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U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended August 2, 2002
OR
[_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from to
Commission file Number 001-14137
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HLM Design, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Delaware 56-2018819
(State or Other (I.R.S Employer
Jurisdiction Identification No.)
of Incorporation or
Organization)
121 West Trade Street, Suite 2950
Charlotte, North Carolina 28202
(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (704) 358-0779
Indicate by check 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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Title of Each Class Outstanding at September 6, 2002
------------------- --------------------------------
Common stock, par value $.001 per share 2,369,224 shares
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HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES INDEX TO FORM 10-Q
PAGE
NO.
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PART I . FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Balance Sheets--May 3, 2002 and August 2, 2002.......................... 1
Consolidated Statements of Income--Three-Month Periods Ended August 3, 2001 and
August 2, 2002..................................................................... 3
Consolidated Statement of Stockholders' Equity--Three-Month Period Ended
August 2, 2002..................................................................... 4
Consolidated Statements of Cash Flows--Three-Month Periods Ended August 3, 2001 and
August 2, 2002..................................................................... 5
Notes to Unaudited Consolidated Financial Statements................................. 6
ITEM 2. Management's Discussion and Analysis of Financial Condition And Results of Operations 12
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk........................... 19
ITEM 4. Controls and Procedures.............................................................. 19
PART II. OTHER INFORMATION
ITEM 2. Changes in Securities and Use of Proceeds............................................ 20
ITEM 6. Exhibits and Reports on Form 8-K..................................................... 20
SIGNATURES................................................................................... 21
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES
CONSOLIDATED BALANCE SHEETS
May 3, 2002 August 2, 2002
----------- --------------
(Unaudited)
ASSETS:
Current Assets:
Cash............................................................................ $ 460,870 $ 444,165
Trade and other receivables, less allowance for doubtful accounts at May 3, 2002
and August 2, 2002 of $1,768,221 and $2,178,473, respectively................. 13,856,090 14,012,973
Costs and estimated earnings in excess of billings on uncompleted projects...... 7,639,530 8,066,998
Prepaid expenses and other...................................................... 1,261,092 1,187,951
----------- -----------
Total Current Assets..................................................... 23,217,582 23,712,087
----------- -----------
Other Assets:
Goodwill, net................................................................... 20,834,104 21,841,583
Non-compete agreements, net..................................................... 302,084 287,500
Deferred income taxes........................................................... 531,661 542,141
Other non-current assets........................................................ 1,061,272 1,158,562
----------- -----------
Total Other Assets....................................................... 22,729,121 23,829,786
----------- -----------
Property and Equipment:
Leasehold improvements....................................................... 2,471,340 2,509,542
Furniture and fixtures....................................................... 5,250,567 5,301,889
----------- -----------
Property and equipment, at cost................................................. 7,721,907 7,811,431
Less accumulated depreciation................................................... 5,758,626 6,056,819
----------- -----------
Property and equipment, net.............................................. 1,963,281 1,754,612
----------- -----------
TOTAL ASSETS.................................................................... $47,909,984 $49,296,485
=========== ===========
See notes to unaudited consolidated financial statements.
1
HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES
CONSOLIDATED BALANCE SHEETS
May 3, 2002 August 2, 2002
----------- --------------
(Unaudited)
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current Liabilities:
Current maturities of long-term debt and capital lease obligations............. $11,262,014 $12,534,030
Accounts payable............................................................... 10,525,274 9,562,711
Billings in excess of costs and estimated earnings on uncompleted projects..... 2,282,782 2,579,246
Accrued payroll................................................................ 1,056,328 739,714
Income taxes payable........................................................... 567,555 671,737
Deferred income taxes.......................................................... 2,357,550 1,913,926
Accrued expenses and other..................................................... 2,156,163 2,688,454
----------- -----------
Total Current Liabilities............................................... 30,207,666 30,689,818
LONG-TERM DEBT................................................................. 4,941,667 5,053,454
MINORITY INTEREST.............................................................. 99,015 139,291
OTHER.......................................................................... 138,050 138,050
----------- -----------
TOTAL LIABILITIES.............................................................. 35,386,398 36,020,613
----------- -----------
Commitments and contingencies
STOCKHOLDERS' EQUITY:
Capital Stock:
Preferred, $.10 par value, authorized 800,000 shares, no shares outstanding
6.5% Series A Cumulative Convertible Preferred, $.10 par value, non-voting,
authorized 200,000 shares, no shares outstanding
Common, $.001 par value, voting, authorized 9,000,000 shares; issued
2,939,082 and 2,945,222 at May 3, 2002 and August 2, 2002, respectively
(includes 620,998 and 575,998 to be issued on a delayed delivery schedule
at May 3, 2002 and August 2, 2002, respectively).......................... 2,939 2,945
Additional paid in capital..................................................... 9,467,106 9,624,608
Retained earnings.............................................................. 3,069,407 3,401,661
Accumulated other comprehensive (loss) income.................................. (15,866) 246,658
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Total stockholders' equity..................................................... 12,523,586 13,275,872
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY..................................... $47,909,984 $49,296,485
=========== ===========
See notes to consolidated financial statements.
2
HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Three Months
Ended Ended
August 3, 2001 August 2, 2002
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REVENUES:
Fee Income................................... $14,357,612 $17,053,284
Reimbursable Income.......................... 1,270,187 778,099
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Total Revenues........................... 15,627,799 17,831,383
CONSULTANT EXPENSE.............................. 4,592,773 4,571,830
PROJECT EXPENSES:
Direct Expenses.............................. 256,643 687,912
Reimbursable Expenses........................ 649,670 558,278
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Total project expenses................... 906,313 1,246,190
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NET PRODUCTION INCOME........................... 10,128,713 12,013,363
DIRECT LABOR.................................... 3,504,047 3,741,660
INDIRECT EXPENSES............................... 6,216,215 7,297,583
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OPERATING INCOME................................ 408,451 974,120
INTEREST EXPENSE................................ 338,387 410,885
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INCOME BEFORE INCOME TAXES AND MINORITY INTEREST 70,064 563,235
INCOME TAX EXPENSE.............................. 37,300 190,706
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INCOME BEFORE MINORITY INTEREST................. 32,764 372,529
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MINORITY INTEREST IN (LOSS) INCOME.............. (16,830) 40,275
----------- -----------
NET INCOME...................................... $ 49,594 $ 332,254
=========== ===========
NET INCOME PER SHARE
Basic........................................ $ 0.02 $ 0.11
=========== ===========
NUMBER OF SHARES USED TO COMPUTE PER SHARE DATA
Basic........................................ 2,517,165 2,941,376
=========== ===========
NET INCOME PER SHARE
Diluted...................................... $ 0.02 $ 0.11
=========== ===========
NUMBER OF SHARES USED TO COMPUTE PER SHARE DATA
Diluted...................................... 2,517,165 2,941,582
=========== ===========
See notes to unaudited consolidated financial statements.
