media. Shoppers also compete in varying degrees for advertisers and readers with magazines, radio, broadcast and cable television, directories, internet sites, other shoppers and other communications media that operate in their markets. The Company believes that its production systems and technology, which enable it to publish separate editions in narrowly targeted zones, and it’sits local ad content, allow it to compete effectively, particularly in large markets with high media fragmentation.

EMPLOYEES

As of December 31, 2003,2004, Harte-Hanks employed 6,3716,399 full-time employees and 655718 part-time employees, as follows: direct marketing – 4,3714,354 full-time and 294353 part-time employees; shoppers – 1,9812,026 full-time and 360364 part-time employees; and corporate office – 19 full-time employees and 1 part-time employee. None of the work force is represented by labor unions. The Company considers its relations with its employees to be good.

ITEM 2. PROPERTIES

The Harte-Hanks executive offices are located in San Antonio, Texas and occupy approximately 17,000 square feet of leased premises. The Company’s business is conducted in facilities worldwide containing aggregate space of approximately 3.53.3 million square feet. Approximately 3.23.1 million square feet are held under leases, which expire at dates through 2023. The balance of the properties, used in the Company’s Southern California shopper operations, Westville, New Jersey direct marketing operations and Hasselt, Belgium direct marketing operations, are owned by the Company.

ITEM 3. LEGAL PROCEEDINGS

The Company from time to time becomes involved in various claims and lawsuits incidental to its businesses. In the opinion of management, after consultation with counsel, any ultimate liability arising out of currently pending claims and lawsuits willare not expected to have a material effect on the financial condition or operations of the Company.

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

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 20032004 and 20022003 were as follows:

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. In the first quarter of 2002, dividends were paid at the rate of 2.3 cents per share. In the second, third and fourth quarters of 2002, quarterly dividends were paid at the rate of 2.5 cents per share.

As of JanuaryMarch 1, 2004,2005, there are approximately 2,9002,800 holders of record.

Incorporated herein by reference from the information in the Company’s definitive proxy statement for the May 18, 200417, 2005 Annual Meeting of Stockholders under the caption “Management — Directors and Executive Officers.”

Equity Compensation Plan Information

The following table sets forth certain information concerning securities authorized for issuance under equity compensation plans approved by the Company’s stockholders. The Company did not have any equity compensation plans that were not approved by the Company’s stockholders in 2003.2004.

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Issuer Purchases of Equity Securities

The following table contains information about the Company’s purchases of its equity securities during the fourth quarter of 2004:

ITEM 6. SELECTED FINANCIAL DATA

Five-Year Financial Summary

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

The Company’s overall performance reflects its commitment to its strategy of remaining a market leader in the targeted media industry, introducing new products and entering new markets, investing in technology and people, and increasing shareholder value. Harte-Hanks is 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, withbased 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 that are zoned into 877952 separate editions reachingwith total circulation of more than 1011 million households 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

Effective January 1, 2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets”, under which goodwill is no longer amortized for book purposes (See Note A of the “Notes to Consolidated Financial Statements”, included herein). For the purposes of the Management’s Discussion and Analysis section of this report, all 2001 results have been restated as if SFAS No. 142 had been adopted for the year.

Operating results were as follows:

Consolidated revenues increased 3.9%9.1%, to $944.6$1,030.5 million, while operating income declined 2.5%increased 12.8%, to $146.5$165.3 million, in 20032004 compared to 2002.2003. Overall operating expenses increased 5.2%8.4% to $798.1$865.2 million. The Company’s overall results reflect revenue increases in both its Direct Marketing and Shoppers segments. DeclinesIncreases in operating income in the Company’s Direct Marketing segmentand Shoppers segments were partially offset by increased general corporate operating income in the Shoppers segment.expenses.

The Company’s overall 20022003 results reflect increased revenue from its Direct Marketing and Shoppers segments, and an operating income declines in itsdecrease from the Direct Marketing segment, partially offset by increased revenue and operating income from the Shoppers segment.

