HARTE HANKS INC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2004

¨	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission File Number 1-7120

HARTE-HANKS, INC.

(Exact name of registrant as specified in its charter)


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

200 Concord Plaza Drive, San Antonio, Texas		78216
(Address of principal executive offices)		(Zip Code)

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

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock: $1 par value per share, 85,320,612 shares as of October 31, 2004.

HARTE-HANKS, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

FORM 10-Q REPORT

September 30, 2004


			Page

Part I. Financial Information

Item 1.	Interim Condensed Consolidated Financial Statements (Unaudited)

		Condensed Consolidated Balance Sheets – September 30, 2004 and December 31, 2003	3

		Consolidated Statements of Operations – Three months ended September 30, 2004 and 2003	4

		Consolidated Statements of Operations – Nine months ended September 30, 2004 and 2003	5

		Consolidated Statements of Cash Flows – Nine months ended September 30, 2004 and 2003	6

		Consolidated Statements of Stockholders’ Equity and Comprehensive Income – Nine months ended September 30, 2004 and twelve months ended December 31, 2003	7

		Notes to Unaudited Condensed Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		12

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		18

Item 4	Controls and Procedures		18

Part II. Other Information

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		19

Item 6.	Exhibits		19

Item 1. Interim Condensed Consolidated Financial Statements (Unaudited)

Harte-Hanks, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets (in thousands, except share amounts)


	(Unaudited) September 30, 2004			December 31, 2003
Assets
Current assets
Cash and cash equivalents	$	19,135		$	32,151
Accounts receivable, net		181,579			152,703
Inventory		5,793			5,213
Prepaid expenses		16,041			13,816
Current deferred income tax asset		8,813			7,682
Other current assets		7,882			5,732

Total current assets		239,243			217,297

Property, plant and equipment, (less accumulated depreciation of $206,678 in 2004 and $194,987 in 2003)		104,651			97,747
Goodwill, (less accumulated amortization of $81,973 in 2004 and 2003)		448,762			437,156
Other intangible assets, (less accumulated amortization of $2,783 in 2004 and $2,333 in 2003)		2,217			2,667
Other assets		3,815			4,263

Total assets	$	798,688		$	759,130

Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable	$	49,565		$	47,891
Accrued payroll and related expenses		32,599			22,808
Customer deposits and unearned revenue		54,283			48,658
Income taxes payable		5,765			7,776
Other current liabilities		7,028			6,939

Total current liabilities		149,240			134,072

Long-term debt		20,000			5,000
Other long-term liabilities		74,472			64,460

Total liabilities		243,712			203,532

Stockholders’ equity
Common stock, $1 par value per share, 250,000,000 shares authorized. 114,176,842 and 113,280,794 shares issued at September 30, 2004 and December 31, 2003, respectively		114,177			113,281
Additional paid-in capital		249,756			235,996
Retained earnings		858,587			798,974
Less treasury stock: 28,935,200 and 25,788,502 shares at cost at September 30, 2004 and December 31, 2003, respectively		(648,590	)		(573,863	)
Accumulated other comprehensive loss		(18,954	)		(18,790	)

Total stockholders’ equity		554,976			555,598

Total liabilities and stockholders’ equity	$	798,688		$	759,130

See Notes to Unaudited Condensed Consolidated Financial Statements.

Harte-Hanks, Inc. and Subsidiaries

Consolidated Statements of Operations (in thousands, except per share amounts)

(Unaudited)


	Three Months Ended September 30,
	2004			2003
Operating revenues	$	262,566		$	239,366

Operating expenses
Labor		99,726			88,442
Production and distribution		91,326			84,906
Advertising, selling, general and administrative		20,987			20,264
Depreciation and amortization		6,871			7,090
Intangible amortization		150			150

Total operating expenses		219,060			200,852

Operating income		43,506			38,514

Other expenses (income)
Interest expense		239			199
Interest income		(31	)		(32	)
Other, net		243			488

		451			655

Income before income taxes		43,055			37,859
Income tax expense		17,402			14,935

Net income	$	25,653		$	22,924

Basic earnings per common share	$	0.30		$	0.26

Weighted-average common shares outstanding		85,612			88,288

Diluted earnings per common share	$	0.29		$	0.26

Weighted-average common and common equivalent shares outstanding		87,259			89,571

See Notes to Unaudited Condensed Consolidated Financial Statements.