3
HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
Accumulated
Common Stock Additional Other Total
---------------- Paid-In Retained Comprehensive Stockholders'
Shares Amount Capital Earnings (Loss) Income Equity
--------- ------ ---------- ---------- ------------- -------------
Balance, May 3, 2002............ 2,939,082 $2,939 $9,467,106 $3,069,407 $(15,866) $12,523,586
Warrants issued in connection
with the acquisition of
SOTA.......................... 145,765 145,765
Issuance of common stock........ 6,140 6 11,737 11,743
Comprehensive income:
Net income................... 332,254
Foreign currency translation
adjustment................. 262,524
--------
Total comprehensive income...... 594,778
--------- ------ ---------- ---------- -------- -----------
Balance, August 2, 2002......... 2,945,222 $2,945 $9,624,608 $3,401,661 $246,658 $13,275,872
========= ====== ========== ========== ======== ===========
See notes to unaudited consolidated financial statements.
4
HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Three Months
Ended Ended
August 3, 2001 August 2, 2002
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................................................... $ 49,594 $ 332,254
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation.......................................................................... 241,591 298,193
Amortization of intangible assets..................................................... 14,583 14,584
Amortization of deferred loan fees.................................................... 49,934 77,019
Deferred income taxes................................................................. (402,699) (449,493)
Other................................................................................. (25,703) 40,276
Changes in assets and liabilities, net of acquired assets and foreign currency
exchange, which provided (used) cash:
Trade and other accounts receivable................................................ (620,745) 83,793
Costs and estimated earnings in excess of billings on uncompleted projects......... 491,788 (370,865)
Prepaid expenses and other assets.................................................. 388,777 (57,626)
Accounts payable................................................................... 74,454 (1,042,960)
Billings in excess of costs and estimated earnings on uncompleted projects......... 429,545 273,410
Income tax payable................................................................. -- 90,310
Accrued expenses, payroll and other................................................ 8,975 93,925
--------- -----------
Net cash provided by (used in) operating activities............................. 700,094 (617,180)
--------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment...................................................... (101,488) (89,524)
Payment for purchase of SOTA, net of cash acquired....................................... (141,576) --
--------- -----------
Net cash used in investing activities................................................. (243,064) (89,524)
--------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment on long-term borrowings.......................................................... (179,952) (593,071)
Net borrowings on revolving credit facility.............................................. (753,236) 1,299,210
Borrowings on long-term debt............................................................. 432,345 --
Proceeds from issuance of common stock under the Employee Stock Purchase Plan............ 13,510 11,743
--------- -----------
Net cash (used in) provided by financing activities................................... (487,333) 717,882
--------- -----------
Effect of currency exchange rate changes on cash............................................. -- (27,883)
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DECREASE IN CASH............................................................................. (30,303) (16,705)
CASH BALANCE:
Beginning of period...................................................................... 243,148 460,870
--------- -----------
End of period............................................................................ $ 212,845 $ 444,165
========= ===========
SUPPLEMENTAL DISCLOSURES:
Interest paid............................................................................ $ 229,657 $ 305,033
Income tax (refunds) payments............................................................ $ (29,702) $ 547,103
Noncash investing and financing transactions:
Acquisition of acquired businesses, net of imputed interest:
Fair value of assets acquired and liabilities assumed, net............................ $ 243,669
Common stock to be issued on delayed delivery schedule................................ $ 211,530
See notes to unaudited consolidated financial statements.
5
HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Business--HLM Design, Inc. ("HLM Design") and Subsidiaries
and Affiliates ("the Company") provides management and services to
architectural, engineering and planning design entities ("Managed Firms") under
long-term management and services agreements ("MSAs"). HLM Design is
responsible for providing financing in connection with the operations and
management of these Managed Firms. As of August 2, 2002, the Company had
wholly-owned subsidiaries and affiliates as follows:
Affiliates:
. HLM Design of North America, Inc. ("HLMNA")
. HLM Design Architecture, Engineering and Planning, P.C. ("HLMAEP")
Subsidiaries:
. JPJ Architects, Inc. ("JPJ")
. G.A. Design International Holdings, Ltd. ("GAIH")
. BL&P Engineers, Inc. ("BL&P")
. HLM Design International Ltd. ("HLML")
. HLM Design USA, Inc. ("HLMUSA") (effective May 4, 2002, HLMUSA became a
subsidiary)
In addition, the Company has a wholly-owned subsidiary, SOTA Software
Systems, Inc. ("SOTA"), which is a software company.
Financial Statement Presentation--The accompanying unaudited financial
information as of August 2, 2002 and for the three-month periods ended August
3, 2001 and August 2, 2002 has been prepared in accordance with accounting
principles generally accepted in the United States of America. All significant
intercompany accounts and transactions have been eliminated. These unaudited
consolidated financial statements reflect, in the opinion of management, all
material adjustments (which include only normal recurring adjustments)
necessary to fairly state the financial position and the results of operations
for the interim periods presented. The results for interim periods are not
necessarily indicative of the results to be expected for the entire fiscal
year. These interim financial statements should be read in conjunction with the
Company's audited consolidated financial statements for the year ended May 3,
2002.
New Accounting Standards--In October 2001, the FASB issued SFAS No. 144,
Accounting for Impairment or Disposal of Long-Lived Assets and Long-Lived
Assets to Be Disposed of, but retains many of its fundamental provisions.
Additionally, this statement expands the scope of discontinued operations to
include more disposal transactions. As of May 4, 2002, the Company adopted SFAS
No. 144. The adoption of this statement did not have a material impact on the
Company's consolidated financial statements.
In January 2002, FASB issued Emerging Issues Task Force ("EITF") 01-14,
Income Statement Characterization of Reimbursements Received for
"Out-of-Pocket" Expenses Incurred. EITF 01-14 requires reimbursements for
out-of-pocket expenses incurred to be characterized as revenue in the income
statement. As of May 4, 2002, the Company adopted EITF 01-14. The adoption of
this EITF did not have an impact on the Company's consolidated financial
statements.