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Direct Marketing

Direct Marketing operating results were as follows:

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 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 grew throughout 2003, ending up withgroup also had double-digit growth for the year over 2002. The company’s select market group,2002, particularly from the government/non-profit and manufacturing industries, also had growthsectors. Revenues from the pharmaceutical/healthcare vertical market were flat in each quarter of 2003 and ended up with double-digit growth for the year overcompared to 2002. Revenues from the retail vertical market, Direct Marketing’s largest vertical market in terms of annual revenue, were flat in the first quarter of 2003 and then declined each remaining quarter of 2003 versus the same periods in 2002, ending the year down compared to full year 2002. Revenues from the financial services vertical market were down for the first three quarters of 2003 and the full year of 2003 compared to the same periods in 2002, but rebounded to show solid growth in the fourth quarter of 2003 compared to the fourth quarter of 2002. Revenues from the pharmaceutical/healthcare vertical market werealso down in the first quarter, but increased in the last three quarters of 2003 compared to 2002 and ended up flat for the full year 2003 compared to 2002.

From a service offering perspective, Direct Marketing experienced increased revenues in business-to-business telesales, technical 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.

The Company has not seen any material change in the competitive landscape during 2003. 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 $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. Direct Marketing’s largest cost components are labor and transportation, and both of these costs are variable and tend to fluctuate with revenues and the demand for the Company’s Direct Marketing services. Continuing increases in healthcare costs also affected Direct Marketing’s total labor costs during 2003 and are expected to continue to impact the segment’s labor costs and total operating expenses in 2004.

Direct Marketing revenues decreased $28.1 million, or 4.7%, in 2002 compared to 2001. These results reflect revenue declines in most of the company’s largest vertical markets including financial services, retail and pharmaceutical/healthcare. Revenues from the high-tech/telecom vertical market sector were flat compared to 2001. The segment’s select markets group had increased revenues, primarily from the automotive and energy sectors, that were largely attributable to the November 2001 acquisition of Sales Support Services, Inc. Direct

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Marketing experienced revenue declines in data sales, data processing, internet services, consulting services, personalized direct mail and targeted mail businesses partially offset by increased revenues from software sales, logistics operations and agency type business. Direct Marketing revenues were also affected by the 2001 acquisition noted above.

Operating expenses decreased $14.8 million, or 2.9%, in 2002 compared to 2001. Labor costs decreased $19.0 million due to lower volumes and staff reductions. Production and distribution costs increased $6.7 million, primarily due to higher transportation costs related to higher logistics revenues and higher temporary labor costs. General and administrative expenses decreased $2.8 million due to a decrease in bad debt expense, professional services and business services. Depreciation expense increased $0.3 million due to new capital investments to support future growth and improve efficiencies. Operating expenses were also impacted by the 2001 acquisition noted above.

Shoppers

Shoppers operating results were as follows:

Shoppers revenues increased $24.8$29.5 million, or 7.4%8.2%, in 20032004 compared to 2002.2003. Revenue increases were the result of improved sales in established markets and geographic expansions into new neighborhoods and household growth in existing neighborhoods in California and Florida, and the once every six year occurrence of one extra publication week in 2003.Florida. Total Shoppers circulation increased by approximately 485,000 households600,000 during 20032004 and at December 31, 20032004, Shoppers circulation reached approximately 10.5more than 11 million households (including 220,000 households240,000 in South Orange County California, where Shoppers publish two editions each week). During the year distribution for theHarte-Hanks ShoppersPennysaverpublication in Northern California expanded circulation by 323,500. The Harte-Hanks ShoppersPennysaverpublication in Southern California increased geographic coverage by adding 150,000 circulation. The Harte-Hanks Shoppers publicationThe Flyer,located in South Florida, expanded geographically by 27,700 households in the South Broward County market, 15,000 homes in Fort Lauderdale and 66,000 homes in Pompano Beach and Coconut Creek. The Harte-Hanks ShoppersPennysaverpublication in Southern California increased its geographic coverage of the Southeast Los Angeles market by 44,000 households, added 26,000 homes in the Silverlake neighborhood and expanded into Bakersfield, adding 167,000 homes. The Company began moving into a new facility with greater capacity in Northern California in the fourth quarter of 2003 in order to further expand circulation in that area.129,500 circulation. The Company believes that expansions provide increased revenue opportunities and plans to cover an additional circulation of 300,000 to 500,000 households per year in each ofapproximately 1.1 million over the next fewthree 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.