Harte-Hanks, Inc. and Subsidiaries

Consolidated Statements of Operations (in thousands, except per share amounts)

(Unaudited)


	Nine Months Ended September 30,
	2004			2003
Operating revenues	$	752,970		$	688,855

Operating expenses
Labor		291,175			262,595
Production and distribution		261,247			241,272
Advertising, selling, general and administrative		61,071			57,202
Depreciation and amortization		21,065			22,523
Intangible amortization		450			450

Total operating expenses		635,008			584,042

Operating income		117,962			104,813

Other expenses (income)
Interest expense		671			650
Interest income		(322	)		(132	)
Other, net		928			1,501

		1,277			2,019

Income before income taxes		116,685			102,794
Income tax expense		46,697			40,410

Net income	$	69,988		$	62,384

Basic earnings per common share	$	0.81		$	0.70

Weighted-average common shares outstanding		86,467			88,887

Diluted earnings per common share	$	0.79		$	0.69

Weighted-average common and common equivalent shares outstanding		88,084			90,327

See Notes to Unaudited Condensed Consolidated Financial Statements.

Harte-Hanks, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (in thousands)

(Unaudited)


	Nine Months Ended September 30,
	2004			2003
Cash Flows from Operating Activities
Net income	$	69,988		$	62,384
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization		21,065			22,523
Intangible amortization		450			450
Amortization of option-related compensation		76			72
Deferred income taxes		7,220			9,103
Other, net		314			297
Changes in operating assets and liabilities, net of acquisitions:
Increase in accounts receivable, net		(27,810	)		(6,615	)
(Increase) decrease in inventory		(580	)		472
(Increase) decrease in prepaid expenses and other current assets		(4,276	)		110
Increase in accounts payable		1,415			9,204
Increase (decrease) in other accrued expenses and other current liabilities		14,107			(1,252	)
Other, net		2,452			(8,836	)

Net cash provided by operating activities		84,421			87,912

Cash Flows from Investing Activities
Acquisitions, net of cash acquired		(17,173	)		(343	)
Purchases of property, plant and equipment		(22,115	)		(25,683	)
Proceeds from sale of property, plant and equipment		181			444

Net cash used in investing activities		(39,107	)		(25,582	)

Cash Flows from Financing Activities
Long-term borrowings		45,000			45,000
Repayment of long-term borrowings		(30,000	)		(36,300	)
Issuance of common stock		9,786			10,069
Purchase of treasury stock		(72,862	)		(68,483	)
Issuance of treasury stock		121			95
Dividends paid		(10,375	)		(7,992	)

Net cash used in financing activities		(58,330	)		(57,611	)

Net (decrease) increase in cash and cash equivalents		(13,016	)		4,719
Cash and cash equivalents at beginning of year		32,151			25,026

Cash and cash equivalents at end of period	$	19,135		$	29,745

See Notes to Unaudited Condensed Consolidated Financial Statements.

Harte-Hanks, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity and Comprehensive Income (in thousands)

(2004 Unaudited)


	Common Stock		Additional Paid-In Capital			Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Income (Loss)			Total Stockholders’ Equity
Balance at January 1, 2003	$	111,535	$	216,149		$	722,231		$	(491,793	)	$	(25,589	)	$	532,533
Common stock issued- employee benefit plans		213		3,199			—			—			—			3,412
Exercise of stock options for cash and by surrender of shares		1,533		10,392			—			(5,828	)		—			6,097
Tax benefit of options exercised		—		6,282			—			—			—			6,282
Dividends paid ($0.12 per share)		—		—			(10,619	)		—			—			(10,619	)
Treasury stock repurchased		—		—			—			(76,393	)		—			(76,393	)
Treasury stock issued		—		(26	)		—			151			—			125
Comprehensive income, net of tax:
Net income		—		—			87,362			—			—			87,362
Adjustment for minimum pension liability (net of tax of $2,652)		—		—			—			—			4,053			4,053
Foreign currency translation adjustment		—		—			—			—			2,746			2,746

Total comprehensive income																94,161

Balance at December 31, 2003		113,281		235,996			798,974			(573,863	)		(18,790	)		555,598

Common stock issued- employee benefit plans		132		2,450			—			—			—			2,582
Exercise of stock options for cash and by surrender of shares		764		7,667			—			(1,981	)		—			6,450
Tax benefit of options exercised		—		3,638			—			—			—			3,638
Dividends paid ($0.12 per share)		—		—			(10,375	)		—			—			(10,375	)
Treasury stock repurchased		—		—			—			(72,862	)		—			(72,862	)
Treasury stock issued		—		5			—			116			—			121
Comprehensive income, net of tax:
Net income		—		—			69,988			—			—			69,988
Foreign currency translation adjustment		—		—			—			—			(164	)		(164	)

Total comprehensive income																69,824

Balance at September 30, 2004	$	114,177	$	249,756		$	858,587		$	(648,590	)	$	(18,954	)	$	554,976

See Notes to Unaudited Condensed Consolidated Financial Statements.