In April 2002, the FASB issued SFAS No. 145, Recission of FASB Statements 4,
44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This
statement eliminates the exception to applying APB
6
HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Opinion No. 30, Reporting the Results of Operations-Reporting the Effects of
the Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions, to all gains and losses related
to extinguishments of debt. In addition, this statement requires sale-leaseback
accounting for certain lease modifications that have economic effects that are
similar to sale-leaseback transactions. The Company is currently assessing the
impact of this statement, which will be effective for the Company for fiscal
year 2004.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. This new standard requires that a liability
for a cost associated with an exit or disposal activity be recognized when the
liability is incurred. This standard establishes that fair value is the
objective for initial measurement of the liability. This new standard is
effective for exit or disposal activities initiated after December 31, 2002.
Management does not believe SFAS No. 146 will have a material impact on its
consolidated financial statements.
2. CONTRACTS IN PROGRESS
Information relative to contracts in progress is as follows:
May 3, 2002 August 2, 2002
------------ --------------
Costs incurred on uncompleted projects (excluding overhead) $137,392,893 $119,574,608
Estimated earnings thereon................................. 101,121,913 102,398,565
------------ ------------
Total...................................................... 238,514,806 221,973,173
Less billings to date...................................... 233,158,058 216,485,421
------------ ------------
Net underbillings.......................................... $ 5,356,748 $ 5,487,752
============ ============
Net underbillings are included in the accompanying balance sheets as follows:
May 3, 2002 August 2, 2002
----------- --------------
Costs and estimated earnings in excess of billings on uncompleted projects $ 7,639,530 $ 8,066,998
Billings in excess of costs and estimated earnings on uncompleted projects (2,282,782) (2,579,246)
----------- -----------
Net underbillings......................................................... $ 5,356,748 $ 5,487,752
=========== ===========
3. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective April 28, 2001, the Company adopted SFAS No. 142, Goodwill and
Other Intangible Assets, ("SFAS No. 142"), which establishes new accounting and
reporting requirements for goodwill and other intangible assets. Under SFAS No.
142, all goodwill amortization ceased effective April 28, 2001. The Company
identified reporting units based on the current reporting structure, assigned
all goodwill to the reporting units as well as other assets and liabilities, to
the extent that they related to the reporting unit. As required by SFAS No.
142, subsequent impairment losses, if any would be classified as an indirect
expense on the Company's consolidated statements of income. The Company
completed the first step of the transitional goodwill impairment test by
comparing the fair value of each reporting unit to its carrying value and
determined that no impairment existed at the effective date of the
implementation of the new standard. The Company also completed its annual
goodwill impairment test as of May 3, 2002 and determined that no impairment
existed as of that date.
7
HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Fair value of each reporting unit was measured using a valuation by an
independent third party as of April 28, 2001 and May 3, 2002, which were based
on the market multiples, comparable transactions and discounted cash flow
methodologies.
These valuations indicated an aggregate fair value of the reporting units
significantly in excess of the Company's market capitalization as of April 28,
2001 and May 3, 2002. The Company believes the market capitalization is not
representative of the fair value of the Company because the Common Stock of the
Company is not actively traded.
Annually, the Company will obtain an independent valuation and perform a
goodwill impairment test. At least quarterly, management will evaluate to
determine if an event has occurred that would more likely than not reduce the
fair value of a reporting unit below its carrying amount. The Company, if
appropriate, will perform a goodwill impairment test between the annual dates.
Impairment adjustments recognized after adoption, if any, will be recognized as
an operating expense.
Impairment indicators which may be considered include, but are not limited
to, the following:
. A significant adverse change in legal factors or in the business climate
. Unanticipated competition
. A significant decline in the operating performance
. Adverse action or assessment by a regulator
The financial information for acquired intangible assets is as follows:
May 3, 2002 August 2, 2002
----------- --------------
Amortized intangible assets-non-compete agreements:
Original cost................................... $400,000 $400,000
Accumulated amortization........................ 97,916 112,500
The non-compete intangible assets are amortized over their contractual life
ranging from four to nine years. Amortization expense for the quarter ended
August 2, 2002 was $14,584 and annual estimated amortization for non-compete
agreements are as follows:
Fiscal 2003 $58,333
Fiscal 2004 $43,749
Fiscal 2005 $33,336
Fiscal 2006 $33,336
The changes in carrying amount of goodwill for the quarter ended August 2,
2002 is as follows:
Balance at May 3, 2002............. $20,834,104
Goodwill acquired during the period 139,059
Effect of foreign currency exchange 868,420
-----------
Balance at August 2, 2002.......... $21,841,583
===========
The Company has not identified any other intangibles with idefinite lives as
of August 2, 2002.
8
HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. FINANCING ARRANGEMENTS
IBJ Whitehall Business Credit Corporation ("IBJ")
At August 2, 2002, the Company had $7,455,328 outstanding, bearing interest
at 5.25%, under the revolving credit facility with $279,539 available on this
revolving credit arrangement based on the calculated aging of certain domestic
assets reported as of July 12, 2002. At August 2, 2002, the Company had
$471,111 outstanding under the term loan bearing interest at 6.75%.
Substantially all domestic assets are pledged under the Company's revolving
credit, term loan and capital expenditure loan (collectively "IBJ Loans"). This
financing arrangement requires that certain financial requirements be
maintained such as minimum net worth, minimum EBITDA, maximum leverage and
senior leverage ratios, maximum fixed charge coverage and senior fixed charge
coverage ratios and maximum capital expenditure commitments. At August 2, 2002,
the Company was in compliance with the minimum net worth, minimum EBITDA,
maximum leverage and senior leverage ratios and maximum capital expenditure
commitments. The Company obtained a waiver as discussed below for the fixed
charge coverage and senior fixed charge coverage ratio.
On June 3, 2002, the Company and IBJ entered into the third amendment to its
IBJ Loans. During fiscal year ended 2002, the capital expenditure loan
commitment was cancelled. The amendment increased the amount available to
borrow under the revolving credit facility by $500,000. The initial $500,000
increase will be reduced by the amount available to borrow to $400,000 on
August 1, 2002, to $300,000 on September 1, 2002 and will be reduced to zero on
October 31, 2002. The scheduled reductions will be accelerated based on the
occurrence or nonoccurrence of certain subsequent events, including the
Company's collecting of certain accounts receivable, obtaining other financing
and renegotiating certain subordinated promissory notes. In addition, the
amendment modified certain future financial covenants related to its minimum
EBITDA requirement. In addition the company renegotiated certain subordinated
promissory notes (as required in this third amendment) as discussed below.