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 run-of-press (ROP, or in-book) 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. In 2004 Shoppers circulation will return to the normal 52 week publication cycle.

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 for the first half of 2003 than in the first half of 2002 and

Index to Financial Statements

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 impactedaffected by the move into the new facility in Northern California and the once every six year occurrence of one extra publication week in 2003. Shoppers largest cost components are labor, postage and paper. Shoppers’ labor costs are variable and tend to fluctuate with volumes and revenues. Continuing increases in healthcare costs are also expected to impact Shoppers’ total labor costs and operating expenses in 2004. Standard postage rates increased at the beginning of the third quarter of 2002, and it is unclear at this time when the next increase might occur. Increased postage rates would impact Shoppers’ total production costs. Newsprint prices began to climb in the fourth quarter of 2003 and are expected to continue to increase in 2004, which will impact Shoppers’ total production costs in 2004.

Shoppers revenues increased $18.9 million, or 6.0%, in 2002 compared to 2001. Revenue increases were the result of improved sales in established markets as well as geographic expansions into new neighborhoods in California. From a product-line perspective, Shoppers had growth in both ROP (in-book advertising), primarily real estate related advertising, and its distribution products, primarily four color glossy flyers. These increases were partially offset by declines in employment-related ROP advertising and coupon book revenues.

Shoppers operating expenses rose $11.8 million, or 4.8%, in 2002 compared to 2001. Labor costs increased $7.5 million due to higher volumes. Production costs increased $4.5 million due to a $5.0 million increase in postage resulting from higher postage rates and increased circulation and volumes. Partially offsetting these increased postage costs were decreased paper costs due to lower rates for both newsprint and job paper. General and administrative costs were flat, as decreased bad debt expense was offset by higher promotion and facilities expenses.

AcquisitionsGeneral Corporate Expense

As describedGeneral corporate operating expense increased $3.3 million, or 39.9%, to $11.4 million in Note B2004 compared to 2003. The increase in general corporate expense in 2004 was primarily a result of the “Notes to Consolidated Financial Statements” included herein, the Company made one acquisition in the past three years.

In November 2001, the Company acquired Sales Support Services, Inc. (SSS), a leading business-to-business lead generation, order processing and fulfillment services companyincreased incentive compensation due to the automotive, energyCompany’s financial performance and other industries.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 primarily 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. Interest expense decreased $1.9 million in 2002 compared to 2001 due primarily to lower outstanding debt levels of the Company’s revolving credit facilities and lower interest expense in 2002 compared to 2001. The Company’s debt at December 31, 20032004 and 20022003 is described in Note DC 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. Interest income decreased $0.2 million in 2002 compared to 2001 due to lower interest rates in 2002 compared to 2001.

Other Income and Expense

Other net expense for 20032004 and 20022003 primarily consists of balance-based bank charges and stockholders expenses.

Index to Financial Statements

Income Taxes

Income taxes increased $8.9 million in 2004 and decreased $0.1 million in 2003, and $0.4 millionprimarilydue to the respective changes in 2002 due to lower income levels. The effective income tax rate was 39.3%40.1%, 39.3% and 38.4% in 2004, 2003 and 38.3% in 2003, 2002, and 2001, 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, for the first time with one solution provider, to define, assess, improve and monitor how well data meets the needs of enterprise 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 InvestmentsResources

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 years’ acquisitions,to 2003, were made in the Direct Marketing segment.