Harte-Hanks, Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements

Note A - Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of Harte-Hanks, Inc. and subsidiaries (the “Company”).

The statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three months and nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the consolidated financial statements and footnotes included in the Company’s annual report on Form 10-K for the year ended December 31, 2003.

Certain prior period amounts have been reclassified for comparative purposes.

Note B - Income Taxes

The Company’s quarterly income tax provision of $17.4 million was calculated using an effective income tax rate of approximately 40.4%. The Company’s nine month income tax provision of $46.7 million, was calculated using an effective income tax rate of approximately 40.0%. The Company’s effective income tax rate is derived by estimating pretax income and income tax expense for the year ending December 31, 2004. The effective income tax rate calculated is higher than the federal statutory rate of 35% due to the addition of state taxes and to certain expenses recorded for financial reporting purposes that are not deductible for federal income tax purposes.

Note C - Earnings Per Share

A reconciliation of basic and diluted earnings per share (EPS) is as follows:


	Three Months Ended September 30,
In thousands, except per share amounts	2004		2003
BASIC EPS
Net Income	$	25,653	$	22,924

Weighted-average common shares outstanding used in earnings per share computations		85,612		88,288

Earnings per common share	$	0.30	$	0.26

DILUTED EPS
Net Income	$	25,653	$	22,924

Shares used in diluted earnings per share computations		87,259		89,571

Earnings per common share	$	0.29	$	0.26

Computation of shares used in earnings per share computations:
Weighted-average outstanding common shares		85,612		88,288
Weighted average common equivalent shares - dilutive effect of option shares		1,647		1,283

Shares used in diluted earnings per share computations		87,259		89,571

For the purpose of calculating the shares used in the diluted EPS calculation for the three months ended September 30, 2004 there were no anti-dilutive options outstanding. For the purpose of calculating the shares used in the diluted EPS calculation for the three months ending September 30, 2003, 753,000 anti-dilutive market price options have been excluded from the EPS calculations.


	Nine Months Ended September 30,
In thousands, except per share amounts	2004		2003
BASIC EPS
Net Income	$	69,988	$	62,384

Weighted-average common shares outstanding used in earnings per share computations		86,467		88,887

Earnings per common share	$	0.81	$	0.70

DILUTED EPS
Net Income	$	69,988	$	62,384

Shares used in diluted earnings per share computations		88,084		90,327

Earnings per common share	$	0.79	$	0.69

Computation of shares used in earnings per share computations:
Weighted-average outstanding common shares		86,467		88,887
Weighted-average common equivalent shares - dilutive effect of option shares		1,617		1,440

Shares used diluted in earnings per share computations		88,084		90,327

For the purpose of calculating the shares used in the diluted EPS calculation for the nine months ended September 30, 2004 and 2003, 93,000 and 762,000 anti-dilutive market price options have been excluded from the EPS calculations, respectively.

Note D – Business Segments

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

Information about the Company’s operations in its two different business segments follows:


	Three Months Ended September 30,
In thousands	2004			2003
Operating revenues
Direct Marketing	$	162,410		$	147,964
Shoppers		100,156			91,402

Total operating revenues	$	262,566		$	239,366

Operating Income
Direct Marketing	$	23,508		$	19,712
Shoppers		23,013			20,719
Corporate Activities		(3,015	)		(1,917	)

Total operating income	$	43,506		$	38,514

Income before income taxes
Operating income	$	43,506		$	38,514
Interest expense		(239	)		(199	)
Interest income		31			32
Other, net		(243	)		(488	)

Total income before income taxes	$	43,055		$	37,859


	Nine Months Ended September 30,
In thousands	2004			2003
Operating revenues
Direct Marketing	$	461,804		$	424,473
Shoppers		291,166			264,382

Total operating revenues	$	752,970		$	688,855

Operating Income
Direct Marketing	$	61,217		$	53,289
Shoppers		64,801			57,678
Corporate Activities		(8,056	)		(6,154	)

Total operating income	$	117,962		$	104,813

Income before income taxes
Operating income	$	117,962		$	104,813
Interest expense		(671	)		(650	)
Interest income		322			132
Other, net		(928	)		(1,501	)

Total income before income taxes	$	116,685		$	102,794

Note E – Stock-Based Compensation

The Company has adopted the disclosure-only provisions of SFAS No. 123. Accordingly, no compensation expense has been recognized for options granted where the exercise price is equal to the market price of the underlying stock at the date of grant. For options issued with an exercise price below the market price of the underlying stock on the date of grant, the Company recognizes compensation expense under the provisions of APB No. 25, as permitted under SFAS No. 123.

