HARTE HANKS INC - Quarter Report: 2007 September (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2007

For the transition period from              to             

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

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.    x  Yes    ¨  No

Indicate by check mark whether registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer's classes of common stock: $1 par value per share, 70,493,269 shares as of October 31, 2007.

Table of Contents

HARTE-HANKS, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

FORM 10-Q REPORT

September 30, 2007

2

Table of Contents

Harte-Hanks, Inc. and Subsidiaries

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

See Notes to Unaudited Condensed Consolidated Financial Statements.

3

Table of Contents

Harte-Hanks, Inc. and Subsidiaries

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

(Unaudited)

See Notes to Unaudited Condensed Consolidated Financial Statements.

4

Table of Contents

Harte-Hanks, Inc. and Subsidiaries

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

(Unaudited)

See Notes to Unaudited Condensed Consolidated Financial Statements.

5

Table of Contents

Harte-Hanks, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (in thousands)

(Unaudited)

See Notes to Unaudited Condensed Consolidated Financial Statements.

6

Table of Contents

Harte-Hanks, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity and Comprehensive Income (in thousands, except per share amounts)

(2007 Unaudited)

See Notes to Unaudited Condensed Consolidated Financial Statements.

7

Table of Contents

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 its subsidiaries (the “Company”). Intercompany transactions and balances have been eliminated.

The statements have been prepared in accordance with U.S. generally accepted accounting principles 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 U.S. generally accepted accounting principles for complete financial statements. The preparation of financial statements in accordance with U.S generally accepted accounting principles for interim financial information requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. 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, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis and the consolidated financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2006.

As used in this report, the terms “Harte-Hanks,” “we,” “us,” or “our” may refer to Harte-Hanks, one or more of its consolidated subsidiaries, or all of them taken as a whole.

Note B – Income Taxes

Our third quarter 2007 income tax provision of $14.5 million was calculated using an effective income tax rate of approximately 39.8%. Our first nine months 2007 income tax provision of $42.6 million was calculated using an effective income tax rate of approximately 39.6%. Our effective income tax rate is derived by estimating pretax income and income tax expense for the year ending December 31, 2007. 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.

We adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (FIN 48), on January 1, 2007. We did not recognize a change to our unrecognized tax benefits as a result of this adoption. At January 1, 2007, unrecognized tax benefits totaled $11.7 million, of which $1.1 million represents accruals for interest and penalties that were recorded as additional tax expense in accordance with our accounting policy. If recognized, $7.8 million, net of tax, would impact the effective tax rate. There have been no significant changes to these amounts during the quarter or nine months ended September 30, 2007.

Harte-Hanks, Inc. and its subsidiaries file income tax returns in the U.S. federal jurisdiction, and various state, local and foreign jurisdictions. With the exception of a few state returns, we are no longer subject to U.S. federal, state, local or non-U.S. income tax examinations by tax authorities for the years prior to 2003. The statute of limitations on the other 2002 tax returns will expire during 2007. An audit of the 2003 U.S. federal return has been completed. We believe that it is reasonably possible that a reduction in our unrecognized tax liabilities in the range of $1.6 million to $1.8 million, net of tax, will occur in the next twelve months related to the statute expiring on various tax returns. If this reduction were to occur, it would decrease the tax expense and effective tax rate for the full year 2007.

8

Table of Contents

Note C – Stock-Based Compensation

We recognized $2.0 million and $1.9 million of stock-based compensation during the three months ended September 30, 2007 and 2006, respectively. We recognized $5.5 million and $5.6 million of stock-based compensation during the nine months ended September 30, 2007 and 2006, respectively. The 2007 amounts include $0.8 million of stock-based compensation recognized during the third quarter of 2007 related to the announced retirement of our Chief Executive Officer and former President, Mr. Richard Hochhauser. At the date of the announcement, all of his unvested stock-based awards were revalued and the total unamortized value was expensed. The 2007 amounts also reflect the reversal of $0.5 million of previously recorded stock-based compensation related to performance stock units, as none of the performance goals associated with these performance stock units are expected to be achieved.