Net cash usedoutflows 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 for 2002 included $17.4 million forand 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 $3.8 million for acquisition-related payments. The capital expenditures consisted primarily of additional computer capacity, technology, systems, new press equipment and equipment upgradesdividends for the Direct Marketing segment. foreseeable future. As of December 31, 2004, the Company had $115.0 million of unused borrowing capacity under its credit facility.

The Shoppers segment’s capital expenditures were primarilyCompany’s contractual obligations at December 31, 2004 are as follows:

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 computer and other production equipment. The acquisition-related payments, which all relate to prior years’ acquisitions, were made in the Direct Marketing segment.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 completionpercentage-of-completion method, as discussed below.

Specifically, Direct Marketing revenue from certain projects and certain services such as database build services, Internetinternet web design, market research and analytical services may be billed onat hourly rates or a set price. If billed at a set price, the revenue is recognized over the contractual period, using the percentage of completionpercentage-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 completionpercentage-of-completion method comprised less than 7% of total Direct Marketing revenue and less than 4%5% of total Harte-Hanks revenue for the years ended December 31, 2004, 2003 2002 and 2001.2002.

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.

Index to Financial Statements

Revenue from the ongoing production and delivery of data is recognized upon completion and delivery of the work and is typically based on a set price or rate. Revenue from time-based subscriptions is based on a set price and is recognized ratably over the term of the subscription.

Revenue from database build services may be billed based on hourly rates or at a set price. If billed at a set price, the database build revenue is recognized over the contractual period, using the percentage-of-completion method based on individual costs incurred to date compared with total estimated contract costs.

Revenue from market research and analytical services may be billed based on hourly rates or a set price. If billed at a set price, the revenue is recognized over the contractual period, using the percentage-of-completion method based on individual costs incurred to date compared with total estimated contract costs. In other instances, progress toward completion is based on performance milestones specified in the contract where such milestones fairly reflect progress toward contract completion.

Revenue related to e-marketing, lead management, multi-channel customer care, inbound and outbound teleservices and technical support is typically billed based on a set price per transaction or service provided. Revenue from these services is recognized as the service or activity is performed.

Revenue from software is recognized in accordance with the American Institute of Certified Public Accountants’ (AICPA) Statement of Position (“SOP”)(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 postcontractpost-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.

ShopperShoppers 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

Index to Financial Statements

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 $1.2 million and $4.4$1.2 million for the years ended December 31, 2004, 2003 2002 and 2001,2002, 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 specificindividual 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.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, 2003,2004, earnings would be impacted by up to $725,000,$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”)(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, 2003.2004. 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, 20032004 and 20022003, 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, and $436.8 million, net of $82.0 million of accumulated amortization, respectively.

Index to Financial Statements

Amortization expense related to goodwill was $16.2 million for the year ended December 31, 2001. Based upon the Company’s analysis, as of December 31, 2003, 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.

Liquidity and Capital Resources

Cash provided by operating activities for 2003 was $124.1 million, down $17.6 million compared to 2002. The decrease in 2003 primarily relates to an increase in accounts receivable at December 31, 2003 over the December 31, 2002 balance due to increased revenues in 2003 over 2002, and a $12.6 million pension plan funding payment made in September 2003. Net cash outflows from investing activities were $31.6 million for 2003 compared to net cash outflows of $20.7 million in 2002. The increase in 2003 primarily relates to higher capital investments, partially offset by a lower amount spent on acquisitions in 2003 than 2002. Net cash outflows from financing activities in 2003 were $85.3 million compared to $126.4 million in 2002. The decrease in 2003 primarily relates to lower net repayments of debt and a lower overall amount spent repurchasing stock in 2003 than in 2002.