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


	Three Months Ended September 30,
In thousands, except per share amounts	2004			2003
Net income – as reported	$	25,653		$	22,924
Stock-based employee compensation expense, included in reported net income, net of related tax effects		15			15
Stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects		(1,057	)		(952	)

Net income – pro forma	$	24,611		$	21,987

Basic earnings per share – as reported	$	0.30		$	0.26
Basic earnings per share – pro forma	$	0.29		$	0.25
Diluted earnings per share – as reported	$	0.29		$	0.26
Diluted earnings per share – pro forma	$	0.28		$	0.25


	Nine Months Ended September 30,
In thousands, except per share amounts	2004			2003
Net income – as reported	$	69,988		$	62,384
Stock-based employee compensation expense, included in reported net income, net of related tax effects		46			44
Stock-based employee compensation expense determined under fair value based methods for all awards, net of related tax effects		(2,771	)		(2,805	)

Net income – pro forma	$	67,263		$	59,623

Basic earnings per share – as reported	$	0.81		$	0.70
Basic earnings per share – pro forma	$	0.78		$	0.67
Diluted earnings per share – as reported	$	0.79		$	0.69
Diluted earnings per share – pro forma	$	0.76		$	0.66

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants during the nine months ended September 30, 2004 and 2003:


	Nine Months Ended September 30,
	2004		2003
Expected dividend yield.	0.71	%	0.63	%
Expected stock price volatility	26.4	%	26.7	%
Risk free interest rate	3.8	%	4.0	%
Expected Life of options	3-10 years		3-10 years

Note F – Components of Net Periodic Pension Benefit Cost

Prior to January 1, 1999, the Company maintained a defined benefit pension plan for which most of its employees were eligible. In conjunction with significant enhancements to the Company’s 401(k) plan, the Company elected to freeze benefits under this defined benefit pension plan as of December 31, 1998.

In 1994, the Company adopted a non-qualified, supplemental pension plan covering certain employees, which provides for incremental pension payments so that total pension payments equal those amounts that would have been payable from the Company’s principal pension plan if it were not for limitations imposed by income tax regulation. The benefits under this supplemental pension plan will continue to accrue as if the principal pension plan had not been frozen.

Net pension cost for both plans included the following components:


	Three Months Ended September 30,
In thousands	2004			2003
Service Cost	$	140		$	131
Interest Cost		1,642			1,640
Expected return on plan assets		(1,849	)		(1,491	)
Amortization of prior service cost		16			16
Transition obligation		24			—
Recognized actuarial loss		491			620

Net periodic benefit cost	$	464		$	916


	Nine Months Ended September 30,
In thousands, except per share amounts	2004			2003
Service Cost	$	421		$	392
Interest Cost		4,927			4,920
Expected return on plan assets		(5,547	)		(4,473	)
Amortization of prior service cost		47			48
Transition obligation		72			—
Recognized actuarial loss		1,473			1,860

Net periodic benefit cost	$	1,393		$	2,747

The Company presently does not expect to make a contribution to either of its pension plans in 2004.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Harte-Hanks is a worldwide, direct and targeted marketing company that provides direct marketing services and shopper advertising opportunities to a wide range of local, regional, national and international consumer and business-to-business marketers. 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. Experts at each element within this process, Harte-Hanks Direct Marketing is highly skilled at tailoring solutions for each of the vertical markets it serves. Harte-Hanks Shoppers is North America’s largest owner, operator and distributor of shopper publications, with shoppers that are zoned into more than 900 separate editions with circulation in excess of 11 million in California and Florida each week.

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

Results of Operations

Operating results were as follows:


	Three months ended				Change		Nine months ended				Change
In thousands	Sept. 30, 2004		Sept. 30, 2003		Change		Sept. 30, 2004		Sept. 30, 2003		Change
Revenues	$	262,566	$	239,366	9.7	%	$	752,970	$	688,855	9.3	%
Operating expenses		219,060		200,852	9.1	%		635,008		584,042	8.7	%

Operating income	$	43,506	$	38,514	13.0	%	$	117,962	$	104,813	12.5	%

Net income	$	25,653	$	22,924	11.9	%	$	69,988	$	62,384	12.2	%

Diluted earnings per share	$	0.29	$	0.26	11.5	%	$	0.79	$	0.69	14.5	%

Consolidated revenues increased 9.7% to $262.6 million and operating income increased 13.0% to $43.5 million in the third quarter of 2004 when compared to the third quarter of 2003. Overall operating expenses compared to 2003 increased 9.1% to $219.1 million in the third quarter of 2004 when compared to the third quarter of 2003.