On September 10, 2002, the Company and IBJ entered into the fourth amendment
to its IBJ Loans. The amendment is summarized as follows: a) waiver of the
fixed charge coverage and senior fixed charge coverage ratio for the quarter
ended August 2, 2002, b) modification of the calculation of the leverage,
senior leverage, fixed charge coverage and the senior fixed charge coverage
ratios as of the quarter ended August 2, 2002 and c) modification of the third
amendment (discussed above) that increased the amount available to borrow under
the revolving credit facility by $500,000, initially; reducing to $400,000 on
August 1, 2002; reducing to $300,000 on September 1, 2002; increasing, however,
to $800,000 from September 10, 2002 to September 17, 2002; reducing to $300,000
on September 18, 2002 and reducing to zero on October 31, 2002.
The scheduled reductions will be accelerated based on the occurrence or
nonoccurrence of certain subsequent events, including the Company's collecting
of certain accounts receivable, obtaining other financing, as well as
renegotiating certain subordinated promissory notes. On September 20, 2002, the
Company received certain other equity financing (see Note 7 below), which
reduced the additional amount available to borrow from $300,000 to zero. As of
the filing of this Form 10-Q, the Company had repaid the increased amount
available to borrow of $800,000.
These IBJ Loans mature in February 2003. The IBJ Loans are classified as a
current liability in the Company's consolidated balance sheets. The Company
will seek a new credit facility to replace, renew or extend these existing IBJ
Loans. Management believes it will be able to enter into a new facility on
terms acceptable to the Company.
9
HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Bank of Scotland ("BOS")
The BOS loan is denominated in British Pounds, bears interest at LIBOR plus
2%, and matures in January 2007. At August 2, 2002, the BOS loan had a balance
of 2,000,000(Pounds) pounds ($3,123,200) bearing interest at 6.3%.
Substantially all assets of GAIH and HLML (collectively, "consolidated
GAIH") are pledged as collateral under this financing arrangement. This
financing arrangement requires certain financial covenants for consolidated
GAIH to be maintained such as maximum debt to equity ratio, minimum account
receivable to debt, minimum EBIT to senior interest, and minimum EBITDA to
total senior charges. In addition, this financing arrangement requires certain
financial covenants for the Company to be maintained such as maximum debt to
equity and minimum EBIT to total interest. At August 2, 2002, consolidated GAIH
was in compliance with the minimum EBIT to senior interest, minimum EBITDA to
total senior charges and the Company was in compliance with maximum debt to
equity ratio. However, consolidated GAIH was not in compliance with maximum
debt to equity and minimum accounts receivable to debt and the Company was not
in compliance with minimum EBIT to total interest. The Company obtained a
waiver from BOS as of August 2, 2002 waiving compliance with these requirements
through August 2003.
Note Payable to Former JPJ and BL&P Shareholders
JPJ-In August 2002, the note payable of $676,151 plus interest at 7% per
annum was modified to agreed upon monthly payments of $52,830 plus interest in
September 2002, $95,002 plus interest in October 2002, $52,830 plus interest
from November 2002 to July 2003, and final payment of $52,849 plus interest in
August 2003. Management believes it will be able to repay these notes on their
respective due dates or obtain any necessary modifications on terms acceptable
to the Company.
BL&P-Notes payable to former BL&P shareholder required agreed upon payments
of $183,600 plus interest at 7% per annum, $183,600 plus interest at 7% per
annum and $61,200 plus interest at 7% per annum for quarters ending August 2,
2002, November 1, 2002 and January 31, 2003, respectively. At August 2, 2002,
the payment of $183,600 plus interest was not paid and the Company has obtained
a waiver from the former BL&P shareholder for this non-payment. Management
believes it will be able to obtain modifications on terms acceptable to the
Company.
5. STOCKHOLDERS' EQUITY
In June 2002, 6,140 shares of Common Stock were issued under the HLM Design,
Inc. Employee Stock Purchase Plan.
6. FOREIGN AND DOMESTIC OPERATIONS
The Company currently has international operations only in the United
Kingdom. The Company has aggregated the operations of the Managed Firms located
in the United Kingdom as follows:
Three-Months
Year Ended Year Ended Ended
April 27, 2001 May 3, 2002 August 2, 2002
-------------- ----------- --------------
United Kingdom
Revenues.................... $2,527,534 $6,374,994 $4,778,950
Operating income........ 122,008 692,338 337,448
Identifiable assets..... 1,279,737 5,417,390 6,010,605
10
HLM DESIGN, INC. AND SUBSIDIARIES AND AFFILIATES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The Company has aggregated its operations in the United States as follows:
Three Months
Year Ended Year Ended Ended
April 27, 2001 May 3, 2002 August 2, 2002
-------------- ----------- --------------
United States
Revenues.................... $61,763,828 $56,960,672 $13,052,433
Operating income........ 2,282,996 963,779 636,672
Identifiable assets..... 25,237,408 21,356,406 21,156,797
7. SUBSEQUENT EVENTS
Preferred Stock Issued:
In August 2002 and September 2002, the Company issued 49,000 and 12,000
shares, respectively, of its 6.5% Series A Cumulative Convertible Preferred
Stock ("Preferred Stock") at $15.00 per share. Holders of the Preferred Stock
are entitled to receive cumulative cash dividends at a rate of $0.98 per annum
per share payable in quarterly installments. Preferred Stock shares are subject
to mandatory conversion to Common Stock if the closing price for the Common
Stock exceeds $6.50 for twenty consecutive trading days. In addition, Preferred
Stock shares are convertible at any time into shares of Common Stock at the
option of the Preferred Stock holder. Upon conversion, the number of common
shares issued will be determined by dividing the original price per preferred
share by the conversion price then applicable per the Stock Purchase Agreement.
IBJ Loan:
In September 2002, the Company and IBJ entered into the fourth amendment to
its IBJ Loans to increase the amount available to borrow as discussed in Note 4
above.
8. CONTINGENCIES
In the normal course of business, the Company is party to various claims and
legal proceedings. The Company records a reserve for these matters when an
adverse outcome is probable and the amount of the potential liability is
reasonably estimable. Although the ultimate outcome of these matters is
currently not determinable, the Company does not believe that the resolutions
of these matters will have a material effect upon the financial condition,
results of operations or cash flows for an interim or annual period.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of the results of operations and financial
condition of the Company should be read in conjunction with the financial
statements and related notes thereto included elsewhere in this report.