Our annual grant of stock-based awards occurred in the first quarter of 2007, which is consistent with the timing of previous annual grants. In the third quarter of 2007, we granted 0.3 million additional stock options with a weighted-average fair value of $8.18. There was no additional significant stock-based compensation activity in the third quarter of 2007.

Note D – Interest Rate Risk

We use derivative instruments to manage the risk of changes in prevailing interest rates adversely affecting future cash flows associated with our credit facilities, which had a combined outstanding balance of $220.0 million at September 30, 2007. The derivative instrument used to manage such risk is the interest rate swap. We account for interest rate swaps in accordance with Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities.

As with any financial instrument, derivative instruments have inherent risks, primarily market and credit risk. Market risk associated with changes in interest rates is managed as part of our overall market risk monitoring process by establishing and monitoring limits as to the degree of risk that may be undertaken. Credit risk occurs when a counterparty to a derivative contract in which we have an unrealized gain fails to perform according to the terms of the agreement. We minimize our credit risk by entering into transactions with counterparties that maintain high credit ratings.

For a derivative instrument designated as a cash flow hedge, the effective portion of changes in the fair value of the derivative instrument is recorded in other comprehensive income and is recognized as a component of interest expense in the statement of operations when the hedged item affects results of operations. The Company discontinues hedge accounting prospectively if it is determined that (i) an interest rate swap is not highly effective in offsetting changes in the cash flows of a hedged item, (ii) the derivative expires or is sold, terminated or exercised, or (iii) the derivative is undesignated as a hedge instrument because it is unlikely that a forecasted transaction will occur.

If hedge accounting is discontinued, the derivative instrument will continue to be carried at fair value, with changes in the fair value of the derivative instrument recognized in the current period’s results of operations. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the accumulated gains and losses included in accumulated other comprehensive income will be recognized immediately in results of operations. When hedge accounting is discontinued because the derivative instrument has not been or will not continue to be highly effective as a hedge, the remaining amount in accumulated other comprehensive income is amortized into earnings over the remaining life of the derivative.

9

Table of Contents

In September 2007, we entered into an interest rate swap agreement with a notional amount of $150.0 million and a two year term beginning on September 28, 2007. This interest rate swap changes the variable-rate cash flow exposure on the $150.0 million notional amount to fixed-rate cash flows by entering into receive-variable, pay-fixed interest rate swap transactions. Under this swap transaction, we receive London Interbank Offered Rate (LIBOR) based variable interest rate payments and make fixed-interest rate payments, thereby creating fixed-rate debt. We designated this hedging relationship as hedging the risk of changes in cash flows (a cash flow hedge) attributable to changes in the LIBOR rate applicable to our Revolving Credit Facility and Term Loan Facility. At September 30, 2007, we have not recorded any amounts related to this swap in our financial statements as the amounts were not considered material. Going forward, we will report the fair value of the swap as an asset or liability on our balance sheet, any ineffectiveness as interest expense, and effective changes to the fair value of the swap in other comprehensive income.

On a quarterly basis, we will assess the ineffectiveness of the hedging relationship, and any gains or losses related to the ineffectiveness will be recorded as interest expense in our statement of operations. We do not expect the ineffectiveness related to our current hedging activity to be material to our financial results in the future. There were no components of the derivative instruments that were excluded from the assessment of hedge effectiveness.

We do not enter into derivative instruments for any purpose other than cash flow hedging. We do not speculate using derivative instruments.

We assess interest rate risk by regularly identifying and monitoring changes in interest rate exposure that may adversely impact expected future cash flows and by evaluating hedging opportunities.

Note E – Earnings Per Share

Basic earnings per share is computed on the basis of the weighted number of shares of common stock outstanding during the period. Diluted earnings per share is computed on the basis of the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and nonvested shares.

10

Table of Contents

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

2.6 million and 2.0 million anti-dilutive market price options have been excluded from the calculation of shares used in the diluted EPS calculation for the three months ended September 30, 2007 and 2006, respectively.