Net income increased 11.9% to $25.7 million and diluted earnings per share grew

11.5% to 29 cents per share in the third quarter of 2004 when compared to the third quarter of 2003. The increase in net income was a result of increased operating income in the third quarter of 2004 when compared to the third quarter of 2003.

Direct Marketing

Direct Marketing operating results were as follows:


	Three months ended				Change		Nine months ended				Change
In thousands	Sept. 30, 2004		Sept. 30, 2003		Change		Sept. 30, 2004		Sept. 30, 2003		Change
Revenues	$	162,410	$	147,964	9.8	%	$	461,804	$	424,473	8.8	%
Operating expenses		138,902		128,252	8.3	%		400,587		371,184	7.9	%

Operating income	$	23,508	$	19,712	19.3	%	$	61,217	$	53,289	14.9	%

Direct Marketing revenues increased $14.4 million, or 9.8%, in the third quarter of 2004 compared to 2003. These results reflect year-over-year revenue growth in all of Direct Marketing’s vertical markets. Revenues from the high-tech/telecom, pharmaceutical/healthcare and select vertical market groups all had double-digit growth compared to the prior year quarter. Revenues from the financial services vertical market and retail vertical market had mid to high single-digit growth compared to the third quarter of 2003. This was the second consecutive quarter that all of Direct Marketing’s vertical markets increased on a year-over-year comparison. Revenues from the Company’s vertical markets are impacted by the economic fundamentals of each industry as well as the financial condition of specific customers.

From a service offering perspective, Direct Marketing experienced increased revenues from customer care, fulfillment, software, logistics, analytics, database processing and telesales. Partially offsetting these increases were declines in revenues from data processing.

Operating expenses increased $10.7 million, or 8.3%, in the third quarter of 2004 compared to 2003. Labor costs increased $7.9 million, or 12.7%, in the third quarter of 2004 compared to 2003 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 $2.6 million, or 5.4%, due primarily to higher logistics-related transportation costs, outsourcing costs, and production services expense, which were partially offset by decreased lease expense. General and administrative expense increased $0.4 million, or 3.3%, due to increased bad debt expense and employee expenses, partially offset by decreased professional services. Depreciation and amortization expense decreased $0.3 million, or 4.5%, due to lower capital expenditures starting in 2001 and continuing into 2002 and assets becoming fully depreciated.

Direct Marketing revenues increased $37.3 million, or 8.8%, in the first nine months of 2004 compared to the first nine months of 2003. These results reflect double-digit year-over-year revenue growth from the high-tech/telecom, financial services, and pharmaceutical/healthcare vertical markets. Direct Marketing also had low to mid single digit revenue growth from its select vertical market group and retail vertical market in the first nine months of 2004.

From a service offering perspective, Direct Marketing experienced increased revenues from customer care, analytics, software, fulfillment, targeted mail, and agency-related business. Partially offsetting these increases were declines in revenues from data sales and data processing.

Operating expenses increased $29.4 million, or 7.9%, in the first nine months of 2004 compared to the first nine months of 2003. Labor costs increased $20.4 million, or 11.1%, in the first nine months of 2004 compared to 2003 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 $8.5 million, or 6.2% primarily due to higher outsourcing costs and production services, which were partially offset by decreased lease expense and logistics-related transportation costs. General and administrative expense increased $2.0 million, or 6.4%, due to increased insurance costs and bad debt expense, partially offset by decreased professional services. Depreciation and amortization expense decreased $1.5 million, or 8.0%, due to lower capital expenditures starting in 2001 and continuing into 2002 and assets becoming fully depreciated.

Direct Marketing’s largest cost components are labor, outsourced costs, and transportation. Each of these costs are variable and tend to fluctuate with revenues and the demand for the Company’s direct marketing services.

The acquisition of Avellino Technologies Ltd. at the end of February 2004 had a minimal impact on revenues and operating expenses for the first nine months of 2004, and is not expected to materially impact revenues or operating expenses for the full year 2004.

Shoppers

Shopper operating results were as follows:


	Three months ended				Change		Nine months ended				Change
In thousands	Sept. 30, 2004		Sept. 30, 2003		Change		Sept. 30, 2004		Sept. 30, 2003		Change
Revenues	$	100,156	$	91,402	9.6	%	$	291,166	$	264,382	10.1	%
Operating expenses		77,143		70,683	9.1	%		226,365		206,704	9.5	%

Operating income	$	23,013	$	20,719	11.1	%	$	64,801	$	57,678	12.3	%

Shopper revenues increased $8.8 million, or 9.6%, in the third quarter of 2004 compared to 2003. Revenue increases were the result of improved sales in established markets as well as new year-over-year geographic expansions into new neighborhoods and household growth in California and Florida. Shoppers expanded circulation by approximately 148,500 in California and Florida during the third quarter of 2004 and at the end of the quarter Shopper circulation was more than 11.0 million (including circulation of 241,000 in South Orange County, California where Shoppers publish two editions each week). The Company believes that expansions provide increased revenue opportunities and plans to expand in each of the next few years. Newer areas initially 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.