RESULTS OF OPERATIONS
Three Months Three Months
Ended Ended
August 3, August 2,
2001 2002
------------ ------------
Revenues........................................ $15,627,799 $17,831,383
Consultant and project expenses................. 5,499,086 5,818,020
----------- -----------
Net production income........................... 10,128,713 12,013,363
----------- -----------
Direct labor.................................... 3,504,047 3,741,660
Operating costs................................. 6,201,632 7,282,999
Amortization of intangible assets............... 14,583 14,584
----------- -----------
Total costs and expenses........................ 9,720,262 11,039,243
----------- -----------
Operating income................................ 408,451 974,120
Interest expense, net........................... 338,387 410,885
----------- -----------
Income before income taxes and minority interest 70,064 563,235
Income tax expense.............................. 37,300 190,706
----------- -----------
Income before minority interest................. 32,764 372,529
Minority interest in income (loss).............. (16,830) 40,275
----------- -----------
Net income...................................... $ 49,594 $ 332,254
=========== ===========
The forward-looking statements included herein, which reflects management's
best judgment based on factors currently known, involve risks and
uncertainties. Words such as "expects," "anticipates," "believes," "intends,"
and "hopes," variations of such words and similar expressions are intended to
identify such forward-looking statements. Actual results could differ
materially from those anticipated in these forward-looking statements as a
result of a number of factors, including but not limited to, the factors
discussed in such sections and in particular the factors discussed in Item 2
under heading "Factors That Might Affect Our Business or Stock Price."
Forward-looking information provided by the Registrant in such sections
pursuant to the safe harbor established under the Private Securities Litigation
Reform Act of 1995 should be evaluated in the context of these factors.
For the three months ended August 2, 2002 and August 3, 2001
Revenues were $17.8 million for the three-month period ended August 2, 2002
as compared to $15.6 million for the three-month period ended August 3, 2001.
This 14% increase is due to additional revenues of $3.5 million related to the
acquisition of HLML in February 2002. This increase in revenues is partially
offset by a decline in the volume of architecture, planning and engineering
services principally attributable to certain clients delaying project start
dates that will delay related revenue recognition to future periods. Management
believes that this trend will continue through the remainder of fiscal year
ending May 2, 2003. See factors that might affect our business or stock price
below.
Direct costs, which include consultant costs and reimbursable project
expenses, total $5.8 million, or 33% of revenues, for the three-month period
ended August 2, 2002 as compared to $5.5 million, or 35% of revenues, for the
three-month period ended August 3, 2001. Consultants are used for certain
technical expertise not available at
12
the Company and at the project owner request. This decrease is due to a
decreased need for consultants on certain client projects that typically
utilize consultants to meet project requirements based on certain project owner
requests.
Direct labor cost was $3.7 million, or 31% of net production income, for the
three-month period ended August 2, 2002 as compared to $3.5 million, or 35% of
net production income, for the three-month period ended August 3, 2001. This
decrease as a percentage of net production income is due to the Company's focus
(initiated in the second quarter of fiscal 2002) on improving the effectiveness
and efficiency of each project and ultimately decreasing direct labor cost as a
percentage of net production income. This decrease as a percentage of net
production income is partially offset by a continued reduction in certain
higher margin projects and, to a lesser extent, an increase in salary and
salary related costs that have not been passed through to the Managed Firm's
clients in all cases.
Operating costs were $7.3 million, or 61% of net production income, for the
three-month period ended August 2, 2002 as compared to $6.2 million, or 61% of
net production income, for the three-month period ended August 3, 2001. The
percentage of net production income was favorably impacted by a decrease in
indirect labor and related fringe benefits and office supplies, which was
offset by an increase in rent and occupancy expenses and marketing and related
expenses.
Amortization of intangible assets was $14,584 for the three-months ended
August 2, 2002 as compared to $14,583 for the three-months ended August 3,
2001. Effective April 28, 2001, the Company adopted SFAS No. 142, Goodwill and
Other Intangible Assets. Under SFAS No. 142, all goodwill amortization ceased
effective April 28, 2001.
Interest expense was $0.4 million for the three-month period ended August 2,
2002 as compared to $0.3 million for the three-month period ended August 3,
2001. This increase is principally due to: (i) increased debt resulting from
the acquisition of HLML, which is partially offset by (ii) a decrease in the
Company's effective interest rate in the current year and (iii) a decrease in
the borrowings under the Company's revolving credit facility with IBJ Whitehall
Business Credit Corporation ("IBJ").
Income tax expense was $0.2 million for the three-month period ended August
2, 2002 as compared to $37,300 for the three-month period ended August 3, 2001.
The effective income tax rate was 34 % and 53% for the three-month periods
ended August 2, 2002 and August 3, 2001, respectively. The effective rate is
lower principally due to the fact that approximately 51% of current year income
before income taxes and minority interest was provided by HLML, which was not
acquired until the fourth quarter of fiscal 2002. The effective tax rate for
HLML is lower than that of the domestic operations. As such, this is causing an
overall decrease in the effective income tax rate from the prior year, which is
partially offset by an increase in non-deductible expenses (primarily meals and
entertainment).
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has met working capital and capital expenditure
needs through cash from operations and bank financing. At August 2, 2002, the
Company's current liabilities of $30.7 million exceeded current assets of $23.7
million, resulting in net working deficiency of $7.0 million. The decrease in
working capital is primarily related to the reclassification of the IBJ
revolving credit facility and term loan to short term due to their scheduled
maturities in February 2003. The Company is pursuing additional financing
through discussions with IBJ and other financial institutions. Possible sources
of additional financing include new term debt with IBJ, extending the IBJ
revolving credit facility and the sale of preferred stock as discussed below.
During the three-month period ended August 2, 2002, the Company's operating
activities provided $24,032 in cash from operations before working capital
changes which used $1.0 million. The Company used $0.1 million primarily for
capital expenditures. The Company provided cash of $0.7 million from financing
activities
13
primarily on borrowings under the Company's revolving credit facility with IBJ
Whitehall Business Credit Corporation ("IBJ"), which was partially offset by
certain payments on long-term borrowings.