11

Table of Contents

2.3 million and 1.9 million anti-dilutive market price options have been excluded from the calculation of shares used in the diluted EPS calculation for the nine months ended September 30, 2007 and 2006, respectively.

Note F – Business Segments

Harte-Hanks is a worldwide, direct and targeted marketing company with operations in two segments – Direct Marketing and Shoppers.

12

Table of Contents

Information about the operations of Harte-Hanks in our two different business segments follows:

Note G – Components of Net Periodic Pension Benefit Cost

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

13

Table of Contents

In 1994, we 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 our principal pension plan if it were not for limitations imposed by income tax regulations. 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:

We made a $5.0 million contribution to our frozen pension plan in May 2007 in order to obtain the Pension Benefit Guaranty Corporation full funding limit exemption. We are not required to make and do not intend to make any additional contributions to either pension plan for the remainder of 2007 other than to the extent needed to cover benefit payments related to the unfunded plan.

14

Table of Contents

Note H – Comprehensive Income

Comprehensive income for a period encompasses net income and all other changes in equity other than from transactions with our stockholders. Our comprehensive income was as follows:

Cautionary Note Regarding Forward-Looking Statements

This report, including this Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A), contains “forward-looking statements” within the meaning of the federal securities laws. All such statements are qualified by this cautionary note, which is provided pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may also be included in our other public filings, press releases, our website and oral and written presentations by management. Statements other than historical facts are forward-looking and may be identified by words such as “may,” “will,” “expects,” “believes,” “anticipates,” “plans,” “estimates,” ”seeks,” “could,” “intends,” or words of similar meaning. Examples include statements regarding (1) our strategies and initiatives, (2) our financial outlook, including adjustments to our cost structure and other actions designed to improve our financial performance, (3) our expectations for our businesses and for the industries in which we operate, including with regard to the negative performance trends in our Shoppers business, (4) competitive factors, (5) acquisition and development plans, (6) our stock repurchase program, (7) expectations regarding pending legal proceedings and other contingent liabilities, and (8) other statements regarding future events, conditions or outcomes. These forward-looking statements are based on current information, expectations and estimates and involve risks, uncertainties, assumptions and other factors that are difficult to predict and that could cause actual results to vary materially from what is expressed in or indicated by the forward-looking statements. In that event, our business, financial condition, results of operations or liquidity could be materially adversely affected and investors in our securities could lose part or all of their investments. Some of these risks, uncertainties, assumptions and other factors can be found in our filings with the Securities and Exchange

15

Table of Contents

Commission, including the factors discussed under "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2006 (2006 Form 10-K) and any updates thereto in our Forms 10-Q. The forward-looking statements included in this report and those included in our other public filings, press releases, our website and oral and written presentations by management are made only as of the respective dates thereof, and we undertake no obligation to update publicly any forward-looking statement in this report or in other documents, our website or oral statements for any reason, even if new information becomes available or other events occur in the future.

Overview

The following MD&A section is intended to help the reader understand the results of operations and financial condition of Harte-Hanks, Inc. (Harte-Hanks). This section is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes to the financial statements contained elsewhere in this report and our MD&A section, financial statements and accompanying notes to financial statements in our 2006 Form 10-K. Our 2006 Form 10-K contains a discussion of other matters not included herein, such as disclosures regarding critical accounting policies and estimates, and contractual obligations.

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. We manage our operations through two operating segments: Direct Marketing and Shoppers.

Harte-Hanks Direct Marketing improves the return on its clients’ marketing investment by increasing their prospect and customer value – a process of “customer optimization” – organized around five strategic considerations:

We utilize various capabilities and technologies to enable our clients to identify, reach, influence and nurture their customers. The services and products offered by Direct Marketing are tailored to specific industries or markets. Our direct marketing business services various vertical markets including retail, high-tech/telecom, financial services, pharmaceutical/healthcare, and a wide range of selected markets. Depending on the needs of our clients, our direct marketing capabilities are provided in an integrated approach through more than 30 facilities worldwide, more than 10 of which are located outside of the United States. Each of these centers possesses some specialization and is linked with others to support the needs of our clients. Revenues from the Direct Marketing segment represented approximately 63% of our total revenue for the three months ended September 30, 2007.