Operating expenses increased $6.5 million, or 9.1%, in the third quarter of 2004 compared to 2003. Labor costs increased $2.7 million, or 10.8%, 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 $3.8 million, or 10.5%, including increased postage of $1.9 million due to increased volumes, and increased paper costs due to increased volumes and rates. General and administrative costs decreased slightly, down 0.4%, primarily due to decreased promotion costs, insurance expense, and professional services, partially offset by higher bad debt expense and business services. Depreciation and amortization expense increased slightly, up 3.6% in the third quarter of 2004 compared to 2003 due to recent capital investments to support future growth.

Shopper revenues increased $26.8 million, or 10.1%, in the first nine months of 2004 compared to the first nine months of 2003. Revenue increases were the

result of improved sales in established markets as well as new year-over-year geographic expansions into new neighborhoods and household growth in California and Florida. Shoppers expanded circulation by approximately, 600,000 in the first nine months of 2004.

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

Operating expenses increased $19.7 million, or 9.5%, in the first nine months of 2004 compared to the first nine months of 2003. Labor costs increased $7.1 million, or 9.6%, due to higher payroll costs as a result of higher volumes and circulation expansions, and higher unemployment taxes, partially offset by lower pension expense. Production costs increased $11.5 million, or 11.0%, including additional postage of $6.2 million due to increased volumes, increased paper costs due to increased volumes and rates and higher outsourcing costs. General and administrative costs increased $1.0 million, or 4.4%, due to increased business services costs, bad debt expense, taxes and employee expense, partially offset by decreased promotion costs. Depreciation and amortization expense increased slightly, up 1.2% during the first nine months of 2004 compared to 2003 due to recent capital investments to support future growth.

Shopper labor costs are variable and tend to fluctuate with volumes and revenues. 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 total Shopper production costs. Newsprint prices began to climb in the fourth quarter of 2003 and continued to increase in the first nine months of 2004. This increase impacted Shopper’s production costs in the first nine months of 2004 and is expected to impact Shopper’s production costs for the remainder of the year.

General Corporate Expense

General corporate expense increased $1.1 million, or 57.3%, to $3.0 million during the third quarter of 2004 compared to the third quarter of 2003. General corporate expense increased $1.9 million, or 30.9%, to $8.0 million during the first nine months of 2004 compared to the first nine months of 2003. The increase in general corporate expense in both the third quarter and the first nine months of 2004 was primarily a result of increased incentive compensation due to the Company’s financial performance, and increased professional services.

Other Income and Expense

Other net expense for the third quarter and first nine months of 2004 primarily consists of balance-based bank charges and stockholder expenses, and was partially offset by currency gains.

Interest Expense/Interest Income

Interest expense was up slightly in the third quarter and first nine months of 2004 compared to the same periods in 2003, primarily due to increases in interest rates.

Interest income was flat in the third quarter of 2004 compared to the third quarter of 2003. Interest income was up $0.2 million in the first nine months of 2004 compared to the first nine months of 2003 due to interest related to a tax refund the Company received in the first quarter of 2004.

Income Taxes

The Company’s income tax expense increased $2.5 million in the third quarter of 2004 and $6.3 million in the first nine months of 2004 compared to the same periods in 2003. These changes were primarily due to the changes in pre-tax income levels. The effective tax rate was 40.4% for the third quarter of 2004 and 39.4% for the third quarter of 2003. The effective tax rate was 40.0% for the first nine months of 2004 and 39.3% for the first nine months of 2003.

Liquidity and Capital Resources

Cash provided by operating activities for the nine months ended September 30, 2004 was $84.4 million, compared to $87.9 million for the first nine months of 2003. Net cash outflows from investing activities were $39.1 million for the first nine months of 2004, compared to $25.6 million for the first nine months of 2003. The difference between net cash outflows from investing activities in 2004 and 2003 is primarily the result of the acquisition of Avellino Technologies Ltd. in February 2004. The remaining net cash outflows in both years primarily relate to purchases of fixed assets. Net cash outflows from financing activities were $58.3 million in 2004 compared to $57.6 million in 2003. The difference between net cash outflows from financing activities in 2004 and 2003 is attributable primarily to net borrowings on the Company’s credit facility of $15.0 million in the first nine months of 2004 compared to net borrowings of $8.7 million in the first nine months of 2003. Partially offsetting the difference in outflows from financing activities in 2004 compared to 2003 were a higher amount spent for the repurchase of treasury stock and higher dividend payments in 2004.