The Company expects to continue expanding its operations through internal
growth, issuing equity securities and strategic acquisitions. During fiscal
2002, the Board of Directors approved the sale of 200,000 shares at $15.00 per
share of 6.5% Series A Cumulative Convertible Preferred Stock ("Preferred
Stock") to be issued during the first six months of fiscal 2003 in order to
obtain additional funds for operating needs and repayment of certain debt
obligations. In August 2002 and September 2002, the Company issued 49,000 and
12,000 shares, respectively, of its Preferred Stock at $15.00 per share. The
Company believes that liquidity provided by its revolving line of credit, the
anticipated issuance of equity securities, anticipated funds from future
operations and that modifications of repayment terms on certain subordinated
notes payable discussed below, will be sufficient to meet the Company's
operating needs for the next twelve months. However, in order to continue its
expansion program through acquisitions, the Company will require additional
capital. If the Company is unable to obtain additional capital, its acquisition
strategy and operations will be adversely affected. Additional capital and an
increased line of credit is needed to maintain and grow existing operations Due
to the current shortage in working capital, the Company has had to delay
certain non-material capital expenditures and negotiate extended payment terms
with certain consultants and vendors. In addition, the Company has negotiated
amendments to the IBJ revolving credit facility and term loan to address the
shortage in working capital. The Company will need to continue to make these
types of accommodations if it does not secure sufficient additional capital.
IBJ
At August 2, 2002, the Company had $7,455,328 outstanding under the
revolving credit facility with $279,539 available on this revolving credit
arrangement based on the calculated aging of certain domestic assets reported
as of July 12, 2002. At August 2, 2002, the Company had $471,111 outstanding
under the term loan bearing interest at 6.75%.
Substantially all domestic assets are pledged under the Company's revolving
credit, term loan and capital expenditure loan (collectively "IBJ Loans"). This
financing arrangement requires that certain financial requirements be
maintained such as minimum net worth, minimum EBITDA, maximum leverage and
senior leverage ratios, maximum fixed charge coverage and senior fixed charge
coverage ratios and maximum capital expenditure commitments. At August 2, 2002,
the Company was in compliance with the minimum net worth, minimum EBITDA,
maximum leverage and senior leverage ratios and maximum capital expenditure
commitments. The Company obtained a waiver as discussed below for the fixed
charge coverage and senior fixed charge coverage ratio.
On June 3, 2002, the Company and IBJ entered into the third amendment to the
IBJ Loans. The amendment increased the amount available to borrow under the
revolving credit arrangement by $500,000. The initial $500,000 increase will be
reduced by the amount available to borrow to $400,000 on August 1, 2002, to
$300,000 on September 1, 2002 and will be reduced to zero on October 31, 2002.
The scheduled reductions will be accelerated based on the occurrence or
nonoccurrence of certain subsequent events, including the Company's receipt of
certain accounts receivable and other financing as well as renegotiation of
certain subordinated promissory notes. In addition, the amendment modified
certain future financial covenants related to its minimum EBITDA requirement.
In addition the company renegotiated certain subordinated promissory notes (as
required in this third amendment) as discussed below.
On September 10, 2002, the Company and IBJ entered into the fourth amendment
to its IBJ Loans. The amendment is summarized as follows: a) waiver of the
fixed charge coverage and senior fixed charge coverage ratio for the quarter
ended August 2, 2002, b) modification of the calculation of the leverage,
senior leverage, fixed charge coverage and the senior fixed charge coverage
ratios as of the quarter ended August 2, 2002 and c) modification of the third
amendment (discussed above) that increased the amount available to borrow under
the
14
revolving credit facility by $500,000, initially; reducing to $400,000 on
August 1, 2002; reducing to $300,000 on September 1, 2002; increasing, however,
to $800,000 from September 10, 2002 to September 17, 2002; reducing to $300,000
on September 18, 2002 and reducing to zero on October 31, 2002. The scheduled
reductions will be accelerated based on the occurrence or nonoccurrence of
certain subsequent events, including the Company's collecting of certain
accounts receivable, obtaining other financing, as well as renegotiating
certain subordinated promissory notes. On September 12, 2002, the Company
received certain other equity financing (as described above), which reduced the
additional amount available to borrow from $300,000 to zero. In addition the
company renegotiated certain subordinated promissory notes (as required in this
third amendment) as discussed above. As of the filing of this Form 10-Q, the
Company had repaid the increased amount available to borrow of $800,000.
The Company is also in the process of seeking a new credit facility to
replace, renew or extend these IBJ Loans, which mature in February 2003. These
IBJ Loans are classified as a current liability in the Company's consolidated
balance sheets. Management believes it will be able to negotiate a new facility
on terms acceptable to the Company. See factors that might affect our business
or stock price below.
Bank of Scotland ("BOS")
The BOS loan is denominated in British Pounds, bears interest at LIBOR plus
2%, and matures in January 2007. At August 2, 2002, the BOS loan had a balance
of 2,000,000(Pounds) pounds ($3,123,200) bearing interest at 6.3%.
Substantially all assets of GAIH and HLML(collectively, "consolidated GAIH
and HLML") are pledged as collateral under this financing arrangement. This
financing arrangement requires certain financial covenants for consolidated
GAIH to be maintained such as maximum debt to equity ratio, minimum account
receivable to debt, minimum EBIT to senior interest, and minimum EBITDA to
total senior charges. In addition, this financing arrangement requires certain
financial covenants for the Company to be maintained such as maximum debt to
equity and minimum EBIT to total interest.
At August 2, 2002, consolidated GAIH was in compliance with the minimum EBIT
to senior interest, minimum EBITDA to total senior charges and the Company was
in compliance with maximum debt to equity ratio. However, consolidated GAIH was
not in compliance with maximum debt to equity and minimum accounts receivable
to debt and the Company was not in compliance with minimum EBIT to total
interest. The Company obtained a waiver from BOS as of August 2, 2002 waiving
compliance with these requirements through August 2003.
Note Payable to Former JPJ and BL&P Shareholders
JPJ
In August 2002, the note payable of $676,151 plus interest at 7% per annum
was modified to agreed upon monthly payments of $52,830 plus interest in
September 2002, $95,002 plus interest in October 2002, $52,830 plus interest
from November 2002 to July 2003, and final payment of $52,849 plus interest in
August 2003. Management believes it will be able to repay these notes on their
respective due dates or obtain any necessary modifications on terms acceptable
to the Company.
BL&P
Notes payable to former BL&P shareholder required agreed upon payments of
$183,600 plus interest at 7% per annum, $183,600 plus interest per annum and
$61,200 plus interest per annum for quarters ending August 2, 2002, November 1,
2002 and January 31, 2003, respectively. At August 2, 2002, the payment of
$183,600 plus interest was not paid and the Company has obtained a waiver from
the former BL&P shareholder for this non-payment. Management believes it will
be able to obtain modifications on terms acceptable to the Company.