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.

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, 2003, the Company had $120.0 million of unused borrowing capacity under its credit facility.

The Company’s contractual obligations at December 31, 2003 are as follows:

At December 31, 2003, the Company had outstanding letters of credit in the amount of $14.7 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, 2003.

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 whichthat 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.

Legislation, Judicial Interpretations, Consumer Environment

There could be a material adverse impact on the Company’s Direct Marketing business due to the enactment of legislation or industry regulations, including the recent creationissuance of do-not-call lists,judicial interpretations, or simply a change in customs, arising from public concern over consumer privacy issues. Restrictions or prohibitions could be placed upon the collection, management, aggregation and use of information that is currently legally available.

Index to Financial Statements

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

Although theThe Company did not complete any acquisitions in 2003 or 2002, it continues to pursue acquisition opportunities, primarily in its Direct Marketing segment.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 achieved.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 ShopperShoppers business competes for advertising, as well as for readers, with other print and electronic media. Competition comes from local and regional newspapers, magazines, radio, broadcast and cable television, shoppers, and other communications media 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 Shoppersshoppers are delivered by standard mail,Standard Mail, and postage is the second largest expense, behind payroll, in the Company’s Shopper business. Standard postage rates increased athave been unchanged since the beginning of the third quarter of 2002.2002, and it is anticipated the next increase in postage rates will occur in 2006. Overall ShopperShoppers postage costs have grown moderately as a result of this increase and are expected to grow further 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 ShopperShoppers 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 ShopperShoppers 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 economics.

Index to Financial Statements

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.

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 were 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.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company’s earnings are affected by changes in short-term interest rates as a result of its revolving credit agreement, which bears interest at variable rates based on EUROLIBOR (effective rate of 1.69%2.91% at December 31, 2003)2004) and has a maturity date of October 17, 2005. At December 31, 2003,2004, the Company’s debt balance was $5$10 million. The Company’s earnings are also affected by changes in short-term interest rates as a result of itsa deferred compensation agreement, which bears interest at variable rates based on Prime (effective rate of 4.0%5.25% at December 31, 2003)2004) and has a balance of $6.0$6.6 million at December 31, 2003.2004. Assuming the current level of borrowing and deferred compensation balance and assuming a one percentage point change in the year’s average interest rates, it is estimated that the Company’s 20032004 net income would have changed by approximately $97,000.$101,000. Due to the Company’s debt level and deferred compensation balance at December 31, 2003,2004, anticipated cash flows from operations, and the various financial alternatives available to management should there be an adverse change in interest rates, the Company does not believe that it has significant exposure to market risks associated with changing interest rates

The Company’s earnings are also affected by fluctuations in foreign exchange rates as a result of its operations in foreign countries. Due to the level of operations in foreign countries, the impact of fluctuations in foreign exchange rates is not significant to the Company’s overall earnings.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Financial Statements required to be presented under Item 8 are presented in the Consolidated Financial Statements and the notes thereto beginning at page F-1 of this Form 10-K (the “Financial Statements”).

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including its Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer concluded that the design and operation of these disclosure controls and procedures were

Index to Financial Statements

effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings. No significant changes were made in the Company’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

Management’s Report on Internal Control Over Financial Reporting and the Report of Independent Registered Public Accounting Firm thereon are set forth in the Consolidated Financial Statements beginning on page F-1.

ITEM 9B. OTHER INFORMATION

None.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

There is incorporated by reference in this Item 10, information from Harte-Hanks’the Harte-Hanks definitive proxy statement for the May 18, 200417, 2005 Annual Meeting of Stockholders under the caption “Management — Directors and Executive Officers” and “Corporate Governance”. Other information required for this item is included under “Item 1. Business-Introduction” of this Annual Report on Form 10-K.