Capital resources are also 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. As of September 30, 2004, the Company had $105 million of unused borrowing capacity under this credit facility. Management believes that its credit facility, together with cash provided from operating activities, will be sufficient to fund operations and anticipated acquisitions, capital expenditures, stock repurchases and dividend payments for the foreseeable future. Management also believes that the Company has the ability to obtain a larger credit facility if it were to become necessary.

Factors That May Affect Future Results and Financial Condition

From time to time, in both written reports and oral statements by senior management, the Company may express its expectations regarding its future performance. These “forward-looking statements” are inherently uncertain, and investors should realize that events could turn out to be other than what senior management expected. Set forth below are some key factors that could affect the Company’s future performance, including its revenues, net income and earnings per share; however, the risks described below are not the only ones the Company faces. Additional risks and uncertainties that are not presently known, or that the Company currently considers immaterial, could also impair the Company’s business operations.

Legislation – There could be a material adverse impact on the Company’s Direct Marketing business due to the enactment of additional legislation or industry regulations, including consumer privacy legislation. Restrictions or prohibitions could be placed upon the collection and use of information that is currently legally available.

Data Suppliers – There could be a material adverse impact on the Company’s Direct Marketing business if owners of the data the Company uses were to withdraw the data. Data providers could withdraw their data if there is a competitive reason to do so or if additional legislation is passed restricting the use of the data.

Acquisitions - The Company continues to pursue acquisition opportunities. Acquisition activities, even if not consummated, require substantial amounts of management time and can distract from normal operations. In addition, there can be no assurance that the synergies and other objectives sought in acquisitions will be achieved.

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 Shopper business competes for advertising, as well as for readers, with other print and electronic media. Competition comes from local and regional newspapers, magazines, radio, broadcast and cable television, shoppers, other communications media and other advertising printers that operate in the Company’s markets. The extent and nature of such competition are, in large part, determined by the location and demographics of the markets targeted by a particular advertiser, and the number of media alternatives in those markets. Failure to continually improve the Company’s current processes and to develop new products and services could result in the loss of the Company’s customers to current or future competitors. In addition, failure to gain market acceptance of new products and services could adversely affect the Company’s growth.

Qualified Personnel – The Company believes that its future prospects will depend in large part upon its ability to attract, train and retain highly skilled technical, client services and administrative personnel. While dependent on employment levels and general economic conditions, qualified personnel historically have been in great demand and from time to time and in the foreseeable future will likely remain a limited resource.

Postal Rates – The Company’s Shoppers and Direct Marketing services depend on the United States Postal Service to deliver products. The Company’s Shoppers are delivered by standard mail, and postage is the second largest expense, behind payroll, in the Company’s Shopper business. Standard postage rates increased at the beginning of the third quarter of 2002. Overall Shopper postage costs are expected to grow as a result of anticipated increases in circulation and insert volumes. Postal rates also influence the demand for the Company’s Direct Marketing services even though the cost of mailings is borne by the Company’s customers and is not directly reflected in the Company’s revenues or expenses.

Paper Prices – Paper represents a substantial expense in the Company’s Shopper 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 Shopper business are dependent to a large extent on local advertising expenditures in the markets in which they operate. Such expenditures are substantially affected by the strength of the local economies in those markets. Direct Marketing revenues are dependent on national and international economies.

Interest Rates – Interest rate movements in Europe and the United States can affect the amount of interest the Company pays related to its debt and the amount it earns on cash equivalents. The Company’s primary interest rate exposure is to interest rate fluctuations in Europe, specifically EUROLIBOR rates due to their impact on interest related to the Company’s $125 million credit facility. The Company also has exposure to interest rate fluctuations in the United States, specifically money market, commercial paper and overnight time deposit rates as these affect the Company’s earnings on its excess cash.

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 3. 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 2.28% at September 30, 2004) and has a maturity date of October 17, 2005. At September 30, 2004, the Company had $20 million of debt outstanding under its revolving line of credit. The Company’s earnings are also affected by changes in short-term interest rates as a result of its deferred compensation agreement, which bears interest at variable rates based on Prime (effective rate of 4.75% at September 30, 2004) and has a balance of $6.4 million at September 30, 2004. Assuming the current level of borrowing and deferred compensation balance and assuming a one percentage point change in the quarter’s and first nine months’ annual interest rates, it is estimated that the Company’s net income for the third quarter and first nine months of 2004 would have been approximately $35,000 and $69,000 lower, respectively. Due to the Company’s debt level and deferred compensation balance at September 30, 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 as of September 30, 2004. The Company does not use derivative financial instruments in its operations.