15
FACTORS THAT MIGHT AFFECT OUR BUSINESS OR STOCK PRICE
Limited Trading Volume of Company Stock
The Company's stock has limited trading volume. Small volumes of trades have
a significant impact on the share price. Until a larger volume of trading is
achieved, the share price may not be a good indicator of the price that would
be needed to purchase a significant position in the Company's stock.
Innovative Strategy
The Company's operating and growth strategies are predicated upon its
ability to contract with architectural, engineering and planning firms ("AEP
Firms") and to generate profits from those firms. The process of identifying
suitable AEP Firm candidates for entering into Management and Services
Agreements and proposing, negotiating and implementing economically feasible
affiliations with AEP Firms is lengthy and complex. Such strategies require
intense management direction in a dynamic marketplace that is increasingly
subject to cost containment and other competitive pressures. There can be no
assurance that these strategies will be successful or that modifications to the
Company's strategies will not be required.
Management and Services Agreements with a Limited Number of Firms
The Company's revenues are derived solely from its contractual relationships
with the Managed Firms (for whom, as indicated below, the Company will also
provide required financing). Currently, the Company has Management and Services
Agreements with four subsidiaries (JPJ, GAIH, BL&P and HLML) and three other
firms. All of these other firms are related to each other and to the Company by
two common principal stockholders, Joseph M. Harris and Vernon B. Brannon.
There can be no assurance that the Company will be able to successfully enter
into Management and Services Agreements with additional AEP firms.
Uncertainties Concerning Ability to Receive Payments from Managed Firms
For services provided to the Managed Firms, the Company earns 99% of the net
income of the Managed Firms, as determined in accordance with generally
accepted accounting principles. However, for cash management purposes, the
Company is to receive 99% of the positive cash flows of the Managed Firms
(calculated for any period as the change in the cash balances from the
beginning of the period to the end of the period). The Company's ability
actually to receive payments in respect thereof during any particular period
will be subject to the cash requirements of the Managed Firms. To the extent
the cash requirements of the Managed Firms continue to exceed 1% of positive
cash flows, the Company will be unable to receive payments against such
receivables, and such payments will be delayed. The Company's ability to pay
dividends on the Common Stock will depend on the ability of the Company to
collect such receivables.
Dependence on Key Personnel and Limited Management and Personnel Resources
The Company's success depends to a significant degree upon the continued
contributions of its senior management team and professional personnel. The
loss of the services of one or more of these key employees could have a
material adverse effect on the Company. The Company carries key employee life
insurance on Joseph M. Harris and Vernon B. Brannon and has employment and/or
noncompete agreements with Joseph M. Harris and Brannon as well as with several
(although not all) of its senior professional staff. There can be no assurance,
however, that a court would enforce the noncompete agreements as currently in
effect. If courts refuse to enforce the noncompete agreements of the Company or
the Managed Firms, such refusals could have a material adverse effect on the
Company. In addition, as the Company expands it will likely be dependent on the
senior professional staff of any firm with which the Company enters into a
Management and Services Agreement. In addition, the lack of qualified
professional staff or employees or the Company's potential candidates for
Management and Services Agreements may limit the Company's ability to
consummate future agreements.
16
Dependence on Managed Firms
The Company's revenues depend on fees and revenues generated by various AEP
firms managed by the Company. Any material loss of revenue by such firms,
whether as a result of the loss of professionals or otherwise, could have a
material adverse effect on the Company. The Company itself is not engaged in
the practice or architecture, engineering or planning and, as a result, does
not control (i) the practice of architecture, engineering or planning by
professionals or (ii) the compliance with certain regulatory requirements
directly applicable to the Managed Firms.
Risks Inherent in Provision of Services
The Managed Firms and certain employees of the Managed Firms are involved in
the delivery of services to the public and, therefore, are exposed to the risk
of professional liability claims. Claims of this nature, if successful, could
result in substantial damage awards to the claimants that may exceed the limits
of any applicable insurance coverage. Insurance against losses related to
claims of this type can be costly and varies widely from state to state.
Although the Company is indemnified under its Management and Services
Agreements for claims against the Managed Firms and their employees, the
Company maintains liability insurance for itself and negotiates liability
insurance for the Managed Firms and the professionals employed by the Managed
Firms. Successful malpractice claims asserted against the Managed Firms, their
employees or the Company could have an adverse effect on the Company's
profitability.
Competition
The business of providing architectural, engineering and planning related
services is highly competitive. The Company's competition includes many other
firms, such as large national firms and regional or small local firms. Several
companies that have established operating histories and significantly greater
resources than the Company provide some of the services provided by the Managed
Firms. In addition, there are other companies with substantial resources that
may in the future decide to engage in activities similar to those in which the
Company engages.
Uncertainties Concerning Additional Financings
The Company's operating and growth strategies require substantial capital
resources, particularly since the Company, as the management company, will be
responsible for the financing of working capital growth, capital growth and
other cash needs of the Managed Firms. These requirements will result in the
Company incurring long-term and short-term indebtedness and may result in the
public or private issuance, from time to time, of additional debt or equity
securities, including the issuance of such securities in connection with the
execution of Management and Services Agreements.
Management is continually reviewing its results of operations and forecasted
business plan to determine whether additional modifications to the financial
covenants in its loan agreements may be required. The Company is also in the
process of seeking a new credit facility to replace or renew or extend the IBJ
Loans which mature in February 2003. These IBJ Loans are classified as a
current liability in the Company's consolidated balance sheets. Management
believes it will be able to obtain any necessary amendments, and/or enter into
a new facility on terms acceptable to the Company.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those
17
estimates. The most significant estimates impacting the condensed consolidated
financial statements relate to revenue recognition under the percentage of
completion method and the allowance for doubtful accounts.
The majority of the Company's revenues are recorded from fixed fee contracts
on a percentage of completion basis based on assumptions regarding estimated
direct labor costs to complete. Each month actual labor costs incurred to date
are accumulated on each project and estimated labor cost to complete is
forecasted for each project. Actual labor costs incurred to date and estimated
labor costs to complete are added together to determine projected final labor
cost. The percentage complete is determined by dividing the actual labor cost
incurred to date by the projected final labor cost. This percentage complete is
multiplied by the contract value, net of direct costs, which may include direct
subconsultants, travel, printing, etc. to determine the amounts of revenue that
can be recognized. Provisions for estimated losses on uncompleted projects are
made in the period in which such losses are first subject to reasonable
estimation. Historically, the majority of the Company's estimates to complete
have been materially correct, but these estimates might not continue to be
accurate.