ITEM 11. EXECUTIVE COMPENSATION

There is incorporated by reference in this Item 11, information from Harte-Hanks’the Harte-Hanks definitive proxy statement for the May 18, 200417, 2005 Annual Meeting of the Stockholders under the caption, “Executive Compensation and Other Information” except for those parts under the caption “Report of the Compensation Committee on Executive Compensation”.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

There is incorporated by reference in this Item 12, information from Harte-Hanks’the Harte-Hanks definitive proxy statement for the May 18, 200417, 2005 Annual Meeting of Stockholders under the caption “Security Ownership of Management and Principal Stockholders”.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

None.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. Mr. Harte is a member of the Company’s Board of Directors.

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. Mr. Harte is a member of the Company’s Board of Directors.

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.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

There is incorporated by reference in this Item 14, information regarding principal accountant fees and services under “Principal Auditor Fees and Services” in Harte-Hanks’the Harte-Hanks definitive proxy statement for the May 18, 200417, 2005 Annual Meeting of Stockholders.

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) (1) Financial Statements:

The financial statements filed as a part of this report are listed in the “Index to Consolidated Financial Statements and Schedule” referenced in Item 8.

(a) (2) Financial Statement Schedule

The financial statement schedule filed as a part of this report are listed in the “Index to Consolidated Financial Statements and Schedule” referenced in Item 8.

Index to Financial Statements

(a) (3) Exhibits

Index to Financial Statements

(a) (3) Exhibits (Continued)

The agreements set forth above describe the contents of certain exhibits thereunto which are not included. However, such exhibits will be furnished to the Commission upon request.

(b) Reports on Form 8-K

The Company filed a report on Form 8-K dated January 29, 2004.31, 2005. The report incorporated the Company’s earnings release for the period ended December 31, 2003.2004. Under the reports, the Company furnished (not filed) pursuant to Item 9 and Item 12, the press release entitled “Harte-Hanks Reports Fourth Quarter andEPS of $0.32; Full Year 2004 EPS Growth”Up 14.4% on Revenue Growth of 9.1%” relating to the results of the fourth fiscal quarter ended December 31, 2003,2004, and the fiscal year ended December 31, 2003,2004, as well as related non-GAAP financial information and filed GAAP financial statements under Item 7.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Harte-Hanks, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: March 16, 2005

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities indicated.

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Harte-Hanks, Inc. and Subsidiaries

Index to Consolidated Financial Statements and Schedule

All other schedules for which provision is made in the applicable rules and regulations of the Securities and Exchange Commission have been omitted as the schedules are not required under the related instructions, are not applicable, or the information required thereby is set forth in the consolidated financial statements or notes thereto.

Index toReport of Independent Registered Public Accounting Firm on Financial Statements

INDEPENDENT AUDITORS’ REPORT

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, 20032004 and 2002,2003, 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, 2003. In connection with our audit of the consolidation financial statements, we also have audited the accompanying financial statement schedule.2004. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with auditingthe standards generally accepted inof the United States of America.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 consolidated 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, 20032004 and 20022003, and the results of their operations and their cash flows for each of the three years in the three-year period ended December 31, 2003,2004, in conformity with accounting principlesU.S. generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.accounting principles.

As discussedWe also have audited, in Note A toaccordance with the Consolidated Financial Statements,standards of the Public Company adoptedAccounting Oversight Board (United States), the provisionseffectiveness of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”the Company’s internal control over financial reporting as of January 1, 2002.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.

/s/ KPMG LLP

San Antonio, Texas

January 28, 2004March 15, 2005

IndexManagement’s Report on Internal Control Over Financial Reporting

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 included review of the documentation of controls, evaluation of the design 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.

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

/s/ Richard Hochhauser

Richard Hochhauser

President and Chief Executive Officer

/s/ Dean Blythe

Dean Blythe

Senior Vice President and

Chief Financial Officer

/s/ Jessica Huff

Jessica Huff

Vice President, Finance and

Chief Accounting Officer

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