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 4. 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-15(e) 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 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.

PART II. OTHER INFORMATION

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

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


Period	Total Number of Shares Purchased(1)	Average Price Paid per Share		Total Number of Shares Purchased as Part of a Publicly Announced Plan	Maximum Number of Shares that May Yet Be Purchased Under the Plan
July 1 – 31, 2004	331,071	$	24.68	257,500	6,858,449
August 1 – 31, 2004(2)	576,500	$	24.14	576,500	6,275,749
September 1 – 30, 2004	154,600	$	24.50	154,600	6,127,349

Total	1,062,171	$	24.33	988,600

(1)

During the third quarter of 2004, 988,600 shares were purchased through the Company’s stock repurchase program that was publicly announced in January 1997. Under this program, from which shares can be purchased in the open market or through privately negotiated transactions, our Board authorized the repurchase of up to 44,900,000 shares of our outstanding common stock. As of September 30, 2004 we had repurchased a total of 38,772,651 shares at an average price of $16.26 per share under this program.

(2)	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.

Item 6. Exhibits

See index to Exhibits on Page 23.

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.


		HARTE-HANKS, INC.

November 9, 2004		/s/ Richard M. Hochhauser
Date		Richard M. Hochhauser
		President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.


		HARTE-HANKS, INC.

November 9, 2004		/s/ Dean H. Blythe
Date		Dean H. Blythe
		Senior Vice President and
		Chief Financial Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.


		HARTE-HANKS, INC.

November 9, 2004		/s/ Jessica M. Huff
Date		Jessica M. Huff
		Vice President, Finance and
		Chief Accounting Officer


Exhibit No.	Description of Exhibit	Page No.
3(a)	Amended and Restated Certificate of Incorporation as amended through May 5, 1998 (filed as Exhibit 3(e) to the Company’s Form 10-Q for the six months ended June 30, 1998 and incorporated by reference herein).

3(b)	Second Amended and Restated Bylaws (filed as Exhibit 3(b) to the Company’s Form 10-Q for the nine months ended September 30, 2001 and incorporated by reference herein).

10(a)	1984 Stock Option Plan (filed as Exhibit 10(d) to the Company’s Form 10-K for the year ended December 31, 1984 and incorporated herein by reference).+

10(b)	Registration Rights Agreement dated as of September 11, 1984 among HHC Holding Inc. and its stockholders (filed as Exhibit 10(b) to the Company’s Form 10-K for the year ended December 31, 1993 and incorporated by reference herein).

10(c)	Harte-Hanks, Inc. Amended and Restated Restoration Pension Plan dated as of January 1, 2000 (filed as Exhibit 10(f) to the Company’s Form 10-K for the year ended December 31, 1999 and Incorporated by reference herein).+

10(d)	Harte-Hanks Communications, Inc. 1996 Incentive Compensation Plan (filed as Exhibit 10(p) to the Company’s Form 10-Q for the nine months ended September 30, 1996 and incorporated by reference herein).+

10(e)	Harte-Hanks, Inc. Amended and Restated 1991 Stock Option Plan (filed as Exhibit 10(g) to the Company’s Form 10-Q for the six months ended June 30, 1998 and incorporated by reference herein).+

10(f)	Harte-Hanks, Inc. 1998 Director Stock Plan (filed as Exhibit 10(h) to the Company’s Form 10-Q for the six months ended June 30, 1998 and incorporated by reference herein).+

10(g)	Harte-Hanks, Inc. Deferred Compensation Plan (filed as Exhibit 10(i) to the Company’s Form 10-K for the year ended December 31, 1998 and incorporated by reference herein).+

10(h)	Amendment One to Harte-Hanks, Inc. Amended and Restated Restoration Plan dated December 18, 2000 (filed as Exhibit 10(l) to the Company’s Form 10-K for the year ended December 31, 2000 and incorporated by reference herein).+

10(i)	Three-Year Credit Agreement dated as of October 18, 2002 between Harte-Hanks, Inc. and the Lenders named therein for $125 million (filed as Exhibit 10(n) to the Company’s form 10-Q for the nine months ended September 30, 2002 and incorporated by reference herein).

10(j)	Harte-Hanks 1994 Employee Stock Purchase Plan As Amended (filed as Exhibit 10(o) to the Company’s form 10-K for the year ended December 31, 2002 and incorporated by reference herein).+

*21	Subsidiaries of the Company.	25


Exhibit No.	Description of Exhibit	Page No.
*31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	26

*31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.	27

*32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	28

*32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the	29

	Sarbanes-Oxley Act of 2002

*	Filed herewith

+	Indicates management contract or compensatory plan, contract or arrangement.

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.

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