Harte-Hanks Shoppers is North America’s largest owner, operator and distributor of shopper publications, based on weekly circulation and revenues. Shoppers are weekly advertising publications delivered free by Standard Mail to households and businesses in a particular geographic area. 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 September 30, 2007, our shoppers are zoned into more than 1,000 separate editions with circulation of approximately 13 million each week in California and Florida. Our Shoppers

16

Table of Contents

segment also provides advertising services online through our websites, ThePennySaverUSA.com and TheFlyer.com. Revenues from the Shoppers segment represented approximately 37% of our total revenue for the three months ended September 30, 2007.

We derive revenues from the sale of direct marketing services and shopper advertising services. As a worldwide business, direct marketing is affected by, among other things, general national and international economic trends. Our shoppers operate in local markets and are largely affected by the strength of the local economies in California and Florida.

Our overall strategy is based on seven key elements:

Our principal expense items are labor, postage and transportation.

Results of Operations

Operating results were as follows:

3^rd Quarter 2007 vs. 3^rd Quarter 2006

Revenues

Consolidated revenues decreased 2.7%, to $286.7 million, and operating income decreased 10.3% to $40.0 million in the third quarter of 2007 when compared to the third quarter of 2006. Our overall results reflect decreased revenues of 12.6% from our Shoppers segment, partially offset by increased revenues of 4.1% from our Direct Marketing segment. The revenue performance from Shoppers was the result of decreased sales in established markets, primarily attributable to the challenging real estate and associated financing markets in the California and Florida geographies in which we operate, circulation reductions, and the discontinuation of commercial printing operations in our Tampa facility. Direct Marketing results reflect year-over-year double-digit growth in our high tech/telecom vertical and mid-single digit growth in our select vertical. Our financial vertical continued to struggle and showed a double-digit revenue decline.

Operating Expenses

Overall operating expenses decreased 1.4%, to $246.7 million, in the third quarter of 2007 compared to the third quarter of 2006. Operating expenses included $4.6 million of restructuring and transition costs recognized in the

17

Table of Contents

third quarter of 2007. The overall decrease in operating expenses was driven by decreased production and labor costs in Shoppers, attributable to the decline in Shoppers revenues. For the quarter, Shoppers operating expenses decreased $10.9 million or 11.1%, while Direct Marketing operating expenses increased $4.9 million or 3.3% and general corporate expense increased $2.7 million or 94.5%.

Net Income/Earnings Per Share

Net income decreased 20.9%, to $21.9 million, and diluted earnings per share decreased 14.3%, to $0.30 per share, in the third quarter of 2007 when compared to the third quarter of 2006. The decrease in net income was a result of decreased operating income, increased interest expense and a higher effective tax rate in the third quarter of 2007 when compared to the third quarter of 2006.

For the company as a whole, we incurred $4.6 million of expenses in the third quarter related to actions designed to improve short-term performance and better position us for longer term growth in revenue and profits. In Direct Marketing, actions in the third quarter were aimed at flattening our organizational structure to improve efficiency and bring our sales, marketing and operations closer to our customers. In Shoppers, actions in the third quarter were designed to reduce fixed costs and headcount, and included streamlining our structure from six operating units into three operating units: the California PennySaver unit, the Florida Flyer unit and the Shopper digital unit. Year-to-date we have incurred over $7.0 million of restructuring costs on a consolidated basis and we anticipate incurring additional costs in the fourth quarter of 2007. For the full year 2007, we anticipate that these costs will exceed the overall benefit we will experience as a result of these initiatives. We expect that these actions will directly reduce our cost base in 2008 by approximately $14 million, although the total change in operating expenses from 2007 to 2008 will be dependent on many different variables.