The asset "costs and estimated earnings in excess of billings on uncompleted
projects" represents revenues recognized in excess of amounts billed. The
liability "billings in excess of costs and estimated earnings on uncompleted
projects" represents billings in excess of revenues recognized.
Included in accounts receivable on the consolidated balance sheets are
reserves for doubtful accounts. Generally, before the Company does business
with a new client, the Company reviews its creditworthiness. Senior management
reviews the accounts receivable on a monthly basis to determine if any
receivables are potentially uncollectible. Based on the information available
to the Company, we believe the reserve for doubtful accounts as of August 2,
2002 was adequate.
Effective April 28, 2001, the Company adopted SFAS No. 142, Goodwill and
Other Intangible Assets, ("SFAS No. 142"), which establishes new accounting and
reporting requirements for goodwill and other intangible assets. Under SFAS No.
142, all goodwill amortization ceased effective April 28, 2001. The Company
identified reporting units based on the current reporting structure, assigned
all goodwill to the reporting units as well as other assets and liabilities, to
the extent that they related to the reporting unit. As required by SFAS No.
142, subsequent impairment losses, if any would be classified as an indirect
expense on the Company's consolidated statements of income. The Company
completed the first step of the transitional goodwill impairment test by
comparing the fair value of each reporting unit to its carrying value and
determined that no impairment existed at the effective date of the
implementation of the new standard. The Company also completed its annual
goodwill impairment test as of May 3, 2002 and determined that no impairment
existed as of that date. Fair value of each reporting unit was measured using a
valuation by an independent third party as of April 28, 2001 and May 3, 2002,
which were based on the market multiples, comparable transactions and
discounted cash flow methodologies.
These valuations indicated an aggregate fair value of the reporting units
significantly in excess of the Company's market capitalization as of April 28,
2001 and May 3, 2002. The Company believes the market capitalization is not
representative of the fair value of the Company because the Common Stock of the
Company is not actively traded.
Annually, the Company will obtain an independent valuation and perform a
goodwill impairment test. At least quarterly, management will evaluate to
determine if an event has occurred that would more likely than not reduce the
fair value of a reporting unit below its carrying amount. The Company, if
appropriate, will perform a goodwill impairment test between the annual dates.
Impairment adjustments recognized after adoption, if any, will be recognized as
an operating expense.
Impairment indicators which may be considered include, but are not limited
to, the following:
. A significant adverse change in legal factors or in the business climate
18
. Unanticipated competition
. A significant decline in the operating performance
. Adverse action or assessment by a regulator
In the normal course of business, the Company is party to various claims and
legal proceedings. The Company records a reserve for these matters when an
adverse outcome is probable and the amount of the potential liability is
reasonable estimable. Although the ultimate outcome of these matters is
currently not determinable, the Company does not believe that the resolution of
these matters will have a material effect upon the financial condition, results
of operations or cash flows for an interim or annual period.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in interest rates
affecting our credit arrangements, including a variable rate revolving credit
arrangement and term loan agreement, which may adversely affect our results of
operations and cash flows. The Company seeks to minimize interest rate risk
through our day-to-day operating and financing activities. The Company does not
engage in speculative or derivative financial or trading activities.
A hypothetical 100 basis point adverse change (increase) in interest rates
relating to the IBJ Loans and BOS Loan would have decreased pre-tax income for
the quarter ended August 2, 2002 by approximately $28,000.
Through the operations of GAIH and HLML, the Company has an exposure to
foreign currency exchange rate fluctuations primarily between United States
Dollar ("USD") and Great Britain Pound ("GBP") resulting from translation.
Foreign exchange rates have limited impact on earnings and net assets of the
Company since the majority of GAIH and HLML sales and assets and liabilities
are denominated in GBP. A 10% deviation (decrease) in conversion of GBP to USD
would have decreased the Company's pretax income and net assets by
approximately $19,243 and $350,791, respectively.
The Company has no other material exposure to market risk sensitive
instruments.
ITEM 4: CONTROLS AND PROCEDURES
Based on their most recent evaluation, which was completed within 90 days of
the filing of this Form 10-Q, the Company's Chief Executive Officer and Chief
Financial Officer believe the Company's disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) are effective. There were no
significant changes in internal controls or in other factors that could
significantly affect these controls subsequent to the date of their evaluation,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
19
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
The Company's Revolving Credit, Term Loan, Capital Expenditure Loan,
Guaranty and Security Agreement as amended as of June 29, 2001, provide that
the Company may not pay cash dividends on its common stock.
Item 6. Exhibits and Reports on Form 8-K
(a) The exhibits filed as part of this Form 10-Q are:
Exhibit No. Description
- ----------- -----------
10.29.4 Fourth Amendment dated as of September 10 2002 to Revolving Credit, Term Loan, Capital
Expenditure Loan, Guaranty and Security Agreement.
10.35.1 Letter from Bank of Scotland dated September 18, 2002 regarding Term Loan dated February 15,
2002 between G.A. Design International (Holdings) Limited and Bank of Scotland.
Certifications of Principal Executive Officer and Principal Financial Officer
(b) Reports on Form 8-K
None.
20
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HLM DESIGN, INC.
(Registrant)
Date: September 23, 2002 By: /S/ JOSEPH M. HARRIS
-------------------- ----------------------------------
Joseph M. Harris
President, Chairman and Director
Date: September 23, 2002 By: /S/ VERNON B. BRANNON
-------------------- ----------------------------------
Vernon B. Brannon
Senior Vice President, Chief
Operating Officer
and Chief Financial Officer
21
Certification of Chief Executive Officer
Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
I, Joseph M. Harris, certify that:
1. I have reviewed this quarterly report on Form 10-Q of HLM Design, Inc. and
Subsidiaries and Affiliates (the "issuer" or "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of issuer, as of, and for, the periods presented in this quarterly
report.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls.
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: September 23, 2002 /S/ JOSEPH M. HARRIS
-------------------- -----------------------------------
Joseph M. Harris
President & Chief Executive Officer
22
Certification of Chief Financial Officer
Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
I, Vernon B. Brannon, certify that:
1. I have reviewed this quarterly report on Form 10-Q of HLM Design, Inc. and
Subsidiaries and Affiliates (the "issuer" or "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of issuer, as of, and for, the periods presented in this quarterly
report.
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls.
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: September 23, 2002 /S/ VERNON B. BRANNON
-------------------- ----------------------------------
Vernon B. Brannon
Senior Vice President, Chief
Operating Officer
and Chief Financial Officer
23