First Nine Months 2007 vs. First Nine Months 2006

Revenues

Consolidated revenues decreased 1.3%, to $859.9 million, and operating income decreased 13.3% to $117.7 million in the first nine months of 2007 when compared to the first nine months of 2006. Our overall results reflect decreased revenues of 7.3% from our Shoppers segment, partially offset by increased revenues of 2.9% from our Direct Marketing segment. The revenue performance from Shoppers was the result of decreased sales in established markets, primarily attributable to the challenging real estate and associated financing markets in the California and Florida geographies in which we operate, circulation reductions, and the discontinuation of commercial printing operations in our Tampa facility. Direct Marketing comparisons were affected by $7.0 million of revenue recognized in the second quarter of 2006 relating to a contract termination fee received from one of our customers in the financial vertical. Excluding revenues from this contract termination, Direct Marketing’s revenues in the first nine months of 2007 would have been up $21.7 million, or 4.3%, and consolidated revenues would have been down 0.5% compared to the first nine months of 2006.

Operating Expenses

Overall operating expenses increased 0.9%, to $742.2 million, in the first nine months of 2007 compared to the first nine months of 2006. This increase includes over $7.0 million of restructuring and transition costs discussed above, including approximately $1.0 million recognized in our Shoppers segment in the second quarter of 2007 related to the shut down of approximately 600,000 of unprofitable circulation at the end of June 2007. The remaining overall decrease in operating expenses was driven by decreased production and labor costs in Shoppers, attributable to the decline in Shoppers revenues. Direct Marketing operating expenses increased $16.6 million, or 3.8%, and general corporate expense increased $2.8 million or 31.5%, while Shoppers operating expenses decreased $12.9 million or 4.5%. Direct Marketing’s results were impacted by $2.4 million of operating expense recognized in the second quarter of 2006 as a result of the contract termination discussed above.

18

Table of Contents

Net Income/Earnings Per Share

Net income decreased 20.2%, to $65.1 million, and diluted earnings per share decreased 13.0%, to $0.87 per share, in the first nine months of 2007 when compared to the first nine months of 2006. The decrease in net income was a result of decreased operating income, increased interest expense and a higher effective tax rate in the first nine months of 2007 when compared to the first nine months of 2006.

Direct Marketing

Direct Marketing operating results were as follows:

3^rd Quarter 2007 vs. 3^rd Quarter 2006

Revenues

Direct Marketing revenues increased $7.2 million, or 4.1%, in the third quarter of 2007 compared to the third quarter of 2006. Our high tech/telecom vertical, which was helped by our September 2006 acquisition of Aberdeen Group, Inc. (Aberdeen), was up double-digits and our select vertical grew in the mid-single digits. Our pharma/healthcare vertical was up in the low-single digits, while our retail vertical was flat in the quarter. Our financial vertical continued to struggle and was down double-digits. Revenues from our vertical markets are impacted by, among other things, the economic fundamentals of each industry, various market factors, including the demand for services by our clients, and the financial condition of and budgets available to specific clients. Revenues for Direct Marketing are affected by a number of factors, including general national and international economic trends.

From a service offering perspective, Direct Marketing experienced increased revenues from telesales, market research and analytics, and internet services. Partially offsetting these increases were declines in revenues from print, technical support and database processing.

The acquisition of Aberdeen in September 2006 also positively affected our revenues in the third quarter of 2007 compared to the third quarter of 2006. This positive affect was partially offset by the negative affect on third quarter revenues from the sale of a print operation in October 2006.

Future revenues will depend on, among other factors, how successful we are at growing business with existing clients, acquiring new clients, meeting client demands, and the strength of the national and international economies. We believe that in the long-term we will benefit from marketing and advertising expenditures being moved from other advertising media to the targeted media space, the results of which can be more effectively tracked, enabling measurement of the return on marketing investment. Standard postage rates increased in January of 2006 and again in May of 2007. Postage rates influence the demand for our Direct Marketing services even though the cost of mailings is borne by our clients and is not directly reflected in our revenues or expenses. While we do not expect the postal rate increases to have a significant impact on our Direct Marketing business, there is no assurance that future postal increases will not have an adverse impact on us.

Operating Expenses

Operating expenses increased $4.9 million, or 3.3%, in the third quarter of 2007 compared to the third quarter of 2006. Contributing to this increase were restructuring costs, primarily severance, of $1.6 million recognized in the third quarter of 2007. Labor costs increased $10.3 million, or 14.3%, in the third quarter of 2007 compared to

19

Table of Contents

the third quarter of 2006 due to severance and higher payrolls and temporary labor due to more labor intensive revenues. Production and distribution costs decreased $4.3 million, or 7.5%, due to lower logistics-related transportation costs and less expense related to printing materials. The shift in revenues from high production cost, less labor intensive work done at our divested print facility to more labor intensive, lower production cost work done at Aberdeen also contributed to the changes in labor and production and distribution costs. General and administrative expense decreased $1.4 million, or 10.0%, due primarily to decreased insurance costs. Depreciation and amortization expense increased $0.2 million, or 3.3%, due to additional intangible amortization related to 2006 acquisitions, primarily Aberdeen, and additional depreciation of assets related to our facility in Manila.

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

First Nine Months 2007 vs. First Nine Months 2006

Revenues

Direct Marketing revenues increased $14.7 million, or 2.9%, in the first nine months of 2007 compared to the first nine months of 2006. These year-over-year comparisons were affected by $7.0 million of revenue recognized in the second quarter of 2006 relating to a contract termination fee received discussed above. Excluding revenues from this contract termination, revenues in the first nine months of 2007 would have been up $21.7 million, or 4.3%, compared to the first nine months of 2006. Our high tech/telecom vertical, which was helped by our September 2006 acquisition of Aberdeen, was up double-digits and our select vertical grew in the high-single digits. Our retail vertical was up slightly, while our pharma/healthcare vertical was flat in the first nine months. Excluding impact of the contract termination fee, our financial vertical was down in the high-single digits.

From a service offering perspective, Direct Marketing experienced increased revenues from telesales, market research and analytics, internet services, software programming and fulfillment. Partially offsetting these increases were declines in revenues from print, data and database processing, and data sales.

The acquisitions of StepDot Software GmbH in June 2006, Global Address in July 2006 and Aberdeen in September 2006 positively affected our revenues in the first nine months of 2007 compared to the first nine months of 2006. The sale of a print operation in October 2006 negatively affected our revenues in the first nine months of 2007 compared to the first nine months of 2006.

Operating Expenses

Operating expenses increased $16.6 million, or 3.8%, in the first nine months of 2007 compared to the first nine months of 2006. These results were affected by $2.4 million of operating expense recognized in the second quarter of 2006 as a result of the contract termination discussed above. Excluding the expenses related to the contract termination, operating expense increased $19.0 million, or 4.4%. The results were also affected by approximately $3.3 million of costs, primarily severance and lease termination costs, recognized in the first nine months of 2007 as part of the restructuring initiative discussed above. Labor costs increased $23.0 million, or 10.6%, in the first nine months of 2007 compared to the first nine months of 2006 due to severance and higher payrolls and temporary labor due to the relative increase in revenues from more labor intensive service lines. Production and distribution costs decreased $11.1 million, or 6.7%, due to lower logistics-related transportation costs and less expense related to printing materials. The shift in revenues from high production cost, less labor intensive work done at our divested print facility to more labor intensive, lower production cost work done at Aberdeen also contributed to the changes in labor and production and distribution costs. General and administrative expense increased $2.5 million, or 6.9%, due primarily to increased employee expenses including travel, recruiting and training, increased business service costs and higher bad debt expense due to timing. Depreciation and amortization expense increased $2.1 million, or 11.3%, due to additional intangible amortization related to 2006 acquisitions, primarily Aberdeen, and additional depreciation of assets related to our facility in Manila.

20

Table of Contents

Shoppers

Shoppers operating results were as follows: